Lessons from Nortel: Acquisitions spree, bad management calls led to tech giant’s fall, study says

Lessons from Nortel: Acquisitions spree, bad management calls led to tech giant’s fall, study says

Jim Bagnall, Postmedia News | March 17, 2014 | Last Updated: Mar 17 5:39 PM ET
OTTAWA — In the five years since Nortel went bankrupt, many possible explanations have been suggested for its demise. Poor strategy, weak finances, low-cost competition from China, a misguided board of directors, hubris, the federal government’s refusal to backstop it during the recession, you name it.

11 lessons from Nortel’s failure (from the case study by University of Ottawa):

• Nortel tried to acquire companies without the processes or culture necessary to integrate them;

• Nortel did not have the appropriate depth and capability to gather reliable external and internal information in order to make timely and informed decisions following the mid-1990s restructuring and dismantling of Bell-Northern Research, the company’s research subsidiary;

• Nortel had people on the technology side who could design leading-edge technology solutions and people on the sales side who understood the customers’ needs. Yet, in restructuring for revenue growth, the company lost this advantage;

• After Roth was installed as chief executive, R & D staff believed management rarely listened to them and that, when they did, they did not appear to understand;

• In winding up BNR, Nortel effectively lost the ability to see and understand longer-term needs;

• From at least the mid-1990s through to the bankruptcy filing in 2009, Nortel’s business operations rarely earned profits. The resulting financial weakness made Nortel more vulnerable to external shocks;

• Nortel’s internal information systems could not provide management or the board with appropriate and timely information;

• Nortel’s customers in 2002 began examining Nortel’s financial statements more closely and discovered a company with a very weak financial position;

• Nortel’s sense of pride was a strength in the early days but it later escalated into hubris;

• From 2001 to 2006, Nortel’s board and senior management were more focused on dealing with restatements and investigations than trying to satisfy customers’ needs and commercialize new products; and

• In 2002, Nortel should have sold off business units to generate cash and dissipate growing doubts about its survival.

Three years ago, the University of Ottawa’s Telfer School of Management — along with faculties representing engineering and law — took on the massive job of trying to sort it all out. They interviewed hundreds of executives from Nortel and firms with which it used to do business. The academics also sought the views of dozens of outsiders familiar with the telecommunication equipment industry. The result is a major case study that purports to offer valuable lessons in how to avoid corporate failure.

Jonathan Calof, the director of the project, made public a 35-page executive summary Monday. Those seeking a definitive explanation for Nortel’s disappearance will be disappointed. “Assigning blame to one person or one decision is overly simplistic,” the summary concludes. “A combination of external shocks and managerial decisions led to the eventual demise of a Canadian giant.”

Nevertheless, two decisions seem particularly catalytic — and both showcase the weakness of Nortel’s board of directors, led until 2005 by company chairman Red Wilson. Indeed, only 2% of those surveyed by the case study agreed that the directors provided effective guidance for Nortel.

The first significant blunder — Nortel’s acquisition spree — occurred on the watch of John Roth, the CEO from 1997 to 2001. Roth spent billions of dollars in a failed attempt to juice Nortel’s performance by purchasing Bay Networks and a string of unproven startups. This was a stark betrayal of the talent in his company’s own labs, the report said.

The second piece of unfortunate decision-making was the directors’ uncritical (and, the Superior Court of Ontario would later rule, unjustified) acceptance of a 2004 report by independent investigators into Nortel’s accounting. It led the board to sack key members of the executive team at a pivotal moment in the company’s turnaround.

The acquisitions binge weakened Nortel; the mishandled accounting investigation contributed to pushing the firm over the edge, the U of O study suggests.

“Nortel tried to acquire companies without the processes or culture necessary to integrate them,” the case study notes. “It was a complete departure from Nortel’s established skills base, culture and history of developing its own products.”

Even though Nortel’s R & D cadre had previously developed the industry’s first family of all-digital telephone switches (computers) and in the 1990s won the race to build the globe’s fastest optical networks, Mr. Roth felt his engineers were slow to the task of designing new products for the age of the Internet. Maybe so, but they also had their eye on long-term industry trends. Nortel’s failure to stay abreast of these proved a great liability, the U of O study concludes.

When the telecom industry crashed in 2001, Nortel was hugely exposed. It had not successfully integrated its new acquisitions, which forced it to rely on its traditional strengths — telephone networking, optical technologies and wireless infrastructure. The U of O case study notes that Nortel had a competitive advantage only in the first two ­— and the business of supplying ordinary phone networks was in permanent decline while the market for optical networks was temporarily over-supplied.

When Frank Dunn took over as CEO from Mr. Roth late in 2001, he executed the largest downsizing in Canadian corporate history — made necessary by the collapse in Nortel’s revenues. The study notes this was when Nortel should have tried moving into more attractive markets, and not just cut costs.


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Indeed, a big focus of the case study is on Nortel’s failure to develop major new products after the telecom crash. The authors cite Nortel customers who complained of being offered software upgrades throughout much of the 2000s, rather than imaginative new technology packages. Had Nortel’s engineers been able to produce the latter, the company would have stood a better chance of winning market share and charging more for its products.

But Nortel couldn’t easily develop fresh technology because it lacked resources. For this, the case study blames the company’s lack of attention to the bottom line in the 1990s. Despite Nortel’s fantastic revenue growth during the early years of Mr. Roth’s reign as CEO, the company didn’t generate a penny of profit. Mr. Roth relied on the company’s inflated market value (share price times number of shares), which reached $366-billion at the peak in 2000, to pay for acquisitions, executive compensation, and provide collateral for borrowing.

Yet, such was Nortel’s cachet at the time it could have easily raised billions of dollars in cash by selling more shares. But it didn’t do that; nor did it generate cash by operating its business units efficiently as did rivals such as Cisco Systems. A significant piece of the blame for Nortel’s inflated spending and extravagant hiring during the late 1990s lies with Clarence Chandran, the former chief operating officer who had been slated to take over from Mr. Roth in 2001.

The case study’s summary does not mention Mr. Chandran; nor does it get into the role played Jean Monty — Roth’s predecessor as CEO — in giving Mr. Chandran the inside track for the top job. (He left Nortel in March 2001, citing complications from a knife wound he received when he encountered a burglar during an overseas business trip). Mr. Monty and other former Nortel executives provided the lion’s share of the financing for the U of O study.

Despite thin cash reserves and the distraction of a massive downsizing, Nortel nevertheless generated a profit of half a billion dollars in the fourth quarter of 2003. The company seemed on its way to recovery. But very soon after these results were announced, the board’s decision to hire independent investigators (Wilmer Cutler of Washington) to examine Nortel’s accounting came back to haunt the firm.

Wilmer Cutler jumped to the early — and incorrect — conclusion that Mr. Dunn and his top financial executives had achieved profits by cooking the books. These executives were sacked in April 2004 while Wilmer Cutler continued its work.

Mr. Dunn was replaced by Bill Owens, a Nortel board member. Mike Zafirovski, a former Motorola executive, would take over from Mr. Owens and serve until Nortel declared bankruptcy. The case study authors note that Zafirovski won few marks from customers for his promise to transform Nortel into a hyper-efficient corporation. What customers wanted, the study concludes, was fresh products. Even so, these same customers (who the report does not name) gave Mr. Zafirovski a pass in terms of blame for Nortel’s failure as a corporation. They told the case study’s authors that by 2006 they had already concluded Nortel might not survive.

“They were unwilling to commit to Nortel for any longer-term related procurement,” the study concluded.

What seems clear from the case study’s research — though the authors do not spell it out — is that had Nortel paid closer attention to its bottom line during the good times it would have had sufficient cash reserves to survive whatever happened after the telecom crash. And even in the absence of a cash cushion, had Nortel’s directors been more skeptical of the work of Wilmer Cutler, the company may very well have continued its recovery.

For how long is simply unknowable. What we do know is that a Canadian tech giant would have finished 2004 with knowledgeable executives, and hundreds of millions of dollars it would not have to set aside to settle a future shareholders class-action lawsuit. The company would have been able to focus on the job at hand, survival, with some resources to spare. Sadly, we never got to see how this might have played out.

Postmedia News


About bambooinnovator
Kee Koon Boon (“KB”) is the co-founder and director of HERO Investment Management which provides specialized fund management and investment advisory services to the ARCHEA Asia HERO Innovators Fund (www.heroinnovator.com), the only Asian SMID-cap tech-focused fund in the industry. KB is an internationally featured investor rooted in the principles of value investing for over a decade as a fund manager and analyst in the Asian capital markets who started his career at a boutique hedge fund in Singapore where he was with the firm since 2002 and was also part of the core investment committee in significantly outperforming the index in the 10-year-plus-old flagship Asian fund. He was also the portfolio manager for Asia-Pacific equities at Korea’s largest mutual fund company. Prior to setting up the H.E.R.O. Innovators Fund, KB was the Chief Investment Officer & CEO of a Singapore Registered Fund Management Company (RFMC) where he is responsible for listed Asian equity investments. KB had taught accounting at the Singapore Management University (SMU) as a faculty member and also pioneered the 15-week course on Accounting Fraud in Asia as an official module at SMU. KB remains grateful and honored to be invited by Singapore’s financial regulator Monetary Authority of Singapore (MAS) to present to their top management team about implementing a world’s first fact-based forward-looking fraud detection framework to bring about benefits for the capital markets in Singapore and for the public and investment community. KB also served the community in sharing his insights in writing articles about value investing and corporate governance in the media that include Business Times, Straits Times, Jakarta Post, Manual of Ideas, Investopedia, TedXWallStreet. He had also presented in top investment, banking and finance conferences in America, Italy, Sydney, Cape Town, HK, China. He has trained CEOs, entrepreneurs, CFOs, management executives in business strategy & business model innovation in Singapore, HK and China.

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