Inside the new Nortel

A high-stakes turnaround plan aims to radically re-engineer Canada's former high-tech darling. But no one should expect a quick fix.

Mike Zafirovski had gathered 200 senior managers at Nortel Networks' lush, 34-acre campus in Richardson, outside Dallas — a long way from headquarters in Toronto. The two-day leadership meeting, which began on Sept. 12, was a chance for the troubled telecommunications equipment company's executive team to lay out what progress was being made on a range of issues — from Nortel's strategic direction and its plans for targeting new technology markets and major contract wins, to the myriad internal programs broadly categorized as its “business transformation” initiatives. For CEO Zafirovski, it was showtime.

He had a full agenda, and a lot for his senior managers to digest, especially since most people in the conference centre were still getting their occupational bearings, 10 months after Zafirovski came on board after five years at Motorola. At one point early in the meeting, Zafirovski posed a question: How many in attendance were new to the company or had started a new position within the prior 12 months? A forest of hands went up. Nearly four out of every five people had new responsibilities.

That show of hands represents the tip of the iceberg. A vast organizational overhaul is underway inside Nortel, flattening the structure of the company's workforce of 35,000. The project began in late winter; eight months in, it's less than a third of the way to completion. The long-term goal is to reach a formula that some experts say is an ideal structure for a company of Nortel's size: 10 by six. In other words, on average, 10 people should report to a single manager, and there should be only six layers of employees from front-line sales forces or engineers up to the CEO. For middle managers, meeting that goal means some will take on new responsibilities, some will no longer be managers — and some will no longer work for Nortel.

But the restructuring is just one way Zafirovski and his new-look executive team are reshaping Nortel. After years of financial mismanagement and strategic drift, the company that made a dirty phrase out of “right-angle turn” — former CEO John Roth's description of Nortel's redirection into Internet mode, which ended in 2001 with a head-on collision with reality — is reinventing itself yet again. It's a complex undertaking, made more challenging by the uncertain industry in which Nortel plays. The managers in the conference centre in Texas were just as curious as everyone else connected to the company — customers and suppliers, investors and analysts — about where Nortel is going, and what it is becoming.

On Nov. 15, Zafirovski will mark his anniversary as CEO of Nortel with an investor conference that, along with the release of third-quarter financial results on Nov. 7, ought to further dissipate the fog that surrounds his company. It better. In public appearances, Zafirovski has always been careful to note that no one should harbour illusions of a quick fix at Nortel. He describes efforts to “recreate” the company into a world-class operation as a three-to-five-year project. But 12 months in, investors don't seem to have much of the one thing Zafirovski was supposed to provide: hope. As of Oct. 31, Nortel shares (TSX: NT) had lost a third of the value they had on his first day as CEO.

Zafirovski came to the job with the right credentials. During a 25-year career at General Electric, he led a series of divisions in Europe and North America under the watch of uncompromising chief executive Jack Welch. The Macedonia-born American joined troubled communications equipment maker Motorola for a five-year stint beginning in 2000, during which he turned around the cellular phone business and became chief operating officer. Zafirovski is, clearly, a more savvy and battle-hardened corporate warrior, with deeper experience in the communications industry than his predecessor, retired four-star U.S. Admiral Bill Owens. Zafirovski also has a reputation for unwavering corporate ethics — a necessity for a company still tainted by financial restatements and an accounting scandal that led to the firings of several executives in 2004, including then-CEO Frank Dunn. If Zafirovski can't fix Nortel, probably no one can.

But he can't do it alone. Upon arriving at Nortel, he quickly set about recruiting a fresh senior team to execute the turnaround — people that would look at the business with new eyes. What they found: a deeply dysfunctional company that had lost its way in the sector's boom, bust and the aftermath and would have to be methodically rebuilt. For the man known as Mike Z and his band of corporate renovation experts, the task is huge and the stakes high. But the opportunity to re-engineer a company of Nortel's size and former pedigree is too juicy to pass up. By the time they're done with it, Nortel will never be the same. But will it be enough?

When Zafirovski took over as CEO, his first recruit was Joel Hackney. In the mid-1990s, the two worked together in GE's mortgage and insurance business, where Hackney was running daily operations and Zafirovski was chief executive. Their careers crossed paths within GE several times before Zafirovski packed off to Motorola, but they kept in touch, and when Zafirovski needed a sounding board to think through Nortel's job offer, one person he called was Hackney. From those conversations, Zafirovski came to recognize an opportunity to apply the kind of discipline he and Hackney had managed at GE — and it only made sense to bring in his old colleague, who was still working with GE in Barcelona as general manager of a US$1-billion electrical components division. Hackney's appointment was announced three weeks into the Zafirovski era. He started the next day.

His title, senior vice-president of global operations and quality, belies his real influence. He oversees 10,500 of Nortel's 35,000 employees and is responsible for everything that happens after a sale is made — order fulfillment, inventories, delivery, installation, customer support. He is a trusted lieutenant of Zafirovski's on many of the key initiatives inside the company. “At the end of the day, leaders have to build high-performance teams, and he has a tremendous skill in doing that,” says Hackney. “I didn't come to Nortel only for Mike Zafirovski, [but] that was a big piece of it.”

Four weeks after starting at Nortel's Raleigh, N.C., campus, Hackney, who had no prior experience in the communications industry, was on a plane to Beijing to meet with an important customer: Li Mofang, then chief engineer of China Mobile, the world's largest wireless carrier. For seven hours, Li took her guest through all the details of the companies' business arrangement. Hackney listened intently. The meeting left a lasting impression. “You can boil it down to one sentence,” Hackney says. “'Too slow, too costly, too expensive.'”

Solving those problems is why the company has adopted Lean Six Sigma — a variation on an approach to managing that was popularized by GE, and a big reason why Hackney and four other new executives have experience from that company. Lean Six Sigma is a rigorous methodology for analyzing internal processes, with the goal of improving customer satisfaction through the elimination of flawed practices and — here's the lean part — by improving speed. Specialized teams run projects with specific targets. One example: it can take Nortel as much as 72 days to confirm delivery after a customer orders an optical product; a project is now underway to reduce that time by 50%.

By the end of the year, 76 such projects will be in gear. Each targets an aspect of customer satisfaction, cash flow, cost of poor quality or time to market. Each involves completely redesigning a process to remove duplication and wasted steps. For instance, customers have told Nortel that the 18 weeks start-to-finish it takes the company to deploy and install a VoIP network is too long. Installers, product engineers and managers worked together to dissect the process for a single base station, identifying steps that could be eliminated to save time, as well as steps that could be completed concurrently. They also examined the product itself, to find ways to speed up the process — like clipping cables instead of screwing them in. By combining all those small measures, the team estimates that a redesigned process will halve time of installation to nine weeks. That's a big improvement, but it will still only put Nortel roughly on par with its competitors, which include Ericsson, Cisco Systems, Siemens and Lucent. “If we get the 50% reduction, we'll be slightly ahead of industry norms, but not a lot,” says Hackney. “That's how far behind we are.”

Lean Six Sigma projects comprise just one approach to becoming more competitive. Hackney is also one of a small cadre of executives leading six areas of what Nortel calls “Business Transformation.” He's responsible for shrinking by US$500 million the total US$3 billion the company spends on materials. Getting there involves renegotiating with suppliers; Nortel approaches them with detailed assessments of the costs of a product's every facet, including assumptions on labour, transportation and a reasonable profit for the supplier. Typically, a supplier will balk, but when pressed to defend its prices, it starts to share better information about the business relationship. “It's much more than just a supply negotiation tactic,” says Hackney. “The communications between a company like Nortel and its partners are not fluid enough to know where they have inefficiencies in their systems that we've actually caused.” The goal is to work smarter with its suppliers — and at less cost.

The first phase of the direct materials initiative targeted US$700 million of what the company spent in 2005. By June, Hackney's team had identified a reduction of 20% to 25%; it will take 12 to 18 months before those savings are realized. The next phase: find savings in US$1.3 billion of its costs, on the way to examining a total US$3 billion. “You don't know,” says Hackney, “unless you comb through it all.”

The transformation isn't only about cutting costs. Deficiencies in operations also hurt revenue growth. In its services division, Nortel has a new focus on what are known as pull-along sales for services to go with equipment orders — the B2B equivalent of “Do you want fries with that?” Sounds simple, but it's something “Nortel's never been particularly smart and good at executing,” Hackney says. So, sales force compensation has been changed and better product information has made it easier to identify opportunities for pull-along sales. “Simple, basic stuff,” says Hackney, “but it really pays off.”

Similarly, a study of the technical support department in June showed that 40% of incoming calls were not warranty related, yet Nortel was treating them all the same. That might be good for customer satisfaction, Hackney says, but it doesn't reflect the value of the work being done. For some cases, Nortel has created a separately priced service offering for which it can charge; for others, it's training channel partners to solve technical issues. “Our competitors do this very well,” says Hackney. “We're kind of the only ones that don't.” He claims he had expected to find such issues when he took his job. “It's typical of any company that's grown at the pace Nortel has, with its heritage and the industry changing on it,” he says. “No big surprises. The only thing that keeps me up at night is, I want us to move faster than we're moving.”

So what's preventing the company from attaining optimum velocity? “It's a complex business,” he says at first, but then pauses. “It's the cultural change we're driving,” he says. “How do we keep the assets of an engineering powerhouse and apply some modern management tools to be more market-based and competitive? Keeping that strength while also addressing some of the weaknesses — that's what slows you down. You just don't change a culture overnight.”

Back when the industry was different, Nortel could get by on its tradition of high-calibre research and development. But times have changed and the company has not adjusted. Engineering will still be central to its success — R&D spending will stay at about 18% of revenue, the company has said, although there are major initiatives to improve its effectiveness — but now Nortel is in training to not just make technology, but also become a better business. “There almost became a view within the company that Nortel was different and the problems they were facing were unique, and that's just not true,” says Hackney. “Business is business.”

To help reverse the culture of complacency, Zafirovski's team has drawn upon experiences at the likes of GE and Motorola and designed a program called “Own It.” It is a formal mechanism for employees and their managers to address bureaucratic headaches and eliminate obsolete processes. Hundreds of small projects have been assigned, each with a deadline and a single person accountable. The idea is not just to operate more simply; it's also that after years of watching helplessly while their stock options became worthless, employees will feel empowered to do their bit to revitalize Nortel. And maybe they'll start to have the hope that many investors lack.

All the programs and six-point plans could just amount to straightening the deck chairs on a rudderless ship — without a broader strategy. That's where George Riedel comes in. On a cold and rainy October day, Riedel, Nortel's chief strategy officer, is settling in to his first day at the company's new headquarters, which overlook 14 lanes of traffic on the western edge of Toronto. Some parts of the building are still under construction, but at least Nortel is finally out of the temporary digs that were set aside by its new landlord in a corner of its former HQ in Brampton, Ont. “I have to talk to Dietmar about my window,” Riedel jokes, referring to president of global services Dietmar Wendt, who has an office nearby (and joined Nortel in May after 25 years at IBM). “I have one small one, and he has three big ones. We have to do a benchmark study.”

Riedel's sense of humour may come in handy. Zafirovski recruited him out of a similar role at Juniper Networks Inc., an IP infrastructure company based in Sunnyvale, Calif., but the scope of this challenge is much greater, he says. “The product breadth, the market breadth, the geographic breadth, the competitive nature of things,” he explains. “At Juniper, you worried about Cisco. Here, you worry about a whole range of competitors, a whole range of things. It's a bigger puzzle.”

Solving it is a collective goal of Zafirovski's so-called cabinet of the 18 senior execs who report to him — although Riedel says Zafirovski is adept at bringing debates to a decisive conclusion. For example, in late May, Zafirovski and four execs (Riedel, CFO Peter Currie, chief legal officer David Drinkwater and president of the mobile networks business Richard Lowe) turned their attention to the woeful 3G UMTS wireless infrastructure business. Within three weeks, they determined it had neither the scale nor the momentum to become profitable, and certainly didn't match Zafirovski's criteria of focusing on markets in which Nortel can achieve 20% share. On Sept. 1, the company announced it was selling the business to Alcatel for US$320 million — its biggest strategic move to date.

Part of the rationale for the divestiture was to free up resources for emerging opportunities in so-called 4G (fourth generation) wireless technologies, which promise to bring ubiquitous broadband to the air around us. Riedel says gaining a time-to-market advantage in 4G is key to establishing Nortel as a leader, so it can co-ordinate the industry. Nortel doesn't want to be in the handset devices business, for example, but it does want to help accelerate other players' plans to make devices that will use new wireless infrastructure. It's an edge, Riedel says, over the likes of Motorola and Nokia, which are “conflicted” with both infrastructure and handset businesses. “We're Switzerland,” he says.

Some analysts have wondered if the strategy is short-sighted. “We believe that [4G] market is very small,” noted Merrill Lynch analyst Vivek Arya in a research note following the Alcatel deal. Arya pointed out that other players — namely, Motorola and Samsung — are ahead of Nortel in the space. “The small scale of the business,” Arya concluded, “could repeat the same issue that is leading to Nortel's exit from UMTS — namely small scale and a hypercompetitive market.”

There are no shortage of skeptics for every move Nortel makes — or doesn't. The Alcatel-Lucent and Nokia-Siemens merger announcements earlier this year set off speculation Nortel would need to find a dance partner. Zafirovski has dismissed this, and Riedel questions the wisdom of acquisitions — although rumours circulated this fall that a US$550-million deal fell through for Force10 Networks, a San Jose, Calif., company that makes Ethernet switches for corporate networks.

Riedel knows proving the skeptics wrong will take time. He believes the company is starting to make headway, however, citing the partnership agreement this summer with Microsoft to collaborate on new communications software for offices intrigued customers. “The nature of the dialogues we're having with folks as a result of that, on a range of fronts, has substantially changed,” he says.

To be fair, it did take years for Nortel to become as dysfunctional as it is. It may take years again — and no shortage of long hours by Zafirovski and his team — to make sense of it. But rationalizing Nortel is just the first step. Getting results is the next one — and the sooner, the better.