Case study: Nortel

The story
In the 1980s Nortel began its evolution from being a supplier of telecommunications equipment to Bell Canada, the telecoms company, into an international competitor in the equipment manufacturing sector.

By the late 1990s, it had become one of the world’s largest telecom equipment suppliers alongside Lucent, Ericsson and Alcatel, and one of Canada’s biggest companies by market capitalisation.

The challenge
The 1990s presented several challenges to telecom equipment manufacturers, particularly those in North America.

These included: the deregulation of the US market as a result of the Telecommunication Act of 1996; this, in turn, led to the arrival of European competitors into North America through acquisitions (for instance Alcatel acquired DCS in 1998) or through organic expansion; the spin-off of Lucent from AT&T in 1996; the emergence of wireless and the internet changed the technology paradigm, which allowed new entrants such as Cisco Systems to penetrate the equipment market.

How did Nortel respond
The company’s leadership adopted short-term reactive tactics which did long-term damage.

First, it chose the wrong leaders who implemented the wrong strategies. This process began with the appointment of Paul Stern in 1989, who stayed in the role until 1992. Rather than hiring someone with knowledge of the company’s strengths in engineering and research and development, Mr Stern’s focus on smoothing earnings and increasing revenue came at the expense of investment in these core competencies. This led to product recalls which damaged the company’s reputation and credibility.

In 1992, the company appointed Jean Monty, another non-engineer, as president. While he restored R&D expenditure to previous levels, he did not adequately respond to the new disruptive technologies. Moreover, under his leadership, Nortel fell into the trap of the “irrational exuberance” of the telecoms industry by boosting its revenue through customer-financing.

In 1997, Nortel appointed John Roth as president and chief executive. An engineer with extensive experience in the organisation, he recognised that the company had responded poorly to new technologies and adopted an aggressive route to transform Nortel into a “software-centred telecom product company” through a series of acquisitions.

Strategically, however, Mr Roth’s plan did not work because it was not aligned with Nortel’s core competencies in electronics engineering. Instead it simply made the company vulnerable to competitors such as Cisco.

It also strained Nortel’s balance sheet as the company spent $30bn within two years to make these acquisitions. Subsequently it had to write off $12bn as goodwill impairment charges in 2001.

Key lessons
Management in a global environment is always challenging, but even more so in the technology industry where disruption is the norm rather than the exception.

Based on the Nortel examples, this leads to the following broad conclusions.

First, good management requires recognising and acting swiftly to disruptions and aligning them with the company’s vision.

Second, companies need to maintain their long-term strategic focus and vision. Nortel suffered because its efforts to branch into other sectors were handled badly, and the constant switching of direction between a series of chief executives focused on short-term issues merely served to confuse and damage the company in the long term.

Third, leaders need to recognise a bubble when one presents itself and respond accordingly. Management by fad never works.

Fourth, maintaining a healthy bottom line is more important than tolerating negative net income.

Finally, management’s incentives should not lead to behaviours such as smoothing earnings or customer-financing.
- Financial Times, 15 Dec 2010