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The Finnish cell-phone titan is (finally) launching a slim handset, and beefing up offerings in multimedia and emerging markets. Analysts are optimistic

It has been a shaky 2006 for Nokia (NOK). While the mobile-phone titan has had a bumper year for handset sales and shipments, it has also been dogged by shrinking margins and unrelenting competition from the likes of No. 2 Motorola (MOT), which has grabbed the initiative with its line of thin phones. Paradoxically, Nokia's successful drive into emerging markets also increased its sales of commodity-type phones—hardly a formula for high profitability (see BusinessWeek.com, 10/19/06, "Nokia's Roller-Coaster Report").

Despite the erosion of its position, the cell-phone behemoth still has the heftiest share in the industry. According to Gartner, the Finns had 35.1% market share at the end of the third quarter, compared to 20.6% for Motorola and 12.2% for Samsung. And Nokia has ambitious plans to regain the advantage in 2007. The Finland-based company is ringing in 2007 with a slew of sleek, new phones—including a long-awaited, ultra-thin number—aimed at plugging gaps in its portfolio.

Building on Nokia's strength as a company known for its feature-rich offerings, the move is designed to capture the momentum ceded to rivals that were quicker to recognize and adapt to consumer tastes. Nokia is "starting 2007 in a significantly better competitive position," says Leif-Olof Wallin, an analyst at Gartner Research in Gothenberg, Sweden. "It's no coincidence there's a new head of design," in Alastair Curtis, who took over as design chief earlier this year (see BusinessWeek.com, 11/29/06, "Nokia Gets Design Conscious—Again").

How's Their Timing?

Nokia's strength has long been at the top and bottom ends of the mobile market. But in the last year or two the lack of a "slim" phone that appealed to the mid-range kept the vital middle largely in the hands of rivals Motorola and Samsung. No longer: The company's ultra-thin 6300, which will retail for $325 before operator subsidies, will go head-to-head with Motorola's RAZR and other mid-range rivals from the first quarter (see BusinessWeek.com, 7/06, "Nokia Knows It, Thin Is In").

The risk for Nokia is that the effort comes too late. Coming out with a slim phone is a far cry from capturing the market share that Motorola's RAZR commands. Samsung brought out a thin phone, for example, to little avail. And if the thin strategy stalls, such a setback would do damage in the U.S., the developed market where Nokia has always struggled to keep pace with Motorola. It's in the U.S. that Nokia's success has been largely confined to the low-margin, bottom end of the market.

What about emerging markets such as Asia and Africa? Here Nokia has built up a head of steam. Nokia expects handset volumes in those regions, which accounted for half of the 88.5 million handsets it sold in the third quarter, to grow by more than 15% next year, vs. up to 10% worldwide.

Improved Product Mix

Here, too, Nokia has jazzed up its portfolio with products such as the 2626, a $98 basic GSM model that comes in five colors with features that include an FM radio and picture messaging. The launch of the 2626 is a clever move to boost margins in a low-margin game and appeal to an emerging middle class that can start to spend a little more. "Just because you're in a low-income country doesn't mean you want a poor man's phone," says Neil Mawston, associate director at Strategy Analytics in Milton Keynes, England.

Despite the risks, analysts think Nokia has a good shot at improving its position. The improved product mix and Nokia's efforts to appeal to both first-time users and the replacement segments (which command higher prices) will shore up overall gross margins in 2007, after they fell to 30.9% in the third-quarter from 33.7% the previous year, according to a Bear Stearns report. Those efforts should also help stabilize average selling price per phone, which plunged almost $12 to €93 ($122) in the third quarter.

There are also efforts to branch out from the basic handset business. Nokia's multimedia arm, which came out with a range of new music and camera phones in 2006, will continue to go from strength to strength in the next 12 months, analysts predict. Two purchases this year signified the company's dedication to throwing its weight behind this higher-margin range. Nokia snapped up U.S. online music distributor Loudeye this summer to offer a wider range of downloadable music. It went on to purchase Germany's gate5, which makes mapping and navigation software.

Smoothing the Edges

Nokia's N95 phone, unveiled early next year, will be its first to offer embedded location-based software. Analysts say Nokia has the muscle and the ambition to make more acquisitions to bulk up its stable of mobile services. Gaming is one area where Nokia is keen to strengthen its position.

Yet the company is well aware that it has rough edges. Nokia on Nov. 28 lowered its operating margin target to 15% from the 17% goal it set a year ago, in part because of its plan to merge its telecom's equipment-making unit with Germany's Siemens (SI). The venture, to create the No. 3 industry player, was set to fire up on Jan. 1, but Nokia said Dec. 14 that it will delay closing the deal for several months amid allegations of bribery at the German firm. This won't have much of an impact if the venture is delayed by a quarter, say analysts. If the uncertainty drags on, however, Nokia, which desperately needs scale to compete in this arena, will be in danger of losing out on lucrative contracts to Ericsson (ERIC) and other rivals.

Meanwhile the enterprise unit, which hawks smartphones and other business devices, is also on Nokia's list of challenges for 2007. In the third quarter, its losses nearly doubled to $81.5 million, but Mary McDowell, Nokia's executive vice-president and general manager of Enterprise Solutions, says the goal is for the unit to break even in the first half of 2007. This may be a "stretch" Gartner's Wallin says. The company needs higher penetration of the U.S. market, McDowell admits.

Bad Decisions

In this area, too, design will play a key role. "We're seeing some new form factors," in e-mail-capable handsets, says McDowell. "Everything will be getting sleeker. There will be more color, rather than just basic black." For example there will be a red E61, which is Nokia's BlackBerry-like device. Business phones will be increasingly equipped with more options normally associated with consumer phones, such as MP3 players and cameras.

Rough edges aside, Gartner's Wallin predicts the Finns now have the product portfolio in place to slightly beat the expected growth for the industry. He expects Nokia to boost its 35.1% to almost 36% in 2007. Citigroup figures operating profit will advance 15% from 2006 to $8.1 billion. The past 12 months were "one of those years when bad decisions affected growth, but they've recognized that with the reinvigoration of the design team," Wallin says. It takes time, but "what we've seen so far is promising."


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