Ramachandran Balasubrahmaniam

What is Nortel’s Investment Thesis?

Mike Zafirovski is a GE guy from the school of Jack Welch, and that is how he is transforming the management culture.

Jack Welch had one principle which said that if a business was not number 1 or 2 in its market then you must fix it, shut it down, or sell it. Mike Z did that with the UMTS access business that will contribute to margin growth by getting rid of a loser. Doing these with 3 or 4 of the big losers will contribute to overall margin growth.

After 5 years of no hiring of new graduates, Nortel has once again started to hire new graduates. This influx of fresh blood will allow the company to continue to develop and deliver products in about 10 years. Without the fresh blood, they would have been dead in 10 years.

Nortel has started to use open-source software to leverage research and development. For example it uses Linux in its BCM products, and other products. It also contributes back to the "carrier-grade Linux" core. As it does so, it will gain progressively more R&D leverage.

Nortel has outsourced software development indiscriminately. Sustaining and evolution work are great for outsourcing, but new product development needs to be kept close to the business leaders. Nortel needs to eliminate the practice of keeping the business and technology leaders in North America while developing software in India and China. If they want to leverage the low-cost labour of those countries, they should set up P&L units in India and China with the business leaders co-located with the R&D teams.

Nortel is trying to bring in process excellence because it worked at GE. Process excellence worked at GE because GE's businesses have extremely high natural barriers to entry. Nortel has no such luxury, and as a result investments in process excellence often have high opportunity costs that manifest themselves in increased time-to-market, high non-recurring engineering costs, and high product costs. They need to tread carefully with this one.

With the successive layoffs and bad news of the last 7 years, Nortel has severely crippled its culture of technology and product innovation. Today, you just don't see technology leaders take chances on key new core technologies as they did in the past (e.g. advanced codecs, Protel programming language, SOS operating system, PLS source code control, credit-based flow control, DSL, etc.). They stick to "industry standard" technologies, and as a result, get "industry standard" R&D. Nortel also used to innovate in products. DigitalWorld turned Nortel from a technology backwater in Canada to a leading telecomms equipment firm. FiberWorld continued on that. The Meridian/Norstar products utterly transformed the Small-Medium Enterprise market by bringing them phone features normally reserved for very large companies. Not having great innovation in products and technologies will hinder them from growing their top line beyond population growth rates. Of course, those great products and technologies came from BNR which was the separate R&D unit. Nortel needs to bring back BNR if it wants to develop innovative new products.

Nortel will become profitable under Mike Z, but top line growth can only come from innovation in products and technology.