Nokia's smartphone problem

Nokia may still dominate the overall cell phone market, but a steady slide in its smartphone market share could threaten the company's long-term standing.

On Thursday Nokia announced third-quarter earnings that, despite an unexpected loss of $832 million in its telecommunications equipment unit, beat expectations. The company managed to ship about 3 million more handsets than analysts had expected. But it also reported that its share in the growing smartphone market is on the decline, a sign that Nokia is losing ground to competitors, such as Apple and Research In Motion.

Nokia's cell phone shipments and revenue were not as good as they were in 2008. But no one expected them to be. Still, the third quarter of 2009 showed a glimmer of hope that the global recession might be subsiding and people may be returning to normal buying patterns in the mobile market.

Nokia's executives told investors that the company's overall global market share is expected to remain unchanged for the year at about 38 percent, good news considering aggressive attacks from competitors, such as Samsung and LG.

Olli-Pekka Kallasvuo, Nokia's CEO, said in a statement that the company sold more mobile phones in the third quarter than in the second quarter. And the company revised its expectations for the entire mobile phone market. Instead of seeing a total sales decline in 2009 of 10 percent, Nokia now sees a decline of only 7 percent compared to 2008.

Even though, Nokia appears to be holding its own in the overall handset business, it is losing ground in a very important segment of this market, which could hurt the company in the long run.

Nokia execs acknowledged that the company is losing market share in smartphones, the fastest-growing segment of the market. The company's market share has fallen to 35 percent from about 41 percent in the previous quarter. Nokia sold 16.4 million smartphones in the third quarter, which was down from 16.9 million in the second quarter. Nokia blamed component shortages like camera modules for its miss on smartphones.

But the slide in market share is best explained by growing competition from iPhone maker Apple and BlackBerry manufacturer Research In Motion, which are each eating into the company's sales.

While Nokia will say that its latest N-series device the N-97 has been a success, the phone--which is not tied to any carrier in the U.S. and sells for more than $600 without a contract here--has seen very low sales compared with the millions of devices that Apple and RIM are selling in the U.S. and overseas. Even Nokia E-series devices that are sold on AT&T's network in the U.S. are not getting the volume of sales that the iPhone and BlackBerry phones are getting. And without a strong showing in the U.S. market, Nokia's smartphone business is at a major disadvantage to its competitors.

The bad news for Nokia is that competition is only expected to intensify as device makers introduce a slew of new products using the new Google Android operating system Other products, such as the Palm Pre, are also likely to gain more traction over the next several months as they strike deals with more wireless operators.

But at least in the short term, the biggest threats appear to be Apple and RIM, which are gaining momentum as more consumers are enticed by carrier subsidized prices that come with two-year service contracts.

Nokia appears to still dominate the low end of the cell phone market. Its strength over the past several years has been in selling high volumes of low-cost devices to developing markets. While volumes are still high, there are indications that trouble is on the horizon.

Nokia said the average selling price for one of its mobile phones fell by 14 percent to 62 euros, from 72 euros a year earlier. The company's gross profit margin narrowed to 30.9 percent in the third quarter compared with 34 percent in the second quarter. And its operating margin for cell phones, which is the profit the company makes on its phones before taxes, fell to 11.4 percent from 12.2 percent in the second quarter and 18.6 percent during the same quarter last year.

It's clear that even as overall mobile phone sales rebound as the general economy improves, Nokia must work harder to maintain its market dominance. The company, which sells over 400 million devices a year, is not going away. But the once mighty Nokia may lose some of its muscle if it cannot develop compelling smartphone products to take on its rivals.

Nokia executives say they are working hard to come up with new products that will compete in this arena, but the company also appears to be devoting attention to adjacent market segments. It is difficult to say whether this strategy is a good one at this point. Nokia seems intent on developing a services business with its Ovi platform. And it is also getting into the PC market with a newly announced Netbook product.

These divisions are still small compared to the company's handset business. And whether these efforts turn out to be successful remains to be seen. But at this point, even success in these businesses will not offset losses in its traditional handset business anytime soon.