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Lucent's CEO faces more challenges ahead

By Ken Belson

NEW YORK TIMES


Patricia Russo has little time to exhale. As chairman and chief executive of Lucent Technologies, she has managed to return the weakened telecommunications giant to modest profitability by eliminating tens of thousands of jobs, slashing billions of dollars in debts and settling major lawsuits with investors.

This week, the company settled a suit by the Securities and Exchange Commission over its accounting practices, and agreed to pay a $25 million fine.

But Russo, who took the helm at Lucent during the depths of the telecommunications collapse in 2002, is anything but sanguine. Having staved off Lucent's financial freefall, she is now in a race against time to develop new products and services that will allow Lucent to survive as the entire industry changes around it. Shares of Lucent have fallen from a high of $63.22 in 1999 to a low of 58 cents in 2002, and closed Thursday at $3.25.

"We've managed our way through an unprecedented and unpredicted industry downturn, and I'm pleased that this three-year period is behind us," said Russo, 51, as she sketched out her company's strategy on a memo pad. "But the world in which we've been competing has been changing dramatically."

Simply put, that world is networks. For decades, phone calls, data and video traveled over wire lines, and Lucent made the switches and other equipment that sent those signals flying around the world. Once part of the AT&T group, Lucent, based in Murray Hill, N.J., was a key supplier to many of the world's biggest phone companies, which had billions of dollars to invest.

But new Internet-based technology and other innovations now allow all that content to travel over unified digital networks. This shift requires not just new hardware but new approaches to the way that data is dispersed, organized and stored. In this new world, rivals like Nortel and Cisco often have the upper hand and Lucent must form partnerships with its competitors, a comedown for a company that prided itself on its independence.

If that were not enough, Russo must change the mind-set of a company that was once a cornerstone of the American industrial landscape. In years past, Lucent's raison d'etre was building the huge switching stations that carriers use to connect calls. That business has been in decline as more customers opt for routers that are roughly the size of a pizza box and made by Cisco and other rivals.

Lucent's revenues have declined more than 70 percent from a peak of $30.6 billion in 1999 to $8.5 billion last year, in part because of spin-offs of some divisions. To generate much-needed growth and forestall the company's obsolescence, Russo is trying to leapfrog into the next generation of products. The strategy is admirable but will succeed only if demand for the technology Lucent is betting on grows faster than the decline in its traditional businesses.

"The question is, can Lucent run fast enough to outrun the decline in its older businesses?" asked Albert Lin, an analyst at American Technology Research in San Francisco. "It will be hard to do."

Worse still, telecommunications equipment is increasingly becoming a commodity, subject to ever greater pressure to cut prices. So Russo is trying to get her 32,500 employees to think of themselves less as manufacturers and more as service providers. The hope is that Lucent will be able to market to its phone carrier clients the technical expertise that was the hallmark of its Bell Labs.

But there are dozens of competitors in the service arena too, who claim to offer similar consulting advice for less money. And rather than charging hefty fees per consulting project, Lucent is paid on some projects based on the amount of money it saves clients, a less stable source of income.

For most former manufacturing titans, the transition into the services business has rarely gone smoothly, especially when the service providers are engineers who have been cloistered in research labs for years. But Lucent's shift into services is proceeding apace.

"We've done more to pull people out of the ivory tower and into the customer site," said John A. Meyer, who was recruited by Russo to run Lucent's services group after a long stint at EDS. "Whenever I run into roadblocks, I fall back on what IBM did."

The company now expects revenue to grow in the "low single digits" this fiscal year, with Lucent returning to profitability for the first time since 2000. Most analysts say Lucent is underestimating the strength of the current recovery, but they don't blame the company for being conservative about its outlook.

"They are just starting to feel like they are back on terra firma," said Steven Levy, who covers the company for Lehman Brothers. "They are willing to say things are better, but they are not celebrating yet. Lucent is not alone in being gun-shy either."

Lucent's chief financial officer, Frank D'Amelio, declined to be more specific about which parts of the company would grow the fastest, but most analysts say the most promising contributions are coming from the company's wireless group, which makes up 43 percent of sales

Lucent is a leader in making equipment for cellular systems that run CDMA technology, which is used by carriers like Verizon Wireless and Sprint. The company has also made a significant push to develop next-generation high-speed data services for networks. That move paid off in March, when Verizon Wireless awarded Lucent a $525 million contract to develop the carrier's third generation, or 3G, mobile phone network.

This week, Lucent won a $120 million contract to expand the phone network for China Unicom, that country's second-largest mobile carrier, and another multimillion dollar contract from a subsidiary of China Telecom, the industry leader in China.

3G networks are widely viewed as the future of the mobile industry because they would allow cell phones to send and receive data at roughly 40 times current speeds, making it possible for consumers to swap music clips, hold video conferences and run other data-hogging applications. Next generation networks are also supposed to make the divisions between CDMA, GSM and other cell phone standards less important.

The promise of 3G, though, has often outpaced the reality in places where the service has already been deployed. In Japan, for instance, the country's biggest carrier, NTT DoCoMo, unveiled its 3G network in October 2001. Yet system glitches, handset troubles, spotty service and high prices turned the start of the service into a huge embarrassment. Only now, after spending $8.9 billion to upgrade its network, is DoCoMo meeting its subscriber targets.

There is no guarantee consumers in the United States will flock to 3G service at a time when the rate of spending on cell phone services has started to flatten out. A slowdown in that sector could delay future rollouts of next-generation phones, hurting Lucent's chances for other big contracts.

Lucent is also looking elsewhere for growth. In addition to selling abroad, the company is making strides in winning more government contracts, particularly from the Department of Homeland Security.

The company is jumping headlong into the broadband Internet access market, too. Lucent's share of the North American market for equipment that helps phone carriers deploy high-speed digital subscriber lines jumped to 17 percent, from 10 percent, in the first quarter, according to Teresa Mastrangelo, an analyst at RHK, a telecommunications consulting firm. The gain was largely due to a big order from Qwest, a big local phone company. Nonetheless, Alcatel still dominates this market with a 59 percent share.

Lucent's gains, though, are small compared with the larger issue of how Lucent participates in the building of new telecommunications networks, Russo said. She said she pushes her executive team to figure out "where the puck is going," though she admits there are no simple solutions, competition is fierce and the questions won't be answered for several years.

Still, she would prefer to fret over how to improve Lucent's business rather than focus on its mere survival.

"The market has clearly stabilized," she said. "It was a scary time, and it feels a lot better to be focused on growth again."

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