Racing Ahead At Nortel

The phone maker's new Net-savvy culture is paying off big

John A. Roth, who rose to the chief executive's post at Nortel Networks Corp. two years ago, seems an unlikely apostle of the Net. Partial to funereal dark suits and soft-spoken enough to be mistaken for a modest librarian, he hardly looks the part of an Internet swashbuckler. But look closer. This avid car collector--his "toys" include a new red Prowler, a '66 Jaguar, and a '67 Corvette--hits a local speedway at up to 160 mph. He shares his need for speed with customers, as well: Last fall, Roth took 40 of them to Pennsylvania's Pocono Raceway, where they zoomed around at a mere 90 mph.

These days, that pace is looking modest for Nortel, too. In the past year, Roth has undertaken an overhaul of the lumbering maker of phone equipment, turning it into a fast-growing seller of Internet gear. As the company approaches $22 billion in revenues this year, its sales are growing at nearly 30%. That's faster than rival Lucent Technologies Inc.--and closing the gap on Cisco Systems Inc.'s expected 36% growth this year. Nortel's net income from operations is pegged to top $1.45 billion, a 48% leap, compared with a maximum of 33% growth in years past. Even rocketlike Cisco can't match that. On Oct. 26, Nortel reported a 61% jump in third-quarter operating income, to $380 million. No wonder Nortel's stock has more than tripled this year, to $55 a share.

Credit Roth's hard-charging--and hardheaded--ways. In 1997, when he took the helm of what was then called Northern Telecom Ltd., he knew he had to do something bold. The Canadian telephone giant was in danger of being eclipsed by fleet-footed rivals serving up Net gear. So in 1998, he shelled out $6.9 billion in stock to snap up Bay Networks, a Silicon Valley maker of Internet and data equipment. There was just one problem: Things seemed to get worse. Employees at both companies started jumping ship. And Wall Street analysts gave the deal a big thumbs-down, driving Nortel's stock to below $15 a share, less than half its price before it bought Bay. The idea that an old phone maker and a struggling California networking company could help each other seemed like a desperation move.

"WEB SPEED." Now, 15 months after the merger, what appeared to be desperation is looking more like divine foresight. Bay brought Nortel top-notch Net technology, setting it up to compete in a brave new world where phone and data networks are fast converging. And Bay's do-it-now Silicon Valley style has helped spark a cultural revival up north: Product introductions have gone from years to months, employee incentive programs are being goosed, and a company sometimes ridiculed for Dilbert-like bureaucracy is showing flashes of entrepreneurialism. "When [Roth] came in, he had a lot of work to do," says Lewis E. Platt, former chief executive of Hewlett-Packard Co., which is collaborating with Nortel to merge computers with phone switches. "I'd give him high marks for making Nortel very Net-aware and Net-savvy." Nortel, crows Roth, now "moves at Web speed."

Especially when it comes to snatching customers away from rivals. In the past few months, Nortel has scored surprising victories against Lucent and Cisco. For starters, Nortel will be supplying more gear for a national network in Sweden after the country's Telia phone company scrapped a deal on Sept. 8 to have Cisco build the system. Cisco concedes it wasn't able to deliver on promised new voice-data combo equipment based purely on Net technology. So Telia used Nortel technology instead. And last year, when Martin Varsavsky, the chairman of Jazz Telecom Inc., was looking for a supplier for a $1 billion fiber network he's building in Spain, he took pitches from Nortel and Lucent. He says he gave the contract to Nortel because it put a design team on the project for three months before winning the business. Lucent wanted commitments up front before designers went to work.

What's even more remarkable is that Roth has succeeded by selling customers on a most prosaic vision: gradual change. While Cisco targets telecom upstarts and labors to persuade phone companies to rip out and replace the billions of dollars worth of "old world" gear they run on, Nortel is pushing a strategy of steady migration to the new world. Roth is offering customers hybrid gear that combines old phone technology with new Internet features. "Nortel has very good technology and very strong implementation," says Daniel P. Caruso, senior vice-president for network services at Level 3 Communications Inc., a Broomfield (Colo.) telecom upstart.

Still, Nortel isn't betting everything on this hybrid technology. It's also the leading supplier of optical systems that move voice and data at the speed of light. On Oct. 12, for instance, Nortel won a $100 million deal to fashion an optical-fiber system linking London, Amsterdam, Dusseldorf, and several other Northern European points for Pangea Ltd., a startup based in Bermuda. Joseph J. Kapusinsky Jr., senior vice-president at Pangea, says Nortel stands head and shoulders above its competitors. "It's at the leading edge of the optical Internet." Recent developments back that up: Nortel is now jamming unheard amounts of data through its optical gear--far more than rivals.

For all that, Roth knows he has a ways to go before customers forget the likes of Lucent and Cisco. Nortel, after all, is still known as more of a technology company than a marketer. Says one former Bay exec who left Nortel a year after the merger: "I'd give them an `F' for marketing."

Nagging challenges like that are one reason investors have only recently started to give Nortel the respect they accord rivals. Cisco's stock trades at a lusty 69 times expected 2000 earnings while Lucent commands a forward price-earnings ratio of 41. Nortel has tied Lucent only in the past few months. One reason it's not higher: Nortel's gross margins of 43% are vexingly lower than those of competitors due to its lingering stake in older, less-profitable telephone equipment. By contrast, Lucent boasts margins of nearly 50%, thanks to higher sales of profitable software and services. "Nortel has more work to do," says analyst Kenneth M. Leon of ABM AMRO Inc.

Roth has already started. He's shedding manufacturing plants, along with some 8,000 employees. And he's diversifying into profitable software and services. On Oct. 18, for instance, Nortel plunked down $2.1 billion for Clarify Inc., a maker of software for managing customer relationships.

Give some credit, too, to the cultural changes now under way at Nortel. Buying $2.2 billion Bay gave Roth far more than just a networking product line: It cleared the path for him to shake up the far larger company. "I'd been looking at a whole bunch of things that were bothering me. When we acquired Bay, I would look at the thing and say, `Well, how do you guys tackle this?"' he says. "Rather than changing the 7,500 people of Bay to adopt Nortel practices, we changed the practices of the 75,000 people in Nortel to look more like Bay."

Consider Nortel's new in-house "phantom stock." Since stock options are a hot motivator in Silicon Valley, Bay had been experimenting with its own type of stock. Roth now gives some employees bonuses in the form of internal shares in special high-risk projects. Nortel agrees to "buy" these projects as if they were companies, in a sort of internal initial public offering. Staffers get paid in two chunks--once when a product is finished and again after it has been on the market for about a year. Some 17 products are in development under the program--although, for competitive reasons, Roth won't say what they are. Already, he says, some employees have seen interim payments worth three times the company's standard bonus.

TRACTOR JOCKEY. If stock is the carrot, fear of unemployment is the stick. With all the acquisitions, Roth has delivered a harrowing message: If staffers don't pounce on Net projects, their careers may be in jeopardy. The purchases, Roth says, "suddenly made a bunch of guys in design teams say, `Wait a minute, John seems to be buying these companies. I should be developing this stuff. Because if he keeps buying these companies, he's not going to need me."'

Roth does need other skills imported from Silicon Valley, though. Nortel is now putting more emphasis on selling products online. Leading that charge is Phyllis S. Brock, an ex-ski instructor who was at Bay for three years and now heads the 40-member group in Santa Clara, Calif., that overhauled the Nortel Web site last July. The result: E-commerce sales have doubled since April. Customers use it to obtain product information or to place orders for some $9.6 billion worth of sales. "The goal is to do everything electronically," says Brock.

A better Web site reflects Roth's taste for well-crafted things--whether they're big, honking data switches or vintage sports cars. Indeed, in what little spare time he has, Roth delicately crafts stained-glass lamps and windows, some of which are in his 50-acre Ontario farm. He also likes tooling around on a tractor. "If I get really frustrated," Roth says, "I'll go take the backhoe and dig up a tree." Or his own company, for that matter.

— With assistance by Andy Reinhardt, and Peter Burrows

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