Case Study: WorldCom













WorldCom grew rapidly and collapsed even faster. Its story includes the biggest merger (at the time) as well as the biggest bankruptcy in US history. The WorldCom failure was one of several that led to the current compliance requirements.


Could the analytical techniques used by Performance Chain™ have shown something was amiss? A look at the WorldCom affair illustrates how Performance Chain™ ensures unusual activity is identified, and provides some details on Telecom industry KPIs.


September 15, 1993

A three-way merger of telecom companies forms what will be named WorldCom

September 14, 1998

WorldCom acquires MCI Communications Corporation


During the 1990’s, WorldCom grew steadily by merging with a number of companies, highlighted by its merger with MCI in 1998. If we compare operating expense to revenue for this period, we see a consistent pattern, except for 1996 and possible 1998. It turns out there were accounting write-offs in those years (note how easy it was to spot these significant unusual amounts). Once we remove these one-time charges, both years fit the pattern.

When we measure this relationship, we see that WorldCom’s operating income was 15.9% of revenue less $800 million per year.


October 1, 1999

WorldCom acquires SkyTel Communications, Inc.


As the growth by acquisition continues in 1999 and 2000, WorldCom posts exceptional results. Operating expense for both years is well below expected, based on the consistent relationship through 1998.


The new estimate for operating profit is 8.3% of revenue plus $4.8 billion. (While percent of revenue dropped, the fixed cost changed to a favorable number. This results in higher profit in the current revenue range, but at some higher level of revenue will result in lower profit than the prior relationship.)


In the revenue range of $35-40 billion per year, this represents about $2 billion per year in reduced operating expense. This favorable variance is hard to explain with only the publicly available information. Presumable there are some economies of scale, although there were none evident from earlier growth. (If this analysis were being conducted by the company, managers would drill down and apply these techniques to detailed accounts and organizational units to identify specifically what caused these results.)


There could be other explanations, however. What if the relationship between revenue and operating expense had not changed, but rather some accounting processes were compromised? Could revenue have been exaggerated, making the expenses look favorable?


Could revenue have been reported correctly, but expenses understated?


July 1, 2001

WorldCom acquires Intermedia Communications Inc.


WorldCom continued it merger activity into 2001, but 2001 results were quite different than any in the past.


Revenue was down, and operating expenses were up, even above what would be expected with the old relationship. What happened? There were no unusual charges to account for the poor performance. If we drill into operating expense in more detail, we can begin to see what might have happened.


Of the three main components of WorldCom’s operating expenses, only line costs (which is tied to volume levels) fell consistent with the fall in revenue. SG&A and depreciation were consistent with growing revenue. Apparently WorldCom was expecting revenue to increase, and continuing to grow and invest capital in anticipation of that increase. For whatever reason, they did not identify and/or respond to falling revenue. (Again, in the actual company they would have been looking at weekly revenue and monthly expenses, which makes this failure even more puzzling.)


April 29, 2002

Bernard Ebbers resigns as President and Chief Executive Officer of WorldCom

May, 2002

KPMG replaces Arthur Anderson as auditors

June 26, 2002

SEC files civil action

July 22, 2002

WorldCom files for chapter 11 bankruptcy

April 20, 2004

WorldCom emerges from chapter 11 as MCI


$500 million + 10 million share civil penalty


Long story short, it all fell apart in 2002. Results for 2002 were not released until spring of 2004, and were accompanied by restated results for 2000 and 2001. 2003 results were released a short time later. It wasn’t pretty.


2000-2002 each contained significant write-offs, which account for most of the extreme variance. (1999 was not restated, although it was also inconsistent with prior performance.) It is interesting to note that revenue in 2000 did not change significantly, and revenue for 2001 was actually increased. So the problem was apparently on the expense side being understated, not with revenue being overstated.


With these impairment charges removed, a new operating expense vs. revenue relationship seems to be forming.


It is running at a higher level than the original relationship. One explanation for this might be that MCI is keeping its prices low to attract customers. This lower markup would produce the higher expenses seen for a given revenue level. Revenue continued to decline in 2003, however, so it is questionable if this strategy is working.


Of course, in an actual implementation, this analysis would be conducted at more detailed account levels, and include more modeling specific to the business practices of the telecom industry.  However, even using annual data for highly-consolidated accounts, the techniques used by Performance Chainprovide remarkable visibility and insight to performance. Beyond identifying successful practices, these techniques can provide assurances that results are understood and are being accurately reported.



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