Why are Nortel's profit margins increasing? This story from the National Post points out that the profit margins from systems integration are
much higher than manufacturing activity. Nortel is moving away from manufacturing and into systems integration.
KEP
nationalpost.com 
Thursday, January 14, 1999
Nortel evolves into a planned
'virtual integrator'
Suspicions confirmed: Ends manufacturing to perform instead as a liaison
David Olive
Financial Post
Visitors to the futuristic world headquarters of Northern Telecom Ltd.
in Brampton, Ont., are wowed by the abundance of employee amenities, and a city-street layout where workers hold meetings at coffee bars, fountains and fast-food kiosks that dot the many "intersections" within the sprawling one-floor facility.
"You wouldn't guess," a Nortel guide will typically say at some
point in a tour, "that this used to be an assembly plant."
Yesterday, Nortel bade farewell to a big portion of its remaining
assembly plants, whichit will sell or close. It has confirmed suspicions long held by its 80,000 employees that Nortel was readying itself to largely bow out of manufacturing, and abandon a legacy of
telephone assembly work that dates back to the firm's beginnings in
1895.
As part of the shakeup unveiled by John Roth, chief executive, the firm will cut its workforce by about 10%, or 8,000 employees, over the next three years. Most of the people affected by the restructuring toil in manufacturing, and they've had plenty of hints that Nortel's future might no longer include them.
There was the Brampton facility, of course, an assembly point for central office switches that was converted three years ago into a temple for knowledge workers. Last year's $7.6-billion (US) purchase of Bay Networks Inc., a leading U.S. maker of Internet equipment, was a another sign that Mr. Roth's costly commitment to new-age networking would likely be at the expense of traditional manufacturing. The purchase, by far the biggest in Nortel's history, roughly coincided with the company's low-key sale of two manufacturing operations that together employed almost 2,000 people. And while successive waves of layoffs swept over the company throughout the decade, Nortel's swelling ranks of R&D workers only grew, and now number some 20,000 technicians at more than 40 research facilities in 17 countries.
"It's positive news, obviously, because it cuts $300-million or so in costs each year, and focuses Nortel on its highest-margin businesses," said Duncan Stewart, a veteran Nortel watcher who runs the Navigator Canadian Technology Fund for Tera Capital Corp. in Toronto. "This has been a work in progress for some time, this project to turn Nortel into a 'virtual integrator'which is no longer a manufacturer but performs instead as a liaison."
Since he became CEO two years ago, Mr. Roth has been rebuilding Nortel into a co-ordinator that brokers networking solutions among its customers,its own design staff, and outside designers and contract manufacturers. Said
Mr. Stewart: "I think yesterday all they did was put a sign up over the construction site to make it official."
Mr. Roth's predecessor, Jean Monty, recognized that the assembly of everything from handsets to room-sized switches for telephone utilities was becoming a low-margin commodity business that's best left to Far Eastern firms, whose access to cheap labour makes them the industry's low-cost producers. Under Mr. Monty, Nortel began redeploying its workforce, so that today, about 75% of Nortel employees are engaged in R&D, sales and marketing. Just 10 years ago, that number was only 45%. The balance of workers were mostly employed in manufacturing, where profit margins are 20% to 30%, compared with the 55% to 60% margins for packages of Nortel software and services that enable its Baby Bell clients to become genuine players in Internet protocol technology.
"Transitions like this are always difficult," conceded Peter Janacek, director of Nortel's corporate press office. "But for a long time there's been a sentiment here that dramatic steps like this are what it takes to grow the company."
It might be more accurate to say that they're required merely to survive in an escalating battle that pits Nortel against larger rivals such as Lucent Technologies Inc. of Murray Hill, N.J., and the giant European telecommunications suppliers L.M. Ericsson and Siemens AG. But dramatic moves in the telecommunications world this week suggest that Nortel, criticized just last summer for clinging to the least profitable aspects of its
heritage, may be gaining an edge over its bigger competitors.
With its latest step, most analysts agree, Nortel has freed itself to drive full-throttle into the lucrative field of cyber-networks. Meanwhile, Ericsson and Siemens are still saddled with vast commitments to old world manufacturing operations.
And Lucent's step, also unveiled yesterday, to acquire Ascend Communications Inc., is a vindication of sorts for Mr. Roth. It's an ill-kept secret that Lucent, the number one telecom firm, actually had its sights set on Web leader Cisco Systems Inc. But Lucent couldn't bag the prize.
At the time of the Bay acquisition, Mr. Roth was criticized for buying the wrong firm. He should have kept wooing Cisco, argued many analysts, even if it meant waiting and submitting to a reverse takeover by Cisco, whose astronomical stock-market value ruled out a straight acquisition.
The message that went out from Nortel's converted factory in Brampton yesterday gave tangible expression to Mr. Roth's assertion: "My competitors keep talking about the big things they're going to do. Well, maybe we're not doing enough, fast enough to suit even ourselves. But we are doing. And I see that many of our competitors are still talking."
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