September 9, 2004

More Cuts at Nortel

How far will Nortel go when it comes to reducing operating expenses? That's the $64,000 question - or perhaps the US$10-billion question given Nortel's annual sales - after CEO Bill Owens said yesterday that he wants to reduce operating costs to less than 25% of sales.

With such an aggressive target, Owens is clearly looking to completely re-invent the struggling telecommunications equipment maker. The question is: why so much, so soon? It may be that Owens wants to make his mark as a CEO given that running Nortel - or any other large, world-class company - did not appear in the cards for the former U.S. Admiral until Frank Dunn was fired in April.

If you look at Owens' track record at SAIC and Teledesic, there is little to suggest he has the pedigree to thrive in the private sector. It makes the five-year package that Nortel gave Owens look extremely generous - particularly the five year timeframe for someone viewed by many at a temporary, stop-the-bleeding selection. Owens' willingness to make dramatic strategic moves may have to do with the fact that given Nortel's need to distance itself from its troubling accounting scandal, he has jumped at the opportunity to overhaul Nortel so it can stay competitive.

There is little doubt that if Nortel maintains the status quo, it will likely become a second tier supplier - while Cisco and upstarts such as Huawei Technologies continue to gain momentum. If Nortel does reduce its workforce even further to 25,000 people, you will be looking at a company with a staggering 75% fewer employees that it had at the peak of the telecom boom.

The question that begs to be answered is what will Nortel look like after Owens is finished his corporate makeover? Will he be a Jean Monty or a Paul Stern? At this point, there is no doubt Nortel will be a smaller company focused on a few high-growth areas. This is a long way from the "be all things to all people" strategy embraced by Frank Dunn and John Roth. It also suggests Nortel may become more like Ericsson, which has morphed itself into a wireless player out of financial necessity. Perhaps a much bigger question facing Nortel is whether its future lies with a marriage to Cisco.

Sure, Cisco CEO John Chambers has made it clear that he does not like doing large acquisitions, but a deal for Nortel would make it an IP powerhouse in the corporate and carrier markets. Chambers may be motivated by the reality there a number of aggressive Asian equipment makers such as Huawei emerging as dangerous threats. If Cisco wants to maintain its dominance, you have to wonder whether it can afford to maintain its small, strategic M&A strategy.

In theory, Nortel seems to be vulnerable to a takeover if Owens slashes costs and improves profitability. In reality, however, the major obstacle may be the Canadian government's reluctance to see its flagship high-tech company falls into foreign hands.

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