While it is impossible to say that any one event started the process that resulted in the breakup of AT&T, one important personality who was involved was “Jack the Giant Killer” Goeken. He was the founder of many businesses including the long-distance provider MCI, two air-to-ground communications providers and the communications system used by FTD florists. The Washington Post wrote about him: “Beneath Mr. Goeken’s frumpy appearance — he wore old business suits that were frayed and carried briefcases bursting with loose papers — was a telecommunications genius who became one of the industry’s most powerful innovators.’ He drove an old rusted out Cadillac El Dorado and when his briefcase broke or was too full he would use a plastic garbage bag instead. Stories about Goken’s tenacity are legendary: “Early on, the business was often low on cash. In order to make hundreds of expensive photocopies for licensing hearings before the Federal Communications Commission, Mr. Goeken loosened his tie, rolled up his shirtsleeves and walked through the offices of a Washington law firm impersonating a Xerox machine attendant — and copied his pages for free.” His appearance was not dissimilar to the character played by John Candy in movie Planes, Trains and Automobiles.
- “All I wanted was the opportunity to fail.” Jack Goeken
Goeken’s formal education ended at high school. He added to what he taught himself in high school about electronics and engineering by serving in the Army Signal Corps. The LA Times wrote about Goeken’s first business in his obituary: “Goeken started Microwave Communications Inc. — the original name of MCI — in 1963 with a simple plan to increase sales at his two-way radio business in Joliet.”
It is doubtful that Goeken knew the other more famous resident of Joilet, but anything is possible (just kidding).
Goeken is a classic example of a missionary founder. His motivation for forming MCI was to sell more two-way radios to truckers traveling between Chicago and St. Louis on Route 66. He knew that if he could build a system using microwave towers to connect the radios that served the route that traveled through his home town, his profits would rise.
The CEO of MCI was not Goeken but a famous successor named Bill McGowan. Steve Coll wrote in his book The Deal of the Century: The Breakup of AT&T:
Long distance was viewed as a very attractive market by AT&T. It required far less capital than other parts of the business of AT&T and made certain ratios that are taught in business schools like internal rate of return (IRR), price earnings (P/E) and return on net assets (RONA) look very good. In contrast, the cost of maintaining “the last mile” physical plant that enables telecommunications was viewed as a burden to the profitability of AT&T. That MCI and other companies were able to provide long distance service without paying for that last mile infrastructure made the AT&T executives unhappy. AT&T executives hated that these upstart competitors were able to take long distance market share.
Nasty and expensive legal battles went on for years over these and other issues. Eventually AT&T formulated what it thought was a clever solution:
A key element of the breakup of the Bell System was a consent decree signed on January 8, 1982. AT&T would provide long-distance service and seven other firms (“RBOCs) would provide local telephone service in different regions. The original seven RBOCs were:
- Bell Atlantic
- Pacific Telesis
- Southwestern Bell
- US West
What the AT&T executives who stayed with the long distance company did not realize was that without the last mile assets the long distance business had virtually no moat even though it had high profit margins before the break-up. They did not take into account that sometimes what gives you a moat is not what delivers the profit. The profits in a situation like AT&T’s before the break-up were delivered by a complementary product to the moat itself. The complementary product to the moat created by the last mile assets was long distance. AT&T did not realize that the RBOCs were not only being given the moat in the divestiture but were free to use wireless revenues to monetize that advantage.
Why didn’t AT&T see what was coming? Like many business that are no longer with us, AT&T managed its business using Siren Call Ratios. What is a Siren Call Ratio? In Greek mythology the Sirens were creatures who lured sailors with enchanting music and voices and wrecked the ships on the rocky coast of an island. In business, Siren Call Ratios like IRR, P/E and RONA create a fatal focus on short term financial results, which eventually “shipwrecks” businesses.
Set out below in four tweet format is the essence of the problem AT&T created for themselves by chasing Siren Call Ratios instead of lifetime customer value (LTV):
Morris Chang: “Americans measure profitability by a ratio. No banks accept deposits denominated in ratios.”
For example, IRR is a ratio, with profit as a numerator; the denominator measures how quickly I return my investment. If managers invest only in projects that pay off quickly, IRR will rise since it reduces the denominator of the ratio. The fewer the assets, the higher the RONA! Siren Call Ratios direct capital toward short-term wins which creates an opportunity for other firms to invest in opportunities with long term payoffs.
Imagine how little the teams created by entrepreneurs like Craig McCaw and John Malone would have built their wireless and cable TV businesses if they had run their businesses based on The Siren Call Ratios. Nothing important would have been created by these great entrepreneurs since their focus would have been on short term metrics and not lifetime customer value. Fortunately these entrepreneurs did run their businesses to create shareholder value and did not optimize their businesses around Siren Call Ratios. What about the RBOCs? Why did the RBOCs run their business differently? Because McCaw and other entrepreneurs pushed the RBOCs to manage their business based on lifetime customer value (LTV) instead of Siren Call Ratios. The RBOCs had no choice but to copy the business methods of their new competitors since otherwise they would have had close to zero customers. This turned out to be the winning strategy for the RBOCs. As a result, one of the RBOCs (SBC) would eventually create enough value so that it was able to acquire AT&T and assume its more well known known brand.
When I make this point about Siren Call Ratios some people think I am arguing for a non traditional valuation method when in fact I am saying that companies should be valued on a discounted cash flow (DCF) basis just as Warren Buffett does. Warren Buffet has never bought a business based on Siren Call Ratios and never will. As Buffett says in valuing an asset like a business: “you take the cash flows that you expect to be generated and you discount them back to their present value.” DCF is a methodology rather than a result. Some businesses will be overvalued and some businesses undervalued when you do the math in a DCF. It depends.
When you focus on DCF and free cash flow you can do the type of long term investing that Jeff Bezos talks about here:
“If everything you do needs to work on a three-year time horizon, then you’re competing against a lot of people. But if you’re willing to invest on a seven-year time horizon, you’re now competing against a fraction of those people, because very few companies are willing to do that. Just by lengthening the time horizon, you can engage in endeavors that you could never otherwise pursue. At Amazon we like things to work in five to seven years. We’re willing to plant seeds, let them grow—and we’re very stubborn.”
To illustrate how creating shareholder value in the form of lifetime customer value is the better way to do business, this letter below was sent in July 1994. Two months later McCaw Cellular was sold to to AT&T for $11.5 billion:
One of the great mysteries in business history is why AT&T let the RBOCs have the cellular business. AT&T certainly received some bad advice from its consultant McKinsey. The Economist magazine describes this bad advice, but misses the core reason why the estimate was so wrong:
“In the early 1980s AT&T asked McKinsey to estimate how many cellular phones would be in use in the world at the turn of the century. The consultancy noted all the problems with the new devices—the handsets were absurdly heavy, the batteries kept running out, the coverage was patchy and the cost per minute was exorbitant—and concluded that the total market would be about 900,000.”
The actual core mistake of the botched estimate was that McKinsey assumed customers would always use a land line phone if one was available. McKinsey did not fully understand the value of mobility. People do not want to be tied to a desk or a phone cord. Craig McCaw once described his views on this aspect of the value of wireless in this way:
“We started out as nomadic. It may be the most natural state for human beings. We’re kind of returning to people freedom they lost starting in the Dark Ages. It was with the discovery of seeds that people ceased being nomadic—and my opinion, by the way, is that people remain nomadic by nature—but it is for economic reasons that we became fixed in our location.”
AT&T’s reliance on this McKinsey study and the conclusions of many other people that were similar is what allowed business people like McCaw to sweep in and buy licenses at far less than their real value. Fortunately other financiers disagreed with McKinsey and that allowed McCaw and others to finance the acquisition of even more licenses to operate in new regions. As the pioneers of the wireless business created more value they were able to use that new value to finance the roll up the of the business nationally and even internationally. Many people forget or were born too late to realize that this was the situation in October of 1991:
“NEW YORK — McCaw Cellular Communications Inc. Wednesday launched the North American Cellular Network (NACN), a move toward a national network of cellular telephones.The network, which McCaw says is the first system of its kind, will have automatic call-delivery while traveling anywhere in the network. It eliminates the need for a caller to know the location (roaming access codes) of the cellular customer being called. Also, a customer’s individual calling features, such as call-waiting, three-way conference calling and call-forwarding, are available throughout the network.”
One account of how the decision was made by AT&T to give wireless to the RBOCs, was written up by a reporter in RCR Wireless News in 2001. It is a very credible account since if anyone knew about what happened it was Michael Altschul, who is quoted:
How it came to pass that AT&T let its cellular licenses slip away during its 1984 divestiture is the stuff of wireless industry urban legend. Some say AT&T was less-than-concerned about giving up its cellular business, believing industry forecasts that at the time predicted limited growth for the nascent industry. Others say AT&T let the licenses go as a strategic move designed to shore itself up for impending competition in other areas. Still others contend AT&T wanted to keep cellular in its fold, but believed it would not be allowed to do so. Whatever its reason, AT&T appeared to put up little fight in the early 1980s to keep its position in the cellular industry-an industry it was instrumental in pioneering. AT&T engineers had largely developed cellular technology, and the company was a catalyst for convincing the Federal Communications Commission to free up spectrum for the new service. It had an experimental license in one market and was on its way to launching one of the first cellular markets in the country. But there was no mention of cellular in the consent decree that settled the antitrust case between AT&T and the government, according to Michael Altschul, who was responsible for part of the government’s case as part of the trial staff of the Antitrust Division at the Department of Justice. Altschul is now general counsel at the Cellular Telecommunications & Internet Association. “The lawsuit was based on prior conduct,” said Altschul. “Wireless wasn’t a part of the government’s case. “There was absolutely no mention of cellular,” he said. Altschul recalled the press conference called to announce the settlement agreement. A reporter asked executives at the company what was to become of the cellular business. Altschul said a huddle between AT&T executives and their key deputies produced the answer. Cellular would go to the Bell companies.
It is hard to imagine this now, but cellular at that time was not considered an important business asset. Wireless was a small detail in the break up of AT&T. Many of the people who ended up running the RBOCs knew the cellular AMP system and technology better than the people who ran the long distance business. In short, wireless was a small detail in a very complex and sometimes chaotic negotiation over the breakup. Wireless infrastructure was considered a local business with little relative importance by many people at AT&T. Considered more important at the time were issues like the independence of the RBOCs, including their ability to offer “enhanced services” and questions like AT&T’s ability to enter the computer and videotext business. Sam Ginn, who went on to fame as a RBOC and wireless executive, said at the time of the AT&T break up the negotiators were “more interested in the Yellow Pages at that time than wireless.”
Another account of the decision by AT&T to give up wireless to the RBOCs is in the book Wireless Nation. The author of that book wrote: “The first indication of where cellular would fall came when AT&T chairman Charles Brown was in the hot seat on a popular TV news show. In an appearance on the MacNeil/Lehrer Report, AT&T Chairman Charles Brown said on January 11, 1982 that AT&T would not interfere “in the local companies business…. all we’ll do is make the technology available.” This account in the book claims that “just like that” Brown gave away the wireless business to the RBOCs. Brown’s appearance on the television show on January 11 was a few days after the press conference that took place on the 8th so it may not be true that this was the first indication of where wireless would end up.
It is worth emphasizing how much AT&T had “person with a hammer syndrome” when it came to the long distance business and the Siren Call Ratios. For example, even in 1992, when AT&T bought about 33% of McCaw and in 1995 when it bought all of the company, AT&T executives thought the reason to be in the wireless business was “to save the long distance business.” I’m not guessing on this point since I heard them say it several times at McCaw HQ in Kirkland. I heard it again in the late 1990s when Craig McCaw and I flew to what we called “carpet land” in Basking Ridge New Jersey to meet with the AT&T CEO. As an aside, in that HQ building you had to walk a mile to “reach out and touch someone.” To get into the AT&T CEO’s office you also had to walk past many layers of executive assistants. There was carpet as far as the eye could see.
The end result of the 1982 AT&T breakup was that one of the RBOCs eventually ate AT&T. In 2005, SBC purchased AT&T for $16 billion. After this purchase, SBC adopted the better-known AT&T name. The executives who thought that they were better off staying with the long distance company since it was going to have better ratios made a massive mistake. As Warren Buffett has said: “When we see a moat that’s tenuous in any way — it’s just too risky. We don’t know how to evaluate that. And, therefore, we leave it alone.”
2. “You do it because it’s something you believe in. Everybody comes in and says you can’t do something, so I do it just to prove it.” Jack Goeken
Goeken’s persistence and tenacity were legendary as was his ability to do a lot with very little money. For example, he slept in the office of his lawyer when he did not have enough money for a hotel. His lawyer once said that Goeken was like yeast in bread dough on a warm day – he would inevitably rise.
3. “When you do something that`s never been done before, you don`t have a blueprint. I navigate in uncharted waters.” Jack Goeken
There is no recipe for success in creating a successful startup (which is very different from executing on a known business model). When you face uncertainty, the best approach to finding success is experimentation using the scientific method. This is true whether the founders are a big company or a startup. There are best practices at least some of them must be broken in order for the business to be innovative. Selecting the right rules to break at the right time in the right industry is part of what makes for a great entrepreneur. If you break too many best practice rules the startup will surely die, just as it probably will if the founders break none.
4. “I couldn’t care less if people laugh at me.” Jack Goeken
Being a founder is far easier if you have thick skin. Most founders are told that they are going to fail many times. Not caring what naysayers think is a kind of superpower for founders.
5. “I can see Orville and Wilbur Wright going to their lawyer and saying, `Hey, we want to invent an airplane.” And the response would be: ‘Oh, my God, the wing is going to fall off. Stick with bicycles!’” Jack Goeken
It is easy to say: “That won’t work.” And most people do. The difference between naysayers and someone like Goeken is that he actually created winners. Creating winners is hard evidenced by the fact that distribution of success for startups it a power law. There are a few winning hands and a lot of failures when it comes to ambitious venture capital backed startups.
6. “I never believe in revenge. Our philosophy is just to do it better and do it faster than anybody else.” Jack Goeken
Charlie Munger says it best: “What good is envy? It’s the one sin you can’t have any fun at. It’s 100% destructive. Resentment is crazy. Revenge is crazy. Envy is crazy. If you get those things out of your life early, life works a lot better.” Goeken made this statement about revenge after settling a lawsuit with GTE over Airfone. His response was to go out and form a competitor to Airfone. It did not work out well financially for Goeken this time, but it also did not for Airfone for GTE.