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‘Ultimate supplier’ Nortel may be out of demand By DAVID AKIN Monday, September 30, 2002 – Print Edition, Page B1

In 1885, just four years before American essayist Ralph Waldo Emerson noted that the world beats a path to the doors of inventors of better mousetraps, Bell Telephone Co. of Canada spun out its manufacturing operations, creating a company called the Northern Electric and Manufacturing Co.

Emerson’s famous phrase seemed to have been a guiding light at Northern Electric, later to be Northern Telecom and, most recently in 1998, Nortel Networks Corp. of Brampton, Ont.

For most of its history, Nortel made its shareholders tremendously wealthy by building better mousetraps in the form of whatever passed for advanced technology of the day. In the 1880s it was sleigh bells, fire alarms and telephone switchboards. In the 20th century it was radios, telephones, TV sets and, during both world wars, ammunition.

“Nortel has always been a technology company that took advantage of opportunities. It’s the ultimate supplier,” said Elliot Schreiber, who now teaches at the business school at McMaster University in Hamilton, but was Nortel’s senior vice-president of corporate marketing and communications, from 1995 to 1999.

For the past few years, Nortel excelled at building and selling fabulously complex machines built out of laser generators, mirrors and hundreds of microprocessors.

These are the optical switches that are at the heart of the all-optical Internet, the network that would ring the globe and that could carry digitized voice traffic, data bits, videos, sound files and much more at fabulous speeds and in mind-bending quantities.

And the world did indeed beat a path to its door for these machines. Sales at Nortel ballooned to more than $30-billion (U.S.) in 2000. But in 2001, the world stopped buying these fabulous machines as abruptly as it had started. Revenue for 2001 was just more than $17-billion. For the first six months this year, revenue has climbed to only $5.5-billion.

“What does an opportunistic company do when there’s no more opportunities?” Mr. Schreiber said. “What do you do when no one needs anything supplied?”

All three main segments of Nortel’s business — metro and enterprise networks, wireless, and optical — have slowed. Metro and enterprise networks are typically geographically concentrated computer networks within metropolitan urban areas or at large enterprises or companies, respectively.

But slow is one thing — bleeding buckets of money is another.

Nortel said its metro and enterprise segment contributed $739-million to the company’s profit margin in the first half of 2002. The wireless segment was good for $173-million of margin. The optical sector’s margin, though, was a negative $1.02-billion. In other words, the cost of selling whatever the optical segment sold exceeded the revenue it earned by more than $1-billion.

And so, just as it was once time for Nortel to stop making sleigh bells and TV sets, it may now be time for Nortel to shut down — or at least suspend — that part of its business involved in the next-generation all-optical Internet.

There’s one simple reason for this: What Mr. Emerson said is not true. A better mousetrap does not necessarily result in customers beating a path to your door. No one wants to buy what Nortel became so good at making.

“You have to build the business case now for your customers. They won’t buy it just on faith,” Mr. Schreiber said.

In Nortel’s glory days in 1999 and 2000, telecom customers were buying the big fancy optical components because their competitor was. No one ran the numbers to see if the equipment would pay off for the service providers. It was purchased on faith, a build-it-and-they-will-come attitude that has sunk companies such as Teleglobe Inc., Global Crossing Ltd., 360networks Inc., and others.

There is now enough capacity on the world’s Internet backbones, some experts say, to last 50 years. Nortel’s equipment was used to build 75 per of those backbones. Demand is just not going to catch up to supply for a very long time.

But in an interview Friday, Nortel chief executive officer Frank Dunn said optical network equipment is central to the company’s product portfolio, particularly when it comes to the metro and enterprise category.

There is rough consensus among analysts and some of Nortel’s institutional investors that the company must shutter at least one of its business divisions. But there is less agreement about which one. Some say Nortel should get out of the metro market and avoid competing with Cisco Systems Inc.; others say wireless won’t pay off fast enough as Nortel must finance the purchases made by cash-poor countries such as China, and those in Latin America. Still, optical seems to come up as the likeliest candidate for pruning.

“I think now is the time to be more aggressive than less aggressive and more focused,” said Steve Levy, managing director and telecom analyst at Lehman Brothers Inc. of New York. “Businesses that are not likely to be profitable in the next year, you should be getting out of. New products like [Nortel’s] HDX, the optical cross-connect, I think they’ve given it a shot. Shut the thing down.”

Mr. Levy also said there are some optical gear products aimed at the metro and enterprise market (Nortel recently started accounting for these products in its optical segment) that are showing little signs of life.

“Unless they’ve got businesses we’re not aware of, that’s a key candidate,” Mr. Levy said.

As a percentage of the firm’s overall revenue, optical made up 11.7 per cent of the company’s sales in 2001, down from 26.3 per cent in 2000. Wireless, though, grew to 29.3 per cent in 2001 from about 18 per cent the year before. The metro and enterprise portion has stayed at about 45 per cent through 2000 and 2001.

As far as this year goes, wireless continues to grow as a portion of Nortel’s overall sales while metro/enterprise and optical have formed a smaller share of sales.

Nortel’s customers are no longer thinking about a bright shiny future of an all-optical Internet. Analysts say they want gear that will cut their costs right now on the kind of networks they already operate.

“Unless they are going to get a 12-month payback, they’re not buying the equipment. That is a very short payback for these carriers historically,” Mr. Levy said.

Mr. Dunn, though, says the optical gear is at the centre of the company’s product strategy.

“Having [optical] in the network is critical and Nortel’s the leader. What I need to do in optical is get the business that does not lose money at this kind of sustaining level. That business is a business that’s viable, that’s important, and that is fundamental to transform networks. I just can’t afford to have a huge infrastructure when no one’s buying that.”

Nortel once had 1,000 customers for its optical gear and the average size of a deal was, well, monstrously huge. Now, Mr. Dunn says, he’s got 60 customers who buy optical gear. Analysts say the deal size is also getting smaller.

“So how we were organized to do what we did in the past has to be adapted to what’s coming in the future,” Mr. Dunn said. “Some of our development programs we’ve adjusted as well. We were bringing out new technologies that no one was going to put in the network for a while. So we’ve managed those profiles.”

That “profile management” led, last week, to the company’s decision to quietly — that is to say, without a press release — shut down its CoreTek business, a unit it acquired in 2000 for $1.16-billion (U.S.) in stock.

The 160 employees in the Boston-based unit made — and here we must rely on the company’s description — “very advanced tunable products, including lasers, filters and optical performance monitoring products for use by Nortel Networks in its own products and for sale to the external market.”

In other words, CoreTek was on the bleeding edge of research into products for the all-optical Internet, the very thing that Nortel and others can no longer afford to sell any longer for the simple reason that no one is buying. David Akin is national business and technology correspondent for CTV News and a contributing writer to The Globe and Mail.