Lucent Tries a New Tack: Just Say No

Lucent (LU Quote) is about to test whether one extreme will repair the damages of another.

After a run of breakneck growth in the late 1990s left it with a broken neck and a broken stock, the company shifted its focus to the bottom line from the top. The telephone gearmaker is now turning down business that isn't immediately profitable and ending projects that aren't pulling their weight, all in the service of staunching a torrent of red ink.

While the new approach appeals to financial logic -- with its legion of problems, Lucent can ill afford to indulge unprofitable businesses -- it also raises questions. Will Lucent give up on projects that could earn big returns just a few years down the road? Will the company hamstring innovation by focusing so sharply on the bottom line? Given the cash crunch in the telecommunications industry and the resulting spending slowdown, how choosy can Lucent afford to be?

For its part, Lucent says it's cutting in accordance with its customers' needs and the current market conditions. But considering the company's many product-development missteps in recent years -- notably its late entry into the hugely profitable OC-192, or 10-gigabit optical transport, category -- Lucent shareholders might be understandably skeptical about this austerity program.

"Initially it looked like they were just shooting off their toes with a pistol," says a former Lucent executive. "Now it appears they're blowing their brains out with a howitzer."

Hard Times

Take the soft switch.

Little more than a series of software applications that control calls, the soft switch is considered the Holy Grail of voice switching because it represents the only bridge between Internet-based advances and the old phone system. As the acknowledged steppingstone in network evolution, it promises to keep selling even as telcos large and small pinch pennies. Network gearmakers like Lucent, Nortel (NT Quote) and Cisco (CSCO Quote) have poured ample time and resources into soft switch development in recent years.

Shrinkage Lucent shedding revenue, workers in recent quarters

*Revenue figures are quarterly. **Sept. '01 and Dec. '01 numbers are estimates. Source: Lucent.

But recently Lucent's well-regarded efforts to build a local network soft switch abruptly hit a wall. After three years and endless hours of programming, testing and rebooting, Lucent's only truly viable local soft-switch customer, Sprint (FON Quote), demanded deep discounts without making any offsetting volume promises. Lucent, in thrall to the new profitability discipline, rejected the terms. Without hesitation, Sprint gave the entire job to Nortel.

Lucent declined to comment on the contract negotiations, though it says 20 other companies are testing Lucent soft switches. But the majority of those companies are testing the long-distance soft switch, which is less lucrative because it is simpler and carriers need fewer of them.

While it is not clear how much of Sprint's soft-switch business Lucent could have claimed, some analysts estimate its value anywhere from tens of millions to hundreds of millions of dollars. And while Sprint continues to be a buyer of other Lucent gear, Lucent has lost an ideal test bed for a lucrative new line of products as part of Sprint's well-funded large-scale network upgrade.

Sprint is not only a big customer, it is a big phone company ahead of others in moving toward the consensus winner in future communications technology: Internet protocol, or IP. So even if Sprint's business didn't cover the cost of product development, at least an inroad with Sprint would keep Lucent's soft switch in the game as other phone companies come calling for a path to IP.

Cutting

As part of the profitability push, Lucent is seeking to cut as many as 20,000 more jobs; that will put its employment at about 60,000 workers, less than half of the year-ago level. Lucent is also preparing a list of unprofitable customers, countries, products and research centers that it plans to phase out as early as the end of the year.

Among the items at the top of Lucent's hit list are overseas sales operations and research-and-development centers. Last week, Lucent announced it was planning to fire 550 people in France and shutter its R&D there. The gearmaker's advanced voice-switching division plans to close two of its seven research centers worldwide.

Lucent also stopped overseas development of its soft switch and doesn't plan to resume the effort until 2003. And in areas that have been deemed unprofitable, including Taiwan, Southeast Asia and parts of Eastern Europe, Lucent is preparing to scale back significant sales and research efforts for the time being.

On a recent conference call with Lucent managers, David Geary, the vice president and general manager of convergence solutions, outlined a series of sweeping consolidations ahead for his division.

A manager on the conference call asked Geary if Lucent realized that by cutting its losses and getting out of certain countries now, the company risked never being able to cash in on future sales in those countries.

Geary said that was an easy decision to make because Lucent's 10-year investment in these countries has yet to pay off.

"These countries have not been delivering good business for years," said Geary. "The hope was to make it up in volume, establish a footprint, get a good return on that. But it hasn't been proven. You can continue to chase that dream, but right now we don't have that option."

And you can bet Lucent's options will be even fewer in light of its new direction.