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Nortel close to outsourcing deal

In talks with Flextronics, the networking company is taking the next step toward fully outsourcing its manufacturing as it looks for more ways to cut fat.

Telecommunications equipment maker Nortel Networks is poised to hand over all of its product manufacturing to outsourcers, as it continues to cut costs and streamline its supply chain process.

On Thursday, Nortel announced it was in discussions with Singapore-based contract manufacturer Flextronics to handle its systems integration, the final piece in the manufacturing supply chain before products are shipped to customers.

If talks between Nortel and Flextronics are successful, the networking company will divest nearly all of its remaining optical, wireless and enterprise manufacturing operations and related supply chain activities to Flextronics. As a result, Flextronics would manage more than $2 billion worth of annual sales costs. Nortel said that taking this next step in outsourcing will allow it to focus more on new product development and other areas of differentiation.

"Flextronics has the supply chain capabilities to meet our time-to-market, quality and cost-reduction objectives,? Chahram Bolouri, Nortel's president of global operations, said in a statement. "They also have substantial resources and presence in many of the countries where we do business, which will enable us to rapidly scale globally. At the same time, divesting the remaining parts of our manufacturing operations would enable us to focus on the core capabilities required to deliver converged networks to our customers."

As part of the new plan, Flextronics will handle all manufacturing activities, including product integration, testing and repair operations. Flextronics will also fully manage Nortel's supply chain, including assembly of printed circuit boards and fabrication of printed circuit boards and enclosures, along with logistics and repair services.

Nortel said it intends to keep some manufacturing and supply chain functions in-house. These include the introduction of new products, and the deployment, integration and support of complex, multitechnology network solutions.

The two companies are still hammering out the details of the deal, but if it goes through, Nortel will hand over more than $550 million of manufacturing inventory assets. In exchange, Flextronics will pay Nortel more than $500 million in cash over a nine-month period for the inventory, as well as an additional amount, for certain intangible assets.

Over the last five years, Nortel Networks has been aggressive in its outsourcing strategy, said Steven D. Levy, an analyst with Lehman Brothers. The company has already divested much of its manufacturing to Flextronics and other suppliers of electronic manufacturing services. Three years ago, it got rid of most of its manufacturing, product integration, configuration and testing of its DMS circuit-switching products in Raleigh, N.C.

"By implementing this model, we have been able to drive reduced inventory and improved customer service and responsiveness, and to focus on those areas of the supply chain of most importance to our customers," Bolouri said in a statement.

Levy said outsourcing and other cuts have already been a big part of the company's turnaround over the last couple of years. In particular they have had a big impact on the company's gross margins. In 1999 and 2000, the annual gross margin level was about 43.5 percent, said Levy. At the end of September, the company reported gross margins, excluding one time charges, around 50 percent.

"There's no question that the outsourcing and restructuring has brought these gross margin levels up to where they are now," he said. "It's hard to argue against outsourcing when you look at Nortel. The company has gone from peak revenues of $8 billion per quarter to about $2.5 billion, and they've got the highest gross margins ever."

Lucent Technologies, Nortel's biggest rival, has also gone down the outsourcing path. But Levy said that this latest deal with Flextronics will put Nortel ahead of Lucent's efforts.

Roughly 2,500 workers at Nortel's systems facilities in Canada, Brazil, Northern Ireland and France, will most likely be affected. But the company said it's premature to talk about the impact of the new strategy on employees. In the past, most displaced workers have found work with Nortel's suppliers, said a company official.