Telecommunications equipment company Alcatel-Lucent has been battered by eroding profit and intensifying competition in its core business, but one bright spot will likely shine in its second-quarter results

Tuesday: its services division's growing business building specialized communications systems for hospitals, police departments, utilities and others.

The services unit nearly doubled in size last year to provide €3.2 billion ($5.02 billion) of the company's €17.8 billion in annual revenue. The majority of Alcatel-Lucent's services business comes from managing networks for telecom operators, but Alcatel-Lucent is branching out to serve new kinds of clients -- governments, transportation and security agencies -- to help them build private communication networks in highly specialized environments.

For example, Alcatel-Lucent is working on a project for the U.K. Highways Agency that is aimed at modernizing communications systems on highways in order to better manage traffic flow.

 Alcatel-Lucent 

Alcatel-Lucent is building a communications network in Gotthard tunnel.

Alcatel-Lucent has helped French electricity-grid operator RTE to lay a fiber-optic communications network on top of its high-voltage power lines. Far under the Alps, Alcatel-Lucent is building a communications network in what will be, upon completion, the world's longest tunnel, the 36-mile long Gotthard Base between Switzerland and Italy.

Alcatel-Lucent's push into new areas is an effort to offset slowing growth in its core business of selling equipment to the world's telecom operators. It also wants to differentiate itself from low-cost Asian manufacturers, such as China's Huawei Technologies Co. and ZTE Corp., which are increasingly commoditizing telecom equipment such as broadband routers and telephone switches.

The transformation from equipment maker to service provider is also happening at Telefon AB L.M. Ericsson and Nokia Siemens Networks, Alcatel-Lucent's main rivals. Unlike Alcatel-Lucent, however, those two companies have decided to stick to the telecom arena.

"We target the telecom operators because that is where our expertise lies," said Jan Frykhammar, Ericsson's head of global services.

Rejeev Suri, who heads Nokia Siemens's services unit, says the company has decided "not to branch into new channels altogether." Nokia Siemens is a joint venture of Nokia Corp. and Siemens AG.

In becoming service providers, telecom-equipment makers are taking a page out of the handbook of technology companies such as International Business Machines Corp. and Hewlett-Packard Co. IBM, the computer hardware manufacturer, has refocused on consulting and information-technology services, which now account for the majority of its sales.

"The way the telecom-equipment business is changing is very similar to the way the information-technology sector changed," says Andy Williams, who heads Alcatel-Lucent's service business after spending many years at IBM. "We're just about five to eight years behind" the information tech industry.

The change of direction won't be easy for Alcatel-Lucent, which is suddenly facing new types of customers, many of whom know little about communications. Mr. Williams says it will take between three and five years to see whether the strategy will actually help Alcatel-Lucent ride out the telecom industry's difficult predicament.

Some are cautious about whether the services strategy will pay off for telecom equipment makers. Rod Hall, an analyst from J.P. Morgan, questions whether managing telecom operators' networks for them "is really an attractive business."

"Margins are low and the tasks they are given can turn out to be more complex and costly than expected," said Mr. Hall, who has an "overweight" rating on Alcatel-Lucent. But Mr. Hall said he was intrigued by some creative steps Alcatel-Lucent had taken to address these problems, such as a joint venture it signed with Indian telecom operator Reliance in which both sides have an economic stake in the outcome of the outsourcing deal.

Indeed, Michael Fabian, head of the nontelecom part of Alcatel-Lucent's service division, said he recently negotiated a five-year contract to help New Zealand's electricity grid operator modernize its infrastructure. When it came time to finalize the deal, the client didn't haggle over price, recalled Mr. Fabian.

"They were more interesting in making sure the technology would be fail-safe even over 50 years," he says. Alcatel-Lucent signed a €150 million contract with the grid operator, TransPower Ltd. TransPower didn't return phone calls seeking comment.

Another of Alcatel-Lucent's recent services contracts involved revamping the communications and security systems for the Paris metro system.

Alcatel-Lucent has fitted the track with emergency buttons that subway riders can press if there is a technical problem with the train or a fight breaks out, for example. A message is sent to the subway's control room, where staff can immediately watch a video feed of the area and dispatch police to the scene if needed. Metro officials declined to comment.

Alcatel-Lucent will manage parts of the system, which runs on digital mobile-radio technology known as Tetra, for 10 years. "This is a new and vast addressable market for us," says Mr. Fabian.

Source:wsj.com