Why Motorola Is Not a Good Play on the Wireless Sector

August 25, 2004 - TheStreet.com: Street Insight The real problem for Motorola will come when the growth rate of the cell phone industry slows down or stalls. Over the weekend, I was analyzing Nokia (NOK:NYSE) and while I have not reached a conclusion on the stock, one issue was evident to me: management has done a terrific job positioning Nokia to compete against Motorola (MOT:NYSE). Nokia has several strong, sustainable competitive advantages that will allow it to maintain and take market share from Motorola in the future. The wireless handset market is divided into two, almost equal-size segments: commodity-type handsets and more feature driven "fad" handsets. Nokia's management has made a conscious effort to position the company to have a strong competitive advantage in each segment. In the commodity segment, customers' main focus is price. Cell phones are considered a utility (not unlike a home phone) by consumers and as long as cell phones are perceived to be of good quality, price is the decisive factor in purchasing decision. On the contrary, in the "fad" segment, features, feel, look, shape and coolness (especially for teenagers) are the crucial factors in the consumer purchasing decision. Commodity Segment: Nokia Is the Dell of Cell Phones To be an effective competitor in the commodity segment, lower cost structure is a must. Nokia is extremely efficient in manufacturing phones and has a much lower cost structure than Motorola. On average, Nokia sells phones 27% cheaper than Motorola but makes 39% per phone more than Motorola. Larger volume definitely helps in lowering the handset average cost. But I think the real key is in the laser focus of Nokia's management on operating efficiency. While Motorola and other competitors choose to outsource a lot of manufacturing, the bulk of Nokia's manufacturing is done in house. Most factories are located in Asia (China and South Korea), putting Nokia on the same footing with Asian counterparts. Nokia Has a Definite Cost Advantage (please email to get the table that goes here) Fad Segment: R&D Is the King In the fad segment product, differentiation is the key driver. R&D is crucial for maintaining a competitive edge since products are bought for their features and look/feel-like qualities. Almost by definition, changes are quick and often unpredictable in the fad business. In the past, Nokia was in the forefront of the fad -- in fact, it created most of the fads. However, last year Nokia missed one: clamshell phones. Motorola's late success was partially at Nokia's expense. Nokia did not have a clamshell phone, and that's what consumers craved. Motorola had a good product, resulting in 52% growth in volume in the second quarter. Nokia's reaction to its misstep was two-fold: it has lowered average handset price by 22% vs. second quarter last year in an effort to maintain market share and it went to work on clamshell phone -- announcing that will be bringing five clamshell phones to the market this year. I realize that just because Nokia spends twice the amount of money on R&D than Motorola does doesn't necessarily mean that Nokia will have twice as many high-quality innovative products. I don't know if Nokia's R&D productivity per dollar spent is equal to Motorola's; that may or may not be the case. Judging R&D productivity is very difficult especially after hearing that Motorola came up with 17 new cell phones in the last quarter. However, not unlike evaluation of pharmaceutical companies' R&D productivity, I have found a company's past track record of product innovation to be one of the few good indicators of R&D effectiveness. In Nokia's defense, with the exception of the last year's snafu with clamshell phones, the company has a spotless record in product innovation, although I believe it will likely take another two quarters for Nokia to fully recover and introduce phones that are as good or better than Motorola's. Today's Feature-Rich Phone Is Tomorrow's Commodity It takes very little time for today's feature-rich phone to become tomorrow's commodity. Features for which a premium was charged in a "fad" stage of the product very quickly become ubiquitous in a commodity stage. For example, color displays were a new fad last year. Cell phone manufacturers were able to charge a significant premium for the phones with color display over the black and white ones. But color display remained a differentiation factor for a very short time since all the phones that are sold today have them. Therefore a low-cost structure leadership and constant ahead-of-the-curve product innovation are extremely important for the leadership to be sustained. The Cell Phone Space Is Motorola's Game To Lose It appears to me that Motorola's recent success is a temporary phenomenon. It is poorly positioned to stay competitive in this constantly changing industry. Nokia, on the other hand, is a low-cost producer and spends significantly more on R&D than Motorola. Current expectations for cell phone industry unit growth are fairly good; the industry expects to sell 600 million units next year. At the present time, 1.5 billion people (24% of world population) have a cell phone, 60% of the U.S. population has one, and cell phone penetration is extremely high in Europe. I have yet to research potential market size, though I have a feeling that we are lot closer to the mature stage than to the growth stage of the cell phone industry. The real problem for Motorola will come when the growth rate of the cell phone industry slows down or stalls; at that point, the real war will begin. Nokia will be fighting fiercely for market share since it will represent a significant (one of the few) source of growth (the recent price competition will pale in comparison). That is exactly what Dell (DELL:Nasdaq) did when PC sales slowed down a couple of years ago. Dell dropped prices on PCs and took market share from poorly positioned Hewlett-Packard (HPQ:NYSE)/Compaq and Gateway (GTW:NYSE). As I mentioned above, I have not made up my mind on Nokia, but one thing is apparent to me: Motorola is not a good play on the wireless sector.

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