Is Nokia Trying Out a New Profit Model?

Chris is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Toy maker Mattel (NASDAQ: MAT) has a unique profit model.  The company has a distinct portfolio of products that falls into what’s known as a “Product Pyramid.”

Mattel’s model is more than selling a single product – the pyramid profit model is a system that sells different products to customers as their needs and wants evolve.  According to one explanation:

It includes having products at more than one price point, including low end loss leaders and high end profit-generators.  Mattel’s Barbie is a good example.  They sell a Barbie at $20-$30, but are always at risk of imitators under-cutting. 

So, Mattel sells a $10 Barbie to seal off that risk.  It’s at the bottom of the pyramid, it’s barely profitable, but it prevents their competition from establishing a connection with their customers.  All clothes and accessories are compatible with the $10 Barbie, which still lends to profitability.  Now think about Mom. 

She grew up with Barbie and remembers her fondly, and mom now has money to spend.  The introduction of Mattel’s $200 Collector Barbies, provides huge satisfaction to mom, and huge margins to Mattel.   Different product, distinct customer sets.  

You can view an example of a high-end Barbie here on Amazon.

Pyramid of Phones

Nokia (NYSE: NOK) announced that it would be selling a $99 phone, the slick 4G-enabled Lumia 822.  The Lumia 822 is available exclusively through Verizon’s (NYSE: VZ) service.  According to The Wall Street Journal, Nokia:

Sells its current Lumia portfolio of smartphones through AT&T (NYSE: T) Inc. and T-Mobile USA, but industry observers have speculated it will eventually need a broader relationship with carriers if it hopes to increase its share of the hotly contested U.S. smartphone market.

Nokia made a wise choice by unrolling its new phone into the Verizon network.  Verizon added a net 1.5 million new postpaid wireless subscribers in the third quarter.  AT&T, by contrast, added just 151,000, a drop from 319,000 in the third quarter of 2011.

The deal comes at a good time for Nokia, which sold just 300,000 units in North America in the third quarter.  For comparison, Nokia has the second-most market share in mobile device sales, selling 82,300,600 units in the third quarter, according to Gartner.  Nokia’s total market share is 19.2%, compared to Samsung’s 22.9% and third-place Apple’s (NASDAQ: AAPL) 5.5%.

Sound Strategy?

Nokia is essentially creating its low-end version of Mattel’s Barbie.  For an example, take a look at Samsung and Apple, Nokia’s top two market share competitors.  Apple’s new iPhone 5 costs $199 with a two-year contract.  Samsung’s innovation-heavy Galaxy SIII costs the same $199 with a two-year contract.

Likely, Nokia’s goal is to mop up extra market share in North America by selling a low-end phone.  An added benefit is that customers who buy and like Nokia’s $99 Lumia 822 device may upgrade to the Lumia 820 or Lumia 900 models, or purchase a high-end Nokia smart phone when it comes time to renew their plans again. So, is Nokia rolling out a “pyramid” profit model?

Yes

Personally, I believe that Nokia is trying to accomplish two objectives with the move.  First is to boost its weak market share in the competitive North American market, which would help to make up the 15.6 million unit difference that it lagged Samsung in the third quarter.

Second is to roll customers into higher-end Nokia phones once their contract terms end.  Because Nokia’s newest phones run Microsoft’s Windows 8 instead of the now-defunct Symbian operating system, Nokia’s products become more “brand name” and thus stand a better chance for a turnaround.  Also, Microsoft is beginning to market its new mobile operating system, another boost for Nokia.

Conclusion

Setting up a product pyramid is a difficult task.  Mattel’s Barbie products succeed because they sell higher-end products to the same woman as she matures and grows older. 

Nokia runs the risk of gaining increased market share (and potentially stagnant or reduced profits) from its $99 phone, only to watch older customers upgrade to an iPhone when they become older.  For example, Nokia’s phone could become the phone of choice for parents who buy their teens a new tech toy, but a neglected device for adults who want brand name smart phones.

In all, I expect Nokia’s tactic to increase market share in North America – however, I am not brave enough to venture a guess as to the long-term viability of the strategy.  Because, while the toy doll industry may get disrupted every few years or even decades, the mobile phone industry faces disruption on a much more frequernt basis – making Nokia’s success with this profit model anyone’s guess.


ChrisMarasco has no positions in the stocks mentioned above. The Motley Fool owns shares of Apple and Mattel. Motley Fool newsletter services recommend Apple, Mattel, and AT&T.; Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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