Recently, we have noticed something interesting. Go to the web sites of the top telecom suppliers and check in which order the words “products”, “solutions” and “services” appear there.
We have done the check:
- Nokia Siemens Networks (NSN): products, solutions, services
- Huawei: solutions, products, services
- Alcatel-Lucent (ALU): solutions, products, services
- IBM: solutions, services, products
- Cisco: products & services
- Ciena: products & services
Interestingly, IBM is the only company that puts ‘products’ last. And NSN, ALU and Huawei seem to put a strong focus on ‘solutions’. But are they really ‘solutions’ companies? Well, not in the IBM sense. Finally, Cisco and Ciena don’t even talk about solutions, at least at the top level.
The truth is that it is really difficult to be a product company, a solution company and a service company all at the same time, because:
- the key success factors for a product business (hardware, software) are different from those in a solution business or in a service business
- the internal DNA of a product hardware, a product software, a solution company and a service company are very different
- last but not least, selling product, software, solution or services are also very different matters. So if you want to do it all, you might need different sales organisation and skills for your various business lines.
In the product hardware business, global market share matters a lot. You want to be as big as possible, and spread your R&D costs over as many customers as possible. To be profitable, your gross margin must be of the order of 50%, so that after deducting R&D costs (15%-25% of revenues), Sales costs (15%-20%) and G&A (5%-10%), you still have a chance to make a profit. In this kind of business, the king is called Cisco: for the year ending July 2010, Cisco has reported 64% gross margin, R&D costs lower than 15% of revenues, Sales costs at about 22%, G&A at 5% only. This gives you a net income, after tax, in the range of 15%-20%. Which is great for a product company.
In the software business, things can even be brighter. Gross margin is virtually equal to 100%, so even if your costs of sales are 30%-40% of revenues, this still leaves another 60% to pay for your software development costs. Look at Oracle: net Income is around 25%-30% of revenues. And this is after tax! The order of magnitude is similar for Google. These companies are money-making machines.
Service businesses on the other hand are very people intensive and don’t scale much. Success is based on your ability to attract the best people and retain them, and develop deep customer understanding and long-term relationship. Half of the business revenues are typically spent on staff costs for the service delivery (e.g. maintenance, professional services staff), and another 30%-40% on selling services. So EBIT margins are typically 10%, but not necessarily much more. In the service business you don’t necessarily have to be big; competition can be intense, as the barriers to entry are fairly low; but you can be profitable even with a low market share, as fixed costs are also low. They are millions of service companies out there that operate service businesses successfully.
Yet again, the solution business requires different kind of skills. It is all about developing a comprehensive eco-system of product partners, develop the ‘glue’ (integration: software, services, processes) necessary to integrate those products into an end-to-end solution, understanding customer requirements and providing customers with the solution that best match their needs. There is no place for the ‘none-invented-here syndrome’ so common in product companies. Finally it is also about being able to make money and profit from reselling partner products, after bundling those products with one’s own value creation.
In the solution business, IBM is the king. In 2010, IBM made 44% of its revenues with software, 39% with services, 9% with financing and only 8% with hardware. Its gross margin was 46%. And its EBT margin 20%. Which is great.
Compare that with NSN. According to Nokia annual reports for the years 2007 to 2010, NSN has an average gross margin of 27%. With R&D costs of 17%-20% of revenues, there is no way NSN can be profitable, when costs of sales are at least 10% and G&A about 5%. NSN has lost 1.3bn Euro in 2007, 300m Euro in 2008, 1.6bn Euro in 2009, 700m Euro in 2010. Cumulative four-year losses: 3.9bn Euros.
What this tells us is that NSN lacks scale as a product company, its average market share across its very broad product portfolio has simply been too low in the last 4 years. No surprise then that the management has signalled that a new strategy is going to be implemented, focusing on the service business as well as key portfolio areas.
We wish NSN success in its transformation to a company with much less hardware, more software, more service and more solutions. IBM has done it in the 1990s, and we know that NSN has great people that can pull it through as well.