Lucent’s Four Acts of Folly
Lucent’s origins were anything but dramatic. The former manufacturing arm of AT&T, it variously supplied switches and phone systems to Ma Bell, her former customers, and her offspring, the Baby Bells. It would be hard to imagine a less glamorous role than that of foot servant to a utility – and a regulated utility at that. When Lucent was spun off as an independent entity in an initial public offering in April 1996, investment bankers expected it to be a dud.
But Lucent’s rebirth coincided with the deregulation of telephony and the twin revolutions of the Internet and the cell phone. Carly Fiorina, an executive noted for her steely ambition, managed the stock offering with energy and dash. Her pitches made buttoned-down institutional investors rise to their feet and applaud. Lucent was slickly marketed as the best of all possible investments – in Endlich’s words, “a low-risk, high-tech company.” It didn’t hurt that Lucent kept the better part of Bell Labs (AT&T kept the rest), AT&T’s storied but underutilized research and development wing. In the pleasing fairy tale told to Wall Street, Bell Labs, whose scientists – several Nobel Prize winners among them – had enjoyed unparalleled freedom to pursue long-term research, was to be the soul of the new Lucent. Here, the arbiters of Wall Street greedily concluded, was a large, established company whose stock was as sexy as a startup’s. By the morning of the Sequoia meeting, four years after the IPO, Lucent’s stock had risen nearly eightfold. Though this paled next to the performance of a stock like Qualcomm (which went up by a multiple of 50 in that timespan), the relative modesty of Lucent’s ascent conferred on its shares the deceptive aura of reasonableness. It was, for a while, America’s most widely held stock.
In the late 1990s, American corporations were in a state of furious transformation. Increasingly, they were governed by markets rather than by old relationships to suppliers and customers. Endlich seems to feel that Lucent was in need of a similar transformation. Noting that former AT&T hands continued to run the company, she blames much of Lucent’s misfortunes on its failure to “reinvent its culture.” This cliché should not go unexamined. Changing the culture was not the cure for Lucent; it was the disease. Because Lucent had long been sheltered by AT&T, once it gained its own stock, its managers felt the pressure acutely. The famously inward company became an extravert, more apt to trust in outsiders than in itself. Each of Lucent’s major mistakes (I counted four) were a function of its straying from its former character.
The first goof was to abandon the Baby Bells and other traditional customers in favor of marketing to so-called competitive local-exchange carriers, or CLECs – that is, the hundreds of new phone companies spawned by deregulation. These saplings had little capital and no profits. Since they could not afford Lucent’s equipment, Lucent lent them the money to buy it.
Lucent could not, on its own, cater to each of these small but demanding customers. For example, each insisted on a modern data network, but Lucent, because of its AT&T ancestry, was weak on data. To fill the holes, Endlich says, Lucent executed a rash of mergers and acquisitions (its second error), including paying $4.5 billion for one company, Chromatis, that had yet to make a sale. Despite the public homage it paid to Bell Labs, Lucent was too impatient to wait for its researchers to develop new products. Rather, it made 38 acquisitions at a frenetic pace, while never integrating them into a seamless whole.
Lucent’s third mistake was ignoring the pleas of its homegrown technologists by delaying the development of a higher-bandwidth optical system, the OC-192. As a result, Nortel, once an afterthought in optical equipment, commandeered a 90 percent share of the OC-192 market.
This leads to the fourth and most harmful act of foolishness: Lucent’s efforts to satisfy Wall Street by misrepresenting its sales. Carly Fiorina, Endlich says, “set the tone” among Lucent’s aggressive salespeople, but she left the company (to run Hewlett-Packard) in 1999, before Lucent’s sales practices got out of hand. The fault lies with the company’s CEO: Endlich ably demonstrates how Rich McGinn became wedded to the notion of 20 percent annual revenue growth, a goal he laid out to security analysts in 1998. This was an extraordinary rate for a company with nearly $30 billion in sales. When the results inevitably failed to measure up, Lucent resorted to accounting games. Revenue mysteriously appeared in quarters where it did not belong. Customers were persuaded “to take delivery of items they had not ordered.” And so forth.
The real risk in forecasting results isn’t that companies may disappoint Wall Street; when expectations are unrealistic, they should disappoint. The danger is that managers put their organizations under mortal strain to meet unrealistic goals.
Ultimately, the fixation with stock price corrupted not only Lucent’s reporting but also its behavior. “You manage what you measure” is an old manager’s maxim. McGinn measured revenue. His sales tactics moved from the aggressive to the self-destructive as Lucent marked down its products by absurd amounts. Customers who got hip to Lucent’s weird desperation would delay placing new orders until the end of a quarter, when the pressure on Lucent was greatest. Contracts were reviewed up until 11:59 p.m. on New Year’s Eve. One sales executive required her troops to publicly pledge to specific volume goals, as though selling switches was some sort of charity drive.
To further inflate sales, Lucent committed a grotesque $8 billion to customer financing. At some point, Lucent wasn’t selling equipment any more; it was giving stuff away and labeling it a sale. When McGinn’s controller told him that “One way or another, we will make it” to the next quarter’s sales targets, the “other way” included accounting contrivances of which investors like my cousin did not have the faintest notion.
Endlich reports all of this, but she cannot quite bring herself to censure Lucent’s executives. After documenting numerous -instances of deception, she concludes, “The sum total of these accounting manipulations was not fraud but a less-than-entirely-clear picture of how and where Lucent was making its money.” This sentence is unfortunate: evasive and legalistic.
She stresses that Lucent’s executives weren’t criminally charged with “wrongdoing,” but deceiving the largest shareholder base in America seems wrong enough. Worse, she pads her account with the retrospective opinions of the major players, which further shades the story in a forgiving tone. In her -summing-up, Endlich concludes, “To this day McGinn does not believe that he was overreaching Lucent’s abilities in the goals he set in 2000.” By this point in the book, our interest in McGinn’s opinion should be rather small. Moreover, the remark misses the point. Lucent’s problem wasn’t that its targets “overreached” but that McGinn employed them to drive operations. In the end, Lucent (and Bell Labs along with it) shrank beyond recognition, and its sales plummeted to levels last seen in the 1980s. Lucent’s story is really the story of American business in the late 1990s, when executives betrayed their supposed devotion to “shareholder value” in order to pump up their stocks in the short term – to their shareholders’ later misery.