Motorola cellular phone accessory

It's the best of times for the wireless phone business overall, but for some top suppliers, it's the worst of times - or at least pretty awful. Exhibits A and B: Motorola and Ericsson, companies that in their recent earnings reports disclosed complex problems plaguing their wireless handset businesses. The companies are No. 2 and No. 3 in the race for market share, but at the rate they're going, they have a slim chance of catching up to market leader Nokia.

To wit: Ericsson's consumer phone group posted an operating loss of $254.7 million in the second quarter, up from $3.65 million in 1999's comparable quarter, despite a 29% rise in sales to $1.47 billion. And it doesn't stop there: Total corporate pretax profit for the next two quarters will be reduced by $443 million to $553.8 million.

On the other hand, Motorola reported an actual operating profit of $132 million for its consumer handset business for the quarter, but that figure was down slightly from 1999. Profit margins remained at a paltry 4% compared with the year-ago quarter, although up sequentially from the first quarter.

So why are two well-recognized cellular phone giants struggling in a burgeoning worldwide market that is expected to sell about 425 million units in 2000?

Each has its own problems, and each is going up against a market leader that was the first to recognize that cellular phones were becoming a consumer mass market, said Ray Jodoin, principal analyst for global wireless services at Cahners In-Stat Group.

Motorola's bugaboo is profit margins. The company expects sequential margin improvement throughout the year, reaching a 10% operating margin by the fourth quarter, said Merle Gilmore, Motorola's president of communications enterprise business.

"We began shipping several new digital phone products and made significant progress in ramping up our new low-tier product platforms," Gilmore said. "This resulted in improved manufacturing margins [in the second quarter], both on a percentage and dollar basis."

Motorola plans to outsource production to Flextronics International and de-emphasize lower-margin phones, basically vacating Europe, where sales have slumped. But the core of the problem might be that Motorola historically hasn't engineered phones to be fashionable, said Todd Bernier, wireless stock analyst at Morningstar.com.

"Nokia has figured out that the cell phone isn't a communications device but a fashion accessory," Bernier said. "Nokia has gained critical mass and become the low-cost producer. That's why they can command margins like 23.5% at the end of 1999."

Ericsson's problems were more severe. The company lost 17cents on every dollar worth of sales in the quarter, Bernier said. Although Ericsson President Kurt Hellstrom blamed the quarterly shortfall mostly on a fire at a component supplier's production plant, the problems may lie deeper: an aging product line, expensive phones and phone manufacturing plants with outdated technology.

Hellstrom vowed to make the mobile phone business profitable within a year. He intends to do so by throwing out unprofitable product lines, outsourcing more products and introducing more entry-level phones. "They need to make a decision real soon about what they're going to do with their business," Bernier said.

Indeed, some observers wonder why these companies don't just sell their phone divisions. "These companies continually say that they want to be end-to-end [wireless] solution providers, but [infrastructure and handsets] are two different markets," Bernier said. "Phone users don't care that the wireless base stations are made by Ericsson, too."