Given the pace of change in the telecom industry, it’s little wonder that the nature of the relationship between telecom service providers and their technology vendors is also changing.

But it’s worth noting the extent of that change and its possible ramifications. Most recently, the industry has seen an increase in service provider funding of technology players but it’s also true that service providers are involving vendors much earlier in their decision-making processes, outsourcing more integration to them, and in general depending more on their expertise.

“They are moving beyond what classically was a partnership,” notes consultant Daniel Briere, president of TeleChoice. “They are now becoming so intertwined that you are seeing equity relationships, joint venture relationships, and partnering on new product development to a degree that you never saw before.”

Technology executives at major service providers acknowledge this change and even embrace it. But analysts raise concerns that tighter relationships could serve to limit carrier options and flexibility and even stifle innovation in the long run.

“There’s enough being done now that it’s time to start asking questions about this trend,” Briere said.

There are multiple forces driving the shifting relationships, according to service provider and technology company executives. High on the list is the rapid pace of change and the movement of telcos into new services, such as video, in which they have little expertise.

“The complexity of some of the systems we put in the field has changed – you no longer buy a box and put it in and put this other box next to it and they work together,” said Stu Elby, vice president of network architecture at Verizon. “There are so many competing standards out there, the vendors themselves are really struggling to determine what they should be building.”

Instead of using the traditional RFP process to solicit information and choose vendors, Verizon set up its own Verizon Interoperability Forum and invites what it considers strategic vendors to attend and work in partnership with the company to craft its technical requirements, Elby said.

“We started the forum to address next-generation options like wavelength switching and ROADMs, because vendors were going in different directions and the standards weren’t clear enough,” he said.

Some of the vendors invited already sell equipment to Verizon but others are invited as thought leaders in their industry segment, Elby said. This process helps Verizon get technology to market sooner, while incorporating best-of-breed systems, he said. By the time an RFP hits the street, it contains few if any surprises for the vendors.

Verizon is willing to take other chances, as well, to get to market quickly in new technology areas. For example, Elby said, when Verizon first got into video, “we handed our initial video work over completely to Motorola for their expertise, and we are just now bringing that more and more in house.”

At BellSouth, Chief Architect Hank Kafka sees changes in vendor relationships but nothing revolutionary. “There are trend-line changes that have been occurring but a lot of it is similar in intent and direction to the much broader set of trends of seeing increasing outsourcing by all kinds of industries,” he said.

Elby and Kafka both say that integration of multi-vendor equipment in end-to-end solutions is one key area of expertise that they look to major vendor partners to handle.

“It’s a lot more rare to buy all the gear from a single provider,” Kafka said. “Even an individual provider won’t offer everything and the volume of integration work that needs to get done in these new areas is higher.”

“We would actually reject a story from [a major vendor] for them to provide all the piece parts – we do expect them to step up as a professional services organization, and we include systems integration as part of the contract,” Elby said.

The need for integration expertise has fundamentally changed the way services and equipment is billed and paid for.

“Instead of there being a product sell from a vendor, this is a network integration sell,” said Curt Hopkins, vice president of services, sales and marketing at Nortel. Where equipment vendors may once have built the cost of integration into the price of the gear they sold, it is now billed separately as professional services, he said.

Service providers want that transparency, Elby said, so they know what they are getting and what they are paying for. And since almost every sale is multi-vendor, the integration is a key piece.

One of the industry’s most notable systems integration deals is AT&T’s contract with Alcatel and Microsoft, under which the two major vendors are managing a host of small vendor contributors to AT&T’s IPTV effort.

AT&T declined to comment directly for this article. In an email response, Maureen Merkle, president - procurement for AT&T, said telecom companies aren’t changing “any more or less than those in supply chains in other industries.”

Derek Kuhn, senior director for strategic solutions at Alcatel, said outsourcing in the video arena is going to be more common because it is new turf.

“There are projects that start and stop – it doesn’t necessarily make sense to always have people with a certain skill set within a service provider when they need these people for a finite period of time,” he commented. “I’ve worked over the last six years in the video space and that’s a new area for service providers. It’s hard even for me to find people that have the skill sets I am looking for – [service providers] knowing that they can rely on a vendor to have those skills, and that vendor is working on projects throughout the region or the world, gives them access to talent they can’t always get.”

The danger, said analyst Briere, is that telephone companies lock into deals with major vendors and, in the process, some companies may get locked out.

“It ends up creating very long-term monopolies that are hard to displace,” he said. “Microsoft knighted Alcatel as global systems integrator and everybody deploying the Microsoft solution has to get in line. The net effect is shutting everybody else out of the telcos.”

Kuhn disputes that, however, saying Alcatel and other vendors are constantly looking for best-of-breed partners including small innovators.

In general, though, the outsourcing trend isn’t likely to abate because telecom companies outsource for the same reasons other companies do, Kafka said –they want to address the fast pace of change in a financially responsible way that lets them stay focused on their core competency.

The closer ties to vendors enable service providers to address almost cataclysmic change in their industry, said analyst David Yedwab, partner, Market Strategy and Analystics Partners.

“There are five or six major structural changes hitting the industry simultaneously,” he said “So naturally, there is an urge to pilot, an urge to partner, and an urge to share ideas to try to find some things that are going to stick with customers. This has become a more experimental rather than a regulated service environment.”

Sometimes, what the service provider is looking for is a vendor’s knowledge of what works in the market, said David H. Deans, an independent consultant.

“Rather than constantly chasing best of breed, service providers look at some of the larger players who are in the best position to lead the way in the marketplace,” he said. “They know that a Microsoft is going to invest the time and effort to see what is going on across the full spectrum of the market. While their own products and services aren’t the full solution, they are able to identify incremental partners.”

In some cases, it even makes more sense for service providers to buy technology as a service, said Nortel’s Hopkins. His company is selling VoIP technology as a managed service offering.

Probably the biggest concerns about the tighter ties between service providers and their equipment vendors are two-fold: First, that the ties that bind can also smother and that innovation will suffer, and second, that financial ties between service providers and vendors in the form of equity investments will skew the technology selection process.

“The major shortcoming of going to these large providers exclusively and not working with small players is that you get the same old, same old, and you are missing a lot of potential innovation,” said David H. Deans, an independent consultant.

He points to Apple’s remarkably successful iPod as an example of a company not looking at how the MP3 player industry was evolving and doing something similar but better.

“Steve Jobs and his Apple team didn’t come at it from that point of view – they started from scratch and created an integrated service that attempted to re-invent the consumer experience to make it easier and more enjoyable,” Deans said.

“We’ve always had a certain cycle where you go through heavy consolidation and the big get bigger and choice is reduced, but that creates opportunities for smaller, nimble innovators,” Briere said. “The concern now is that service providers can become so entrenched with vendor partners in their most strategic areas that they can’t really afford to move away from these guys. The innovative player isn’t going to have a shot.”

This may be particularly true for companies that invest in technology players and then give them big contracts, he said. “It becomes a self-fulfilling prophecy for success of the investment, but it somewhat limits their future choice.”

AT&T’s recent equity investments in 2Wire and Akimbo Systems are prime examples of a company investing in companies developing strategic technology. In her email response, AT&T’s Merkle said those investments don’t restrict her company’s choices.

“I don’t think service provider investments in small technology firms will limit innovation in any respect,” she said. “Regardless of whether we have an investment in a particular technology firm, we look to the best technology available. We do not limit our search for the best technology to companies in which we have an investment. Finding the best technology is paramount. We would look anywhere promising technology resides, regardless of whether that technology resides with a rival. I would see no reason for our rivals to do otherwise.”

Both Kafka and Elby agreed that they are still looking for innovation from smaller players and that, if anything, there is more opportunity today because larger companies who serve as integrators are being pushed by their customers to partner with others who have developed best-of-breed technology.

“I’m not too concerned that innovation will be stifled,” Kafka said. “In terms of smaller suppliers and bringing those into play, our experience has been that our larger vendors are more willing to partner with smaller players and third parties that they have been in the past.”

BellSouth has pushed vendors to partner, he said, but then looks for a pre-integrated solution. Where it has a choice of multiple vendors, the willingness of a vendor to cooperate with others in a working relationship can be a decided factor in selection, Kafka added.

Verizon is hoping to stimulate innovation with its forum, Elby added.

“It’s setting up an ecosystem that allows an opportunity for an innovative company,” he said. “They can find someone in the room that is a strategy partner, or even an acquisition partner.”

Vendors are having to view themselves more as a solution providers than product providers, Nortel’s Hopkins said, as the value is increasingly based on the application or service that is produced and not on a specific piece of technology, equipment or software.

BUYING INTO THE SUPPLY CHAIN

Service provider making investment	Technology vendor	Nature of investment
AT&T	2Wire	AT&T and Telmex both took minority stakes in the residential gateway when Alcatel took a 25% stake
AT&T	Akimbo	AT&T and Cisco Systems invested as part of a $15.5 million funding round
Comcast	Exent	Comcast Ventures and AOL Time Warner Ventures both invested in this online game-maker
Verizon	Super Computer Int'l	Verizon took an equity stake in the online game-maker as it developed more interactive content
SaskTel	Alcatel	Canadian service provider formed a joint venture with Alcatel to do R&D on advanced software
Comcast	BelAir Networks	Comcast Interactive Capital invested in broadband wireless company