Ericsson today announced major losses in its mobile handset department.
Ericsson revealed in its Q3 figures that its handset division has lost $584 million in the last nine months. The Swedish firm is now planning to move production to low-cost areas in Asia, eastern Europe, and Latin America. Earlier initiatives to increase outsourcing and streamline production have failed to deliver substantial costs savings.
The problem for mobile handset manufacturers is that the majority of the production cost is upfront, in designing chips and tooling up plants. The handset unit cost is comparatively low, so economies of scale in the industry are extremely high. Nokia has a 32% share of the global handset market, while its nearest rivals Motorola and Ericsson only have 19% and 11% respectively – so Nokia’s average cost per unit is vastly lower than anyone else’s. Its profit margins per unit are around 20%, whilst other companies hover around 10%. This makes it very hard for rival companies to compete on price.
Other manufacturers’ woes are compounded by a projected fall in the growth of the handset market. Penetration in Europe is approaching saturation, so future sales will rely on the replacement cycle. This means that companies will have to innovate in phone design, and also market their phones more effectively to create further demand. So far, Nokia has also been ahead of its rivals in creating reasonably priced products perceived as fashionable.
It may be a question of get together or get out for Nokia’s rivals. To compete effectively, they must reduce costs and increase demand. Although shifting production abroad will lower costs, this is unlikely to be enough. Competing effectively will require R+D alliances, producing phones with common chips to build economies of scale. The more radical step of greater consolidation could also be worth taking. Alternatively, players who have substantial revenue sources elsewhere could leave the handset market altogether. Ericsson derives the majority of its business from telecoms infrastructure – it could be well-advised to concentrate on this and abandon its lossmaking handset subsidiary.
