SEATTLE-Go to any trade show where mobile phone operators congregate, and you will hear grumbling about how AT&T Wireless Services Inc.’s Digital One Rate pricing plan has wreaked havoc on business plans. The play for the high-end business user seems to be falling in AT&T Wireless’ favor.
Dan Hesse, two-year chief executive officer and president of AT&T Wireless, likes it that way.
“We’re going to continue to push the envelope and move the industry in a direction that plays to our advantages and plays against the weaknesses of our competitors,” he said, leaning forward in his chair in the office once occupied by wireless mogul Craig McCaw in Kirkland, Wash.
Standing 6-feet-5-inches tall, Hesse, 45, has a commanding presence, and he is making sure AT&T Wireless takes a commanding lead well into 1999.
“One thing that this year has taught is that we can occupy a position of leadership in this industry,” said a confident Hesse.
Leader wasn’t the adjective to describe the company months ago. When aggressive PCS operators launched service and began offering enticing bucket-minute pricing plans across the country, the nation’s largest wireless carrier-along with other incumbent operators-watched its subscriber addition numbers begin to erode severely. As Bob Egan of Gartner Group characterized it: “They needed to stop the bleeding.”
“I give the PCS carriers a lot of credit,” said Hesse. “They introduced big-bucket plans that were revolutionary to the industry. The industry got a big wake-up call, and that drove us to be as creative as we could.”
So in May, Hesse and his AT&T Wireless team launched a high-end pricing plan called Digital One Rate, bucket-minute pricing that eliminates roaming and long-distance fees no matter where a customer travels in the United States.
The result? A squeeze on wireless carriers’ stock, a sharp decline in net adds for some carriers and a paradigm shift toward simplified pricing.
Bell Atlantic Mobile, Sprint PCS, AirTouch Communications Inc. and Nextel Communications Inc. are a handful of the carriers that have adjusted pricing to fall in line with DOR, although all have fallen short of offering mimicking plans as the economics don’t play in their favor, say analysts.
“Sprint would open itself up to big costs if it were to eliminate roaming rates everywhere,” said Christopher Larsen, senior wireless analyst with Prudential Securities in New York. “They pay a higher roaming rate, and they don’t have as much leverage like AT&T. No cellular carrier wants to roam on Sprint PCS’s network, while a lot of cellular carriers have customers roaming into AT&T’s markets.”
Customer expectations are changing. Larsen, who recently completed a pricing study, noted: “The industry is moving toward more simplified rate structures. Customers want this and are willing to pay a slight premium for it to know what their bill is going to be at the end of the month.”
“The biggest impact DOR has had is on roaming rates in the country and how customers’ willingness to pay for roaming has changed,” said Thomas Lee, wireless analyst with Salomon Smith Barney in New York. “I’d say the ones really affected are those who built the business on making money on roaming.”
Lee said net adds for incumbent cellular carriers continue to fall as AT&T Wireless’ now are rising. The carrier added 325,000 customers in the third quarter, a 74-percent increase from the previous year.
“AT&T Wireless’ growth rate is at the expense of other cellular carriers. Cellular carriers are down even more,” said Lee.
Lee noted that while industry net additions grew 11 percent in the third quarter, cellular operators’ growth rate was 25 percent slower. In the third quarter, PCS operators had more net additions than cellular carriers for the first time.
AT&T Wireless had more than 500,000 DOR customers by the end of September, all of which are paying between $90 and $150 per month. It is adding an average of 100,000 DOR customers per month, and 50 percent of its customer base are Time Division Multiple Access users. Two-thirds of the company’s DOR customers are from its competitors, while many existing AT&T Wireless customers have upgraded to the new package. Average revenue per user and minutes of use are increasing.
“I thought we did a double or triple, and now, not only have we hit a home-run, we’ve hit a grand slam,” said Hesse, who wants to make sure his wireless team receives the credit. “Digital One Rate continues to be a positive surprise every month … It continues to be better than our business case.”
AT&T Corp., which partly attributes its third-quarter boost in revenue to its wireless business, reportedly is so pleased with the success of DOR, it no longer has immediate plans to fold AT&T Wireless into the corporation. An AT&T memo revealed months ago that Hesse was to head up customer-care units on the consumer side of the business once the company was absorbed into AT&T sometime next year.
The blueprint
“We were going through a planning process for some time to try to figure out how best to more effectively bring multiple AT&T products to a particular customer, and there were lots of possibilities being considered,” said Hesse. “I think what we’ve decided is that there are more effective ways that we can do that. You have a wireless division working very, very effectively right now that is hitting on all cylinders … At least this coming year, we’re going to stay with wireless as a division.”
One-rate type pricing was nothing new when AT&T Wireless launched DOR in May. The idea of no-roaming or long-distance fees nationwide had been bounced around at McCaw Cellular prior to AT&T Wireless’ purchase of the company in 1994. Nextel can be credited with offering the first one-rate type plan when it introduced service with no-roaming fees, and Sprint PCS had offered customers Home Rate USA and Toll-Free USA features.
No one had offered nationwide pricing or gone to the extreme AT&T Wireless did by offering one rate anywhere in the country with no strings attached.
“I think there are both financial and technical hurdles for our competitors in terms of their ability to do this,” said Hesse. “That’s why it wasn’t done. Nobody could figure out a way to make money and do it.”
Last year, Hesse and his team began figuring out a way. The challenges seemed daunting. The carrier needed to build out 10 of its largest PCS markets and align the company to reflect a nationwide footprint that would allow PCS and its existing 850 MHz networks to work seamlessly together. To make DOR work, said Hesse, the company needed to start with as large a footprint as possible to keep customers on the network and keep AT&T Wireless from paying too many roaming fees. AT&T Wireless also was divided into five different regions, with some using disparate technology platforms and each running its own territory.
“We really hadn’t taken a look at how to try and take advantage of the power we could have to take those five regions together and put them together nationally and think about a national footprint and a national offer. (AT&T Corp.) had a national brand; we had national distribution on both the consumer side and the business side,” said Hesse. “We had all these assets as a company that we weren’t adequately utilizing. I had challenged the team and particularly Bill Malloy and his marketing team to come up with an idea that would really put us on the map and take advantage of all these strengths and capabilities.”
Once the five regions were reorganized, Hesse’s team worked to deploy an intelligent roaming database that would allow it to move minutes between carriers and negotiate more favorable roaming rates. This, said Hesse, is the most vital element in implementing DOR.
“The crucial element of the finances of Digital One Rate isn’t so much just how big our footprint is, but it’s the relat
ive price we pay vs. our competitors for roaming minutes, and we’re able to get better deals for roaming because of the combination of the quantity of minutes and our ability to move minutes between carriers,” he said.
Nokia Corp. had a critical role to play in the launch of DOR too. It was working diligently to get tri-mode handsets capable of intelligent roaming out the door. Without the handsets, AT&T Wireless had no offer.
“The stars were lining up in May. The earliest we could have possibly offered it is the day we offered it.”
Hesse said, “All hell broke loose if a memo went out mentioning Digital One Rate and somebody had it that wasn’t supposed to. We knew we had something special.”
The plan’s critics
Of course the plan is not without risks or critics. The biggest uncertainty is whether AT&T Wireless can make money as off-network roaming increases. And off-net roaming has increased, admitted Hesse, though he would not indicate how much.
AT&T Wireless is years away from achieving a full nationwide footprint. Today it covers about 52 percent of the country and pays an estimated 35 cents to 55 cents per minute for roaming, while customers are paying 11 cents to 15 cents per minute.
Reports indicate people living outside of AT&T Wireless’ footprint are using the service, causing the carrier to lose money on every minute these subscribers talk.
Hesse said the company has accounted for the increased off-net roaming in its business plan and is confident increased revenue from the plan will offset any negative effects from increased roaming costs. Fraudulent use, he said, is not a rampant problem, and the company is taking aggressive steps in making sure billing addresses lie within its footprint. The carrier’s billing system is supposed to kick out any address that doesn’t coincide with its service areas. Still, analysts say, the carrier is susceptible to fraudsters using false billing addresses.
“We’re trying hard to terminate fraudulent relationships, and we’re stressing that it’s only for people in the AT&T footprint,” said Hesse.
Hesse noted that roaming rates are falling and will continue to fall in the future. If they don’t? “We’ll either build a footprint over those carriers that have high rates, or we’ll move our minutes to another carrier,” he said.
And one can bet AT&T Wireless will reorganize existing partnerships and buy other carriers to decrease the off-net mix of minutes of use. Recently, the carrier revamped its partnership arrangement with BellSouth Corp., giving AT&T management control of the Los Angeles market. AT&T announced in October plans to purchase Vanguard Cellular Systems Inc. in a stock and cash deal valued at $1.5 billion. The deal fills in second-tier markets where many of AT&T Wireless’ customers roam. Prudential’s Larsen estimated Vanguard would have brought in $56 million in roaming revenues next year, half of which would have come from AT&T Wireless customers.
Minutes of use on AT&T Wireless’ network has increased so much that the carrier’s infrastructure vendors are having trouble delivering radios fast enough, said Hesse. Keeping enough handsets in stock is a challenge as well. Earlier this year, the carrier was short Nokia handsets.
“We are stressing to our suppliers of network equipment to be able to give us the radios fast enough,” said Hesse. “We’re stretching our suppliers of phones, so absolutely our capacity is being strained. We’re working very hard to keep up with the kind of growth of minutes we’re seeing on our network.”
AT&T indicated it is reallocating some of its corporate capital expenditure budget to wireless. Analysts believe the company is likely to need significantly more capital expenses than used in the past to keep up with the demand.
John Bensche, wireless analyst with Lehman Brothers Inc. in New York, said the biggest question looming in investors’ minds is whether AT&T has made a conscience choice to take a lower return on the wireless business than it historically has received. Other carriers’ EBITA margins are significantly lower than AT&T Wireless’ even though AT&T Wireless’ ARPU is higher.
“The margins are less,” Bensche said in a recent report. “With higher costs and more invested capital, and AT&T not backing off the DOR promotion, it appears willing to manage the wireless business for a lower return than it had in the past.”
Hesse explains: “We have focused on the high-value segment to increase, not decrease profitability. As opposed to the rest of the industry, we have focused on revenue growth, not subscriber growth as our key growth indicator,” he said. “Our margins have gone down for two reasons: One, we adopted a more conservative accounting treatment this year, which makes margins look lower. Second, DOR has been so successful, our new subscriber adds are way up. Due to the high cost of acquisition, margins are depressed when you’re adding a lot of customers. If you correct for the change in accounting treatment and the addition of new subscriber, margins are flat year over year in spite of more aggressive pricing.”
Then there are quality issues. Gartner Group, a consulting firm that caters to Fortune 500 companies, has placed AT&T Wireless on problem watch since February because of TDMA network quality issues. Hesse insists the company has not been affected by the rating as it aggressively seeks valuable corporate accounts.
Quality is something customers will begin to demand as pricing becomes more simple, said Egan, research director with Gartner Group in Stamford, Conn.
“One Rate was a good step. It raised the bar in terms of national service pricing, but it also is generating an increased awareness of service quality. It will become interesting this coming year because from a business standpoint, people are going to require enforceable quality service levels,” Egan said.
Next year
So what are Hesse’s continuing concerns about DOR? Simply put, his competitors.
“That’s why you take a look at where we’re going and continue to improve it and try to come out with new offers to stay ahead of the game,” said Hesse. “We’re not expecting to sit and think no one will follow. 1999 could be as revolutionary,” promised Hesse. “We’re looking for a repeat.”
Sooner or later, other carriers will find ways to effectively dull the shimmer of DOR. Sprint PCS still was the industry’s leader in subscriber additions during the third quarter and historically is a pricing and marketing leader. While specialized mobile radio operator Nextel, with its sleek clamshell-shaped Motorola i1000 handset, will be heavily targeting the business market next year.
Nokia is expected to introduce a tri-mode Code Division Multiple Access handset in the first half of next year capable of intelligent roaming. This will allow players like Bell Atlantic and AirTouch to leverage their ownership in PrimeCo Personal Communications L.P. and offer stronger rate plans. Mergers and acquisitions will give more carriers the financial strength to make big competitive strikes against AT&T Wireless.
AT&T Wireless already has tried to enhance DOR by offering discounted bundles of AT&T services like Internet access, personal 800 numbers and cheaper landline long-distance calling. For an extra $20 per month, DOR customers can expand their pricing plans into Canada.
But financial strength can only go so far. DOR is a good first step, noted Egan. “Now what is step No. 2?”
The local loop market may be the answer.
Project Angel, said Hesse, is on target for a market test in 1999 with commercial launch scheduled for 2000. Project Angel is a proprietary McCaw project that uses beam-forming techniques drawn from U.S. military technology to provide fixed wireless service. The system will snip into the home telephone wiring system, allowing a last-mile connection to the home and giving AT&T Wireless the opportunity to avoid paying interconnecti
on fees.
“All the technical milestones and tests were met on or ahead of schedule,” said Hesse. “Now the question we have to answer is: Does the marketplace want it?”
Much insight will be gained from another market test AT&T Wireless is conducting in Plano, Texas. The carrier is testing a new mobile phone pricing plan aimed at the consumer considering a second phone line in the home. The trial offer allows Plano customers to choose from two plans priced to be competitive with local exchange carrier rates.
“We’re testing how wireless rated like a landline local service compares. I personally believe we have the opportunity to redefine the way customers think of pricing. The way we’ve done with Digital One Rate.”
If all goes well, a national offer could come down the pipe.
Finding the next market-shattering change is not a new challenge for Hesse. His life is characterized by change. The son of an army officer, Hesse attended 10 different schools between first grade and his senior year in high school. A 21-year veteran of AT&T, Hesse has held numerous jobs at the company, from international services to human resources to the head of its international equipment business in Europe before AT&T’s spinoff of Lucent Technologies Inc.
“I think I’ve always been kind of a utility player that AT&T has always been able to put in different places and businesses wherever they thought there was either a particular problem or in the case of wireless, where there was a great opportunity … I think they’re still trying to find something I can do,” he joked.
Hesse is AT&T Wireless’ first senior executive to come from within the corporation. His ties around the company will help in the corporation’s plans to bundle more AT&T products together and effectively sell wireless, he said. His relationships helped make DOR happen.
“I came over, and I had a terrific team in wireless, but we had to figure out how to take advantage of all the assets AT&T could bring. I knew what those assets were and had relationships with the people of AT&T that could bring those to bear for the advantage of AT&T Wireless,” said Hesse.
His academic achievements read like a rap sheet: M.S. degree in Management as an Alfred P. Sloan Fellow at the Massachusetts Institute of Technology where he graduated with a 5.0 grade-point average; M.B.A. in finance from Cornell University, where he graduated in the top 5 percent of his class; an A.B. in government and international studies, cum laud, from the University of Notre Dame, where he was a Notre Dame and Crowley scholar.
Hesse, who moved from New Jersey to head the wireless group, hopes he and his family have found a permanent place in the Seattle area. Hesse’s wife of nine years, Diane, was formerly a vice president with AT&T and essentially gave up her career when they moved to Seattle. She now is a full-time mother, raising their two children, Ryan, 3, and Evan, 2 months.
Much to Hesse’s chagrin, AT&T Wireless will relocate its offices from Kirkland to Redmond. He no longer will be able to sit at his desk and gaze at the view of Lake Washington down below or the Cascade Mountains above, though these days, thick, gray clouds tend to hide the mountain range.
“I can honestly say I’ve never lived anywhere that I like better than the Seattle area. I hope that it’s a long run here.
“There’s never a dull moment,” Hesse said of the wireless industry. “I take a look at 1999 and it really gets me excited about coming to work every day. We have the opportunity to make some radical changes going forward.”
