Blinded With Science

After an awful nine-month stretch in which almost everything that could go wrong did go wrong, there's finally some good news at Lucent Technologies Inc. The one-time king of the telecom equipment business last week confirmed plans to spin off its fiber-optic division in what promises to be a bonanza payday. Next week the public offering of Agere, its microelectronics group, is expected to bring in US$6.5 billion, making it the second-largest IPO (initial public offering) in history. The massive restructuring should help the company regain its footing following a series of earnings disasters and ill-advised financing deals that left it with a dangerous amount of debt - and a stock price about 80 percent below its peak.

Even if the financial engineering succeeds - not a given in a down market in which more than a dozen IPOs have been pulled since March 7 - Lucent will still have to prove it has what it takes to compete. Its biggest weapon? A decidedly old-economy asset that Wall Street views as an anachronism, but might yet prove a savior: the massive R&D machine known as Bell Laboratories.

R&D is what separates Lucent from its biggest rivals, Cisco Systems Inc. and Nortel Networks Corp. Those two companies rode to the top of the business by using mergers and acquisitions as an R&D tool, snapping up scores of young companies with hot new products. While Lucent nurtured its homegrown network equipment product lines, its rivals roared ahead in fast-growing areas like Internet routers and optical gear.

But the tables may be turning: A sudden collapse in demand, linked to the economic slowdown and overcapacity across the industry, has hurt Cisco and Nortel almost as much as Lucent. Plummeting share prices will make M&As more difficult - and just might open the door for old-style Lucent and its famous lab to mount a comeback.

"Bell Labs is the engine for this entire company," says Bill O'Shea, executive VP of corporate strategy. "Everyone else has been content to rely on M&A activity to acquire technology, but no one has the kind of research organization we have." O'Shea says Lucent will maintain its current support for research, which is 11 percent of its revenue. That comes to a tidy sum of $4 billion this year.

It will be a long climb back. After a deceptively strong run following its 1996 separation from AT&T, Lucent has suffered a series of devastating reversals. In October, it was forced to pull its first CEO, Henry Schacht, out of retirement to replace the ousted Rich McGinn, who left following four consecutive earnings warnings and a 22 percent drop in profits. Last month, Lucent saw its bond rating fall to near-junk status. The company hasn't managed to transform its product line quickly enough from voice communications to one that can compete in data, where the action is. And management is under investigation by the SEC for alleged accounting irregularities. Those missteps have dropped it from No. 1 to No. 3 among equipment makers, behind Cisco and Nortel.

It seems long ago that Lucent and Bell Labs were the biggest, meanest competitors in the industry. "The first time I visited Bell Labs, I was standing in the lobby and I kept hearing this loud 'thunk,'" says a top executive at a Lucent competitor. "It was coming from this big clock on the wall. I was told that every time the clock ticked, Bell Labs had been awarded another patent."

Bell Labs is the last vestige of AT&T's bygone phone monopoly. In the serene, uncompetitive days before its 1984 breakup, there was plenty of room for the company to engage in endless research, file countless patents and create enough technology to overwhelm any adversaries. It hired the best scientists and engineers, and let them loose to pursue their dreams. The results included many of the seminal advances in contemporary technology, from the computer chip to the communications satellite.

But that approach was already looking like a luxury a decade ago, and over the past few years rivals that leave the science to others have managed to outmaneuver Bell Labs. "Traditional research has its place, but it's much smaller now," says Marek Wernik, director of disruptive market and business solutions at Nortel. "We prefer to look to partnerships with VCs or other relationships for partners or potential companies to acquire. That's a much more reliable route to get new technology."

With 30,000 researchers and engineers in 30 countries, Lucent still thinks it can prove Wernik wrong. And the story of the LambdaRouter shows how that might happen.

Susanne Arney joined Bell Labs 10 years ago straight out of Cornell University, where she was one of a handful of students in the world in a little-known field: micromachines. Arney's particular know-how "wasn't necessarily something Bell Labs could use," says Cherry Murray, VP of physical sciences research. "But we decided it was just something we wanted to have. It was too interesting, and Bell Labs couldn't afford not to have it."

Arney's work in machines that are barely visible to the naked eye is now critical to Lucent's next generation of telecommunications switches. The first product based on the technology is the LambdaRouter, and Lucent is betting on it to help regain its fortunes.

LambdaRouter systems will help simplify networks. Currently, voice and data are transmitted as pulsing light and electrical current. The LambdaRouter, built around an array of microscopic swiveling mirrors, is a big step toward a system that uses only light, which is faster than, and therefore preferable to, current systems that use both electricity and light.

The first Lambdas shipped July 31. The company hasn't begun mass-producing them yet, but Arney has been readying engineers to install the routers in customer networks worldwide. "I'm dying to get back to do more research," she says. "But I am dying to ship this."

It's taken Lucent 10 years of research to get to this point. But in the meantime, Nortel has acquired similar technology. If Lucent can get its product out before Nortel, it'll be a major validation of the Bell Labs model.

Lucent admits many of its mistakes were the fault of management, not Bell Labs. The best-known case involves Lucent's recent gamble building gear that moved data at 2.5Gbps. Nortel bet on 10Gbps and loped past Lucent. "We missed the boat," says Lucent's O'Shea. "We're not going to get everything right. But the Labs were strong supporters of 10Gbps. It was the product manager's decision to go a different route."

That disconnect shows a lack of coordination between scientists and the sales and marketing departments. "Bell Labs' problem has always been with its marketing people. Most of them are failed engineers who get no respect from the researchers," says Hilary Mine, an industry analyst with Probe Research. "When you've got no respect for the marketing function, your marketing will obviously fail. "Other large corporate research divisions already have gone through what Bell Labs is experiencing. IBM's still has a sterling reputation, despite the hard times the company endured over the past decades. "In the '70s, we were a research organization by charter," says Robert Morris, director of IBM's Almaden Research Center in California. "But going into the '80s, it became clear we had to look for ways to get research and product groups together. We were letting good science go out the door without IBM profiting from it."

In the ensuing years, IBM cut doors into the walls between business and research. Now, scientists move into the business units to help push research into development. This flexibility has produced impressive results. In particular, physicists at IBM have made important discoveries that have put Big Blue on top in microchips and computer hard-drive technology, and the company has beaten industry leaders like Intel to market with new products.

Following IBM's lead, Lucent is trying to get researchers to spend time with customers. The most drastic move came in October when Arun Netravali, president of Bell Labs, and Bill Brinkman, VP of research, were given titles and responsibilities within the company's business units. "When I came here in 1978 I don't think I even knew what the products were," says research VP Murray. "Little by little, researchers have had to move closer to the business units."

Still, as Lucent spins off business groups, it's finding it harder to incorporate Bell Labs' innovations into its dwindling product lines. But Lucent has found one decidedly new-economy way to capitalize on the Labs' work: venture capital. The New Ventures Group funds and helps spin off firms based on research done within Bell Labs. Last year, it funded 17 new companies, a number no one expects to duplicate anytime soon, since the capital markets have skidded to a virtual standstill. The group claims a 50 percent rate of return over the past three years.

But the New Ventures Group is only a small outlet for some of the pressures building inside Bell Labs. There are other opportunities for scientists outside of Lucent these days, and Bell Labs is suffering double-digit turnover annually - a much higher number than in the past. And in the past few months it shut down its Silicon Valley research park, which was key to Lucent's highly touted effort to get in closer touch with innovations coming out of California.

Back at Bell Labs, researchers still exude the superiority you'd expect from the birthplace of the transistor and the laser. But a first-class research facility hasn't translated into a first-class business for Lucent in recent years. Consider the labs' work in DNA micromachines, a biotech tool very different from the LambdaRouter. DNA micromachines are integral to genetic research - but certainly not to Lucent's core business. "Will DNA micromachines be important for telecommunications? I doubt it. But what everyone here is sold on is that we're No. 1 in the world," says Murray. Few would argue: Bell Labs is the most important research park of the 20th century with 11 Nobel Prizes to its name, its most recent awarded in 1998.

Just two weeks ago, Lucent announced that after 20 years of research, Bell Labs had helped create the first superconductor made of plastic. It's not clear how this discovery will pan out - it's still years from production - but like the transistor before it, plastic conductors should offer cheaper, faster and more efficient ways to transmit data.

That's the kind of development that keeps Bell Labs central to Lucent. "We have an innate confidence that the work they're doing [in Bell Labs] will lead to products or projects for Lucent," says corporate strategy VP O'Shea. "Like plastic superconductors - we didn't know at the outset if this would work out. Now we're the world leader."

So now comes the hard part - turning leadership into dollars.

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