Cuts loom as Nokia sets its enterprise business free to chase growth

Nokia’s latest quarterly results revealed slight revenue improvements, a 40% year-on-year drop in net profits but improved operating margins. They were overshadowed by news of more job cuts, making it clear that, to achieve more impressive figures, the Finnish company still needs to slash its costs, as well as accelerating its expansion into new software and enterprise markets, and leveraging 5G.

Its efforts to inject growth into its business and move beyond the current period of stagnation show a contrasting approach to that of arch-rival Ericsson. While Ericsson’s CEO, Börje Ekholm, reversed his predecessor’s strategy of expanding into new markets, especially vertical industry sectors, Nokia has been pushing aggressively to turn itself in to a software-driven company which has a strong focus on other verticals apart from telecoms.

This keeps its options more open than Ericsson’s should the initial acceleration of 5G deployment fizzle out for a while (Ericsson remains over-dependent on near term 5G deployment). It also makes Nokia less dependent on just one set of customers, at a time when mobile operators are under intense pressure themselves; and appears to see it better positioned to compete against new competitors in a largely software-defined networking market.

So, from January 1, it will break out its enterprise vertical activities – which are initially centered on transport, energy and public sector sectors – into a standalone business unit, headed up by Kathryn Buvac, former head of strategy. This unit will also be responsible for web-scale companies, which Nokia has been wooing assiduously with products like its high-performance router chips, and what it calls “extra-large technical enterprises” like Bank of America.

To some extent, Nokia is emulating Huawei with this move. The Chinese firm also has an enterprise and vertical business – far more mature and broad-ranging than Nokia’s – which has its own R&D, delivery channels and sales structure. Nokia’s unit will include its whole product and service portfolio, optimized and tailored for the target verticals, and others in future. Key offerings will include the high-performance IP routing family acquired with Alcatel-Lucent, optical platforms, private LTE, the cloud-based evolved packet core (EPC), and the WING IoT platform.

Nokia’s enterprise business has an annual run rate of €1.2 bn, which means it accounts for 5% of total revenue, and it is growing at around 16% a year, a rate which the vendor will hope to boost by giving the business control over its own destiny, and heightened agility.

It estimates the addressable market for the new unit to be about €18bn ($20.1bn) a year, with predicted compound annual growth of around 13% over the next five years. Its main telecoms market is worth about €113bn ($129bn), but Nokia expects its five-year CAGR to be just 1%.

“On the enterprise side, our strategy has been to target high-growth, high-margin opportunities with a limited set of companies needing telco-grade networks,” said CEO Rajeev Suri. “Our strong results to date have validated this approach and we are taking steps to build even further on our progress.”

When the Finnish company first unveiled offerings like Cloud Packet Core and WING, it seemed clear that it would, if required, bypass its traditional cellular operator customer and deliver connectivity, security and platform-as-a-service to enterprises directly. It has been vocal about the rising requirement for private cellular networks, to support specific enterprise connectivity needs which are not well addressed by the generic mobile operator network.

In time, network slicing will help forward-looking telcos to support these specialized requirements from a single platform, but in the meantime, there is a growing gap that can be filled by private cellular or by unlicensed spectrum solutions like LoRa. Nokia’s platforms embrace all these options and put the vendor, rather than the operator, in pole position to dominate the enterprise connectivity and services value chain.

In recent months, Nokia has pulled back, at least in public positioning, from any hint that it might compete, in some circumstances, with its largest customers (or better still, with Ericsson or Huawei operator customers). But the logic remains intact, and by establishing a separate business unit, it may hope to pursue opportunities where the operator is surplus to requirements (or just a bitpipe), with fewer conflicts of interest with the core business.

The company announced another reorganization which reflects the more advanced state of its move to a software-driven model – at least compared to Ericsson’s. it will move its mobile core R&D into its Software Group, so that all its software will be developed and run on the same platform – the Common Software Foundation, originally defined at Alcatel-Lucent. This will help address the webscale companies which Nokia is so keen to target, with an end-to-end software platform.

However, the visionary aspects of Nokia’s announcements were offset by the high degree of awareness that moving to a software-based, vertical-driven model is not just about new revenues – it is also about transforming the cost base, recognizing that the traditional equipment business is commoditizing and that open software platforms will never deliver the kind of market control and margins that Nokia enjoyed in its heyday.

So the company warned of imminent job losses, as part of a program to cut a further €700m ($798m) in annual costs over the next two years. About €500m ($570m) of that will come from reduced operating expenses, particularly cuts to central support functions and consolidation of some activities. But these days, job reductions don’t just come from slimming down existing operations to reflect shrinking markets or margins.

They can also be enabled, even in modern growth units, by introducing automation, and Nokia acknowledged that its ongoing investment in digital tools and business automation would lead to lay-offs. It did not say how many of its 103,000 employees faced redundancy, but said the new restructuring effort – the latest in a process which has been going on for over five years now – will have a €900m ($1bn) impact on cashflow.

In its third quarter, Nokia reported sales of €5.46bn ($6.23bn), down 1% year-on-year, but up 1% in constant currency terms (an improvement on the second quarter’s 1% year-on-year decline at constant currency). On a non-IFRS basis, Nokia’s operating margin improved to 8.9% from 6.3% in the second quarter.

At the Networks business, which accounts for about 90% of sales, operating margin was up from just 1.5% in the second quarter to 5% for the third. However, this was still down on the year-ago figure of 12.7%, while group net profit fell 40% year-on-year, to €309m ($352m).

Sales at Nokia’s global services business grew 2% year-on-year to €1.38bn ($1.57bn), or 5% on an organic basis. There were also improvements across all units of the IP networks and applications division, except the IP routing business, where Nokia said it had suffered from a components shortages across the supply chain.

Nokia Software reported a 3% increase in sales, to €363m ($414m), and a 4% rise in constant currency terms. In its statement, Nokia said the business had benefited from “investments to build a dedicated software salesforce with specialized go-to-market capabilities”.

Nokia Technologies, the licensing unit, reported a 27% drop in sales, to €351m ($400m), and a 26% decline in operating profit, to €290m ($331m).

Suri said in his statement that the results “validate our earlier view that conditions would improve in the second half of the year”. He added that Nokia saw growth at all five of its networks business groups, and had achieved better profitability than in the first half of 2018. But while sequential uplifts are encouraging, the markets will want to see year-on-year improvements to be convinced that Nokia really is turning a corner rather than riding on seasonal ups and downs – hence the importance of the new cost-cutting program.

The firm said it was on track to achieve targeted cost savings of €1.2bn ($1.4bn) by the end of this year, while the new cuts are intended to raise its operating margin to between 12% and 16% for the 2020 financial year.

“The plan we are announcing today is the logical step to take as the completion of our Alcatel-Lucent-related cost saving program draws near,” said Suri. “Since the acquisition closed, we have been integrating and capturing synergies and now it is time to focus on optimizing and ensuring that we are lean in every part of our business.”

The company repeated its full-year guidance for an operating margin of between 9% and 11%. It expects net sales at Networks business to outperform the addressable market, which it thinks will fall by 1% to 3% this year in total revenues.