Telco suppliers go from boom to bust

Why are the big telecoms equipment vendors struggling in the age of IP?

When Huawei was confirmed as the world's largest supplier of telecoms networking equipment in the first half of this year, it marked the culmination of a challenging decade for all the other major suppliers that had, until the emergence of Huawei and ZTE, dominated the market.

While Huawei and ZTE had prospered by offering aggressive pricing, first winning customers in emerging markets before moving in on the US and Europe, they alone were not the cause of the crisis among the venerable giants of the global telecoms equipment world.

A combination of standardisation and unexpected changes in customer demand, combined with a global slowdown in demand for new equipment, has caused a decade of bankruptcies, mergers, acquisitions and consolidation across the market – which has even rebounded to affect Huawei and ZTE.

A major part of the problem, according to Emir Halilovic, program manager, networking and infrastructure EMEA, at analyst group IDC, is that the industry did too good a job of driving through standardisation.

As a result, their once high-margin, proprietary products have become commoditised and the market has become price-driven rather than technology driven – and the industry's giants were ill-prepared to adapt to this shift.

"All those vendors agreed on a set of standards that opened the industry to competition," says Halilovic. "They are now in a situation where the telecoms providers, who are practically their only clients, are basically squeezing margins as much as they can."

"When you had only voice equipment, right up until the early days of GSM [the 2G mobile network standard], only a few people could make that. Nowadays, it's pretty much open for a lot of other parties and now it's a question of who can do it cheaper and on the largest scale; and, who can best fit their products to the requirements of the clients," he adds.

As a result, the price-driven strategies of Huawei and ZTE – unencumbered by a legacy telecoms business – has reflected this market shift, rather than driven it. They also pioneered the concept of multi-mode base stations, base station that could handle 2G, 3G and even 4G on a single platform, which were attractive to cost-conscious mobile operators.

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Telco suppliers go from boom to bust

Why are the big telecoms equipment vendors struggling in the age of IP?

Mobile mirage
At the same time, the boom in mobile data communications ignited by the Apple iPhone has not proved the saviour of the business that many had hoped it would be.

While the epicentre of telecoms operators' technology investment shifted from fixed to mobile technology, standardisation has squeezed prices and margins before, more recently, investment started to stall, too.

And for the survivors of the past decade, their current troubles are all the more worrying given the level of consolidation that has occurred over the past decade.

A number of well-known vendors – such as Marconi (formerly GPT) and Nortel – have disappeared, while mergers and acquisitions have helped bolster product portfolios on the one hand, while taking out rivals on the other.

Alcatel merged with Lucent to form Alcatel-Lucent in 2006; a year later, Nokia and Siemens, likewise, merged their respective telecoms equipment units into a spin-off company, Nokia Siemens Networks, 51 per cent controlled by troubled Nokia; and, Ericsson has made a number of major acquisitions, including the greater part of Marconi and Redback Networks.

That ought to have left more than enough room to accommodate Huawei and ZTE, yet all are facing still more consolidation and another recent wave of restructurings.

Alcatel-Lucent, led by former BT CEO Ben Verwaayen, is in the most trouble. In the past five years, it has burned about €4bn (£3.14bn), while in the next three years it has bonds to repay (or rollover) of €850m (£670m), €585m (£460m) and €925m (£725m).

In response, the company is cutting 5,000 jobs as part of a bid to save €1.25bn (£980m) in costs.

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Telco suppliers go from boom to bust

Why are the big telecoms equipment vendors struggling in the age of IP?

"Alcatel-Lucent had a lot of voice business before; it still has a lot of optical business. It has a very good IP networking business that has been growing. That's probably the healthiest part of the company at present, though, and it is putting a lot of effort now into LTE 4G networking," says Halilovic.

A key area of growth for Alcatel-Lucent is "small cell technology", which involves smaller, shorter-range wireless infrastructure installed in volume in city centres closer to users. The market is forecast to boom over the next decade, but Alcatel-Lucent will have to overcome competition from Cisco Systems and Ciena.

However, in mobile networking Alcatel-Lucent is almost starting from the back. "Its biggest problem is that it did not have a position in the UMTS [3G] space and that's hampering all their efforts in wireless at present," adds Halilovic.

Furthermore, the shift from 3G to 4G does not require the same level of equipment upgrades that were required in the shift from 2G GSM-standard networks.

"In many cases, part of the upgrade is only a software licence compared to the past, where they needed to buy big-iron boxes," says Daryl Schoolar, principal analyst, network infrastructure telecoms, at Ovum.

Nokia Siemens Networks, meanwhile, is cutting even more deeply than Alcatel-Lucent, with 17,000 job cuts planned – about one-in-five of the workforce. Indeed, it has even appointed a "chief restructuring officer", Alexander count Matuschka von Greiffenclau, to oversee the programme.

Of the major European vendors, Ericsson is arguably in the strongest position, due to its acquisition of companies such as Redback – giving it a strong position among some of the biggest internet service providers – and its historic strength in mobile telecoms equipment.

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Telco suppliers go from boom to bust

Why are the big telecoms equipment vendors struggling in the age of IP?

Pulling back
And of late, even Huawei and ZTE have not been immune, with spending by China's telecom operators slowing down, and Huawei and ZTE's sales growth declining.

"There's been some evidence that they are pulling back on their aggressive pricing practices; that they intend to focus more on growing their profit margins," says Schoolar.

Indeed, ZTE recently issued a profits warning, while Huawei has admitted that it is grappling with rising wage costs and declining gross-profit margins. Both are focusing more on telco services.

"The telecoms industry is in a state of flux, with margins lowering all the time, and even the available spending within 'telcos' is heavily under pressure as a result of their own revenues levelling out," says Halilovic.

And just when many might have thought that the market is settling down, they may face some stiff competition – or maybe another merger partner – in the form of Samsung, says Schoolar. It is already a major supplier to Korea's telecoms operators, both fixed and mobile, and is focusing on LTE technology.

Hence, when broad spectrum wavelengths are sold off and operators shift from strategic implementations in major urban areas to nationwide rollouts, it may be Samsung that seeks to aggressively gatecrash the "big five".

"I don't think the economy is encouraging investment right now. Everyone's holding on to their money, worried about what might happen," says Schoolar.

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Telco suppliers go from boom to bust

Why are the big telecoms equipment vendors struggling in the age of IP?

Austerity among the major players

Alcatel-Lucent – formed from the merger of France's Alcatel and US vendor Lucent in 2006 and has yet to post a full-year profit. CEO Ben Verwaayen claims that the company has now been "returned to normal", but profit margins remain low compared to market leaders such as Ericsson.

Ericsson – The main developer of the 3G networking standards lost its position as the world's largest telecoms equipment maker to Huawei earlier this year as sales of CDMA equipment fell by half. The company also sold its interest in Sony-Ericsson, in which both companies had merged their respective handsets businesses in 2001, earlier this year.

Huawei – Became the world's biggest vendor of big networking equipment in the first half of 2012, just ahead of Ericsson, but it has seen its margins squeezed by rising labour costs.

Nokia Siemens Networks – Formed by the merger of Nokia and Siemens' telecoms equipment businesses, with Nokia enjoying a 51 per cent controlling stake. It is shedding 17,000 staff worldwide – approximately one-in-five of the workforce – in a bid to save €1bn (£790m) and prepare the company for an initial public offering.

ZTE – The number five in the market for major telecoms equipment, and the number four mobile handset vendor, leapfrogging BlackBerry maker Research In Motion. However, recent falls in sales have severely dented the company's margins, leading to a profits warning.

Lest we forget...

Marconi/GPT – bulk of the company acquired by Ericsson in 2005 after failing to win a single contract for BT's 21st Century Network project.

Nortel Networks – former Bell Canada plunged into Chapter 11 bankruptcy protection in January 2009 after a decade of financial crisis. Major assets sold off, while former CEO Frank Dunn and his chief financial officer, Douglas Beatty, have recently been tried for fraud.

Redback Networks – acquired by Ericsson.

Motorola – mobile handset division acquired by Google; telecoms equipment division sold to Nokia Siemens Networks.

Newbridge Networks – acquired by Alcatel for $7.1bn (£4.54bn) in 2000