Two turkeys do not make an Eagle
That was the disparaging tweet from Vic Gundotra, a senior Google executive, as Nokia announced this month that it was to use Microsoft’s software as the basis for its fightback in the rapidly growing market for internet-enabled mobile phones.
Mr Gundotra’s message referred to the Finnish company’s rejection of Google’s Android software for its next generation of so-called smartphones. Stephen Elop, Nokia’s new chief executive, responded by comparing himself and Steve Ballmer, Microsoft CEO, to Orville and Wilbur Wright, the American aviation pioneers.
“I think of two brothers who made bicycles in Dayton, Ohio, and one day they decided to fly,” he told the Financial Times, visibly irritated by the comment posted on the Twitter microblogging site.
Mr Elop has made an enormous bet that Microsoft, his own former employer, can enable Nokia – the world’s largest maker of mobiles – very belatedly to strike back at Apple and Google in the $120bn global smartphone market. His plan to use Microsoft’s Windows Phone operating system to power Nokia’s devices is an admission of defeat in the Finnish company’s lengthy efforts to build its own software and services platform.
Since Apple released its iPhone in June 2007, Nokia’s share price has fallen by more than two-thirds as it tried unsuccessfully to produce an “iPhone killer”. But Nokia’s handset leadership is in doubt not just because of its lack of sophisticated smartphones. The company is also under growing pressure from low-cost Chinese manufacturers that are eating into its sales of basic handsets in emerging markets.
Nokia’s malaise also highlights Europe’s waning influence in mobile phone innovation. For the first 20 years of the mobile industry, the continent set the pace in cutting-edge handsets. But the arrival of the iPhone, followed by Android in 2008, showed that the main centre of innovation had shifted from Europe to California’s Silicon Valley. Apple and Android are now the pre-eminent brands in the industry.
So will Mr Elop’s strategy fly or will Nokia crash and burn? Mr Elop’s choice of Microsoft’s Windows Phone software – well received by technology commentators on release last year though yet to capture the consumer’s attention – has given his company a chance to revive its fortunes.
“With a clear strategy, the fighting spirit of Nokia worldwide . . . has been brought to bear. As people can see, I am here to fight,” Mr Elop declared when he unveiled the partnership.
However, the odds are heavily stacked against Finland’s biggest company. The edge gained by Apple and Google is starkly illustrated by the hundreds of thousands of games and other applications that software developers have produced to run on the iPhone and devices featuring Android. Just like Nokia, Microsoft also has a record of being a laggard in its responses to Apple and Google in the mobile market.
Even if Mr Elop’s plan does work, the profitability of Nokia’s handset unit could yet take a permanent plunge. Apple is demonstrating that earnings power in the mobile industry now resides in software and services. Nokia, by relying for these on Microsoft, will increasingly resemble a mere hardware maker.
Pierre Ferragu, analyst at Bernstein, the research firm, says Nokia could suffer the same fate as Motorola, formerly the leading mobile maker. Like Nokia, Motorola missed the trend towards touchscreen smartphones, and subsequently ran up huge losses for three years from 2007. It is now trying to reinvent itself as a maker of Android-based smartphones.
In the fourth quarter of 2007, Nokia was at the peak of its power. It made four in every 10 mobiles sold worldwide, and its handset unit boasted an industry- leading 22.8 per cent operating profit margin. But the iPhone was about to change everything.
Nokia’s long-standing strength had been in hardware – initially making basic mobiles capable of calls and text messaging, to which it added features such as cameras. The iPhone, by contrast, was a full-blown computer with touchscreen technology that turned the mobile internet into a user-friendly experience for the first time. The apps that started appearing in 2008 enabled consumers to customise their iPhones to suit their lives.
Nokia’s answers to the iPhone came slowly and the user experience was poor. Supposedly simple tasks – for instance, such as posting a picture on social networks such as Facebook – were difficult. Criticism centred on the company’s clunky Symbian operating system, which became a symbol of Nokia’s technological shortcomings. Critics say the failure to produce a rival to the iPhone can be partly explained by a bureaucratic structure that stifled innovation, made worse by an arrogant attitude that developed during Nokia’s glory years.
Olli-Pekka Kallasvuo, who succeeded the long-serving Jorma Ollila as CEO in 2006, contributed to the company’s problems, says one former senior Nokia employee. Unlike Mr Ollila, an engineer, Mr Kallasvuo was a lawyer turned finance director who did not fully understand technology, says the ex-employee.
Though Mr Kallasvuo would not comment, one person close to him accepts that he does not have the technological expertise of an engineer. However, this person adds that Mr Kallasvuo’s bigger problem was that he could not transform Nokia fast enough to a software and services company to compete with Apple and Google. Last September, Nokia’s board ousted Mr Kallasvuo and named Mr Elop, former head of Microsoft’s business unit and a software expert, as his successor.
The dire nature of the situation was apparent to all involved. The operating margin at Nokia’s handset unit had fallen to 9.5 per cent in the second quarter of 2010, and Android was emerging as an even bigger threat than the iPhone. Google’s platform is being used by several handset makers – including HTC, Samsung, Sony Ericsson and Motorola – and its advance is the result mainly of the fall in price of smartphones that use it.
Android is marching into Nokia’s former stronghold of mid-priced smartphones. While the iPhone has a wholesale price of $600, Android smartphones now cost $200 or less. It overtook Symbian to become the most popular smartphone operating system in the fourth quarter of last year, according to Canalys, a research firm.
Against this backdrop, Mr Elop had been undertaking a no-holds-barred review of Nokia’s business. This month he wrote a doomsday e-mail to staff in which he compared the company’s predicament to that of a man standing on a “burning” North Sea oil platform. The man faces the choice between being burnt alive on the rig or jumping into the icy waters below.
It was unsurprising, then, that Mr Elop ripped up Mr Kallasvuo’s strategy of persisting with its ageing Symbian platform while developing a new operating system, MeeGo. After deciding Symbian would be phased out, he looked at the case for adopting Android, concluding the company risked a “commoditisation” of its products. In short, according to Credit Suisse analysts, intensifying competition means all handset makers face the medium-term scenario of operating margins falling to the 5 per cent level that prevails in much of the personal computer industry. But the risk is most acute for the many brands using Android, which are likely to struggle to differentiate their products.
This left Mr Elop with little choice but to strike a deal with Mr Ballmer, his old boss, under which Nokia would use Microsoft’s Windows Phone platform as its main smartphone operating system. Unveiling the tie-up, Mr Elop said the two companies were taking on Apple and Google, creating a “three-horse race” in smartphones.
But to Mr Elop’s clear frustration, his strategy has gone down badly. Nokia’s stock market value has fallen about 20 per cent since the February 11 announcement, as investors fretted that the company could suffer a further significant loss in smartphone market share as it attempts a tricky transition. The first Windows Phone models are not due until late this year or early 2012. But even when the transition is over, Nokia is targeting an operating margin of only “10 per cent or more” at its handset unit.
The biggest task will be persuading consumers that the Windows Phone devices are as “sexy” as the iPhone and Android models, says Carolina Milanesi, analyst at Gartner. Noting Mr Gundrota’s “two turkeys” tweet, she says the Nokia brand has been tarnished by its failure to produce sophisticated smartphones; meanwhile most consumers have little or no awareness of Windows Phone.
Several analysts say the partnership is a good deal for Microsoft but a bad one for Nokia. The Finnish company, unlike handset makers operating on Android, must pay royalty fees to use Windows Phone. Microsoft, by tapping Nokia’s global scale in hardware, has the opportunity to transform itself from a niche player in the mobile market. The most obvious financial benefit for Nokia is the chance to cut its research budget as it is Microsoft that will develop Windows Phone.
Nokia’s best hope during its transition is that mobile operators will provide support by buying its Symbian smartphones, though it might have to cut prices to ensure significant sales. European operators, fearing a duopoly involving Apple and Google, are keen for a popular alternative to emerge. But a senior executive at one large operator says much hinges on whether the Finnish company can limit Android’s advance by producing models based on Windows by early 2012. “It’s a race against time for Nokia,” says the executive.
Software developers, too, are wary of Mr Elop’s plan. Jeremy Statz, a Houston developer creating animated wallpapers for Android mobiles, says he will consider working on Windows Phone only if it gains popularity. “In the US at least, Nokia seems very much dead in the water as far as smartphones go. I know they have market share in the rest of the world but I want to work on things I know people will be interested in.”
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