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Mobile giants: 4G is so yesterday. Better IT can kickstart revenue growth

Hear that, IT crowd?

By Wireless Watch, 7 Nov 2014

Just as operators struggle to make direct profit improvements from LTE, so the vendors have long given up on 4G upgrades being the solution to all their problems.

LTE is the most significant factor in driving revenue growth for the big five infrastructure suppliers, for sure, but the margins and differentiation in the equipment itself are in sharp decline, and trends such as virtualisation and HetNet will only worsen that trend for the OEMs.

As Nokia’s and Ericsson’s third quarter results show, the vendors are shifting more aggressively than before to the key new technologies – which will not only deliver the revenues of the future, but could do so with more attractive margins.

A few years ago, the companies’ CEOs would have talked of little but LTE network deployments and managed services as the key to a golden future.

Now it is all about software – radical concepts like virtualisation and SDN (software defined networks) hover on the horizon, but the companies see their carrier customers already thinking about their networks in a new way, and recognising that their own future success will lie in new core and back office platforms that can squeeze maximum value out of their LTE and LTE-A investments.

Look to Nokia Networks

Nokia Networks has been a trailblazer in many areas of network software, paving the way for a fully software-defined future with its Liquid architecture. This seeks to allocate network resources flexibly – and increasingly, dynamically – where they are needed, throughout the RAN, core and transport. With the Liquid Applications offering, it also pushes more applications, content and intelligence to the edge of the network. This draws Nokia into valuable alliances with the IT giants like IBM, alliances which are increasingly targeting carriers as networks turn into applications platforms. Last week, Nokia established an industry alliance around its edge-based architecture in the hope of driving de facto standards.

Nokia hopes such activities will give it a headstart in terms of operator trust, stable technology and industry alliances, as carriers start to deploy their networks in a new, more virtualised way. Its Liquid approach has already started to boost its LTE sales and mobile broadband contracts were the star of its strong third quarter. However, CEO Rajeev Suri was clear that wireless infrastructure has become a very seasonal and fluctuating business, and that other revenues, in software and services, would be essential to delivering predictable levels of profitability in future.

Ericsson’s third quarter raises US fears

As for Ericsson, those fluctuations are already affecting its performance, notably in its largest market, North America, and that will intensify its efforts to dominate the process of transforming the OSS/BSS platforms for a virtualised era, and to become an IT powerhouse as well as a telecoms giant.

The Swedish firm’s third quarter revenues came in above expectations, but were overshadowed by concerns about north America, which has been its strongest region since it acquired the bulk of Nortel Networks in 2009. In north America and globally, the strongest area of growth was support solutions, particularly OSS/BSS, in which Ericsson has made important investments and acquisitions in the past couple of years – most recently Metratech.

Support solutions rose by 30 per cent year-on-year in revenue terms, while global services, including outsourcing, were up just two per cent.

Once a difficult market for Ericsson, the company changed its US situation around when it acquired much of Nortel out of bankruptcy and laid the foundations of a strong US presence, fortified by big wins in the early LTE rollouts at Verizon and AT&T. North America is now the company’s largest region by revenue.

Overall, Ericsson’s net income fell by 13 per cent year-on-year to SKr2.65bn ($365m), hit by higher R&D expenses and the impact of currency hedge contracts. However, total sales were up 8.7 per cent on the year-ago quarter, reaching SKr 57.6bn ($7.94bn), and one of the most important metrics, gross margin, held steady, rising from 32 per cent to 35.2 per cent, in line with analyst forecasts.

In the Networks unit, sales were up 13 per cent. As in Q214, and at Nokia Networks, this was helped by a shift in carrier spending from upgrades, modernizations and coverage extension, to high capacity mobile broadband contracts, which are more lucrative and profitable in general. Ericsson saw its best mobile broadband growth in the Middle East, China and India rather than its traditional European and US territories.

Sales in North America fell by three per cent year-on-year and eight per cent compared to Q214. In contrast to more emerging markets and newer LTE deployers, the North American carriers are cutting back on network quality and capacity projects, said Ericsson, and focusing on “cashflow optimization”.

It added that the change in operator spending patterns in the region made it hard to forecast near term sales. "I think that is the main uncertainty for Q4," CFO Jan Frykhammar said on the earnings call.

CEO Hans Vestberg commented: "But we're not seeing any change in the underlying market demand in the US. Demand for new smartphones remains high."

However, investors were concerned that Nokia had reported a 53 per cent leap in Norht American revenues, admittedly from a far lower base, especially in LTE, where the Finnish firm only recently secured major contracts, notably with T-Mobile and Sprint (Ericsson is also a Sprint supplier).

Over-reliance on China

"The trend is clear: Ericsson's biggest customers in North America and Japan have largely completed their large roll-out programmes of LTE, and revenues are to an increasing level coming from other markets, among them Middle East and China," Bengt Nordstrom, CEO of telecoms consultancy Northstream, told Reuters.

"It will be increasingly important to grow market share in China which by far will be the biggest LTE market for the coming three to four years." Sales in north east Asia were up 16 per cent year-on-year, boosted by China and Taiwan but offset by lower spending in Japan and South Korea.

This raises a common concern for infrastructure players – over-reliance on China, where LTE rollouts are indeed huge, but where there is fierce competition from the incumbents Huawei and ZTE.

This was clear in ZTE’s Q3 results, which were in sharp contrast to those of its European rivals, with profit soaring 191 per cent year-on-year to CNY703m ($114m). This was driven by strong revenue increases in LTE, especially in China, Japan, north America and Europe, said the firm, as well as by a 40 per cent leap in its handset sales. Network equipment sales were up by 13 per cent and software and services by 6.63 per cent. Total company revenue grew 24 per cent to CNY21.1bn.

Telco OEMs become IT giants

While Nokia may be the cheerleader for bringing IT systems and content to the cell site, Ericsson wants to grow its capabilities in IT platforms at the back end, and especially in cloud services. It has increased its investments in Silicon Valley over the past few years and has a large lab, CTO and other teams based there.

Earlier this year, it created a dedicated cloud unit in the California hi-tech region, headed by Jason Hoffman, co-founder of cloud provider Joyent. One of Hoffman’s remits is to acquire startups and other companies to bolster Ericsson’s credentials in service provider IT and "as a service" offerings. Recent purchases in this area have included Apcera, Fabrix and Metratech.

The latter may be cloud-based versions of core carrier systems such as OSS/BSS or even packet core, or they may be platforms which operators can white label to deliver their own services such as device management and connectivity for internet of things applications. The IoT raises potential conflicts of interest though, as Ericsson is also increasingly providing cloud services directly to auto makers and other new players in the mobile world – it has a major deal running Volvo’s connected cars and other M2M services, a deal which a more traditional Ericsson carrier customer, with its own IoT cloud, might have wanted.

In all cases, the move to virtualisation will accelerate the trend and will often be the spur for MNOs to outsource major systems, rather than take on the full burden of such a huge architectural and cultural shift. Some are planning to run their virtualised systems in the public cloud, or split them between public and private clouds, while others aim to outsource their legacy systems, to be maintained and eventually run down while the carrier’s in-house teams focus on creating the new platforms.

To address any of these variations, Ericsson has to expand from traditional managed services – building, running and maintaining mobile networks – into offerings which will bring it up against IBM and Hewlett-Packard.

The conventional network outsourcing, once a very important source of growth and profitability, has seen its margins squeezed, to the extent that Nokia and others have sometimes backed away from contracts they believed would be loss-making, especially in price-competitive markets like India. Ericsson has the scale to take on such deals and stay in the black, but it could certainly see better margins from transformation and IT projects in future.

Hoffman believes that the carrier cloud market is so nascent that there are plenty of opportunities for Ericsson to catch up with IBM, Microsoft and other enterprise IT powerhouses. He said in an interview with Bloomberg: “The vast majority of the market isn’t using cloud, can’t use cloud, doesn’t want to use cloud. And you have all these use cases showing up.”

When up against the enterprise IT brands, especially in the non-MNO markets, it needs to target to restart its stagnant growth. Ericsson will talk up its huge understanding of how mobile networks and devices work, and like Nokia, it knows that the more IT activity is moved to the edge of the network, the more its expertise comes into play – as opposed to that of firms used to building centralised data centre services.

Hoffman sounded very Nokia-like when he said that smartphones, connected cars and other devices would increasingly get their resources and content from a nearby base station, not a remote data centre, in order to improve responsiveness, speed and personalisation.

“We’re in an enormous transition,” Ericsson CTO Ulf Ewaldsson said in an interview. “It would put networks in the center of a transformation in the world where industries get digitalized.”

Ericsson will offer a detailed update on its emerging business areas – IP networks across fixed and mobile; cloud; telco data centres; virtualisation and transformation – at its Capital Markets Day on 13 November. While it will certainly look to be in the vanguard of big trends like SDN, its priority will be to kickstart growth after three stagnant years, with new projects that will deliver new revenues in the short to medium term. That means IMS-related projects, as VoLTE starts to take off and as carriers look to build their own new revenue streams on 4G, to boost their own returns on the technology; and it means a strong focus on IT and transformation projects, particularly in OSS/BSS, which require systems integration and intensive professional services.

Copyright © 2014, Wireless Watch

Wireless Watch is published by Rethink Research, a London-based IT publishing and consulting firm. This weekly newsletter delivers in-depth analysis and market research of mobile and wireless for business. Subscription details are here.

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