August 2010
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Month August 2010

The Stupid Manager Theory applied to Nokia

“I would say that the highest abstraction level of the problem is that there are incompetent people managing, ordering or directing things.”

via Rescuing Nokia? A former exec has a radical plan [printer-friendly] • The Register.

Risku believes in the Stupid Manager Theory of business failure. It’s still the overall most popular theory describing why large companies fail. It’s so attractive because it’s so simple.

However, I have several counters/questions to this theory:

  1. When did management become stupid, exactly? The same group was in charge when the company was successful and the corollary to the Stupid Manager Theory is the Smart Manager Theory for describing company success. So how and when did they become stupid.
  2. The conspiracy of simultaneous stupidity. How did *all* managers in a given company become stupid all at once? Did they conspire to lose competence together? Was there something in the water? Didn’t anybody escape the stupidity pathogen? A further observation to be made is that when one company in an industry fails, it’s usually not alone.  Motorola, Sony Ericsson and now LG are in dire straits.  Is the stupidity contagious across companies? Should we quarantine managers at firms like Samsung that have not yet been impacted? If the stupidity comes from reading market news, should we just keep them ignorant?
  3. If the managers were always stupid then how did HR get so good at singling out the stupid (or those susceptible to stupidity after periods of intelligence). Isn’t the remedy to simply act in perfect contradiction to their choices and hire only the people that HR rejects. After all, being perfectly wrong is a precious gift.

LG dreams of smartphones [Updated]

LG has decided to reduce its bloated mobile phone lineup by half to around 70 from last year’s 145.

It plans to release 20 sets of smartphones this year with 15 models being Android phones.

He said that 4.2 million phones will be Android-based, while 1.8 million will use Microsoft’s Windows Mobile operating system, the executive said.

via LG jacks up smartphone sales target to 6 mil.

LG’s already thin margins were wiped out last quarter.

As of the end of the second quarter, Samsung’s global smartphone share was 4.8 percent, according to IDC. But LG’s presence was negligible.

[Update] From early 2009,

LG, the third-biggest phone maker, will produce about 50 models that run Windows over the next five years, said Scott Rockfeld, a director in Microsoft’s mobile business. Seoul-based LG will use the software as its primary program for smart phones, devices that can send e-mail and browse the Web.

Microsoft Signs LG Phone Deal, Updates Windows Mobile (Update1) – Bloomberg.

Why does Microsoft and LG keep talking about how many phone models they will launch? Since when does a large portfolio make up for poor products?

The opening salvo in an open war

The shit finally hits the fan…. : On a New Road.

So Oracle, who now owns Sun, who open-sourced Java(1), is suing Google over the way open Android is mis-using open Java.

Sounds like an open and shut case. I, for one, am looking forward to the opening statement.

(1) On November 13, 2006, Sun released much of Java as open source software under the terms of the GNU General Public License (GPL). On May 8, 2007, Sun finished the process, making all of Java’s core code available under free software/open-source distribution terms, aside from a small portion of code to which Sun did not hold the copyright.

HP's PC group spends 0.7% of sales on R&D

The research and development budget used to be 9 percent of revenue, Mr. House told me; now it was closer to 2 percent. “In the personal computer group, it is seven-tenths of 1 percent,” he added. “That’s why H.P. had no response to the iPad.”

via Talking Business – The Real Reason for Ousting H.P.’s Chief – NYTimes.com.

HP, by sales, the largest technology company in the world, can’t be bothered to spend money on R&D for its PC division. This is a surprise?  Since when does any PC company spend any money on R&D? Put another way, even if they did spend the money, what would they be researching and developing? PCs are commodity products where any improvements would neither be valued nor used.  On the measures of performance that everyone has for the PC, the product has been more than good enough for a decade.

They did not have a response to the iPad because they did not think anybody needed an iPad.  And that is mostly because Microsoft did not think anybody needed an iPad.

None of this has anything to do with Mr. Hurd. His peer group all agree on these fundamentals.

Phone incumbents' average operating margin: 4.5%. RIM and Apple: 34%

After ASPSales, and Unit Volumes we look at the three year history of operating margins for the seven most significant mobile phone vendors (Nokia, Samsung, LG, Motorola, Sony Ericsson, RIM and Apple).

The following chart shows the OM from mobile phone sales. These figures are as reported by the companies with the exception of Samsung and Apple. Samsung reports OM for its telecommunications unit as a whole and we have to assume that it’s largely accurate for mobile phones. Apple does not report margins for its iPhone but it’s possible to estimate gross margin percent for the iPhone and then subtract its overall OPEX as percent of sales. This assumes that OPEX is allocated to the iPhone in proportion to sales, which is the best assumption we can make at this time.

The data shows that the iPhone has been considerably more profitable, due mostly to a high ASP, than other vendors. Motorola and Sony Ericsson have been “underwater” with respect to margin for much of the time period, with LG recently dipping into the red.

Nokia’s margin erosion is a source of significant angst but note that it has just reached Samsung’s historic level (around 10%). LG, long seen as an up-and-coming vendor who took over the number three spot from Motorola is shown to have done so with moderate-to-low profit margins.

Overall, the phone incumbents have an unweighted average operating margin of 4.5%, down from 8.6% three years ago. In contrast, RIM and Apple have an average OM of 34%, up from 24%.  In other words, profitability has halved for the volume leaders while it has increased nearly by half for the entrants.

This goes a long way toward explaining the “smartphone gap” which is being filled by Android. As vendors see their unit growth, ASP and operating margins under pressure from low end disruptors, there is a tendency to flee to the high end that smartphones represent. Android offers an irresistible siren’s song.

Apple's Opex Efficiency

asymco | Apple’s R&D Efficiency.

Following up on R&D efficiency, we are measuring operational expenses for Apple.

Here is the chart showing how, as a percent of sales, R&D + SG&A have declined, though R&D has been more resilient holding fairly steady at 3 percent and SG&A dropping from about 11% to approximately 9%.

The iPhone growth rate

John Gruber puts things in perspective:

The key bit: “At the critical juncture […], when they should have gone for market share, they went for profits.” I think this encapsulates Jobs’s philosophy since taking over Apple in 1997. Take the high end of the market first, establish a brand and presence, then steadily start to expand.

Daring Fireball: N92.

I’ve long argued that Apple is in the phone business to win significant share (i.e. greater than the share they have had in the PC business).  Since the phone market is vast (1.2 billion phones sold in the last four quarters) iPhone volumes must be as well.

So how has share evolved, and what can we expect? This is a graph of quarterly share for iPhone including a four period moving average:

The trend is clear to see.  With seasonal variation due to the launch cycle, the share is likely to increase over 3% and keep going. How far can it go? That’s a strategic decision for Apple’s management. If we are to take Steve Jobs’ word that their plan is not to be a niche player in any market they target then I have to conclude that Apple is aiming above 10%.

The volume expansion in the US due to the end exclusivity is only the latest in a series of distribution deals that Apple has brought to bear: International expansion, dropping exclusivity in other countries and broadening the portfolio (including earlier models in current line-up) are all natural and obvious moves in a broader market push.

Pricing might be considered another lever that Apple could use, though that seems unnecessary today.

I conclude that growth in iPhone sales of 50% per year seems entirely possible for the next few years. Such growth would allow Apple to reach 10% of the world’s 3G subscribers by 2013. That would still be only 4% of all phones and 20% of smartphones.

Apple growth trading at GE value

Speaking of correlation

General Electric, the largest holding in the S&P 500 Value Index Fund, has a forward price-earnings ratio of fourteen. Apple, the quintessential growth stock and largest member in the S&P 500 Growth Index Fund, sports a P-E based on forward 12-month estimates of just 15.5 right now.

via CNBC’s Fast Money : Growth Vs. Value Confusion as Apple, GE Treated Equally – CNBC.

The near-death experience prerequisite

All phone vendors saw smartphones coming.  They hired all the right market research companies and spent lavishly on analysts to confirm that phones with operating systems were imminent.

Nokia was one of the early movers, establishing its own software platforms group as early as 2002 while others like Samsung licensed Windows Mobile or PalmOS as early as 2003. Yet not much happened to sales. The number of smartphones units sold as percent of total has been fairly low.

The following chart shows the number of smartphones sold as a percent of all phones sold for the top three vendors (as of the time when the chart starts early 2007). Note that the percent of smart products shipped did not accelerate or grow dramatically for the largest two vendors even into last year.  It’s still a pittance at Samsung (<5%) and even less at LG.

The one vendor that did stage a shift was Motorola. (and Sony Ericsson, though later and softer) Both converts did this shift when faced with near-death experiences of sequential earnings losses and catastrophic market share collapses.

Nokia is showing signs of a secular shift to smartphones but it’s been a decade-long process so far, a slowness that ripped shareholder value to pieces.

So is the precondition for a shift to smartphone focus a collapse in the core business?  It certainly seems so from the data. Motorola first, Sony Ericsson second, Nokia presently and Samsung and LG later.

Each of these decision points reflect precisely the timing of pain points with the core businesses.

Why this asymmetry? At first glance, the smartphone business should be sustaining and an attractive option to be exercised as soon as possible.  It offers better margins, better prices and a better return on capital.

So why is there this disconnect? As regular readers of this blog can probably guess, my hypothesis is that the smartphone business is disruptive.  Incumbents are motivated to ignore this business because it makes money in ways they cannot control. More importantly, their best customers are signaling (in non-transparent ways) that they don’t want their top vendors to participate in this market.

Is an iPhone worth 8 Nokia phones or 2 Blackberries?

Pricing is a leading indicator of value. Some might argue price and value are often out of whack but, in the long term the two converge.

So it’s instructive to measure how a vendor creates value by what it’s able to charge for its goods. In the case of mobile phones, price is summarized by something called ASP (average selling price) which is measured each quarter across a vendor’s entire portfolio.

Again, there might be local fluctuations, but the trend is your friend here.

Take a look at these charts I prepared based on the group of seven vendors I previously analyzed in terms of their sales and volume performance.

First, a history of pricing since Q2 2007. All figures are in US dollars current as of time of reporting.