Did Motorola Make The Wrong Call?
If a company could use a hotgrowth market right now, it's Motorola Inc. And it seems there's one at hand: Just as Motorola's semiconductor and cellular-phone businesses are in the doldrums, a new kind of wireless calling known as personal communications services (PCS) is on the horizon. The Federal Communications Commission has auctioned licenses to three PCS operators in each city across the U.S., and over the next five years, these operators will spend $15 billion to $23 billion building PCS networks, estimates market researcher Yankee Group Inc. It's a perfect opportunity for Motorola, a top supplier of cellular-network gear.
But Motorola has all but guaranteed itself a trailing position in the U.S. PCS market. Its share of the U.S. PCS-equipment market so far is only about 12%, well below its 20% share in conventional cellular transmission equipment, according to Yankee Group. "They don't have that many contracts," says Peter Nighswander, a senior consultant at Economic Management Consultants International. "It looks like Ericsson, Lucent, and Northern Telecom are beating them out."
PUZZLEMENT. How did Motorola get in this position? For starters, the company has continued to push a single technology for PCS in the U.S. rather than offering carriers a choice. Equally important, the company is reluctant to offer the kind of financing deals that the network builders have been asking for. That's why Motorola took itself out of the bidding for the biggest deal so far, a $3 billion network being built by Sprint Corp. and a group of cable-TV operators. Lucent Technologies, the soon-to-be-independent AT&T equipment arm, and Northern Telecom teamed up and agreed to underwrite the cost of the contract, a common practice for huge telecom infrastructure projects.
It's a puzzling state of affairs for a company that has long been the envy of Corporate America. For three years, the high-tech behemoth had shown that even a huge company, if managed correctly, can rack up impressive growth. Revenues grew an average of 27% annually, to $27 billion in 1995, while net income surged 58% a year over the same period, to $1.8 billion. "They were firing on all cylinders," says Ajay Diwan, analyst with Goldman, Sachs & Co.
On July 9, the growth machine officially stalled. After reporting second-quarter results 22% below what analysts were expecting, Motorola sent other high-tech stocks and the entire market into a tailspin. Worse, analysts warn that revenues will be flat for the year and profits will fall 15%.
Vice-Chairman and CEO Gary L. Tooker placed much of the blame on circumstances beyond Motorola's control--specifically, slowing demand and a profit-killing price war in cellular phones and a downturn in chip sales. But a downturn in business cycles doesn't explain Motorola's missteps in PCS, where it has badly bobbled the chance to replace fading markets with a new one.
PCS networks are expected to be immensely popular. The first one in the U.S., Sprint Spectrum in Washington, D.C., signed up more than 80,000 subscribers in eight months. Like conventional cellular, PCS transmits calls over radio frequencies. But PCS is completely digital, so sound quality is better, more calls can fit on each frequency, and extra services such as wireless data communications are easy to add. And because PCS networks use many low-power transmitters instead of a few high-power ones, eventually the phones and the service charges should be cheaper.
PCS has already taken root in Europe, where every country has agreed on a single technical standard called GSM. GSM is also spreading across Asia. In the U.S., though, there is no such consensus, which led to Motorola's first mistake. It favors a format known as CDMA and offers only CDMA equipment in the U.S., even though about a quarter of the PCS operators plan to use GSM. "Strategically, they made a big mistake," says David Lasier, president of Telecom Wireless Solutions Inc., an Atlanta-based consulting firm. "Motorola should have positioned themselves to do both GSM and CDMA in the U.S."
Oddly, Motorola isn't anti-GSM overall, just GSM in the U.S. It gladly sells GSM equipment overseas. But lots of other companies sell GSM equipment as well, whereas Motorola is one of the few manufacturers licensed to push CDMA--which it hopes will give it a competitive advantage. "We're focusing on CDMA because we think it's the best technology in features and functions," says Jack Finlayson, corporate vice-president and general manager of Motorola's Pan-American Wireless Infrastructure Div. CDMA can, theoretically, carry 10 to 20 times as much traffic as standard analog cellular systems, while GSM offers a three- to sixfold capacity boost.
Problem is, many phone companies no longer buy that argument--or CDMA. Although about half of U.S. PCS networks are planned around CDMA, there are only a handful of commercial CDMA systems in operation, and just one in the U.S. Some phone companies that have tested CDMA say it delivers only six times the capacity of analog cellular--about the same as GSM. Since GSM has been used for years in Europe, it's a proven technology and components can be as much as 40% cheaper than comparable CDMA parts. "We think we have a cost and availability advantage," says Don Warkentin, president and CEO of American Portable Telecom, which is building GSM systems in six U.S. cities and Guam.
Motorola is beginning to hedge its bet in the U.S. It plans to offer some GSM equipment in the U.S. in about a year, figuring it can pick up some add-on contracts from GSM operators that are expanding their networks. But that's a tough sell: It's difficult to displace rivals who get the initial PCS contracts. "If you're an incumbent supplier to a wireless operator, you're almost assured of the add-on business. It's like an annuity," says Marc Cabi, analyst at Salomon Brothers Inc.
As to its reluctance to finance PCS deals in the U.S., Motorola says it's making such investments overseas--in Asia and Latin America, where demand is even greater. "You have a limited amount of investments to make," says Finlayson. "We have to prioritize the global opportunities." He says it's smarter to pursue contracts in Brazil, for example, where 1 million people are on a waiting list for wireless telephone service--and only minimal financing is required.
RICHEST MARKET. Certainly, sales of wireless equipment outside the U.S. are booming. Already, 80% of the revenues for Motorola's wireless infrastructure group comes from overseas markets, where annual growth is 35%--twice the U.S. rate. Still, analysts say, Motorola can ill afford to let the world's richest market slip through its fingers. "If Motorola had the resources, they could have been more aggressive. Long term, there will be a return on these investments," says John Ledahl, a consultant for market researcher Dataquest Inc. So far, Motorola's only major PCS contracts are with GTE Mobilenet and PCS PrimeCo, a team of three Baby Bells and AirTouch Communications.
Of course, Motorola's future does not hang on PCS alone. With innovative products such as the palm-size StarTAC, Motorola is likely to keep its lead in cellular phones. The market for wireless phones is expected to more than double over the next five years, to 35.5 million units a year, according to Dataquest. Revenues will grow from $6.25 billion this year to $11.45 billion in 2000.
Paging, although relatively small, is growing rapidly as well. Hambrecht & Quist analyst Rakesh Sood estimates that Motorola's paging revenues will grow 20% to 25% annually for the next few years. Motorola's cable modems and two-way radio products also look promising.
The recovery path in Motorola's chip business isn't as clear. The unit, which generates 31% of revenues and 38% of operating profits, is caught in a bind and in mid-July announced layoffs of 225 people. One of its biggest businesses, microcontrollers used in cars and appliances, is under assault from a rash of newcomers, including giant memory-chip makers seeking a more profitable niche. And the PowerPC, the Motorola microprocessor used in computers, is losing market share. Beleaguered Apple Computer Inc., the biggest customer, reduced its orders by 25% in the first two quarters. "We need 20% market share of the computer business just to get to a stable position," laments Phil Pompa, director of marketing for Motorola's reduced instruction-set computing (RISC) microprocessor division. Right now, its share is only 7%.
Motorola's troubles show how quickly a highflier can lose momentum. "You can fault the company for not reading the tea leaves better," says Sood. "The core businesses are eroding faster than expected, and new products have not yet become significant." That combination could signal the end of Motorola's reign as a corporate Golden Boy.