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March 25, 2007 9:01 pm

A market where margins shrink as fast as handsets

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Even the most retiring Nokia executives must be suppressing delight at Motorola’s troubles.

The US group has had rival Nokia in its sights ever since the Finnish company missed the global trend for clam shell mobile phones in 2004 and sales collapsed. Helped by the success of one handset in particular – the ultra-thin Razr – Motorola raised its global market share from 14 per cent in 2003 to 22 per cent in 2006.

But now Motorola is paying for that success. Average selling prices and profit margins plunged in the fourth quarter as Motorola cut handset prices – including for the Razr – to boost sales, especially in fast growing emerging markets such as China, India and Brazil.

Ed Zander, Motorola’s chief executive, acknowledges that it was a mistake to target market share at all costs and has ordered sales executives to hold the line on price, even if it meant losing contracts.

But Motorola’s problems go deeper. Last week the Illinois group had to admit that sales in the first quarter would be substantially below expectations and its core handset division would report an operating loss.

In an apparent effort to shore up investor confidence and head off a challenge from Carl Icahn, the Wall Street investor who has built up an almost 3 per cent stake in the company, Motorola accelerated its share buy-back programme.

It also reshuffled a senior management weakened by defections including the resignation of Ron Garriques, head of mobile phones, who quit last month to join Dell. Motorola named Greg Brown president and chief operating officer and appointed Thomas Meredith acting chief financial officer.

Mr Zander and other officials admitted that the company had operational weaknesses and needed to streamline technology and cut manufacturing costs.

They acknowledged that Motorola had been slow to respond to changes in the global handset market, including growing demand for higher-priced, higher-margin 3G handsets in Europe and cheaper phones in developing markets.

In contrast Nokia has benefited from its own crisis. It has outsourced manufacturing, enhanced productivity and targeted the large emerging markets of China and India with low-level, competitively priced phones.

But even Nokia has felt pressure from increasingly dominant mobile operators. Vodafone recently unveiled a deal with ZTE Corp, a Chinese manufacturer, to make ultra-low-cost handsets. “The balance of power is shifting towards the operators,” say analysts at Fitch, the US credit rating agency.

This pricing pressure has been exacerbated as mobile phone makers have turned to emerging markets.

Since the end of 2002, Nokia’s average selling prices have dropped by a fifth and gross margins by 10 percentage points to about 15 per cent. Further declines seem inevitable. The number of phones Nokia sold for less than €50 ($66) increased from 23 per cent total volume in 2005 to 42 per cent in 2006.

None of the big five handset makers has been immune to these trends. Samsung Electronics, Sony Ericsson and LG have all suffered operating margin erosion
in handsets.

But some handset makers have adapted to these market dynamics more quickly than others. Sony Ericsson, the five-year-old joint venture between Japan’s Sony group and Sweden’s Ericsson, has gained market share and sales. It has focused on building the brand and on higher-priced GSM multi-media phones. As a result Sony Ericsson became the industry’s No.4 in 2006 and its fourth-quarter sales jumped 64 per cent year on year.

In contrast, Samsung, the No.3 maker after Nokia and Motorola, reported a 7 per cent decline in fourth-quarter sales.

For its part, Nokia, which managed to report full-year operating profits up 18 per cent from €4.6bn to €5.5bn last year, is pinning its hopes on a strong presence in emerging markets.

Nokia’s internal figures reveal that 58 per cent of devices to be sold globally in 2007 will be to emerging markets, up from 51 per cent in 2005.

Nokia has a 36 per cent share of the global handset market compared with Motorola’s estimated 20 per cent and it is the market leader in emerging markets.

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