What Is to Come for Nokia?

To put it in Mike Tyson’s words, “Everybody has a plan until they get punched in the mouth.” Chief Executive Operator (CEO) of Nokia Rajeev Suri’s announcement of the financial results of 3Q 2019 on October 24, 2019 was the “punch in the mouth” for Nokia: while the company reported net sales of EUR€5.7 billion (US$6.28 billion, corresponding to an increase by 3.6% quarter on quarter), it also announced a pause in paying a dividend to its shareholders in order to increase the company’s cash flow to cope with necessary investments into 5G technology that proved to be more costly than expected. As a result of this decision, and the lowering of 2019 and 2020 outlooks (to account for margin pressure, additional 5G investments, and additional digitalization investments), share price dropped by a dramatic 23% on October 24, when the quarterly results were announced, and has remained at this low level since then.

Now, one could argue that this is just another instance of the stock market overreacting, which shows its extreme focus on short-term profitability, and part of that would certainly be true. Large parts of the Q3 results, and therefore the decision to pause dividend payment until the company’s net cash position exceeds EUR€2 billion (equivalent to US$ 2.2 billion), however, can be attributed to problematic commercial decisions in the past that are beginning to show their effect now.

In a way, Nokia’s current situation serves as a perfect illustration of infrastructure vendors’ difficult position when it comes to reacting to the changing shape of the 5G value chain in addressing enterprise verticals, as has been discussed in The Changing 5G Value Chain and What It Means for Mobile Service Providers (IN-5618).

In order to be able to assess what is to come for Nokia, it is important to understand the underlying reasons why it ended up in this situation in the first place:  

• Poor Timing of 5G Investment: Even though Nokia’s acquisition of Alcatel-Lucent dates back to 2015, its integration into Nokia’s product portfolio proved to be more challenging than anticipated, meaning that the company’s operations are still affected by this internal restructuring. As a result, the company was not in a healthy enough position (both either financial or operational points of view), to stem the necessary investment into 5G infrastructure (even though it was the right choice to remain competitive). Furthermore, the still unresolved question about the extent of Huawei’s involvement in providing network infrastructure in the United States and Europe and the announced merger of T-Mobile and Sprint in the United States did not help create a stable situation, but rather resulted in even more uncertainties. For example, DT recently decided to halt all 5G contract decisions until clarification on the Huawei situation.

• Bad Strategic Choices on 5G Components: Nokia’s decision to rely on a third party for a core component of its 5G infrastructure—Field-Programmable Gate Array (FPGA) processing for its 5G radios—forced it to delay the evolution of its 5G products to System on a Chip (SoC), which would allow lower costs. As such, the Bill of Materials (BOM) of Nokia 5G’s products is higher than its competition and, as such, more expensive. Nokia is currently in the process of evolving its 5G products, but it remains to be seen if it can catch up to the competition.

• Underestimating Current Technology Trends and Market Dynamics: The company has made some less than optimal decisions based on wrong perceptions of the market: for example, while fiber is becoming more important for fixed networks, Nokia invested heavily into copper, which is continuously losing its importance. These wrong investment choices start to take effect now. Furthermore, Nokia seems to have underestimated the pricing pressure (especially on the Chinese market) when it comes to 5G infrastructure, meaning that profit margins are rather limited.

• Poor Communication of the Q3 Results: Last but not least, poor communication of the Q3 results also contributed to the stark effect they had on Nokia’s share price. While the public has mostly picked on pausing the payments of dividends to shareholders, little attention has been given to communicating the fact that the sales figures of both the enterprise and software divisions went up (by 30% and 5%, respectively), indicating that the company is looking to diverge from a traditional network infrastructure vendor and move toward a provider of End-2-End Solutions (E2ES).

To remedy the situation (apart from the obvious cutting of operational costs), the company does have a long-term strategy in place that focuses on two main aspects from a product portfolio point of view: E2ES and product diversification, resting heavily on Nokia Software and Nokia Enterprise. Focusing a strategy on these two aspects, however, is prone to creating more problems, of both strategic and of operational nature.

From a strategic point of view, focusing efforts on E2ES means two things: firstly, by approaching enterprises directly to market E2ES, you end up competing with Communication Service Providers (CSPs), which are still important clients for network infrastructure vendors (taking into account that 99% of spectrum globally is owned by CSPs). Secondly, by promoting E2ES, Nokia would effectively enter a new market in which System Integrators (SI) hold a distinct competitive advantage, since they have spent decades building up knowledge about market dynamics and long-term business relations. Succeeding in this market as a new player would be rather difficult. Rather than reinventing the wheel, a vendor like Nokia would be far better off utilizing the knowledge base that already exists within SIs by facilitating agreements and partnerships.

In addition to this, the proposed strategy also has important implications from an operational point of view: resting on even further product diversification means that you will spread your wings out even wider, so in the worst case you as a vendor end up doing a little bit of everything, while not having enough resources to do each of these things thoroughly enough. Secondly, E2ES do not scale easily, while their sales process is time-consuming and requires a very large salesforce. In other words, for a new player, the sales process is hugely inefficient.

Even though Nokia’s current strategy has some important shortcomings, it should be clear that long-term restructuring of its business is necessary. Since this will be far from a smooth ride, it needs a financially healthy company with the supporting confidence of its investors to be able to address challenges and cushion financial setbacks along the way. Anticipating the short-term profitability focus of the capital market, this means instituting short-term cost-cutting measures to reinstate the confidence of investors. Departing from an E2E focus would, for example, allow the streamlining of sales processes and create a much more efficient salesforce.

More important, however, is the underlying long-term strategy for restructuring. Considering the problematic implications of too wide product diversification, the focus should really be on streamlining the product portfolio to strengthen key competencies instead. Of course, this needs additional strategical decisions on which areas, verticals or applications to focus on and which to abandon. These will be tough choices, which should not be taken lightly.

Furthermore, the long-term repositioning strategy should center around opportunities to create scale rather than focusing on E2ES. The key question to address for a vendor in this context is how to combine the enterprises’ requirements for network customization on the one hand while offering product that is standardized enough to be able to create scale. One way to do this could be by offering packaged solutions to the industry that are configurable in size.