Bad signals on mobile phones

With Motorola under pressure from investor Carl Icahn as its sales fall and Sony Ericsson warning on profits, the signs are that market saturation is taking its toll on the mobile phone industry. By Sarah Arnott

It looks like choppy waters ahead for the mobile phone manufacturers as slowing growth in mature markets starts to take its toll.

Carl Icahn, the billionaire investor, is suing Motorolaas part of a proxy battle to win four seats on the board. The documents being demanded by Mr Icahn – who upped his stake in the company from 5 per cent to 6.3 per cent earlier this month – include the strategy for the firm's loss-making mobile phone business, and come against a background of calls for the spin-off of the division.

Although Motorola retains its second-place ranking in the world's handset league, it has serious problems. In the three months to December, mobile sales were down 38 per cent year on year, leaving a loss of $388m (£194m). And the third quarter was little better, with sales down 36 per cent and a loss of $138m.

Analysts blame the problems on complacency after the whirlwind success of the Razr handset, which became the world's top-seller when it was launched in 2004. And at the end of January, the firm announced plans to explore "structural and strategic realignment", including the possibility of separating its mobile phone business.

But Motorola is not the only manufacturer that is suffering. Last week Sony Ericsson, which has about 9 per cent of the global market, issued a warning predicting pre-tax profits for the first quarter this year to between €150m (£117m) and €200m, compared with €362m for the same period last year. The company is blaming slowing sales of its mid to high-end handsets in mature markets.

The mobile phone industry is in a period of change as the precipitous growth in developed economies flattens off. A number of European countries, including the UK, Italy and Ireland, have penetration rates of more than 100 per cent – that is, more than one phone per head of population – and growth in the region was just 2 per cent last year. In the UK, there are some 72 million mobile phones, and 1.4 subscriptions per user. In Japan the trend is even more pronounced, with sales down by 3.6 per cent in the last quarter of 2007, according to the analyst Gartner.

Not only is the consumer market saturated, but manufacturers are also being hit by network operators' attempts to boost margins by pushing up contract lengths and spreading the cost of handset subsidies over as much as two years. In the UK alone, customer acquisition costs the industry more than £1bn per year, so the operators have much to gain, but slower churn is bad news for device suppliers.

There is also the pressure of "convergence" – single multi-function devices combining voice, internet browsing and entertainment such as music and video. Apple and Research in Motion – makers of the iPhone and Blackberry mobile email device respectively – both made it into Gartner's top 10 suppliers for the first time in the last quarter of 2007. And as voice-only handset sales slow, next-generation devices are showing strong growth.

Customers are also becoming more sophisticated. "Devices now tend to be higher-end and therefore more costly, but with a higher cost at the outset, users are holding on to them for longer," Andrew Parkin-White, a principal analyst at Analysys, said. "The average phone life of 14 months is increasing and the average replacement cycle is longer."

But despite the gloomy signs, there is plenty of life in the old dog yet. Global growth in 2008 will be slower than last year's 16 per cent, but is still expected to run at a healthy 10 per cent, according to Gartner. And the emerging economies, particularly India and China, have by no means exhausted their potential. The mature markets already account for only 30 per cent of the world total, and a massive 112 million units were shipped in Asia-Pacific in the last three months of 2007 alone.

One of the success stories is Nokia. The Finnish giant met its target to take 40 per cent of the global market in the fourth quarter of last year – more than twice the share of its nearest rival – and shipped more than 133 million phones across the world.

The company is as much a bellwether as Motorola or Sony Ericsson, according to Carolina Milanesi, a research director at Gartner. "Nokia has been able to have profit margins going up even with average sale prices going down," she said. "If Nokia starts to struggle then we really need to worry, but it is in a strong position because of its range – if top-tier handset sales go down, then it will make up for it with lower end devices in different markets."

And the size of the global market is such that it can absorb some slower growth. "Even if it reduces in size, it will still be one of largest consumer electronics sectors, because very few devices sell more than one billion units per year like mobile phones do," Paul Lee, director of telecoms research at Deloitte, said.

The shift is more about a change of dynamics. One of the reasons for Sony Ericsson's problems is that it has a narrower product range than, for example Nokia, and its higher-end focus is gaining less traction in the developing world, say analysts.

Even the pressures in the mature markets may not be all they seem to be. The correlation between rising sales of converged devices and a drop-off in standard voice phones is not black and white. There is already more than one mobile phone per user in the UK, and there is no reason such expansion will not continue, according to Mr Lee. "Mobile data devices are good at email and phones are good at calls. If you have one converged device and the service is lost, then you lose everything," he said.

The biggest manufacturers are also looking at ways to diversify their services. Nokia launched OVI last August, which gives customers access to internet sites, as well as the firm's own music and games portal and navigation services.

There is also scope for including mobile phone-type devices in all kind of different machines from parking meters, for payment authentication, to GPS navigation systems, for real-time traffic updates, to domestic cars, to run telemetry systems for maintenance or even insurance purposes.

"There are lots and lots of different machines that manufacturers could put a mobile phone capability into and work out a way to make money," Mr Lee said.

Licensing battles end in courts

Nokia and InterDigital, a wireless chip developer, said yesterday that there was substantial progress towards a settlement of their US dispute over alleged patent-infringement.

The case is just one of the areas of dispute between the firms. They have already settled one major claim. The Finnish mobile-phone company paid InterDigital $253m (£126m) in 2006 over a claim focusing on second-generation handset technology. But InterDigital launched another suit last year, claiming further infringement in the manufacture of third–generation phones. It added a similar claim against Samsung, which will continue regardless of this week's developments. And another challenge to Nokia is going ahead in the UK courts.

The Nokia/InterDigital disagreement is just one fight in an industry that is a hive of litigious activity in patent courts across the world.

Nokia has just seen the end of a case brought by Qualcomm, another chip maker, claiming it was violating two European patent rights. The High Court threw out Qualcomm's claim this month, a week after the US International Trade Commission (ITC) threw out Qualcomm's appeal against the December 2007 decision in another case against Nokia.

In January, a US judge ruled that Qualcomm was itself infringing a patent held by rival Broadcom for video-encoding technology. And in June last year, the ITC banned the import of certain 3G phones because they infringed another Broadcom patent.

But in June last year, Qualcomm was ordered to pay Broadcom $20m in a separate US case. And Nokia paid $20m to Qualcomm to settle an earlier dispute.

"There is lots of patent litigation around cross-licensing," said Jeremy Morton, a partner at Simmons & Simmons. "And saying that you have patents that are essential to a mobile-phone technical standard is very commercially important."

Sarah Arnott