Alcatel-Lucent will release its quarterly results, which are likely to be ugly. In September the company disappointed investors with news that its revenues would barely grow and that there would be no operating profits to speak of in the third quarterits third profit warning this year.
At first, telecoms analysts thought Alcatel-Lucents problems were merely the travails of a recently merged company. But last week Ericsson, Alcatel-Lucents main rival and a darling of the sector, shocked investors when it announced a fall of 36% in quarterly earnings. This week it replaced its chief financial officer. Now people fear the whole industry may be in deep trouble.
Certainly forces are at work which will make life difficult for the vendors of telecoms gear. First, the market for wireless networks is beginning to mature. After years of bumper profits, telecoms operators are facing more competition and are having to cut costs. In America carriers have delayed purchases, which explains much of what went wrong for Alcatel-Lucent. In Europe operators are increasingly renting their networks out to virtual service providers and are sharing capacity. That has allowed them to delay network upgrades which would otherwise have boosted Ericssons and other telecoms-equipment firms earnings.
Second, Western firms face competition from two Chinese companies, Huawei and ZTE. In 2006 Huawei had revenues of $8.5 billion, up 42% from the year before. ZTE has grown even more quickly, and had revenues of $2 billion for the first half of 2007. The firms low cost bases allow them to offer prices up to two-fifths lower than Western competitors.
A third headache for established telecoms-equipment firms is that some of their product is becoming commoditised. This makes it easier for newcomers, such as the Chinese, to build cheap alternatives. But the trend should not be exaggerated. As Alcatel-Lucents Michel Rahier points out, the industrys hardware will never become as much of a commodity as personal computers have done because more of its equipment is highly complex. And neither Chinese firm is any match for Western vendors when it comes to building sophisticated telecoms networks.
Furthermore, Western telecoms vendors are working hard to get out of their bind. One strategy is to move into a different areathe selling of software and services to telecoms operators. The software allows operators to create new offerings for consumers. The services help them build and run their networks.
To cope with competition from Chinese companies, telecoms-equipment firms are moving big chunks of manufacturing and research and development to countries with cheap labour costs, including China itself. More than a quarter of Nortels 12,000 engineers, for instance, are in China. Because of these global R&D networks, argues John Roese, Nortels chief technology officer, Huaweis and ZTEs cost advantage is no longer what it was.
In the short term, the health of telecoms-equipment makers will depend largely on whether changing patterns of demand play to their strengths. If wireless carriers start upgrading their networks again, for instance, because consumers spend money on bandwidth- hungry data services such as music-downloading, Ericssons profit warning would be forgotten. Demand for fixed-line gear, the least sexy bit of the industry, has already picked up. Operators are upgrading their networks in order to offer, among other things, triple play products with telephone, broadband internet and television. This part of Alcatel-Lucents business should provide some good news when the firm announces its results next week.
In the longer run, much will depend on which technology will be used for the next generation of wireless networks. WiMax, a standard supported by the computer industry, is supposed to make wireless networks much cheaper to build and operate. Nortel has made a big bet on this technology. It recently made headlines with accounting problems, but would look much better if WiMax gains traction. If, instead, carriers continue to build 3G networks, the future could be Ericssons. The firm is backing a long-term project called Long Term Evolution, which is more similar to existing mobile phone standards.
For now, though, the biggest question is what will happen at Alcatel-Lucent. To restore profitability, some analysts say it will have to lay off at least twice as many employees as the 12,500 it already planned to fire as part of its merger. Others say it will need to sell its troubled 3G wireless business. Whether the task falls to Ms Russo or someone else, Alcatel-Lucents boss has a long slog ahead.
The Economist Newspaper Limited 2007