Tough Calls at Nokia

By Burt Helm The last year hasn't been kind to Nokia (NOK). The Finnish the mobile-phone giant is still the world's biggest handset maker by a wide -- but slipping -- margin. And it's far from certain that the strategy Nokia is mapping out will halt that slide.

Recent numbers tell the story: On Oct. 14, Nokia announced that third-quarter overall profits fell 20%, to $1.17 billion (928 million). Although total revenues rose 1%, to $8.77 billion (6.9 billion), phone sales dropped 13%. Nokia said price cuts caused handset profits to tumble 44%, to $997 million. And while market share rose 2%, to an estimated 33%, that's still less than the 39% Nokia captured in the third quarter of 2003.

Is Nokia's dominance in mobile phones really threatened? Probably not, for now. Its market share still equals that of Motorola (MOT) and Samsung combined, the next two biggest phone makers.

NOT AS STRANGE. And it looks like Nokia has finally woken up. It's responding quickly to some of its most vexing problems. It fixed design flaws in its mobile-phone-enabled gaming console N-Gage by releasing the N-Gage QD, a new model that no longer requires users to remove the battery to change the game cartridge or awkwardly hold the phone sideways to talk on it. It also added a version of the 3650 mobile phone with a standard button-pad configuration, after consumers complained that the original circular configuration was just too strange.

Nokia will also probably be able to increase its customer-satisfaction ratings by customizing its products more for specific for providers. That's because in the coming years customization will come from software rather than hardware. Programming code is a lot cheaper and a lot easier to implement, particularly with Nokia's huge manufacturing volume.

Nokia is becoming hipper, too. This month, it introduced its new "fashion line" -- three sleek art-deco-style camera phones -- and the "Connect to Art" program that allows users to download screen backgrounds designed for Nokia by Finnish artists.

LESS RELEVANT. But the road ahead will be tough. The increasing emphasis on software could be a double-edged sword, for one thing. As providers install uniform software, "you're looking at phones that are far more interchangeable," says Paul Jackson, a senior analyst at Forrester Research in Amsterdam. "If you look at the user interface [now] on Nokia, it's still far superior, [and] Nokia has been able to [charge] a price premium." But once all of a provider's phones use the same operating system, the handset brand will become less relevant.

Nokia's growth strategy also may prove problematic. This year it divided into four business units: Mobile Phones, Networks (which sells wireless infrastructure equipment to providers), Enterprise Solutions (which provides wireless corporate networking products) and Multimedia, which looks into new types of convergent technology, including camera phones, wirelessly connected MP3 players, and wireless gaming systems such as N-Gage.

This diversification plan pits Nokia against many well-entrenched competitors such as Sony (SNE), Nintendo (NTDOY), and Apple (AAPL). So far, the N-Gage fiasco has demonstrated that simply adding wireless connectivity won't give Nokia much of an edge.

WRONG MARKETS? "Whenever you look at a great company, it tends to build on its strengths rather than move into [other markets]" says Ken Dulaney, vice-president for mobile computing at Gartner Research. "Nokia's strength is voice. It's interesting to me that they haven't done a lot of acquisitions." Specifically, Dulaney thinks Nokia should target companies with key voice technology, such as innovative enterprise PBX products.

It's also not clear that Nokia is aiming at the right new markets. In the next two or three years, according to Tero Ojanperä, the head of Nokia's Research Center, the company will introduce more convergent technology, such as a camera/video phone that allows users to edit and splice clips together with music using software similar to PC video-editing software.

But will demand emerge for these combos? Forrester Research recently published a study entitled "The Next Wave of Mobile Devices," suggesting that this approach may be the opposite of what consumers actually want. So-called smart phones, for instance, "combine the worst of both worlds...they are overkill in size and function," the report says.

"NO RESONANCE." Also, Korean makers such as Samsung and LG are carving out a position in the handset market at the same time Nokia's brand strength has been eroding. This year Nokia fell from sixth to eighth in Interbrand/BusinessWeek's rankings of the best global brands.

Worse, the erosion has taken place particularly among tech-savvy users. "When I think Nokia, I get almost no resonance out of that brand at all. I think old monopoly," says Jeff Swystun, global director of Interbrand, a research firm that rates the brand values of world corporations. "What they look like is someone defending themselves against an onslaught of more progressive players."

Samsung has become a leader in both the clamshell mobile-phone design and the camera phone. And despite Nokia's huge volumes and efficient manufacturing, the Korean rival now makes significantly higher margins on handsets -- 18% compared to Nokia's 13%, according to analysts' estimates. Samsung has solidified its name as a high-quality handset maker known for its sleek ergonomic design.

NO SENSE? Further pressure on earnings could be in the offing. Combined, the slippage in Nokia's technology reputation and the weakening of its brand make it tough to justify the historically high margins. "For mass-market phones," says Jackson at Forrester, "that doesn't make sense. You end up in the same position as Sony in electronics -- all the [companies that] make stuff cheaper move into the space."

For Nokia, simply maintaining its current profit numbers may be an uphill battle. Helm is a reporter for BusinessWeek Online in New York

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