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Executives at Japan's Nippon Telegraph and Telephone (NTT), the world's largest telecommunications company, admit they've been watching the merger wave now engulfing U.S. phone companies with a sense of foreboding. Especially unnerving was the announcement earlier this month that 130-year-old AT&T, the American former monopoly carrier that not long ago was the oldest, biggest and baddest telecom firm on the planet, was about to be swallowed up by upstart regional player SBC—providing a sobering reminder that in the information age, no institution is too big to fail if it squanders its competitive edge. "Technology is advancing fast," says Shuichi Deguchi, senior manager of NTT's broadband-Internet promotion department. "A complete transformation is required to make sure we stay ahead."

"Transformation" was not, in the past, a word heard frequently at NTT, which as a former monopoly carrier with 60 million customers is the Japanese version of Ma Bell. Like AT&T, NTT now finds itself beset by a variety of nimble competitors offering local and long-distance calling and Internet access at cheaper prices. In its most recent earnings statement, NTT reported a $6.7 billion profit but saw falling revenue in almost all of its businesses. Its stock price has dropped about a third since early last year. Indeed, in Japan, where there are today more mobile-phone numbers than there are fixed-line phones, POTS (plain old telephone service) is rapidly becoming a thing of the past. Survival in the future depends upon phone companies' being able to provide businesses and households with a broad slate of communications and entertainment offerings, including Internet-based calling and even cable-TV-style video services. NTT may be big and rich, but the company "is not used to thinking competitively and reacting quickly" to exploit new business opportunities, says Credit Suisse First Boston analyst Hitoshi Hayakawa.

Until recently, it hasn't had to. Although ostensibly privatized and deregulated during the 1980s and '90s, NTT's fixed-line business remained virtually unchallenged. With a 99% market share, NTT used monthly fixed-line fees as a multibillion-dollar annuity stream to fund growth enterprises such as DoCoMo, its successful mobile-phone service spun off in 1992 (NTT still owns 64%). But two new entrants in the fixed-line industry have rocked the company's complacency. Last August, Softbank, a leading Japanese broadband provider, announced it would begin offering traditional home-telephone services at a discount. Two weeks later, KDDI, Japan's second largest mobile-phone carrier, said it too was invading NTT's turf. NTT quickly reduced prices to match its competitors', but the cuts will hurt: Deutsche Bank forecasts that NTT's revenue will decline by 15% over the next two years.

This raid on NTT's war chest could not come at a more critical time. Only about 40% of Japanese households currently have high-speed Internet access, meaning an all-out battle is being fought for the fast-growing market. Leading the charge has been Softbank, which initiated a broadband ADSL service in 2001 under the Yahoo! BB logo at rates that far undercut anything then on the market. In December that same year, it added VOIP (voice over Internet protocol)—telephony delivered over the Internet—at deep discounts to NTT's fixed-line phone fees. And in July 2003 it rolled out BBTV, a selection of 24 channels streamed to users' televisions not via cable-TV wires but over the Internet. Today, 4.7 million households (or nearly a quarter of the broadband market) subscribe to at least one of Yahoo! BB's three major businesses.

While Internet television is still in its infancy, telecom executives now confidently opine that success awaits the companies that can reliably and economically provide consumers with what is called the "triple play": TV, Internet and telephone service. Softbank is not the only triple player in Japan. In late 2003, KDDI added television programming to its Internet access and telephone services, while J-Com, with nearly 2 million subscribers the country's largest cable-TV operator, last month began rolling out video-on-demand to augment the TV, phone and Net access it already provides via digital cable.

So far, NTT has kept up with the competition. More than a third of the country's 20 million broadband households get their service through NTT, for example. But KDDI's and Softbank's rapid advances into nearly every field of its businesses convinced NTT that more drastic measures were required. In a major strategy shift, NTT declared two months ago that it would spend $47 billion to convert 30 million Japanese households to fiber-optic service—bringing superfast optical cables right into living rooms—by 2010. Today, 3 million households in the country have direct fiber-optic connections (compared with 14 million who access the Web over ordinary phone lines via ADSL, and 3 million who subscribe to broadband cable). But NTT believes Japan's future is fiber-filled because the technology allows for faster transmission speeds and more flexible two-way communication than alternatives, meaning NTT should have the best triple-play capability in the nation. "They have changed their mind-set," says Kenshi Tazaki, a vice president at Gartner Research in Tokyo. "They have moved from a defensive strategy to an offensive one."

There's one glaring problem: to encourage competition, Japan's telecom regulators require NTT to allow competitors like KDDI and Softbank to use the giant's system, paying wholesale rates set by regulators—which means the competition will be able to reach customers via NTT's gold-plated network. "We spend all this money on our infrastructure, and we have to rent it out at a very low price," complains Yasuo Sakurai, chief researcher at InfoCom Research, an NTT subsidiary. "Softbank builds nothing, yet they have enough money to buy a baseball team?" (Softbank recently purchased the Hawks, a Japanese pro ball club.) "This is crazy." NTT executives argue that since the company is no longer a monopoly, its network should not be treated like a public utility. So far, regulators have been unimpressed, countering that NTT is paying for its fiber-optic network with cash amassed from its regional phone businesses, which maintain monopoly-like market share.

Without government relief, NTT will need to find a way to provide enough compelling TV content and services to stay out in front. "Otherwise, they are relegated to this role of a back-end, network wholesaler," says Nikko Citigroup analyst Toru Hosoi. NTT officials are aware of this challenge, but they admit to being newcomers in the entertainment arena. NTT's Plala interactive television subsidiary, which launched consumer programming last July, offers viewers 30 basic channels such as MTV, the National Geographic Channel, as well as 12 premium channels that carry Hollywood and Japanese movies—which is similar to NTT's competitors', who say they aren't cowed by their much larger rival. "I don't believe telcos know how to develop and sell entertainment," says Toru Kato, senior vice president of business development at J-Com. Indeed, NTT has never demonstrated multimedia savvy. As early as 1995, it was exploring interactive TV technologies with Microsoft, but the partnership produced nothing. "We go to Hollywood looking for content, and we don't know what is the appropriate price for things," admits NTT broadband senior manager Shuichi Deguchi.

Still, although analysts say NTT is bloated with inefficiencies and hampered by conservative management, the company enjoys significant advantages and is not necessarily fated to disappear like AT&T. Softbank's success in capturing broadband market share, for example, has come at a high price. The Internet firm is deeply in debt and has posted widening losses for three years running. While KDDI has expanded more cautiously, it also lacks NTT's deep pockets, which give the latter an edge in punishing price wars. In the U.S., the incumbents have decisively lost to telecom upstarts. But in Japan, the battle is just getting under way. Don't count on the Eastern version of Ma Bell to follow its U.S. cousin into the corporate graveyard.

• Jim Frederick | Tokyo
• As nimbler players pick off NTT's customers, Japan's telecom giant discovers it may be too big for its own good