Nokia's Next Act

Can the Finnish giant stay on top in an age of commodity phones and stalling sales?

The get-togethers were cordial and businesslike, the agenda ambitious. There were no raised voices, no objects hurled against the wall. And above all, there was no sense of panic. But in a series of meetings starting last summer, the top five executives of Nokia Corp. (NOK ), the world's No. 1 maker of mobile phones, hammered out a strategy to remake the $28 billion company's handset business from top to bottom. A decade after Nokia chucked its heritage as a maker of everything from toilet paper to rubber boots and bet its future on wireless communications, it was time for the next act.

The venue for the meetings was always the same. At 7 a.m. or 5 p.m., the managers convened for two hours at a stretch in an elegant, blond-wood-paneled conference room on the top floor of Nokia's soaring steel-and-glass headquarters overlooking the Gulf of Finland. Their immediate objective was to deal with the consequences of a dramatic slowdown in sales of wireless phones and equipment, both in the industry and at Nokia itself. Nokia's revenues had soared 54% in 2000 but hit a wall in the first half of 2001. This year the company will be lucky if they notch up 5%, analysts say. The top brass also had to face up to resurgent competition from rivals left in the dust years earlier and the threat posed by Asian manufacturers, ranging from Korean giant Samsung Electronics Co. to Chinese newcomer TCL Holdings Co. Then there was the challenge from software behemoth Microsoft Corp. (MSFT ) Its push to get phone makers to adopt a stripped-down version of its Windows software threatens to erode Nokia's power.

At every meeting, Chairman and CEO Jorma Ollila would throw out a hypothetical proposal. "What if Nokia expanded from two to four business units?" he asked the group. "What if the company merged manufacturing of mobile phones and networking equipment to reap new economies of scale? Or what if it was reorganized along regional lines?" Each scenario was painstakingly picked apart--and all but one was ultimately discarded. No slick management gurus were hauled in to provide the Big Think. As with virtually everything Nokia does, the solution was homegrown.

Just before Christmas, the executives settled on a scheme that Ollila is convinced will propel his company to the next level. Few in the industry know the details of the changes, which Ollila was set to outline for analysts on June 20. But they are already in place: Effective May 1, Nokia split its monolithic $21 billion mobile-phone unit into nine profit-and-loss centers, each charged with bolstering the company's position in a particular market, from $1,000 smartphones for corporate customers to $160 bare-bones handsets for users in developing countries such as Brazil. There's always a risk that such a massive overhaul could slow down the 53,000-person company. But Ollila, 51, argues it will have the opposite effect. "We foresaw that being too big was a real danger," he says. "We had to break up the company in a meaningful way to retain the entrepreneurial thrust we had in the 1990s."

It's the next stage in the maturation of the mobile industry. Nokia gets credit from analysts and rivals alike for having been the first to grasp that cell phones were becoming consumer items. In the mid-1990s, it started segmenting its product line by "styles," such as Basic, Classic, and Fashion. But the mobile-phone division remained a single, increasingly unwieldy business unit. Now that old structure is gone, replaced by a stable of mini-Nokias. Heading them up is a new generation of managers--six Scandinavians, two Brits, and an American--one of whom could someday graduate to CEO.

Pretty dramatic stuff for a company that's still clearly on top. Despite the industry's woes, Nokia boasts enviable operating margins of 18% in handsets, and should see overall profits rise 6% this year, to $3.7 billion on sales of $29.7 billion. Yet there are some worrisome signs that Nokia is losing its edge. It has been outpaced in color-screen phones, for instance, and had to watch helplessly this spring as rival Sony Ericsson Mobile Communications Inc.--the new joint venture of Swedish giant Ericsson (ERICY ) and Japanese powerhouse Sony Corp. (SNE )--scored a huge hit with the color T68.

That wasn't Nokia's only miss. It's trailed a resurgent Motorola Inc. (MOT ) with phones supporting GPRS, an enhancement to the dominant European GSM standard. It has less than 10% market share in CDMA phones, a fast-growing segment dominated by rivals such as Samsung. And the vast majority of camera phones--which snap digital pictures and transmit them wirelessly--come from Japanese producers such as NEC Corp. (NIPNY ) That is a big weakness: By the end of this year, predicts Philip Vanhoutten, corporate vice-president for marketing at Sony Ericsson, some 50% of the new phones sold in Japan will likely include cameras, and Nokia won't be in a position to grab much of the business.

The new structure is designed to prevent such missteps. "We wanted to move faster, be more flexible," says Matti Alahuhta, 49, president of the mobile-phone business and the primary architect of the reorganization.

The time was certainly right for radical measures. The mobile industry is in the midst of an historic transition driven by financial crisis and fast-changing technology. Cell-phone ownership is approaching saturation levels in the developed world. The wireless Web was supposed to spur demand for pricey new computerlike handsets capable of handling everything from real-time stock quotes to videoconferencing. But the introduction of so-called third-generation wireless services is running behind schedule. What's more, financially strapped carriers are rolling back the generous subsidies that made it possible for new customers to take home $200 phones for $10. No wonder handset manufacturers lost money overall last year and should show only a modest profit in 2002, says Nomura International analyst Richard Windsor.

Making handsets profitably is one challenge. Figuring out what increasingly confused customers want is another. Mobile phones used to be about talking--anytime, anywhere. Now they're becoming devices for sending and receiving data as well. More than half of new phones come with built-in browsers, and a growing number include digital cameras or music players. Leaders in the PC business, including Microsoft and Intel Corp. (INTC ), have concluded that this is their moment to barge in. "The trends are playing to our expertise," says Intel Vice-President Ron Smith, who is spearheading the chipmaker's bid to sell processors and other technology to phone makers.

Hand in hand with convergence comes another trend that also could sap Nokia's luscious profit margins. Thanks to relentless improvements in chip design and manufacturing, it's possible to cram more and more features and power into silicon with each passing year. Such reductions have already made possible ever-smaller phones with more and more capabilities. But the same trend also feeds a steady commoditization of the basic building blocks of electronic products.

In the past, only Nokia and a few others had the technical chops to design the special-purpose electronics that go into cell phones. Now, once-esoteric components are available off the shelf from multiple suppliers, and companies like Motorola, Texas Instruments (TXN ), and France's Wavecom (WVCM ) are hawking ready-to-assemble phone kits.

The upshot? It's easier than ever for low-cost Asian producers to cobble together me-too phones and undercut Nokia. Retail prices for handsets have fallen from an average of $275 five years ago to $155. To stay ahead of the pack, Nokia must increasingly differentiate its product through fancy software and hardware, such as the colorful graphic interface now showing up on the 9200-series Communicator and the 7650 camera phone. Thus Nokia spends 60% of its $2.7 billion research and development budget on software development--up from 30% five years ago.

All of these concerns weighed on Nokia's managers as they contemplated the future. As the industry's top dog, with an estimated 37% global share, Nokia figured it had to reassert its leadership. "Our objective is to renew the whole industry in the next two years," says Alahuhta.

That goal has already prompted unprecedented steps by Nokia to share its technology with other companies, on the premise that it's better to enlarge the pie than to hold on to your share of a stagnant market. Last fall, Nokia shocked attendees at the computer industry's Comdex trade show by revealing plans to license its crown-jewel phone software to rivals. The move is meant to counter Microsoft's push into cell phones.

But nothing equals Nokia's internal reorganization for symbolic import. Gone is the unified structure of a business that grew so fast nobody had time to consider alternatives. In its place, Nokia has conjured up a complex organization of separate businesses, each with its own product R&D and marketing. One unit, for instance, will address the particular needs of business users, while another will chase the nascent market for phones with built-in digital cameras. Perhaps the boldest gambit is a unit focused on ultracheap phones for markets such as Russia, India, and China. The very existence of such a group is a tacit admission that the old Nokia lacked the focus to win this segment. "Nokia became its own worst enemy," says Juha Christensen, the vice-president of Microsoft's mobility group. "By having vast economies of scale, it lost the ability to deal with niche markets."

The changes at Nokia parallel those that have occurred in other industries. By the 1920s, Henry Ford had figured out that not every customer wanted a black Model T. But his rival Alfred P. Sloan Jr. gained the upper hand by building a General Motors Corp. (GM ) that housed separate divisions--Chevrolet, Oldsmobile, Cadillac--targeting different classes of buyers. It even happened to the most generic of all products, the microprocessor, when Intel split its Pentium line into three price brackets to focus engineering and marketing efforts on specific customers.

But GM had decades to perfect its system, and Intel enjoyed a near-monopoly with its microprocessors. Nokia has neither of these luxuries. That's why Ollila's reorganization is fraught with risk. Nomura's Windsor worries it could raise fixed costs. Plus the sheer complexity of it might--instead of producing nimble, market-focused teams--simply gum up the works and confuse employees, clients, and investors.

To keep the separate units from straying too far apart, all will tap the 4,500-person central research lab for basic technology and product design. And to avoid diluting Nokia's efficiencies in procurement and manufacturing, each will hand off its products to a shared operations and logistics group.

In theory, that's an elegant solution. But there's ample room for overlap and turf battles. "These kinds of reorganizations look good on paper, but in practice they're difficult to implement," cautions John Jackson, an analyst at Boston-based telecom researcher The Yankee Group. With one unit set up to create phones using the CDMA standard pioneered by San Diego-based Qualcomm Inc. (QCOM ) and another charged with devising camera-phones, who will be responsible for CDMA camera-phones? Ollila acknowledges the risk of such conflicts but says Nokia had to draw lines somewhere and figured such problems will be worked out as they arise. "We tried to respond to the realities of the marketplace, not to get mired in management philosophy and orthodoxy," he says.

There are plenty of tough realities to deal with. Take the challenges facing the new Mobile Entry Products division, led by Nokia's former Southeast Asia general manager, Bengt-Ake Gyllenberg. More than most senior executives at the company, he saw the ferment of Asian phones up close and understands the needs of customers in developing economies. He also realizes that to reach Nokia's goal of increasing the number of mobile users worldwide from 1 billion today to 1.5 billion in 2005 will require cheaper phones and mobile services. Up to half of all phones sold today are already in the budget category. With his new unit, Gyllenberg has the freedom to do what it takes to ensure that Nokia phones become the brand of choice for first-time buyers--even if that means taking such radical steps as buying technology from other suppliers or outsourcing more of its manufacturing.

The challenges are totally different at the Imaging Unit. Headed by veteran Juha Putkiranta, the division has to catch up quickly to the Japanese, who dominate the market. When Nokia was developing its 7650 camera-phone, he says, managers came to realize they were dealing with an entirely different ecosystem than what they were used to. "We were running one big business with a basic set of drivers," says Putkiranta. Nokia had to line up new component suppliers and create software for translating photos among mobile and Internet standards. What's more, Putkiranta says, "The people I compete with aren't even on Bengt-Ake [Gyllenberg]'s list."

Everybody who competes with Nokia will be watching its experiment with a mix of curiosity and dread. If it works, the rush to imitate will be swift and massive. If it doesn't--well, Nokia will have to work even harder to stay on top. One way or another, there's no going back to the Model T.

By Andy Reinhardt in Espoo, Finland

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