The reinvention of Embratel

It's been three years since Brazil privatized its telecommunications sector, beginning long-distance carrier Embratel's long struggle to transform itself from languorous incumbent to competitive tiger. Its secret weapon: a CEO with a background in marketing, not engineering.

In the heady explosion of today's telecom market in Brazil, it's hard -- not to say painful -- to recall how dysfunctional the market was just a half decade ago. Well into the 1990s, it would take Brazilians literally years to get a phone line installed in a home or business. Facing a bloated, state-run telecommunications system, customers routinely resorted to bribery in order to avoid the wait. Even those with service frequently scrambled to redial phone calls that were abruptly cut off.

Fast-forward to today, when Jorge Rodriquez, the 44-year-old CEO of Empresa Brasileira de Telecomunicacoes SA, known as Embratel, is busy transforming the biggest piece of the old sprawling state monopoly into a powerful and nimble player in Brazil's rapidly growing telecom sector.

To hear Rodriguez tell the story dragging Embratel into the future has been no picnic. The company has clashed with government regulators who required Embratel to wire remote Brazilian outposts and then asked the company to pay millions in taxes left over from its pre-privatization days. Rodriguez himself, born in Cuba and raised in Miami, has had to win over skeptics who said a non-Brazilian could never turn the corporate culture of a state-owned company into a modern, competitive business. But his biggest challenge to-date is overseeing Embratel's expansion into local telephone service -- and high-speed Internet access -- while stemming mounting losses.

In July 1998, US-based MCI WorldCom purchased Embratel -- then Brazil's only long-distance telephone company - for US$2.27 billion (2.65 billion reais), US$1 billion above the minimum asking price. Since the privatization, WorldCom, as the parent company is known today, has invested billions more to wire most of Brazil and make Embratel's telecommunications network the largest in Latin America.

At the time of the acquisition, Rodriguez was at the peak of a successful four-year run as head of marketing for Mexico-based long-distance upstart Avantel, a joint venture between WorldCom and Mexican bank holding company Grupo Financiero Banamex-Accival. During his tenure there, the Mexican government broke Telmex's monopoly on the long-distance market and Rodriguez boosted Avantel's share from zero to 10 percent in just one year of operation -- thanks to an effective advertising campaign featuring Mexican actress Salma Hayek.

The achievement caught the eye of Embratel's owners, who in 1999 hired Rodriguez to be Embratel's marketing director and then -- just 14 months after the company went private and much to the surprise of analysts -- appointed him CEO.

"In Brazil Rodriguez finds himself in the position that his Mexican adversary [Telmex] was in," says Dario Dal Paiz Jr., a vice president for research firm Yankee Group. Rather than break into the dominant market share of a former monopoly he has had to defend it. "In many respects, his job has been much harder in Brazil. When you start a company from nothing it is much easier to create a corporate culture. Embratel had been in the market for decades, and had many employees who had been with the company for decades [and] who were very resistant to change."

It was during Rodriguez's stint as Embratel's marketing director that Brazil's long-distance system underwent a complete overhaul -- a transition that did not go as smoothly as expected. Weeks after going online with the new system, many Brazilian customers were still not receiving telephone calls from abroad and only 25 percent of all domestic long-distance calls were going through to their destinations. Federal and local governments threatened Embratel with stiff fines and angry customers filed thousands of complaints with consumer protection groups. The resulting chaos forced former Embratel CEO Dilio Sergio Penedo out and ushered Rodriguez into the hot seat.

Rodriguez inherited myriad problems from Penedo, not the least of which was billing. Prior to privatization, customers were billed for local and long-distance service together. Once the monopoly was broken, however, Embratel had the task of modifying the system used to bill its 50,000 data services customers to a "system capable of billing all of the 40 million telephone numbers that exist today in Brazil."

Bill collection complicated matters even more. As a long-distance carrier, Embratel could only cut long-distance service to non-paying customers, whereas in the past all telephone service could have been cut. Now customers can jump from one long-distance carrier to another to avoid bills. Delinquent accounts ammounted to US$67 million, or 8.7 percent, of second quarter revenues, Embratel CFO Jose Maria Zubiria disclosed. "That means that Embratel is still having billing problems and despite their efforts to solve this problem, we expect any solution to take at least two quarters to work out," says Bruno Queiroz, a telecom analyst for Banco Santander in Sao Paulo.

This June, Embratel launched a program to collect the nearly US$126 million (300 million reais) that 600,000 of its customers owe the company for long-distance service provided since January 2001. To entice the debtors, Embratel is waiving interest and inflation adjustments on the money owed. The company is also negotiating with its competitors to share information regarding non-paying customers in a bid to stem carrier jumping by cutting off long-distance service to habitual offenders. So far, Embratel has cut service to approximately 100,000 customers under the new plan.

In a press conference June 11, CFO Zubiria said the program should cut delinquent accounts to between 2 percent or 3 percent of revenues by year-end. Investors responded positively to the news, pushing up Embratel's stock value more than 8 percent the day of the announcement.

Rodriguez says the company is trying hard to change the character of how Embratel does business. "We've become a customer-friendly, customer-focused company. We design all of our products with the customer in mind and we spend a great deal of energy making sure that our customers are satisfied and happy" Rodriguez says that when he took over Embratel "there were no more than a couple of hundred people doing sales and servicing for Embratel. Today there are over 5,000."

Personnel changes weren't the only ones he made. After Rodriguez became CEO, the company embarked on a quest to build Brazil's most comprehensive fiber-optic cable network. Covering every state in the nation, the network is part of an extensive array of products Embratel is offering customers, including domestic and international long-distance service, data transmission, teleprocessing, text communication, television and radio signal transmission, and maritime communication services. Embratel also owns the biggest Latin American Internet backbone that, like Worldnet's US-based UUNET subsidiary, is a heavy-duty network carrying high volumes of data for regional Internet service providers. Embratel's more than 85 percent share of Brazil's Internet backbone means the vast majority of that nation's Internet clicks travel Embratel's system.

Notwithstanding the company's march forward, Embratel still faces one headache it hasn't been able to shake. One month after Rodriguez took over as CEO, the Brazilian government slapped Embratel with a demand for back-taxes, totaling roughly US$500 million (1.1 billion reais). Rodriguez, surprised by the ruling, says the taxes are due for international calls made while the company was still state-owned. Countless appeals later, the dispute remains unresolved.

Competition Looms

While those preoccupations may seem like enough to keep Rodriguez awake at night, he is now preparing the company to enter a new era. Next year, Anatel -- Brazil's telecommunications regulatory agency -- is scheduled to complete its deregulation of the industry.

Already the competition is crowding in. In addition to Embratel, Brazilian consumers can use Intelig, a competitive start-up launched when Embratel privatized. Every time Brazilian phone customers make a long-distance call they have to choose a carrier by dialing a two-digit access code. To promote its own access code -- 21 -- and its brand name, Rodriguez took a page from his success in Mexico and hired popular Brazilian soap opera star Ana Paula Arosio to pitch for Embratel. He also spent US$99.5 million on advertising last year, up 30 percent from 1999, according to data from Sao Paulo-based marketing research firm Ibope Monitor. The investment seems to have paid off. The name Embratel, once synonymous with dropped phone calls, now appears as one of the Top 10 Brazilian brand names in a ranking compiled by brand research firm Interbrand, "It was all carefully thought out so that we'd have the best recall possible," Rodriguez says. "We made an effort to ensure that the Embratel brand and '21' are very well -known and are the preferred choice - that we hold a special spot in the customer's mind."

Not to be outdone, Embratel's competitor Intelig spent US$108 million on its own advertising campaign. Together, the two companies were the top marketing spenders in Brazil last year, according to Ibope Monitor. Intelig -- a joint venture of National Grid, Sprint and France Telecom -- entered the Brazilian market just as it was opening up in January 2000. But the start-up, known in Brazil as a "mirror-company" because it covers the same territory with the same services as the original state company failed to unseat the incumbent in market share.

"Embratel won," says Yankee Group's Dal Paiz. "Their marketing plan was extremely well done. Embratel created slogans that stuck in people's minds. The company didn't act like an incumbent, but like a new company, entering the market for the first time." Dal Paiz adds that while Embratel may have won the battle, it hasn't won the war. "The horizon is turbulent. They are going to have to do much more and do it much better starting next year."

To be sure, Rodriguez's biggest challenge will begin in January 2002, when local carriers will be allowed to enter the long-distance market and Embratel, in turn, hopes to begin local telephone services. That means that Embratel could face seven new competitors, possibly more. Furthermore, local phone service companies such as Telemar and Telefonica will not only have billing leverage, but also a relationship with the consumer that Embratel does not. "Both Telemar and Telefonica are extremely aggressive companies and if Embratel doesn't act quickly in the local market, they are going to lose even more market share in the long-distance market," says Yankee's Dal Paiz.

Tucker Grinnan, an analyst for Deutsche Banc Alex. Brown, casts an even darker shadow on the long-term viability of the long-distance business model, both inside and outside Brazil. "Over the past six months, there has been a very significant reevaluation of the long-distance sector in the US," he says. "Long-distance companies have had little to no success moving into the local service business while the local exchange incumbents have had tremendous success getting into the long-distance business."

Much will depend on the extent to which telecom regulator Anatel will provide a level playing field for local competition. "Anatel has a marvelous opportunity to do something right," says Rodriguez. His comments were echoed by Alain Riviere, an executive for competitor Intelig, who praised Anatel on the editorial page of the daily Brazilian financial newspaper Gazeta Mercantil but also challenged the regulator to take a stronger stance against anti-competitive practices.

This June, Embratel formally asked Anatel for permission to offer local telephone service, revealing that it will initially offer the service in Brazil's largest metropolitan areas.

But to even enter the local fray, Embratel must meet requirements set by Anatel -- as must would-be competitors who want to move from local to long-distance. One of Embratel's requirements has been to link all of Brazil's state capitals via a fiber-optic network, and provide public telephones in remote regions.

The scale of the undertaking has been staggering. In 1999, Embratel had to install a public telephone in every Brazilian town with more than 1,000 inhabitants and located more than 30 kilometers from the telephone lines of the local provider. During 2001, the mandate moved up a notch to include towns with more than 600 inhabitants. And by year-end, Embratel will have to being installing public phones in 1,250 towns with 300 or more inhabitants - so far, 700 of those towns are hooked up -- in order to meet the final requirements to compete in local market service.

"While the distance may be 30 kilometers" between villages, Rodriguez says, "it can take as long as two days to reach some of these remote regions." The company has also tripled the capacity of its 9,000-kilometer fiber-optic network since 1999, and begun the process of linking Brazil with its Mercosur trading partners.

The process hasn't come cheap. To meet its goals, Embratel will have invested nearly US$2.5 billion by the end of 2001. Rodriguez says the company has been working round-the-clock to improve services and to maintain its current client base while doing everything possible to bring in more revenue and keep costs down.

The new Embratel, for better and worse

With an eye toward more lucrative market segments, Rodriguez says Embratel is redefining itself as a "business-to-business company that happens to provide long-distance service to millions of Brazilians." With that in mind, Embratel plans to pursue the local business market, which already accounts for roughly 70 percent of its current income. Leading the charge is Purificaci6n Carpinteyro, a WorldCom vice president from Mexico whom Rodriguez brought on board to oversee Embratel's plan to wire more than 14,000 Brazilian offices with fiber-optic cable. The project will bridge the so-called "last mile" gap required before Embratel can offer high-speed data and voice services to those offices.

As Brazil's economy becomes more globalized, the demand for a pan-national infrastructure will increase, as will the types of services demanded by corporate clients. That's where Embratel's parent company WorldCom comes in. Rodriguez says his company's data services, for example, operate on the same integrated frame relays WorldCom uses worldwide, so a corporate customer notices no difference, whether they are in "London, Paris, or New York."

The Internet, too, has become a keystone in Embratel's strategy Last year, the company bought AcessoNet from Brazil's largest Internet service provider, Universo Online (UOL), giving Embratel a continuing and potentially growing stream of revenue as more Brazilians come online. The deal calls for Embratel to maintain AcessoNet's 186 points-of-presence (POPs) -- computer links to the Web's backbone -- and allow UOL access to the POPs for five years

Embratel's satellite subsidiary Star One recently signed a deal with UOL to offer the nation's first consumer, two-way satellite broadband Internet service. The service, which will cost users around US$45 a month, will be pitched to both consumers and businesses. Demand for such high-speed services in Brazil is strong, according to the Yankee Group, which reports that only 39 percent of Brazilian companies have access to any type of data transmission services at all. Even in metropolitan Sao Paulo, 19 percent of all businesses go without the service because of lack of infrastructure, says Yankee vice president Dal Paiz.

So far, Embratel has been able to fend off the 250 or so companies that offer corporate telecommunications services by leveraging its infrastructure to expand its client base. But hundreds more companies have begun wiring Brazil's business centers, says Dal Paiz, and "are bringing with them not only the top-of-the-line technology, but a business culture based on efficiency and competition."

While Embratel's embrace of high-speed data service helped produce a stellar 2000, the company got off on the wrong foot in the first quarter of 2001. Embratel lost US$15.7 million (33.7 million reais) during the first three months of this year, shocking both analysts and investors who were still euphoric about the company's 2000 record profit of US$297 million (577 million reais). Embratel blamed the poor financial results on the Internet economy's collapse, noting that many dotcom customers were forced to close up shop. With the slowing Brazilian economy Embratel's data transmission business grew only 20 percent in the quarter, rather than the 60 percent originally projected.

Santander telecom analyst Queiroz says the loss came as a surprise and that he had expected Embratel first quarter profits of around US$10 million. In contrast to Embratel's claims, Queiroz says the company's losses were across the board, compounded by the weakness of the real. From January to May, the real lost more than 20 percent of its dollar value. Ninety-nine percent of Embratel's debt is foreign-denominated.

And the scenario isn't likely to improve in the near-term for Embratel, says Queiroz, because "with increased competition, long distances prices will no doubt be lowered, decreasing the company's margins." Similar pressures are being put on the data transmission sector as new players such as AT&T Latin America, MetroRed and Pegasus vie for the Brazilian market.

Embratel's stock has mirrored investor concerns, losing 25 percent of its value since Jan. 1. By comparison, Brazil's Bovespa stock index has lost only 3.6 percent this year. Investment firm Goldman Sachs recently downgraded Embratel and removed its stock from the company's "recommended list" because Embratel lowered growth projections for the year, says Goldman Sachs telecom stock analyst Daniel Henriques. "Nonetheless, we think that Embratel will continue to be the market leader," he adds, though cautioning that "their leadership position will no doubt deteriorate with increased competition."

Rodriguez is determined to prove his critics wrong, and believes the company's growth strategy will win out in the end. Indeed, Brazil's telecom sector remains promising and poised for growth. According to Anatel statistics, in 1998 there were 20 million fixed telephone lines nationwide, and those levels have nearly doubled in the three years since the privatization. Anatel estimates the numbers should reach 60 million by 2005, not including growth in the wireless and satellite telecommunications sectors.

"Embratel still has a hangover from the Internet bust, but nonetheless, having 20 percent growth in data transmission is still impressive," Rodriguez says. "Few companies in the world can say they had the growth that Embratel had starting from the multi-million dollar base that we did."

The one strong suit that Embratel has with Rodriguez is his track record as a marketing maven. If the game is primarily one of winning the hearts and minds -- not to mention the ears -- of the Brazilian consumer, Rodriguez has already made huge headway Says Dal Paiz, "Embratel is a completely different company today than it was four years ago. Jorge Rodriguez and the WorldCom team have turned the company's image around, completely."

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Since the privatization of the Telebras system in Brazil, the telecommunications industry has experienced nothing short of a revolution. At the time of the privatization, Brazilians were forced to wait years for a telephone line--and those who didn't want to wait that long were coerced into paying as much as US$10,000 on the black market. Once they got telephone service it often took several attempts to complete a long-distance call, and when a call finally went through it was not uncommon for the antiquated system to cut a caller off in mid-sentence. According to statistics from Anatel, Brazil's telecom regulator, there were 20 million fixed phone lines in Brazil in 1998. In the three years since the privatization, that number has doubled to nearly 40 million and should reach 60 million by 2005.

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