Is Nokia's Star Dimming?

Antsy investors, 3G glitches--how the cell-phone giant plans to cope

It's fast becoming the Helsinki conundrum. When cell-phone king Nokia is thrashing Ericsson and Motorola, and those two announce dreadful earnings, what's to stop jittery tech investors from punishing the whole sector, including Nokia? In markets like today's, where fear rules supreme, absolutely nothing. So Nokia Chairman Jorma Ollila is taking preemptive steps. A day or two before his rivals release their numbers, Ollila often puts out some good news of his own. It's a nod and a wink to investors.

And sometimes it backfires. On Jan. 9, Nokia Corp. proudly previewed 2000 numbers. They showed Nokia extending its lead in handsets, rising to one-third of the 405 million unit global market--and double its closest competitor, Motorola Inc. In total, the Finns sold 128 million handsets, up an impressive 64% from 1999.

Yet as soon as the Nokia release hit the wires, all hell broke loose. Investors brushed past Nokia's competitive gains and zeroed in on the size of the market: 405 million seemed puny, some 20 million smaller than earlier analysts' projections! Suddenly fearful that the world's love affair with cell phones could be topping out, investors ditched Nokia stock, dropping the share price 9% and axing $17 billion from its market value. The current worry is that Nokia could announce disappointing results when it unveils its fourth quarter, on Jan. 30. "In this environment, any negative surprise will take the stock down," says Edward F. Snyder, analyst at J.P. Morgan H&Q in San Francisco. And a long-term bear market in telecom could dry up the pool of desperately needed capital for next-generation wireless systems.

KILLER BRAND. Setting aside jumpy markets, the story in cell phones is one of growing dominance. The Finnish giant, neck-and-neck with its top two rivals barely two years ago, is now lapping the field. The $27 billion company boosts its share simply by nudging down margins to a still-hefty 19%, this while the rest of the industry is struggling to make money. Nokia sits, debt-free, with $2.5 billion in cash, the biggest research-and- development budget in the industry, a killer brand, and unrivaled leverage not only over suppliers but also over customers. Those are the world's biggest phone companies, from AT&T to Deutsche Telekom, who supply millions of cell phones to the public. They pay top dollar to have the snazziest Nokias on hand. Few can afford to pass. "Nokia's the gorilla," says Joris de Beul, equity strategist at Fortis Investment Management in Brussels.

Sure, cell-phone growth will slow down from this year's 45%, especially in near-saturated Western Europe. But even pessimists project an additional 140 million units next year, many of them in developing markets such as China, India, and the United States. Within three years, the cell-phone market should reach 1 billion units per year, says International Data Corp. No one's better positioned to cash in on this monster market than Nokia. The Finns predict 25% to 35% sales growth through the next three years.

Yet in this skittish climate, even a slight stumble on Nokia's part could jeopardize more than the Finnish giant's stock price. At risk is the company's whole ambitious gamble on the mobile Internet, which barely exists today. More than any other outfit, Nokia is spurring the global phone industry ahead on this trillion-dollar push. If the strategy pans out, the Finns could well sit atop the next stage of the Web, kings not just of Web-surfing machines, but also a power in software and networks.

DEEP DEBT. This is a dicey situation, however, because Nokia can never go back to just selling phones. Also, it needs huge commitments from its partners, the phone companies, to forge the wireless Web. But all the telcos have plunged deeply into debt. And in this new ball game Nokia faces fierce competition from the world's leading tech companies, from Silicon Valley to Tokyo.

Only a year ago, the wireless Web seemed to be falling neatly into place. The phone companies dutifully accepted Nokia's thesis that this high-speed mobile Net, known as Third Generation, was the next big thing: To miss it meant death, no matter how much it cost. With that, the telcos went on one of the biggest spending binges in history, throwing billions of dollars at spectrum licenses like so much cab fare. When Britain's Vodafone Group PLC launched a $183 billion takeover of Germany's Mannesmann, the markets barely quivered. They were too busy applauding.

It was back in those cheery times, one evening at Nokia headquarters, that Chairman Ollila mentioned his company's market value and broke into laughter. "$250 billion," he said, shaking his head. Suddenly, it didn't seem like much money.

Today, it does. In a manic market, the noise surrounding 3G is every bit as grisly as the soundtrack of Scream 3. Phone companies are spending a spine-tingling $125 billion just for spectrum licenses in Europe, plus another $100 billion for the networks--this before any of them have figured out how to make a business from data on mobile phones. In a switch from cockeyed optimism to paranoia, investors have punished phone stocks, driving down giants like Deutsche Telekom and British Telecommunications PLC by 60% since last summer.

Such stampedes throw plenty of dust on Nokia. For now, though, the Finns' drive to build and dominate the mobile Web is not even off schedule. And the telcos, battered as they are, remain committed to 3G. Most of them are locked in, by the terms of their spectrum licenses, and ready to plow ahead.

Hazards lurk up ahead, though. The drive to 3G is pushing Nokia from the simple radio-based handsets it knows so well into the dizzying world of computers and consumer goodies, from digital cameras to tiny video machines--all of which will soon communicate with one another over the wireless Net. This process is known as digital convergence. And it's leading Nokia away from its home-telephone counter at Best Buy into different sections of the electronics store. It's here the Finns run smack into Microsoft Corp. and Sony Corp, which are busy making similar machines.

For Niklas Savander, Nokia's mission is like that of a surfer looking for the next wave. Savander, Nokia's vice-president for software applications, says that with mobile voice, Nokia caught a tsunami in the '90s. The first company to design colorful phones and build a consumer brand, Nokia left competitors such as Motorola and Ericsson floundering in its wake. Those engineering companies viewed mobile phones for far too long as boring and expensive business tools. And Motorola made a disastrous bet on analog phones, just as Nokia was pushing digital. But those triumphs are in the past. "The next wave," says Savander, looking out the window at the lapping Baltic, "is the mobile Net. The question is whether we can catch two in a row."

"CLOSE-KNIT." Five floors up from Savander at the Nokia House, Jorma Ollila scowls at the wave analogy. "It's a bit too simple," the 50-year-old Nokia chairman says in his clipped British accent, a product of a stint in London at Citibank. Ollila insists that his close-knit team of managers, the same five Finns who mapped out Nokia's course in current cell phones, have been preparing the company for the mobile Web for years. He notes that Nokia produced the first Web-surfing mobile phone--a brick known as the Communicator--way back in 1996, the Jurassic era of the wireless Web. From his glass-walled office, Ollila has been reassigning radio engineers into software and Internet technologies for the past three years. And he's been preparing his managers. More than smart software, Nokia's debt-free balance sheet, or its heavyweight brand, it's Ollila's inner circle of managers that promises to power Nokia in the coming wireless Web wars.

All Finns, these top execs took over Nokia as thirty-something managers when the national icon was wavering on the brink of bankruptcy. They jettisoned much of the company to focus on wireless. There they pushed design and branding, and set up a low-cost industrial scheme that gave Nokia a head start when the cell phone became a mass-consumer good.

But while winning the cellular wars, Ollila was busy training his team for the challenges ahead. He shifted their jobs every two or three years. He dispatched his chief financial officer, Olli-Pekka Kallasvuo, to run the U.S. division in Dallas. There, the money man learned not just about manufacturing, but the all-important U.S. capital markets. Ollila sent his networks chief, Sari Baldauf, to run Asia--giving her a good look at the jumping-off markets for 3G.

Perhaps most important, Ollila pulled his No. 2 and heir apparent, Pekka Ala-Pietila, away from handsets in 1998 and sent him to Silicon Valley. Ollila says he has always counted on the 44-year-old Ala-Pietila as a visionary, and he makes a point of talking to him every day. Ala-Pietila's mandate is nothing less than to divine the future of the wireless Web--and put Nokia on track to get rich there.

From Nokia's leafy campus in Mountain View, Calif., Ala-Pietila is piecing together an entire Internet division. The idea is a bold one for a hardware company: Nokia can make all the fancy phones it wants, from almond-size units that nestle in the ear to combo phone-organizers with color touch screens and the zippiest games. But all of these phones are going to flounder--and Nokia will, too--if the network they depend on falls flat. This is driving Nokia to funnel much of its $2.5 billion R&D budget into 3G projects extending far beyond the mere handset.

Some 20,000 engineers from California to Nokia's labs in Oulu, just south of the Polar Circle, are venturing far from their radio roots, reaching into nearly every technology that touches the Web. They're developing tiny Web-browsers and firewalls, e-commerce security systems, and vast programs known as "middleware" that will allow phone companies to manage the expected blizzard of 3G traffic.

Nokia's risk? In an industry where companies zero in on specialties--Ericsson on transmission towers, Qualcomm Inc. on chip design--Nokia's covering the wireless waterfront. "Nokia is clinging to a vertical industrial model," says Hjalmar Widbladh, general manager of Microsoft's Stockholm-based mobility division. "That goes against the times."

And the complexity of 3G systems is daunting. Consider a phone-toting German businesswoman in Malaysia. The network must locate her, offer a full load of German-language-services, from a list of vegetarian restaurants in Kuala-Lumpur to travel sites that permit her to postpone her Lufthansa flight by a day--and pay the $50 penalty, by phone of course. For the system to work, phone companies the world over must trace the steps of hundreds of millions of customers, adjust services to billions of different Web-surfing machines, and figure out the right billing for each customer's subscription. Building these systems "may be the most complex job humanity has ever faced," says Greg Papadopoulos, chief technology officer at Sun Microsystems Inc.

REDMOND RIVAL. One of the few companies with resources to tackle it is Microsoft. The software giant is pulling out all the stops to extend its dominance from the desktop to the wireless Web. Three years ago, Nokia and Ericsson headed up an effort to block Microsoft from mobile-Net operating systems. Joined later by Motorola, they created a London-based joint venture called Symbian to produce a competing system.

But in the past year, Microsoft has flexed its mobile muscles. Last winter, it forged a joint venture with Ericsson to develop mini-Web browsers for handsets. "We can't do everything on our own," says Ericsson President Kurt Hellstrom. Months later, Microsoft hired away a key Symbian executive. In November, the Redmond giant unveiled prototypes of its first Internet phone, a joint venture with French phonemaker Sagem. The product is a slick palmtop device with a color screen, games, and a speaker phone--similar to Symbian-based products still in the lab. It's designed for generation 2.5, the next step in Europe's mobile Net, which should roll out this year. The worst part? Microsoft's product, due out within months, could beat Nokia to the marketplace.

The Japanese promise to arrive early, as well. While Europeans thrash about to finance their next-generation systems and the U.S. debates which part of the airwaves to devote to it, the Japanese are forging ahead. Generation Three should debut by May in Tokyo. Already, Japanese powerhouses Sony and Matsushita Communication Industrial Co. are unveiling zippy new phones, some connected to MP3 players, others to cameras and mini-game consoles. What's more, when the first 3G systems open in Europe, early next year, the Japanese will likely be ready first with handsets. "Panasonic is going to be a good six months ahead of Nokia," says Lloyd Carney, president of wireless Internet solutions at Nortel Networks.

One question is what the machines will look like. Nokia developers predict a broad and wacky wireless world. They see wireless Barbie Dolls and Yankee caps, phones equipped with global positioning hitched to dog collars and planted in school lunch boxes. They see people eventually accumulating gobs of wireless machines, just the way we pile up clocks and radios today. "The market will be big enough for everyone," predicts Ollila. But amid the tumult, Nokia's betting that users will continue to buy phone-like devices--albeit with a camera or game console or electronic organizer attached. Those multifeatured phones will remain Nokia's core market.

WAP WOES. But don't expect the market to take off like a rocket. When 3G rolls out, the service is likely to be spotty and pricey for months, perhaps longer. Nokia is betting, with the confidence of a powerhouse, that the market won't truly develop until the Finnish giant thunders onto the stage, complete with its phones, software, and a host of service providers in tow--and a massive P.R. campaign.

Chances are the market will continue to be iffy long after Nokia arrives. That was certainly the case with Europe's first generation of the mobile Internet, a disaster known as WAP, or wireless access protocol. Launched amid great fanfare 16 months ago, WAP has limped from the beginning, hobbled by slow connections, high prices, lackluster services and, most embarrassingly, undependable phones. "Nokia's first [WAP] phones were buggy as hell," says Nigel Deighton, Gartner Group analyst.

The next phase promises to be rocky too. The market is likely to swoon every time Ericsson beats Nokia to a 3G contract, every time a Net phone appears with bugs. But from the very start, Nokia's managers have thrived precisely when they're working through crises. Every tumble Nokia takes hardens it for the wild ride ahead. It's bound to be bruising. But these Nordics are proving they have the patience, the riches, and the smarts to withstand the heat.

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