Nokia: The Path To Recovery

What this country needs is a good $99 smartphone.

That’s what Thomas R. Marshall, Woodrow Wilson’s Vice-President (1913-1921), might have said today instead of ‘a good five-cent cigar’. Smartphones are still very expensive, at least at the pre-subsidy price. Carriers pay over $600 for top-end phones and ‘subsidize’ customers who pay a discounted price if they commit to a multi-year wireless plan. But prices are destined to fall in the next few years. Within a decade, we could be looking at a $99 phone (pre-subsidy) which will approach the same functionality as today’s flagship phones.

Regarding their competitive strategy, there are two ways for smartphone producers to deal with this evolution.

1. A Top Product Strategy

One way is to start at the top with the best possible product and to continually improve its features. The flagship phone produced by each company can then remain at prices similar to today’s prices but its capability will grow year after year. This seems to be the strategy followed by Apple with each of its product lines. Each has a similar price as a few years ago but its functionality is much greater.

This strategy however has its limitations: at some point, whether it is in 2013 or in 2018, a majority of the buying public will not care as much about new features because the new phone’s capability will far exceed whatever need or use the consumer may have for it. Adding music and cameras was huge. Adding wifi was huge. Adding apps was huge. At some future date, they will be adding things that only tech geeks, or the few people who use their phones’ full capability, really care about. Even within the apps catalogue, most of us will truly care about only a dozen or so. And most of us are rarely more than thirty minutes away from our personal or work desktop computers. There are truly very few apps we ever need to use urgently, in less time than it takes to reach a desktop.

For companies with a product strategy, it is a challenge to keep people interested in new features. And it is a race against time to release these features on a schedule which will preserve high prices and high margins. In most such races against time, time ends up winning.

2. A Bottom Price Strategy

The other way for smartphone producers to deal with new competitive pressures is to start from the bottom with a preset price for a phone and to see how many features can be packed in at that price while the phone is still profitable. So say a company chooses $99 as a price before subsidies and it sets out to discover how good of a phone it can deliver at that price. The first few phones priced at $99 will look very inadequate. But here, unlike with a product strategy, time is an ally. The more time goes by, the better the $99 phone will become. In the future, a $99 phone will be as good as an iPhone 5 or a Samsung Galaxy S4.

Asha Rising.
Asha Rising.

The question then is which company would you rather be? Would you rather be the first company racing against time trying to slow down margin erosion by offering more and more features, while hoping that customers will still want them? Or would you rather be the second company, with time as an ally, securing a growing segment of customers who want a low price and who only use a few apps on a regular basis? In the early days of the smartphone, when new features addressed important market wants and needs, I would have to put my money on the first company and it made sense to invest in Apple. Going forward, I would have to put my money on the second company.

Industry Shift to Dumb Smartphones

This is where Nokia could make a strong comeback. I have no idea whether it will pull it off, but it has a plausible path to recovery. Nokia lost the first smartphone round to Apple and Android. It could gain market share in the high end with its Lumia Windows Phone 8 phones but this looks like a difficult proposition, as noted by many authors here. It is not enough for the Lumia flagship to be as good as a top Apple or Android phone; it has to be significantly better or its price has to be much lower to compensate for consumers’ inertia, brand loyalty and switching costs. You may not consider a top Lumia phone if it is $50 cheaper than an iPhone but you would consider it if it was $100 cheaper and if you are not too rooted in the Apple or Android ecosystem.

Within the Lumia range, Nokia recently introduced the Lumia 521 priced at $150 with no contract, but its margin on this phone is probably low, or possibly negative. The challenge for a ‘bottom price strategy’ is to deliver a low-price phone which is still profitable for the manufacturer. Entry level phones like the Lumia 521 may be unprofitable and positioned as loss leaders to gain market share and to attract buyers in the hope that they will later migrate up to more profitable phones.

Generally speaking, when comparing Lumia to iOS (Apple) and Android (Samsung and others), there is rarely room for a number three to prosper in a space that is dominated by two aggressive well-financed players. Lumia has been gaining market share but it has yet to break into double digits.

Instead of banking too much on Lumia, Nokia can instead win the next round when prices start to fall quickly, or to put it differently, when the functionality of inexpensive phones starts to rise quickly. That is why, of Nokia’s two recent phone launches, the Asha 501 was in my view the more exciting. Not because of the phone itself, but because of the strategic shift it may bring. While the industry’s heavyweights are battling to claim the title for the smartest smartphone, an increasing number of consumers will be satisfied with a low-priced ‘dumb smartphone’.

The Asha 501 is priced at $99 and its functionality is very limited today. See CNET’s video review of the Asha 501 and a review by TechCrunch. But as noted above, its capability is only going to improve in coming years. Launched in India, it will ship in June via 60 carriers in 90 countries, mainly in emerging markets and Europe, but not the US. Instead of Windows Phone, it uses the Smarterphone OS, a stripped down operating system, and runs on 2G GSM networks. Not exactly the kind of stuff that would get an American buyer excited. But at a future date, Nokia may be able to launch a much improved low-priced phone in the US. Of course, Apple and Samsung can do the same but they are hamstrung by their high stock prices and the market’s expectation that they will maintain strong margins. Nokia has no such “problem” since its stock and margins are now distressed. Low expectations can sometimes be an advantage. (The same applies to other players who have fallen behind and have little to lose.)

To be sure, there are already lower priced or even free iOS and Android phones sold by the US carriers. For example, AT&T sells the 8GB iPhone 4 for 99 cents + an activation fee of $36 and a two-year contract. But a $99 price for an Asha-like phone, pre-subsidy or without contract, would still be significantly cheaper. AT&T sells the iPhone 4 without contract for $450.99.

In recent years, the key success factors in the smartphone business were product and technology. As prices tumble and consumers’ appetite for more functions start to fade, the new success factors will be price, manufacturing and logistics, all factors at which Nokia has excelled in the past. Perhaps it can do it again. If it does not, someone else will.

Disclaimer: The views expressed here are not intended to encourage the reader to trade, buy or sell Nokia stock or any other security. The reader is responsible for any loss he may incur in such trading.