Ericsson Choosing
To Take New Route
In Cell-Phone Field
By Peter Benesh
Investor's Business Daily
L.M. Ericsson AB said Friday it will have an outside company make its handsets, a move that surprised few analysts and investors, yet disappointed many.
There were two levels of disappointment. Some observers thought Ericsson should have kept the manufacturing, and thus the chance for greater profit, in-house. Others said the company should have exited the handset business altogether.
Those two critical opinions added up to a 13% decline in Ericsson’s American depositary receipts, which fell 1 3/4 to 11 1/4.
The Swedish firm, the world’s third-largest mobile phone maker, is on the same path as No. 2, Motorola Inc. Last month, Motorola said it will contract out much of its handset business, close one plant and hand over two U.S. handset factories to contract manufacturer Celestica Inc. of Toronto.
All of which is good news to No. 1, Nokia Corp., says Mike Walkley, an analyst with Dain Rauscher Wessels in Minneapolis.
While Motorola and Ericsson transition to their outsourcing plans, "Nokia will have time to gain market share from those guys," Walkley said.
He says Nokia isn’t likely to hire an outside company to make its handsets.
"They view manufacturing as their competitive advantage," he said. "They think their abilities are better than contract builders in terms of sourcing components and building things efficiently."
Will Lose 4,900 Jobs
Ericsson will retain control of marketing and sales of its handsets, which will keep its logo. But it’ll shift the huge manufacturing task to Singapore-based Flextronics International Inc. Flextronics will buy Ericsson handset plants in Brazil, Malaysia, Sweden and the U.K. and part of a plant in Virginia.
In the changeover, slated to occur by April 1, 700 Ericsson jobs will be lost and 4,200 workers will transfer to Flextronics. Ericsson now employs 105,000 workers in 140 countries.
Ericsson’s consumer products division has been losing money for much of the past year because of poor handset sales. The company reported a fourth-quarter operating loss of $155 million, worse than analysts had expected. Ericsson blamed component shortages and what it called an uncompetitive product mix.
In a statement, Ericsson Chief Executive Kurt Hellstroem says the changes will save Ericsson $1.6 billion per year.
Still, Dain Rauscher’s Walkley says the company should have left the handset business altogether.
"The mobile phone division was only 20% of Ericsson’s sales, but that 20% piece was eating away all its profitability," Walkley said. "The Flextronics deal is not the drastic step people were hoping for. People were hoping they would sell the handset business outright."
He questions Ericsson’s plan to continue as a supplier of all wireless system components, from handsets to the other products used in a wireless network, such as switching stations and antennas
That infrastructure business, Walkley says, is Ericsson’s strength. It should concentrate there, he says.
"Ericsson has said offering mobile phones gives it a key competitive advantage to win infrastructure contracts," Walkley said.
Should Add Flexibility
He says the company has more than 30% of the world market for wireless network hardware, aside from handsets. He predicts the figure will hit 40% as the wireless industry moves to 3G, or third-generation, wireless technology.
Some analysts lament Ericsson and Motorola’s failure to keep their handset brands in-house.
"It’s disappointing to me that Ericsson and Motorola weren’t able to get their internal cost structures where they ought to be," said Charles DiSanza, an analyst with Gerard Klauer Mattison in New York. But since the two companies couldn’t make handsets in-house profitably, he prefers hiring outside contractors to selling the business outright.
Contracting out is a viable strategy, DiSanza says.
"You have lower gross profit margins," he said, but Ericsson and Motorola now have the probability of making money on this business, rather than losing money.
Consumers don’t care who builds the phones, he notes. "Ericsson and Motorola will be the brands and they’ll do all the customer hand-holding, the customer liaison," he said. "They will add a lot of value and they will get themselves profitable."
He calls Ericsson’s decision a good strategy. It "gets rid of the losses and supports the infrastructure business."
Walkley, too, says the move gives Ericsson flexibility. "But if the company doesn’t start to return to profitability by the second half of the year, then I would expect more drastic measures."
Ericsson didn’t release financial details of its contract with Flextronics or give the sales price of its plants. The companies haven’t yet settled on a price, an Ericsson spokesman says.
An executive at Ericsson rival Siemens AG questioned the move. Volker Jung, who is in charge of Siemens’ mobile phone unit, told Reuters that Siemens and Nokia will benefit.
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