Can Nokia Get The Wow Back?

To turn profits around, it's making cooler phones, cutting prices, and moving into new businesses

To grasp why Nokia Corp. (NOK ) is suddenly in the hot seat, check out the glittering display of cell phones at the big FNAC electronics store near the St Lazare train station in Paris. Here, at one of Europe's premier gizmo emporiums, you can tell at a glance what's hot and what's ho-hum. The shelves are jammed with sleek Samsung flip-phones, gorgeous new designs by Sony Ericsson, and big-screen color models from Sharp and Sagem. By contrast, the handful of Nokia phones look dowdy and uninspired. Shopper Antoine Chapuis, a 34-year-old Parisian and longtime Nokia fan, is switching brands. "Nokia phones are less fashionable nowadays than they used to be," he says.

Nokia the Uncool. Who could have imagined it would come to this? Yet something has suddenly gone awry for the Finnish mobile giant. After a blowout fourth quarter, when Nokia sold a record 55 million handsets, it looked to be on track for another solid year in 2004. Then came Apr. 6. That's when Nokia shocked investors by disclosing that instead of 3% to 7% revenue growth in the first quarter, its top line would shrink by 2%. Although unit sales had soared 19% year-on-year, they lagged bigger growth for the industry as a whole, meaning Nokia lost five points of market share -- dropping below 30% for the first time since 2001.

A BRUTAL REACTION. Worse, the company suffered a stomach-churning 21% drop in its average selling price. Nokia blamed a weak lineup of midrange phones -- those costing between $150 and $250 before subsidies -- and especially its lack of clamshell models, which hinge at the top. Invented by Motorola and popularized by Samsung and LG Electronics, clamshells have surged over the past few years: They fit nicely alongside the face and slip easily into pocket or purse.

Reaction was swift and brutal. Nokia's stock plunged 16% in one day on the Helsinki exchange. Things deteriorated on Apr. 16 when the official results confirmed its warning. Nokia also cautioned that second-quarter sales would probably be flat to down. Now shares are 40% off their Mar. 8 peak. "Nokia misread the market," says mobile analyst Richard Windsor of Nomura Securities International Inc. (NMR ) in London. "They have dashed our hopes for growth in 2004."

Does this signal the end of Nokia's remarkable reign atop the mobile world? Not so fast. With its unequaled brand recognition and distribution channels, analysts say, Nokia will be able to maintain market share above 30% for the foreseeable future. Unparalleled purchasing power and manufacturing prowess still let it churn out phones more efficiently than even rock-bottom Asian makers. And the company's huge resources, including a $13.6 billion cash horde and $4.4 billion in annual research and development spending, keep Nokia far from the brink. Analysts figure its revenues will be flat to down this year, at about $35 billion. But by 2006 they should rebound to $41 billion as handset sales top 225 million units. "This is not the fall of Nokia," says Bengt Nordström, CEO of Stockholm mobile consultancy Northstream.

Still, there are troubling signs that Nokia is off its game. Failing to jump sooner into clamshell phones, which could make up nearly 40% of the industry's sales this year, was a major oversight. At the least, it suggests the Finns may have lost their renowned feel for consumer taste. What's more, despite a recent push, Nokia still has only about 13% market share in phones using the CDMA standard, which account for one-fifth of the total market. Even Nokia's brand -- sixth in the world last year according to consultancy Interbrand Corp. (OMC ) -- is showing signs of slipping in consumer surveys.

Business is likely to get even tougher. Credit Suisse First Boston (CSR ) figures the number of mobile users worldwide will climb just 16.3% this year, down from nearly 30% in 2001, and growth will keep slowing through 2007. At the same time, basic wireless technology is becoming commoditized, which lowers barriers to entry for newcomers, especially from Asia. Add fierce competition among the majors, and average prices for phones are falling about 4% annually. To stay ahead, phonemakers are increasingly outsourcing production to cheaper locales. By next year, predicts Northstream, 40% of global handset production will be farmed out to low-cost makers in Asia.

All this raises profound questions for Nokia. The company's business model relies on churning out huge volumes of standardized phones in its own factories around the world. It has worked so well that Nokia's operating margins on mobile phones last year exceeded 23%. Its next closest rival, Motorola, earned just 4.9%, according to Strategy Analytics Inc. But to keep its high market share -- still twice Motorola's -- Nokia may have to lower prices. At the same time, growing demands from operators for highly customized handsets could force Nokia to retool its manufacturing to accommodate smaller production runs. That will take a toll on profits. Nokia could see pretax handset margins drop to just 15% by 2006. "Competitive pressures are here to stay," Credit Suisse concludes in an Apr. 29 report.

Nokia is moving fast. It has cut prices on select handsets by 10% to 25%, which will help hold market share but hurt profits short-term. To kick up growth in the second half, Nokia plans to roll out 30 more phones on top of the 10 it has announced so far this year, including five more flip-phones and several CDMA models. Most are expected to be loaded with goodies such as cameras and high-resolution color screens. Nokia executives declined to speak publicly for this article, but privately they say that some projects, including clamshell phones, are being sped up by several months. To address complaints that its aesthetics veer between boring and bizarre, Nokia is trying to harmonize around a streamlined look typified by the new 6230 phone, which sports a bigger display, built-in video recorder, and MP3 music player. "Nokia is reacting quite quickly," says Neil Mawston, an industry analyst with researcher Strategy Analytics in London.

Still, the question remains how Nokia dropped the ball in its core mobile-phone unit, which contributed 96% of operating earnings in the first quarter. To some extent, Nokia suffered because major rivals executed well simultaneously for the first time in years. Samsung and Sony Ericsson Mobile Communications both sold more phones than in the previous quarter, and Motorola dazzled investors with a 67% sales increase and 2.5 percentage point market-share gain. Yet even Motorola CEO Edward J. Zander admits to the volatile nature of such shifts. "We were the guys who [people said] missed everything in the fourth quarter and got totally ragged on," he says. "Nokia got its turn this quarter."

BUILT-IN LAG TIME. More troubling is the sense that Nokia is consistently late to market with new technologies such as cameras, color screens, and speedier data rates. This lag isn't entirely accidental. Nokia tends to wait to introduce new technologies until they're available in high volumes from suppliers, leaving rivals to suffer the setbacks inherent in rolling out cutting-edge features. But trend-conscious customers don't know or care about Nokia's internal logic, and its feature gap appears to be hurting sales. "Nokia is focused on running a tight ship at the expense of a wow factor," says Ben Wood, mobile analyst at market researcher Gartner Research (IT ), near London.

Nowhere was Nokia's logic more self-defeating than in clamshells. The company was long suspicious of the format, given that flip-phones are more complex and expensive to make than Nokia's signature "candy-bar" handsets and are considered less durable. And because flip-phones first came from rivals, "Nokia didn't want to appear to be a follower," says Albert Lin, director of research at American Technology Research Inc. in San Francisco. Hoping clamshells would prove a fad, Nokia held back, only announcing its first model, the 7200, in October. It's way behind: Analysts figure flip-phones will this year make up 20% of all handsets sold in Europe, 40% in the U.S., and 60% in Asia.

Another factor that probably hurt Nokia is the growing industrywide battle between phonemakers and mobile operators. It has long been the norm in Asia for carriers to order batches of custom-built handsets, designed around specifications they dictate. Now the Asian model is spreading to North America and Europe, where giants such as Vodafone and T-Mobile International are flexing newfound muscle. "Carriers now have the power to influence handset design and command enough volume to make customized handsets viable," says mobile analyst Andy Buss of market researcher Canalys in Reading, England.

This creates big hurdles for Nokia, which must shift from mass production to mass customization. What's more, Nokia has invested more than any other handset maker in building a strong brand identity, so it's loath to share the limelight with carriers. "Nokia is a bit inflexible in terms of adapting to what we want," confides an executive at one operator. In response, he and other mobile operators are ordering more handsets from Nokia rivals. In Spain, for instance, 11% of the handsets sold last quarter by Telefónica Móviles were custom-built by Vitelcom Mobile Technology in Málaga.

Nokia argues that this phenomenon is being overplayed. But behind the scenes, says Gartner's Wood, "there's a major offensive going on to court carriers." At the annual mobile-phone show in Cannes in February, Nokia CEO Jorma Ollila and Vodafone CEO Arun Sarin held a rare joint press conference that analysts viewed as a public bid to demonstrate goodwill. Nokia is agreeing to more co-branding and is making it easier for carriers to add features, such as their own logos and menus, to Nokia's phone software. "Nokia has stepped forward in a very big way," says John Garcia, senior vice-president for sales and distribution at Sprint PCS Group in the U.S.

At the same time, the company is continuing to push a long-term plan to move beyond mobile phones into all manner of consumer- and business-communication devices. "There has been no change in our fundamental strategy," says a top executive. Last fall, Nokia reorganized into four business units intended to reflect -- and accelerate -- its diversification strategy. One, which sells mobile-network equipment, already represents a fifth of Nokia's revenues and saw a 16% sales uptick in the first quarter. Nokia recently snatched the contract to build Vodafone Group PLC's 3G networks in Australia and New Zealand from archrival Ericsson and scored another win in Israel. Analyst Per Lindberg of brokerage Dresdner Kleinwort Wasserstein in London figures Nokia network sales will climb 23.5% this year, to $8.3 billion, and top $12 billion in 2006.

Prospects are less clear for the other divisions. One, called Multimedia Products, is responsible for selling gizmos that offer much more than voice calls and text messaging. It's experimenting widely with camera phones, music players, and even portable video-game consoles -- taking the concept of a handset far beyond what any rivals are doing. The division posted sales last year of nearly $3 billion and should see revenues soar 80% this year, to $5.3 billion, predicts Nomura Securities analyst Windsor, thanks to new products such as a megapixel camera phone and a music and video player that looks a bit like a Wurlitzer organ.

From a loss in 2003, the unit will see 12.5% operating margins this year, Windsor figures. Yet its riskiest bet, the N-Gage portable game deck, flopped when it was introduced last year, selling only 600,000 units. A redesigned version introduced in March is getting warmer reviews. Nokia continues to announce new N-Gage titles but will face stiff competition from portable players recently announced by Nintendo and Sony.

Nokia's other new division sells business-oriented handsets, software, and network equipment designed to help companies take their workforce wireless. Nomura's Windsor forecasts the unit will book revenues this year of $860 million, up 37%, but will post 17% operating losses. Still, analysts applaud Nokia's diversification strategy. "If handsets continue to commoditize, Nokia will have to find growth elsewhere," says mobile analyst Tim Mui with researcher IDC in London.

Many observers question whether Nokia will ever regain the market share and profit margins it enjoyed even as recently as last year. With lower margins, Nokia may not be a growth stock anymore, either. Yet, the company has been through turbulent periods before -- such as the near-collapse of its logistics system in 1995 -- and emerged stronger than ever. Counting Nokia out would be a big mistake. But the Finns need buzz again -- and that's the hardest thing of all to recapture.

By Andy Reinhardt, with Adeline Bonnet in Paris and Roger O. Crockett in Chicago

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