Nortel's problem isn't spending, but lack of focus, say analysts

It's oft repeated that Ottawa is the heart and soul of Nortel Network Corp.'s research and development operations, and as the telecom giant is by far and large Canada's largest R&D spender, any comments regarding the company's strategy in this area is bound to attract attention.

So what's the significance of chief technology officer John Roese's recent pronouncements about the company's plan to reduce R&D spending as a percentage of revenue and focus its efforts around "skills" rather than specific projects and locations?

At OCRI's last Technology Executive Breakfast, Mr. Roese said Nortel's research intensity had been cut from 17.8 per cent of revenues in 2005 to between 14 and 15 per cent today, and that the company was planning to keep it at that level from now on.

That still represents a much higher figure than any other large R&D spender in the city or the country: Nortel spent 15.7 per cent of its revenues on research in its fiscal 2007 year, or $1.72 billion. Compare that to Ottawa's largest telecom company, Mitel – whose founder Terry Matthews is well-known for his gung-ho R&D spending strategy – which spent 10.8 per cent of its fiscal 2007 revenues on research expenses, or $41.7 million.

That information was coupled with news of Nortel's "20-60-20" strategy, which would have the company spending about 20 per cent of its R&D budget on new and emerging technologies, 60 per cent on its current or "mature" product lines and 20 per cent on legacy technologies that are on the decline. This would compare to its current spending pattern of less than 10 per cent on emerging tech, 35 per cent on current product lines and 55 per cent on legacy products.

As well, Mr. Roese said the company was on its way towards a "skills-based strategy" which would concentrate certain areas of focus such as optical or wireless in one area, rather than having pockets of similar research across several global facilities.

"Our R&D geography today is a consequence of the way we operated through the late '90s through to the early 2000s, in a very decentralized fashion," said David Hudson, Nortel's vice-president of portfolio management. "With our new strategy, we want to be more focused in which technologies we invest in and where we do it."

This plan would obviously have an effect on Nortel's Ottawa operations, as Mr. Hudson notes there is research done across all three categories in the company's local facilities.

All these measures have been implemented with the goal of bringing focus to a company long known for its diverse areas of research – some would say too diverse.

But analysts appear unconvinced that Nortel's new approach is enough to resurrect the behemoth that ruled the Canadian telecom scene in the heady days of the tech boom.

"(Nortel's) pursuing multiple-end markets, so it's jack of all trades but master of none," said Deutsche Bank Securities analyst Brian Modoff. "People are asking, 'Why is this a $6 stock again?' because no one knows who they are as a company. They muddle in a lot of things. Where are their core competencies?"

Mr. Modoff said Nortel is very strong in areas such as optics, Internet protocol (IP) products and core networking, and should concentrate on these product lines, instead of working on so many different technologies such as the competitive wireless space.

As well, another problem is that Nortel is neither a dominant larger player on a global scope like Ericsson, which Mr. Modoff said has 40 per cent of the wireless networking market, nor an aggressive smaller player like China's Huawei, which is currently number three in 3G technology, precisely because the company dabbles in so many fields.

"Until they can decide what they want to do as a company, they're not going to be a very competitive player ... They talk about playing in wireless, in WiMAX and LTE (long-term evolution UMTS mobile), but it's not going to help them," Mr. Modoff said.

While Nortel says it is number one or number two in all of the markets in which it is involved, Mr. Modoff said the company's footprint is not as large as it claims.

"The CDMA (code division multiple access) wireless market, for example, is only 20 per cent of the overall wireless market, which means that even if Nortel is number two in this space, it is only number six in the wireless market," he said. "You can slice and dice the numbers accordingly."

The company's retooled strategy is a step in the right direction when it comes to regaining its competitive edge, but challenges still abound for Nortel, according to Frost and Sullivan analyst Ronald Gruia.

"The portfolio strategy for Nortel needs a pretty radical overhaul ... and there are benefits if you cut costs, but those benefits are being persistently undone by Nortel's investments to stay competitive in a tough environment," Mr. Gruia said.

"Nortel has to constantly watch curves to see what's happening in enterprise, wireless, optical, carrier data and all these waves which are going on simultaneously, so it becomes very complex to administer R&D."

Mr. Gruia agrees with Mr. Modoff's assessment that Nortel's ventures into new markets such as the recently announced 40G project – which aims to quadruple network capacity without customers having to build new cables – are "not impossible but pretty difficult."

However, he noted that measures such as cutting down on legacy product lines and creating centres for the research of each technology make sense in "rationalizing" Nortel's R&D and bringing about synergies.

"It's an issue of trying to optimize your resources and match them the best possible way against what you anticipate," Mr. Gruia said.