Commentary: Nokia's Costly Stumble

It had come to be a summer ritual for executives at telecom giant Nokia Corp. A few weeks at their Finnish country cottages, then back to Helsinki to announce record second-quarter earnings. But the July 27 earnings report carried a nasty surprise: Nokia Chairman Jorma Ollila announced that the release of two phones in the coming quarter would be delayed, depressing earnings by a couple of percentage points. The stock market responded with fury, knocking Nokia shares down by 25% and chopping $60 billion off the company's market cap of $255 billion. In the following days, shares failed to make up the ground.

Is the behemoth teetering? Competition is certainly picking up. In Europe and Asia, a host of challengers, from Siemens and Samsung Co. to a revived Motorola Inc. are coming out with cool phones that attack the franchise Nokia created: the branded cell phone. Indeed, it's this competition, in part, that has spurred Nokia's rush to produce new models. "This proves what kind of pace you have to have," says Ollila. "If you miss a beat, it hits your margin."

CELLULAR BACKWATER. Nokia holds one ace. It has a towering 37% market share in the world's richest cellular backwater: the U.S. While the U.S. has lagged behind Europe and Japan in mobile phones, its tremendous growth potential forces companies with global ambitions to have a presence there. And although a host of Asian players are inching their way in, mostly with cheap, low-margin phones, Nokia's only real global challenger is Motorola, which sells less than one-third as many phones.

But competing in the U.S. is no picnic. Unlike unified Europe, the U.S. is fractured into three major cellular technologies. To offer all three is very costly. For that reason, most of Nokia's European competitors have simply avoided America, sticking to home turf instead.

Except Ericsson. Once No. 2 in the U.S., the Swedish company has seen its U.S. phone sales shrivel from 19% of the market to 11.5% last year alone. This has punished profits and may well push Ericsson to drop out of the U.S. handset market altogether.

So far, handset makers in Japan, such as Matsushita Electric Industrial Co. and Sony Corp., have a limited presence in the U.S. But the plan is to make a splash with Net-surfing phones built for the high-speed third-generation networks. That threat to Nokia could be three or four years away.

In the meantime, Nokia's profit margins are a staggering 25%, and are unlikely to fall below 20%. Motorola, in contrast, earns single digits on mobile phones. Nokia's profits fuel a $2 billion a year research and development effort that produces a new phone on average every month. It's a blinding rate that causes occasional bumps, but one that no competitor can match yet.

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