UK: Can british telecom's Vallance keep his balance?

UK: Can british telecom's Vallance keep his balance? - Profits of £100 a second and a 9% annual earnings growth bring queues for BT shares but the global challenges ahead are formidable. Shirley Skeel.

Last Updated: 31 Aug 2010

Profits of £100 a second and a 9% annual earnings growth bring queues for BT shares but the global challenges ahead are formidable. Shirley Skeel.

An Aunt Sally rather than Maureen Lipman's Beattie would be more appropriate of late in British Telecom's Television commercials. Britain's second largest company has hardly been able to do anything right, as far as Fleet Street and a recession-weary public are concerned. Whether it is a rising tide of user complaints, chairman Iain Vallance's £50,000 salary rise or profits of £100 a second, the barbs are hurled BT's way. "BT 'doctored profits'," rails the Sunday Times; "More Phone Moans", agonises The Sun.

Yet, in December, this same public queued up for shares in the lumbering telecoms giant, hopeful that some of the pot of gold would spill their way and unblushingly discovering a new loyalty to BT. And why not? Based on past performance they have every reason to be optimistic, and if Britain is to become a major force in global communications, BT will be it. But those who held back rom the euphoria have their reasons too: BT is moving into a new era of competition at home and abroad - and though the opportunities may seem dazzling, the price of failure too is greater than ever before.

Whether BT will hold its position as the world's most profitable telecoms group and make its name in the hostile markets overseas, depends very much on one man-chairman Iain Vallance. That Vallance, an Oxford-educated, BT careerist, is ambitious is unquestionable. An old colleague who knew him 21 years ago in his role as personal assistant to the then chairman, recalls, "He had himself marked out for the top job from the start." In 1987, after playing his hand of cards impeccably, he got it.

That Vallance has confidence in himself is also beyond question. A query put to him mid-interview as to whether BT would be able to handle planned expansions into both the US and Europe, is met by a large smile and vigorous nod. The confidence is catching, if, in retrospect, a little disturbing, but heightened no doubt by the fact that something big was obviously on the boil. "Watch this space," he had remarked from the start.

Vallance, a polished Scotsman oft accused of being publicly detached but closely bound to his own key team, has so far, done a good job, even an admirable job, early sceptics admit. BT is far more quality conscious and efficient than in the early years after its 1984 privatisation. The challenge ahead, however, outweighs those of the past, ten-fold.

To some extent BT is sitting sweet. It has 95% of the £13 billion British telecoms market and last year made profits of over £3 billion. But fresh competition is on the horizon, from its burgeoning rival Mercury Communications and from the (to date) 19 new telecoms licensees who want to set up here. Add to this the restrictions set on its pricing by the telecoms watchdog Oftel and the fragility of the UK economy and BT has very reason to swallow hard over the challenge of maintaining is past profits growth.

In the last five years BT averaged 9% per annum growth in earnings. Today more pessimistic predictions, like those of James Capel's Stephen Owen, foresee that falling to an average of 2% over the next five years, even if BT continues to shed labour at 12,000 jobs a year. The slowdown in profit growth is not inevitable, but can only be circumvented if BT stires up new income sources at home, and - importantly - from abroad.

How to go about "making it" internationally, though, is nothing short of baffling. The major markets - Europe, the US and Japan - are still largely closed to competition. This year that will begin to change: the EC will review its telecoms market, while the US began removing obstacles to foreign entrants in January.

The popular view is that cross-border alliances will be the way of the future. But the pudding is so thick with regulations, changing technology and multiple players that it is all, as CIT Research commercial director Graham Wilde puts it, "a bit of a nightmare". Communications International editor Tim Hills adds, "There's a lot of hype. But nobody knows what the right answers are."

Teetering at the edge of this nightmare, peering down for those elusive answers, is BT's 14-man board. BT-watchers describe the board as something of a kitchen cabinet, a "very competent, but grey" board dominated by "mandarin civil service types", to quote one. The sudden departure of "outsiders" like former managing director Graeme Odgers in 1990 and ex-director David Dey last year have not helped to dispel this view. Admittedly, the challenge of the new telecoms world is having some effect. Last September ex-Lloyds Abbey Life chairman Michael Hepher, a shrewd marketing innovator, was headhunted as BT managing director, while earlier Bruce Bond, an American ex-quarterback who earned his stripes at Baby Bell company US West, was brought into help with BT's global perspective.

By all accounts, a key triumvirate holds the reins: Iain Vallance, who was tipped into the chair by ex-chairman Sir George Jefferson at age 44 despite qualms about his inexperience; Michael Bett, a tough level-headed industrial relations specialist; and Malcolm Argent, a lifelong BT man, described by former directors as a pillar of the company. Also indispensable is Tony Booth, one of three board members with telecoms engineering experience.

Vallance himself has impressed the outside world with his talent for fighting BT's corner politically and for impassively bringing off a shakeup of BT in March 1990. Known officially as Operation Sovereign or more disparagingly as Operation Scoop, the reorganisation peeled through 12 layers of management and brought operations previously handled by 28 regional managers under central control. Over 6,000 managerial jobs and 12,000 other jobs were lost. Another 40,000 are expected to go. The effect on morale has been punishing, but on BT's focus and efficiency, first-rate.

Looking to BT's future, one industrialist remarks of Vallance: "He doesn't have the charisma or vision that one would want. There is a sense of grumbling rather than of instilling people with a sense of challenge." But perhaps the only truly relevant doubt cast his way is his lack of experience and influence internationally. Whether he can supplement this with good advice and good intuition we have yet to see.

If you put the question "What are you going to do?" before the politely-raised eyebrows of the chairman, the answer is practised and easy. First, he emphasises that what is critical for BT is not the new competition, but the growth and strength of the UK market as a whole.

"There are a series of things that can be done to drive up the size of the market. The telephone usage here is very much less than in, say, the US or Sweden. Much more can be done with the right kind of marketing and right kind of advertising." He cites the potential of new services such as Star (teleconferencing, etc) and digital exchanges.

The balance of the needed new income will come from international forays, Vallance says. Where and how? "It depends on how you see the grain of deregulation going in different parts of the world. Those parts of the market opening up most quickly are firstly, data and secondly, mobile services. But we have a little saying in BT: that when customers want something and the technology can provide it economically, then sooner or later the regulators and the politicians will allow it."

Three themes are to make up the backbone of BT's international ambitions. First, to be geographically set up across the major markets of North America, Europe, Japan and the pacific Rim. To this end BT has opened offices from Rome to New York and Tokyo to Sydney. Secondly, to offer services with critical mass and good growth potential, ie voice and data networks. "In the mid-1980s we did a number of things which were letting a 1,000 flowers bloom, but some turned out to be weeds. We now recognise that we are better at doing things which are large and can command top management attention." And thirdly, "We want control."

This is all very broad brush stuff, more of a wash on the canvas than a painting, but specific events emerging this year will help fill in the colour. Most important is the oftel consultation paper, due out soon. This will canvass views on the next set of price regulations to take effect from August 1993. Tougher price control will curtail BT profits and please the public. More lenient pricing will enhance competitors' chances of customers.

Sir Bryan Carsberg, Oftel's keen-witted director-general, who will move to a new job heading the Office of Fair Trading in July, is not one to drop robust hints about his intentions. But he points out that the effect of the interim review last spring, when the end of the BT/Mercury duopoly was announced, has still to be seen. Earlier he had hinted that BT's 23% return on capital, against an average of 17% overseas, was too high. But last year BT's overseas charges were dropped 10% and tighter general price controls took effect. "These will influence BT's profits over the next year or two," Carsberg says, though denying that this means Oftel will be any easier on BT in the next round. No doubt BT will be lobbying hard for a sympathetic successor to Sir Bryan. On the plus side for BT, Carsberg remarks that any break-up of the company to separate international and local services - a concept discussed last year - is "not on my active agenda".

Probably the biggest matter now in Carsberg's hands is the question of whether to end BT and Mercury's duopoly on overseas calls. In the New Year, Sprint International, America's third largest long-distance carrier, announced that it will apply for a UK overseas calls licence, on the basis that the US is now to allow similar rights to foreign telecoms. If Sprint gets its UK licence (and it would be no surprise if the US giant AT and T tried to follow) it will rattle a few nerves at BT. International calls are by far the most lucrative part of its business.

Mercury's success in this same sphere has been the elixir for the "new image BT". In eight years Mercury has captured 19% of the UK international calls market, according to Peter van Cuylenburg, a group director at Mercury's parent, Cable and Wireless. This has been achieved by a £1.5-billion investment programme that gave Mercury a high speed, high capacity trunk network using modern optical fibre cable and that allowed it to discount BT by some 15%. Some observers believe that BT's squeeze on prices and the entrance of the new cable and trunk line operators over the next few years will hurt Mercury more than BT. But van Cuylenburg disagrees. "As we get broader use of our lines we get economies of scale and we can afford lower service charges."

If one is to listen to some experts close to BT, it would seem that Mercury et al are the least of Vallance's worries. They say BT's position is so entrenched that competitors' progress will be comfortably slow. But then it all depends on whose figures you want to believe. SG Warburg, BT's own broker, predicts that though Mercury may push its UK overseas calls market share to 25% in the next five years, BT will maintain 95% of the total market. In contrast, James Capel's Stephen Owen believes Mercury could lift its total market share from 5% to up to 16% by 1996, with the new cable operators taking 1% - thus leaving BT with less than 85% of the market. Should the latter forecast prove true, this gap would have to be filled by new income sources.

The good news that comes with this is that our little-loved utility is learning better than most how to survive in a rough and tumble street. Apart from Sweden, Britain has the only telecoms market in Europe not run by a public monopoly. The lessons learned will be invaluable to BT as markets open up overseas.

Not that BT can brag about all its adventures abroad so far. The 51% stake in Canadian PBX maker Mitel, purchased for £167 million in 1986 and now up for sale, is a clear embarrassment. Metrocast, a US mobile phone operator ought in 1988, was shut down in 1990, losing BT some $US 50 million. BT's 20% owned US mobile operator McCaw Cellular Communications is showing more promise, but, to date, is still losing money.

In December Robert Fleming analyst Laurence Heyworth pointed out that, at that stage, BT had lost some £1 billion on its overseas acquisitions, taking into account falls in value and financing costs. "Having lost a billion, BT will have to be very careful where it steps in the future," he says drily. The one operation that brings cheer is BT Tymnet, a global data communications service for US and European clients. It has become a major force in the US and helped to establish BT's credentials overseas.

But most in the news at the moment is the ill-launched Syncordia, a venture unveiled last September with no customers and no partners - provoking the description from one former BT executive of it as "a cock-up but the right idea". Syncordia is to offer multinational businesses end-to-end management of their communications networks, relieving them of the complex job of negotiating voice and data line packages from the local PTT (telecoms company) in each country they operate in. The market globally is estimated at $US 5 billion.

Similar management packages are planned or are already on offer by groups like Cable and Wireless, AT and T, IBM and the American MCI. BT had hoped to trump these individual efforts by forming an alliance with two giant PTTs: Germany's Deutsche Telekom and Japan's NT and T, offering each 26% of Syncordia. At the launch, however, neither of these was committed.

While admitting that the search for a partner is ongoing, Vallance says today that a partnership is "desirable but not essential". Many in the business disagree, including CIT Research's Graham Wilde. "Running the American end of syncordia without a partner is absolute folly," he comments. Possibly Vallance knows something others don't: BT has, after all, been working on syncordia for three years. The chairman, certainly, reveals no concern. He points out that partnerships simply lead to disagreements over whose technology and whose management system get used. And he adds, "A major North American partner almost certainly would want to keep the North American part of the partnership, so you're trading the UK (market) against the US. That isn't a good trade." He hints that foreign PTTs could be offered some "local incentive" to ensure they maintained the quality of service on the lines Syncordia leased from them in their respective countries.

Interestingly, Cable and Wireless's Peter van Cuylenburg hints of similar "benefits" for local PTTs when arguing the merits of C and W's rival "Plant" system. He claims that C and W's private optical fibre network, already spanning major continents, puts them well ahead of BT. Vallance, nonplussed, responds: "It is the network management system that is the key to success. It's far more important than owning a bit of fibre. And in order to develop that you have to have a very strong development capacity." His point is good. Money talks. But if rumours prove true of a link-up between C and W and the American AT and T, possibly through Mercury (a matter hotly "no commented" by C and W), BT could be up against some daunting competition at home and overseas. It is a prospect at which Vallance hardly wavers. "My guess is that the embarrassment of that moment will be that there is more demand than can be met."

BT's other focus overseas is the US and Europe. Asked about any new plans for the former, Vallance almost shines. "I'd love to be able to tell you," he replies - and then goes on blandly to say that "significant niches in the corporate sector" will be pursued. Despite the tombstones of many a UK company in America, the BT chairman insists he does not want a US partner to help pull the ropes. "Major American potential partners also have their regulatory restrictions, for example, on long distance services. There is something to be said for doing it yourself without those constraints." Should Vallance choose the US for an acquisition, money, at least, will be no problem. BT could easily raise several billion now and by 1997 it could have net cash of over £5 billion, if no prior purchases were made.

As to Europe, any move will have to wait for the slow dance of deregulation to take effect. Vallance is optimistic that this year's EC discussions will lead to significant change in local monopoly policies. Preparing for any softening, BT is "getting its marketing in". It is that word, "marketing" that holds the magic needed by Iain Vallance, or by any contender in the world telecoms stakes. Marketing will make all the difference when BT's 60%-owned UK mobile phone operator Cellnet launches its next generation of phones in 1994. Marketing too will make the difference with Syncordia, with UK business clients and with exploits overseas.

Fleming's Laurence Heyworth suggests it is the development of this skill that is perhaps BT's biggest challenge. "That is the problem, as with any utility: to motivate people and replace the old monopoly culture with a vibrant one." One can only say in response that Vallance has hardly spared the whip in trying to bring this change to BT. And certainly the utility's own entrepreneurial forays have not been lacking - if sometimes misguided.

Unquestionably the big challenge ahead for BT is how to secure new markets and new income, and ensure its continued prosperity. Subliminal to this is a question every shareholder and every politician must be asking themselves. Heyworth articulates it plainly. "Are they actually going to be able to crack it?"

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