Nortel Networks Is a Leading

Nortel Networks is a leading designer and manufacturer of the infrastructure to support the Internet and world-wide communications. According to Golden Capital Securities (2001), during 1999 and 2000, Nortel had positioned itself well in the optical networking market. Its main competitor at that time, Lucent Technologies, had not moved into optical networking as early as Nortel had, leaving room for Nortel to become the dominant telecommunications vendor in the world. Nortel's stock price came to reflect this probable dominance, rising to an all-time high of $124.50 and giving the company a valuation equivalent to a third of the 2000 Canadian gross domestic product. But, a series of events and corporate missteps would soon threaten the financial viability of the company. This research explains what happened to Nortel's stock and why it happened. It then assigns accountability and details what should have been done to prevent Nortel's downfall.

What Happened and When?

Nothing better illustrates the meltdown of the beleaguered Nortel Networks that its rapid stock price decline. According to Erwin (2004), Nortel's stock reached its peak of $124.50 in July 2000. However, only months later, the stock was worth only half this amount after the company missed revenue targets as a slump in the entire telecommunications market took hold. In January 2002, Nortel announced a loss of $27.3 billion for 2001, including $1.83 billion in the fourth quarter of that year. Later, on September 24, 2002, the stock fell below $1.

Why Did It Happen?

A brutal combination of weak demand and excess capacity was the major cause of Nortel's poor financial performance. The overall economy was in the beginning of a recession, but the telecommunications infrastructure market was hit particularly hard. Infrastructure spending by phone companies and Internet service providers in North America declined by twenty percent in 2001 and, as a result, Nortel's revenues plummeted by forty-one percent that year (Kharif, 2001a).

And, network companies that had created overly optimistic forecasts of the long-distance market that were twice the size of the actual market (Noan, 2003). Thus, they all rushed to build capacity to overwhelm competitors and gain scale. From 1996-2001, capital expenditures grew by annual rate of twenty-nine percent. But, as the incremental cost of bandwidth fell by approximately fifty-four percent a year, demand grew far less than this rate (Noan, 2003).

Unfortunately, market forces are not the sole cause for Nortel's troubles. Between the fourth quarter of 2000 and the second quarter of 2001, Nortel's market share in the optical-gear market dropped from forty-seven percent to seventeen percent (Kharif, 2001b). Kharif explains that this was a huge problem for the company because nearly forty percent of its revenues depended on its integrated optical product OPTera Connect, a system that had allowed carriers to quickly set up services and increase the capacity of their backbone networks at a lower cost than previous generations of switching gear. But, Nortel's technology edge was quickly being eroded by competitors such as Cisco Systems that offered Internet protocol-based equipment rather than Nortel's older circuit-based gear (Kharif, 2001a). Cisco's Internet protocol-based approach allowed service providers to better manage their fast-growing Internet traffic. And, Ciena Corporation's bandwidth management platform positioned as an operationally effective, intelligent next-generation optical network, began to gain traction at Nortel's expense (Jander and Bulkey, 2001).

Bad debt and poor investments also came to plague Nortel's fortune. Nortel, eager to obtain new customers, engaged in risky financing deals, loaning money to purchasers of their products. Nortel was "giving products away to startups and having startups lease equipment without doing credit checks." (LaMonica, 2001). This practice would later came back to haunt Nortel as bankruptcies surged. Nortel also invested too aggressively in technology startups that were in vogue in the late 1990s, using its high-priced shares as the currency to conduct the transactions (Erwin, 2004). As one of many examples, Nortel bought customer relationship vendor Clarity for $2 billion in 1999, only to unload the company in 2001 for $200 million (McClimans, 2001).

Trying to compete in too many market segments was yet another issue for Nortel. For example, the company divided its attention to serving carriers and enterprises (Kharif, 2001b). For the later market, Nortel saw slow growth due to competitors that devoted their attention there. Nortel also lost ground in the 3G wireless market to a host of new startups with focused business models and an optical/IP emphasis that appealed to that market (Jander and Bulkey, 2001). In 2001, Nortel made the decision to exit the DSL business after experiencing weak demand.

Last, but not least, Nortel's management was slow to react to market conditions. As evidence, closest direct rival Lucent Technologies overtook Nortel in 2001, growing its share of the global market from nine percent in the further quarter of 2000 to twenty-one percent in the second quarter of 2001. Analysts attributed this success to Lucent's quicker restructuring of its business that allowed it to undercut Nortel's prices (Kharif, 2001b).

Who Was Responsible?

Clearly, market conditions were a huge factor in Nortel's decline. However, Nortel's downfall is also largely attributable to its own strategies executed by its CEO John Roth and the company's senior management team (Erwin, 2004). Poor acquisitions and investments distracted Nortel from concentrating on developing its own technology. Once an innovator in optical networking products, the company now found its technology being eclipsed by the research and development efforts of competitors such as Cisco and Ciena. This problem was further compounded by Nortel's broad focus across too many market segments.

As a company, Nortel had its own share of internal issues. Its risk management policies were far too liberal and exposed the company to massive amounts of bad debt. Executives had foolishly counted on the demand for Internet bandwidth to keep ballooning indefinitely. Further, the company lacked the ability to quickly restructure and cut costs. For example, it did not divest of non-core, unprofitable businesses as soon as it should have, giving room for competitors to win deals by offering lower prices, a move well received in a sluggish economy.