Tough Times for Telecom Gearmakers

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Forsee's replacement will no doubt review the merits of that $5 billion investment, which some board members are said to question. At a minimum, that review could mean delays in the Sprint project, hurting suppliers Motorola (MOT) and Nokia Siemens. Other operators are waiting for alternative technologies that are still in early development, such as Long-Term Evolution, to begin taking shape before placing their bets.

The result: This year's capital expenditures by wireless carriers will drop 6% or more from 2006's level, according to Infonetics. The decline is driven in part by AT&T (T), which will have spent $1.5 billion less in 2007 than a year ago, Infonetics estimates. All gearmakers, including Motorola and Nortel (NT), likely will be touched by this slowdown.

Focus on Software and Services

The prognosis for a spending rebound in 2008 isn't very encouraging either. On Oct. 16, when Ericsson reported a 36% plunge in quarterly profit (BusinessWeek.com, 10/16/07) CEO Carl-Henric Svanberg said he expects this environment to persist through 2008. Even that outlook may be too optimistic. "It's not going to be a six-month fix," says Rich Nespola, CEO of consultancy TMNG Global (TMNG). "It's going to be 18 to 24 months."

In response to market conditions, telecom gearmakers are investing heavily in software research and development, an area that can offer superhigh profit margins, often two to three times the margins on selling hardware. Equipment suppliers are also increasingly providing basic network maintenance and operations. Starting in early 2008, Alcatel-Lucent will take on technical operations and management of Orange's (FTE) network in Switzerland. And Nokia Siemens recently opened a global services hub in India.

To provide software and services, equipment makers often partner with computer-industry players. For example, Nortel has partnered closely with Microsoft, winning 300 contracts in just over a year, while IBM is working with Alcatel-Lucent. But partners can quickly morph into competitors. Take IBM, which has invested several billion dollars in its telecom practice since 2000. Earlier this year, Big Blue acquired Vallent, a Bellevue (Wash.) company with 400 employees that makes software that wireless operators use to monitor dropped calls and traffic bottlenecks on their networks.

One of IBM's customers is Sprint, whose subscribers shop for ringtones and music using IBM software. So is India's telco Bharti Airtel, which last year inked a seven-year, $100 million deal with IBM. "[Carriers] are looking for ways to deliver services with less capital investment," says David Mangini, who runs IBM's global communications solution business. "We give carriers a lot more choice."

Competition from Low-Cost Providers

Telecom gearmakers also are being forced to lower their prices amid competition from lower-cost Chinese suppliers such as Huawei and ZTE. These vendors' hardware prices are 20% to 40% lower, figures Mark Bieberich, an analyst with Yankee Group. This competition from China may only intensify.

Huawei is seeking to buy a stake in U.S. networking hardware maker 3Com (COMS) with an eye toward expanding its presence in America. ZTE is ramping up its portfolio of higher-end products and services. "We hope to provide different kinds of products—both high end and low end, but always with good quality," ZTE Chairman Hou Weigui said recently.

To weather the gear-buying lull, industry players will need to establish more service centers and partnerships in emerging markets to push their software and services, analysts say. Many Western companies' capabilities in these new, growing markets are still underdeveloped. Software innovation also will be key.

But most of all, since gearmakers will need to rely on sales of the lower-margin, legacy gear to tide them over, cost-cutting remains crucial. Chances are that's exactly what Russo will propose to Alcatel-Lucent's board at month's end.

Kharif is a writer for BusinessWeek.com in Portland, Ore. With Dexter Roberts in China.