Cell-Phone Shakeout

For some European makers, it could be time to hang up

For a fleeting few months at the turn of the century, it appeared that a host of Europeans could make money manufacturing cell phones. Siemens (SMAWY ), Alcatel (ALAO ), and Philips (PHGZF ) rushed into a business already occupied by Nokia (NOK ), Ericsson (ERICY ), and others. Briefly, it paid off. Phone companies eager for customers bought their handsets by the truckload and virtually gave them away to customers. German operators alone added a whopping 25 million subscribers last year, luring them into the mobile world with cut-rate phones. The phonemakers churned out handsets as if there were no tomorrow.

Now, tomorrow has come, and it's looking grim. On Apr. 17, Philips announced that its cell-phone operations, profitable a year ago, lost $106 million in the first quarter alone. Similar bleak numbers are likely to emerge elsewhere as a host of manufacturers come to grips with an industry in which only one company--Nokia--makes profits on cell phones. With inventories of phones, chips, and components piling up from Taiwan to Rotterdam, manufacturers are racing to cut the bleeding. In April alone, Siemens announced 2,000 job cuts, Ericsson 6,000 more, and Philips executives hinted that the Dutch company might drop out of the handset business altogether. "Second-tier manufacturers are just being toasted at the moment," says Mark Davies Jones, an analyst at Schroeder Salomon Smith Barney.

OVERCROWDED. This spells a shakeout for cell phones, the world's biggest electronics industry. With growth slowing and the $76 billion industry struggling to develop a costly new generation of Internet phones, smaller players in coming months are likely to fall by the wayside--or join forces. This is sure to hit hardest in overcrowded Europe. The upshot? Only a handful of global players, including Samsung, Motorola (MOT ), and Matsushita, will be around to grapple with the industry leader, Nokia, in the next stage: the race to create wireless Web devices.

Nokia is a galloping target. With its competitors struggling, the market leader announced plans in early April to boost its share from 31% to 40%--and that's of a cell-phone market that is still expected to grow 15% this year, to 475 million units. To pull this off, the Finns say they're prepared to sacrifice a few points of their fat 20% margin. Already, Nokia is slashing prices on so-called youth phones, especially the popular 3310, a phone that sends picture messages. The idea is that once kids get used to Nokias, they'll stick with the brand, even as phones morph into mobile computers. Nokia's hardball marketing stands to punish No. 2 Motorola Inc. And it could help push Alcatel, Philips, and perhaps Ericsson out of the handset business.

CLOISTERED. As Europeans head for the exits, a host of Asians are eager to replace them. For a decade, Japan's consumer electronic powers, Matsushita and Sony Corp., have been largely cloistered in the Japanese market, which has operated on a technology incompatible with the rest of the world. This has reduced these home market giants to dwarfs on the global stage. Now, with the approach of the high-speed mobile network known as Third Generation (3G), the Japanese and Korea's Samsung will finally be sharing global technology. This, along with their expertise in consumer electronics, gives them the chance to expand in Europe and America.

Japan and Korea will lead with Internet phones. Already, they're preparing a raft of machines for the next phase of the mobile Net, so-called Generation 2.5, which is being rolled out this year in Europe and parts of North America. Here, the Asians and Motorola will be selling their handsets before Nokia's devices hit the market.

The Asians may also raise their profile in Europe by teaming with the victims of consolidation. Topping that list is Alcatel. The French company holds a 4.6% global share, most of it in the cheap, low-margin phones suffering most from the price squeeze. In early April, Alcatel Chairman Serge Tchuruk announced that the company would be "participating" in the coming consolidation. What does that mean? Look for Alcatel to join forces with an Asian--or simply sell its cell-phone business.

Philips is in a similar bind. Three years ago, the company's botched mobile handset venture with Lucent Technologies Inc. led to a loss of $500 million. Afterward, CEO Cor Boonstra pushed to keep the company in the business. He figured Philips needed a position in wireless to master the next stage of mobile Net machines. But his successor, Gerard Kleisterlee, who takes over at the end of April, has warned that he may cut the losses and drop the business.

One company poised to benefit from the disarray is Microsoft Corp. (MSFT ), which wants to dominate the software needed for the wireless Net. Three years ago, the phone industry formed a united front to block the software giant from the cell-phone business. Since then, though, Nokia itself has run away with market share and profits--and is unwittingly pushing bruised competitors to seek help from Microsoft.

And Microsoft is ready to lend a hand. From its wireless headquarters in Stockholm, the software titan is shipping operating systems and mini-Web browsers for palm devices and mobile phones. The appeal: Cash-hungry phone manufacturers can piggyback on Microsoft's research and development. What's more, if the mobile Web machines live up to their billing, they'll link neatly with desktop computers at home or in the office. Already, Mitsubishi and France's Sagem are making palm-size phones with Microsoft's program. And by the end of the year, Samsung, Sony, and Britain's cell-phone startup, Sendo, will be producing smaller Microsoft machines that look and feel more like phones.

Of course, making cool machines is only half the battle. The trickier job is developing data services to entice hundreds of millions of mobile talkers to upgrade to fancy smart phones, perhaps costing between $500 and $1,000. So if and when the mobile Net springs to life, more manufacturers may well jump into the game. But for now, the roster's set to shrink as fast as the margins.

By Stephen Baker, with Emilie B. King in Paris

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