Nokia's Big Leap

It's challenging Nintendo and Sony with a handset that plays games. Can a phonemaker score in the entertainment biz?

It's near dusk in Milan's trendy Naviglio district, and the cafés and pizzerias are filling up with revelers. Drawn by the sound of blaring rock music, a stream of teenagers and twentysomethings wanders toward an 18-wheeler parked on the Piazza 24 Maggio. The truck is open on one side to reveal a stage, giant TV screens, a disk jockey, and break-dancers. But the main attraction is 40 diminutive electronic-game consoles set up for free trial runs. Visitors put the gizmos to the test, yelping with joy when they blow away bad guys and growling with frustration when they spin off a racetrack into a brick wall. "I've never seen anything like this," exclaims Vincenzo Coni, an 18-year-old university student.

Milan is but one stop on Nokia Corp.'s (NOK ) N-Gage European tour. Cruising through 55 cities in 16 countries, it's an audacious sales pitch aimed at building buzz among young Europeans for the newest wireless gadget from the world's No. 1 mobile-phone maker. This is no ordinary Nokia phone, though. The N-Gage, which goes on sale in most parts of the world on Oct. 7 for a retail price of $300, is a bona fide monster game machine with high-speed 3-D graphics and stereo sound -- akin to a Game Boy for grown-ups, or a PlayStation that fits in your pocket. It's also a phone, text messager, FM radio, and digital-music player, all in a cool-looking case.

Sounds like a toy, but for Nokia this is no child's play. The Finnish company is trying to crack the tricky game industry, where one breach of coolness protocol can crash your credibility and send sales skidding. Nokia has spent tens of millions developing N-Gage and will spend another $100 million promoting it. Now, the fate of its highest-profile launch in years is in the hands of irreverent gamers, some of whom have already ranted online that N-Gage is a "brain fart" and called Nokia a "laughing stock." Ouch.

As it enters this land of make-believe, Nokia is tackling a whole new batch of challenges. It has to line up the world's best game producers, a famously demanding and fickle bunch who will bolt fast if N-Gage doesn't fly. The company says it will have 20 N-Gage titles available by Christmas -- including new versions of Tomb Raider and Tony Hawk's Pro Skater product lines, which are expected to be the two hottest titles. But will that be enough to pull in buyers? Nokia also is scrambling to get the N-Gage carried in stores that sell games, not just phones. In targeting these retail outlets, Nokia risks alienating its core customers, the mobile operators.

Such perils are hauntingly familiar to those faced by Microsoft Corp. (MSFT ) when it launched the Xbox game console -- a move that has yet to yield profits. But as the Finns see it, they have no other choice. Nokia is the longtime leader in mobile communications, with a 39% global market share. But intense rivalry is whacking sales and profits. Although Nokia is on track to sell 12% more phones this year than in 2002 -- an amazing 170 million units -- price pressure will likely erode its overall handset revenues by 1.4%, to $26.3 billion, figures Merrill Lynch (MER ) & Co. Heavy spending for the N-Gage launch and continued losses in Nokia's mobile-networks business will trim overall profits by 1.6%, to $3.8 billion. Investors smell a commodity trap and are losing enthusiasm: Nokia shares are 20% off last December's high.

That's why it's so essential for the company to keep pushing out innovative products that rev up growth. Nokia aims to sell at least 6 million N-Gage consoles in the next two years, which could yield it more than $1.2 billion in revenues with estimated gross margins of 45%, higher than Nokia's overall 40% average. But analysts remain uncertain how much incremental business N-Gage will contribute. Merrill Lynch figures Nokia's handset revenues will sag another 5% in 2004 under continued price pressure.

Hardware sales are only part of the picture, though. Nokia has its eye on a stream of luscious royalties. If industry patterns hold true, N-Gage could spur a game software market that is twice as large as hardware sales. Analyst Stuart Jeffrey of brokerage Lehman Brothers in London figures that 10 million N-Gage owners buying an average of three games a year would spin out $150 million annually in royalty income for Nokia. Plus, Nokia plans to start selling its own games next year, which could earn twice as much per unit.

And then there are services. For now, Nokia will offer free access to its online "N-Gage Arena," where players can swap game tips and upload their best scores. But starting next year, Nokia and third parties will likely start selling software there to the growing base of N-Gage users, everything from upgrades to new game characters. "We're building a whole new business system," says Nokia Chief Executive Jorma Ollila.

The N-Gage is Nokia's boldest move to date in an evolution that began in the mid-1990s. That's when the company first began differentiating its products to target different consumers -- novices, fashion mavens, business execs, and so on. On Sept. 26, Nokia went further, splitting into four major divisions: mobile networks, general mobile phones, wireless entertainment devices, and mobile business products, each aimed at vastly different market opportunities. "Strategically, Nokia is doing the right thing in trying to expand its addressable markets," says analyst Tim Luke of Lehman Brothers (LEH ) in New York.

DOG-EAT-DOG INDUSTRY. Nokia has already proven it can master new businesses. Since mid-2002, it has sold more than 5 million digital camera phones in Europe, where people are now hooked on snapping, storing, and e-mailing images with a handset. That's a feat that No. 2 phonemaker Motorola Inc. (MOT ) is only just now trying to emulate, with decidedly mixed results.

It's not hard to figure out why Nokia picked gaming as its next frontier. With $30 billion in annual sales, the business dwarfs Hollywood -- and is growing a whole lot faster. But a long string of electronics makers, from Apple Computer (AAPL ) to Philips Electronics (PHG ) to Samsung, have fallen on their faces trying to crash the party. "This is a very dog-eat-dog industry with a long history of failures," says games analyst Richard Ow of market researcher NPD Group Inc. in Port Washington, N.Y.

The criticism has already started. "Trying to put high-quality games on a cell phone is like adding a TV to your washing machine," snipes Alan Caron, a 21-year-old Milan deliveryman who sports five studs in his lips and has a Game Boy at home. Such skepticism doesn't faze Nokia. "It's a tradition to be criticized when you enter this market," says Stefan Lampinen, Nokia's European games director, who joined up three months ago from No. 1 game software maker Electronics Arts Inc. (ERTS ). of Redwood City, Calif.

What sets N-Gage apart from all predecessors -- no surprise -- is its ability to communicate. Thanks to the built-in short-range radio technology called Bluetooth, it is the first handheld that lets gamers compete or collaborate wirelessly across a room. "This is without a doubt a major improvement on all the games available on mobile phones," says Marco Zanon, a 19-year-old university student who tried out the N-Gage in Milan. Nokia hasn't announced plans for Wi-Fi support. That will have to wait for 3G.

The N-Gage also includes a phone capable of sending data, but it's a work in progress. Because it's built on the GSM standard, the N-Gage can't be sold in Japan or Korea until a later version comes out supporting third-generation CDMA networks. More important, mobile networks aren't fast enough yet for real-time game playing with a buddy across town or across a continent.

Still, Nokia figures there are millions of people aged 18 to 35 who have outgrown their Game Boys but still want to play while commuting or hanging out. A handful of early N-Gage titles also breaks new ground in multiplayer gaming. Take Splinter Cell, created by Paris-based Gameloft: Zapping data wirelessly from machine to machine, players help each other scale walls or sneak past traps. "Nokia is really carving its own path with this device," says Gameloft CEO Michel Guillemot.

Even so, the Finns don't expect N-Gage to sell itself. That's why they're pulling out all the stops to promote it. Nokia has created an entirely new brand and look for N-Gage, eschewing the soothing blue, green, and white of its corporate identity in favor of black backdrops, grabby red typography, and a Web site stoked with Flash animation and pulsing music. The $100 million N-Gage advertising blitz will be about one-third the size of the entire company's ad spending last year. And to boost its hipness factor, Nokia sponsors events such as the snowboarding World Cup.

Nokia has also brought in outside talent. The head of its Asian entertainment and media unit, Loren Shuster, joined three years ago from MTV Asia, while his counterpart in the Americas, Nada Usina, came on board a year ago from Yahoo! Inc. (YHOO ) Even with such hires, though, a few false steps are inevitable. Nokia President Pekka Ala-Pietilä remembers the first time execs attended the E3 gaming show in Los Angeles in 2001. "We dressed all wrong, in ties," he says with a laugh. "Even when we took them off, we looked out of place." Now they wear bright red N-Gage t-shirts, and guys working the booth have ponytails, blue hair, ski caps, or even (gasp!) pimples.

FATEFUL DECISION. Nokia may have had trouble projecting street cred, but it has been working on gaming for years. As far back as 1998, the company started bundling a simple "time wasting" application called Snake into its phones. In 2001, it also began making phones that played simple games written in the popular Java language. Around the same time, under the leadership of Ilkka Raiskinen, now senior vice-president of the entertainment and media unit, a small team began mapping out plans for a portable game console that would run more sophisticated titles. That's when Nokia made its most fateful decision: To sell the games on removable memory cards rather than via over-the-air downloads. "The publishers wanted a physical distribution medium for better control," Raiskinen says. Plus, downloading over today's mobile networks would have been slow and expensive.

This seemingly innocuous technical choice changed the N-Gage story forever. It allowed publishers to develop larger, richer games, comparable to Game Boy or even original PlayStation titles -- and charge accordingly, in the range of $30 to $40, vs. typical prices of $5 for Java games customers download from mobile operators. But Nokia's tactic was a blow to carriers, who are currently enjoying a boom in Java game sales. Though they can sell N-Gage titles in their stores and earn retail markups, operators won't rake in big airtime charges from downloading games over their networks.

The repercussions of Nokia's design decision are still reverberating. Lining up a new distribution channel -- stores that sell games and consoles, not just phones -- was one of the biggest challenges. Lampinen, who heads the European effort, says N-Gage will be carried in 28,000 retail locations in Europe alone, some 15,000 of them stores that have never sold a Nokia product before. In North America, giants such as Target (TGT ), Circuit City (CC ), and Electronics Boutique (ELBO ) have signed on as well.

Meanwhile, Nokia still needs mobile operators to support N-Gage, since it works only if its phone chip is activated. Some seem a bit tepid, however. One European major says it worries N-Gage will suck away money from its lucrative Java business -- an odd concern, since the N-Gage can also play Java games. Most multiplayer gaming on the N-Gage will be done via local Bluetooth connections, not the mobile network. "The operators don't see what's in it for them," says Paul Maglione, senior vice-president of marketing for London-based Java game publisher Digital Bridges Ltd.

Some have nevertheless signed on, hoping to be the first to catch the wave. The most enthusiastic backer is Deutsche Telekom (DT )-owned T-Mobile, which will roll out N-Gage in Europe and the U.S. and is offering all-you-can-eat mobile data access for $10 per month. Others include Britain's Vodafone (VOD ), Orange, and mmO2, and Germany's E-Plus (ATVI ).

Nokia has managed to line up a solid stable of 10 launch titles, with 10 more expected before Christmas. "To Nokia's credit, they've gotten a lot of game makers on board," says Jay Defibaugh, a Credit Suisse First Boston (CSR ) games analyst in Tokyo. The big coup was nabbing Electronic Arts in August: The software giant's first N-Gage title, an American football game, is expected late this year.

Still, game makers grumble that the N-Gage suffers a few serious flaws. Players have to turn it off and take off its back cover to put in a new game. Nokia defends the design as suitable to a mobile phone, but has already modified it in a second version of the N-Gage expected before Christmas, 2004, according to industry sources. Likewise, most partners have complained that the $300 retail price for N-Gage is too high -- three times that of the latest Game Boy. But this price could soon be a moot point: Operators plan to sell subsidized N-Gages with bundled service plans at prices ranging from $1 to $160, with many settling around $100.

HUGE JAPANESE RIVALS. The bigger concern is whether Nokia can continue finessing the video-game minefield. "The success won't be determined by the launch," says Brian Farrell, CEO of Calabasas Hills (Calif.)-based game maker THQ Inc. (THQI ), which has produced three N-Gage titles including Red Faction and MotoGP. "It's how Nokia manages over the next two to three years." One challenge is attracting second- and third-tier games makers. "Having can't-miss launch titles only gets you through the first 90 days," says one small-game producer. "Nokia has to open up the program to more parties or it risks failure."

Then there's the competition. Since 1989, Nintendo Co. (NTODY ) has sold some 157 million Game Boys, of which about 40 million are still in use. Its newest, the Game Boy Advance SP, features a clam-shell design reminiscent of mobile phones and is a clear attempt to move beyond the traditional under-15 male Game Boy audience. So far, analysts say, the SP has sold about 5 million units. "N-Gage won't affect us," says Kyoto-based Nintendo spokesman Ken Toyoda. "It's not a mass market product."

Of greater concern to Nokia is Sony Corp. (SNE ), which has already announced a PlayStation Portable that it aims to ship in Japan by the end of 2004. Not much is known about the system, but it's expected to have Wi-Fi and infrared communication built in. "Sony is a master at creating buzz around platforms like this," says Nicolas Petit, a consultant with Arthur D. Little in Paris.

Even the N-Gage's fiercest critics concede that its arrival will change the gaming industry forever. N-Gage will not only popularize the concept of wireless links among game players, but it will also spur development of a new generation of multiplayer titles. Some doubters say that the innovations pioneered by Nokia are more likely to be successfully exploited by Sony and Nintendo. But don't tell that to Nokia CEO Ollila. "We're in this for the long haul," he says. Spoken like a true video-game action hero.

By Andy Reinhardt in Helsinki, with Eric Sylvers in Milan and Irene M. Kunii in Tokyo

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