A Major Shift in Competitive Power in the Enterprise Communications Market

Breaking News

After months of turmoil and speculations, Nortel has picked Avaya as the preferred bidder (stalking horse) for its enterprise business unit. On July 20^th, Avaya and Nortel announcement an agreement, based on which Avaya will acquire Nortel’s enterprise unit for $475 million, also assuming $28 million of debt with the acquisition. An auction is still pending, but chances are Avaya will be the one to offer Nortel’s enterprise technologies a new home. It is worth taking a look at the implications of this potential merger regardless of the final outcome of the auction. Should another bidder offer a better deal and this merger fails to take place, we will, at least, know what could have been the consequences, if it did.

So much has been said about Nortel’s troubles and how it got to this point that I feel it is completely unnecessary to dwell on that any further. It is now clear that it is not going to emerge from bankruptcy intact and the only question is who will acquire the pieces and for how much. On an analyst call, Joel Hackney presented the pending Avaya acquisition as the most beneficial outcome for Nortel as far as all stakeholders are concerned – shareholders, customers, partners and employees. He noted that other potential bidders will be evaluated not only based on price but also other, unspecified criteria. We can only guess that such criteria will include some specific commitments to the above stakeholders.

Why Avaya?

One of the most important questions is – what makes Avaya such a suitable partner after years of intense rivalry? Challenged by Microsoft and Cisco at the top and SMB vendors such as Mitel, ShoreTel, open-source vendors, etc., at the low end, Avaya and Nortel don’t have much of a choice but to hold hands and form a unified front against the newcomers. Many of their customers can be described as “risk-averse” or the kind that would prefer an established vendor with a long history of delivering reliable, enterprise-grade communication solutions. In our experience, some of these customers wish to preserve their TDM equipment a bit longer and Microsoft, Cisco, etc. would not be their vendors of choice. But vendor viability is critical and especially Nortel, but even Avaya, will not be able to withstand the aggressive push from the new-age competitors on their own. By combining their installed bases and diversified portfolios they can now offer their customers – from the most conservative ones to those pursuing migration to IP telephony and unified communications – better longevity and a wider array of options.

Speaking of portfolios, redundancies will be inevitable in this kind of merger. Some products will have to be eliminated or else the new entity will experience major inefficiencies and will confuse partners and customers. For example, Nortel’s Joel Hackney identified the two vendors’ most advanced and truly innovative solutions – ACE and Aura – as synergistic, but they will have to be integrated into a commercial offering and positioned with a marketing message that clearly identify their role and benefits to enterprise customers. Integration may be less challenging at the low end of the telephony spectrum as Nortel’s SMB products can prove to be a most valuable addition to Avaya’s portfolio. Further, both vendors have strong contact center portfolios, which, if successfully integrated, can position them very competitively against Cisco and the other communication vendors. Finally, Nortel’s government business must have been perceived as offering a major value proposition to Avaya’s stakeholders as well. 

But what will Avaya do with Nortel’s data portfolio? Will it be able to integrate it with its other product lines and leverage it for growth and a more competitive positioning in the communications market? Most vendors are looking to become more focused rather than diversified today. For example, enterprise and carrier solutions don’t seem to mesh so well together any more. Similarly, as the data networking market becomes increasingly mature and commoditized, it doesn’t seem like a viable growth opportunity for a telephony vendor.

I would like to take a step back here to comment briefly on the lost opportunity for a Siemens-Nortel partnership. These two vendors’ portfolios would have generated better synergies with Siemens being particularly strong in the large enterprise space and Nortel offering an appealing SMB portfolio. Further, their geographic distribution of power would have been more complementary. Finally, both vendors have crafted major partnerships with Microsoft perceiving those as critical for their future success in the unified communications space. There must have been, however, factors that tipped the scales in favor of Avaya (and money can’t have been one of them given the fire-sale value attached to Nortel’s enterprise business).

I believe that one major aspect of the acquisition negotiations and a leading selection criterion was the acquiring party’s channel strategy. Nortel has historically been heavily dependent upon its channels for market reach and customer support. The channel partners represent major stakeholders in the process of Nortel disintegration and sell-out. Avaya, on the other hand, has recently admitted that its channel strategy had been lacking . For one thing, its direct sales force competed with the channel and created conflicts of interest. It has, however, stated that it intends to re-vamp its channel strategy and shift most of its sales to the channel. As part of this process, it is working towards improving its channel programs and growing its partnerships. Needless to say, the addition of Nortel’s partners will enhance its overall customer reach. Avaya’s new approach, on the other hand, guarantees Nortel’s partners some continuity in terms of product support and service delivery. 

One can’t help but wonder if Siemens’ bid did not fail (at least for now) because of its historical preference for direct sales. It seemed like a great opportunity for Siemens to grow both its channel reach and its North American presence through the acquisition of Nortel’s assets. But could Nortel and its stakeholders trust Siemens that it would indeed preserve such an extensive channel?

The Making of a Super Power or Delayed Transformation?

Should Avaya end up acquiring Nortel’s assets, the new entity is likely to go through two or three main phases over the next five to six years. Phase One is going to be marked by gradual and most likely painful integration of two portfolios and two business cultures. With the economy likely to curtail growth for some time to come, the new entity will struggle to first come up with a cohesive and comprehensive strategy and then communicate it to partners and customers. Organic growth is likely to be limited for at least 12 if not 18 more months. 

Assuming that Avaya’s management succeeds in integrating the two businesses and sends a VERY STRONG  message to the market about its growth objectives and means of accomplishing these objectives, the new entity can become a very powerful communications vendor with an unrivaled installed base and one of the most diversified unified communications portfolios. This is where Phase Two starts for the new entity looking to secure a competitive position in the evolving communications market. 

Cisco has been breathing down Avaya’s neck for two or three years now and has contested its leadership in telephony line shipments and revenues. Cisco’s determined advancement in the unified communications space is not going to be slowed down by a potential Avaya-Nortel merger. Cisco targets businesses that are determined to adopt a truly IP-centric architecture and many of those associate Avaya and Nortel with their legacy portfolios. Further, it has put together a comprehensive unified communications portfolio including instant messaging, audio, web and video conferencing, telepresence, collaboration, etc. that makes it a one-stop shop for more than just telephony and voice/unified messaging. Finally, with its increasing focus on cloud-based, SaaS-type offerings, Cisco is preparing for a completely different play in the communications marketplace. 

The bottom line is, Cisco’s march towards market leadership will continue and it will gradually shorten the distance with the new entity as well. The potential Avaya-Nortel merger can delay Cisco’s market share gain but will not deter its ability to grow. I strongly believe that the market (customers, partners, etc.) need competition and options. Therefore, a stronger communications vendor with a different, yet similarly diversified portfolio, and a quite different approach and reputation is highly needed to compete against Cisco in order for innovation to continue and end users to enjoy the benefits of more compelling, yet less expensive solutions. I expect Phase Two to be market by healthy competition with two dominant players, but also some very strong Tier-2 and Tier-3 competitors.

There is another factor in this marketplace, however, that will determine the outcome of Phase Two and the transition into Phase Three. The enterprise communications landscape has changed dramatically since Microsoft’s entry two years ago (arguable it started much earlier). Microsoft has forced the incumbent vendors to reform themselves and adopt more open, software-based approaches. It has emerged both as a potentially powerful competitor and a highly sought after partner. There are many industry pundits who believe that the future of all the incumbent vendors – Avaya, Alcatel-Lucent, Mitel, Nortel, Siemens, and even Cisco is challenged not so much by competitive dynamics among them but by Micosoft’s rally for a market share of enterprise telephony. 

How Phase Two ends for a combined Avaya-Nortel entity will depend on how it positions itself vis-à-vis Microsoft. It can choose to aggressively pursue an alliance and ensure that, in the short term, it is the preferred vendor for the telephony component of OCS-based unified communication implementations. It can instead choose to align itself more closely with IBM and thus slow down Microsoft’s penetration into the enterprise UC space. Eventually, however, Microsoft will be able to grab a significant market share of the telephony market and, alliance or no alliance, the incumbent vendors (not just Avaya-Nortel) will need to find new growth opportunities. They can choose to transform themselves into primarily services companies and provide integration and professional services in deployments where Cisco provides the “plumbing” and Microsoft – the applications, or they can continue to fight a very hard battle continuously looking to out-perform Microsoft by developing new competitive advantages in various application areas – conferencing, mobility, customer care, Web 2.0 integration, etc. 

Phase Three can be a period of dramatic transformation for Avaya-Nortel as well as all incumbent vendors as they choose different evolution paths – either becoming services-oriented businesses, getting acquired by larger and more diversified vendors, or focusing on specific market niches such as vertical industries, etc. 

Conclusion

In essence, transformation is inevitable. It will permeate all phases of market evolution throughout the next five to six years.  It is really a matter of when it takes place for each individual vendor and how it is executed. It is critical for both Avaya and Nortel to understand that and do not delay the process because of a somewhat illusionary sense of greater power and security based on the size of a merged entity.

We can dwell further on Avaya-Nortel’s fortune once the acquisition is final. If it does not go through, Avaya will have to face a number of challenges on its own and Nortel’s fate will be determined by where it ends up. For now, I have a positive feeling about the potential merger and hope it goes through.