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Telecom gear suppliers are breathing easier now that Verizon (VZ) - Get Verizon Communications Inc. Report has reached a contract settlement with its unions.

Trouble is, some observers say Verizon's apparent victory was a pyrrhic one, the agreement coming as it did without the big cost savings that the New York telco had sought. That means more pressure on a steadily eroding revenue base -- and less money to spend on upgrading a creaky network.

"There's a widespread feeling that Verizon needed relief from the sort of job protection terms that were created in an earlier era," says RBC Capital analyst John Wilson. "If you can't realize savings because you can't resize your workforce," says Wilson, "then it's an inhibitor."

On Friday, Verizon shares fell 42 cents to $36.23.

Security

Thursday evening's tentative five-year contract, covering 79,000 Verizon employees, calls for wage hikes and continued job security. Those measures will prevent the company from cutting union workers or transferring jobs to other states.

Going into the negations, the nation's largest phone company had hoped to take greater control over job cuts and other expenses, as its core business shrinks and sales flag. Though Verizon will hand out an immediate 3% bonus to union members this year and raise wages by 8% over the next five years, company reps say the new deal will save millions of dollars compared to the previous three-year contract.

Certainly, by settling the labor dispute, the nation's largest equipment buyer can turn its full attention back on lowering its $52 billion debt load and upgrading its network. But gearmakers that had once braced for a bitter, prolonged strike and subsequent order delays now have to wonder what happens to spending levels as Verizon returns to status quo.

In the near term, says Lehman Brothers' analyst Steve Levy, "this should be a positive for the group," referring to vendors who should get some orders as Verizon returns to business as usual.

Levy lists outfits like

Lucent

(LU)

,

Tellabs

(TLAB)

,

ADC Telecom

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and

Adtran

(ADTN) - Get ADTRAN, Inc. Report

among those that get more than 10% of their sales from Verizon.

But longer term, some on the equipment side say that even though Verizon enjoys a virtual monopoly in its 13-state region, it is long overdue in its transformation to a leaner, less-labor-intensive business.

Shifting Sands

Wireless services, cable's invasion of the phone market, the Net and long-distance companies reselling cheap local service are but a few of the changes that have swept through the phone industry in recent years. Verizon and its peers

SBC

(SBC)

and

BellSouth

(BLS)

can no longer hide behind their dominance of the local phone markets, say analysts.

In many ways, the Bells have been slow to adopt new practices, and now they face serious challenges as they try to modernize their networks and change their labor structure to address more nimble competitors.

To a large degree, say analysts, the Bells still base much of their staffing levels on antiquated labor models. For example, says Wilson, adding a new phone circuit in the old system required weeks as a team of workers manually installed line cards and reprogrammed the necessary computers. But today, much of the new network equipment is set up so a new pathway can be created with a few clicks of a mouse.

The Bell Diet
Employment declines at big telcos*

*Index of relative employment, 2000 level=100.
Source: Companies.

With 228,000 employees, Verizon is not only the largest telco, it has also taken the proportionally smallest workforce cuts in the past three years, compared to its peers. Verizon says it will have to rely on the more expensive buyout packages and early retirements to trim headcount.

"Getting some concessions from the unions," says Wilson, "would have allowed more opportunity for capital investment, where they have under-invested for a number of years."

To Wilson and others, the union victory in the contract talks was a setback for the necessary transformation of the Bells. To some, it was a blown opportunity to take money out of operating costs of the past and use it on the future.