Make Versus Buy in Information, Communications and Entertainment –Comparing the Strategy of AT&T with Facebook, Google and Other Unicorns

            With ample lines of credit and a relaxed global monetary policy, AT&T can easily move up and down the ICE food chain with massive acquisitions.  Sensing opportunities presented by changing marketplace conditions and threats to legacy business lines, the company has opted to buy market share and expertise. Other major ICE ventures have opted to make new products and services, or to blend make and buy as appropriate. 

            I believe differences in strategy largely depends on the confidence a venture has in its ability to integrate acquisitions into the family by exploiting the skills, expertise and market share the acquired venture offers.  We hear how merged companies will exploit synergies and efficiencies, but doing this requires great finesse.  Can AT&T embrace people, plans and skills not invented from within?

            Consider what Amazon, Facebook, Google, Microsoft and other major firms have done on the make versus buy dichotomy for telecommunications transmission capacity.  These firms have opted to build undersea fiber optic transmission capacity rather than lease it from incumbent carriers on a cost plus, plus basis.

            Making content carriage instead of renting it makes absolute sense, because content companies can achieve savings in a major cost center, but one that is fungible. In other words, transmission capacity has substantial costs that content companies must incur, but transmission capacity does not significantly differ between carriers, or between a self-provisioning venture and one that leases capacity.

            Content does not have such fungible characteristics, because of a far wider range of good versus bad quality. Fiber optic transmission capacity matches, best practice, global standards, while content can be nation specific, idiosyncratic and quite risky to produce.  Perhaps Netflix has found ways to reduce risk of failure through data mining and a business plan where even large investments in single series will not threaten the ongoing viability of the company.  Generally speaking, even today, generating a winning content formula involves gut instinct, a long learning curve and many failures.  That explains why producers stick and copy with winning formulas resulting in countless sequels, prequels and duplicates.

            AT&T has ample funds to experiment, but with such a deep pocket the company risks buying at the top of a market and paying too great a premium over the stock price.  Consider its $48.5 billion DirecTV acquisition.  AT&T has bought a venture that has substantial recurring investment costs including the satellites with ten year useable lives and launch technology that historically has a one third probability of failure or live reducing anomaly.  Worse yet, AT&T did not get any internally generated content for its investment, at a time when consumers appear increasingly disinclined to pay for large and costly bundles of content, only a small portion of which they want to view.

            On the other hand, AT&T has grown and become a major powerhouse through successful acquisitions.  Only AT&T and Verizon remain from the seven divested Bell Companies.  Additionally AT&T knows how to bundle services and bill for it.

            Maybe AT&T can keep its acquisition success streak intact.  If it succeeds, it will have beaten stiff odds and proven its superior management skills, forecasting talent and business acumen.

Lessons From the Hawaii Telcom Bankruptcy

Hawaii Telcom, the incumbent local exchange telephone company, has filed for bankruptcy protection. Press accounts attribute this outcome to increased competition, the company’s struggle to finance capital spending while making debt payments, a significant downturn in the economy, as well as the difficulties in the transition following the leveraged buyout of the company from Verizon Communications Inc. See http://www.starbulletin.com/news/bulletin/35318244.html.

I have a few other bogus and credible explanations that may offer greater insights. When something like this happens, it seems too easy for the culprits to evade responsibility by invoking the “perfect storm” explanation as appeared in the press account above. No person or group bears any specific responsibility. Bad things happen like the breaching of flood gates and levees in New Orleans. The perfect storm defense does not just shift the blame, it deflects the responsibility and accountability issue by claiming something akin to force majeure, an unavoidable event, or series of unfortunate events.

Another bogus defense invokes the “destructive” aspect of capitalism and competition. Joseph Schumpeter, an Austrian economist coined the phrase “creative destruction” in the early 1900s to refer to the long run creative and production benefits accruing when new firms replace failing firms. Some economists consider competition destructive if after a short period of low prices, competitors exit the market and consumers end up worse off by having fewer choices as surviving firms raise prices to recoup previous losses.

In HawTel’s case the firm’s troubles have not resulted primarily from macro-level assaults on its bottom line by the business cycle, VoIP and the cost of capital. As to destructive competition, few if any informed industry observers would declare local exchange telephony a natural monopoly, entitled to insulation from competition presumably in exchange for rigorous rate of return, public utility regulation.

The massive fees extracted from the leveraged buyout of HawTel, coupled with a vastly greater debt burden, sank the firm. Time after time state and federal regulators accept the pitch that a merger or acquisition will serve the public interest by “promoting competition” and “enhancing productivity and efficiency.” In reality some leveraged buyouts make the deal makers rich and the public worse off. A firm saddled with far greater debt may not have the wherewithal to handle its vastly higher debt load. The so called efficiency gains result by firing workers and cutting corners on customer service, maintenance and infrastructure upgrades. In HawTel’s case the house of cards fell down, and it may appear that the Carlyle Group, the private equity firm buyer of HawTel, ends up with a losing investment. I suspect that with close forensic scrutiny of the deal, the Carlyle Group, was able to extract ample upfront fees to abate if not eliminate the financial harm resulting from HawTel’s bankruptcy. Hawaiian wireline telephone subscribers probably will not end up harm free.