One of the biggest surprises to come out of the second-quarter earnings season was Alcatel-Lucent's (NASDAQ: ALU) announcement that it would review around 25 percent of its managed services contracts--or around 17 of its 68 in total--by the end of next year. Alcatel-Lucent CEO Ben Verwaayen and CFO Paul Tufano said the vendor will either renegotiate the contracts or drop them as part of a new cost-cutting program designed to save around $1.54 billion by the end of 2013.
Managed services were once touted as a new and important source of recurring revenue for vendors--one that would propel them beyond mere sales of boxes and other types of network equipment. Under the arrangements, vendors argued that due to economies of scale they could run networks more effectively and at a lower cost than operators can. It's a potential trump card when bidding against other vendors for contracts. However, the flipside is that such deals are often long-term arrangements that lock both parties into commitments, and both carriers and vendors may find them difficult to unwind if they become unprofitable.
So is Alcatel-Lucent's announcement the beginning of the end for managed services?
I don't think so. But I think it should force both vendors and carriers to re-evaluate managed services as a panacea. The deals need to be profitable and beneficial for both the vendor and the carrier to work in the long term.
"They're all going to have to figure out where the profit is and what the value is," noted Current Analysis analyst Peter Jarich. "The question is, it's a great source of revenue, but revenue at a cost of what? Is it profitable revenue?"
The market for managed services is clearly not going away. Ericsson (NASDAQ:ERIC), the market leader in managed services, saw the business grow by 37 percent year-over-year in the second quarter. Indeed, Ericsson manages the networks of Sprint Nextel (NYSE:S) and Clearwire (NASDAQ:CLWR). And in recent months Huawei has scored major managed services deals with the likes of O2 UK and Sunrise in Switzerland.
Alcatel-Lucent spokesman Simon Poulter said the company remains absolutely committed to the market for managed services, though he acknowledged Alcatel-Lucent needs to review the status of its deals and decide which ones work financially. "We have a fairly good idea internally about which contracts make the best financial sense for us, which contracts make the best business sense for us," he said. "We've signed some deals at some points in history with customers based upon the relationship potential--rather than whether it made good financial business sense or not."
Bradley Mead, Ericsson's head of network managed services, said he expects the market to continue growing, based upon carriers' desire to cut operating expenses and get more bang for their buck out of capital expenditures. While he said that managed services is now a "core" part of Ericsson's business, he also acknowledged that entering into such deals does not create a blank check that can simply be cashed. "These are long-term business relationships that you have to work on," he said. They have to evolve and they have to be aligned with the operator's business objectives.
Nokia Siemens Networks sounded similar themes. The company said in a statement that it wants to "engage in deals in which we can add significant value to the operator, through our focus on innovation and leveraging our global service delivery and innovative software." Huawei and ZTE did not respond to requests for comment.
It seems clear that managed services as a business for vendors is here to stay. However, I don't think it's a business model that's a surefire win-win for both carriers and vendors. Needs are sure to change, on both sides. Alcatel-Lucent's decision to review its deals is a salient reminder of that. --Phil