Weaker Signals for Mobile Phone Firms
By Ari Bensinger
The worldwide mobile phone market is clearly decelerating, growing 44% in 2000 to an estimated 410 million units, versus a 64% increase in 1999. New subscriber growth is being hampered by reduced subsidies and higher overall penetration rates, particularly in Europe and Asia.
The lack of "killer applications" for Internet-enabled phones has hurt the handset replacement cycle, as customers are less prone to upgrade to newer phones. Compounding these factors is the rapid economic downturn in the U.S. market.
The sector will continue to experience high levels of mobile phone inventory throughout the first half of 2001. For the full year, market research firm Gartner Dataquest forecasts worldwide handset sales of 507 million. This optimistic forecast is well above the industry's own expectations. Leading mobile phone maker Nokia cut its 2001 forecast to 450-500 million units from previous estimates of 500-550 million; Motorola guided unit sales below 500 million from 525-575 million; and Siemens recently suggested that global handset sales could be less than 450 million units this year.
Gartner believes that strong unit growth in the major markets of Asia and Europe will offset any softness in the United States. Shipments to Asia are expected to increase over 30% from 2000 to 170 million, while shipments to Western Europe will grow 19% to 167 million. North America will be the number three region, with shipments forecast to reach 90 million units, an 18% increase. Latin America will grow 17%, with sales expected to top 42 million units. The rest of Europe, Middle East and Africa are on track to have sales of 38 million units, up 23%. Even using this most bullish handset estimate, mobile phone unit volume will increase only 24% in 2001, a far cry from the 44% growth achieved in 2000.
Operational efficiency will be the key to achieving solid financial performance in this slowing economic environment. Companies will have to adapt their overall cost structures, workforce, and production levels in line with the lower demand.
Below we take a look at some of the cost controls and efficiency programs at The "Big Three" handset manufacturers - Nokia (NOK ), Motorola (MOT ), and Ericsson (ERICY ) - which account for over 50% of worldwide mobile phones sales.
Nokia is the clear leader of the handset sector with a market share of 32% in 2000, more than its two nearest competitors combined. Given the weaker economic environment, Nokia recently lowered its 2001 sales growth forecast to 20%, versus earlier guidance of 25% to 30%. Still, the company expects improving operating margins of nearly 20% (in contrast to the low single-digit/negative operating margins at Nokia's main competitors) to more than offset the slower sales growth. This confirmation of earnings demonstrates Nokia's superior operating execution, as it capitalizes on its large size, strong manufacturing capacity, and unmatched distribution channel.
In mid-March, Nokia announced it would sell two manufacturing plants to U.S. electronics group SCI System, eliminating 1,250 jobs in the process. The company plans to double its outsourcing of handset production to 20%. It is also shifting production from the U.S. to lower cost countries like South Korea and Mexico.
Nokia plans to use the current turmoil as a chance to widen its market share lead through aggressive price reductions. Being the low cost producer, Nokia can afford to cut prices more than its rivals. We expect the Finish giant to emerge from this difficult market time in a much stronger market position.
Motorola manufactures a variety of electronic products, but the company is best known for its wireless communication products (about 30% of sales), which have experienced historically weak profits. Based on a weak order rate, Motorola stated in late February 2000, that it did not expect to meet its already reduced guidance of $8.1 billion sales and $0.12 EPS for the first quarter of 2001.
In mid-March, Motorola announced steps to make the struggling personal communications sector (PCS) more nimble by removing complexities in its handset portfolio, reducing its supply chain, closing certain manufacturing facilities and establishing global supply agreements with premiere outsourcing companies. Motorola also announced the termination of an additional 7,000 PCS employees, bringing the total PCS workforce reduction to 12,000 since December 2000.
On the profitability front, Motorola substantially missed its original internal target of double-digit operating margins in its handset division by year-end 2000. The company posted measly margins of 2% in the fourth quarter of 2000. We believe Motorola has too many moving parts in too many markets. The end result: a lack of focused execution.
While Ericsson solidly holds the number one position in the wireless infrastructure market, its mobile handset division continues to be a drag on earnings and profit margins. The company, which has been trying to improve this struggling division for more than a year, recently implemented a comprehensive restructuring program aimed at yielding annual cost savings of at least SEK20 billion by 2002. Under the plan, the company will eliminate 2,100 workers in Sweden and terminate production at two U.K. mobile phones plants. It will also reduce the number of consultants (estimated at nearly 17,000) - in some areas by more than 50% - and shift work to internal resources. Ericsson will outline the full cost savings program when it announces first quarter results in mid-April.
Many investors may wonder why doesn't the company simply sell the handset division. Ericsson for its part maintains that the handset division plays an intricate role in its network infrastructure success, as it makes the company an end-to-end supplier to telecom providers. With the network division seeing a temporary sales slowdown due to 3G deployment delays, cash difficulties in the handset division will become more apparent. We expect management to put the handset division up for sale if it does not achieve a significant operating improvement by year-end.
Although near term growth in the mobile phone industry will slow, the long-term picture for the sector remains bright, due to the eventual transition to Internet enabled phones.
In particular, the mass deployment of 2.5G general packet radio service (GPRS) phones, which will offer data speeds of greater then 100 Kbps, should help the mobile phone market gain momentum in 2002. The widespread adoption of 2.5G depends on several key factors, including the availability of 2.5G handsets and applications, packet data billing software, and seamless switching between voice and data services.
Bensinger is a technology analyst for Standard & Poor's