Ericsson Sees Light at End of Digital Services Tunnel

Ericsson knows just how difficult digital transformation can be. The Swedish vendor's digital services business has been a drag on performance for years. In 2017, not a single product area was profitable, said Börje Ekholm, Ericsson's CEO, during an earnings call on January 25. (See Ericsson Hails First Annual Sales Growth Since 2013 as 5G Comes Calling.)

The latest snafu was made apparent on January 10, when Ericsson AB (Nasdaq: ERIC) revealed that Revenue Manager, a business support systems (BSS) platform it launched in 2016, had been a miserable failure. Having attracted hardly any customers, and made zero impact on sales, Revenue Manager would get benched like a misfiring soccer player, Ericsson made clear. (See Ericsson Will Take $860M Hit to Prop Up Digital Services.)

Its decision to stop investing in or selling Revenue Manager looks costly. Ericsson has written off about 3 billion Swedish krona ($330 million) and spent another SEK3.1 billion ($340 million) on further restructuring in the final quarter of 2018. Another SEK1.5 billion ($170 million) in restructuring costs is expected this year.

Yet the overall digital services business enjoyed something of a turnaround at the end of 2018, despite all the BSS problems. Sales were up 10% in the fourth quarter, to SEK13 billion ($1.4 billion), compared with the same part of 2017, and they rose 5% on a constant-currency basis. A year earlier, revenues had fallen 3% organically, and they were down 6% in constant-currency terms in the recent third quarter.

Unfortunately, with all the write-downs and restructuring charges, digital services still racked up a hefty operating loss of SEK7.1 billion ($780 million) in the fourth quarter. That was an improvement on the loss of SEK12.3 billion ($1.4 billion) a year earlier. But even when restructuring charges were stripped out, Ericsson reported an operating margin of -27.2%. Hitting its 2020 target of a "low single digit" margin will be no cakewalk.

Perhaps for the first time in years, however, there is a degree of optimism surrounding digital services. "If we look at all areas except BSS, we see improvements and they are tracking on turnaround," says Helena Norrman, Ericsson's soon-to-depart chief marketing officer. "There is good traction and that has a lot to do with 5G pickup and the cloud-native portfolio."

Sorting out the BSS is a priority. In a case of out with the new, in with the old, Ericsson is turning back to an existing set of BSS products called simply Ericsson Digital BSS. R&D spending that previously went into Revenue Manager will now be redirected toward the older BSS goodies. With more than 300 service providers using those products, Ericsson's U-turn suits most customers, says Norrman.

So what went wrong with Revenue Manager? Just how did Ericsson so badly misjudge a product launch?

"The strategy was based on the assumption that customers would want to do big transformation projects and it turns out they are more interested in taking it step by step and in smaller pieces," says Norrman. "We took big-bang transformation projects and that did not work out as intended and so it didn't become a very good business for us."

Certain BSS rivals that have long touted a different approach would undoubtedly agree. "Today's news from Ericsson confirms what we've known for a long time," said Niall Norton, the CEO of Irish BSS company Openet, in a statement issued after Ericsson first alerted markets to problems. "The traditional delivery mechanisms for BSS capabilities are out of date. The days when operators tied themselves to one major vendor for all their service monetization needs are over."

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But James Crawshaw, a senior analyst with Heavy Reading, says operators will still recognize trade-offs between a "best of breed" model -- where a software stack includes products from multiple vendors -- and the "best of suite" approach that Ericsson has pushed.

"The former can potentially bring greater functionality, but the latter gives you one throat to choke, which means that inevitable problems are usually fixed more quickly and cheaply from the operator's perspective," he says. "Ericsson will continue to push its best-of-suite approach, but instead of it being one highly integrated product it will be separate software systems that are tied together with some middleware."

Whatever it has spent on Revenue Manager, Ericsson insists the investment has not been entirely wasted. Bits of the platform will make their way into the Digital BSS portfolio, says Norrman. The real uncertainty is what happens to the few operators using the Revenue Manager product. Veon, Ooredoo and T-Mobile Czech Republic were all previously touted as customers. And Veon's deal with Ericsson was valued at more than $1 billion, the telco revealed in 2016. (See VimpelCom Aims for BSS Overhaul by 2019.)

While Norrman does not wish to comment on specific deals, Ericsson has said it will carry on supporting customers. But it also claims not to have generated anything in sales from Revenue Manager, suggesting its write-downs include reimbursement for paying customers. And would any telco want to keep using a platform that is no longer an investment priority?

"Exactly what choices they make I won't go into, but you can develop products for the mass market or work specifically for a customer developing more customized solutions -- both are possible," says Norrman. "We are saying we will not have a big platform product as previously intended."

Beyond the specific area of BSS, Ericsson has now renegotiated, quit or completed work on nearly half the 45 digital services contracts it previously identified as problematic. It hopes to be three quarters of the way through that process by the end of this year. Assuming there is no unexpected turbulence, the bumpy ride at digital services may be coming to an end.

— Iain Morris, International Editor, Light Reading