Monday, March 2, 1998; Page F10

C. Michael Armstrong was named AT&T's chairman in October. He met last month with a group of Washington Post editors and reporters to talk about the challenges his company faces in local markets, and what it's like taking over the world's leading telecommunications company. Here is an edited transcript of that conversation.

Q. How would you like to start?

A. I'd like to say a few things about the telecom bill [the Telecommunications Act of 1996], because there is a perception promoted by the Bell operating companies that the bill's not working because there's no local competition. The facts are that the act has never been tested in the marketplace. The bill was conceived by the Bell operating companies, the long-distance companies, the regulators and the legislators back in 1995 and 1996, and as soon as the bill got passed, the Bells took it to court.

There have been two court decisions. Those two decisions are on appeal. And so what we have is the American way at work. It doesn't make the bill wrong; it just means that the bill has been challenged by one of its authors and is now in the courts, and where it has to be demonstrated whether it works or not is in the markets. That's the way new products have to be tested -- in the marketplace.

Second, there is a myth going around that AT&T is not interested in local markets, that we're just interested in business markets. What I have with me is a certified public accountant's report of what AT&T has spent in the pursuit of local markets since the Telecom Act has been passed. And the number is $3.66 billion dollars. We spent that under the pursuit of a thing called Total Services Resale. Total Services Resale is defined in the Telecom Act of 1996 as an interim means in transition to a more economical resale. As a result of spending $3.6 billion, we have 300,000 customers and we lose $3 to $5 per customer per month. The only good news is we don't have 3 million customers or I'd be in receivership.

Q. But what is the source of the reports that you want to focus more on business customers?

A. We want to focus on the consumer customer. But the principle that I wish to convey is: There's only one way to have local competition. And that is to resell the only consumer connection to the phone system, which is the single wire that the RBOCs [regional Bell operating companies] own. If there's not an economically viable way to resell that wire, there can be no competition. AT&T pursued a definition of that. And the RBOCs gave a 22 percent discount off of retail [to sell the wire to AT&T]. . . .

Q. Well, what did you spend $3.6 billion on?

A. Primarily on the systems, in order to implement a local telephone system.

You've got to have orders; you've got to have invoicing; you've got to have remittance processing; you've got to have sales; you've got to have advertising; you've got to have merging -- all the things to conduct business in that local market. Now, I mean, just think about it. You've got a $30 local bill from your local exchange, right? And you've got to give $24 back to the RBOCs. And you've got $6 to cover what I just described to you. I think it's amazing we only lose $3 a customer.

So there's no economic definition of the resale of the only wire that will permit competition. And there must be. We -- the long-distance industry -- deregulated 14 years ago. There are now 500 long-distance companies. Five hundred. When people come in to resell the facilities, the long-distance wires, we offer a 50 to 60 percent discount to cover those costs. Why? Because it's a competitive market. If I don't have that kind of discount against MCI or Sprint or GTE, I lose the traffic. Plus, if they don't have that kind of margin, they can't stay in business. So it doesn't help me to sell a business that goes bankrupt.

So we've got 22 percent off versus 50 to 60 percent off, and there's only one wire. And so, for there to be local competition, it's absolutely essential that the resale of that wire be economically viable. And the Telecom Act thus can work, if it can ever get out of the courts and into the market, and exercise that definition. But the RBOCs, who have gained market share since the Telecom Act, the RBOCs used to have what, 98 percent market share. Now they have 99. And they claim, "Hey, there's plenty of competition out there."

Q. What's the way out of this box?

A. To get it out of the courts and into the market. I mean, it hasn't been in the market yet. The act never got to the market. The FCC was in the process of requiring [the RBOCs] to meet the checklist. [For example,] today, if you're an AT&T customer, MCI might call you up and say, "We'll give you 5,000 air miles if you come to MCI." And you say, "Well, okay." By the time you hang up, your account's transferred. This is a very important point.

In California, 4 1/2 months ago, we were competing for local business with Pac-Tel [Pacific Telesis Group]. We still have a backlog [of local service customers waiting to switch to AT&T]. They do not have the operational systems to permit competition, let alone the terms and conditions to make the investment economically viable.

So what does it take to get competition in the market? You gotta get the act out of the courts and into the market. And you've gotta get the jurisdiction to enforce economic resale into the market.

Q. How realistic are your fears, do you think, that the Bells will be allowed into long distance before you are freely able to get into the local business?

A. I believe America really wants consumer competition for local exchange. . . . There is something in the industry called access charges. Access charges are collected by long-distance companies for long-distance origination and long-distance termination and given to the Bell operating companies. It's the biggest expense of AT&T; We pay access charges to the Bell operating companies for $16 billion. It's huge.

Now, we have to pay those for long distance to the Bell operating companies. If the Bell operating companies can keep everybody out of their market and go into long distance, they don't have to pay themselves access charges. So then they can offer long distance without access charges. And this will be the greatest scam, the transfer of revenue from the private sector -- the long-distance companies -- to the public sector -- the protected monopolies called the Bell operating companies -- in the history of the country.

Q. Notwithstanding these regulatory and political problems, since October when you became CEO, AT&T has gained roughly $30 billion in market value. Why is that?

A. Well, I think there are two sides to the answer. I think the company was being punished by the market. And so it had to be a bit undervalued. And when the team got together after I came and we decided what we were going to do, the market rewarded that ahead of performance. I think what's built in with price is the expectation that we're going to fulfill the strategy that we laid out.

I'd have to say it's as simple as that. It started out undervalued because of what the company hadn't done. It hadn't gotten itself competitive. It had an SG&A [sales, general and administrative expenses] cost structure at 29.6 percent of revenue. I hadn't seen a cost structure like that since the IBM days with the mainframes. It was outrageous. The competition was in the low 20s.

We've made very clear we have no strategy that will work if the company isn't cost competitive. And here are the things that we're going to do to make sure it is cost competitive. And here is when those things will be done. And here's how you can measure us on getting them done. And they said, "We believe you." And so they put us at a price-earnings ratio that would reflect that.

Q. A lot of your goals for getting SG&A down to 22 percent by the end of '99 are due to the reductions in payroll that you have announced?

A. It's a combination of things. In 1998, our chunk on the way to the 22 percent will be a $1.6 billion absolute year-to-year reduction in SG&A; Seven hundred million will come from personnel [cuts]. Eight hundred will come from operations. And 100 million from a category we just said was "other."

Q. Tell us your reaction to this culture that has a reputation of being a little stodgy, a little set in its ways, a little too eager to spend 29 percent of revenue on administration instead of 22?

A. I dealt with AT&T both from an IBM standpoint on computers and from a Hughes standpoint, both as a partner and as a competitor. And I found AT&T to be very, very slow. I used to tease that AT&T had one-stop shopping. Any manager any place could stop any decision any time. And there are too many layers of management. But you have to understand that AT&T was really born not of the market but of regulation. . . .

But AT&T people have a tremendous will to serve and win. I think it's fair to say that they took some tough shots publicly, whether it was in stock price or press reports. And they were really kind of beaten up, but they have a wonderful pride. They came from an institution that many found synonymous with America. And so harnessing that pride and that will to win has been both fun and not that hard to accomplish.

Q. Are you looking for other major acquisitions, either domestically or internationally?

A. The best way I can answer that is to outline where we're going to invest. I don't know how to grow without investing.

Now, there are a lot of ways to invest. You can invest internally, deploy your capital through your own organization and technology. You can invest in things like joint ventures. You can invest in external facilities. You can invest in acquisitions. Our business strategy was all of the above.

Q. From a policy point of view, does it matter that the "fast track" trade legislation wasn't passed?

A. I was very disappointed the fast track wasn't passed. I'm not completely objective, because one of the things I do on the side is I'm chairman of the President's Export Council. I firmly believe the economic growth phenomenon of this country is not only the result of balanced economic and monetary policy, but that it is primarily driven by increases in trade. . . . The absence of fast track is the absence of the most meaningful trade future. . . .

Now the good news is that we've got an IMF bailout going on in many areas of the world where fast track would be have been useful. So I'm a little encouraged, and in talking to some people here in Washington I think they believe the opportunity exists to tie market opening to IMF support.

Q. Prior to your being named CEO, there was a great debate about whether AT&T should have an insider who knew the business or an outsider who could address the culture from a different viewpoint. And now that you've been in the job for a little while, can you talk about the advantages and disadvantages of coming in as an outsider?

A. I think a lot depends on the situation and the individual -- before I went to Hughes and before I went to AT&T, I knew a lot of change had to take place. At Hughes, we'd won the Cold War, the defense budget had been cut in half and we had to redefine ourselves. And what I did was look very closely, not at the products, financial statements, the competitors, but at the management team. And I studied it. Before I came to AT&T I did the same thing, because you can't change a culture and change the management team at the same time. If you don't believe that management team's going to make it with you, then you'd better change the management team to a team that will make it with you.

But you have to do those things sequentially because can you imagine saying, look, we're going to freeze executive salaries, we're going to lay off or downsize by 18,000 people, we're going to cut two layers of management out, we're going to take all these perks away. And nobody trusts you. And so you've got to have trust and respect in order to pull off change. That's true down the organization as well as across the top.

But in both cases I learned enough about the team to know it was a team that I would bet on. And that we could make it happen.

The second thing is, being an outsider, you can be pretty objective, you don't have to live with stuff -- prior history and decisions and carry-over and opinions and the prior expressions of direction and all that kind of thing. I've heard a lot of it in the last 90 days and it's so easy to simply rise above it and to deal with the reality of where we are rather than to have to justify how we got here. I spend zero time on that and that's a definite advantage of being an outsider.

A disadvantage of being an outsider is that you don't know the business because a lot of business decisions . . . are not just based on what you know, it's on instincts to help you apply what you know. And if you've lived with something for 10, 20 or 30 years, those instincts are pretty finely honed.

So I think that it's very individual.