Rajeev Suri, Nokia's erstwhile CEO, had largely justified his €15.6 billion (US$18.3 billion) takeover of Alcatel-Lucent in 2016 by arguing that customers wanted an "end-to-end" set of products. Pekka Lundmark, his successor since August, has just torn up Suri's manual. "It is interesting to have 'end-to-end' discussions but that is not how customers buy," he told reporters this morning.
The market has been waiting to see what Lundmark would do at the Finnish equipment maker, which has struggled to keep pace with Ericsson, its big non-Chinese rival, in the last couple of years. Today it was provided with a clearer view as a major restructuring and strategic U-turn accompanied the release of troubling third-quarter results. Sales were down 3% year-on-year, to about €5.3 billion ($6.2 billion), and they fell 7% on a constant-currency basis.
Tumbling 17% in Helsinki, Nokia's share price was trading at its lowest level in five years this morning, as investors reacted to the news. Lundmark is under immediate pressure to show that his turnaround strategy can restore competitiveness at a firm whose earlier merger activity and decision-making has failed to work out.
While there are no plans at this stage for asset sales, Nokia is to be carved up into four new business groups around mobile, IP and fixed, cloud and network services, and technologies. Each will prioritize market leadership, using revenues and profitability as measures of success and disregarding any cross-sales matrices.
"We have analyzed these four businesses and have concluded that deal overlap is going to be only 20%," said Lundmark. The goal is to shorten the distance between the customer and critical decisions about research-and-technology investment, he told reporters.
Set for launch on January 1, the new operating model will "simplify the structure, make it easier for customers to do business with us and help investors assess the value of business groups better than today," said Lundmark. Feedback from stakeholders in recent weeks has shown that Nokia's operational model is "too complex."
Much of the world's attention will be on mobile networks, carved out of Nokia's existing networks division. It will be led by Tommi Uitto, the current head of mobile, and account for nearly half of Nokia's entire revenues. But mobile has been on the back foot after various strategic blunders under previous management. Perhaps the costliest was a 5G product decision to use field programmable gate arrays, fancy components that have torn into profit margins.
Recent mobile results have been disappointing next to Ericsson's. Revenues for the third quarter fell 13%, to €2.5 billion ($2.9 billion), compared with the year-earlier period, dropping 8% on a constant-currency basis after Ericsson cited a 7% rise. Lundmark hailed several important 5G wins, including contracts with seven entirely new operators, and blamed a services slowdown for the sales decline. But Nokia has yet to overcome a market perception that it lags in 5G.
It was not helped by a gloomy forecast triggered partly by a contract loss at Verizon, which has instead awarded a $6.6 billion 5G network deal to South Korea's Samsung. Outside China, where it has failed to win any 5G radio access network (RAN) business, Nokia today warned that its RAN market share may next year dip below the current level of 27%.
While the costly 5G chips are being phased out, they still accounted for 63% of all third-quarter shipments and are not expected to vanish entirely until the end of 2022. The gross margin at the networks business improved to 32.8% in the third quarter, from 29.1% a year earlier, but remains well below Ericsson's 46.5%. Competing on cost looks difficult.
The full-year outlook has been lowered, too, with Nokia guiding for an operating margin of about 9%, down from 9.5% previously. "We have a challenging deployment in North America on mobile," said Marco Wirén, Nokia's chief financial officer, in offering an explanation. Lundmark similarly blamed "margin pressure" in North American mobile for weak profitability.
Rather like Ericsson back in 2017, Nokia hopes a renewed focus on mobile will restore its leadership and competitiveness. "We are a technology company and the only acceptable goal is for technology leadership," said Lundmark. "I want to be very clear that we will do whatever it takes to lead in 5G and are ready to invest more and want to repeat our 4G success in 5G."
Overall research-and-development costs have been falling at Nokia and dropped 5% at the networks business in the third quarter alone, to €666 million ($781 million). That has unnerved the Finnish company's fans as Ericsson's budget has continued to rise. Yet even before Lundmark took charge, Nokia insisted the 5G business was receiving additional investment. It slashed this year's cost-saving target by €200 million ($235 million), to €500 million ($586 million, compared with costs in 2018), to help pay for that.
But today's restructuring should make R&D spending and profit margins more transparent in mobile, which has previously been lumped together with other network units. It should certainly make that division more focused and less worried about the performance of those other units.
The unknown at this stage is how much additional margin pain Nokia is prepared to shoulder as it tilts at technology leadership. Unveiled this morning, its operating margin target for 2021 is 7% to 10%, a wide range that at the lower end would disappoint investors. Ericsson expects to deliver an operating margin of 10% this year, despite competing fiercely for business in China.
Nokia's overall profitability was better in the third quarter, with operating profit up 2%, to €486 million ($570 million), and net income rising 14%, to €305 million ($358 million). The €500 million ($586 million) savings program remains on track, said Nokia, and COVID-19 has brought some temporary benefits, due largely to lower travel and personnel expenses.
Outside mobile, Lundmark's carve-up makes an entirely new division out of IP and fixed networks, which Federico Guillén, the current president of customer operations for the EMEA and APAC regions, will lead. He has less to worry about than Uitto. Sales of these products rose 2.5% in the third quarter, to about €1.6 billion ($1.9 billion), and there was particular strength in optical networks.
A bigger change is the creation of a cloud and network services group, which combines today's software and enterprise units and adds some global services to the mix. Raghav Saghal, the head of enterprise, will be in charge. His current unit remains a high-flyer at the firm, with sales up 15% in the third quarter, to €383 million ($449 million). But software came partly off the rails. Revenues dropped a tenth, to €585 million ($686 million), and operating profit sank 44%, to €87 million ($102 million).
It is to this division that Nokia will be looking for growth, however. Commenting on the mega trends he observes, Lundmark believes operator spending will remain constrained as enterprise demands grow. The transition to so-called network-as-a-service offerings will gather pace, he predicts.
Unchanged by all this upheaval is the technologies or licensing division. Jenni Lukander will continue as president of a unit that made just €331 million ($388 million) in third-quarter sales but remains highly profitable, with an operating margin of 82.8%. Expansion into segments like the automotive sector, and the much-hyped Internet of Things, could make technologies a much bigger deal for Nokia in future.
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— Iain Morris, International Editor, Light Reading