Nokia’s Grand Strategy: China. Silicon Hutong’s Verdict: Ollila’s Waterloo

In the Silicon Hutong Command Post, Shunyi

Jorma Olilla, prancing around China in a fit of self congratulation that Nokia has managed to be in business in China for 20 years (and please explain why anyone NOT on Nokia’s payroll should care?), is promising his shareholders two things:

1. No more price cuts this year; and

2. Sales growth in China is the key to the company’s future.

There’s a ton of coverage on this, a good example being Alan McEwen’s piece in the Scotsman, one of the few article I’ve seen that is not either a) a dutiful reproduction of Nokia’s press release, or b) a re-print of the Reuters wire story.

There are a couple of problems with both parts of that strategy.

No More Price Cuts? Check Mr. Ollila’s Medications, Please

Jorma admits that price reductions in the industry are going to continue driven by increased competition. He maintains that Nokia will not reduce prices and yet will grow 25% faster than the rest of the industry because Nokia will be focusing on high-end phones.

That’s fine, but how does that explain how Nokia will grow faster than the rest of the industry and grow market share without matching price cuts at the low-end and mid-range, where the majority of sales take place?

Answer: it doesn’t. Nokia will still be in a price war at the low end, because at that level consumers are focused on price, and if Nokia won’t match falling prices, it won’t sell. Their only hope at the low end is market share domination that will allow them to squeeze competitors through superior economies of scale. Want to maintain market share? Cut your price.

Pressure at the mid-range won’t be quite as intense, but let’s understand something: there is little evidence to suggest that consumers are going to stop looking for the best combination of price and relevant features. While there is some brand premium in this segment, it won’t hold up if prices drop precipitously in this region.

China is the Future? Be Afraid…

Nowhere in the world is pricing pressure more intense than in China. Local manufacturers – and there are close to 20 of them now, not counting those doing exclusively contract assembly – continue to drive prices down. And they’re not doing it for fun – they’re doing it because they have to.

Which brings us to the core of Nokia’s strategy to drive growth in China – break out of the major cities and into the lower-tier cities and rural areas. These are regions where the competition is strongest, where the price pressure is the highest, and where Nokia and its global pedigree mean the least. Taking market share in these regions is going to be about cutting price.

The news gets worse. Prices in the mid- and upper range are dropping rapidly as well, and China’s carriers are starting to pressure Nokia for special treatment, like coming up with exclusive models with distinct software and hardware. Interesting as this sounds, this will increase Nokia’s costs, and you can bet the operators will be cutting the same deals with everyone, neutralizing the marginal value of the deal and squeezing profits even further in the critical mid-range.

China’s dirty little secret is how bloody small the high-end is. So don’t count on the high end.

Expect 3G to be the savior for margins? Think again. Most experts see the potential of a $50 retail price on a color W-CDMA phone within 1218 months, driven in no small part by Chinese manufacturers, and possibly even a sub-$30 GSM phone in China.

So Nokia doesn’t want to cut prices, but it’s primary growth in its most important market is going to require extreme pricing competition.

Hello…?

This kind of unconscionable denial is why Nokia’s troubles are just beginning, and will not end until the company wakes up, discards Ollila, and navigates itself onto a course that is more in keeping with the current realities of the industry, rather than those of ten years ago.