Outsiders on the inside

It's being hailed as a world first, a development that could bring a new business model for a ravaged telecommunications industry finding its feet after two years of financial forest fires.

Over the past couple of months, Telecom has signed about $380 million worth of deals under which its main equipment suppliers, Alcatel and Lucent, will take control of running and developing its fixed and mobile networks on both sides of the Tasman.

Outsourcing is old news in the telco world, but the scope of the deals Telecom has negotiated is unprecedented.

International telecommunications companies are watching to see if the move is worth copying.

At the heart of the deals is acceptance of a concept that doesn't sit well with monopolists - relinquishing control.

Telecom will still own its networks and have the final say over what investment is made in them.

But Alcatel and Lucent will have an equal hand in steering technology and operational decisions.

For French vendor Alcatel, the deal involves moving Telecom from its old circuit-switched technology installed by NEC in the 1970s to an IP (internet protocol) network able to deliver voice and data - from local and toll calls to high-speed internet access and corporate networking - over the same infrastructure more cheaply and reliably.

Lucent, an American company, takes responsibility for Telecom's 027 mobile network.

Telecom's general manager of network investment, Stephen Crombie, says the deals will reduce costs and ensure Telecom can keep up with technological change.

"It requires a cultural shift because you're changing a hundred years of practice," he says.

"What's different about this deal, and what has got the world intrigued, is the way Alcatel and Lucent take responsibility for planning the development of our network assets."

The deals firmly entwine the fates of vendors in this part of the world with Telecom, for better or worse.

They trim Telecom's staff by 350 - 50 go to Lucent, 200 to Alcatel in New Zealand and 100 to Alcatel in Australia.

The employees occupy the same seats they always did, which in some cases means the fiercely competitive vendors are sharing office space in what one source described as a "mini United Nations" of equipment makers.

Most of the people now working for Alcatel and Lucent are ex-Telecom staffers.

Alcatel, which reported a 2001 New Zealand profit of $3.2 million on revenue of $88.7 million, is increasing its staff from 70 to 270.

Lucent goes from 30 to 80 staff.

Sydney telecommunications commentator Paul Budde says the network outsourcing is a "brave move", but one that makes better sense than trying to manage the introduction of tricky technology in-house.

"The plan is certainly not without risk. This is not to say that I believe the company is moving in the wrong direction. On the contrary. The plan is charting the right course. The question is, will Telecom in its current format still be in charge in, let's say, five to 10 years?"

Budde has reservations about equipment vendors helping steer the strategies of their customers.

"They may be excellent engineers, but most of them don't have a clue about what is involved in delivering the services that end users want," he writes in a report on the deals.

US research company RHK says the deals ultimately narrow Telecom's technology options, leaving it with "few or no options to consider alternative suppliers of changes to its business plans".

Telecom knows the approach has risks.

"We're putting our eggs in the baskets of Alcatel and Lucent," says Crombie.

But he points out that it took two years of extensive analysis to whittle down the outsourcing shortlist to settle on Alcatel.

The supplier will have a near monopoly on equipment sales to Telecom for the near future, but may contract in other suppliers if necessary.

"If Alcatel doesn't have a product which meets our requirements, there's a considerable disincentive for them to push their own products," Crombie says.

"We'd expect them to go out into the market themselves and look for product from another supplier.

"The contract enables that to happen."

Telecom has shed a wealth of expertise, but has kept the "brains" of its operation - a team of 60 that works with Crombie to oversee the vendor relationships.

Alcatel's managing director, Mark Giles, says the contract includes a monthly governance programme, a "risk reward" arrangement where payments to Alcatel are linked to targets being reached and a requirement to maintain customer satisfaction levels.

Giles says Telecom will now be able to put more resources into customer-focused activities, leaving complex technology decisions largely to Alcatel.



IDC telecoms analyst Landry Fevre believes Telstra and Optus, the other large carriers in the region, are unlikely to enter into such an arrangement.

"Telstra is too entrenched in building its own network. Singtel Optus wouldn't do it. They've spent enough time integrating the two companies."

Fevre suggests other possible reasons for the outsourcing.

"Maybe at board level it shows a lack of trust in their own team. Maybe it's to remove a bit of weight from their balance sheet."



Telecom's arch rival, TelstraClear, is watching the Alcatel deal with interest. But its chief of customer opportunities, Connell Graham, says outsourcing core network functions is not on the agenda.

"We need to hold on to the things that are important," he says.

But the company has its own conventional outsourcing in IT and field services.

An IT outsourcing contract with Unisys will soon be renewed, and a contract worth tens of millions of dollars will be awarded for network maintenance.



TelstraClear is aiming to reduce the number of agreements it has with contractors to maintain its network from 60 to one or two.

Telstra, despite dissatisfaction with its Australian outsourcing deals, is increasingly looking at network outsourcing, but is yet to go down the same path as Telecom.

With Alcatel sharing responsibility for its networks, Telecom in theory will become a more customer-focused, marketing-savvy operation.

Budde sees this as essential if incumbents are to stem market share losses to new entrants that are "far more market-driven than the good old national operators".

This is certainly true of the mobile market in New Zealand, where Vodafone has jumped from the 17 per cent share it had when it bought BellSouth in 1997 to 51 per cent today. Its marketing has left Telecom Mobile for dead.

Early signs are that Telecom is embracing a long overdue marketing focus, better integrating its Telecom Mobile, Xtra internet and fixed-line services in its marketing and looking to enhance its retail presence. But it has a long way to go.

"To be honest, I don't think too many telcos will be able to accomplish such a complete transformation as to enable them to compete with truly marketing-driven organisations," says Budde.

Some commentators suggest that if the partnership with Alcatel is a success over the next few years, Telecom may divest direct ownership in its network.

Instead, it may form a joint venture company with Alcatel to run it and sell capacity - a bit like the arrangement with the Southern Cross cable, of which Telecom has a 50 per cent stake.

This would undermine all the current arguments about whether the local loop should be unbundled and how much competing carriers should pay to subsidise Telecom's Kiwi Share losses.

Neither Telecom nor Alcatel rules out the possibility, but both think it unlikely.

"Ownership of the assets is very important to a telco, it defines the telco," says Crombie.

Giles is also sceptical about the notion.

"I don't see a vendor ever becoming a telco, it's not our core mission."

Budde's pick is that networking outsourcing in the telecoms industry over the next 10 years will lead to structural separation, where equipment vendors run the networks and share the capacity among a number of service providers.

On Tuesday, Telecom is expected to post a profit for the year to June of between $676 million and $700 million, helping to erase the memory of last year's $188 million loss.

Cost cutting has played a large part in the strong result, and chief executive Theresa Gattung will be looking to Telecom's numerous outsourcing deals to cut its costs even more this financial year.

The market has generally embraced the outsourcing decisions, but is more interested in the savings.

"At the moment, people are more interested in the full-year result and whether they'll increase the dividend," says one analyst.

Last June, when the partnership with Alcatel was announced, Salomon Smith Barney estimated a network deal "could yield discounts of up to 20 per cent" depending on Telecom's eventual spending with Alcatel.

Broker JBWere predicted a reduction of up to $100 million in New Zealand operating costs.

The real test of the vendor deals will come when Telecom launches increasingly sophisticated services based on its IP network and starts turning off sections of its aging circuit switched infrastructure.

If the move to IP goes smoothly, the savings will be worth it.

In the carrier world, all eyes will be on this experiment in the South Pacific.