The Painful Lessons of MCI v. ATT

"It was the best of times, it was the worst of times..." for two of the world's leading telecommunications companies. The year was 2000 and the marvels of fiber optics resulted in the supply of telecommunications transmission capacity increasing much faster than the demand. Prices were falling and the telecommunications industry was entering a deep and long recession. The financial decisions at MCI and ATT represent the polar opposites of management reactions to the onset of the recession.

Even though their revenue had increased that year, ATT began to aggressively cut costs by laying off employees at an unprecedented rate. Employment fell even faster than revenues, which were also contracting at a record pace. Over a 4 year period of time, ATT's employment dropped by nearly 70% while their revenue dropped by 50%. ATT also aggressively cut capital spending to nearly zero, in an attempt to preserve precious cash.

Meanwhile MCI (named Worldcom at the time), whose revenue dropped almost 40% that year, reduced their employment by less than 10%. In 2002 they hired aggressively and spent heavily to drive revenues up to within 15% of their 1999 level. They delayed by one year making the decision to reduce capital expenditures. This delay resulted in an additional $7B in capital investment that would otherwise have been avoided.

These two managment responses were vastly different, even though these two companies were operating under the same market environment. ATT embraced the trend and MCI resisted the trend.

In effect, ATT acknowledged that aggregate demand for telecommunications services (as measured by revenues) was falling rapidly, and they jumped out in front of the trend and cut supply FASTER than the demand was falling. The result was that they were able to generate a large war-chest of cash even in a declining market. In 2006 ATT leveraged that war-chest of cash to purchase Bell South and become once again the largest telecommunications company in the country.

MCI on the other hand tried to fight the trend of falling demand and actually increased supply in the form of both employees and capital investment. The result was that they ran out of cash and filed for bankruptcy in 2002. MCI was eventually purchased by Verizon at a fire-sale price.

Some would argue that a similar story is being played out now with GM and Ford who both face a falling-demand trend in their industry. (Ford appears to be responding like ATT and GM appears to be responding like MCI).

The painful lesson of the MCI v. ATT story is that the survivor (ATT) was willing to submit to the intense short-term pain of steep layoffs and disciplined spending reductions in order to protect their long term viability. MCI on the other hand resisted the short-term cost reductions and quickly found themselves in bankruptcy.

Attempting to resist a falling-demand trend is both expensive and dangerous. But embracing a falling-demand trend involves short-term pain and disciplined cost cutting.

So what is the better course of policy action? Are the dangers of resisting the current falling-demand trend easier to deal with than persuading a whole nation that short-term pain is in their best long-term interest? This practical dilemma sets up what I call the "Schumpeter curse" on capitalism in a representative democracy, which I will address in a subsequent posting.