What Really Happened At Northern Telecom

Perhaps in no industry but technology could a company fall so far, so fast. In January, everything seemed so right for Northern Telecom Ltd. The phone-equipment giant announced record results for 1992, and its then-CEO and chairman, Paul G. Stern, expressed optimism for the year ahead. Stern's once obscure Canadian company had successfully stolen market share from industry leader American Telephone & Telegraph Co. in the U.S. (chart) and had established strong footholds in such fast-growing regions as Asia. His bold goal of unseating AT&T to make Northern the biggest telecommunications equipment supplier in the world by 2000 didn't seem too farfetched.

That vision unraveled quickly and dramatically. Days after the bullish earnings report, Stern abruptly announced he would step down as CEO to pursue other, undefined interests. The former IBM executive was replaced by Jean C. Monty, a longtime executive of Bell Canada. Then, on June 25, Monty dropped a bombshell: Northern would post a second-quarter loss, its first in almost five years. But Monty's warning didn't prepare investors for the actual results, announced on July 21--a staggering $1.03 billion in red ink, due mostly to a $940 million charge against earnings to pay for 5,200 layoffs, plant consolidations, and other items. The company blamed the cutbacks on increasingly tough price competition.

CUSTOMER COMPLAINTS. How did Northern slip into a tailspin so severe that half its stock market value has evaporated since January? Simply put, a company famous for quality products and service let down some of its key U.S. customers, selling them shoddy goods while management focused instead on overseas expansion. Executives delayed a painful decision to revamp overly complex phone-switch software, compounding the problems. And there was tension between Stern, the cocky American CEO, and customers and employees of the company Canada regards as its high-tech treasure.

The trouble started sometime last year, when several major U.S. phone companies experienced problems with the software in Northern's phone switches, the computerized devices that direct calls at phone-company central offices. An executive at one of the companies, speaking anonymously, says Northern took too long to fix the glitches. According to analyst Michael Arellano of market researcher Northern Business Information, things got so bad that several Baby Bells went over Stern's head to complain to Bell Canada parent BCE Inc., which owns 53% of Northern's stock. Northern wouldn't comment on the assertion.

Even worse for Northern, some phone companies began to delay acceptance of the switches and software upgrades they had ordered, according to analysts and the phone executive. "It was really a way to get Northern to act," says Arellano. Northern subsequently delayed new versions of its software until the problems could be fixed, helping drive revenues down 4% in the second quarter, to $1.87 billion.

Stern, in his first interview since Northern's problems were disclosed, argues that switch software always has bugs. The trick, he says, is to work closely with customers to fix the problems. He denies that customer service deteriorated during his tenure and says he knows nothing about customer complaints to BCE. The former CEO has his own explanation for Northern's problems: The company, he says, lost momentum and its customer focus due to a string of executive changes following his own departure. "That destabilizes an entire organization," he says.

BLUNT STYLE. Monty and others tell a different story. Monty says he realized there was a problem soon after the board installed him last October as the company's No.2 executive, naming him president and chief operating officer. In talks with customers and Northern managers, the software problems kept coming up. "Customers are saying: `You guys are not as good as you used to be,"' Monty told BUSINESS WEEK. Bugs were not the only problem. Software sales also slowed as Northern was unable to issue new versions as quickly as in the past, he says. Updating with new features used to take six months; now, with each change requiring thousands of tests, it takes up to a year and a half. That's due to the complex, custom-written development of the software, compared with AT&T's standardized approach.

Monty says he proposed to Stern late last year a major software revamping and simplification. Stern agreed in principle, Monty recalls: "The issue was how much and how fast." Stern says he had studied the software revamping while he was still CEO but "I could never figure out how to do it" without disrupting operations.

Some observers speculate that Northern's customer problems drove Stern from the company. Stern denies that. "I was at no stage asked to leave or pushed out," he says. Stern says he resigned because Northern's board, apparently at BCE's behest, installed Monty without his consent last fall. "Nobody is going to shove a president down my throat," he says. Stern says Monty lacks international experience and a manufacturing background. His own candidate for the post: Edward E. Lucente, a former IBM colleague that Stern had brought in as a marketing expert. Lucente is now at Digital Equipment Corp.Stern apparently had lost the support of Northern's board, which is controlled by Canadians, including two BCE executives. A source familiar with the board's reasoning says BCE had concerns about Stern's blunt management style, which didn't sit well with some employees and customers and clashed with Canada's business style. At a time when Northern needed to improve its customer relations, Stern and Lucente were considered wrong for the job, the source says.

Now, Northern must mend fences with customers. There are hopeful signs: The company just signed a $102 million deal with China. But rewriting millions of lines of software to end the problems will cost $158 million. Monty says new software won't be rolled out until 1995.

Will that be quick enough? "They've got 18 months to solve their problems. That is about the time that their best customers will stand still" before shopping around, says Howard Anderson, managing director of telecommunications researchers Yankee Group Inc. Monty better hope his customers have at least that much patience.

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