The consolidation trend within telecom has become so inevitable that each major new deal, such as last week's Nokia/Siemens merger announcement, only serves to trigger further speculation as to who's next.

But behind all the numbers and speculation is the reality of what mega-mergers of all types — service provider and equipment vendor — are doing to transform the telecom marketplace. Behind the admitted long-term benefits of such combinations is the real potential for short-term pain.

Then there's the hard work of actually integrating large companies into even larger companies, with the inherent clash of cultures and rationalization of people, products and initiatives. And finally, there's concern over what happens to innovation, which often is driven by smaller, more nimble players.

“Getting from here to there is tricky; it's not easy,” said Michael Howard, president of Infonetics Research and a longtime telecom industry analyst. “There is a lot of difficult integration ahead. The larger the organizations are that are merging, the bigger the challenges are. They have to be smart, but really the most important quality would be to be incisive. They need to figure out quite quickly what they need and tear away what they don't need to get everybody moving in the right direction.”

The best-case scenario for telecom service providers is for a set of vendors to emerge that “are large enough to provide adequate logistical support, carry more inventory with short lead times to accommodate success-based builds, [equip, furnish and install] support and have the ability to offer some outsourcing capabilities around networks and an end-to-end portfolio, with aggressive pricing to match,” said Ken Twist, Ovum analyst.

The stated trends behind the consolidation push — the need for global economies of scale and fixed/mobile convergence — to some degree mask the fact that telecom is still bloated from its feasting days in the late 1990s and, from an investors' viewpoint, must operate more efficiently, said Kneko Burney, an Amsterdam-based analyst who is president and chief strategist for Compass Intelligence. “There is still too much fat, too much duplication,” she said. “This consolidation is a major step in this industry getting back on the right track.”

The challenge is to do that without derailing major technology initiatives. For example, the two planned mega-mergers on the equipment vendor side — Alcatel/Lucent Technologies and Nokia/Siemens — will bring together four separate IP multimedia subsystem (IMS) architecture efforts.

“The merger process is particularly interesting with IMS because it is access-agnostic,” said Joe McGarvey, senior analyst for Current Analysis. “So presumably, Siemens and Nokia's IMS boxes are going to naturally overlap because there's not a fixed-line version and a mobile version of IMS, like there is in the softswitch world.”

Analysts agree that the merging partners should use a best-of-breed solution that combines their previous efforts instead of adopting one partner's IMS initiative wholesale.

“Absolutely, they will choose the best solution, and, in a lot of cases, it will be combining parts of their IMS technologies that they already have or have in development,” Howard said. “You take the best technology to build the best solution.”

That aids service providers by creating more capable solutions that come out of more cost-efficient, and therefore more financially stable, vendor partners, said Fred Briggs, executive vice president of network operations and technology for Verizon Business. “They become more capable of focusing on our needs,” he said.

But there is some inevitable delay involved in the merger process, as companies must be — at least briefly — internally focused on such details as hammering out the best IMS solution while avoiding turf wars. Analysts agree that could mean short-term delays in implementing IMS.

“Alcatel and Lucent are going to have the most difficulty in defining those subtle strategic synergies — not just cost savings but inspirational innovation,” Burney said. “They are going to struggle the most because they have the most significantly different cultures. But Nokia and Siemens will struggle some also.”

Another major technology initiative — IPTV — also lies at the heart of the merger efforts as equipment vendors bulk up to provide an end-to-end solution for delivering voice, data and video to their ever-larger customers. Delays in IPTV deployment could be crushing to telephone companies seeking new revenue, both to replace wireline shrinkage and fight off cable competition.

“I think the IPTV rollouts are of such high priority to the service providers that they are not going to let them be impacted by the integration of any vendors,” said Vince Vittore, Yankee Group senior analyst. “It's survival to them to get this rolled out correctly and in a timely manner.”

Thus, service providers are likely to put pressure on their vendors, at the highest levels, to insulate IPTV from the impact of integration issues, he said.

At least, larger service providers will be able to exert that pressure — smaller companies may well find themselves left out in the cold.

“It's going to slow the pace for us,” said Phil Erli, executive vice president of Ringgold Telephone of Ringgold, Ga., one of a number of independents that pioneered deployment of IPTV, starting in 2004. “The vendors are controlled by the big companies, and more and more as the vendors get bigger, they don't have an interest in dealing with smaller telcos. We are seeing that today — Microsoft has no interest in dealing with us.”

As the consolidation trend rolls up smaller vendors, as Twist believes it will inevitably do, there are fewer players willing to partner with smaller service providers, Erli said. He foresees a market dominated by very large telcos, with smaller independents surviving to serve a niche or a community with which they have a special relationship.

“The tweeners — the companies that are not big enough to compete on the scale with the big guys and too big to have a tight relationship with the communities they serve — are going away,” he said.

Chinook Wireless, a smaller player based in Great Falls, Mont., is in the midst of a project to convert its CDMA-based network to GSM technology using a Nokia infrastructure. Ronald Belin, executive vice president and co-founder of Chinook, doesn't expect the Nokia/Siemens merger to have a direct impact on his company. But he does see a downside to vendor consolidation.

“What it limits more than anything is the innovation,” he said. “If you have fewer players that have no incentive to spend the money to look for better ways to compete in the market, you inevitably have less innovation.”

“Unfortunately, the pace and direction of innovation will change,” said Ovum's Twist. “Innovative technologies are likely to emerge from existing relationships between operators, their established vendors and a standards body rather than from entrepreneurs funded by venture capitalists. To some service provider folks, this is not a bad thing since they do not have the time to entertain ever new ideas emerging from start-ups as they did six to seven years ago.”

More than likely, the market will see tighter relationships between the biggest carriers and their biggest vendors, said McGarvey of Current Analysis.

“As much as anyone talks about interoperability with open interface and application modules, it is going to come down to one of these mega-carriers partnering with a mega-equipment supplier and having them supply the entire solution,” he said. “It may not be all the supplier's product, but with consolidation, more of the products will come from one company.”

Ed Gubbins and Tim McElligott contributed to this report.

NOKIA/SIEMENS PROFILE

Combined business value: $31.6 billion

Units combined: Networks Business Group of Nokia and the carrier-related operations of Siemens for fixed and mobile networks

Projected start date: Jan. 1, 2007

Executives: CEO: Simon Beresford-Wylie, currently executive vice president and general manager of networks for Nokia

Chief operating officer: Mika Vehviläinen, currently senior vice president & general manager of core networks for Nokia.

Chief market operations officer: Karl-Christoph Caselitz, currently president of mobile networks for Siemens Communications.

Combined 2005 pro forma revenues: $19.87 billion.

Projected synergies (cost savings): $1.88 billion

Employees at start: 60,000

Headquarters: Helsinki, Finland

THE BIG GET BIGGER

Before mergers

Top telecom equipment vendors by market share

Ericsson, 19.9% (includes Marconi acquisition)
Alcatel, 10. 3%
Nortel, 10.2%
Siemens 9.7%
Lucent, 9.3%
Nokia 8.7%

After mergers

Ericsson, 19.9%
Alcatel/Lucent, 19.6%
Nokia/Siemens, 18.3%
Nortel, 10.2%
Motorola, 5%
Huawai, 4%

Source: Dell'Oro Group