Nortel's $9.1 billion acquisition of Bay Networks has brought the fashionable issue of convergence into the spotlight.
As corporations increasingly blur the boundaries between their voice and data services, telecomms equipment makers need to buy expertise in data networks, while the largest data firms - notably Cisco - are even taking the more ambitious step in the opposite direction, acquiring voice and carrier class products.
So the Nortel-Bay alliance seems a perfect and logical combination - on paper at least. But however good the theoretical fit, the deal will come with all the usual risks and problems of a merger. In addition, the two companies will suffer from extensive product overlap and, on the Bay side at least, a beleagurered position in core markets.
"This could be a more painful merger than Wellfleet and Synoptics [which led to the formation of Bay]," said an analyst at Merrill Lynch. "And in such a fast changing market, nobody can afford too much time trying to fit companies together."
Predictably, the two companies were keen to play down product overlap, but their chief executives admitted that one-quarter of Nortel's business now comes from enterprise systems that would also be targeted by Bay.
John Roth, head of Nortel, stressed that the partners want to focus on their common ground in IP to create a desktop-to-carrier IP supplier of a type that does not currently exist. "Voice networks need to handle data, people who build data networks are moving into the carrier space," said Roth in a teleconference. "This is a new industry category that needs the attributes of both. IP competency in backbone networks does not exist anywhere."
A very logical strategy in a world increasingly dominated by the Internet and other IP systems - but one that does not encompass the majority of the companies' existing offerings. Through its recent Aptis acquisition, Nortel has a range of switches and concentrators that compete head-on with Bay's Versalar 15000 range. Both companies offer similar network management, DSL (digital subscriber line) and remote access equipment.
The overlap of several product lines has inevitably led to speculation that the axe will soon fall on certain ranges and jobs. The companies will not make any comment on this as yet but some analysts are already predicting swingeing cuts, particularly on the less financially stable Bay side.
David House, head of Bay, is not known for flinching from difficult decisions. He will head Nortel?s enterprise networking operations, boosted threefold by the addition of the new company, and so will take hands-on responsibility for any restructuring. His experience is likely to help avoid some of the problems that beset the merger of Wellfleet and Synoptics, a process from which Bay has really only just recovered. Those two companies were too slow to take hard product and people decisions or to integrate their ranges and channels and found it hard to meld divergent cultures, ranges and even locations. House?s former career at Intel taught him tougher ways, but rapid integration of the two operations will be vital. However, he denied that Bay and its new partner would consolidate in a single headquarters.
Even where products do not overlap, they are not necessarily suitable for both companies? customer bases. The idea of offering a single, IP oriented range to all types of client seems simple, but Roth admitted that there will a great deal of work to make Bay?s products robust and scalable enough to meet the needs of telecomms carriers, Nortel?s prime buyers. ?The challenge is to do this just as rapidly as possible,? he said, without giving details of how this might be accomplished without a major R&D effort. Conversely, many of Nortel?s products are too complex and expensive for all but the largest corporates.
It is not just product lines that will clash - partnerships and channel strategies also seem to be in opposition. Prime among these is Nortel?s close relationship with Shiva, which led to widespread rumours that Shiva would be the Canadian giant?s prey rather than Bay. This is now likely to fall by the wayside as Shiva?s remove access and virtual private networking kit competes with the range acquired earlier this year by Bay when it bought New Oak Communications.
Channel policies also raise thorny dilemmas. Nortel has a powerful direct salesforce and this is already worrying Bay resellers, who fear that the company will compete with Bay?s channel. Bay had already encountered criticism from its own Vars for moving its own products more heavily through direct sales, in its bid to target large corporates through its own salesforce, and commodity markets via retail.
Many observers believe the commodity end will be downplayed by the enterprise focused Nortel, taking Bay out of 3Com?s and Intel?s sights and focusing it more directly on Cisco. Bay will have more weight to do this than it has in recent years, since it will be merged into Nortel?s existing Enterprise Data Networks arm. This had revenues of only $785 million last year, but will add significant direct sales clout, corporate contacts and installed base to Bay?s $2.09 billion operation. And the market impact of the parent company will give Bay significantly more standing in the large corporate space, putting an international player with revenues of over $15 billion - dwarfing even Cisco - behind its efforts.
For all the possible difficulties, the acquisition has changed the ground rules in the convergence market and will force other players to adapt. By grasping the IP space where enterprise data, carrier voice and Internet service provider networks meet, Nortel has taken the high ground. Its voice rivals, such as Lucent, and the data king, Cisco, will now need to react to this initiative. Both have been on the acquisition trail to move into voice-data systems, but have bought nothing on the scale of Bay. If Nortel can integrate its new company quickly and relatively painlessly, it will have gained significant competitive advantage in a market where IP accounts for 50 per cent of the backbone, growing at 30 per cent a year, and where new spend on voice-data systems, estimated at $30 billion and rising, can be added to a carrier market worth $250 billion.
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