Randall Stephenson: Making connections

randall_stephenson.top.jpg Interview by Geoff Colvin, senior editor at large


FORTUNE -- AT&T chief Randall Stephenson faces high-class problems, but they're still problems. As the exclusive U.S. wireless carrier for Apple's iPhones, AT&T has suffered embarrassing glitches -- website failures, accidental release of customer info -- caused by overwhelming demand for the devices. Many subscribers complain about the speed and quality of AT&T's network, another effect of too much demand; iPhone owners use a lot of bandwidth. The upside is that users of iPhones and other smartphones pay AT&T twice as much a month on average as users of other phones do, and about half of AT&T's customers use smartphones -- twice the industry average. Those facts help AT&T remain America's largest communications company.

Stephenson, 50, joined Southwestern Bell Telephone 28 years ago (his brother, who's still a company technician, got him the job) and stayed as the company morphed into AT&T (T, Fortune 500). An accountant, he became CFO, COO, and in June 2007, CEO. Stephenson talked recently (before Consumer Reports knocked the iPhone 4) with Fortune's Geoff Colvin about investing more in the U.S. this year than any other company, telling the board he was "spending $9 billion on air," why he won't promise not to drop health care coverage for AT&T's 280,000 employees, and much else. Edited excerpts:

The new iPhone 4 -- exclusive to AT&T in the U.S. -- came out recently, and its most notable feature is the ability to do video chats, which use a lot of bandwidth. Right now these chats cannot be done on a cell network for technical reasons, but it raises a big question: Can the AT&T network keep up with the tremendous bandwidth demands of today's devices?

It's able to keep up. It's just requiring an unbelievable amount of investment. We fully expected what you're seeing today -- we just didn't expect it to happen as quickly as it happened. About four years ago we said mobile broadband is where it's headed, so you want to get wireless bandwidth out there. When [Apple CEO Steve] Jobs brought us the concept of the iPhone, which was literally a PowerPoint slide, that fit with where we wanted to go. So we put this thing on the network, and our mobile data volumes were up 5,000% in three years. And as you have experienced if you live in New York, New York City is one of the problem areas. We've had a challenge keeping up with the bandwidth. We're starting to get ahead of it, but this is not going to stop. We think this goes 40 times, 60 times over the next five years.

In the latest Consumer Reports survey the Verizon network ranked first, AT&T last. What can you do about that?

You get the network speeds and network quality up, and that's what we're doing. We're investing a lot of money, and I think you're seeing that pay off. In PC World's recent tests on mobile bandwidth speeds, AT&T ranks first, hands down. It's really not close. T-Mobile did well in the Northeast, but across the country we're doing very, very well in mobile broadband speeds.

Voice quality in some of these areas is suffering. New York and San Francisco are cases in point. We think we're really getting ahead of it in New York. I know we still have some trouble spots, but we're getting ahead of it. To put this in context, of all the mobile broadband traffic in the U.S., half of it runs on AT&T's network.

It's inevitable that the exclusive deal for the iPhone comes to an end at some point. The analysts all seem to think that happens at the end of this year. Are they right?

We've obviously never disclosed that.

I know, but I thought I'd give it a shot.

There will be a day when it won't be exclusive, but the iPhone will always be a significant part of our device lineup. So that's not a cataclysmic event.

What kind of a dent does it put in your business when Verizon gets the iPhone?

We think we'll do very well. The voice-network issues have obviously gotten a lot of press, particularly in a couple of markets. But at the end of the day, what is the iPhone? It's a computing device. It is a mobile broadband computing device, and when this device moves to other networks, it's going to move to a much slower network. The experience will not be as good. I feel very comfortable with that.

You've announced that this year you're investing $19 billion. Very few companies anywhere invest that much in a year. Since everyone seems to agree that interest rates will rise, how do you protect yourself when you have to make such enormous investments?

We've been in an environment where we price data on a flat-rate basis -- you pay $30 a month, and it's all the data you can eat. Everybody's paying this, but the top 2% are consuming the lion's share of this bandwidth. That's an illogical pricing equation. It's not conducive to earning decent returns on the investment you're putting in the ground. So we stepped out recently and changed the pricing model. We said if you use a little, you pay a little. If you use a lot, you pay a lot. That's a sustainable model where you can earn respectable returns, and that will encourage you to continue investing in these businesses. It was a very important move, one that took a lot of thought and a little courage, and we went ahead and did it.

It looks like a price cut for 98% of users, at least in the short term. Do you expect that to change?

You just said it -- in the short term there may be some migration in pricing down in some of your base. But over the long haul it's a sustainable, rational pricing model. When you have mobile data growing 5,000% in three years, it's a model you have to get in place.

Let's look at the bigger picture. You compete not only with other phone companies but also with cable TV companies, because you offer TV service and wired data service. You even compete, through your directories, with the local newspaper and Google, and anybody else who sells advertising. So as Peter Drucker would have asked, What business are you in?

We're in the connectivity business. We like to say we connect people to their world. Our objective is to make sure you're connected to your business information needs, to your home entertainment information needs, to your family, to your associates. Also that the machines you possess that transmit data are connected to other machines that are important. We have this really terrific, world-class global network. Hanging off of that network are well over 1 billion devices that are allowing you to connect with data and machines. That includes ATMs and gas pumps and so forth. So we're in the business of connecting people to information and data.

In that world, what will determine who wins and who loses?

This is really important. Our objective is to mobilize everything you do. Whatever your connectivity needs are, I want those needs mobilized. And the more mobile, the more wireless you become, the more wireline-centric we become. What has been the biggest obstacle to getting the bandwidth required for iPhone penetration in a city like New York? Spectrum is important, but the No. 1 issue is getting fiber to these cell sites. That's where the bottleneck is. As you get more and more penetration, what do you need? More and more cell sites. But those cell sites need more and more fiber. In fact, the cell sites are getting smaller, which means more fiber. So the more wireless you become, the more wireline-centric we as a company become to deliver bandwidth. The companies that will win are the companies that can do it all. They have the spectrum as well as the fixed-line infrastructure to deliver this kind of traffic.

So what's the constraint? Is it the actual supply of fiber available, or the ability to finance a tremendous amount of capital spending, or something else?

There's a short-term constraint, and that is just literally people down in manholes, digging trenches, deploying fiber into the cell sites, the homes, and whatnot. The long-term constraint in wireless is, Where does the bandwidth come from? The airwaves? The spectrum? There's a limited supply of this spectrum. One of the first things I did when I took this job was pursue a company called Aloha Communications. A good friend of mine down in Austin, he and I were talking. He and a bunch of friends over the years had assembled a big footprint of 700-megahertz spectrum, which is really, really rich spectrum. This is really good stuff, all right? If you're transmitting in this spectrum, you penetrate walls, go down into basements and subways, and so forth. We bought this company, paid $2 billion close to three years ago for spectrum that we knew we would not be able to deploy for probably four years. Then, year before last, we entered the FCC auction to buy even more of this spectrum. Within a couple of years we spent $9 billion on airwaves. You want to talk about fun, go to your board and say, "I want to spend $9 billion on air." But we're going to need that spectrum.

Wireless accounts for the bulk of your revenue. In the U.S., wireless is not growing very fast. Where else in the world do you look for growth?

Let me start with the premise of your question. Our wireless business is about a $50 billion business, and it's growing at 10% year over year.

It's fast revenue growth, but not fast growth in subscribers.

Total subscribers have slowed, and you would expect that. Everybody has a wireless phone now. But less than 40% of the U.S. has a smartphone, and average revenue per customer for smartphone subscribers is often double that for traditional wireless subscribers. We believe 70% to 80% of subscribers will have smartphones. We think there's a lot of growth potential there.

What else?

A new business we call emerging devices -- people connecting everything to the wireless network. Imagine you walk into a Best Buy (BBY, Fortune 500). Everything you see in Best Buy at some point will be wirelessly connected. I fundamentally believe that. We started this business two years ago. We said we're going to go after this and go after it hard. In the fourth quarter of last year we announced well over 1 million new devices connected to the network. In the first quarter, another million devices. E-readers, navigation devices -- you name it. This is going to grow and grow. So we think there's a lot of growth left in the U.S. market for wireless. That said, where else do you want to be? We have a major stake in Latin America through América Móvil, and it contributes a lot to our earnings and our cash flow. I went down to Mexico to run that operation in the early '90s, when it was 20,000 subscribers. Today it's 200 million subscribers, and it's still growing 30% a year. Where do you go after that? India's tough. It was reported that we were looking at Reliance Communications, or that there were talks. There have not been any talks. India is an exciting place, but the regulatory situation is a little messy. It is hypercompetitive -- you have six, seven competitors in most of the regions, and this is an industry not conducive to that kind of structure. China is a hard place for an infrastructure company like us to invest. So internationally it's going to be very selective.

You're in a business where two players -- you and Verizon -- have two-thirds of the wireless market. We have an activist administration. Is more regulation inevitable?

They regularly have to study the wireless market and give an assessment on the state of competition. And the most recent report failed to state that the wireless market is competitive. As somebody who lives and breathes this every day, I can't think of a word other than, that's laughable. Open up a newspaper and tell me how many different wireless ads you see, and look at what's happening to pricing, and look at what's happening to investment to try to stay ahead of the competition. As a regulator, what is your objective? If the outcome one desires is more broadband infrastructure investment and more broadband deployment and penetration, one equation that I know doesn't work is more regulation.

This administration is pushing for net neutrality. How are you going to fight that battle?

They want broadband to be put under the same rules as POTS: plain old telephone service. I cannot think of anything that would be more disastrous for this industry and investment in this industry than that type of move. How are we going to fight it? We're being very vocal. We're working with the FCC extensively on this. This is an industry-defining moment to me, and it's not just an industry-defining moment. You mentioned we're investing $19 billion a year. That is more than any other company will invest in the U.S. this year, period. Probably No. 2 is Verizon (VZN). This is not a time when you want to cause people to pause on the investment they're making in this infrastructure. The result of that kind of regulation will invariably be lower investment.

AT&T took a well-publicized noncash charge of about $1 billion after the health-care reform was enacted. An internal document showed that the company figured it could save $1.8 billion a year if it dropped health insurance. Is that actually a possibility?

I do not know where we're going to land on this. Long term, things will land where economic gravity takes them. Every element of the health-care plan that we look at says that if you just follow economic gravity, you're better off paying the government a fine and dropping health care coverage for your employees. That's not what I want to do. It's not what I personally want nor is it what I want for our employees. But you're going to see people in industry begin to move that way. People we compete with will begin to move that way, and it will create an economic gravity. That's just the reality. Where will we land? I don't know yet. But something will change. It's inevitable.  To top of page

The C-Suite series: This is the latest interview with top executives by Fortune senior editor-at-large Geoff Colvin. See video excerpts of this interview at fortune.com/csuite - plus find other Colvin interviews, including those with Charles Schwab, the team of Jeff Immelt (General Electric) and A.G. Lafley (Procter & Gamble), Chevron chief executive David O'Reilly, New York City school chancellor Joel K lein, Pimco's Mohamed El-Erian, Vanguard's William McNabb, and many more.
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