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News and analysis of developments in the enterprise communication industry and market with primary focus on Europe.

The author aims to tap into ideas, insights and thoughts of the readers to get varied perspectives.

Views expressed in this blog are solely the author's opinion and in no way reflect those of his employer.

Monday, July 24, 2006

Product and Services-Gross Margins

Last week Nokia reported their second quarter 2006 results. Unfortunately, I couldnot attend the conference call hosted by Olli-Pekka. From their press release, it is understood that the quarter was a very positive one for the vendor, well yes, the vendor because when Nokia wore the service provider hat, it ended up in losses. Enterprise solutions reported an operating margin of (22%). How do we analyse this?

Motorola's Eric comes to help. I had a chat with him on Friday when he educated me on the offerings of Motorola's services business. They have recently merged their networks and GEMS (government and large enterprise) to form a single entity to offer end-to-end service and solution. Eric is heading the business in EMEA and CA . He helped me understand the business model and the financial outlays. Eric spoke about two extreme situations.

Case 1:

Network operators in mature markets are fanatic over control and they like to own their infrastructure. Hence, its a sell market. However, vendor financing is very strong in this space. On the other hand, in the greenfield opportunities in emerging markets, either the operator has a strong support from a financier who acts more as a guaranteer, or else the vendor helps the operator get upto speed, a fact that was coroborrated by the CEO of Ericsson during second quarter earnings call on the Friday last.

Case 2

Large enterprises believe in the mantra of 'core competence' and in 'efficiency'. Therefore, there is a general trend to out-task/outsource/offshore their infrastructure.

However, in both the cases, the comonality is the requirement of high capital outlay for the vendors to be compensated for regular long term revenue inflows. It is to be noted that the vendor bears the technology risk and this is affecting the value-chain. In today's world of fast changing technology, a new disruptor gives a vendor the edge for no more than 12 months, however, if he misses the boat, his value proposition drops by 10 points. When we compare the two and extrapolate over a $75 billion global market, with price differential on products dropping at an average of 11% in the services market, being a product vendor offers less advantages than being a service provider because-

1. Service provider is the prime contractor and therefore the owner of the account. This presents him with possibilities to upsell, cross-sell etc.
2. With operating margins in high teens, a price differential on products by 10 percent can be easily offset as products constitute around 40% of the total project in a typical multi-year managed service contract.

Mapping the pros and cons, while the gross margins drop to 30-35% in a services business, it guarantees longetivity.

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