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How Big Ed Torpedoed Lucent, and Other Stories
[April 17, 2006]

How Big Ed Torpedoed Lucent, and Other Stories

ionary Consulting
The telecom equipment marketplace was surely one of the bigger victims of the 2000-2002 meltdown.  An industry that grew rapidly in the late 1990s, fueled by the growth of the Internet, mobile telephony, and local competition, it hit the wall hard when the money dried up.  Capital expenditures are particularly sensitive to economic conditions, after all.

It’s also important to recognize the historic role of the manufacturing sector.  The original 1984 AT&T (News - Alert) divestiture began with a 1949 antitrust case against Western Electric, AT&T’s manufacturing arm.  The heart of the problem was the cozy relationship between the telephone giant and its own manufacturing arm, which largely excluded the rest of the manufacturing industry from selling to over 80% of the telecommunications marketplace. This was hardly a way to promote progress.

Europe’s industry worked a bit differently in those days.  Each country had a government-owned telephone monopoly, the PTT, but it didn’t manufacture its own supplies.  Instead, it generally worked with national vendors, creating little protectionist markets for each country’s own suppliers.  So Germany’s PTT, Deutsche Bundespost, was good to Siemens, while France’s PTT supported Thomson and Alcatel (News - Alert), and Britain’s BPO was good to Plessey, GEC, and other names that are now receding into history.  These manufacturers were at least somewhat competitive in sales to smaller countries around the world, ones that didn’t have their own vendors.  Sweden’s Ericsson (News - Alert) and the consummate multinational ITT had widespread deployment.
Rather than divest Western Electric, which the Department of Justice had originally asked for, AT&T management decided in 1982 to divest its local telephone operations, the Bell Operating Companies.  They thought that “WECo” could lead the company to new riches in the rapidly-growing computer industry, from which it was banned by the 1956 Final Judgment (which turned out to not be so final).  This was one of many bad bets placed by AT&T over the past three decades.  Indeed its senior leadership could hardly have been less prescient had it been nothing but an inbred boys’ club of suck-ups who rose by praising each other and not being the bearer of bad news… or were they?
So as the divestiture era began, the RBOCs, now freed from having to buy from WECo, largely adopted a two-vendor strategy, with Northern Telecom, then owned by Bell Canada, as the second supplier of major capital gear such as switches.  Other vendors also got a good piece of the pie, with Fujitsu becoming a leader in fiber optics.  But most switching remained with two players.
The resulting industry dynamics had an interesting impact on the attempted rollouts of ISDN on both sides of the puddle.  The PTTs were monopsonies, sole buyers, for national switch vendors.  They collectively wrote firm standards and held their vendors to it, so Euro-ISDN could develop.  Terminal equipment vendors could thus build to a stable, unified continental standard.  But seven RBOCs were outgunned by two switch vendors, who wrote their own “custom” specs and never really followed anybody else’s standards, and made life hard for terminal equipment vendors.  Two sellers or two buyers do not a true marketplace make.
Following the Telecom Act and the beginnings of the CLEC industry, a number of startups got into the switching business.  The Internet boom led to demand for new transmission gear. While Cisco has maintained a dominant position in the router market, a number of suppliers still occupy niches.  But it’s not the kind of marketplace where you can party like it’s 1999.  And it has just gotten a whole lot worse.
Rather than sell to seven RBOCs, GTE, and a lot of Independents, the marketplace of Incumbent Local Exchange Carriers has become highly concentrated, and is getting even more so.  SBC, er, AT&T Inc. (“Bell West”) and Verizon (“Bell East”) have the lions’ share of the phone business between them.  The major long distance carriers are gone, with only Sprint, of the one-time big four (AT&T, MCI, Sprint and Worldcom), remaining independent.  Wireless is still a vibrant business, but it too has become concentrated.  All of this shifts the power in the equipment marketplace from sellers to buyers. With BellSouth (News - Alert) likely to be another notch on his belt soon, Big Ed Whitacre will have more buying power than ever before.  Between him and Verizon’s Ivan Seidenberg, suppliers who want to sell into the RBOC marketplace will be facing a situation not all that much different from the European monopsonies of the past.  But without the protectionist friendliness.
That’s probably why Lucent chose this time to bow out, selling what was once one of America’s most important manufacturing and technology firms to a French suitor.  They’ve been fighting an uphill battle since the meltdown, getting onto a firmer footing, but the consolidation of the telephone industry was a fatal blow.  Arch-rival Nortel (News - Alert) Networks is perhaps a bit more protected, with its strong market share in its Canadian home base, but it too will suffer.
With fewer buyers and fewer sellers of capital gear, progress cannot help but slow down.  Both traditional giants, Nortel and Lucent, faced serious problems in their core switching and transmission businesses.  ILECs haven’t been buying many switches anyway, but Lucent’s flagship 5ESS family is about as modern as a VAX-11 minicomputer.  Nortel’s DMS family is not much different.  Adding ATM or VoIP warts to the side of an ancient system doesn’t make it modern; both companies largely concentrate on milking the embedded base.  Lucent, at least, got modern switching gear when it purchased Telica, though having to go outside for one was an embarrassment.
Smaller vendors will have an even harder time of it.  A decade ago, when the boom began, an equipment startup could hope to win a contract with a big ISP, IXC, or even an RBOC.  Qwest, for instance, was famous for making deals with startups, back when its stock price was high.  True, those deals may not always have been on the up-and-up, but there were lots of potential buyers for a manufacturer to court. 
Nowadays, smaller equipment vendors are drifting back to shrinking niche markets not all that unlike the pre-1984 marketplace.  True, the niches are no longer just the independent ILECs like the old GTE, Continental Telephone, CenTel and rural mom’n’pops.  But the CLEC and IXC marketplaces are not what they once were.  Some vendors don’t even bother to try to sell to the RBOCs any more – it’s a tough market to crack.  And it’s going to be tougher still.
Mid-sized vendors who have cracked into the Bell markets are likely to tread more carefully now, lest they offend their ever-stronger customers.  This may show up in public policy discourse.  Ever notice how Corning, for instance, was never slow to call for regulatory changes that would help the RBOCs shut out their competitors?  These position statements, and the Astroturf groups who put them out, are about what you’d expect in a Washington shaped by  Jack Abramoff and the K Street Project.  Putting a company’s name on an insincere policy statement is just one more part of the price of doing business with a near-monopsony. 
Some in Washington like to pretend that deregulation brings about a free market.  But that assumes a large number of willing and able buyers and sellers.  Telecom doesn’t work that way – the perquisites of incumbency haven’t gone away.  With fewer buyers, the marketplace will be even less free.  Deregulation and consolidation just give the big players even more market power.
Fred Goldstein is principal of Ionary Consulting. He advises companies on technical, regulatory and business issues related to the telecommunications and Internet industries, especially in areas where they overlap.

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