Lucent's McGinn Vies to Win Back Customers, Investor Confidence
By Erik Schatzker
Murray Hill, New Jersey, Sept. 29 (Bloomberg) -- Joe Nacchio, chief executive of Qwest
Communications International Inc., was in a bind.
As competition to handle the explosion of Internet use heated up last year, Nacchio found
himself scrambling for more fiber-optic equipment to bulk up Qwest's data network. His lone
supplier, Nortel Networks Corp., was sold out.
Facing a logjam that could bog down service and drive away customers such as America Online
Inc., Nacchio rang up Lucent Technologies Inc. CEO Rich McGinn, a former colleague in AT&T
Corp.'s executive suite.
It was a timely call. Unlike the plodding Baby Bells that Lucent sold to, Qwest was moving fast,
and McGinn was ready to make promises for a share of the billions the company was spending
on Nortel gear.
When Nacchio said he needed equipment installed by January to handle a surge in data flowing
from Los Angeles to New York, McGinn took the rush job. It was July 1999.
Six months later, the agreement lay in tatters. Qwest was ripping out Lucent's gear, and
Nacchio was looking elsewhere after getting some products late and others that didn't work. He
took funds earmarked for the Lucent equipment and bought what he needed from smaller Ciena
Corp. in time to avoid a capacity crunch.
Leader to Laggard
The episode says a lot about how the AT&T spin-off -- once lauded by Wall Street, revered
by customers, and feared by rivals -- lost its edge. The 58 percent plunge in Lucent's stock this
year is a vivid reminder of just how far the world's biggest maker of telecommunications
equipment has fallen.
Strategic blunders and delays in converting research from its renowned Bell Laboratories into
marketable products left Lucent behind in fiber optics, the hottest market in communications.
Then, hundreds of engineers quit, hobbling the company just as Nortel was ready with optical
gear.
Development of a new voice switch for traditional phone companies dragged on longer than
Lucent planned, holding back sales of the devices that can fetch millions of dollars apiece.
Investors had no idea anything was awry. McGinn kept the problems hidden -- as Lucent's
stock rose to records -- by making up for the lack of revenue from new products with sales of
the voice equipment that had built Lucent's reputation and generated a fifth of its $38.3 billion in
fiscal 1999 sales.
Fessing Up
When customers slowed purchases of voice gear and related software last year to focus on
data networks, McGinn had to fess up.
In a late-day press release on Jan. 6, 2000, Lucent said earnings per share in the quarter that
had ended in December fell unexpectedly, lagging the company's own estimates by a third.
Lucent's first-ever profit warning sent its shares tumbling 23 percent the next day, erasing $50
billion of market value.
That was just the beginning. Lucent warned in July that profit would miss estimates in the fourth
quarter ending in September and would drop 15 percent in the next period. In all, McGinn slashed
four quarters of profit forecasts in the middle of the biggest boom in telecommunications history.
``Anytime you surprise that way it puts you in the penalty box,'' said portfolio manager Ken Turek
of Northern Trust Corp., which held 21.2 million Lucent shares on June 30. ``Lucent ratcheted
down from being a tier-one company to something else.''
Great Expectations
Could this be the Lucent whose IPO wowed investors in April 1996? The then biggest U.S. initial
stock sale raised $3 billion for 18 percent of AT&T's telecommunications equipment business.
Optimism that the two-month-old U.S. Telecommunications Act would unleash an era of unbridled
phone company expansion spurred record first-day trading.
The plucky spin-off went on to beat profit estimates 15 quarters in a row. Lucent's stock, the
second most widely held in the U.S., soared to a peak of $84.1875 on Dec. 9, 1999, from a
split-adjusted IPO price of $6.75 -- a gain of 1,147 percent. By yesterday, the shares had
dropped to $31.125, the lowest in two years, after dipping to $28.875 on Wednesday. Investors
were reeling from the shortfalls and relentless advances of Nortel, Ciena, and Cisco Systems Inc.
The swoon has left a deeper scar: A depressed stock makes it harder for Lucent to keep up with
archrival Nortel, which is using shares that have surged as much as 76 percent this year to buy
start-ups with hot products and engineers.
``We're always crossing things off the shopping list,'' said Bill O'Shea, the executive vice
president in charge of acquisitions. ``Do we cross off more now than before? Sure.''
Big Changes
It's no wonder that McGinn, 54, is hustling to make changes. The former AT&T salesman who
joined Illinois Bell in 1969 knows he needs to deliver on promises to big companies like Qwest
and impress the young carriers that abandoned Lucent when it failed to supply new products on
time.
ClearData Communications, a start-up in Phoenix, went to Nortel for $300 million of fiber-optic and
data-networking gear in August, even though it's 5 percent owned by Lucent. ``They didn't have
the right equipment and didn't indicate that they wanted more of our business,'' said Ric Tarbox,
ClearData chief operating officer. ``Nortel put on the full-court press.''
McGinn's solution is to focus on five areas: equipment for both voice and data networks;
fiber-optic transmission systems; wireless communications; and services such as network design.
He's unveiled plans to spin off or sell the rest of Lucent: businesses that employ a third of its
150,000 workers and generated more than 30 percent of sales in the fiscal year ending in
September 1999.
Slimming Down
Until this year, U.S. accounting rules governing Lucent's own spin-off prevented it from divesting
major assets. Now, as if he's going through a box of old toys, McGinn is looking at every bit of
Lucent to decide what to keep and what to discard.
Gone is Avaya Inc., a maker of office phone and data systems that will be spun off to Lucent
shareholders tomorrow and begin trading on the New York Stock Exchange Monday. Next is
Microelectronics, the semiconductor and fiber-optic components unit. Lucent plans to sell 20
percent of the business by the end of March in an IPO that analysts say could raise as much as
$15 billion and become, like its parent's had been in 1996, the biggest IPO in U.S. history. Lucent
will spin off the rest.
McGinn also may sell or shutter factories in Oklahoma City and Columbus, Ohio, and let other
companies do Lucent's manufacturing. Power Systems, a maker of power supplies for
communications networks, went on the block in May.
``The idea that we could be the leader in 18 different areas probably isn't the right way to think,''
said McGinn, who rises at 4:30 a.m. to plot his moves on long walks near his Bernardsville, New
Jersey, home and then scans the Internet for information on rivals and customers before arriving
at the office in nearby Murray Hill about 7:30 a.m.
`Relentless' Effort
McGinn is wagering that a narrower focus will make it easier for Lucent to go head-to-head with
Nortel and Cisco in a worldwide market for communications equipment he estimates will double to
$450 billion in five years.
The strategy worked once before. As Lucent was being spun off, McGinn, then president, and
Chief Executive Henry Schacht cut a fifth of the company's workers, sold marginal businesses
such as a unit devoted to defense systems, and expanded overseas. Sales rose 13 percent in
Lucent's first year and 21 percent in fiscal 1998 to $31.8 billion.
The spin-off was completed in September 1996. McGinn was named CEO in October 1997 and
chairman three months later. Schacht is now chairman of Avaya.
This time, McGinn's goal is to finish reshaping the business next summer, less than 18 months
after starting in March. ``We have to be relentless,'' he said.
New Blood
McGinn pitched his strategy in August to Lucent's top 20 executives, mostly AT&T veterans. In a
windowless boardroom in Warren, New Jersey, he told them that Lucent has an opportunity as
great as when it became independent. ``No one should doubt our ability to reenergize this
business,'' he said. ``We're sitting on a gold mine.''
To speed the process -- and to inject some fresh thinking -- McGinn is appointing outsiders to
replace executives he dismissed and others who quit or retired.
He personally recruited Debby Hopkins, who'd been chief financial officer at Boeing Co. for 16
months, over dinner at his home. She became Lucent's CFO in April. In August, he promoted
Jeong Kim to president of fiber optics from No. 2 in the unit. Now McGinn is searching for an
operating chief.
Will It Work?
Some investors question whether McGinn can accomplish the latest overhaul without losing more
ground to Nortel, which is free of major distractions.
``We're not convinced what they're doing is working,'' said Erick Weis, who manages the $5.3
billion Omega Fund at Ohio Public Employees Retirement System. Weis reduced his Lucent
position in January after the first profit warning.
McGinn has said revenue will increase 20 percent next year, a target some analysts say is too
high. Nortel is predicting at least 30 percent growth for its business.
If not apologetic, McGinn has been contrite about Lucent's woes. On a conference call following
the January profit warning, he listed reasons for the shortfall: A big customer had delayed
purchases, sales of software for voice switches had fallen unexpectedly, and Lucent had been
too late in seeing a shift to faster fiber-optic systems like Nortel's.
McGinn had painted a different picture at a company event two months earlier in Murray Hill,
where he crowed that Lucent was leading or coming a close second in every market it served:
from wireless to switching, to optical networking. What he didn't say then was that signs of
trouble were emerging. In fiber optics, distressing signals had been there for years.
Early Successes
Lucent was an early leader in fiber optics, harnessing the speed of light for telecommunications
by using tiny lasers to beam information on hair-thin strands of glass known as optical fiber.
Scientists at Bell Labs invented a device to convert electrons into photons -- the magic of fiber
optics -- in 1974. Advances in the 1980s spawned products like under-sea cable.
Whatever edge Lucent had in those days was gone by 1996. That's when Ciena, seemingly out
of nowhere, introduced a device that put five times as many calls on a piece of fiber as Lucent's
best equipment. The breakthrough was a shock, not least because it won Ciena a trial at AT&T
the following summer, putting a sale by Lucent to its former parent and best customer at risk.
The threat from a new rival roused Lucent into action. With McGinn's backing, two dozen of the
company's top marketers and engineers checked into the Courtyard Lincroft, a Marriott hotel in
Red Bank, New Jersey, in August 1997 for 10 days of secret brainstorming. ``It became a
personal challenge,'' said Kathy Szelag, a vice president of marketing who took part.
Wrong Bet
On the group's recommendation, McGinn and Schacht made a decision they would live to regret:
to cut spending on speedier lasers and electronics in favor of developing a product with more
capacity -- like building a bigger car instead of a faster one.
While the design was more advanced than anything Ciena had, within a year it became clear
Lucent had chosen the wrong path. Aggressive carriers with big spending plans, including Qwest
and Williams Communications Group Inc., were shunning Linthicum, Maryland-based Ciena and
Lucent to sign up with Nortel, which had developed a system four times as fast. Qwest was
among the earliest buyers; it ordered $150 million of Nortel gear in May 1997 and added $600
million in June 1999.
The emphasis on speed catapulted Brampton, Ontario-based Nortel over Lucent to No. 1 in
fiber-optic equipment in 1998, a lead it has since widened. Nortel got 43 percent of the $5.94
billion spent worldwide on fiber optics in the second quarter of 2000, almost triple the 15 percent
Lucent got, according to researcher Dell'Oro Group in Portola Valley, California.
McGinn wants to ensure he doesn't make another wrong bet. He now spends 40 percent of his
time on operations, more than double his involvement three months ago. ``I'm working with people
on network architecture, on going to market, on business strategies they're pursuing,'' he said.
``I'm being more demanding about the speed with which decisions are made.''
Playing Her Hand
His approach suits CFO Hopkins, even if the mess at Lucent was bigger than she expected.
Hopkins says she didn't plan on having to cut sales and profit estimates during her first
conference call in the driver's seat. And given a choice, she would have taken a few quarters to
understand Lucent before embarking on a major restructuring.
``I was handed a set of cards, and I'm making the most of the cards I've got,'' she said. ``This is
not the order I would have put them in.''
Still, the 45-year-old is leaving her mark with a budgeting process that promises to ruffle some
feathers among the old guard -- as it did at Boeing. Starting in October, all spending will be
governed by strict guidelines on returns after the cost of capital is subtracted. Gone are the days
of budget allocation based on persuasive arguments or seniority.
The change is bigger than it sounds. A factory that seemed profitable for years may no longer
make the grade because it employs too many assets, Hopkins says. Other businesses, like
services, will become more attractive because they occupy few buildings and require little
equipment.
Budget Fixes
Hopkins hasn't identified areas with unacceptable returns yet, though she's found one business
worth expanding. She says the opportunity to generate cash by servicing equipment that Lucent
and others make is so compelling that Lucent will form a separate company to manage it.
``The car guys have figured out that all the value is in after-sales,'' said Hopkins, who spent three
years at General Motors Corp. before moving to Boeing. ``The computer business figured this out
10 years ago.''
McGinn gave Hopkins's budgeting plan a thumbs-up the first time he heard it, two months after
she arrived. ``When I sat down with Rich, it took two nanoseconds. He said, `Do it,''' she recalled.
Now she's doing even more, changing everything from supplier management to closing the
books, a total of eight processes in all. The moves may help reduce inventories and speed
collection of receivables, two areas of the balance sheet that analysts have criticized Lucent
about. The company will introduce her new system starting in January, and in the December
quarter, will take a charge that it hasn't yet calculated.
Need for Speed
The budget fixes won't resolve every concern. GT Group Telecom Inc. CEO Dan Milliard has
been waiting for Lucent to come through with a product it began touting in April 1999. Milliard
wants to update the Canadian phone company's voice network for data and planned to install
the 7R/E voice switch. Problem is, Lucent has told Milliard it won't begin shipping 7R/Es, which
are as big as a minivan, until the end of the year.
``They've got people out there hawking wares that can't even be brought out of the labs yet,'' he
said. GT, which has Lucent financing but is free to buy products from any vendor, is now looking
at some 7R/E alternatives from Nortel and Cisco.
McGinn tapped Bill O'Shea to eliminate such lags, promoting him to head of corporate strategy
and business development in May. The new boss has started by stripping Lucent's 10
business units of planning responsibility in favor of a central authority. ``When we're too slow,
we're a quarter or two late,'' O'Shea said.
Even though some companies, such as Network Associates Inc., are decentralizing product
development, O'Shea is betting his plan will prevent the delays that resulted when Lucent units
charted their own strategies. At times, Lucent developed products in such isolation that they were
incompatible until engineers wrote a complicated piece of software to connect them.
Revamping Bell Labs
Shaking up Bell Labs, arguably the world's most famous R&D center, is a tougher assignment.
For decades, few, including McGinn, have dared to fiddle with a formula that yielded the laser, the
transistor, the Unix operating system, and countless other innovations, as well as six Nobel
prizes in physics.
The labs still get 11 cents of every dollar Lucent generates in sales -- a total of more than $4
billion last year -- a tenth of which is devoted to basic research like mathematics.
Now, McGinn wants O'Shea, who began his career in the labs in 1972, to meddle in a serious
way. O'Shea intends to reorganize the scientists and engineers into groups that would see a
product from invention to production.
That's a switch from today, when researchers work on several projects at once -- or none at all.
Lucent may even let venture capitalists take a stake in and manage some projects to inject
entrepreneurial verve and money.
``We have to relook at our whole R&D model,'' O'Shea said. ``If you look at a start-up, the same
guy who wrote the Ph.D. paper is living in a cubicle and building a system.''
Culture Shock
What O'Shea really means is changing the culture. Many engineers came to Bell Labs instead of
going to Hewlett-Packard Co. or International Business Machines Corp. to escape the pressure
to develop.
``I do what interests me and excites me,'' said Gerard Holzmann, a stereotypical Bell Labs
scientist with his scruffy beard, calculator watch, and plaid shirt. ``I won't lose any sleep if
nobody uses it.''
The independence of basic research isn't the only throwback on the leafy, 195-acre campus
AT&T built in 1940 to house Bell Labs. While executive offices now occupy newer wings in
Murray Hill, in some of the rambling older buildings, doors are painted gaudy yellow, brown, or
green; linoleum tile hasn't been replaced for decades; and elevator dials are numbered by hand.
The hurdle for O'Shea, 53, and Bell Labs president Arun Netravali will be cultivating a start-up
mentality in people like Holzmann, a specialist in software testing who joined Bell Labs in 1980,
without destroying the mystique that attracted them. Loyalty may prove an obstacle.
``I don't work for Lucent; I work for Bell Labs,'' Holzmann said. ``If this were to become a place like
any other, you could work anywhere.''
`Like a Jailbreak'
McGinn has another reason to want Jeong Kim, whom he appointed to run Optical Networking in
August, to adopt a start- up model: The business has lost almost 10 percent of its 5,000
engineers and product developers this year, mostly to competitors.
``It's like a jailbreak,'' said Dan Smith, CEO of rival Sycamore Networks Inc., which has been
hiring from Lucent.
Even those who have stayed wonder if the unit, which makes equipment to run fiber networks for
customers like Global Crossing Ltd., has the critical mass to compete with Nortel anymore.
Kim, a 40-year-old billionaire, is abandoning the layers of management that Lucent inherited from
Ma Bell in favor of less bureaucracy and higher salaries for engineers. The former U.S. Navy
submarine corps lieutenant, who sold Yurie Systems Inc. to Lucent in 1998 for $1 billion, will
grade employees on innovations, speed of introduction, product improvement, revenue, gross
margin, and efficiency -- like a start-up does.
Unlike the rest of Lucent, pay will be calculated mainly on the performance of small development
teams, not company wide sales or profit.
Defections are hurting Lucent in data networking too. Just two months after Lucent had paid $25.2
billion in stock for Ascend Communications Inc. in June 1999, the company had to borrow experts
from Sycamore to fix a network outage at WorldCom Inc. because so many engineers had fled.
More-recent departures could turn Lucent's $1.1 billion July 1999 acquisition of Nexabit Networks
Inc. into a bust. Nexabit head Mukesh Chatter quit in May, followed by several engineers in July,
stripping Lucent of software talent once again.
If the remaining engineers can't soon finish the router that Nexabit was developing to direct traffic
on the Internet, Lucent may have to shell out billions for another company, O'Shea says.
Bright Spots
To be sure, McGinn doesn't have to mend everything. Lucent has a thriving business in data
networking, where it's second to Cisco, and trails only Ericsson AB in wireless gear. It could beat
Nortel to market with revolutionary products in fiber optics like the LambdaRouter switch and
faster transmitters.
On a July conference call, McGinn promised that voice switches will become the smallest of
Lucent's four equipment lines by 2001, moderating the impact of a dwindling business.
Sales of equipment for wireless, data, and optical networks are each poised to climb at least 20
percent next year, as is services revenue, says J. P. Morgan Securities analyst Greg Geiling,
who, along with most of the other analysts who cover the company, rates Lucent a ``buy.'' He
figures total revenue will increase at least 24 percent in fiscal 2001 -- faster than Lucent has said,
though slower than at its rivals.
Holy Grail
McGinn already was first to deliver an optical switch, a device that many carriers considered to be
the holy grail. Lucent's LambdaRouter, a metal box containing dozens of tiny mirrors and
sprouting hundreds of fiber strands, can redirect beams of light from one city to another without a
costly conversion to electronic signals.
If it's successful, the switch could be a big winner for Lucent -- and Bell Labs, where it was
developed by the kind of small team McGinn and O'Shea are pushing. Industry wide sales of
optical switches will swell to about $2 billion in three years from almost nothing in 2000, according
to RHK, a South San Francisco, California, market researcher.
McGinn's challenge is to convince phone companies that he can back up claims of great
technology with timely deliveries of working products. ``Nortel is good at devising a strategy,
explaining it, and then executing,'' said RHK analyst Dana Cooperson. ``A lot of people have
trouble figuring out exactly what Lucent's strategy is.''
Report Card
Strategy or none, McGinn has a chance to win back business from Qwest's Nacchio, who like
the Lucent CEO rose through the ranks at AT&T and served as executive vice president.
Chromatis Networks Inc., a start-up Lucent acquired for $4.76 billion in June, has a product in
trials at Denver-based Qwest.
If the equipment works as planned and is on schedule, it could mean a new era of credibility for
Lucent -- with customers at least.
Investors may be harder to win over. McGinn knows that his reputation, and perhaps his job, are
riding on shareholder approval. ``Our ultimate report card is the market,'' he told executives at the
August retreat in Warren.
McGinn gets high marks for effort. He now must prove that Lucent can compete by introducing
new products and can boost revenue as fast as rivals while completing a major restructuring and
keeping employees from jumping ship -- all in the next 11 months. The timetable leaves little room
for error. |
