The smartest telco CEO, Bell Atlantic's Ray Smith, reveals what really torpedoed his merger with John Malone's TCI, why the telcos are going to kick cable's butts, and precisely how the I-way is going to reach your home.
__Point! Last year, Wired's David Kline snatched an amazing interview with the cowboy of cable, TCI chief John Malone. The mogul's uncensored revelations about the collapse of his US$33 billion merger with Bell Atlantic Corporation - not to mention his audacious jest about shooting the chair of the Federal Communications Commission - ignited controversy (Wired 2.07, page 86). Counterpoint! Now Wired has returned Kline to the gladiator arena, this time to the opposing corner - that of Ray Smith, CEO of Bell Atlantic. Clearly the most enterprising and farsighted of the telco leaders, Smith was the first to start construction on a broadband network, the first to win federal approval to offer commercial video dial-tone service, the first to win court permission to develop the company's own video content, and the first to begin shifting his once-stodgy utility to a more entrepreneurial footing.
Smith enjoys poking fun at his old monopolist image as much as anyone. On the white board in his office he wrote: "1) Buy AT&T 2) Sell Pennsylvania 3) Retire 4) Work for IBM (depose Gerstner) 5) Cancel subscriptions to all magazines and newspapers."
Here, then, is what Ray Smith, the titan of telephony, has to say about John Malone, the telecom wars, Jane Seymour (yes, Jane Seymour), and what the broadband network in your future is going to look like.__
Wired: So, what's the plan? Are you going to buy AT&T, or sell Pennsylvania?
Smith:
No, don't use that. I put that up just to amuse you. All we need is to have a rumor going around that we're going to sell Pennsylvania.
I can imagine. Even John Malone said that you telco guys are the real monopolists.
Yeah, in my career I've come to know a number of humble, one-shoe-over-the-other billionaires.
So you're not a monopolist, and you have no near-term plans to sell Pennsylvania?
Absolutely not.
I see.
We're gonna sell West Virginia.
[Laughs.] Well, now that we've got that settled, can we talk about Bell Atlantic's aborted merger with TCI? People still want to know what really happened the day the biggest deal in American history crashed and burned.
You know what amazes me? There were only four people in the room that day, but there are at least twenty different versions of what happened. It's like the movie Rashomon.
Well, Malone said the merger was aborted because you couldn't get your board of directors to go along with the deal - they were skittish about changing from a regulated utility into a high-growth company.
No, that's absolutely not true. The entire board was in favor of it. There wasn't a single voice against it. Let me tell you what is true. There was a struggle in the shareholder base. We have a million shareholders, and they are high-yield-oriented. We froze the dividend, and it frightened the life out of our shareholders. And our stock, which leaped for a while on the promise of the merger, dropped as the yield-oriented shareholders pealed away. So, the struggle was really in the investment community. It was not a debate on our board about whether to change into a high-growth company versus a low-growth company. My cash-flow growth is faster than John's!
I'm not trying to say we didn't have cultural differences in terms of TCI being more entrepreneurial. But the issue was, how do we get the cash out of our company to complete the deal without scaring off our shareholders? If you cut the dividend too much, the shareholders leave, and the stock drops so low you can no longer do the deal.
But you knew you faced that problem going in.
I knew it going in. I knew it'd be a struggle that we'd have to handle with some sensitivity. Unfortunately, it became public. At one point, John was quoted as saying we'd have to cut the dividend in the future, and the stock dropped five points.
Why'd he say that?
[Shrugs.] He thought that was what we had to do. John was just being honest. But to say it like that is like lighting a match in a gas-filled room. Not that you aren't going to tell shareholders the truth. You are. It's just that we were trying to find less onerous ways of making the deal work financially. Why announce something like that before you know for sure? You see, John's approach to this issue was like his regulatory approach. He didn't say, "Shoot the shareholders" - don't quote me on that - but he was saying, Let's just go cut the dividend. John, being the road warrior you pictured him on the cover of Wired, just wanted to get it over with. But that's not how you deal with regulation, and it's not how you deal with a large shareholder base.
I'm more of a builder. An architect. I like to do things one brick at a time. My view is, Align and conquer.
So what finally killed the deal?
John's cash flow went down. Remember, when we set the deal, John's cash flow was at $200 a subscriber and we agreed to pay him about 11.75 times cash flow. But there was a cash-flow test. If his cash flow were to go down, as it did after the FCC cable-rate rollbacks of February 1994, then I would give him fewer shares of my stock, which had a fixed price of $64 in the deal. Now, by February 1994, because of the declining cash flow, the value of TCI stock was by then dropping close to $20 or $21. I was willing to pay something like $25 per share. But John still had it in his head that it was a $35 stock. That's just too big a difference.
In the final meeting, we kept trying to figure out some way to make it work. John said, "If I take this reduced number of shares, I'll never get my major shareholders to accept it. And there's no way you can give me the number of shares I need. You'd be paying 14 times cash flow." And I said, "You're right."
Finally, he said, "Well, we can't just sit around here forever." And I said, "Yeah, let's look at the press release and get this over with."
What's your strongest memory of that last meeting?
[Pause.] I guess it's the last words he said as we separated. He said, "Nice try, my friend."
You guys really like each other.
We do. We're both old techies, and we get along very well. John and I were just on a Networked Economy Conference panel together, and we were standing at the urinals talking about things, and Barry Diller comes in and stands between us. And Barry says, "C'mon, you seem like such good friends. Just split the difference."
[Laughs.] What does the failure of the merger tell us about the strategic-planning capabilities of big companies like yours? One day you're spinning together these huge deals, and the next day you're taking them apart and going about your business.
Actually, I think it's positive. It shows that although we had a good strategic idea in trying to merge with TCI, when the conditions changed, as they did, we were willing to pull back. You don't just stick to a deal out of sheer, cussed egotism when it's no longer good for the shareholders. Cutting mergers is a hard thing to do. And you know what? If I could get the same deal today that I agreed to a year ago, I'd sign it right now. Right this minute.
What if Malone reads this in Wired and calls you up and says, "OK, Ray, you're on!"
I'd take it. Exactly as I signed it a year ago.
Gee, as a finder's fee I'd get something like $50 million! Of course, Wired would want a piece of that, no doubt. In any event, many now say the collapse of the merger shows that the info highway is way overhyped. What do you think?
There was a lot of hype before the merger. The media was full of it. But for all the hype, there was also a lot of naysaying. Still, I do think the merger announcement moved things forward. The moment it hit, there was no way that anyone could say that it all was just hype, or that the whole notion of the info highway was silly. The naysayers were just swept away.
You mean, the naysayers in your company?
Not so much in our company. Remember, we were the first of the regional Bell companies to see it coming. We very consciously set out to prepare for it in 1990 when we filed the court case to change the Cable Act of 1984, which barred telephone companies from owning the video programming they delivered. And you know, when we launched that court case, we offered it to all of the other telephone companies, including GTE. None of them saw any need to get into the video industry.
And the merger changed that?
It really began to change when we won the court case in 1993. Before that, there was not one single procurement by the other Bell companies concerning video. There was no support of ADSL [asymmetric digital subscriber line, a way to send data down a phone line]. There were no hybrid fiber-coax discussions whatsoever among the other phone companies. Now, I happen to know there were battles within at least four of the seven Bell companies over whether video was practical. A lot of discussion along the lines of, We'll never be able to make it pay, We can't do it, that type of thing. They were in the "Yes, but" phase. Once the court case was won, that was the end of "Yes, but." They all called and said, We want to get into this. Even then, there wasn't critical mass in most of the telephone industry to move forward on video.
But the day after the TCI merger announcement, there was. Suddenly, video became a necessity. The top decks of all the Bell companies knew that, at the very least, they'd have to get into the video business because cable was going to get into the telephone business.
There was no argument any more. It wasn't whether we should do it, but how we should do it. The announcement changed the picture so much that the merger became less necessary for us. Because one of the motivations for the merger was to get enough scale to bring equipment costs down. But when all these other companies suddenly jumped in after the TCI deal with their own infrastructure investments, costs were going to come down anyway.
So while many debunkers, especially in the media, point to the collapse of the merger as proof that all this is hype, the evidence shows it moved things forward. It was like a demonstration atomic bomb. Of course, then it became not only conventional wisdom, but conventional wisdom times two. We were in hyperspace, and we were all going to have talking television sets by the end of 1994.
And Time Warner's Full Service network in Orlando was going to be up and running in early '94, remember?
Yeah, they were saying they had solved all the technical problems. Well, sure, they solved the technical problems. But the set-top was $11,000! So now it's $3,000. Big deal. I mean, the issue is, can you do it at a price that people can afford, so it can be deployed in the real world? Anyway, the merger announcement served its purpose. It moved things forward.
And its abandonment four months later kick-started the war between the cable and phone industries that we see today. What do you think about the conventional wisdom that says the telcos will probably lose 30 percent of their market share to cable-provided telephony services, while cable could lose 30 percent of its video business to the telcos? I mean, cable executives say that's fine with them, because their 30 percent is going to look a lot sweeter than your 30 percent.
Oh, for Christ's sake! This notion that cable companies are going to get 30 percent of the $100 billion telephone business, whereas we'll get only 30 percent of cable's $20 billion business - that's ridiculous. Bell Atlantic is not one business but 13 different businesses, most of them not subject to any real competition from the cable industry. RBOCs get a billion dollars of our revenues from the federal government. You're saying cable's going to take our 25-year contract with the Pentagon? Nonsense! Cable companies aren't going to touch that. Or look at the Yellow Pages. If the cable companies offer local telephone services, is that going to affect our Yellow Pages business? And are they going to compete for our life-line services?
Oh, I'm sure they're dying to get their hands on that!
Right, we're quivering in our boots waiting to see a cable company come into New Jersey and offer local phone service for $6.50. So the more you look at it, the more the percentage of our revenues that are really subject to cable competition keeps shrinking. Of our $13 billion in total revenues, only $4 billion of that - the consumer business - is subject to competition from cable companies. Now, the cable companies in our territory also have about $4 billion in revenues. But while we cover 100 percent of their customers, they cover only 60 to 70 percent of our customers (the telephone-using homes that subscribe to cable TV service). So there is only about $3 billion they can try to get their hands on.
But how successful are they likely to be? Consider that Philadelphia, for example, is served by maybe 10 or 11 cable companies. Even inside the city there are four different cable companies. Four!
Now you're telling me a consumer is going to subscribe with a cable-phone service that serves only one section of the city? That's going to be a pretty hard sale. And what about power? Remember, when the power's out so's your cable phone!
So, this 30 percent versus 30 percent.
It's wrong. It won't be dollar-for-dollar. It'll be 10-to-1 in our favor. I would say that by 2000, we'll have 50 percent of the cable TV business - no doubt about it, which is why some cable companies are in a panic. Meanwhile, the cable companies won't have even 3 percent of telephony revenues in their best market. Not in their best market. It's just not going to happen.
But isn't your real concern here not so much that cable companies will take a big chunk of your total revenues, but that they'll cherry-pick your most profitable businesses, like your $3 billion-plus local access services?
We've already got competition there. No, cable is not where our real competition will come from. The competition's going to come from AT&T and from wireless, not from cable companies reequipping their ancient and crappy systems.
But now TCI and two other cable firms have hooked up with Sprint Corp. to bid on wireless personal communication services spectrum.
Bidding is one thing. Building a truly robust and competitive service is another.
Well, your wireless business has certainly gotten more robust lately. By combining with Nynex, AirTouch Communications, and U S West, you've now got the biggest wireless footprint in the country. But what about the failure of your talks with MCI? Doesn't that leave you without the sort of national brand name you'll need to compete with AT&T, or even Sprint-TCI?
For us, the most important thing is the footprint, not the brand name. We estimate we need a footprint that covers somewhere around 150 million potential customers to give us the scale to compete with AT&T. As for the brand, we can create it. It'll cost money, and it won't be as quick as if we had MCI with us. But we can create a national brand that's up in the 60 percent range within a year in terms of recognition, maybe up to 85 percent in two years.
So have you given up on MCI?
MCI needs a wireless strategy. They have to be connected with a company that has a wireless presence. As for what may or may not happen, that certainly isn't going to be talked about today.
You've laid out some of your competitive advantages over the cable industry. But you also have some disadvantages, don't you? For instance, whereas cable firms have already laid their coax - 80 percent of the cost of building the network - don't you still have this massive construction job in front of you?
We've been equipping our network for years now.
But I'm talking about laying coax, especially that "last mile" to the home. Look what happened to Pacific Telesis in Milpitas, California. When city officials there saw that PacTel planned to dig up 60 miles of city streets and disrupt businesses for months - just to lay coax to 1,000 homes - they refused to grant construction permits unless PacTel forked over $1 million in remuneration. And that's just one city. So how easy is it going to be for the phone companies to go into thousands of towns and cities nationwide and get similar permits?
Well, I think Milpitas was an anomaly. We know how to build so you hardly know we're there. We have a construction permit for Dover [the township in New Jersey that is the site of Bell Atlantic's first commercial interactive video service]. If you polled the people in Dover and asked, "What cataclysmic thing is going on here?" they wouldn't know what it was. Maybe what happened in Milpitas was an overreaction by the city council or something. In any case, we know how to build in a way that would satisfy any community. It can be done with care, delicacy, and with a little bit of explanation. In Morris County, New Jersey, it's like the Persian Gulf War or something, and everyone's waving Bell Atlantic flags saying, "Please come! Please come!"
Cheering, no less?
Sure, because they see us as finally bringing decent cable TV service. We've had people calling us, asking how soon they can sign up for our cable service. I mean, look. I'm in Montgomery County, Maryland. Just this week, my cable TV service has been out for three days. Fortunately it wasn't out on Monday when the Steelers were on, but it went out Tuesday, and today's Friday! We get terrible cable service, really lousy service. And everybody says so.
But what's going to happen to your service as you make Bell Atlantic leaner and meaner and more competitive? Look what's happening with U S West. It's been reengineering, laying off workers, and cutting costs to become more competitive with the cable companies. And guess what? Colorado regulators have now charged them with major violations of state service guidelines because their customer service has gone down the tubes.
Well, they may have gone over some line, but.... Look, just because U S West has a couple of problems, that doesn't compare to every cable company in the country being the worst service provider in the community. I mean, I don't remember my telephone ever going out of service. We have good service and I don't see that changing. We have such a competitive advantage over cable because of our service reputation that we'll get 15 percent of video market share easily just by putting out our shingle.
You know, all this downsizing raises an interesting point: people say the info highway will create jobs, yet to compete in building it, the telcos have become the biggest job destroyers in America. In fact, collectively, the Bells have announced more than 80,000 layoffs in the past year. [Protesting Bell Atlantic workers were sent home without pay one day last November for wearing T-shirts describing themselves as roadkill on the info highway.]
Like you said, it has to do with competition, which is coming into our business. We've already streamlined, but we still have a way to go - and so do the other RBOCs - to meet the ultimate competition. So that's what you're talking about. That's the downward pressure on the work force. But we think that after these downsizings are done - and when the market begins to develop fully in 1996 - you're going to see a lot of hiring going on. The building of the superhighway will act as an upward pressure on the work force. There'll be a great expansion to build all these new interactive services.
So we see a short-term need to get our costs down. Long term, in 10 years, we're going to be a much bigger company.
Well, you certainly sound like you're ready and willing to take on all competitors. So why do you think Senator Fritz Hollings, Representative Ed Markey, the Consumer Federation of America, and even Vice President Al Gore put the blame for killing the 1994 telecom bill - which would have opened communications markets to greater competition - squarely on the regional phone companies?
I don't think that's fair at all. I think the Senate just ran out of time.
But wasn't that because some of the telcos - notably Bell South - just wouldn't compromise on certain of the bill's provisions regarding the opening of their markets to competition? Whereas your company and other Bells were much more willing to work out a compromise?
I think that's pretty accurate. We certainly were more willing to move forward with that bill and negotiate some of our differences in conference. Some of the other telephone companies felt it was too dangerous to do.
Ultimately, does it matter whether there's a telecom law in 1995? I mean, you seem to be moving forward anyway to build out your network, develop programming.
It does matter. We've got to get these barriers down. We've got to get into full competition in our business and in long distance. We obviously are already in the cable business (because of the 1993 federal court ruling allowing Bell Atlantic to offer video dial tone). So that side of it isn't important to us. But we have to open everything up to expand the market. This Balkanization we have now is causing dislocations in pricing and so on that are unnecessary. The market won't expand the way we want unless we have full and open competition in all areas.
Let's talk about what precisely this network is going to look like. You mentioned earlier that you saw yourself as a builder, an architect, rather than a John Malone-style road warrior. So sketch it out for me. What's your grand plan? What's the blueprint for your network?
It's going to be built differently in every town. That's the part that hasn't been captured yet, the unspoken story. The way it's been reported to date is that we are all going to put out hybrid fiber-coax and connect it to a so-and-so with a micronet. Like there's a grand plan. Of course, that's ridiculous. It's that old manufacturing model, like you create one automobile design and then make 100 million cars that all look the same. But that's never how things of this sort are deployed. It's going to be quite different from some great, grand plan.
Here's how it's going to be built: There are five different technologies that we'll use to provide video services in competition with cable companies. The first will be the fiber to the curb, which is the approach taken by companies like BroadBand Technologies. This is what we're going to do in Dover.
Your original ballpark estimate of the cost per home was $1,200. Is that still your figure?
It's probably about $900, including the drops into the home, but not including the cost of the servers and set-tops. And once that kind of technology gets ordered in larger volumes, we'll get down well below that number.
For fiber all the way?
Fiber all the way to curbside, with two lines then going out to between 20 and 30 homes. One line will be coax and carry video, the other is twisted pair for voice. Clearly, that's the preferred architecture. It's switched, digital, fully interactive, and you get a tremendous reduction in maintenance expense and an improvement in service. So that's one way. Number two is hybrid-fiber coax, where we run fiber to a neighborhood hub and then coax from there to a few hundred homes. In some locations, this will be the preferred solution, especially where the interactivity is not expected to be as robust, or where the demographics of certain areas demand lower costs.
Today's price for that?
Maybe a couple hundred less than for fiber to the curb, but we're Wired's readers know that these estimates are based on certain caveats and assumptions about early roll-out volumes, rather than full-blown nationwide deployment. The third approach is ADSL. When you see what we're doing with it, you'll see that it's not an interim technology - at least not in the sense that it's second-best or doesn't work well. It has excellent quality. You can do the virtual VCR over it. You can fast forward and back, and you can have a whole batch of channels. It's server-based. It's digital.
But it is interim in the sense of being a transition technology, right?
Yeah, transition. That's a much better way to say it. It's a market entry kind of thing. It doesn't require conditioning the whole plant. It doesn't require big switchers or anything like that. It's modular. You go in house by house, and if people want it, you just stick in a circuit pack. When you get enough people in the neighborhood who want interactive services, then you bring fiber to them. Pull out the ADSL circuit packs and bring them out to a more remote area. They're reusable hundreds of times, so it's an interim technology that will be with us for 40 years.
Then what's limiting about it compared to fiber?
The cost is higher per house.
The cost of ADSL?
It's higher, yes, for each house. But remember when you cover a whole batch of houses, not every one of them takes cable television. When you do ADSL, each house costs more, but you do it only after the sale is made. But isn't the level of interactivity different?
There's a big difference between that and full fiber to the home. A big, big difference. It doesn't give you infinite channels and infinite interactivity, but it does give you video-on-demand and home shopping. And it gives you excellent picture quality and good production values and our Stargazer user interface.
What about live broadcasts, live sports?
Well, as currently deployed, no. It's 1.5 Mbits per second. But future versions of ADSL will carry 6 Mbits a second. That gives you live broadcasts. It'll give you everything except the gee-whiz levels of interactivity. Then the fourth approach is wireless cable. Twenty-eight GHz is working, and it's great. And remember you're talking about antennas that are small enough to be pasted on a window. You paste it on and put in your telephone jack, and you now have video. Of course, it's not applicable to every location and every terrain.
Direct broadcast satellite is the fifth approach. And these will all be integrated, so if you're the customer, you can say, "Yes, I'd like your telephone service and your wireless cable TV service." Or you can say, "Give me ADSL service," or whatever. It'll depend on your location, how far the engineering and construction of the network in your area has developed.
Do you think eventually there'll be one common architecture?
There will be. But I can't predict whether it'll be fiber-to-the-curb or fiber-to-the-node plus coax. But probably those two will be the most common. But who knows? Remember, the capacity of wireless cable is 28 GHz. That's huge. It's gigantic. If you can get that to work well - and be interactive, too, which we have high hopes for - then it has the capacity for as many channels as you want. If that develops, we won't have to build out all the other things.
But by whatever combination of means, we will deliver broadband services to all of our customers within the next 10 years. We'll deploy it in each location and each market differently, depending on the economics. But we will deliver it to all of our customers.
Why deliver it through the TV? Many would argue that the PC is a better vehicle for these services, and some even predict that by 2000 the PC will be the dominant interactive appliance in the home.
That's not going to be the case. I think they're missing the whole point, because you're going to have intelligence in the home. The intelligence, of course, could be a set-top box or a personal computer. In fact, the PCs that will come out in the next few years will be able to act as a set-top, once they figure out what the interactive set-top will look like. And all it will take is a wire from the one to the other to make that intelligence energize the tube. But you're not going to watch television on a little monitor. You're going to watch it on a big set. That's what you'll use when you want entertainment, and you'll use the PC and keyboard when text is more important. So you're going to have both in many houses. But even in 2000, you'll still have 75 percent or more of the population that doesn't have a sufficiently intelligent PC to handle the kind of interactive services that we'll be able to offer over television sets.
The other thing to keep in mind is, the real diffusion rate of PCs into the home is not progressing the way people say it is. They talk about the number of PCs shipped each year, and there are a lot of them. But many of them are seconds and replacements. What percentage of the homes in Pittsburgh today, for instance, do you think have have a 486 PC in their residence?
Based on the best estimates I've seen, which put total PC penetration at somewhere around 25 percent of American homes, I don't know - 4 to 5 percent maybe?
That might be my guess, too. Don't forget, when they call and ask, "Do you have a PC?" many people will say yes. But what they've got is some old Amiga or 286 or something. There's no doubt that the number of more powerful computers is going to grow, but there's a stupendous amount of churn in those figures about PC usage in the home. And remember, it's also a demand question. More people want entertainment. You've got to start with entertainment - entertainment-on-demand, time-shifted sports and time-shifted news. And people will be able to get all that without having to put a $2,000 PC in the house.
So it's the Willie Sutton factor? You know, the bank robber who, when asked why he robbed banks, answered, "Because that's where the money is."
Exactly. Why TV? Because that's where the people are.
Ameritech recently announced it expects to see 20 percent of its revenues coming from video. Do you have similar goals for your joint programming venture with Nynex, PacTel, and The Creative Artists Agency in Hollywood?
How can I answer that? I mean, everything's up in the air. There'll be new competitors in every field. So there's no way I can answer that question.
Will video transport turn voice transport into something that's too cheap to meter? What will happen when someone wants to receive a data service via your video network at the transport cost of video?
As a theoretical question, I see your point. And I can imagine at some point we'll need to provide cost breakdowns to our regulators. But right now I couldn't tell you what video transport versus voice transport will cost, say, five years from now. But I can envision one day offering various packages of services. And one of them might be a package of video and interactive services in which the customer also gets phone service for another two or three bucks.
All right, before we end, could I conduct a little free-association thing with you? Kind of a Rorschach test, you might say. You game?
OK.
All right, here's the first one: Bill Gates?
Jane Seymour.
Pardon me?
Jane Seymour.
I'm sorry, I don't -
I saw a movie last night with Jane Seymour in it. She's been on my mind. She's intelligent and beautiful-
[Laughs.] OK, I get it. Now, everything's not going to come up Jane Seymour is it?
No, sorry. Go ahead.
OK ... Bill Gates?
Many more billions to make.
The Internet?
Unruly wave of the future.
Electronic Frontier Foundation?
[Pauses.] One of many.
Government regulation?
Barriers coming down.
Your worst business nightmare?
Government regulation.
Equal access?
All for it.
That's interesting. Because you and the other Bells have been accused of red-lining - of concentrating your roll-out efforts on more upscale and whiter communities.
You know, that's an absolute red herring. Lord knows where it comes from. Have you looked at our demographics?
Yes, and truthfully, the demographics in your proposed service areas show not only higher minority representation than in your region as a whole, but higher than the country as a whole, too.
That's right. So the only thing I can think of is that because the first location that we requested was in New Jersey, somebody may have looked at that one town and said, "Aha! Red-lining!"
Has the coalition - you know, the Center for Media Education and the Consumer Federation of America - since retracted its charge?
Retracted? Of course not. Never in the history of any coalition has that happened!
OK, one last question: How do you expect the provision of video content and interactive services to change your company? Is Bell Atlantic really prepared to shed its old monopolistic ways to compete in this new world?
I'm not sure anyone is able to fully appreciate how powerfully the openness of these new networks is going to affect our lives. All I can say is we'll do our best to meet the challenges as they come. Oh, I know what they say about the old Bellhead mentality - and it's absolutely true! I remember the old days in the '60s when we had a rule for everything, including the correct way to hold a pencil. We even had a written rule that said, "Before you go to a meeting, always go the bathroom, even if you don't have to."
Well, those days are gone, at least here at Bell Atlantic. It's become clear that all the old givens - like "monopolies are forever" - no longer apply. Which is why we've been working very, very hard for more than five years now to transform ourselves.
The world's changing, and we intend to manage that change in a powerful way. It's really that simple.
Ray Smith: The I-way, My Way
The typical American family has the tube turned on nearly every minute someone is home and semiconscious. The average adult watches between four and five hours a day. These statistics don't change from year to year and likely never will. In other words, no company is going to make money trying to get people to spend more time in front of the set. "Television is probably a zero-sum game," says Michael Lasky, director of digital production for Bell Atlantic Video Services Company.
So why has Bell Atlantic built a US$200 million "digital factory" in the edge city of Reston, Virginia? Why is the mid-Atlantic telephone monopoly declaring war on cable companies and parachuting into the supposedly zero-growth business of gluing people to the TV? When you visit this video supercenter, you begin to see the answer. This is ground zero for a much larger plan.
Bell Atlantic doesn't call this place a digital factory for nothing. It's an industrial-age metaphor for the most ambitious of information-age endeavors. On the crisp November day of my visit, the factory is still a work in progress. Wet-paint signs are everywhere, but the show is ready to begin. An analog source tape of a That Girl episode is cued up in a wall-sized bank of input decks - digital beta cams, VCRs, 1-inch reels and other media-eating machines. The raw material is refined into a clear stream of ones and zeros and piped into one of about a dozen production suites - small rooms packed with PCs as well as waveform monitors, audioscopes, vectorscopes, and other gear that looks like radar equipment. In these rooms, encoding engineers flip the bits until they are normalized, synchronized, aligned, and color-coordinated. Marlo Thomas has now been digitally enhanced for your viewing pleasure.
This is only the start of the assembly line of bits, for which your brain is the ultimate destination. Next stop is the squad of Silicon Graphics-armed digital artists who are breeding the new interactive viewing "environment," including onscreen venus, logos, and promos.
Then Marlo, the viewing environment, and all the other content piped in from around the world are compressed and channeled through thousands of black cables that snake under the floor, across the hall, and into a basketball court-sized data center. Sporting a white, raised floor with air conditioning vents, this room houses a network control center befitting a small airport. But most importantly, it holds a big, black nCube supercomputer fitted with 256 microprocessors as well as Oracle's multimedia database software and enough Gbytes of storage capacity to warehouse all the video that will be requested by tens of thousands of households in the Washington, DC, region.
For a viewer who has used a personal computer or played a videogame during the past five years, selecting something to watch from the Bell Atlantic system seems rather mundane. The user interface for the Northern Virginia market test of 1,000 households that was slated to begin late this winter or early this fall consists of five onscreen icons that customers can choose with their remote controls. In the center of the TV screen is a shiny, happy sun face, welcoming viewers to Stargazer, Bell Atlantic's brand name for interactive TV. The sun face smiles and winks as customers make their selections. The other four icons allow viewers to choose a) movies, b) shopping services, c) children's programming, or d) "lifestyle" programs such as documentaries and how-to shows.
For now, the programming on this network travels at the relatively modest speed of 1.5 Mbits per second over ordinary copper telephone wires, using a digital-routing scheme known as ADSL. The data rate means that the picture is no sharper than today's cable reception, says Lasky. The set-top box for this test, made by IBM and a consortium led by DiviCom, gets plugged into an ordinary telephone wall jack. It will cost about $300, based on a projected production of 1 million, and customers will pay for it in small monthly rental installments. While watching TV, customers can still use their phone lines as before, even while pausing, rewinding, and fast-forwarding through movies, which will cost $3 or $4 per viewing.
If all this doesn't sound as revolutionary or alluring as the info highway hype you've been hearing, it isn't meant to be. Bell Atlantic has relatively modest but concrete aims. A recent poll of 500 customers throughout its six-state service region found that 46 percent of cable subscribers said they would dump their cable company if a similar service were offered by their phone company. If a store-sized library of videos-on-demand were thrown in, 56 percent said they would switch. And a full 61 percent said they would buy in if the combined cable and video service were 10 percent cheaper than they are now. Over the next few years, Bell Atlantic wants to take these customers at their word and win over all that business. Or at least as much as they can before their local telephone monopoly starts to erode.
Then the real gambit kicks in. "It's a Trojan Horse," says Larry Plumb, director of communications for Bell Atlantic Video Services. By becoming the first company to supply both telephone and entertainment service to tens of thousands, perhaps millions, of customers, Bell Atlantic is aiming for a scale no one in the nation is able to match. The company is investing $11 billion over the next five years to make sure a full-blown, blazingly fast, fiber-optic network is in place by the time demand for more advanced interactive services kicks in.
But what worries many cable executives is that phone companies like Bell Atlantic won't be offering these things, or anything else really new, for many years - just spending billions to cut into an existing market. "There is another potential monkey wrench. The movie studios typically don't release their biggest hit films to pay-per-view cable until those movies have been in video stores for 30 to 90 days. If Bell Atlantic cannot negotiate a contract to get those movies sooner, people will continue to flock to their local Blockbuster and other video stores for the most popular new releases.
That's one reason why Bell Atlantic showed up at the Hollywood doorstep of Michael Ovitz last fall. The head of Creative Artists Agency will use the buying clout not only of Bell Atlantic but also of Nynex and Pacific Telesis Group. These companies have serious cash, and Ovitz doesn't mind getting a percentage of all deals.
The goal is not only to buy rights to movies, but also to buy minority stakes in programming networks, much like Nynex's investment in Viacom. The result would be a new content empire akin to Liberty Media, the programming arm of TCI.
The Reston supercenter is already equipped to handle whatever magic Ovitz can conjure up. Gleaming but vacant new video-production studios stand ready so new programming can be created on premises, or pumped in over high-speed lines for 30 million households in six of the top seven media markets in the nation: New York, Boston, Philadelphia, San Francisco, Los Angeles, and Washington, DC.
The Bell Atlantic executives call the whole process "virtual creation" because they expect creative people all over the planet to work together zapping new movies, TV dramas, videogames, sporting events, and educational programming to the factory.
Perhaps the biggest question is: Who ends up paying for all of this? Bell Atlantic executives realize that all the costs cannot be shifted to subscribers. Indeed, research by Hewlett-Packard Company and others getting into this business shows that consumers are willing to pay only $5 to $10 per month for all the new interactive services anyone can think of. That's why Bell Atlantic is working on advertising schemes to generate revenue.
In part, these ideas center on taking micromarketing to absurd levels. For instance, if Ace Ventura: Pet Detective is exceedingly popular in a certain zip code or even just in a certain household, the viewers might be targeted with personalized ads for pet food. Or when you watch an Indiana Jones movie, it could include ads for the type of clothing he is wearing.
Other ideas involve the video mall concept. The company has already signed deals with three giant retailers: Lands' End, Nordstrom, and J. C. Penney. Bell Atlantic would receive transaction fees every time a customer purchases something. For now, the user interface for interactive shopping is fairly crude. The company is at work developing more compelling ways to present merchandise.
What's clear is this is not so much an info highway, but an entertainment highway. "It's predominantly entertainment," says Lasky. But, he says, that's what the people want. They want to watch what they want, when they want. And they want the convenience of ordering everything from pizzas to power tools from their sofas.
Of course, Bell Atlantic could be wrong. It's possible there isn't enough demand for interactive television services to justify the costs. Presumably, we'll know either way by the summer of 2001, when Bell Atlantic's lease for the digital factory building in Reston is up for renewal.
