The AT&T/BellSouth merger wreaked havoc on equipment vendors late last year, as both carriers curbed spending. But the tension didn't subside when the merger closed. Heading into the new year, equipment vendors held their collective breath waiting to see when and where the merged company would return to spending. Some dimmed their first-quarter outlooks after getting their first glimpse of a carrier-consolidated world.

Mega-mergers under their belts, AT&T and Verizon together account for about two-thirds of all domestic carrier capital spending, and their influence may rise as the overall spending growth cools. After growing at double-digit rates for each of the past three years, U.S. carrier spending on telecom gear will grow just 8% this year to $24.4 billion, according to the Telecommunications Industry Association. That growth should stay in shrinking single digits for the rest of the decade.

Spending is a mixed bag for the big two this year. Verizon expects to spend $17.5 billion to $17.9 billion this year, a 2% to 5% increase from last year. That includes roughly $10.8 billion on wireline spending (up 1% to 3%) and $6.7 billion on wireless. AT&T predicts its capex will be a mid-teen percentage of its sales this year, which could put it at $18 billion — a 5% decline from last year. About $5 billion will go to wireless and the rest to wireline, Morgan Keegan predicts. (By comparison, Sprint expects to spend $8.5 billion this year, only $600 million of which is wireline.)

Both carriers will consolidate their acquired networks over time in what will be, for vendors, a game of musical chairs — likely forcing all of them to lower prices in an attempt to keep a seat. AT&T expects to save more than $300 million a year that way while integrating BellSouth.

Sales cycles will drag on even longer than before. Adtran, for example, was forced to lower its revenue expectations twice last year when AT&T kept moving back the goalposts on an optical contract for wireless backhaul. “The larger the customer, the longer it takes,” said Tom Stanton, Adtran chief executive. And the customer just got much larger.

Bell customers loom large enough that even the potential to win a single contract can influence vendor acquisitions. Video equipment maker Tut Systems struggled throughout last year to land a Bell deal for its edge modulation gear. The customer (probably Verizon) told Tut to partner with a bigger vendor. Tut did, and it used the promise of that edge modulation contract to convince Motorola to buy the company at a hefty premium.

To safeguard against the whims of 800-pound gorillas, equipment vendors will be pressured to diversify their customer base. Ciena has been working hard to further penetrate cable and government markets to lessen its reliance on big telcos. Forty percent of Ciena's fiscal 2006 revenue came from just three customers: AT&T, Sprint and Verizon. In contrast, Zhone Technologies' top five customers combined contributed just 25% of its revenue last year. Much of Zhone's focus going forward will be on serving its existing base of more than 600 customers, rather than penetrating new markets.

Larger vendors have more to gain, of course, as super-sized Bells become more dependent on them. Domestic carrier spending on professional services to support network infrastructure will grow nearly 8% this year to more than $61 billion, TIA said. But smaller vendors will increasingly be pressured to consolidate.

“In a nutshell,” said Michael Howard, Infonetics Research principal analyst, “size matters.”