Nortel/John Roth's Quest

John Roth was not at all happy. For two months last winter, a Dallas-based advertising agency had been working on a hip new TV commercial for Nortel Networks Corp., the Canadian telecommunications giant of which Roth, 56, is chief executive officer. The goal of the campaign, based on the Beatles song Come Together, was to change Nortel's image from that of a sleepy manufacturer of old-line phone equipment to an innovative supplier of hardware and software for the INTERNET age. But after screening an early version of the ad on Feb. 18, Roth fired off an e-mail message to the man in charge of the new campaign, William Conner, Nortel's executive vice-president of marketing.

"I told Bill I didn't like it at all," Roth said recently during an interview at his Brampton, Ont., office. The ad showed a silver-haired executive reciting the lyrics to the Beatles tune - "Here come old flat-top, he come groovin' up slowly" - before an assemblage of straitlaced businessmen. Roth saw how the song title fit Nortel's new corporate-branding strategy, but for the life of him, he couldn't figure out the ad. "It was dark and foreboding and the script was confusing," he recalled. "Plus there were all these foreigners. I didn't know Nortel was owned by the Japanese, but in the ad the chairman seemed to be a Japanese guy - and he's frowning. I thought, 'What's this guy doing? Why are all these people standing around? And what does any of this stuff have to do with Nortel?' " The ad talked about the era of "unified networks" but scarcely mentioned the biggest network of all, the Internet. "Look, this is all about the Internet," Roth told Conner. "That's what the marketplace recognizes, so let's claim the space."

Conner got the message, and in less than two weeks the ad agency produced a radically different commercial. Gone were the moody lighting and the Japanese businessman. At Roth's suggestion, the director had inserted shots of ordinary people using computers, mobile phones and other high-tech paraphernalia. Best of all, a voice-over stressed the company's Internet credentials. Nortel, the ad said, is "bringing it all together with the true power of the Internet." Roth loved it. Conner and the ad agency, he told associates, had worked miracles.

They had, but Roth himself clearly deserves a healthy share of the credit. Since he took over as chief executive of Canada's biggest high-tech company in October, 1997, the lanky, soft-spoken native of Lethbridge, Alta., has instituted a radical overhaul of NORTHERN TELECOM, a transition symbolized by the recent adoption of Nortel Networks as the company name. Changing the name, however, was the easy part. The bigger challenge is Roth's attempt to change Nortel's culture. He wants to prove to Nortel's customers, staff and shareholders that a 104-year-old company headquartered in suburban Toronto can compete and win against the hotshot engineers and hard-driving upstarts of California's Silicon Valley.

And it's not just Nortel that Roth is trying to change. Earlier this year, he publicly took on the Liberal government of Prime Minister Jean Chrétien, claiming that high personal income tax rates are "testing the allegiance" of Canada's top engineers and researchers, driving a growing number of them to the United States. Critics later accused Roth of putting his business interests ahead of the country, but the Nortel CEO has not backed down. "I think it's something Canada has to face up to," he told Maclean's. "The issue is, can Canada maintain this huge tax differential sitting next door to a country that's as easy to enter as the United States? You can't do that and maintain your best talent."

But it is Nortel's own future that most concerns Roth. He calls his attempt to transform the company "a right-angle turn," a term borrowed from Microsoft Corp. chairman Bill Gates. In late 1995, Gates used the phrase to describe Microsoft's D-Day-like assault on the Internet, which threatened the company's lucrative PC software business by opening up the market to a host of nimble new competitors.

Now, Roth is steering Nortel in the same direction - and for much the same reason. For decades, Nortel has earned its money by manufacturing and selling switches and other phone gear to telephone carriers such as BELL CANADA (which, like Nortel, is part of the corporate empire of Montreal-based BCE Inc.). Roth, however, believes that by the end of the next decade nearly all TELECOMMUNICATIONS - voice and data - will travel over the Internet. If and when that happens, it will demolish the traditional economics of the phone business, which has been based on tolls for voice traffic. The future also holds perils for Nortel, because in an all-Internet world there may no longer be a market for the circuit-based switches that have been its core products.

"The market in which we're competing has changed drastically, and so has our competition," Roth warned in a memo last year to Nortel's 75,000 employees, 23,000 of whom work in Canada. "In addition to competing against our traditional competitors, we're going head-to-head with the best in the computing industry, the best in the consumer electronics industry, and the best in the data networking industry. And those new competitors were born and raised in an environment vastly different from the one we grew up in."

Lately, analysts and investors have been applauding Roth's strategy. Since he replaced Jean Monty as Nortel's chief executive 21 months ago - Monty moved on to become BCE's president and CEO - the company's shares have climbed 80 per cent, closing last week at $130. In the first six months of this year, Nortel was the second-fastest-rising stock on the Toronto Stock Exchange; its market capitalization, $86 billion, is equal to 9.2 per cent of the combined value of all Canadian-based companies on the TSE. In domestic terms, the company is a colossus: it spends more on research and development than any other corporation in the country ($3.6 billion last year alone), it employs more engineers and technology workers than any other Canadian company (9,250), and it ranks fourth in the country in terms of revenues ($26.1 billion in 1998), behind GENERAL MOTORS OF CANADA Ltd., BCE, and FORD MOTOR CO. of Canada Ltd. At its current rate of growth, it could easily be number 1 in revenues within two or three years.

As big as it is, however, Nortel is just one of many players fighting for a share of the $400 billion-a-year world market for telecom equipment. The competition is cutthroat, pitting Roth's company against such global behemoths as Lucent Technologies Inc. of Murray Hill, N.J. - spun off from AT&T Corp. in 1996 - Sweden's Ericsson, France's Alcatel and Germany's Siemens AG. Each of those companies is bigger than Nortel, yet the Canadian company has more than held its own against them. Since 1995, Nortel's revenues have increased by an average of 18 per cent a year. In part, that's because the market itself has grown rapidly as deregulation sweeps through the industry, giving birth to new competitive carriers and fuelling demand for the equipment required to build new telephone networks. "Over the past few years," Roth says, "we've gone from serving less than 100 customers to serving more than 1,000."

The other trend shaping the industry is the continuing growth in the amount of data travelling over the world's telecom networks. As recently as the early 1990s, data was an afterthought for most big phone carriers, accounting for only a tiny portion of their total traffic. But the rise of computer networking - both within companies and among residential computer users, who typically use telephone lines to connect to the Internet - has set off an explosion in data movement. "Nortel's a company that grew by building telephone systems," Roth says, "but telephone conversations only grow at about three per cent a year. In my mind, it grows either with the GNP or with the population of the country. Data networking, on the other hand, has been growing at 30 to 40 per cent per year. So, in a very short time, it grows from being nothing to being everything."

That is no exaggeration. In the fall of 1996, for the first time ever, the amount of data traffic worldwide overtook the amount of voice traffic. "You do the math and by the year 2000 it's going to be 75 per cent data, 25 per cent voice," Roth says. "In a few more years it will be 95 to five. Gets to the point, who cares about voice?"

The increase in data traffic has huge implications for Nortel and other telecom-equipment makers, because their mainstay products - refrigerator-sized boxes known as circuit switches - are primarily designed to handle voice transmissions. Circuit-switching is an efficient way to handle voice traffic because most phone calls are short and consist of a continuous stream of conversation. Data traffic, however, tends to occur in big bursts - for example, when a person downloads a file from the Internet - followed by long periods of silence. To avoid tying up lines, a group of engineers at the U.S. defense department in the 1960s invented a technology called packet-switching in which data is broken into chunks, or packets, which are then transmitted over the network and reassembled when they reach their intended receiver. The advantage of packet-switching is that it allows the same network lines to be used by many people simultaneously.

Nortel has been a major supplier of data-networking gear since 1989, but until recently the company's efforts focused on a particular type of packet technology known as ATM (for "asynchronous transfer mode"), which is popular with phone companies and large telecom users such as multinational corporations. It was Roth who decreed that Nortel should change direction by embracing an alternative technology known as Internet Protocol, or IP. Doing so, he realized, would cause massive disruption and consume many millions of dollars worth of R and D, but Roth was convinced that the rapid growth of the Internet, which runs on IP, would transform his industry. Unless Nortel got on the IP bandwagon, there was a danger it would be pushed aside by a fast-rising Silicon Valley star such as Cisco Systems Inc., which dominates the market for IP data equipment.

Roth's epiphany came in the summer of 1997 while he was still number 2 to Monty. That February, Nortel's board of directors had announced that Roth would be taking over as CEO in the fall, the crowning achievement of a 28-year career at Northern Telecom and its former research subsidiary, Ottawa-based Bell-Northern Research Ltd. In the previous five years under Monty, Nortel had undergone a top-to-bottom transformation, shedding obsolete business units, integrating R and D more closely with sales and restructuring the company along product lines rather than geography. "I found myself in the summertime saying, well, what am I going to do here?" Roth says. "I'd been in charge of more and more of the portfolio as time went on, and I'd reached the point where the company I was going to take over was really my own design. So I'm looking at this thing, saying, you know, I've got the company structured the way I want, everything's going pretty good - this is going to be a really boring job. I started thinking, well, what's coming up? And one of the things I thought I should do is get more involved with the people feeding traffic on the Internet and see where it's going."

Over the next few months, Roth talked to a succession of Nortel customers about their data needs. He also spent hours surfing the Web in his office and at his home in the Caledon Hills, north of Toronto. One of the things he was curious about was the growing interest in electronic commerce, considered by some to be the single most important Web application. A collector of old automobiles, he decided to test the Internet's usefulness by searching on the Web for something he had been unable to obtain from a Canadian dealer - a replacement liner for the glove compartment of his prized 1966 Jaguar E-Type. "I started poking around and within five minutes I'm in a little garage north of London, England - a four-man operation - and he's got my parts. How would I have ever have found this person if he wasn't on the Web? The idea that some guy north of London can carry out a business transaction with someone he's never met in Canada - it struck me what a powerful force this was, and how could something like this ever be stopped?"

Roth bought the glove-box liner. From other Web sites, he purchased a 1950s jukebox and a pool table. By then, he had become convinced that Web commerce was the wave of the future, and that Nortel needed to position itself to profit from the explosion in Internet traffic. That meant shifting the firm's primary development efforts away from ATM towards IP, a step that flew in the face of conventional thinking in the industry. "I'm convinced the future success of Nortel will depend, to a large extent, on our ability to do for IP networks what we've done for voice networks," he said in a letter to employees two months after becoming CEO. "IP networking will become one of the corporation's core competencies."

For months, Roth worked at selling his vision within the company. In its current stage of development, IP is in some ways technically inferior to ATM, so many of Nortel's engineers were convinced that Roth's road would lead to problems. What's more, IP networks are typically built not with conventional circuit switches but with routers, devices that sort and interpret individual data packets and ensure that each one is sent to its proper destination. Nortel wasn't in the router business, and many insiders believed it would be a mistake to challenge the companies that were - Silicon Valley firms such as Cisco, 3Com Corp. and Bay Networks Inc. Roth flatly disagreed. "Hey, time out," he recalls saying to one group of employees. "The customer buying all this stuff doesn't want to worry about that crap. So if we can't beat 'em, join 'em, and let's build better routers." Roth didn't need to remind his staff of the last time he had championed a new direction for Nortel. In the 1980s, he pressed the company to get into the wireless game at a time when some executives were convinced cellular was a fad, like CB radio. Today wireless systems generate a fifth of Nortel's revenues.

Roth ultimately bought his way into the router business, engineering a $13.4-billion takeover of Bay Networks in August, 1998. It was the first time a major telecom equipment maker had joined forces with an IP networking company, and many investors worried Roth had seriously overpaid, shelling out more than three times Bay Networks' annual revenues at a time when Bay was losing market share to Cisco, its much larger rival. Nortel's stock plummeted, losing 53 per cent of its value in four months because of widespread concern over the cost of the Bay acquisition and its impact on future earnings. "He was the first guy out of the gate and everybody said, 'What is he talking about? He must be nuts,' " says John Tyson, Nortel's senior designer. "I and my children had about a two-year setback in our future [financial] planning because the share price just tanked."

Roth stuck to his guns, however, and before long the critics - both inside and outside the company - started to come around to his way of thinking. In January, Lucent Technologies, acknowledging that it had fallen behind in the packet-switching race, struck a deal to buy Ascend Communications Inc. of Alameda, Calif., for $30.4 billion, a price that made Nortel's deal for Bay Networks look like a bargain. Meanwhile, Nortel has moved quickly to exploit its newfound strength in the data market. This past spring, the company unveiled a raft of IP-networking devices for the business market, most of which incorporate Bay Networks technology. The company has also announced a series of lucrative, multiyear supply contracts with telecom carriers around the world, promising to help upgrade their existing networks to more efficiently handle IP and other types of data traffic.

Most of Nortel's competitors dispute the Canadian company's claim to be a leader in next-generation technology, although they do concede that Nortel has advantages in certain areas, such as fibre-optic networks. But one thing no one questions is Nortel's success in remaking itself. "Technically, we're at least as good, if not better, but they've stolen the show through aggressive marketing," says Prabhas Ganguli, a senior competitor analyst at Ericsson in Stockholm. A recent article in Tellus, an in-house Ericsson magazine, acknowledged that Nortel "has a much stronger image than Ericsson in the IP and datacom market," adding: "All around the world, they are on the offensive, buying market shares through kamikaze-like pricing strategies."

The challenge for Roth now is to maintain his company's position in the traditional telecom industry while waging war against Internet giants such as Cisco. It is a battle of perception as much as technology - one reason why Roth and his team plan to spend almost $150 million this year on advertising, at least three times the ad budget in 1998. "Having all this technology is great, but it's not enough," says Conner, 40, a former AT&T marketing executive and native of Arkansas who is one of Roth's rising stars. "Nortel was always known as an old-world carrier company," he adds. "Some people think it's very un-Nortel to be aggressive about marketing - un-Canadian to a certain extent - but this is all about going from defence to offence." Cisco CEO John Chambers agrees that Nortel has moved quickly. "If you go back and look at what our old-world competitors were saying 12 months ago, it would shock you how far they have come," he says. "I have a lot of respect for John Roth. I just wish he'd retire or go into a different industry."

Ironically, Nortel's heightened concern for corporate image did not prepare it for the controversy in late April over Roth's call for lower tax rates. The issue erupted after a Nortel executive, Clive Allen, told a Cleveland audience that Nortel and other high-tech firms "owe no allegiance to Canada," and might be tempted to leave the country unless Ottawa moves quickly to slash tax rates. "I don't think Canada should feel they own us," said Allen, whose remarks made headlines across the country. "The place has to remain attractive for us to remain interested in staying there."

Eager to distance himself from Allen's comments, Roth later issued a statement pledging Nortel's allegiance to the country, but reiterating that high taxes were making it harder for the company to retain highly skilled Canadian workers. From a public relations standpoint, however, the damage had been done. At Nortel's annual meeting on April 29, television cameras caught 72-year-old shareholder and Brampton homemaker Carmel Kristal publicly berating Roth for Allen's "gratuitous and nasty" remarks. "Nowadays, everybody just thinks of themselves," Kristal said. "I feel what [Allen] said was very offensive."

Roth doesn't argue the point. "That lady and I were in a lot more agreement than she realized," he says. Allen, who retired as planned in May, "communicated very poorly," Roth says. "He thought he was speaking in private, but he's a very experienced man." If he had wanted to, Roth could have refused to discuss the tax issue, noting that Allen was not authorized to speak for the company. But it's not his style to duck a sensitive issue.

In the same way that Nortel is being forced by circumstances to change, Roth is convinced Canada has to change. "Canada's got a great quality of life, but you've got to balance that with other things," he says. His own loyalty isn't in question, he says, but he worries about the younger generation. He and his wife, Margaret, have two daughters, both in their 20s, and Roth expects one will soon move to the States with her husband, a retail manager. "I just watch where the kids, the friends of my children, and the children of the folks here at Nortel are going after university. And it's astounding the number who are heading out of Canada. Someday, they're going to run companies and have tremendous responsibilities, and they're deciding not to stay. It's their allegiance we have to worry about."

Roth knows his voice is just one of many, that it's far easier to shake up a company - even one as large as Nortel - than it is to re-engineer a country. At least in his own world, he has had a lot of success. An internal Nortel survey this spring found that employee satisfaction was up five percentage points over last year, to 75 per cent. "I was a little worried, because we've made a huge amount of changes, we've merged with Bay, and lots of people don't know what their job is anymore," he says. "But I think it's partly the fact that we have a direction - that we're doing it. I think people find the change exhilarating." That goes double for Roth.

Maclean's August 2, 1999