Nokia

In the recent series of exposés on Nokia's new strategy I sought to paint a background for what caused such a dramatic decision:

• A history of previous Microsoft "strategic alliances" in mobile brought Microsoft to a level of desperation
• The question of how many horses are in the race coupled with operator feedback on what matters to them in terms of balance of supplier power
• The installed base of Symbian although great is fragile
• A confused tablet strategy from both partners.
• The impact of pricing on addressable market and share
• The "Osborne effect" on Symbian and how the transition could be impossible to navigate

This gives a backdrop to the decision, but it does not explain the most crucial part of the decision: why did Stephen Elop decide to maintain an exclusive platform for Nokia rather than a multi-platform approach as chosen by successful competitors such as HTC, Samsung and Sony Ericsson.

Going from backing one "burning" platform exclusively to backing another "ice cold" alternative without bothering with a hedging alternative is very risky. This may be the biggest puzzle and mystery for outside observers.

Here I put forward a few reasons why exclusivity attracted Nokia:

1. The lessons of product focus (see why focusing on a few products is hard).
2. The costs associated with Symbian and Meego were unreasonably high. (see Nokia employs as many people to develop its smartphone software as Apple does to develop all its products).
3. The psychology of change management.

This last one may be the most crucial of all.

What has to be appreciated is how bloated Nokia has become. It has 140 thousand employees. It's been organized and re-organized countless times and is completely intractable even to insiders. Cutting headcount can only accomplish so much. It deals with costs, but not with motivation. What management needs to do is also incentivize the survivors.

This is where exclusivity comes in as a motivational tool.

To explain we need to dip into a new metaphor. Conquistador Hernan Cortés landed in Mexico with the intention to conquer it. Legend has it that as soon as he landed, he burned his ships to prevent his men from retreating and motivating them that conquest their only option.[1]

Leaders motivating their followers by removing the means to surrender or retreat is not uncommon. It's harsh and brutal. It's not a natural thing do do: destroying perfectly useful options is value destructive and generates outrage, even mutiny.

In Nokia's case, institutional inertia with a vestigial Symbian effort would compel the organization to maintain the current platform while treating the new alternative as a pathogen.

Counter-distruption theory states that the response to a disruption requires a focused approach through an autonomous challenger protected from corporate antibodies by the CEO herself. In this case, the autonomous organization is outside the company (Microsoft). Protecting the new effort was not possible with a Chinese wall. The only alternative was to simply get rid of the old and start with a clean slate.

While there are times it makes sense to burn ships to eliminate any ideas of retreat, there are other times when doing so is reckless. You can do the calculation on the basis of cost of being wrong and levels of uncertainty [2], but even when armed with all the data linked above, this decision can hardly become something that can be quantified.

It's a gut-level decision.

I would say that Nokia's new CEO did not just jump off a "burning platform" but that once he jumped he made sure it kept burning so that nobody thought of going back on board.

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Notes:

1. There is a Microsoft precedent to this story. See Amazon.com: Burning the Ships: Transforming Your Company's Culture Through Intellectual Property Strategy (9780470432150): Marshall Phelps, David Kline: Books Burning the Ships recounts the decision that forced Microsoft to face its own 'succeed or die' moment. It's a lesson in strategy and survival that speaks about the courage required to embrace radical business transformation.
2. See also: Burning Ships

The Windows Phone platform currently has hardware specifications that imply a cellular phone device. What is interesting in light of the new WebOS TouchPad, the newly announced Android tablets, the RIM Playbook and the iPad is that this supposed "third horse" of Windows Phone has no hint of present or future presence in the tablet form factor.

That might have something to do with the plans to move Windows to the tablet form factor. Perhaps Microsoft thinks that pocket size devices deserve a separate operating system, platform and ecosystem than portable mobile computers. Perhaps Microsoft plans to have two separate interfaces for these tablets (slates vs. tablets?) Then again, Ballmer held up a Windows Phone and said "This is Windows too."

It gets confusing.

The bottom line is that without a tablet implementation, Windows Phone developers and content providers will find that the WP ecosystem will have a limited addressable market and will not be suitable for all forms of media or apps. Tablets are currently expected to grow even more rapidly than smartphones did and so there will be significant numerical advantages to those platforms that support multiple screen sizes and form factors.

Now that Nokia has anointed the Windows Phone platform as its exclusive conveyance to the device market, the question in the headline becomes: Where is the Nokia tablet?

In the last quarter Nokia sold 28.3 million Symbian phones. The average selling price was €156 or approximately $210. That price was down 17% year-on-year.

According to the company,

The 17% year-on-year decline in our converged mobile devices ASPs was mainly driven by general price erosion and an increase in the proportion of lower-priced converged mobile devices sales.

ASP erosion has been a fact of life across all of Nokia's products for quite some time, checked only by the increasing mix of smartphones. However the smartphones it sells have been consistently positioned for lower price points. This is consistent with Nokia's long-term goal of serving "billions" of users.

The trouble with the new strategy is that the Windows Phone product lines currently in the market are not likely to be priced in the $200 range. The reason is that the minimum specifications for Windows Phone 7 are:

• Capacitive, 4-point multi-touch screen with WVGA (480x800) resolution
• 1 GHz ARM v7 "Cortex/Scorpion" or better processor
• DirectX9 rendering-capable GPU
• 256 MB of RAM with at least 8 GB of Flash memory
• Accelerometer with compass, ambient light sensor, proximity sensor and Assisted GPS
• 5-megapixel camera with an LED flash

These don't add up to a product that can be sold profitably at $200. The bill of materials is likely to be in that range (and one has to add $15 for Microsoft).

So there are two possible implications for Nokia's new smartphone strategy.

1. Windows Phone will be ported to lower spec/cost hardware to allow the traditional Nokian market growth model to continue and perhaps combat Android proliferation
2. Nokia's smartphone portfolio will consist of high-priced products, and exclude mid-to-low price products.

Option 1 is difficult to imagine. The user experience that Microsoft is putting forward as its differentiation depends on significant hardware which is unlikely to become very cheap very soon. It is an interesting exercise to think through however. What would we have to believe for this option to become real?

Option 2 is more likely as Nokia conforms to this a new definition of smartphone as "high-end" only. This seems to be the default option given what is visible to observers today.

If Option 2 is in fact the outcome of the new strategy, then it leaves Nokia very vulnerable to a low-end disruption (after it's succumbed to a new market disruption.) The $50 smartphone will be reality this year.

Option 2 also most certainly guarantees that Nokia's current market share of 30% in smartphones is likely to be lost and never regained.

Some might argue that's no great loss. After all, Apple does very well with low share and high prices. However, Nokia is almost religious about market share. The reason being that scale offers significant purchasing power and logistical leverage. It sustains a cost structure, distribution network and a business model that is central to the company's core competency. It's also presumably the reason Microsoft partnered with Nokia in the first place: volumes and wide distribution.

So we're back to the old question: how does the new deal lead to a thriving ecosystem? Does it depend on vendors other than Nokia? If so how does Nokia benefit from the sale of Samsung phones?

Stephen Elop stated that Nokia expects to sell approximately 150 million more Symbian devices before the transition to Windows Phone is complete. Assuming that figure is achievable (which is far from certain) I tried to understand how that figure will affect the volume and share numbers for Nokia in the coming years.

It's very likely that the first WP phones will not ship in large volumes until 2012. Product development cycles being what they are, unless there is an ODM rebranding (i.e. taking an HTC phone and gluing a Nokia sticker on it) the minimum development time is at least 12 months. Keep in mind that Nokia does not have engineers to build such a product today and hiring them alone can take months.

The following two charts show what a two year forecast that adds up to 150 million Symbian devices looks like. I assumed Windows Phones begin to ship in 2012 and, keeping in mind that WP7 is designed for a higher hardware specification than the current Symbian phones, I show a modest ramp for a total of 15 million units in the first year.

I also forecast the overall market assuming continuing growth levels and calculated the effect of Nokia's share.

The share at the end of 2012 would be approximately 6%.

Note however that the share above depends highly on Nokia selling 150 million Symbian units in the next two years. One could question why would anyone buy a product whose platform that's been declared end of life. Perhaps there is a built-in assumption that end users are inherently stupid. However even in that scenario the question is which distributors will make the same bet with Nokia? Or, even more perplexing, which operators are willing to stock EOL products for two years when that shelf space is getting strong bids from Nokia's rivals.

In a recent post I pointed out that Apple's R&D was about 2.2% of sales in the last quarter. Bernstein took a look at the R&D for Nokia and presented a chart showing the difference between the mobile industry players in terms of total expenditure on R&D.

I took inspiration from that to plot the Devices R&D for both Nokia and Apple over the entire 2010 period. I also compared that with sales and computed the ratio between R&D and sales.

The result is shown in the chart on the left.

Bottom line: Nokia spent 10.2% of phone sales in 2010 on phone R&D while Apple spent 2.5%.

Bernstein goes on to argue that at least for Devices,

Nokia spent $3.9bn in R&D in 2010, almost 3x the average of its peers, 31% of the industry's R&D total spending, for an output that we can qualify as visibly disappointing.

To relate the $3.9 billion for Devices into head count, they estimate that Symbian projects employ 6,200 people; MeeGo and Qt 1,800; Services 1,800; and S40 1,800. Hardware headcount is assumed to be 4,700 and 900 more for fundamental research.

So Nokia's total software headcount adds up to 11,600 people. Nokia smartphone headcount adds up to about 8,000.

Applying a similar formula ($240k/employee[1]) to Apple's estimated iPhone R&D (from Bernstein's chart) yields a headcount of about 3,200 and a total Apple company R&D headcount of 8,200.

So Nokia employs about the same number of engineers[2] for its smartphone software platforms as Apple does for all its product lines[3].

In fact, Symbian alone may cost twice as much to develop than the iPhone (including the hardware).

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Notes:

1. The cost per employee is obviously different between the companies as they operate in different countries. However there are enough sources of error in these estimates that they probably overwhelm the cost of living/tax differentials.
2. I know that engineers are not all that R&D headcount covers, but let's assume that the mix of overhead is similar for the two companies.
3. The total for Symbian + MeeGo is 8000 and the total for Apple overall is 8,200, however one can comfortably allocate 200 out of 900 researchers out of Nokia research to their mobile software effort.

Yesterday I made my predictions on Nokia's new platform strategy. They should  be treated as pure guesswork, but they are informed guesses. I based them on public information.

That information comes in the form of statements from Nokia's CEO at the earnings call. I made a table of all the statements that dealt with platform decisions and my interpretations of those statements.

You may do your own interpretation, but to me there is significant evidence here to support my predictions.

What Elop Said	My interpretation
In certain markets where there’s a greater preponderance of competing platform devices, we have some competitiveness problems	We have problems in the US
Broadly the conversation about operating system and positioning of relative operating systems in different places is something that we'll reserve for the February 11th meeting,	Different markets require different operating systems
The general comment I’d like to make though is that in today’s world it is the case that given the different price performance characteristics of different chipsets, we get into situations, where the best experiences are not necessarily delivered by systems that are capable of delivering the highest end experiences. We have to be very mindful at what level of the price curve we deliver what type of device with what operating system.	Different price points require different operating systems
When I think about geographies, the area, I've mentioned this indirectly during my comments, but I'll be more precise in answering your question and that is clearly, there is a pattern of disappointments in the United States. A pattern there where efforts have been made, competitiveness, challenges exist and we very much need to address those	We have problems in the US. We're going to address these.
That's why I characterize very clearly in the framework for the decision making ahead, that whatever the strategy is that we outline on February 11th, we very clearly will be ensuring that it gives us the opportunity to reopen doors in markets such as the US and some others where we have not recently been present	We are going to enter the US with this platform
With respect to the question of ecosystems and so forth, it's important to note, in my opening comments, I referenced the fact that there are today different ecosystems and different patterns at play	Different OS for different markets
If you like the high-end ecosystems where there is particular rate of momentum and share gain taking place. At the same time, the dynamics at the very low end of market which itself is an ecosystem of sorts, is very different with very different demands and expectations	High end and low end require different OS
I'll just offer that observation that today broadly in the world without any specific comment on us or our competitors, there are multiple ecosystem patterns that need to be considered	More on the need for multiple OS
I'd also point out that very critical in whatever combination of ecosystem or ecosystems or whatever our strategy outlines, the need to maintain sustainable differentiation between ecosystems and within the ecosystem relative to our competitors in that ecosystem is a top priority. In everything we consider, that’s something that will be very much on our mind.	What we chose gives us some degree of differentiation--It's possible concessions were negotiated
With respect to comparisons to other ecosystem shifts and things like that, the real thing that one must focus on is the quality of products in the market, the momentum that one already has	Symbian is not going to disappear
As we’ve described the Symbian momentum that we have today; a consideration of shift of ecosystem, certainly you have to consider that potential of market share changes	Symbian will lose share
With respect to the ecosystem comment, without getting into specifics of different options and things like that in detail, what I will say is that the word catalyze is to imply that there is a wide variety of participants in our world, and that includes competitors, it includes operators, other technology firms and so forth who in many respects have a common interest relative to the potential strength of other ecosystems and how they may develop over time	Partner is a tech firm that has common interest -- i.e. market entry
The catalyst of an ecosystem could be considered as making sure the right conditions are formed in the right companies, work in such a way that alternatives emerge in a marketplace that may not exist today	Looking at growing the market for the partner-- Microsoft
We made a decision to not proceed as people have thought we would proceed	This is not going to be business as usual
You'll see that pattern of decision making from us in terms of being very crisp about what constitutes great experiences and ensuring that that is what we are delivering to our customers.	This is a marketing-led effort. We're going to stay on message and not waffle on about technology

Nokia must compete on an ecosystem to ecosystem basis.

In addition to great device experiences we must build, capitalize and/or join a competitive ecosystem. The ecosystem approach we select must be comprehensive and cover a wide range of utilities and services that customers expect today and anticipate in the future.

Nokia CEO Discusses Q4 2010 Results - Earnings Call Transcript - Seeking Alpha

These kind of statements are signaling that there will be fundamental changes announced.

Here are my guesses for the February 11 announcement:

1. There will be a multiple OS strategy
2. The US market will be the first to see a new non-Nokia OS. I would guess Windows Phone with AT&T.
3. Low end devices will remain with Symbian due to price considerations for the chipsets, components.
4. MeeGo will be phased out in phone products but development will continue for tablets

This may seem like a radical departure, but in many ways it's not. Nokia has nothing to lose in the US as its platforms have zero traction. By maintaining Symbian for low end devices, they can still aim for differentiation where Nokia feels it still has distribution and cost leverage. This strategy will also allow speed in time to market.

Several readers pointed out that in my discussion on the market share of modular vs. inter-dependent market shares for smartphones, Nokia was incorrectly classified as having an inter-dependent software architecture since the Symbian platform is/was a modular component.

The problem is that the relationship between Symbian and Nokia is not that of independent modules. Nominally, the two are independent and mutually exclusive, but, in practice, Symbian has always been so heavily dependent and influenced by Nokia that it's never been possible to declare its governance fully independent.

I won't describe the full history since there are many other sources (good example here.) But I will point out that since Nokia licensed Symbian exclusively and Symbian obtained the vast bulk of license fees from Nokia, the relationship was one similar to a bilateral monopoly.

Nokia's bargaining power over Symbian was always high enough to affect its operations. "Ownership" does not only infer a formal control over equity, and many would agree that Nokia "owned" Symbian even when it held less than 50% of the equity. The relationship was so tight, that even though there were other members of the consortium with board seats, the licensing by Nokia's competitors was always very limited. The only significant non-Nokia revenue for Symbian came from Japan where Nokia did not have a presence.

After Symbian was effectively acquired by Nokia, the ownership became both de jure and de facto. The open sourcing of the Symbian code made it no less a Nokia operation than the open sourcing of Android makes it no less a Google operation.

So for all intents and purposes, the relationship between Symbian and Nokia makes Nokia's smartphone hardware inter-dependent on Symbian's software.

Now, given that the way the products are built in practice may be far from integrated, it would seem that Nokia's management captured the worst of both worlds: Modular implementation of an inter-dependent business. Nokia captured all the downside of modularity (poor integration and polish) without any of the benefits (e.g. flexible supply chain or lower R&D.)

A complete market overview will follow when all the top tier vendors report the last quarter, but in the mean-time here are some data that are available:

Smartphone volumes for Nokia, Apple and RIM:

Whereas Nokia is often criticized for being weak in smartphones, the fact is that they have grown at a decent rate over the last two years. In fact, they've opened a gap with RIM. Apple has increased share but it will take quite a while to overtake Nokia.

So why is Nokia's smartphone performance so under-valued? Partly it's because ASPs have been dropping. A lower price and lower margin is sometimes seen as a sign of weakness. But Nokia has had a strategy of expanding into more price brackets in their core markets (i.e. outside the US). Half of Nokia's smarpthones are sold through distributors not operators and probably end up being sold unlocked and unsubsidized. Price matters in those markets.

The other problem that Nokia takes a beating over is that their products don't get used as smartphones. Many are sold without data plans at all which makes one wonder what exactly makes their phones "smart". So many of these 100+ million/yr.  smartphones are really hired to do a feature phone job. They're "overqualified" and thus underutilized. The statistics in terms of app downloads, browser and ad impressions all lag as a result. The ecosystem suffers.

Lastly, they are all but absent from the US. Due to accidents of history (CDMA) and various mistakes, Nokia never got a foothold in what turned out to be the most important mindshare market. A decade ago the US was a mobile data backwater, with lower data ARPU than Nigeria. It was not a market Nokia felt particularly deserving of investment. In hindsight, this was a big mistake.

But these knocks against Nokia still should not detract from the fact that they do sell a lot of Symbian phones. Distribution still matters as does having 600 operator customers. And in many parts of the world, Nokia is synonymous with mobile phone. Many of those buyers will migrate to future Symbian devices.

My mobile platform thesis has been that as long as penetration is not 80% and as long as operators are still in the value chain, mobile platforms will remain fragmented and split shares. The graph above shows exactly how that has evolved among the top three smartphone vendors.

“I am sure there are things we could have done better and innovations we missed,” Ms. Suominen added. “But that happens to all companies. We have been very successful with some other innovations.”

She cited Nokia’s large patent portfolio and its 770 Internet Tablet, a compact, flat-screen device without a phone, released in 2005. It worked with a pen stylus and was made for Internet browsing but is no longer sold.

via Nokia’s New Chief Faces a Culture of Complacency - NYTimes.com.

If I may suggest a better list of innovations for Nokia to stand behind:

1. The first GSM call in 1991 was made on a Nokia phone and a Nokia network
2. The first mass-market smartphone, the Communicator in 1998
3. First compact smartphone, the 7650 in 2002.

While these innovations and "firsts" happened many years ago, Nokia's ability to innovate is just as important at the low end. Nokia was the first company to address the lowest tiers of the market with over a billion customers served. This was no small feat and many observers faulted the strategy when it began in the middle of the decade.

I would not discount the difficulty and determination required in reaching those customers. Engineering a profitable low end product is as hard if not harder than engineering a high end superphone. More importantly, you have to find a way to distribute to these hard-to-reach customers and find ways to make the product useful, usable and affordable. Were it not for these efforts, the company would be facing collapse today, similar to the fate of Motorola or Ericsson: squeezed in the mid-range.

Blaming "culture" is nothing more than suggesting bad management. The culture of Nokia did not change between the few years when it was successful and the years when it was not.

The challenge Nokia faces is not complacency. It's that the business model for selling voice-oriented phones is diametrically opposed to the business model for selling data-oriented phones. In one case you cooperate with and sustain operators, in the other you compete with and disrupt them.  It looks damn near impossible to do both with the same organization. Everything must be done differently. The real problem is that Nokia has not realized this and therefore can't build its own replacement.

Will Nokia build Windows phones? | VentureBeat.

The chances are extremely small. There are three scenarios where this would make sense:

1. If there was a specific market that required it. It would also need to be a large opportunity since developing a new platform and diluting existing platforms need significant upside. The only such market is the US, but there are better options available, namely Android that have better potential and Android is treated as a toxin by Nokia (see metaphor).
2. Specific users. Windows Mobile used to be justified for business users, but Windows Phone is not targeting business users.
3. The last option would be "strategic" i.e. Microsoft paying Nokia for using the OS (directly or indirectly through marketing co-spend or other symbolisms). I don't think Nokia is desperate enough yet.

Although it's never prudent to say never, I just don't see any logic for Nokia to add to its bill of materials for phones while facing price pressure.