Shipment growth reassures handset industry

By Gavin Byrne

The recent 2Q09 earnings results of the world’s top five handset vendors by volume showed a quarter-on-quarter growth of 12.1% in shipment numbers, led by LG, Samsung and Nokia. With channel inventory reduced to more normal levels, prospects for continued quarterly growth in 2H09 have improved. However, challengers such as ZTE could displace Motorola or Sony Ericsson while they restructure. Meanwhile, Nokia is increasingly focusing on value.

By end-2Q09 it seemed that the handset industry’s channel-inventory problems had been largely resolved. Without the destocking experienced earlier this year, vendors are experiencing a better balance between sell-in and sell-through. This balance, combined with early signs of a possible recovery in demand and the impending launch of many advanced handsets, should see quarter-on-quarter growth in the remaining two quarters of 2009. However, Informa Telecoms & Media still expects total handset shipments for 2009 to be down 9.8% year-on-year, at 1.07 billion units.

Growth in the handset market is occurring in the low end, because more people are being cost-conscious and demand is higher in emerging markets, and in the high end, particularly with smartphones. Touch-screen and qwerty devices continue to be popular. Vendors with products in each of these segments are in the best position to benefit from what growth there is in the market.

Price competition continued to be strong in 2Q09. In the face of reduced market demand, many vendors were willing to secure additional sales by reducing prices. Such a strategy helps the vendors increase market share and ensure a higher use of in-house manufacturing capacity, though they must achieve regular efficiency gains if the strategy is to be sustainable in anything but the short term.

Because of the growth being seen in the low end and the probable lackluster performance of Motorola and Sony Ericsson in 2H09, other companies have a real opportunity to become one of the top five handset vendors, by volume. ZTE would seem to be the most likely one to do so, particularly if it can achieve its target of 60 million handsets shipped this year.

Most vendors are also trying to generate additional revenue per handset in an increasingly competitive market by continuing to develop their own application stores or ensuring strong compatibility with third-party application stores.

Nokia

Volume-share market leader Nokia shipped 103.2 million handsets in 2Q09. That figure was up 10.7% compared with 1Q09 but down 15.4% compared with 2Q08. More concerning was the continued slide in the company’s ASP, which fell 3.3% quarter-on-quarter and 15.6% year-on-year. This meant that the Devices & Services division’s net sales fell 28.1% year-on-year, to €6.59 billion (US$9.25 billion), with Services accounting for just €140 million of it.

Although not low for the mobile handset sector, Nokia’s Devices & Services operating margin of 11.6% is a nearly historical quarterly low for the company. Given Nokia’s reliance on that division to generate profits, the company needs to ensure that its profit per handset does not fall further. It can do so by increasing its ASP, reducing its costs or developing alternative revenue streams. Nokia is looking to address all three areas in a bid to generate additional revenue.

It is essential that Nokia continue its impressive success in emerging markets if it is to maintain its economies of scale. Increasing sales of low-end devices is reducing the company’s ASP, though the lower figure is offset by the company’s industry-leading logistical and manufacturing efficiencies. Nokia needs to ensure that it can continue to generate large-enough margins at the low end while also developing its services revenue from this device tier through initiatives such as Nokia Messaging, which has now been technically rolled out in more than 40 countries.

The number of Nokia smartphones shipped in 2Q09 was up 23% quarter-on-quarter and 10% year-on-year, to 16.9 million. Since the 5800’s launch in late 4Q08, 6.8 million of the devices have been sold. As the company’s highest revenue- and gross-margin-generating product, it is the star performer in Nokia’s smartphone range. The company has seen improvements in its E-series range, which recorded 4.7 million units sold in 2Q09, notably with the E71. However, the company lacks other strong performers, and it will be later in 3Q09 before the success of the high-end N97, and many of the company’s other new handsets launched late in 2Q09, can be measured.

Nokia is continuing to reduce its devices and services operating expenses. The company has slashed its use of outsourced production, helping increase its use of its own facilities, and has laid off 4,000 employees this year. Nokia is also working to make its industry-leading logistics and production-management processes more efficient. Other advantages Nokia has over its rivals include its advanced segmentation model and broad, balanced product portfolio. But in the future, a greater portion of the company’s revenue will come from the enablement and sale of services.

During Nokia’s earnings call, Olli-Pekka Kallasvuo, the vendor’s president and CEO, spent much time emphasizing that the handset industry is changing from being device-centric to being driven by seamless experiences, the consumption of content and services and Internet access. Nokia says it is seeking to transform itself into a “solutions” company – one that focuses on applications and services as well as making handsets – and will seek to increase the number of people actively using its services, offering its employees incentives to do so. Furthermore, the company has set itself targets of 80 million active users by end-2009 and 300 million by end-2011. These targets might prove challenging, since Kallasvuo reported that Nokia had 4-6 million active users at the start of 3Q09.

If successful, the company will benefit greatly from developing “direct and continuous consumer relations” and from the revenue opportunities. Nokia is working hard to make its services strategy operator-friendly, supporting revenue sharing and operator billing, and is seeking to tightly integrate its services with its devices.

The more positive outlook for the rest of the year is tempered by the prospect of growing competition, particularly in the smartphone segment. Nokia’s reliance on the profitability of its Devices & Services business means it might need to make the company even more efficient in future quarters.

Samsung

Samsung Electronics’ shipment figure grew to 52.3 million units in 2Q09, up 14.4% both quarter-on-quarter and year-on-year. It was the company’s second-highest quarterly shipment figure ever, achieved despite the contracting market. Samsung is benefiting from an improving breadth to its product portfolio. In developed markets, such as Europe and the US, the company is experiencing success with a strong lineup of touch-screen and messaging phones. The company also has an improving range of lower-tier models, which can help it benefit from continued growth in demand in emerging markets.

Revenues for the company’s Wireless Telecoms division were up 2% quarter-on-quarter in 2Q09, to SKW6.94 trillion (US$5.56 billion), excluding Samsung’s numerous overseas subsidiaries. The increase was helped by a slight rise in the company’s ASP, to US$124.

With 98.1 million handsets already shipped by Samsung this year, the company felt confident enough to maintain its 2009 shipment target of 200 million units. Its confidence is party due to its pipeline of new models, including the Jet, Galaxy and Star. Samsung had already recorded 2 million preorders for the Samsung Jet before launch – the highest level of preorders ever for a Samsung handset. Nevertheless, 3Q09 could prove more challenging for Samsung, because of both intensifying competition and the prospect that the South Korean won, which has been at a low rate since late 3Q08, might appreciate.

Importantly, in late July Samsung announced the launch of its application-seller site, a back-end component that links Samsung’s Mobile Innovator developer forum and the Samsung Application Store. The company plans to expand its application store outside the UK in 3Q09.

Samsung is also looking to lead the nascent 3G-handset market in China with an aggressive “3G Samsung, 3G for all” initiative. The program will see the vendor launch close to 30 3G handsets by end-2009, across TD-SCDMA, WCDMA and 1xEV-DO network technologies and feature sets.

LG

LG Electronics’ 2Q09 handset-shipment figure of 29.8 million units represented a growth of 7.6% year-on-year and 32% quarter-on-quarter, helping the South Korean vendor record SKW4.87 trillion (US$3.8 billion) in quarterly revenues, up 29.9% year-on-year. Its operating margin of 11% was down from 14.4% in 2Q08.

A large portion of LG’s continued success is due to a much improved product portfolio, helped by some strong demand in the middle and high tiers. New handsets, such as the Arena and ENV Touch, have seen some success in Europe and North America, respectively. At the same time, LG has been able to increase its shipment numbers by expanding the distribution of existing models, such as the Cookie and the qwerty-based KS 360. The Cookie was especially important to the strong gains LG made in the South Korean market. The company is also in a relatively good position to benefit from growing sales in emerging markets, having already performed strongly in China, the Middle East and Africa.

However, some of LG’s strong performance can be attributed to the continued weakness of the South Korean won. Like its fellow South Korean handset vendors, LG could face a more difficult 2H09 because of the prospect of the won’s appreciation and intensifying competition.

Motorola

Motorola’s 2Q09 earnings results, announced last week, showed a degree of stabilization in the company’s fortunes, largely thanks to what Sanjay Jha, co-CEO of Motorola and CEO of the vendor’s Mobile Devices unit, described as “solid demand from [Motorola’s] North American customers, including certain prepaid markets.” Compared with Motorola’s disastrous 1Q09, the vendor’s handset-shipment numbers were up marginally, to 14.8 million, average selling prices improved to US$124, and net sales reached US$1.83 billion. Motorola’s operating margin remained negative, at -13.8%, but it was an improvement on 1Q09’s -28.3%.

The company seems to be slowly succeeding in its efforts to rescale itself. Compared year-on-year, Motorola’s shipment figure was 47% lower in 2Q09 than in 2Q08, its net sales were 45% lower, but its operating margin was -13.8%, compared with -10.4% in 2Q08. For now the company is focusing more on improving its product portfolio, operating profit, gross margin and ASP than on improving its shipment volumes.

Motorola’s future strategy is clearly focused on addressing the smartphone market. Android is the company’s key platform to achieve that. Motorola is working closely with Google on the Android platform and ecosystem and is actively bringing its MotoDev developer community to Android. The majority of Motorola’s 2010 devices will be smartphones, and the company will take Android into lower price tiers. For 4Q09, Jha announced that Motorola will have “two Android devices in stores for the holiday season,” though he did not clarify when in Q4 they would launch. Importantly, the company has already signed deals with operators. It was notable that Jha made no mention of Microsoft during the earnings call.

Motorola’s applications strategy is firmly linked with the Android marketplace and operator app-store initiatives, such as Verizon’s. Jha sees it as Motorola’s role to ensure that its devices deliver a better application-and-service user experience than its competitors’.

Outside the smartphone segment, Motorola will look to take advantage of its ODM relationships to deliver new low-feature and voice-centric handsets.

For now the company remains largely dependent on its success in North America, which accounted for almost 60% of its sales, by value, in 2Q09. But its improved smartphone portfolio in 2010 should enable it to address other regions, including Europe.

Sony Ericsson

Sony Ericsson’s 2Q09 earnings results marked another painful three months in its recent history as the company seeks to reorient itself toward more-profitable segments. Handset-shipment numbers fell over 43% year-on-year, to 13.8 million, in 2Q09, the company’s lowest quarterly total since 2Q06. Sales fell 40% year-on-year in 2Q09, to €1.68 billion, while its ASP rose slightly, from €116 in 2Q08 to €122 in 2Q09, thanks to new product launches and the realignment of its portfolio.

Sony Ericsson’s improved ASP performance is due partly to a streamlining of its portfolio. Today the company has half as many products as it had a year ago. Although this should have a positive effect on profitability, in the short term it will have an impact on its handset shipments. So 3Q09 device shipments will probably be flat at best.

The introduction of better-designed, better-sourced and more-profitable phones should help Sony Ericsson improve its performance and profitability. Three of these new devices – Aino, Yari and the Symbian Foundation Platform-based Satio – were unveiled in May. They are the first devices in the company’s Communication Entertainment strategy, and although the Satio is particularly impressive, they are not expected to be on the market until the start of 4Q09. Sony Ericsson cannot afford any delays with these new products or the expected Xperia X2.

Some other positives included continued investment in Play Now Arena, the company’s content-delivery platform. Sony Ericsson’s decision to make Play Now Arena available in 17 markets shows that it recognizes the growing importance of content and applications to mobile handsets across Sony Ericsson’s different OS platforms. The company plans to soon open its application store to developers. However, Play Now Arena will remain an asset only while the company can sell handsets in large enough numbers.

Another positive was Sony Ericsson’s announcement of a partnership on 3G handsets with China Unicom. The deal might point to some future sales of the four new 3G models it unveiled for China and continue the company’s strong performance in 3G-handset sales.

Sony Ericsson is right to focus its portfolio on higher-tier devices, such as its Communication Entertainment range. Such devices will help extend the brand and also offer greater profitability. However, Sony Ericsson’s weakness in the low end has seen it lose out where demand has grown for handsets that are cheaper than those made by Sony Ericsson. In the medium term, the company must increase its scale and profitability so that it can afford the R&D investments necessary to ensure its future success.

The joint venture’s operating margin remained negative in 2Q09, at -16.3%. Although that was a slight quarter-on-quarter improvement, helped by reductions in stock-write-off costs, it seems likely that profitability will be hard to achieve until the remaining €300 million restructuring charges have been paid off by mid-2010. With this financial performance, Sony Ericsson is likely to require additional capital investment in the coming quarters. If it doesn’t, the company might be forced into an early decision to reduce the number of smartphone platforms it supports.