Mergers Reshaping Telecom Equipment Market

Shareholders approved last week the merger of Lucent and Alcatel (NYSE: ALU), a deal first announced in March. The pairing is one of a handful that has taken place in the telecommunications equipment market since the year began. The changes underscore the diminishing vitality of the telecom equipment market and serve as a precursor to additional consolidation in the coming years.

"The telecommunications equipment industry is moving to a model where carriers will rely on a few large suppliers," predicts Bob Hafner, an industry analyst with market research firm Gartner (NYSE: IT).

A Changing Marketplace

In addition to the Lucent-Alcatel marriage, Ericsson (Nasdaq: ERICY) acquired Marconi, and Nokia (NYSE: NOK) and Siemens (NYSE: SI) formed a joint partnership, Nokia Siemens Networks. Not surprisingly, diminishing growth rates is one reason for the consolidation. The recent buildup of wireless communications and the Internet has slowed, so it has become difficult for equipment vendors to maintain historic revenue and profit growth rates.

The emergence of new suppliers has also put pressure on product pricing. Chinese networking vendors such as Huawei Technologies and ZTE, for instance, have been experiencing some success by offering low-priced systems. The end result is that network equipment pricing has been dropping.

The merged companies expect that they will reduce their operating expenses by consolidating duplicate functions. "Network equipment suppliers are quite cognizant of the benefits of economies of scale," notes Thomas S. Valovic, program director, VoIP infrastructure, IDC.

Fewer Carriers, Fewer Equipment Vendors

Another factor is the number of telecommunications carriers has been decreasing. Longstanding industry leaders such as AT&T (NYSE: T) and MCI have merged with or been acquired by other companies, thus the number of potential telecommunications customers has dwindled.

Like the telecom equipment vendors, carriers have been under competitive pressure and have been looking for ways to reduce their operating expenses. Carriers want to deal with fewer suppliers because it enables them to streamline the procurement process and realize the benefits of volume discounts.

Telecom companies have become more global as well as larger. T-Mobile and Vodafone are two companies with significant international presences. To serve such firms, some of the merged companies are trying to balance their geographic reach more evenly. In 2005, Alcatel made about half of its sales in Europe while Lucent consummated about two-thirds of its sales in North America. As a result, the new company is expected to make 35 percent of sales in Europe, 34 percent in North America and 31 percent in the rest of the world.

Movement to Hybrid Equipment

Another factor is that the design of telecom networks has been shifting. Carriers have been moving away from traditional circuit switching technology to IP systems. Increasingly, carriers are looking for hybrid devices that support both types of networks. Many of the newly merged companies should be in a better position to offer such products.

Also, in some cases, the equipment vendors did not have all of the products that a carrier desired. Alcatel has done well with optical devices and digital subscriber line equipment, which U.S. phone companies have been buying at a rapid clip to expand their broadband businesses. Lucent has been strong in the wireless space. Ericsson was strong in the wireless market, and Marconi's business was built with wired products. Siemens expertise was in packet networks while Nokia's experience centered on wireless technologies.

While the changes present some potential benefits, there are also possible pitfalls. The new companies have to determine the best way of melding their different product lines. Lucent decided to spin off its enterprise networks business into Avaya in 2000 and focus on delivering equipment to carriers, for instance. Alcatel has continued to deliver a wide range of enterprise systems as well, along with pushing products to carriers.

Companies, therefore, will have to figure out which items to keep and which to ditch.

Reshaping Corporate Workforces

A sticky issue is determining how to cut their new workforces. In the Alcatel-Lucent case, about 10 percent of the new company's workforce, which stood at about 88,000 employees at the beginning of the year, is expected to lose their jobs as a result of the merger. When the issue of potential cutbacks arises, politics emerge, and employees often end up fighting to hold their positions, sometimes at the expense of the companies they work for.

"As they go through a large merger, many companies tend to become distracted and do not move as quickly when developing new products as they have in the past," IDC's Valovic told TechNewsWorld.

Because the new companies are so large and the work they are doing is so complex, the long term impact of the changes may be hard to determine at the moment. In the short term, the potential for additional consolidation seems clear. "While there has been significant consolidation recently, a number of large telecommunications equipment vendors are still standing," Gartner's Hafner told TechNewsWorld.

Ayava, Enterasys, Motorola (NYSE: MOT), Nortel and 3Com (Nasdaq: COMS) are among the companies that could benefit from becoming larger. Cisco (Nasdaq: CSCO) has been able to grow its business mainly through small acquisitions and may be ready for a large acquisition. Fujitsu and Samsung are a few Asian suppliers that may want to team up with other vendors.

The end result is the telecom equipment market has only begun to reshape itself. "Additional consolidation is not just possible: it is quite likely," concluded Gartner's Hafner.