Did Outsourcing and Corporate Espionage Kill Nortel?

October 24, 2012

By Jim Smith Ph.D. ABD

 

Last time here, I wrote about warnings from the House Intelligence Committee of Congress about buying telecom equipment made by Chinese companies Huawei Technologies and ZTE Corp. But a reader comment reminds me that I may not have gone far enough. The demise of a major North America telecom equipment company, Nortel, may have been caused by its contract manufacturer, Huawei.

Many Canadians believe that Huawei stole the core technologies and business strategies from Nortel and used that knowledge to drive Nortel out of world markets and into bankruptcy. “How can you survive when you have a competitor basically right there knowing all your moves, what you’re doing, what you see as the future products?” Nortel’s former senior systems security adviser Brian Shields told CBC News.

Nortel, formerly known as Northern Telecom, was the Canadian equivalent of Western Electric and the most important Canadian technology company for more than 100 years. At its peak in the 1980s, Nortel became the dominant North American supplier of business telephone systems and was very successful as a provider of switching systems to telecom operating companies like AT&T. But a spectacular fall followed those glory years. The company filed for bankruptcy in 2009 and completely shut down the following year.

Nortel’s demise began with corporate management buying into the business school ideology that manufacturing doesn’t matter. So it closed its factories in Canada, the United States and Mexico, and handed production over to Huawei. But Nortel went even further than outsourcing production; it handed off considerable engineering responsibility as well, much of the work apparently being taken on by Huawei.

Apparently Nortel’s leaders hadn’t read the history of American television companies. In 1960, for example, RCA occupied a position in this country similar to the importance of Nortel in Canada. RCA created broadcast television and, subsequently, color television. It was the largest and most prestigious of the 29 American TV companies making televisions in here. But, like most of the other American TV companies, it began outsourcing manufacturing to Japanese companies that were completely unknown to North American consumers. One of those Japanese companies was an unknown outfit named Sony. Contract manufacturing provided the cash flow and engineering experience for the Japanese companies to move up the food chain to become dominant brand names. RCA doesn’t exist anymore, nor do any of the other 28 American manufacturers from 1960. (I wrote about the demise of American television manufacturing in more detail in my 1996 book Optimizing Quality in Electronics Assembly. Now the Japanese electronics companies are being killed by Chinese competitors that are following the same development playbook written by the Japanese 50 years ago.)

Nortel during the 1980s was good at more than telephone system engineering. Most of its U.S. and Canadian factories defined world class efficiency and reliability. Their corporate executives traditionally came from and understood manufacturing. But the executives who took over beginning in the late 1980s came from business schools, not factories. And business schools were preaching that manufacturing doesn’t matter. Spin off the dirty, physical side of the business to contract manufacturers, the professors said.

Nortel had set up a factory in Mexico in the late 1980s and assigned one of its most competent manufacturing executives to run it. Along with the Canadian and U.S. plants, however, that plant was closed and its work handed off to Huawei. The decision baffled and angered the plant manager. “I spent months analyzing our costs and the prices from China,” he told me at the time. “We were cheaper, and our quality was great. But corporate didn’t want to hear about it. They were determined to get out of manufacturing.”

It seems that Nortel went even further than outsourcing production. Huawei took over much product engineering as well. And that may explain how Chinese hackers were able to infiltrate Nortel’s corporate computer system right up to the CEO’s own computer—backdoor entrances may have been coded in by Chinese software engineers. If so, not only did the Chinese gain thorough knowledge of Nortel’s product technology, they also knew Nortel’s marketing plans.

Huawei denies that any nefarious actions took place. But Shields, the computer security specialist, is convinced Huawei was responsible. And Mike Rogers, chairman of the U.S. House Intelligence Committee, certainly didn’t pull any punches in commenting on findings of the committee’s year-long investigation of Huawei and ZTE, another Chinese telecom manufacturer. “We have serious concerns about Huawei and ZTE, and their connection to the communist government of China,” Rogers said. “China is known to be the major perpetrator of cyber espionage, and Huawei and ZTE failed to alleviate serious concerns throughout this important investigation.”

The House Intelligence Committee strongly recommended that U.S. companies avoid buying equipment manufactured by Huawei and ZTE. It now seems that the recommendation should have gone farther and urged American companies not to trust Chinese contract manufacturers.

We’ve known for years that trusting Chinese suppliers carries enormous risks from shoddy quality to development of a competitor. Now we can add corporate espionage to the risks. Considering the history, can anyone make a meaningful case for outsourcing to China? Please let me know.