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Tele-Communication, Inc

internet business models

text and cases

Tony Gauvin

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TELE-COMMUNICATIONS, INC.

ACCELERATING DIGITAL DEPLOYMENT

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Overview

• Introduction

• Company History

• Goals and Strategies

• GBF??

• 20-20 Hindsight

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Introduction

• Describes how the top management team at Tele-Communications, Inc. (TCI), the largest U.S. cable company, conceived and implemented a dramatic operational turnaround and a radical new technology strategy over an18-month period beginning in late 1996.

• The problem is whether to move to digital converters (first or second generation) to response to market pressures and move into the ISP market

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TCI’s History & Facts

• TCI was founded in 1956 by Bob Magness, an Oklahoma cottonseed salesman and part-time rancher.

• In 1970 the company was taken public.• In 1978 TCI played an important role in HBO’s

early success. TCI started providing HBO to 700,000 of its subscribers.

• In early 1980s TCI expanded by acquiring suburban and small town cable systems.

• In 1990s the company expanded to the UK and other international markets.

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TCI’s History & Facts

• TCI’s managers had long been prolific deal makers: between 1973 and 1994 the company had completed 650 acquisitions, divestitures, and joint ventures.

• IN 1993 TCI collaborated with Microsoft. Also in 1994, the company and three other large MSOs joined Sprint in a joint venture called Spectrum.

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TCI’s History & Facts

• By year end of 1996 they wanted to expedite the deployment of first-generation digital converters.

• In 1996 the largest US cable system operator. With 14 million subscribers.

• TCI diversified beyond its core US cable system business by investing in programming, telecommunications services, direct to home satellite broadcasting, and international cable television businesses.

• TCI also invested in joint ventures that employed digital technologies to deliver new telecommunications services

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UBIQUITOUS DEPLOYMENT OF

ADVANCED DIGITAL CONVERTERS • Cost of advanced digital converter in 1999: $300

– Less cost of advanced analog converter in 1999: $150– Less value of gi warrants/converter: $40– Equals incremental cost/converter of accelerated deployment in 1999:

$110• 1999 advanced digital converter penetration of basic subscriber base

with accelerated deployment: 80% of 14 million basic subs = 11.2 million advanced digital subs

• 1999 advanced digital converter penetration of basic subscriber base under “business as usual” scenario, i.e., Deploying converters only for customers that respond to solicitations: 20%, or 2.8 million subs

• So, incremental capital cost is $110/converter x 8.4 million subs = $924 million

• Can TCI create that much value?

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Key Stakeholders

• Customers – 94 Million households had access to cable in

1996 (97% of all households in US)– 68% market penetration

• Regulatory– FCC, PUCs, Municipal Governments– 1996 & 1998 Telecommunications Acts– Judicial (Anti-trust)

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Key Stakeholders

• Management– John Malone, CEO– Leo Hindery, COO– Donne Fisher, CFO

• Investors

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Managing Strategy at TCI

• TCI had evolved into a large global company. The company’s top management had to attend to multiple markets, including cable systems, cable programming, telephony, DHT satellite broadcasting, and Internet services.

• It was critical for the company to establish and revise strategic priorities.

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Managing Strategy at TCI

• TCI’s CEO Malone had an exceptionally strong and flexible intellect. In meetings he verbalized his thought processes – not just conclusions.

• Compared with many CEOs, Malone was more secure in his position and therefore more willing to act decisively in the face of uncertainty. He owned a large block of TCI stock and controlled 40% of shareholder votes in late 1997.

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Trouble in Late 1996

• In late 1996 TCI reported an unexpected loss of 70,000 subscribers, due largely to competition from DHT services.

• TCI also had deterioration in the spread between their pricing and programming costs. The company became dysfunctional.

• Changes:– After analyzing TCI’s margins, Malone set a goal of cutting

SG&A costs by $100 million through a workforce reduction. – Malone formulated a plan to reduce TCI’s programming expenses

by about $200 million by dropping certain programming services.

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Trouble in Late 1996

• Malone froze capital expenditures, pending a review of the company’s technology strategy.

• By early 1997, Malone had concluded that TCI needed to accelerate the deployment of digital converters to respond to competition from satellite broadcasters.

• TCI planned simultaneously to launch digital video, telephone, and high-speed Internet access services.

• Malone believed that the new technology strategy would conserve capital, allowing TCI to boost free cash flow and reduce its debt.

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Accelerating TCI’s Turnaround

• Leo Hindery, former CEO of InterMedia Partners which controlled 1.4 million cable subscribers, accepted Malone’s offer to join TCI.

• His first step was to rebuild the top management team. Within a few weeks of Hindery’s arrival, 25 senior executives left the company.

• TCI reduced costs of marketing by clustering its geographically scattered systems into a few regions.

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Accelerating TCI’s Turnaround

• Through the partnerships, and by trading some systems with other MSOs, TCI was able to concentrate its system portfolio into six major markets where it was the dominant MSO (Chicago, Dallas, Denver, Pittsburgh, San Francisco, and Seattle) and ten other big cities where it controlled a large share of cable customers.

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Accelerating Digital Deployment

• Early in the year of 1997, Malone had focused the company on a defensive technology strategy that would accelerate the deployment of first-generation digital converters. By year-end, however, TCI was planning the rapid and widespread rollout of second-generation digital converters. These converters would deliver more video channels, also provide high-speed Internet access, integrate Web content with traditional television signals, and enable cable systems to provide telephone service.

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The Case for Ubiquitous Digital Deployment

• By early 1998, the specifications for TCI’s second-generation digital converter were set.

• The rapid, ubiquitous deployment of second-generation digital converters offered 2 other potential benefits.

• First, it could tap the unmet demand for interactive services in households that had not yet acquired a personal computer.

• Second, ubiquitous deployment would preempt competition from telephone companies seeking to deliver digital services.

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GBF?

• Tci followed a “get big fast” strategy• Payoff

– Scale economies in programming procurement, system operations

– Leverage to acquire equity stakes in programming and technology ventures

• Risks– Overextend balance sheet– Chaotic post-merger integration– Strain management capabilities (especially given

reliance on ceo as architect of strategy)

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GBF?

• Network Effects were Low for cable providers

• Scale economies are great

• Customer retention rates for Cable customers are high but not so for digital services (many competitors)

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GBF?

• Risks and rewards of pursuing scale for access providers

• Payoff from vertical integration and “walled gardens”

• Causes of organizational inertia in large, established companies; advantages and limitations of “top down” management approach for addressing inertia

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TCI LESSONS

• Traditional “bottom up” resource allocation processes are not ideal in risky, turbulent environments– Division managers understand substance of strategy;

corporate managers typically do not, so they base their decisions on the reputations of division managers

– Division managers must protect their reputations; they propose projects that are consistent with the accepted concept of corporate strategy, and with the company’s reward system

– Bottom up process is slow, political, and inherently conservative

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TCI LESSONS

• “Top down” process is faster, and shifts responsibility for “bet the company” risks to the ceo, who is better able to bear them (particularly true for owner-managers).

• However, top down processes suffer from two limitations:– “Bounded rationality.” In large, complex organizations, CEOs

have too many competing demands for their attention to personally play the lead role in developing division level strategies.

– “Groupthink.” Faced with a threat, management team often rallies around a strong leader, offering uncritical support of the leader’s policies. They ignore alternative strategies, edit out disconfirming data, and stifle criticism.

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MALONE’S MANAGEMENT STYLE

• Overcoming ‘Bounded Rationality’– Wide bandwidth network for collecting real time data from inside

and outside TCI (e.g., from myriad joint venture partners)– 25 years of cable industry experience yields “pattern recognition”– “Best Processor Of Information Among Fortune 500 CEOs”

• Avoiding ‘Groupthink’– Constantly testing ideas: “thinks out loud;” looks for devil’s

advocates – TCI culture encourages open flow of information, “honest

autopsy”– Continuity of management team serves to buffer and translate

malone’s ideas– Found coo with complementary skills and attitudes

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• “I think it’s going to be very big — and for me, what I really love is strategy. I like financial strategy. I like technical strategy. I hate running things, I hate getting subpoenas, I hate giving depositions, I hate getting called before a city council — I hate all that. And I hate having 35,000 employees who need to be patted on the back. That’s great for Leo; I hate that stuff. Just give me a corner somewhere where I can sit and scheme.”

JOHN MALONEBROADCASTING &

CABLE

JULY 1998

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ECONOMICS OF HFC APPLICATIONS

Digital Video

Cable Modem Phone Service

APPLICATION PENETRATION

% BASIC SUBSCRIBERS, ‘03 41% 24.7% 11.5%

% HOMES PASSED (HP), ’03(BASIC SUBS = 70% OF HP)

28.7% 17.3% 8.1%

APPLICATION MARGIN

REV./APPLICATION SUBSCRIBER/MONTH, ‘03 $17.44 $21.70 $41.48

EBITDA MARGIN, ‘03 42% 38% 34%

EBITDA/HP/YEAR $25.23 $17.12 $13.71

% OF INCREMENTAL EBITDA FROM APPLICATION 45% 30% 25%

CAPITAL COSTS

APPLIC.-SPECIFIC VARIABLE COST (VC)/APPLIC. SUB, ‘03 $150 $125 $545

APPLIC.-SPECIFIC VC/HP $43 $22 $44

APPLIC.-SPECIFIC FIXED COST/HP, ‘03 $20 $11 $32

ALLOCATION OF $193/HP HFC UPGRADE/HP $87 $58 $48

TOTAL INCREMENTAL CAPITAL COST/HP $150 $91 $124

YEARS TO BREAKEVEN 5.9 5.3 9.0

Source: DLJ Research

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Conclusion

• TCI’s operational turnaround program showed quick and impressive results. The company reported a 31% increase in operating cash flow in fiscal 1997, compared to 1996.

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20-20 Hindsight

• On March 9, 2002, AT&T acquires Tele-Communications, Inc. (TCI), the second largest cable company in the United States. TCI is renamed AT&T Broadband & Internet Services.