Nokia restructuring and issues with outsourcing strategy

Nokia outsourced less than 5% of smartphone volume beginning 2010. Finding balance between leveraging internal strengths and faster execution. Competition from Apple, HTC, RIM driving margins downward. Nokia’s size obscures the fact their competition has been growing in recent years. Nokia attempting to make a hard change in course using Yahoo as one of its rudders.

Nokia recently announced it would be reshuffling executive ranks for the fourth time in less than four years.  This time it has retired mobile phones czar Rick Simonson. However, a simple retirement is not the entire change internal Nokia. The Company has also restructured the mobile handset unit into three groups. The new mobile handset groups are:

• Mobile solutions
• Mobile phones
• Mobile markets

I believe the changes are part of a major restructuring of Nokia’s mobile handset business, designed to better focus resources and intellectual capital on the highly competitive smartphone and mobile computing market segments.

Nokia is attempting to find the correct balance between business continuity, better leveraging internal strengths, and faster execution. However, it does not take a rocket scientist to know Nokia is having a tough time in the global handset marketplace.

Nokia is by far the world’s dominant handset vendor. Apple’s iPhone, HTC’s Evo and other devices, and even RIM’s Blackberry have garnered such publicity and attention in the last three years these other vendors have taken away millions of handsets in new annual business from Nokia. This said, Nokia is still selling almost 30 million handsets each month.

Apple’s iPhone does not even come close to Nokia’s sales figures.

However, when you consider Apple and HTC are brand new to the handset business, their sales data is disturbing to Nokia. Why this situation is significant is because for the first time in nearly a dozen years Nokia actually now has competition to contend with.

The handset industry is highly competitive with a per unit market lifespan average of six to eight months. At the end of this cycle, vendors sell new handset models or their existing models are upgraded with new software platforms. Typically, by the end of 12 months a completely new physical model replaces the device.

Normally, handset vendors look to shave as much cost out of the manufacturing and assembling of handsets. Handset vendors have spent years developing component supply relationships to help shave costs…they no longer manufacture handset casings; the chips, the display screens, or even the cheap leather-like cases the handset sometimes sit in.

Outsourcing / sourcing is a necessity in the handset business and Nokia has credited sourcing as a key element to its ability to control costs. Every component, from the handset cover to the chip, is fair game for outsourcing.

In the mid-1990s, the handset business was happy with 15% margins. Since the mid-2000’s we have seen handset profit margins in the low 20’s percentile. Outsourcing in the early to mid-1990s led to handset manufacturers buying chips from other vendors. Today, handset manufacturers are nothing more than system / device integrators.

Competition from vendors like Apple, HTC, and even RIM has driven handset margins down to the 12% range.  Traditional outsourcing will not help Nokia. In fact, Nokia cannot gain much of a benefit outsourcing any part of their new smart handsets unless they get the components for free.  Sourcing logistics and distribution management is another area of cost savings.  Even then, outsourcing is only a solution for reducing capital and some operating expenses.

One thing to keep in mind is that China is a major supplier of outsourcing services and components to the technology community. Hopefully, Nokia is not relying on the Chinese for sourcing.

Nokia’s problems have nothing to do with cost structure.  The company has not been able to come up with a smart handset that can compete against the iPhone, Blackberry, and the hype of the Evo.

Since 2007, Nokia has been acquiring companies and developing relationships in the media space; content creation and access. Nokia began this effort because it recognized that its revenue and profitability was and still is driven by their success in the traditional mobile handset business.

The traditional mobile handset business is transitioning into a business where the mobile devices are “smart” and are content management platforms. Nokia’s size obscures the fact their competition has been growing in recent years.

Restructuring meets challenges
Meanwhile, Nokia has been attempting to turn the ship in a new direction these past few years.  A company the size of Nokia will require time to turn the ship around. What we are seeing is a restructuring effort, even if Nokia has not said so.

Typical restructuring efforts begin with restructuring of a company’s financial structure.  However, Nokia’s past track record shows a company working diligently to control costs. The restructuring that Nokia is currently undergoing in its mobile group will actually cost money, and time.

The biggest immediate challenge facing Nokia is determining what shape the Company believes its converged media business should take. Essentially, Nokia must decide what is its business model.

Is Nokia’ model going to be fixated on selling handset units? Is Nokia’s business model going to focus on numbers of handset units and content management? Is Nokia’s business model going to focus on content management?

After Nokia figures out what it thinks this model ought to look like, Nokia will have to create administrative structures and likely develop new technologies. All of these efforts will cost money.

Nokia has been busy acquiring companies in order to gain critical skills, intellectual property, and relationships.  In fact, one can say Nokia’s restructuring has been going on since 2007 with its mobile acquisitions. Nokia’s acquisitions in the last couple of years have included:

• Twango: media sharing solution for organizing and sharing photos, videos and other personal media
• Enpocket: supplier of mobile advertising technology and services
• Navteq: supplier of digital mapping data
• Cellity: mobile software specializing in aggregating address book data
• Plum Ventures: specializing in social location services
• Novarra: mobile web browser firm
• MetaCarta: technology-based location search and services provider
• Symbian Ltd: developer of Symbian operating system for the smartphone

Looking at the above, Nokia is clearly acquiring assets to enable it to operate in the content space. While Nokia is acquiring content-related companies, it has yet to fully integrate these pieces into the Company’s core business.

Nokia has spent more than $8 billion acquiring companies in less than three years. (Nokia spent roughly $8 billion just on Navteq)
Outsourcing not always the answer
Assuming we believe Nokia’s core business is the converged media business. The question becomes:  Why did Nokia buy these companies rather than outsource the functions and services? The answer:  Outsourcing is not always the best solution in restructuring a company.  (Read no vs. no-go analysis: When outsourcing is not the answer)

As of the beginning of 2010, Nokia Siemens Networks (equally owned by Nokia and Siemens) consisted of eight manufacturing facilities around the world. About 20% of Nokia Siemens Networks’ production is outsourced.

Nokia’s mobile device business is a customer of outsourcing services and is so complex that part of its needs are met by sourcing to other companies.

As of the beginning of 2010, Nokia outsourced less than 5% of its manufacturing volume for smartphones. Most of whatever outsourcing Nokia currently is doing for smartphones is focused on flexible printed circuit board assembly and other component related activities.

At the time of writing this article, electronics manufacturing services (EMS) companies serving Nokia include Flextronics, Jabil Circuit, Foxconn International Holdings, Elcoteq plus the battery-making arm of Chuanfu’s Shenzhen-based BYD Co. (Sanmina-SCI also builds infrastructure equipment for Nokia, but no handsets)

Nokia sourced more than 17% of its manufacturing volume in 2008. The reason for the shift downward is not clear to me except the company does have a lot of capacity. However, outsourcing by Nokia is expected to resume this year.

Meanwhile, in my opinion, this internal capacity is necessary (for now) to rapidly adjust the company’s product line in the rapidly developing smartphone and mobile computing device marketplace.

I know this runs counter to traditional thinking but keep in mind two years ago Wall Street was still arguing over what exactly is a smartphone.

In order for a company as large as Nokia to deal with the changes on the scale it operates, it must control all major functions. Do not even think of comparing Apple’s iPhone business to Nokia’s mobile phone business.

Since the iPhone launch, Apple has sold only 34 million, or so, iPhones. Nokia sells nearly this many handsets each month.

Yahoo! to the rescue?
When companies restructure, whether it be voluntarily or involuntarily, they focus on either financial or operational aspects of the company.

One typical restructuring outcome is a reduction in overall operating costs.

I am certain Company advisors and investors will be focused on Nokia’s operating costs this year. Such is normal an organization is facing mounting competition and is losing market share.

However, Nokia’s restructuring is not typical. Nokia’s restructuring is a transformative one. The Company is not in financial distress but it needs to behave as if it is in distress. To wit, Nokia should not be slashing and burning operations to maintain profitability.

Nokia and Yahoo recently announced a partnership where Nokia will drive Yahoo’s maps and navigation services. In turn, Yahoo will run Nokia’s email and chat room programs across Nokia’s Ovi platform.

Nokia must feel it is in trouble. You don’t establish a working relationship with a company like Yahoo (also in trouble) unless you believe you are in trouble. I do not have a problem with Nokia doing a deal with Yahoo because you would be surprised what motivated parties can do when their backs are up against the wall.  We may actually see something of enormous value to consumers come out of this business relationship.

What is Nokia planning? Based on Nokia’s actions I believe Nokia is attempting to make a hard change in course using Yahoo as one of its rudders. I have been critical of Yahoo in the past but I have to hand it to Bartz and Nokia’s Kallasvuo, this is a pretty good idea. However, there are lots of reasons why outsourcing is bad.

Relative to Nokia’s restructuring, some reasons for not outsourcing include Nokia is in the midst of significant change and the Company really does not know what it will end up looking like.

Nokia is acquiring all of these tools they believe will help them. But if they outsource core functions, they run the risk of entering into a contractual agreement with a company that may ultimately not be able to help them long-term and outsourcing manufacturing service agreements can be difficult to break plus, doing so can create bubbles in Nokia’s supply chain.

Additionally, since Nokia is in the midst of change, and outsourcing functions, while also acquiring assets before it even knows what it is going to be doing with the acquired assets, the Company could find itself outsourcing critical functions that could be part of its core competency.

Keep innovation inhouse
I recognize many sourcing experts believe that innovation is helped by outsourcing. The traditional thinking is that two heads are better than one and with outsourcing you can often get way more than two heads for less than the price of one full-time employee.

The problem with outsourcing innovation is that economics drives all companies. Hence, innovative ideas created by EMS or original design manufacturers (ODM) will eventually be resold to other OEM customer programs. (See: Top 10 EMS / ODM providers)

What good is it to have intellectual property when the outsourcing company owns it?

Sure, companies could sign exclusivity agreements with each other, but, exclusivity is expensive for the client.

Exclusivity is also dangerous for the source provider because it cannot optimize revenues on its products and services. Rather than outsourcing innovation, Nokia has bought it.

Most companies undergoing massive restructurings do not have every detail of a grand plan mapped out. Details are typically worked out only when major pieces are put in place.

Companies undergoing massive restructurings have, at best, a general idea pertaining to direction and what the ‘new’ company ought to look like.

Functions to be outsourced are identified during the integration process. Time needs to pass, allowing merger and integration processes to take shape, before companies should do anything about outsourcing what could become functions.

Nokia needs to hold off on cost reduction efforts like outsourcing until it has completed its change in course.

VentureOutsource.com, June 2010