(I really didn't want to write this blog nor its two follow-ups, but after I saw the Stephen Elop interview on CNBC just a few hours ago, I knew I really had to come and do these blogs. This is part 1 of a 3 part series of blogs about Nokia and its Annus Horribilis, year 2011)
So Nokia announces a Profit Warning. We knew this was coming. I told you on February 15 what Nokia's change in smartphone strategy would do to the Nokia smartphones performance this year, and what (damaging) impact the new strategy would have for Nokia dumbphones and (no help) to the networks unit. So if you read the 10,000 word deep analysis of how Nokia's 2011 would pan out after CEO Stephen Elop's sudden total change to Nokia's strategy, that was all to be seen 3 and a half months ago, on this blog.
Now we know. It is my sad duty to report that I was right on all counts of that forecast up to this point in time. Nokia has announced a profit warning and explained it further in a conference call to investors. Where does it leave us now looking at that wounded giant we so used to love?
FOUR SLOPES, FOUR DATES
What we have now, is four slopes that relate to four dates. And to understand what Nokia's profit warning now means, we need to examine those four slopes in a bit of detail.
First, the two other units. Nokia's main business is divided into three business units of very nearly same size: the networks unit, the dumbphones unit and the smartphones unit. Each generates roughly speaking about a third of Nokia's total income. The smartphones unit makes most of the profit, the dumbphones unit a modest profit and the networks unit struggles to break even in any one quarter.
So. Four slopes. What do I mean? Well, lets go first to the time before Stephen Elop's Microsoft announcement, ie the time before February 11. This is our control point and it will help understand Nokia's management view.
Nokia invented the smartphone so it started the world with 100% market share. Since then, Nokia has seen its market share steadily decline a few market share points per year, some years a bit more, some years a bit less. It was down to 29% by Q4 of 2010 (when Apple was its nearest rival at 16%. Yes, even today, even after the disasterous Q1 after the Burning Platforms memo etc, and after Apple's best quarter ever, Nokia still towers over all of its rivals as by far the biggest smartphone maker on the planet. I know you may read or hear from news sources and pundits that Nokia has somehow 'lost' to Apple and Google and RIM but the reality is, that Nokia is still easily the world's biggest smartphone maker. This blog deals with reality, not fantasy. Even in its worst quarter ever, Q1 of 2011, Nokia sold 24 million smartphones. World number two, Apple sold 18 million. So lets keep to the truth and not go to nonsense hype.)
The major analysts who made forecasts for the smartphone manufacturer global market shares for the near future ie the next couple of years, most had Nokia safely continue as the biggest smartphone manufacturer, some predicted that Apple would pass Nokia and Nokia would fall to number 2. These were a minority of (mostly Apple-friendly) analysts. Remember, I am talking of the time before Elop's Burning Platforms memo and Microsoft alliance in February.
So. Nokia's year was starting at about 29% market share and most analysts expected Nokia to end this year 2011 with anything from about 25% to 21% to maybe as low as 19% market share. A severe decline yes, but Nokia would still safely be well above the market shares of HTC or RIM or SonyEricsson or Motorola, the only potential challenger would be Apple's iPhone.
And there is a very important point to mention here. The world is going from smartphones to the rich few, and spreading to the middle class many. The prices of smartphones worldwide are declining every quarter as the mass market buys more of ever cheaper smartphones. Nokia being a mass-market oriented brand, Nokia's average sales price for smartphones was far below the global average. And more relevantly, almost every quarter, Nokia's average sales price for smartphones would decline - as it was selling ever cheaper phones to ever more customers. The normal for Nokia smartphones is to see average sales prices gradually decline quarter on quarter.
And lo and behold, what happened from Q3 to Q4? Nokia's smartphone average sales price bucked the global trend - and increased. Why was this? Its because Nokia had previously gone many quarters without an honest flagship premium phone (The N8 was delayed by a year). But it finally shipped during Q4 and was eagerly picked up by loyal Nokia premium phone buyers, and helped turn Nokia's smartphone average sales price into an increase.
I am not trying to say Nokia was winning in the wars. It was a rough time in 2010. But for the first time in about a year, Nokia had great news in its smartphone unit, just conveniently in time for Stephen Elop's first full quarter of stewardship. Nokia seemed to be legitimately turning the corner. Its Ovi app store was the second bestselling app store in the world behind only Apple's iPhone App Store (ahead of many supposedly strong rivals like Microsoft, Blackberry, HP/Palm and yes, Android).
In the same category was Symbian. The much-maligned 'old' operating system was showing very strong form with S^3 powering the new N8 and other premium Nokia smartphones and winning lots of converts in the tech press and accolades, that Symbian was still viable (again far ahead of other older operating systems that had tried to do touch screen interfaces such as Microsoft's Windows Mobile and RIM's Blackberry OS).
And most of all, Nokia now had scheduled two new flagship premium phones for early Q1 launch. The E7 was like a souped-up N8, adding the slider QWERTY keyboard and even more expensive but running the same OS version as the N8. And the first MeeGo powered smartphone, the N9, was also ready for launch in early in Q1. These would come in perfect timing for the Chinese gift-giving season of Chinese New Year, traditionally a very strong sales quarter for Nokia (as it turned out to be as well).
It is very legitimate to think, that Nokia, which had struggled for years to come up with a solid answer to the iPhone, had finally done it with the N8, and now had true iPhone killers about to launch both in hardware (E7) and the first MeeGo powered smartphone. (Elop killed the first MeeGo phone earlier this year)
This is our base case. I am not arguing Nokia would not have lost market share this year. But I am arguing, that it is very fair to make the projection, that Nokia in year 2011 would do better than it did in year 2010, both in desirable smartphones and also in further raising its average sales prices - which should greatly help Nokia as the smartphone unit was Nokia's primary profit engine.
There is the saying you don't kill the goose that lays the golden eggs. And Nokia's Symbian S^3 powered touch screen smartphones were definitely the gold-laying gooses (or is it grammatically said 'geese' haha). While Nokia's profit was still far less than that of Apple or even RIM, Nokia was very arguably on the mend. The worst had been seen and all evidence suggested Nokia had just turned the corner in Q4.
So this is slope 1. We had major analysts suggest Nokia would likely end the year in the low to mid 20s in market share percentage, and if buoyed by some average sales price boosts by premium phones like the N8, E7 and MeeGo N9, Nokia could well see also reasonably good profits in the smartphone unit helping the whole company stay above the water.
ELOP BURNS THE PLATFORMS
So we get to February 11. Stephen Elop announces his Microsoft alliance. This action immediately causes Nokia's enterprise/corporate/business phones unit (the E-Series) sales to collapse. The following weeks see globally random handset stores and sales staff start to steer customers away from Nokia phones. Soon many carriers/mobile operators stop selling Nokia's Symbian phones. What phones are sold, are suddenly no longer desirable, and have to be sold at discounts which hurts Nokia sales prices.
It is not rocket science. I am not a genius for calculating the projected market share. Any competent Nokia strategy guy or vice president could have written a memo similar to my blog posting and done the calculation of how severely Nokia's market share would take a hit.
The relevant points were - that Nokia would terminate Symbian. That Nokia's previously announced migration path to MeeGo was also ended. And that Nokia would switch to Microsoft's operating system Phone 7. And worse - that Nokia would not deploy the current version of Phone 7, but rather wait for the next version, expected in the summer or autumn from Microsoft. And that there were no phone prototypes to show, and the first Microsoft based Nokia phones would not be available until early in 2012.
This is market share suicide, nothing less. Note, Nokia knew it was not going to have Microsoft phones for almost a year, but the damage to Nokia's Symbian based smartphones would take effect immediately after any Nokia CEO announcement like the above. Now, a smart CEO would have arranged it so, that the announcement of a shift in smartphone operating systems would have been made very near to when the next phone become available - to minimize the loss to current sales. That is elementary management. But for some unknown reason, Stephen Elop felt compelled to tell the world this news in February. (I will come back to that point in the next blog)
Three days after Stephen Elop's Microsoft announcement, I wrote my analysis of what happens to Nokia smartphones this year. That is not the only such analysis and not the first one either. But all major analysts who examined this situation, came to similar conclusions, that Nokia's market share this year, until the Microsoft phones arrive, will collapse. My analysis had Nokia's market share hitting 12% by Q4.
That would also mean that Nokia phones would be undesirable, hurting their average sales prices. That would also damage Nokia's premium price phones far more than low-cost smartphones - further diminishing Nokia's average sales prices. The damage to Nokia employee morale from 7,000 job cuts etc would cause far more costs and all sorts of internal confusion and more related costs, plus the integration with a totally new operating system, suddenly forced upon the designers, would add to even more confusion and delays and costs.
So Nokia's unit sales would plummet, Nokia's average sales prices would crash and Nokia's profitability would go from healthy profit margins in the smartphone unit at the start of the year, to losses by the summer, and the troubles (combined with struggling networks and struggling dumbphones units) would push all of Nokia into loss-making by year end.
That was the prognosis after February 11. The opinions on my blog were very closely echoed by many of the most respected analysts of our industry. The effects of the Microsoft announcement were obvious and did not take any sort of genius to see. Any internal Nokia senior manager would have FORE-SEEN this pattern when Stephen Elop would have discussed the possibility of a change from Symbian/MeeGo to Microsoft this February.
This pattern was like I wrote, the best case scenario, the optimist scenario, and that it was quite likely the reality would be worse (as it turned out to be). But any middle manager worth his salt could have told all the above to Stephen Elop or any of his new team. That was 100% predictable. And we know Stephen Elop made his strangely timed announcement of Microsoft (lets ignore if the decision was the right one, I mean just the timing. There was no possible reason why it had to be made so early in February). He made that CEO decision knowing full well it will plunge Nokia's profit engine into loss-making and slash Nokia's market share at least into half - of what it was projected to be under normal situations (where Nokia would anyhow have seen a significant decline in market share to begin with).
The decision to announce Microsoft in February was made inspite of its harmful timing, willfully, by the CEO. This tells us something. That he could have had his Microsoft OS just as well while postponing the announcement until October, and he could have kept Nokia smartphones (and his whole company most likely) profitable for the full year. But he ignored that, set his platforms on fire and pronounced his Microsoft partnership.
So we have the second slope, a far more perilous slope that pushes Nokia Corporation to at least the brink of profitability by year-end. But the second slope is conjecture, it was a theory at best, in February, not based on real numbers. Now for the third slope.
So we get the Q1 results. Nokia reported smartphone unit sales numbers, average sales prices and revenues well below those of Q4. How close to my projection? The average sales price is almost exactly what I predicted, but the smartphone unit sales and total revenues were far below even my forecast for Q1. So Nokia is already nose-diving faster than even I could forecast. Its total revenues for the smartphones unit are .. get this .. 17% below what I had forecasted in my doom and gloom projection of Nokia's worst year ever. 17% is one sixth. In just one quarter Nokia is doing a massive one sixth worse than my horriffic forecast.
At the quarterly results, Nokia gives guidance for the rest of the year, saying it will be rough until the new Microsoft phones arrive for next year. Nokia says it sees profitability fall into the single digits. But Nokia also discusses how well the China region had outperformed the rest of the markets. This is the same Nokia which last year specifically said in its Q1 results, that Nokia's strong smartphone sales in China were due to the gift-giving of Chinese New Year. So what happened, did Nokia forget or did Nokia try some clever PR spin? Because the Chinese New Year period this year terminated just before Stephen Elop gave his infamous Microsoft announcement. Nokia knew fully well, that most Chinese smartphone sales happened prior to the Microsoft deal. Thus China's sales were not typical of the rest of Nokia's markets. Even a child can see this. Did Nokia somehow delude itself about it?
So we have the third slope. This is reality now, versus the theory of Slope 2. And Slope 3 is worse than my second slope. And this disasterous Nokia market share and average sales price crash happened after China's gifts, and only covered a six-week period after the mid-February announcement. So Q1 actual sales did not even reflect a full quarter of Stephen Elop's announcement's effect. The reality is for all practical purposes 'twice as bad' as the real numbers reported in Q1 quarterly results.
And this third slope is even admitted by Nokia to threaten Nokia profits towards the end of the year. And if my second slope had Nokia at about 12% by end of year (and Nokia Corporation becoming loss-making by Q4) now this third slope suggests a Nokia market share in smartphones somewhere maybe in the 8%-9% range by Q4, and corporate losses possibly already by Q3. Lets be very clear. All of my early predictions have come true already - but in every case as bad or worse - and there is no counterbalancing good news (a new Nokia product line or major acquisition or whatever). The reality of Slope 3 is significantly worse than it was with Slope 2.
NOW THE PROFIT WARNING
So now six weeks after Nokia gave us guidance that they expect profits in single digits, they come back with a profit warning (!!!) that Nokia's smartphones may be close to losses already now! in Q2. Wow? What happened? They didn't know how to do basic math in April? Come on guys, even if the HQ lost its collective math skills, I know there are plenty of Nokia HQ visitors to this blog (I see who reads the blog, makes for very interesting insights into what companies are interested in which of my blog stories). And I drew the diagrams here several times. It is not rocket science. This is elementary calculations, primary school math.
But yes, the slope? Nokia tells us average sales prices are falling faster than they expected, that Nokia's desirability is suffering and that rivals are gobbling up Nokia's traditional stronghold markets from China to Asia to Europe, led by Android based smartphones. And now Nokia sees such a disasterous view to the future, it won't release annual guidance anymore, only quarterly guidance. This while the smartphone market itself is in hypergrowth (the total market grew 85% last year - yes, a 100 Billion dollar sized industry nearly doubled in size - and is projected to grow at nearly the same rate again this year).
Slope 4 means an even deeper crash-dive than it was with Slope 3. Remember, this is not now me, this is Nokia who say that while their Q1 results were bad, the year will be far worse still. Nokia is now guaranteeing to us that this year will be horrid. (And the news that the first phone will launch on Microsoft by Q4 - is not good news, it is very likely more bad news. It means now that the first and most observed Nokia Microsoft phone will be a rush-job, it will be hurried, it will not be well tested, it will be buggy, it will be flawed and it will disappoint. And meanwhile as Stephen Elop fired 7,000 people already, and now with the profit warning no doubt finds cause to fire some more - where do those rush-job resources come from? From other Nokia phone projects of course, causing more delays or buggy products also in the Symbian line. I would not be surprised if Elop uses the Profit Warning as the excuse to renege on the promised one MeeGo phone.. Meanwhile some reality check to those eternal optimists. How often has Nokia kept to its first promised launch dates recently? If they do launch in Q4, then remember, that is most likely the last week and only limited countries. It will only be one phone model. That phone is symbolic only, it won't matter in Nokia's bottom line this year, not unless they launch in October with a hit phone in most major markets.. Very very unlikely..)
But yes, what kind of numerical effect. Can I believe it myself? If its worse than Slope 3, then by Q4 according to Slope 4, Nokia's smartphone market share could be as bad as 6%-7%. And Nokia's corporate profits could vanish as early as Q2 of this year! That is THIS quarter now, with 29 days left to go to the end of June.
I said on February 14, that my initial reaction to the Nokia Microsoft deal, that I reacted to on Twitter and on this blog may have seemed harsh and hostile, but that the reality was worse than I had thought. Now we have seen the real numbers from Q1 and find that I was being an optimist in February. And after that, we have found out that Nokia management is that far out clueless, that they completely misjudged their disasterous quarter and have had to issue a profit warning only weeks later. This management team does not exactly attract votes of confidence.
Now, this blog is not a financial analysis blog and I usually try not to discuss Wall Street evaluations. But back to the point of Nokia just turning the corner in Q4 and to the start of the year. From when Stephen Elop was announced as Nokia's new CEO, Nokia's share price had climbed about 10% roughly speaking to mid-February. Since his Microsoft alliance announcement in February, the investors have rewarded his leadership by sinking Nokia's share price by about 45%. The sudden jump yesterday in Nokia's price was due to a rumor that Microsoft will buy Nokia... This Canadian Microsoft wunderkind was supposed to be Nokia's golden boy. So far he seems to have taken good growth trends and turned them into a world-record speed market share nosedive and the fastest destruction of profits of any company that didn't suffer a natural or engineering catastrophy. He is well on his way to be in the history books, but not as someone Nokia shareholders could be proud of... (To quote 'Sir Humphrey' from BBC TV series classic, Yes Prime Minister:) He is acting very single-mindedly to ensure he snatches defeat from the jaws of victory.
Which brings me to part 2 of this trilogy. We now know about the four slopes and yes, Nokia's Annus Horribilis has only started, softly. It is now proceeding at increasing pace to the pit of terror. If you can, get out while you can. This year is not going to be pretty and the scars will be visible for long even if Nokia manages to turn this around somehow miraculously and recover maybe to say a 10% market share by end of 2012 with the wonderful powerful consumer-friendly superphones powered by the guys who never managed any of that before, Microsoft.
So yes, read Part 2. I am puzzled about the timing. Why did Stephen Elop announce Microsoft on February 11 when he had no phones to show. Is it the desperate act of a madman? You might well think that, but I could not possibly comment.