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Lucent Looks Longingly at Services

By Olga Kharif For Lucent Technologies, 2002 was tough, and next year doesn't look much better. Many of the telecom equipment maker's customers cut capital spending by as much as 50%, a figure that could drop an additional 20% in 2003, according to Lucent's own estimates. In the red and searching for ways to return to breakeven in 2003, Lucent (LU) is sniffing for pockets of growth that could help it pull through hard times.

In particular, it's betting on services. In the past, Lucent has provided equipment assembly and integration, which accounted for $2.7 billion, or 22%, of its revenues in its latest fiscal year (ended Sept. 30). But as equipment purchases have stalled, so has demand for installation work -- a low-margin business anyway. Now, Lucent plans to increase its annual service revenue by 10% or more by offering new kinds of support -- such as taking on network operations and maintenance for telecom carriers, says Bill O'Shea, executive vice-president for corporate strategy and marketing (see BW Online, 12/19/02, "Nobody Can Do Everything").

SEARCHING FOR HELP. For many carriers, outsourcing these functions is starting to make sense, in part because of the cost savings. For example, thanks to its huge economies of scale, Sweden's Ericsson (ERICY), the world's largest maker of wireless gear, offers its outsourcing customers 15% to 20% lower operations costs, claims Johan Wibergh, vice-president for managed and support services.

Plus, carriers increasingly lack the technical expertise to run their own networks. Some have laid off a third of the staff involved in the telecom network build-out, according to consultancy Booz Allen Hamilton. Also, networks are growing more complex.

All this means carriers might be willing to look outside for help. "Before, I'd call a customer and suggest [they outsource network operations], and they'd throw me out of the room," says Frederic Rose, chief operating officer for network services at telecom equipment maker Alcatel (ALA), based in France. "Today, they initiate this conversation."

START OF A SHIFT? In fact, services could prove a big help for Alcatel, which hopes to double revenue from this source in 2003, in getting to profitability. The same is true for Lucent, analysts say. "It's a very important part of the Lucent [turnaround] story," says Steve Levy, an analyst with Lehman Brothers.

By many measures, the telecom industry is still in a shambles. But 2003 could mark the beginning of a shift for many equipment manufacturers from hardware to software and services. As the industry matures, the services market represents a bigger opportunity than hardware. Carriers spent $80 billion on outsourcing network operations, maintenance, and installation in 2002, according to a Booz Allen November report. But they also spent $188 billion on billing and maintenance and operations internally -- and at least half of that amount could be up for grabs in the next few years, says Eric Riddleberger, a vice-president at Booz Allen. Compare that to the $60 billion equipment market, which isn't expected to recover any time soon.

Wireless carriers are likely to jump on the outsourcing bandwagon before regular phone companies do. The wireless networks are complex, and operating them involves a steep learning curve, points out Steve Wright, director of stakeholder relations at telecom Hutchison. After moving to a more advanced wireless technology and allowing for more new applications, such as video streaming, the number of Hutchison's operating platforms -- for things like billing and text messaging -- should shoot from 6 to 45, says Wright. "We shouldn't devote our resources to the technological challenge," he says. "We'd end up doing a lot of rework and end up paying a lot more."

UNION RESISTANCE? Still, it'll take years and a big strategy shift for carriers let themselves outsource what many of them consider their core business. They also worry about creating conflicts with their unions and jeopardizing their networks' reliability. "Our people are the best qualified" to take care of our network, says Dave Johnson, a spokesperson for long-distance provider AT&T (T), which runs the world's largest telecom network. Most of AT&T's several thousand technicians have been with the company for an average of 25 years, he says, adding, "They understand the network inside out."

Plus, much of AT&T's workforce is unionized, and unions usually don't look upon outsourcing kindly. Still, their resistance can be overcome. Hutchison won't lay off most of the 300 employees affected by its outsourcing agreement with Ericsson. Instead, Ericsson will take these workers on. They'll continue to focus exclusively on maintaining and operating Hutchison's network, explains Wright, while Hutchison will concentrate on marketing and designing new wireless services.

One big challenge telecom equipment makers face is that most telecoms networks are a mesh of equipment from different suppliers. And if a switch breaks, a supplier might not want to explain its workings to a competitor that's managing the network, says Andrei Jezierski, a founder of tech strategy consultancy i2 Partners in New York.

"REAL OPPORTUNITY." Lucent, for one, is developing a strategy to counter such situations. "In this environment, no individual player can do it all," says O'Shea. That's why Lucent is expanding its products and marketing agreement with server king Sun Microsystems (SUNW) and is working on new partnerships. "We think this will be a real opportunity to consolidate the business," O'Shea says.

Of course, the equipment makers will face tough competition in this new market, too. Many info-tech consultancies are also looking to the services market for new revenue. Plus, computing and services giant IBM (IBM) is talking to many U.S. telecoms about network operations outsourcing, says Dean Douglas, telecom-industry vice-president at IBM Global Services.

And on Dec. 2, Ericsson Australia announced a seven-year agreement to operate Hutchison's paging and wireless networks. The wireless carrier estimates the outsourcing should result in $22 million to $28 million in savings over the time of the contract. Nine days later, Ericsson also announced an agreement with mobilkom Austria to integrate and support its advanced wireless network.

RISKY BET? Systems integrators and services companies like Accenture (ACN) and IBM could beat out Lucent and it ilk. After helping telecoms with strategic consulting, they have the services expertise and the customer relationships in place. Plus, much of the initial outsourcing will be in areas like billing and customer support, says Booz Allen's Riddleberger. And IBM, with its standardized, highly popular equipment and services expertise, might be better positioned to pick up that business than the likes of Lucent.

"I would not bet on any equipment provider becoming a major services company as well," says Jezierski. Still, many analysts say this market is up for grabs and that some equipment makers have the expertise to help their customers manage complex networks. It's a business these companies didn't see themselves entering, but as the telecom industry struggles to recover, they're eager to convince investors they have new ways to turn a profit. Kharif covers technology for BusinessWeek Online in Portland, Ore.

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