Nokia's Moment of Truth: Time to Hang Up on Smartphones?

(MoneyWatch)  Nokia Corp. is losing ground quicker than original expectations -- especially on its home turf, Europe. Worse, efforts intended to address share erosion and boost sales of high-end smartphones will depress profits at the world's largest cell-phone maker.
According to the handset manufacturer's internal estimates, overall industry mobile device volumes in third-quarter 2010 grew 14 percent year-on-year and eight percent sequentially to 364 million units. Nokia's (NOK) aggregate market share declined 400 basis points from last year to 30 percent, mostly due to component supply shortages (particularly displays and cameras), aggressive price discounting from competitors, and surging worldwide popularity for Apple (AAPL) iPhones and mobile devices equipped with Google's (GOOG) Android operating system.

The Nokia brand is sold worldwide, but continental operations remain integral to the fabric of its financial model: In third-quarter 2010, the Finnish vendor derived approximately 32 percent of its aggregate $9.79 billion in mobile phone cellular sales from European markets (1 EURO = $1.365).

Whether true or not, a perception exists among mobile application developers that design and other technology flaws embedded in Nokia's Symbian operating system have proven too disruptive and time-consuming for them to even bother writing compatible apps (lessening commercial appeal of Symbian handset models to end-users, the consumers).

Referencing strong shipment sales and an expanding array of Android devices available to consumers, International Data Corporation (IDC) analyst Francisco Jeronimo predicted unit volume of Android phones sold would dethrone Nokia's Symbian software platform as the king of smartphone handsets in Western Europe by 2012:

The popularity of devices from mobile phone "vendors HTC, Sony Ericsson, and Samsung are contributing to strong awareness of Google's operating system," said Jeronimo. "Consumers recognize they can get a similar awareness from Android as they would from the Apple (AAPL) iPhone and for a lower price."

Piper Jaffray analysts opined a few months back, too, that Nokia's inability to challenge the high-margin, high-end smartshare market gains being posted by Android and the iPhone could be attributed to a fundamental identity problem:

"Google is clearly a software company focused on making Android a great mobile OS. Apple is clearly a software company focused on making iOS a great mobile OS -- and takes it a step further by providing integrated hardware. We view competitors like Research In Motion (Blackberry) and Nokia as hardware companies that are dabbling in software."

With 2010 shaping up to be another disappointing year for its high-end, high-margin smartphone operations, it appears unlikely that even Iku-Turso -- a malevolent sea creature from the pages of Finnish mythology -- could scare off these popular rivals.

Unfortunately, Nokia's troubles extend beyond the premium smartphone segment. With more than 650,000 points of sale worldwide -- in addition to its own online retailing presence -- the company has long reigned atop the low-end handset market (voice and text messaging). As traditional mobile device markets mature, the company has stepped up penetration efforts in developing economies:

• In the faster growth markets of Africa (60% +), Asia-Pacific (36%, excluding Japan), India (56% +), and the Middle East (60% +), Nokia remains the top supplier of entry-level handsets, according to telecom analysts at VisionGain.

This handset market segment -- where operating margins are already razor-thin -- is getting more crowded, as the on-the-ground growth rates appeal to high-volume, low-cost Chinese competitors and regional or "white-label" manufacturers.

Nokia's retail presence and rural outreach initiatives (like mobile sales vans traveling to isolated villages) no longer ensure consumer brand loyalty in emerging markets. "Money talks -- everything else walks" is the adage that motivates brand fidelity these days. Specifically, Nokia has stemmed share erosion in its low-end handset operations only by matching the aggressive price cutting tactics of challengers -- branded, local, or knock-off.

In the last six quarters, unit volume gains haven't offset falling prices:

• The average selling price (ASP) for Nokia-branded phones declined more than 45 percent to a recent $57.30; and, the reported gross profit of 29 percent in third-quarter 2010, was well below the gross profit of 36.5 percent posted back in third-quarter 2008.

The question thus becomes: What happens to already-compressed margins when competitors accelerate pricing battles? Villagers in rural India can now find ASPs for Nokia handsets at purchase prices cheaper than $30.

Additionally, Vodafone (VOD) has launched its VF-150 handset in similar regions of India for just under $18 (799 rupees), to be followed by the rollout of other ultra-low cost handsets in Egypt and other emerging African markets.

Come 2011, ASP dynamics for entry-level smartphones will continue to trend lower -- pressured by the arrival of sub- $100 Android smartphones, according to Taiwan-based makers.

"The winner of the game is the player who makes the next-to-last mistake" ~ French chess Grandmaster Savielly Tartakower (1887 - 1956)

Chief financial officer Timo Ihamuotila said on the third-quarter earnings call that operating margins for Nokia's mobile device segment improved 100 basis points in the third quarter, landing at 10.5 percent. Unfortunately, this supposed efficiency gain was artificial, benefiting from a one-time royalty income (80 basis points and hedging activity profits (40 basis points) totaling 1.2 percent!

Guidance given for fourth-quarter operating margin is in the range of 10 percent to 12 percent. Given announced increase in Symbian advertising programs and trending lower ASPs for mobile devices -- including high-end smartphone segment -- expect Nokia to temper profit outlook.

Good tidings for Nokia come January 2011 might be wishful thinking.