SP-4217 Beyond the Ionosphere

 

Chapter 22
 
Net Gain: The Use of Satellites at MCI
 
by Adam L. Gruen

 

[283] From 1983 to 1987, MCI used satellites to enhance its national telephone network during a critical period in the corporation's history, even though MCI realized that using satellites for voice transmission was a bad idea and that other technical alternatives were available. In 1985, MCI knew that it was acquiring a money-losing operation called Satellite Business Systems. MCI's use of satellites during the 1980s was not at all a mistake, however, but rather a necessary part of greater and deliberate business schemes.

 

The Background

 

The MCI that exists today began in 1968 with a key decision by the U.S. Federal Communications Commission (FCC) affirming the right of telephone users to connect private communications equipment to the AT&T network. This was the so-called Carterfone decision of June 1968.1 In August 1968, William G. McGowan established Microwave Communications of America, which changed its name to MCI three years later.2

A later decision in May 1971, called the Specialized Common Carrier Services decision, affirmed the right of corporations to offer only specialized services.3 Carriers were only supposed to connect to the AT&T system; nobody had said anything about allowing anyone to compete with AT&T by offering basic phone service. This formula was a recipe for shenanigans. What exactly was a specialized service? Also, what was to prevent AT&T from gouging customers trying to connect to the system?

McGowan loved the potential of satellites for two reasons. First and most important, he saw them as a way to bypass the existing AT&T network. Second, he believed that satellites would be a cheap and effective way to reach remote areas without the necessity of building microwave towers every thirty or sixty miles (forty-eight or ninety-six kilometers) from one point to another. In October 1970, therefore, even before MCI had actually finished setting up its towers between Chicago and St. Louis, McGowan set up a subsidiary corporation called MCI Satellite Incorporated. Three months later, MCI and Lockheed Missiles & Space Company formed a joint venture called the MCI Lockheed Satellite Corporation. [284] The plan was to build a $168 million satellite communications system. MCI Lockheed indeed was one of the first companies to request FCC authorization for domestic satellite-based communications.

The problem was that $168 million back then was really big money, the equivalent of about $400 million today. In 1972, MCI Lockheed needed cash and acquired a new partner called the Communications Satellite Corporation, known as Comsat. At that point, the enterprise became a three-headed joint venture called CML Satellite Corporation.4 During the following two years, 1973 and 1974, however, MCI was in deep financial trouble. Undercapitalized to begin with, it had managed to survive by selling stock and borrowing money. To make matters worse, AT&T decided to pull the plug on interconnection, meaning that MCI could not use the existing network to offer its services. Ultimately, this was the kind of monopolistic behavior that was the basis for AT&T's defeat in the antitrust suits brought against it, but that was six to seven years in the future. In the meantime, all that MCI could see was that it had a lot of cash going out, but very little coming in. Therefore, MCI sold its third of CML Satellite Corporation to IBM in late 1974. Lockheed, which also had hit hard times, did the same. IBM and Comsat added a new partner, the Aetna Satellite Communications Company, and the entire enterprise was renamed Satellite Business Systems (SBS) in 1975.5

 

What Comes Around Goes Around

 

During the following seven years, MCI survived mostly by winning court decisions. There was a joke around town that MCI was actually a law firm with an antenna on its roof. The first victory came in 1977 and 1978, when MCI bypassed the FCC and won the right essentially to offer common carrier services.6 The second major victory came in 1980, when MCI won a massive antitrust case against AT&T.7 After exhausting the appeals process, AT&T agreed in 1982 to divest itself of most of its local holdings by 1 January 1984.8 These victories meant that MCI could compete head-on with AT&T for voice, data, and video communications customers. MCI had a one-shot, roughly five-year chance at building a new nationwide coast-to-coast network in the period from 1979 to 1984 and grabbing as much residential market share as possible.

[285] Building a coast-to-coast network was a daunting proposition. Three new kinds of technologies could be employed as part of a network: microwaves, satellites, and fiber optic cables. Microwave repeaters could carry only so much traffic before the quality of transmission suffered. For example, an analog FM radio could carry 2,100 circuits. Using a technique called single sideband radio, engineers could boost this to 5,400 circuits with some loss of transmission quality. Digital radios, although providing a much cleaner signal, could carry only 1,344 circuits. It was obvious that digital technology was better for transmitting data, but MCI at this point needed to build a nationwide network for voice as quickly and as cheaply as possible. Therefore, the old analog microwave technology, supplemented by single sideband radio, had to suffice.

To accommodate the growth in network capacity that surely would be needed following 1982, MCI had two alternatives: satellites and fiber optics. Each technology had its advocates within the corporation, and in the end, as with most institutions struggling with a choice between two options, MCI decided to pursue both.

McGowan and his chief of corporate development, H. Brian Thompson, favored satellites for two reasons. Ostensibly, the main argument in favor of satellites was an argument against fiber optics: fiber optics was an untried, untested technology unavailable in large quantities. Ignoring internal advice to the contrary, in 1979 McGowan stated that it would be generations before fiber optics became significant for long-distance point-to-point transmission. Perhaps the real reason he favored satellites was that they had sex appeal from a marketing perspective. Using satellites made MCI a space age company instead of one with just boring microwave towers.9

However, MCI's chief operating officer, V. Orville Wright, and the chief of transmission systems, Thomas Leming, contended that satellites were not appropriate for domestic voice transmission.10 Satellites were appropriate for international voice, because it was the only obvious alternative to undersea cables. Also, satellites would be terrific for digital video and data because of its "bursty" nature, but in 1982 these markets were just opening up for MCI. Leming and Wright argued against using satellites for voice on the very simple basis that they caused a delay and an echo, which most customers would find unacceptably irritating.

Acknowledging the logic of that argument, but unwilling to abandon the allure of satellites altogether, Thompson pushed the notion that even if satellites were not ideal for voice, they offered network redundancy, which was critical to overall network operations. In other words, Thompson felt that customers would be willing to suffer the indignity of a delay or an echo rather than face the outright loss of service in the event of a partial network failure.

In the final analysis, it was McGowan's decision to make, and he decided in favor of satellites. In February 1983, MCI announced the largest purchase of satellite transponder capacity in telecommunications history: twenty-four transponders, carrying 48,000 circuits, were to be purchased for the Galaxy II and Galaxy III spacecraft under construction by Hughes Aircraft. MCI planned to spend between $200 and $300 million for the satellite portion of its network. In September 1983, and again in August 1984, two Delta launchers worked perfectly, and the two spacecraft began to operate.11 Neither Leming nor Wright had given up on the belief that single-mode fiber optic cable was the pipeline of the future, however.

[286] Bell Laboratories had invented--and AT&T already had deployed--multimodal optical cable. Single-mode optical cable theoretically was cheaper: it did not need to use as many repeaters. This could only be proven over fairly long distances. Leming reasoned that if MCI deployed single-mode cable over a long enough stretch of distance for a high-traffic-volume route--for example, from Washington, D.C., to New York City--then the economies of scale would bring the cost of the new technology down to the point of profitability.12 This was a gamble, probably the biggest gamble MCI made in the 1980s. MCI's Washington-to-New York City fiber optical system was operational by March 1984, and by the end of that year, MCI proved that single-mode cable was enormously profitable.

Meanwhile, as Leming and Wright had predicted, in 1984 the number of customer complaints about delayed voice transmission skyrocketed. In 1985 and 1986, even McGowan had to acknowledge defeat. MCI eventually leased back some circuits to Hughes and rented out some transponders to other companies.13 This brings us to the curiosity of the MCI decision to purchase SBS in June 1985, a full year after the decision to deploy fiber optic cable had proved itself.

 

Satellite Business Systems

 

Back in early 1984, MCI executives did not know that the fiber optic gamble would work. McGowan set up a corporate development group, code-named "Orbit," to study candidates in the satellite industry for possible acquisition. One of the candidates was SBS. During the eight years from 1975 to 1983, SBS produced no profits and demanded periodic infusions of cash. Orbit discovered that SBS in fact had lost exactly $120 million for the last three years in a row. By July 1984, as SBS was on its way to losing another $120 million, Comsat finally backed out, selling off its one-third interest to IBM and Aetna.14

IBM kept a 59-percent share of SBS, because the satellites' digital data capacity was useful to IBM internally. In East Fishkill, New York, IBM had a laboratory devoted to computer modeling of semiconductor interaction and surface physics interactions. Anyone in IBM designing a semiconductor chip communed with the Fishkill laboratory. This required a huge amount of bandwidth for data, which SBS transponders satisfied. IBM paid cheap bulk rates for the bandwidth, and SBS took the loss. Meanwhile, Aetna and Comsat lost big, in effect paying for two-thirds of what would have been IBM's costs. In 1984, then, IBM found itself stuck with a majority interest in what one journalist called "a dog it did not know how to make grow." According to Richard Liebhaber, then IBM's director of business policy and development, IBM realized it had three options: shut the whole thing down and write it off as a loss; continue to lose $120 million a year; or sell it to someone.15

If MCI knew that SBS was losing money, then why did MCI want to acquire SBS? The answer has to be understood within the context of the larger business picture at the time. The 1980s was the decade of the takeover, the corporate raider, and innovative financing tactics, such as the issuance of unsecured corporate bonds or raids on pension surpluses. McGowan and other MCI executives realized that MCI was vulnerable to a hostile takeover. What MCI needed, they realized, was an alliance with a company so big that no one would dare attempt a raid. McGowan called this "shark repellent."16 An arrangement.....

 


[
287]

Figure 36. The first of three Satellite Business Systems (SBS) satellites designed solely to serve the communications needs of U.S. business and launched by NASA.

Figure 36. The first of three Satellite Business Systems (SBS) satellites designed solely to serve the communications needs of U.S. business and launched by NASA. MCI purchased an interest in Satellite Business Systems in 1975 in the hopes of acquiring needed carrier services. (Courtesy of NASA, photo no. 80-H-873)

 

[288] ....with IBM was the perfect "shark repellent." By selling off a chunk of its stock to IBM and announcing the possibility of joint ventures and partnerships, MCI gained capital and, perhaps more important, instant credibility with Wall Street and potential business clients. In fact, two days after the alliance was announced, MCI's stock price jumped more than 30 percent.17

Meanwhile, IBM also gained. It purchased 16 percent of MCI stock. Many analysts expected Big Blue to purchase the rest of MCI within a few years. However, whether by partnership or acquisition, it seemed evident that IBM had gained an important toehold in the telecommunications industry, thereby hedging against the very real threat that AT&T posed as it moved into computers. Finally, a very specific part of the overall deal was that IBM would finally get to unload SBS on someone else.

By the time this deal was consummated in March 1986, MCI was well aware that satellites did not compare with fiber optics for either voice or data. The reason MCI wanted SBS was not for its transponders in space, but for its business customers on Earth. By this time, the battle for access to residential customers was waning, and MCI was beginning to chart out a new direction for its business policy during the rest of the 1980s. While it would continue to scrap for residential market share, MCI decided that its future lay with obtaining business and government contracts. Here, the rolodexes of the SBS sales representatives were golden. That was the theory behind the acquisition. As it turned out, MCI swallowed SBS whole, but it had trouble digesting the meal. Contacts were one thing, but business arrangements for new telecommunications services were another. Eventually, SBS was dismantled, and the unprofitable pieces were written off as losses. Some people stayed on with MCI; most left to find new jobs elsewhere.18

 

Conclusion

 

MCI got out of the satellite business as much as it possibly could after 1988. Only recently has the firm expressed interest in getting back into the game.19 The reason why, again, has to do mostly with context. MCI is moving away from its traditional long-distance voice transmission business into the business of packaging, distributing, and owning digitized content. Its alliance with News Corporation was one step in this direction. MCI recently expressed an interest in purchasing rights to direct-broadcast satellite technology. The lesson in all of this is a simple one. Private industry will embrace unprofitable technologies because companies do not see them as unprofitable, even if they lose money. One has to be willing to expand one's definition of profitability from the narrow frame of return-on-investment to the bigger picture.

 


END NOTES

1. Federal Communications Commission (FCC) Docket 16942, "Carterfone Device," Decision, 26 June 1968, 13 FCC 2d, 420.

2. Minutes, MICOM Board of Directors, Special Meeting of 27 August 1968, Minute Book A, MCI Corporate Archives, Washington, DC. MICOM changed its name to MCI Communications Corporation on 19 July 1971. Philip L. Cantelon, The History of MCI, 1968-1988: The Early Years (Dallas: Heritage Press, 1993), pp. 117, 570, fn. 10. The History of MCI is the property of MCI; the work is not available to the general public. All of the files and documents collected for the work are located in the MCI Corporate Archives, which is not open to members of the public.

3. FCC Docket 18920, "Specialized Common Carrier Services," First Report and Order, 3 June 1971, 29 FCC 2d, 872.

4. Cantelon, The History of MCI, p. 341.

5. Telecommunications Reports 51(26) (1 July 1985): 4.

6. In the so-called Execunet decisions, the U.S. Court of Appeals of the District of Columbia overruled the FCC's decision to prohibit MCI from offering Execunet, a shared private-line service. See Cantelon, The History of MCI, pp. 250-56. In effect, the original ambiguity of the Specialized Common Carrier Services decision had finally come back to haunt the FCC. The federal court argued that if Execunet was a specialized service similar to a regular long-distance service, that was too bad. Once the FCC had come out in favor of competition and innovative services, it could not dictate the validity of specific offerings.

7. The 1980 case of MCI v. AT&T began in 1974, when attorneys of Jenner and Block filed a suit for damages on behalf of MCI in the U.S. District Court for Northern Illinois on the grounds that AT&T had violated the Sherman Antitrust Act of 1887. On 13 June 1980, a twelve-member jury found AT&T guilty of abusing monopoly power in a relevant market, and it awarded MCI the astounding sum of $600 million in damages, which under federal law had to be trebled to $1.8 billion, making it the largest monetary award in U.S. history. However, this amount subsequently was reduced to $113 million on appeals. The real damage to AT&T was not monetary, but in public policy; having lost such a suit in civil court, there seemed to be no real hope of defending against pending antitrust action brought by the U.S. Department of Justice. See Ibid., pp. 297-313.

8. AT&T and the U.S. Department of Justice agreed to implement divestiture of twenty-two local operating companies--about two-thirds of AT&T's assets--on 24 August 1982. This agreement modified the Consent Decree of 1956 (known also as the Final Judgment). This agreement, which became known as the Modified Final Judgment, set the boundaries and conditions of divestiture that were to take effect on 1 January 1984. See Ibid., pp. 326-27.

9. McGowan quoted in F.I.R. Associates Inc., Corporate Conference, MCI Communications Corporation, 15 February 1979, p. 18, History Project Files, MCI Corporate Archives.

10. Thomas Leming, interview with Philip Cantelon, 24 February 1988, San Francisco, CA, pp. 84-86, MCI Oral History Volumes, MCI Corporate History Archives.

11. MCI Press Release, 3 February 1983; Washington Times, 4 February 1983, MCI Corporate Archives.

12. Leming interview, 24 February 1988, pp. 84-86.

13. Cantelon, The History of MCI, p. 343.

14. Telecommunications Reports 51(26) (1 July 1985): 4; see also The Economist, 29 June 1985, pp. 69-70.

15. Richard Liebhaber, interview with Philip Cantelon, 1 and 13 April 1992, Washington, DC, p. 8, MCI Oral History Volumes, MCI Corporate Archives.

16. Cantelon, The History of MCI, p. 434.

17. Ibid., p. 436.

18. Ibid., pp. 437-44.

19. MCI wanted to bid in an FCC auction for licensing direct-broadcast satellite television service. On 29 September 1995, the Senate unanimously agreed to direct the FCC to proceed with an auction, and on 16 October 1995, the FCC announced that it would do so. "MCI Wins Round in Satellite TV License Battle," Washington Post, 30 September 1995, p. A14.


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