Nokia Rocks Its Rivals Flawless execution put Nokia on top. Will customer love keep it growing?
By Janet Guyon Reporter Associate Paola Hjelt

(FORTUNE Magazine) – Last year was the worst ever for the telecom industry, but Jorma Ollila, CEO of Finland's Nokia, comes across like a man who has just returned from a six-month sabbatical in the South of France. At 51, he looks thinner and younger than he has in years. "I started watching my diet 18 months ago," says the smiling Ollila, who still hasn't any gray hair. Playing tennis at least three mornings a week, he's as fit as he's ever been.

By most appearances, Nokia is in peak condition too. In a year when all of the giant telecom makers but Cisco lost money on operations, Nokia posted $4.8 billion in operating profits, nine times more than John Chambers' Internet-router-and-switch company. Unit sales of Nokia cellular handsets grew 9% even as, for the first time ever, industry sales dropped (by 6%). Nokia grabbed share from its rivals, winning 37% of the global market last year, just three percentage points from its goal of 40% and more than twice that of Motorola. Most impressive, the Finns maintained operating margins of 20% in the cell phone business, which accounts for 74% of Nokia's sales. Few manufacturing companies can boast that kind of profitability, let alone in a down market.

Yet not everyone is impressed. A few days before Nokia reported fourth-quarter and year-end earnings on Jan. 24, Angela Dean, an influential technology analyst at Morgan Stanley in London, downgraded the stock. Nokia's shares swooned, bringing its market capitalization to $100 billion, $150 billion less than it was two years ago when its price/earnings ratio was a lofty 100. Dean says she's less upbeat than Nokia executives about growth this year in the Chinese market, which accounts for 11% of Nokia's sales, and doubts that the new "technophones" due out this year will impress consumers enough to make them buy. "We hope these new phones will drive growth," says Dean. "But we are less confident than Nokia." While the Finns project market growth of 10% to 16% this year, Dean is predicting a more anemic 6.5%, with just 410 million cell phones sold worldwide.

She has a point. Whichever numbers you believe, they illustrate what is not happening in the wireless-phone industry. It's no longer growing at stunning speeds, with annual sales zooming up by 45% to 65% a year, as they did between 1995 and 2000. Most people who can afford a cell phone in practically every developed country already have one (except in the U.S., which is burdened with competing technical standards). That means the industry can grow only by pushing phones in newer markets such as Russia, China, and India, where fewer people can afford them, or by persuading existing subscribers that they need either a second phone or one that's more state of the art. "From the early '90s until the first quarter of 2001, it was a spectacular continuous-growth story," says Ollila. "But it was as if on Dec. 15, 2000, someone had turned off the lights in the U.S. Then, in the third week of May 2001, they turned them off in Germany."

That leaves Ollila and Nokia with a problem that the company hasn't had to face before: how to keep growing as the industry matures. Ollila says Nokia will return to revenue growth of 25% to 35% by the fourth quarter of this year, with operating margins in the high teens--"if we implement well," he adds. The results include profits from the network-equipment division, where margins are in the low teens, vs. the 20% of the mobile-handset division.

Crucial to the outcome will be Nokia's ability to capitalize on a quantum leap in the technology of the world's wireless networks. Beginning in Europe this year, cellular operators will roll out packet-switched networks that route signals in the same hyperefficient manner as the Internet. The services that run over these networks will mark the first major step toward implementing so-called 3G (third generation) technology, which will let users of a new generation of cell phones cruise the Internet as easily as they can from a PC. The phones designed for these networks will also be able to send and receive images, and much more cheaply and quickly than the fanciest current models. So critical are the new networks to growth, says Ollila, that "this is a defining year for the industry."

If any cell phone maker can thrive in this new world, Nokia can. The company is a little bit Wintel, a little bit Apple, a little bit Dell, and a whole lot Coca-Cola. While rivals have stumbled over the past few years, Nokia has come up with the best products, the best manufacturing logistics, and the best brand name in telecom. Mastery of all three disciplines, executives in Finland say, is what sets Nokia apart. "This isn't a business where you do one big, strategic thing right and you're set for the next five years," says Ollila. "It's a big orchestration task."

The Coke-like brand-building exercise began when Nokia listed on the New York Stock Exchange in 1994. At the time, the company needed capital, but Ollila also understood that, especially in America, a widely known stock would boost sales of the company's products. "In the U.S., Wall Street dominates the media and the attention of the people," he says. Last year, Nokia spent $900 million, or 3% of sales, on advertising and sponsorships, and was ranked the world's fifth-most-valuable brand by consultant Interbrand, just behind GE and just ahead of Intel. Two years ago, Nokia was in 11th place. (Ericsson is No. 36 and Motorola No. 66.)

Nokia believes that such brand recognition will pay off as the market switches from one that adds new subscribers to one that sells existing subscribers new things. About 300 million of the globe's 930 million cell phone subscribers use Nokia phones. The company's research suggests that 80% to 90% of them will buy a Nokia when they replace their phone. "Our competitors have a much lower brand loyalty," says Matti Alahuhta, head of the mobile-phone division. And because Nokia's installed base is so large, it will get the lion's share of the replacement market, which the company expects to account for 55% of sales this year, and even more in the years to come.

With Dell-like mastery of logistics, Nokia reinforces that brand loyalty by delivering the right products at the right time. It learned this skill the hard way in 1995, when a parts shortage caused it to disappoint network operators and other customers that were expecting Nokia deliveries in time for critical Christmas sales. Logistical problems often hang up the mobile-phone industry. Phones are made from a huge variety of highly specialized parts, from microprocessors to transceivers to long-life batteries, and few makers produce all their own components. To succeed, a manufacturer must stay in close touch with its suppliers, making them virtual partners.

Few events illustrate Nokia's logistical prowess better than the aftermath of a March 2000 fire that broke out when lightning struck a Philips semiconductor plant in Albuquerque. The plant supplied Nokia and Swedish rival Ericsson with critical radio-frequency chips. Weeks passed before Philips was able to resume shipments. The resulting shortage devastated Ericsson, which had no backup suppliers; it missed production targets and posted a $1.7 billion loss in its handset division that year.

In the days immediately following the lightning strike, Nokia's constant scrutiny of its supply chain alerted it to a blip in chip deliveries even before Philips told it about the fire. Ollila intervened personally and within two weeks persuaded the Dutch company to dedicate other plants to supplying Nokia. The Finns also redesigned their chips so that producers in Japan and the U.S. could make them also. Despite the fire, Nokia made its production targets and took market share from Ericsson, gaining economies of scale unmatched in the industry. "We were supplied by the same factory, but we acted faster," says Pertti Korhonen, who was Nokia's troubleshooter.

Nokia anticipated the current slowdown sooner than its rivals too. In early 2000, when employment was approaching 60,000, Ollila decided the company was getting too big, too fast. For four years it had added people at the rate of 1,000 a month. That couldn't go on. "We had to make sure everyone knew what they were doing," says Ollila. Nokia quit hiring, stopped adding new projects, and began outsourcing production of network equipment and cell phones. Although the sales drop hit harder than Ollila dreamed, Nokia avoided big layoffs.

So far, Nokia has also been quicker to master the technology and design quirks of cell phones and make the most consumer-friendly devices. With an Apple-like flair for melding form and function, Nokia has given most of its phones a smoothness and roundness that make them pleasant to hold. Interfaces are instantly understandable. The Finns have carefully segmented the market according to style, from ultraluxury, with the new Vertu platinum and gold phones, to basic.

That strategy has worked until now, but to succeed in a maturing industry Nokia will have to learn some new tricks. With demand for plain-vanilla phones nearing saturation in many countries and Nokia approaching the upper limits of market share, the company needs to drive prices higher. But as Dean of Morgan Stanley points out, when commoditization takes hold, average selling prices go down. Indeed, cell phone prices have declined by 15% to 20% a year for the past decade.

If it wants to lift prices, then, Nokia will have to introduce products and services so compelling that people will not only want to buy a new gadget but also pay more for it. "If we only had to add new technology, it would be easy," says Alahuhta. "Our challenge is to understand what services people will use and in what ways."

To date, neither Nokia nor any other company has had much success selling more than voice service with a bit of text messaging. Two years ago, Nokia talked about making phones for browsing the Internet. The idea never took off. Now company executives are hoping to have a hit with devices that support so-called multimedia messaging--sending not just voice but also graphics, audio clips, and photographic images over cell phones. Nokia also sees a future for phones that double as entertainment devices--a phone-enabled Sony Walkman, if you will--and for ones that allow game-playing, electronic shopping, and mobile access to office applications. "All the research tells us that this will be the next explosion," says Alahuhta.

To exploit the fatter pipes of the new wireless networks, Nokia will need a helping hand from network operators like Vodafone, which has 100 million subscribers worldwide, and from its competitors too. After all, why would anybody buy a phone that can send pictures if nobody else has one that can receive them? This is why the company is pushing for open software standards--and why it is battling Microsoft, which wants to extend its dominance in personal computers to mobile phones. The new multimedia mobiles must also connect to PCs. "It is essential that we collaborate with competitors to make all these devices interoperable," says Korhonen, now senior vice president of the mobile-software unit.

By tapping into new markets, though, Nokia is butting up against a new class of competitors well versed in selling consumer gadgets. Samsung, for example, built share from nothing five years ago to 7% in 2001. And don't forget Sony, which has teamed up with Ericsson and is another formidable brand.

So Nokia is blitzing the market with new products, promising 20 in the first half of 2002, nearly double the number in the same period last year. Its digital-camera-in-a-phone, the 7650, will start selling in the second quarter. Late last year Nokia introduced its 5510 entertainment phone, which incorporates an FM radio and digital music player.

It's too early to tell how well these phones will sell. But Ollila has been nothing if not in sync with the times. He put the company on its head-count diet at the same time he went on his own. "I didn't want to be CEO of this company with 100,000 people because you can't keep in touch with the front line," he says. "And when management stops being interested in the front line, or can't see it, the company gets in trouble."

Given the upheaval in Nokia's business, Ollila can't afford to be blindsided.