Beginning of the End for Ericsson?

Ericsson is not in terminal decline, insists its acting CEO, but the vendor will struggle to escape its current downward spiral.

Iain Morris, International Editor

October 12, 2016

6 Min Read
Beginning of the End for Ericsson?

At some point in the not-too-distant future, will 2016 be remembered as the year when it all started to go wrong for Ericsson, a former giant of the telecom equipment market that ultimately lost its way?

Even posing that question will inevitably prompt guffaws and heckles from some corners of the industry. For all of its current problems, Ericsson AB (Nasdaq: ERIC) remains one of the world's biggest suppliers of network gear. Sales are falling, but they are not plummeting like a stone. At least some initiatives that form part of Ericsson's "targeted growth areas" -- which include the cloud, media and virtualization -- have been reasonably well received.

But the thought is clearly on a few minds, today prompting Jan Frykhammar, Ericsson's chief financial officer and acting CEO, to rebut any notion that Ericsson is in terminal decline. "This is absolutely not the beginning of the end for Ericsson," Bloomberg quotes him as saying, after the Swedish vendor issued a profit warning for its third-quarter results. (See Ericsson Profit Warning Sends Shares Tumbling.)

Right now, Ericsson certainly appears to be in a downward spiral from which it cannot escape. Having only recently announced plans for major redundancies, and lost Hans Vestberg as CEO, the company has now warned investors that operating income was nearly wiped out for the July-to-September quarter. This all comes after major restructuring efforts in the first half of the year. Frykhammar does not appear to have any fresh answers. (See Ericsson Ejects CEO Vestberg.)

What's more, we are constantly being told -- at industry conferences and during discussions with key executives -- that technology and market upheavals currently in motion will claim some big victims over the next few years. Tier 1 players, that is. If you had to pick candidates in the network equipment market, Ericsson would surely make the list.

The problems the Swedish vendor faces aren't just related to belt-tightening by customers, triggered by a cyclical or economic slump. China's Huawei Technologies Co. Ltd. is becoming all-powerful, sucking countries and companies into its vast embrace. Recent sales development shows that Ericsson cannot compete. Its only consolation is that Huawei still remains locked out of opportunities in the US, where policymakers say it represents a security risk. (See Is There No Stopping Huawei?)

At the other end of the spectrum, startups and IT boffins are pioneering software technologies that could blast apart the modus operandi of the traditional vendor. Operators like France's Orange (NYSE: FTE) are experimenting with containers and white box technology -- breaking down network functions into their component parts, and then stitching these together as software programs that can run on cheap servers.

"Cisco [Ericsson's key partner on IP technology] and others are not looking at this very nicely because it is a way of changing their business model and separating the hardware from the software, meaning the replacement of the solution can be much easier," said Pierre-Louis Biaggi, the vice president of sales development and partnerships for Orange Business Services, Orange's enterprise division, during a meeting with reporters in July. (See Orange Plots Mass Network-as-a-Service Rollout.)

Ericsson's tie-up with Cisco Systems Inc. (Nasdaq: CSCO), and the moves it is making in software and virtualization, show it is trying to adapt to this brave new world. But it is weighed down by legacy. In the April-to-June quarter, sales from "targeted growth areas" rose by about 520 million Swedish kronor ($59 million) compared with the year-earlier period, to SEK10.82 billion ($1.2 billion), according to Light Reading's calculations. Overall sales (adjusted for comparable units and currency) dropped by nearly SEK4.1 billion ($460 million), to SEK54.1 billion ($6.1 billion), over the same period.

Analysts have also expressed concern about the execution of the growth areas strategy, including some of the M&A moves that Ericsson has made. Built around the acquisition of Redback Networks Inc. in 2007, Ericsson's IP strategy has been "uninspiring," according to Gabriel Brown, a senior analyst with the Heavy Reading market research business. Bengt Nordström, the CEO of the Northstream consultancy, also questions some of the investments Ericsson has made in video technology. "What have the acquisitions delivered?" he said during a recent conversation with Light Reading. (See Vestberg's Seeds May Yet Bear Fruit for Next Ericsson CEO – Analyst and Ericsson Board Has Been Asleep at the Wheel – Consultant.)

Next page: Eric the Dead?

Eric the Dead?
From a cost angle, takeover activity combined with the legacy burden has made it hard for Ericsson to shape up. The latest news on layoffs is that Ericsson is looking to shed about 3,000 jobs in Sweden, where it employs around 16,000 staff. Yet restructuring efforts over the years have not made Ericsson much slimmer. In 2015, it points out in its last annual report, it dispensed with the services of nearly 17,000 workers but picked up another 15,000, leaving it with about 116,000 in total. That's nearly 30% more than it had in 2010, when revenues per employee were about 6% higher than last year. (See Eurobites: Ericsson to Close Remaining Swedish Plants – Report.)

Hiring and firing is an expensive business, of course, and it's partly for that reason Ericsson's operating income slumped to just SEK300 million ($34 million) in the third quarter, from SEK5.1 billion ($580 million) in the year-earlier period. Ericsson's share price was trading down about 18% in Stockholm today, at the time of publication, as investors took fright.

For all the latest news from the wireless networking and services sector, check out our dedicated mobile content channel here on Light Reading.

What may have alarmed them most was the size of the earnings decline given the impetus that Ericsson gave to efficiency measures in July. By cutting back R&D spending (to Huawei's probable delight), said executives, Ericsson would reduce the annual run rate of operating expenses (minus restructuring fees) to SEK53 billion ($6 billion) in the second half of 2017, from SEK63 billion ($7.1 billion) in 2014. That would equate to "double the previously targeted savings in operating expenses," said the company in its earnings report. Despite all that, operating income excluding restructuring charges fell by 73% in the third quarter, to SEK1.6 billion ($180 million). (See Ericsson 'Doubles' Savings Goal as Sales Slump.)

Ericsson clearly needs a new leader with a bold vision: A dramatic turnaround is improbable while Frykhammar is in caretaker mode. But the task facing an incoming CEO is indisputably immense. A mid-term economic improvement looks unlikely, as does another cycle of spending on mobile equipment before the arrival of 5G. The future CEO may have to restore faith in Ericsson while operating conditions remain grim.

These are problems affecting other vendors, too, and particularly Finland's Nokia Corp. (NYSE: NOK), following this year's takeover of Alcatel-Lucent (NYSE: ALU). Yet they are hitting Ericsson especially hard because of its mobile focus, IP shortcomings and strategic uncertainty. Nokia's own helter-skelter journey this century -- from mobile-handset market leader to zero in just a few years -- proves that seemingly impregnable fortresses can fast become ruins.

— Iain Morris, Circle me on Google+ Follow me on TwitterVisit my LinkedIn profile, News Editor, Light Reading

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About the Author(s)

Iain Morris

International Editor, Light Reading

Iain Morris joined Light Reading as News Editor at the start of 2015 -- and we mean, right at the start. His friends and family were still singing Auld Lang Syne as Iain started sourcing New Year's Eve UK mobile network congestion statistics. Prior to boosting Light Reading's UK-based editorial team numbers (he is based in London, south of the river), Iain was a successful freelance writer and editor who had been covering the telecoms sector for the past 15 years. His work has appeared in publications including The Economist (classy!) and The Observer, besides a variety of trade and business journals. He was previously the lead telecoms analyst for the Economist Intelligence Unit, and before that worked as a features editor at Telecommunications magazine. Iain started out in telecoms as an editor at consulting and market-research company Analysys (now Analysys Mason).

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