The talks could still fall apart, but a deal is on the table that would see Nokia acquire Alcatel-Lucent in a stock swap, the companies said.
A merger would give the combined entity a broader product portfolio and greater scale, but would bring its own challenges.
It makes sense for Nokia, a mobile broadband specialist, to merge with Alcatel-Lucent, which has a strong position in fixed networks, according to Mark Newman, chief research officer of Ovum's telecoms research business.
As mobile and fixed networks become increasingly integrated, not having the latter is becoming a disadvantage for Nokia, Newman said. The growing worldwide popularity of smartphones has increased the focus on mobile networks, but fixed broadband networks are still needed to deliver high-resolution video content and to provide backhaul for Wi-Fi networks in homes. The integration of Alcatel-Lucent's fixed offering with the best parts of the two companies' respective mobile offerings could in that regard be a boon for end-users, he said.
The companies' size makes it no surprise that they are plotting a merger.
The two vendors are a distant third and fourth to Ericsson and Huawei Technologies in the access networks market, Newman said. A merger would give them scale and a larger footprint that would help them compete with Ericsson and Huawei.
In any case, said Gartner research director Sylvain Fabre, the market for telecommunications access equipment probably isn't big enough to sustain more than three major vendors in the long run.
For Alcatel-Lucent, the acquisition talks come at a time when its so-called Shift reorganization plan is starting to bear fruit, so it can negotiate from a better position, Fabre said.
Merging a Finnish-German company with a French-American one comes with big cultural challenges at time when speedy innovation is necessary. The key to a successful merger will be getting everyone to work together as quickly as possible. The companies' past merger history leaves them with large groups of employees in the U.S. (Lucent), France (Alcatel), Finland (Nokia) and Germany (where Nokia previously acquired the networking activities of Siemens). The governments of those countries will also have to be appeased for a deal to be approved.
With the development of 5G ramping up and the industry going through a major change where software is becoming more important than hardware, no vendor can afford to slow down.