Communications equipment makers enjoyed years of high-flying growth in the 1990s as wireless and traditional carriers rapidly expanded their networks and added new services. That all had changed by 2001 as carriers began to sharply cut back their investments in new equipment, a trend that reversed only modestly last year.
Telecommunications equipment maker Tellabs spent the last several years positioning itself to compete in this new environment, the past year under the leadership of Chief Executive Officer Krish A. Prabhu. An industry veteran who has served in research and development and management positions at AT&T’s Bell Laboratories, Rockwell International and Alcatel, Prabhu focused on dramatically cutting Tellabs’ costs and making targeted acquisitions to broaden its product offerings.
Prabhu recently spoke about the changing telecommunications landscape, managing a business through a downturn, and Tellabs’ strategic priorities and organizational response to industry trends.
Price: During the past six months or so, we have seen several merger and acquisition announcements among the large communications service providers. What is behind these moves to consolidate?
Prabhu: When the industry went through its downturn, it was very clear to us that there would be consolidation. But before this consolidation could occur, bankruptcies and debt restructuring had to be taken care of. Additionally, in 2003, the FCC eliminated a restriction on the amount of wireless spectrum a company could own in a particular market, which had limited wireless companies’ ability to merge. The next year, the federal government loosened the unbundling requirements placed on local phone companies for providing network access to their competitors. This set the stage for traditional (non-wireless) phone companies to consolidate their networks.
What we are seeing today is the natural consolidation that occurs in an industry that can support only a certain number of players. We are in the third phase. The first phase was cleaning up following the excesses that occurred in the bubble years. The second phase was getting clarity on the regulations. The third phase is consolidation leading to the right number of players in the industry.
Price: As the consolidations of these major players are completed, what will the telecommunications services industry look like a few years from now?
Prabhu: I believe we will reach a point in the next five to 10 years where we will have three established players in each market. This will provide good competition amongst the suppliers so the customers can benefit. Once we get to that point, there probably will not be any additional consolidation for some time. The only disruption that could occur is the introduction of a new technology that is somewhat cataclysmic, something really radical that spawns a whole generation of new players.
I also expect that the technology distinctions among service providers will continue to fade. Whether a company is an Internet service provider, a voice provider, a video provider, a cellular operator, a local or long-distance company, it’s not going to matter. In the future, it’s going to be communications devices talking to other devices, people communicating with people, people communicating with computers, computers communicating with computers, the whole gamut; the network will facilitate all this whether you are on the move or at a fixed location.
Price: What impact is the consolidation that is happening at the service provider level having among communications equipment vendors?
Prabhu: I think it’s logical to expect that there will be consolidation among the suppliers because there are still far too many vendors competing for a piece of a much smaller pie.
Suppliers need to evaluate what response is in the best interest of their shareholders. Does it make sense for them to merge with another company, eliminate some costs, extract synergies and reposition themselves, similar to what we did in our acquisition of Advanced Fibre Communications (AFC), or does it make sense for them to stay independent and hope that the tide turns?
Price: When the equipment spending began to drop in the 2000 time frame, how did Tellabs respond and what changes helped prepare the organization for the strategy you are pursuing today?
Prabhu: Back in 2000, just before the bubble burst, Tellabs was roughly a $4 billion-a-year company. It had healthy margins. It also had substantial expenses. Roughly 40 cents of every dollar sold went to internal expenses. As the market started sinking, what had been a very healthy position for Tellabs suddenly became more difficult. In response, Tellabs undertook a series of measures to reduce costs. We outsourced manufacturing to eliminate the fixed cost of maintaining production capacity; we trimmed R&D spending. We also pulled back on certain channel and sales costs, and cut out a lot of overhead, but maintained whatever was needed for customer support. Over a period of about two to three years, the company went from 9,000 employees to 3,000. Since I arrived, we have done a little more tweaking. For example, we have tried to adjust international expenses to be more in line with our international opportunities. We have also eliminated the overlapping functions that emerged when we acquired AFC.
Price: What were your main priorities when you first arrived?
Prabhu: The big question for the company at that time was how do we spur growth. We were right-sized. Business was picking up as equipment spending started growing. We had a good balance sheet, with zero debt and a healthy cash position. The question now was, “How could we grow?” So, our focus was on making the right investments, building on the platform that we had with our traditional customers and products. One of the first things we did was to acquire a company that allowed us to play in an adjacent area, but serving the same customers. The net result of our acquisition of AFC was that, in the eyes of major customers like Verizon, we went from being an important supplier to a strategic supplier.
We also instilled a new discipline in terms of how we make investments. In this day and age, you must choose areas to invest very carefully because it takes two or three years, at a minimum, to have the technology that the market may need.
Price: Given the situation that you walked into, what strategies or approaches did you take to ensure that employees, who had been through so much by then, stayed motivated to pursue the company’s growth strategy?
Prabhu: No doubt there was anxiety among employees. They were somewhat shell-shocked when I arrived. They didn’t know what to trust or what to believe, so morale was low. One of my first challenges, then, was to help them understand that the company had been through the worst times and that it was very well positioned for the future. I spread the message that the next three to four years will be good if we work on the right things, work hard like we’ve done in the past and build upon our strengths. I did a lot of face-to-face interactions with small groups of people and hosted several Q&A sessions. We talked a lot about our strategy. We worked on some near-term successes, which always mobilize people when they’re in this sort of situation. And we had a good run through the next three or four quarters last year. Our top-line revenue grew significantly compared to the prior year, so did our profits. People could see that and, as a result, their anxiety levels subsided.
Price: It has been said that Tellabs is fighting a “two-front war,” managing costs in your traditional business while launching products in new, fast-growing areas. Can you talk about the organizational requirements for battle in these two areas?
Prabhu: This is the essence of managing a technology business. You always try to leverage your positions of strength, which is the steady-state existing business, while making sure you’re investing in the right business for tomorrow’s opportunities. Any time you’re in a technology business where 14 or 15 percent of your revenue goes into R&D, you have to be cognizant of this.
From a leadership standpoint, the challenge to delivering the maximum potential of an existing business is to keep your eye on the ball. Tellabs is very well positioned in this regard. We have good processes and good people who consistently are recognized by customers through annual supplier service awards. Staying ahead of new opportunities requires us to ask a lot of questions. Is our approach the best? Do we understand the competitive landscape? Are we still connected with the customer in the market so that we hear their voice? Are there opportunities to leverage partnerships more fully so that we can get maximum bang for our buck?
Price: How do you see Tellabs going forward?
Prabhu: Tellabs is a strong company. We are not the biggest in our field, nor are we the smallest. The key for us is to understand where we are positioned, what we are good at, what we do that delivers maximum value to our customers, how we leverage that position into opportunities for growing the company. So, as I look to the next three or four years, I see Tellabs charting an independent course. We understand our strengths. We try to overcome our weaknesses through partnerships. And we will continue to look for opportunities to consolidate by merging with or acquiring companies that we think can add something to our offering.
Price: Before joining Tellabs, you had a long career in the telecommunications equipment industry at Alcatel and then joined Silicon Valley-based Morgenthaler Ventures as a partner. What about the Tellabs opportunity lured you back to the industry?
Prabhu: I had a very good feeling about Tellabs even before I joined the company. Now that I have been on the inside for more than a year, I must say that not only were my initial impressions right, they have been further validated and strengthened by the people I see here: their work, the processes that this company has developed, their commitment to satisfying their customers, etc.
I also think this is a unique point in the industry as it is moving out of the “phone” business and into broader communications and a future when almost anything can be done virtually. It’s a unique privilege and honor to be part of this company and in this industry at this time. We have an opportunity to make sure we do the right things during the next five to 10 years so that, when we look back, we will be very proud of what we’ve achieved.
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