Mobile companies may make the most money by going downscale

Friday, October 28, 2005

When it comes to sexy mobile phones, the stars of the moment are multimedia wonders such as the new RAZR V3x handset from Motorola Inc. and Nokia Corp.’s top-of-the-line N-90 camera phone with Carl Zeiss optics. Yet for all the attention they grab, these pricey gizmos are a sliver of the 800 million unit-per-year mobile-phone business. Increasingly, the real action is at the unglamorous end of the scale, among bare-bones Nokia and Motorola models priced under $50. Sales of such phones, which often handle just voice and text messaging, could grow 100% annually for the next five years.

That’s feeding an explosion of new mobile users worldwide, especially in developing countries. In the past year, for instance, South Africa’s No. 1 operator, Vodacom, has expanded its customer base 35%, thanks in part to ultracheap phones. “We’ve pushed for years to get cheaper handsets,” says managing director Shameel Joosub. Vodacom has placed an order for 700,000 units of a new $30 Motorola model slated for 2006.

There are now about 2 billion mobile-phone users in the world, and market penetration is above 50% in advanced countries. But as prices for phones and service drop, another billion customers could sign up by 2010 from places such as China, India, Brazil, and Russia. “All the growth in subscribers is coming from emerging markets,” says David Taylor, Motorola’s director of strategy and operations for high-growth markets. Researchers predict that of the 1 billion cell phones expected to be sold in 2010, half will be in developing economies. Most will cost less than $40 — still out of reach for the poorest one-third of the world’s population but affordable for the middle third. “This market is wicked big,” says senior analyst John Jackson of telecom researcher Yankee Group Research Inc. in Boston.

For now, the only serious contenders are Nokia and Motorola. The world’s No. 1 and No. 2 makers, respectively, are scrambling to grab first-time buyers and build lifelong loyalty. “We want to bring new customers to our brand,” says Antonio Torres, the director of business development and industry marketing for Nokia’s entry business unit. Only Nokia and Motorola are able to churn out ultracheap phones with the features, quality, and brand names customers want. “This market is suited to mega-vendors with economies of scale,” says senior analyst Neil Mawston with researcher Strategy Analytics near London. “Nokia and Motorola will own this segment.”

Samsung Group, LG Electronics, and Sony Ericsson Mobile Communications haven’t yet announced plans to sell sub-$50 handsets, preferring to rake in rich profits at the high end. That strategy could backfire, though, as the market shifts. “Samsung needs to do something because its share is not growing,” says Carolina Milanesi, mobile analyst with researcher Gartner Inc. () near London.

Emerging low-cost Chinese makers have a different problem: Their volumes aren’t high enough to match the efficiencies enjoyed by Nokia and Motorola, so they lose money on rock-bottom handsets. They’re also not as adept at shrinking electronics and producing durable packages. Plus, status-conscious buyers in the third world turn up their noses at unknown marques. “Brazilians want brand names and are willing to pay a bit more for Nokia and Motorola,” says S?rgio Pelegrino, director of GSM for Brasil Telecom.

Of course, moving downscale also poses risks for Nokia and Motorola. On Oct. 20, the Finnish giant reported that it sold 15 million entry-level 1100-series handsets in the third quarter alone. But despite an overall 29% jump in net profits, Wall Street was spooked by a 5.6% year-over-year decline in Nokia’s average selling price, to $122.40, and drove its shares down 4.5%. Analyst Albert Lin with American Technology Research Inc. in San Francisco thinks investors are underestimating Nokia’s ability to prosper in the low-price segment. “These phones can actually have higher margins than new high-end models,” he says.

Already, both Nokia and Motorola are managing to produce handsets for as little as $25, allowing gross margins of 15% to 30% at current prices. That compares with overall 33% margins across Nokia’s entire handset portfolio; Motorola’s figures aren’t disclosed. Big volumes of low-end phones also unleash scale economies that reduce production costs even for high-end models. “It’s a key factor in getting our cost structure down,” says Nokia’s Torres. As sales shift to low-end phones, such savings should help Nokia maintain overall operating margins of 13.5% for years, forecasts analyst Richard Windsor of Nomura Securities in London. To seal the deal, Nokia is churning out technologies to slash the cost of building and operating wireless networks by a half. Bargain service boosts the impact of cheaper phones — and should help the 4 billion people on earth who have never made a phone call.

Source: BusinessWeek (link opens in a new window)