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Will Rewiring Nokia Spark Growth?


Tero Naumi has a job any couch potato would love. The 40-year-old Nokia Corp. (NOK) engineer watches television eight hours a day. As product manager for Nokia's mobile-TV technology, which will let handsets receive a dozen channels of digital TV on the go starting next year, Naumi spends workdays in his cubicle viewing the news and soap operas on a specially equipped Nokia 7710 phone, which features a 3-inch wide screen and sells for $650 before subsidies from phone carriers. Sometimes he tools around Turku, some 145 kilometers west of Helsinki, in a van to test reception in hard-to-reach places. It may sound like kid's stuff, but Naumi's work is deadly serious. Nokia hopes mobile TV will become a multibillion-dollar business by the end of the decade.

Digital television on handsets is just one of the far-out schemes the world's largest mobile-phone maker is hatching to resurrect flagging growth. At a Nokia development lab near Vancouver, programmers are writing new video games that let thousands of players battle each other over the airwaves using Nokia's N-Gage wireless game console. Engineers in Boston and Tampere, Finland, are busy weaving new e-mail readers and security software into Nokia's handheld Communicators -- pint-sized hybrid phone-organizers aimed at corporate customers. And in factories from Germany to China, assembly-line workers are churning out millions of sleek camera phones that work on new third-generation mobile networks. "Nokia is a beehive of experiments these days," says John Jackson, senior wireless analyst for telecom market researcher Yankee Group (RTRSY) in Boston.

BATTLE STATIONS

The Finnish phone giant has little choice but to wade into new waters. Although the company sold an amazing 208 million handsets last year, up 16% from 2003, fierce competition and sagging prices pushed mobile-phone revenues down 3%, to $30 billion. It's not just that garden-variety handsets are becoming commodities. Nokia also had a wretched first half in 2004, when a stale product portfolio and strained relationships with mobile operators cost it nearly a fifth of its hard-won 35% global market share and pushed revenue growth into reverse. As the company's prospects dimmed and analysts cut their ratings, dismayed investors pounded Nokia's stock down to a 12-month low of $11.03 in New York on Aug. 13 -- 52% off its March peak. Customers weren't surprised. "Their attitude was that, given their size, they didn't need to listen to us," says an executive at a European mobile operator.

To get Nokia back on track, chief executive Jorma Ollila has cranked up the introduction of new phones, especially "clamshell" models that hinge at the top -- a popular category where the Finns were missing in action. He has also wooed operators, agreeing to tailor phones to their specifications as never before. And to regain lost share, Nokia slashed prices on certain models by up to 25%, at the expense of operating earnings, which fell 15% in 2004, to $5.6 billion. By yearend, Nokia had managed to claw back nearly all its lost market share, according to market researcher Strategy Analytics. The company turned in fourth-quarter sales and earnings that beat Wall Street estimates. And its stock recovered to finish 2004 down just 7%.

Nokia has climbed out of its hole. But the company still faces a fundamental problem -- no growth. Its top line has drifted down by an average of around 1% annually since 2000, hitting $38 billion last year, while net profits have fallen 18.6% in the same period. By comparison, rival Samsung Electronics has seen mobile phone sales and profits triple over the last five years, while Motorola endured plunging revenues and deep losses before a turnaround last year.

To get Nokia's engines revving again, Ollila is halfway through a two-year makeover that he's convinced will launch the company into a new growth era. He's redirecting research and development to areas where Nokia stands apart, especially radio technology and mobile-phone software, not wasting it on reinventing things the company can buy elsewhere. Nokia spent more than $4.8 billion last year on R&D, 60% of that for software. At 12.8% of revenues, Nokia's R&D spending was three points higher than Motorola and about twice the R&D ratio of Sony Corp. "Nokia can only retain its current position and grow through innovation," says Declan Lonergan, a Yankee Group telecom analyst in London.

But the scramble to find growth through innovation carries huge risks. Nokia is racing into unfamiliar markets, where it faces competitors ranging from Microsoft (MSFT) and Apple Computer (AAPL) to Samsung and Sony (SNE). Despite its strong brand and global reach, some efforts are not panning out. Nokia's Communicator, for instance, has never enjoyed the popular success of Palm and PocketPC PDAs, though the newest models are getting a warmer response. Nokia's N-Gage wireless game console has sold 1.3 million units, far below expectations. "Innovation, in and of itself, isn't the cure," says analyst Per Lindberg of brokerage Dresdner Kleinwort Wasserstein. "You have to make products people want."

Misfires are part of the price Nokia must pay to keep ahead. As basic mobile phones become more cookie-cutter and barriers to entry fall, particularly for Chinese newcomers such as TCL and ZTE, Nokia and other established phonemakers have to pile on more features. That's why Ollila has created two new business units that require higher levels of R&D and market development. One handles multimedia devices -- camera phones, game machines, and mobile TVs -- and the other sells devices aimed at businesses. Ollila has farmed out basic cell phones to a division whose main job is to deliver mass-market units at the lowest possible price. That group still represents 63% of revenues and 87% of operating profits, but its contribution is expected to decline as new initiatives catch on. Another division, accounting for 22% of revenues, sells wireless networks to operators.

The new structure better reflects the changing industry. Because of market saturation in the developed world, analysts expect total handset shipments to grow only in the single digits for the next few years, reaching about 750 million units in 2006. Meanwhile, price-cutting could keep industry revenues nearly flat. In search of growth, Nokia is diving deep into developing countries like China, India, Brazil, and Russia. They demand less-expensive phones but are growing much faster than Europe or North America. Equity analyst Jari Honko of Helsinki brokerage eQBank says Nokia's goal is to profit from the company's huge volumes in purchasing and manufacturing. "They want a situation where competitors cannot keep up on price," Honko says.

At the other end of the scale, Ollila is casting a wide net for high-margin opportunities outside conventional handsets, especially in the hotly contested "convergence" arena. Nokia's new multimedia group, for instance, offers gadgets that take pictures, play games and music, and will eventually show digital TV. The group booked revenues of $4.7 billion last year, up 46%, and earned its first operating profit of $232 million.

To court corporate users, Ollila has also established an "enterprise solutions" group. The goal: persuading companies to outfit their workers with voice-and-data gizmos such as the $1000 Nokia Communicator, which looks like a phone when folded shut but opens up to reveal a keyboard and wide color screen. The enterprise group topped $1 billion in revenues last year, up 57%, but will likely continue losing money through 2005.

Brokerage Credit Suisse First Boston (CSR) figures the new units will boost Nokia's top line by $2.6 billion this year, enough to make up for a $1.7 billion decline in conventional handset revenues. "I am more convinced than ever that the reorganization was right," Ollila says. The next step in his plan is to exploit Nokia's technology assets to revamp the way it builds phones. The idea is to turn the handset from hardware into software. Already, phones can be built by snapping together modules of chips and radios to accommodate different wireless standards and feature sets. On top of that Nokia wants to add its secret sauce: flexible, easily customized software that the company has spent the last decade developing.

The foundation comes from Symbian Ltd., a British consortium Nokia helped launch with a half-dozen other mobile phonemakers. Symbian's "smartphone" software is as sophisticated as Microsoft Windows or Linux but was designed from the beginning for mobile devices. It already commands 82% market share among smartphones, thanks mostly to the 15 million Symbian-based devices Nokia has already sold. On top of that, Nokia adds its Series-60 user interface, which it now makes available for license to other phonemakers. The shift to standard software marks a sea change for the mobile industry. Until now, Nokia's older phones, as well as those of rivals, had to be painstakingly reworked to accommodate a software change as simple as moving the photo messaging feature from the main menu to a special section devoted to imaging. Now, with Symbian and Series-60, engineers can make the change in a matter of days -- and send the modification to the factory floor to be burned into thousands of customized phones.

HIGH-SPEED CUSTOMIZATION

Such ease of reconfiguration will revolutionize Nokia's production model. Until last year, it was oriented mostly around building huge runs of mass-produced handsets. To keep costs to a minimum, Nokia held off adding new features such as better color screens or higher-resolution cameras until the components were available in big volumes.

Nokia's new modular hardware and flexible software make it easier for the company to customize products faster. With its new 6630 3G phone, for instance, Nokia created entirely different menus and screens for Vodafone Group PLC (VOD) and Orange (FTE). Nokia also aims to speed the latest technology to market by creating smaller batches of some new phones. That will allow it, for instance, to produce limited numbers of its new 7280 phone, which resembles an Art Deco lipstick case. "We need to take new features to market more aggressively," says Olli-Pekka Kallasvuo, head of mobile phones.

Having made its fortune in "candy bar" handsets, Nokia now aims for 50% of its product line to sport alternative designs -- clamshells, sliders, swivels -- by the end of this year. Within three years, it figures a quarter of its models will be smartphones that sport advanced software and run programs just like a computer. Faster. Smarter. More flexible. It's the new Nokia. But those gadgets better be what customers want.

By Andy Reinhardt in Helsinki, with Moon Ihlwan in Seoul


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