MCI: Back in Control

By Baselinemag  |  Posted 2004-06-08 Print this article Print

MCI rolled out new cost-analysis software as part of its recovery from massive accounting fraud and the biggest bankruptcy in U.S. History.

Obscured by the attention paid to the $11 billion worth of accounting fraud at telecommunications giant WorldCom was this staggering detail: The company, now known as MCI, didn't really know what its costs were for each line of business when it filed for bankruptcy in July 2002.

The idea that the $20 billion-a-year company couldn't figure costs by business surfaced last month. Michael Capellas, the ex-CEO of Compaq Computer hired as WorldCom's chief executive in November 2002, told Wall Street analysts on an earnings conference call that the company had established internal processes for determining profit and loss by business unit.

The message: Evaluating the performance of business units wasn't a part of how the company had been run. "You may say, 'Well, that shouldn't be particularly new,'" Capellas said, "but that's obviously something we've had to put in place over the last year."

Because federal accounting rules require public companies to disclose financials by segment if they manage their business that way internally, MCI plans to begin reporting profit-and-loss figures starting with the second quarter of 2004 for its three newly reorganized business units: Enterprise Markets, U.S. Sales and Service, and International and Wholesale Markets.

How MCI implements new financial controls and reporting systems will be key to its recovery. If it fails to adhere to general accounting standards or the tight financial reporting strictures of the Sarbanes-Oxley Act of 2002, MCI's business is likely to wither.

Before its bankruptcy, WorldCom's processes were not up to snuff. An internal audit found the company had inappropriately transferred more than $9 billion of access-cost expenses to capital accounts between 1999 and 2002. Of course, finance officers make choices like this, and even the best financial information systems would not be able to catch such activities. "It's the people you have and the structure for reporting," says Richard Tilton, CEO of Greenacre Asset Advisors, a New Jersey firm that provides financial consulting to bankrupt firms. "The software by itself can't prevent this kind of manipulation."

The problems were not rooted in the controls a well-maintained information system provides. The company kept its accounts on SAP's R/3 financial and operations planning software, which MCI had adopted before it was acquired in 1998 by WorldCom. "It's not like they had outdated systems," says Joe D'Amico, senior managing director with FTI Consulting, a firm hired to sort out the financials of WorldCom's subsidiaries.

But information systems are only as good as the managers who run them. Capellas led the charge last year to start analyzing profit and loss for each business unit. John Nolan, MCI's vice president of planning and analysis, and an 80-person team of financial analysts, had to figure out how to assign costs.

The challenge Nolan's group faced in mid-2003 was how to compile enough detail to divide expenses previously lumped together—such as selling, general and administrative expenses—among the company's three business units. Such SG&A amounted to $1.6 billion, or 30% of revenue, for MCI's most recent quarter, ending March 31.

The group already had a head start. For an earlier project that analyzed product-line profitability, Nolan's team had decided to use "activity-based" cost management, an accounting method that tracks expenses based on the day-to-day activities employees perform, rather than as lump sums. Those activities are further subdivided until they are associated with a specific unit or product line (the "cost owner").

In early 2002, the group e-mailed spreadsheets to 200 business managers, asking them to assign costs to activities in their units. "That way, it's not just the finance department making up the numbers," Nolan says.

The process took six months. Even so, much of the data was either inaccurate or incomplete. The answers also were stored on spreadsheets, which was not a viable method of gathering information every quarter for consolidated financial reporting.

The group decided to replace the spreadsheets in December 2002, settling on software that tracks costs by activity, from SAS Institute of Cary, N.C. The software, Nolan says, can break down a given cost into several components and attribute that breakdown to more than one person or operating group.

WorldCom began implementing the SAS application, known as SAS Activity-Based Management, in June 2003 and sped up deployment to eight weeks from 13. Why? The company's business analysts realized they could use the SAS software to compile financial results by segment for an audit that was submitted on Sept. 8 to the U.S. Bankruptcy Court at its Chapter 11 hearing.

About two dozen SAS consultants and MCI employees worked nights and weekends to meet the deadline. The shortened timeline meant the model didn't have the level of detail Nolan wanted—it drilled down costs only three levels, for example, instead of five—but he says the model has since been updated to include more information.

The SAS application isn't fully automated yet. Until it is, analysts must manually import information from different sources, including the SAP system (for data such as salaries and computer-equipment expenses) and the homegrown MCI billing system (for revenue-related information).

But Nolan says simply building the activity-based cost model has contributed to "consciousness raising" among MCI 's managers, who are becoming more attuned to which costs will go into a given service. That way, pricing for a new service, such as an unlimited calling plan, can be assessed more accurately. The initial cost-analysis reports provided to business-line managers have left them thirsty for more, says Nolan.

There are still hard decisions ahead for MCI, which lost $388 million in the most recent quarter and faces an ugly price war from rivals. Capellas announced the company will lay off 7,500 employees, or 15% of its workforce, in the second quarter. The job cuts, along with another 5,700 announced earlier this year, are expected to save MCI $150 million per quarter. Nolan says the SAS tool will provide some information to help managers identify which employees to cut, though he says it's only one of many factors the company will consider.

How You Can Track Costs by Activity

  • Gather Information. Know precisely which financial metrics you need from different parts of the business.

  • Automate Data Collection. Connect cost-analysis software to data sources to speed up financial reports.

  • Hold People Accountable. Turn managers into "internal auditors" responsible for profits and losses.

  • Educate Service Managers. Give leaders of "shared services" an understanding of how their costs get assigned.


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