Six long years after the great telecom crash, Ottawa's tech industry remains surprisingly fragile.
Consider just a few of the more dramatic signs:
- Dozens of startups have emerged from the wreckage, but they haven't been able to hire fast enough to make up for the losses suffered by the rest of the industry. Employment in the sector -- about 64,400 by StatsCan's reckoning -- is 10 per cent below the peak.
- Investment money has slowed dramatically, potentially choking off growth in early-stage companies. Ottawa entrepreneurs last year received less than $150 million, compared to $1 billion annually during the boom.
- And, not least, it's no longer unthinkable that Ottawa's champions -- Nortel Networks and Cognos -- could lose their independence through merger or acquisition.
In short, there is a real risk Ottawa's tech community could slip into the status of a branch-plant city, its growth and prospects dependent on the strategies of companies based elsewhere. It's not inevitable. But the community needs a few dramatic wins to be able to re-create a tech industry with critical mass. And these victories need to happen in 2007.
Few better symbolize the raw urgency of the tech sector than Leo Lax, the co-founder of Skypoint Capital.
Since its inception in 1998, Skypoint has raised a small fortune and redirected most of it at Ottawa entrepreneurs. In all, Skypoint has bought equity in more than 30 companies. In a perfect world, Skypoint's bets would by now be paying off. Lax has had a few wins, but nothing really dramatic.
Most years, this wouldn't be a concern because his is a business that rewards patience. However, Lax and his partners at Skypoint began disbursing their $100-million U.S. Telecom Fund II in 2001. Sometime this year, nearly all of that money will be committed. If Skypoint wants to keep investing in new ideas, it will need to raise more money for Fund III.
Here's where the urgency comes in. In order to convince pension funds and other big-league investors to contribute to a new Skypoint fund, Lax has to be able to show results. And that means either selling one or more of his startups for a big profit or taking them public on a major stock exchange.
Will any of these events happen? Lax likes the portents but would prefer something real.
"We are definitely getting a lot more interest from investment bankers," says Lax. "We'll know better by the end of March."
Lax is far from alone in viewing 2007 as a crucial year.
Nortel Networks, the city's largest private-sector employer with 5,000 R&D workers, faces some momentous choices this year.
CEO Mike Zafirovski spent 2006 assembling a fresh team of executives with a mandate of turning things around. The new managers have dived deep into Nortel's various units and are now analysing what businesses the company should really be in. Zafirovski's top guns are also busy re-creating how and where Nortel should do its business.
The decisions involving organization and operations will almost certainly be made this year, while the tougher calls about what market segments to target -- and which to exit -- could come anytime during the next two years.
John Roese, the chief technology officer since last June, is developing a potentially far-reaching plan for making Nortel's R&D more efficient.
Among the options being considered is closing smaller research centres that lack economies of scale or doing more research in low-cost countries. Indeed, Nortel may finally install an R&D lab in India.
"It's something I'm looking at in 2007," Roese says, in reference to the analysis.
Ottawa's R&D labs, considered a medium-cost facility, will likely continue to handle the development of next-generation products but could lose the less strategic R&D work to specialists in Asia.
Some of the biggest changes taking root inside Nortel involve the nuts and bolts of operations. Joel Hackney, Nortel's new senior vice-president in charge of global operations, recently unveiled his game plan for cutting $1.5 billion annually in costs. That's about 14 per cent of sales -- an ambitious target. But Hackney told financial analysts there is plenty available for trimming.
For example, Nortel expects to reduce the number of parts it keeps on hand (known as stock keeping units) to 25,000 by the end of this year, compared to 80,000 at the beginning of 2006. The huge SKU total from a year ago reflects Nortel's longstanding practice of making one-of-a-kind items to please individual buyers. The tradition engenders customer loyalty but makes for a very inefficient supply chain.
Nortel also has plans to source more of its parts in low-cost countries -- the company currently does 75 per cent of its components procurement in higher-cost countries as well as 70 per cent of its manufacturing. Nortel, in keeping with the practice of rivals such as Cisco Systems, has also begun to sell more of its products online.
Underlying Zafirovski's push to create a more profitable and competitive company is a crushing reality.
The telecommunications equipment industry is relatively mature and consolidating rapidly. Under such conditions, only the top players tend to do well. Unfortunately, of 26 market segments identified by Dell'Oro, a U.S. consulting firm, Nortel is first in only one (carrier voice) and No. 2 in five others.
The underlying message is that Nortel may not survive as a standalone firm. Indeed, this may be true even if Zafirovski and his lieutenants succeed in transforming Nortel into a superbly run company.
Nortel's independence rests on its ability to successfully dominate enough market segments to give it economy of scale. It's not clear yet whether Zafirovski can manage this trick. By the end of the year, it likely will be.
Nortel isn't the only local giant racing to acquire enough heft to survive as an independent. Cognos, one of the best-run companies in the history of Ottawa's tech sector, tops $1 billion-a-year in annual sales.
That's easily good enough to claim the top spot for a Canadian software company. But in global terms, Cognos remains a niche player.
Its segment, business intelligence and performance management software, is undergoing consolidation of its own. Cognos's main rival, Business Objects of Paris, recently jumped ahead in annual revenues -- thanks to a more aggressive strategy of acquisitions. This doesn't mean Business Objects will prevail, but there is deep concern within Ottawa's business community that Cognos could soon be the target of a buyer -- if not by direct rivals, then by a software giant such as Microsoft looking to enter a new business.
Does it matter if Cognos and Nortel don't survive as independents? Yes, because control resides in head office -- and people who call the shots tend to be much better role models for would-be entrepreneurs.
Terence Matthews, the region's most prolific entrepreneur, has been frustrated by his inability to take his latest crown jewel public -- and hopes 2007 will be different. He filed last May for an initial public offering of shares in Mitel Networks but has been unable to find the right moment for getting the potential $150-million U.S. offering underway.
An IPO would help replenish Mitel's coffers following five years during which cumulative losses topped $300 million U.S. It would also signal investors' confidence in Matthews' latest reading of the equipment market. Mitel was one of the first to make gear for sending voice calls over the Internet but the VoIP market hasdeveloped somewhat slower than Matthews expected. With some market analysts projecting annual growth rates of nearly 30 per cent for the next few years, things could finally come together for Mitel this year.
If they do, an IPO could serve as a catalyst for some of Matthews' affiliated companies.
BreconRidge, in which Matthews holds a 28-per-cent stake, serves as Mitel's primary manufacturing arm. It had contemplated an IPO last year but was hurt by the rise in the value of the Canadian dollar, which raised costs relative to competitors based outside the country.
BreconRidge has adopted a number of strategies to cope but it's not yet clear whether an IPO is back on the table -- it almost certainly won't be until Mitel's is completed.
Ottawa's tech community depends heavily on the success of companies such as Mitel and BreconRidge -- independent operations, each with annual sales well above $100 million. They are essential for the establishment of a tech sector with critical mass and decision-making talent based in Ottawa. Surprisingly few of these relatively mature operations are based here -- software star Cognos, Corel (which re-launched as a public company last year), Calian and Zarlink Semiconductor.
A dozen or so, including March Networks, Mosaid and Tundra are approaching $100 million-a-year in sales. The rest of the home-grown sector consists of hundreds of startups with uncertain prospects.
It's possible a handful of companies could break out and give Ottawa a win that would make venture capitalists elsewhere take notice.
But even if Ottawa's tech sector does score a few good wins -- the sale of a startup for $500 million U.S. plus, or a string of IPOs -- it won't necessarily lead to a recovery in jobs. That's because the local tech industry has recently been persuaded that moving at least some of its R&D to lower-cost countries -- offshoring, in other words -- is essential to survival.
Over the past 12 to 18 months, Ottawa tech firms have moved with surprising speed to employ offshore suppliers and software developers. Until recently, only a few companies relied on offshoring, in part because setting up such arrangements tended to be complicated and, for small companies, not particularly efficient.
But a 32-per-cent rise in the value of the Canadian dollar since early 2003 has been a significant catalyst. So has the maturity of the Indian software industry. There is grumbling about the quality of some Indian programmers -- the industry on the subcontinent has hired so many new ones so quickly that this is a serious issue. Nevertheless, Matthews says up to 30 per cent of the R&D done by his companies is now done offshore -- a group he says includes Mitel, March Networks, Ubiquity Networks and Newport Networks.
Skypoint Capital's Leo Lax says anywhere from 10 to 20 per cent of the R&D at his firms tends to be performed offshore. The R&D work on second- or third-generation products is farmed out while the latest generation research stays in Ottawa, close to headquarters.
Increasingly, this is the pattern of Ottawa's tech industry. But if offshoring helps to create a competitive home-grown sector, it's not necessarily a bad thing -- especially when compared to the alternative.
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