Soaring demand for games, video and music will stretch the Internet to its limits, Canada's Nortel Networks Corp. (NT) says, and it expects service providers will make big investments in its technology to avoid a crunch.

But the telecom equipment giant, still struggling to turn its fortunes round after the tech bubble burst, is treading carefully as it prepares for what it sees as a looming buildout of capacity by telecommunications companies.

Massive overbuild of Internet bandwidth capacity helped lead to the meltdown six years ago, and the company says it doesn't want things to go wrong again.

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"It's driven by caution, because none of us want to repeat the mistakes of 1999 to 2001," Nortel's chief technology officer, John Roese, told Reuters in a recent interview.

The mistakes he refers to saw billions of dollars in Nortel losses, as well as tens of thousands of job cuts and a precipitous plunge in its stock price. Nortel stock peaked at more than C$120 a share in 2000. They are worth about C$2.50 a share today.

But perhaps ironically, Roese also believes the capacity bubble helped service providers cope with the surge in demand for bandwidth that came with the advent of online video Web sites like YouTube.com.

"The only reason YouTube didn't destroy the Internet is because there was a bit of a bubble in terms of excess capacity out there," Roese said. "But, boy, don't take that for granted."

Nortel believes its Metro Ethernet unit, which uses technology similar to the one used to connect local, short-distance networks to build Internet infrastructure, will soon draw carriers that need more capacity and let them stay safely ahead of the demand curve.

This curve has been growing steeper as users demand more bandwidth for online video, music, games and, increasingly, television.

"That's our underlying fear," he said. "If the industry cannot keep up with the demand because we kind of take it for granted after the buildout in the 2000 timeframe, if we ever hit a wall, the impact on global economies, the impact on innovation is just profound."

He said market research into trends like Internet video had led the Toronto-based Nortel to believe the surge in demand for bandwidth capacity is real.

"Over the last six months we've absolutely convinced ourselves — and we think we have a lot of empirical data to back it up — that this is not a short-term trend," he said.

Tim Daubenspeck, who covers Nortel for Pacific Crest Securities, thinks the company has got the right idea.

"I fully believe in the video thesis, both kind of over-the-top video, browser-based video, as well as the coming Internet protocol television trend ... as telcos push video to the home," Daubenspeck said.

"If you look at the bandwidth demand that video drives, it's an order of magnitude more than what we're used to."

LOW-COST COMPETITORS AWAIT

Nortel faces competition, not least from low-cost Asian competitors like Huawei Technologies Co. Ltd. But it insists that its strength lies in its people and their ability to plan, deploy and operate networks and says Huawei cannot provide that.

Huawei declined to comment.

Daubenspeck agrees that there is a shift away from price as the ultimate factor determining where a telecom company puts its network infrastructure dollars.

"We've seen Huawei make inroads into the European market using cost or price as a competitive advantage, but I think functionality and performance is going to be increasingly important," he said.

"So just pure raw price is not going to be a differentiator like it was a year or two ago."

He said carriers now favor vendors who can deliver a complete network package.

"In periods of dramatic technology change, which is what's going on, being driven by things like video and the requirement to reduce costs. You tend to go back to the guys who are more end-to-end, more solutions-focused, as opposed to just a cheap-point product company."