Nokia should stick to its guns on diversification, whatever the analysts say

Shiny suit, bright future? Nokia’s new President and CEO, Rajeev Suri. Nokia/handout/EPA

Nokia has announced its new strategy. The Finish technology company will focus on the infrastructure business that keeps our mobile lives operating smoothly and will continue to chase opportunities in digital mapping and patent development & licensing. The risk is that it listens too closely to market players who don’t like their companies to have fingers in too many pies.

Investors seemed happy enough with new CEO, Rajeev Suri. Following the announcement Nokia’s share price was up 5%. No doubt a commitment of more than €5 billion towards dividends, share buybacks, and debt reductions contributed to the positive reception. But the fundamental message to concentrate on mobile telecommunications infrastructure makes sense as well. As the world’s largest mobile telecom carriers get ready to invest heavily in fourth-generation high-speed mobile phone equipment Nokia is waiting to deliver equipment that is considered to be among the most advanced in the industry.

One part of Nokia’s announcement was more controversial though: the decision to remain diversified, and pursue the mapping and patents businesses. As some analysts pointed out, it is not clear whether there are any connections between these three businesses. Analysts typically prefer narrowly focused firms but I see three reasons why Nokia (and others) are well advised to keep a level of diversification.

Eggs and baskets

Industries inevitably go through cycles. While generating almost 90% of its revenues in its core mobile phone equipment business looks great for Nokia at the moment, it is less clear what happens when the likes of Vodafone, AT&T, and British Telecom reduce their investment in infrastructure.

There is also new competition from China to reckon with. Consider that China Mobile recently awarded 25% of its $3.2 billion contracts for building its first 4G network to ZTE, while only 10% went to Nokia. Activities not exposed to the same cycles and competitive trends mitigate against this risk. If anything it is advisable for Nokia to grow HERE and in its patenting business.

Innovation

Nokia had a history of fundamental industry shifts. Starting as a paper manufacturer in the late 19th century, it later became a conglomerate with activities from cable production to power generation, and phone production. Until its recent sale its core business was mobile phones. Allowing activities on the fringes provides the necessary freedom for people to develop new ideas which might ensure the future of a corporation.

Diversity in terms of activities also has the potential to stimulate new ideas which are less likely in a more streamlined organisation. It is not a coincidence that some of the world’s most consistently innovative firms, for example Google, GE, Samsung, are diversified.

Resources sharing

When analysts mention “synergies” they often think of reducing costs, for example by reducing the number of staff in corporate functions. While this is important, an equally important consideration is the opportunity to share ideas, technologies, and best practices across an organisation. Reviewing 55 academic studies on the performance-diversification relationship, Leslie Palich, Laura Cardinal, and Chet Miller conclude that there is a consensus that diversification into related businesses is beneficial as companies are able to leverage their resources.

The three businesses Nokia pursues have sufficient similarities to work together. Whether they will succeed in this will depend on the systems and incentives the new CEO and his team put in place. Yesterday he announced that these are currently revised to fit the strategy – hopefully with an eye on co-operation across the firm. Equally important will be personal networks and connections – for example through cross postings.

Diversification has been a hot topic for many decades. Fashionable in the early 1980s but seen as a license for wasteful cross-subsidization since the 1990s, we see successful conglomerates such as Tata and Samsung and start to wonder again. In a study of companies which succeeded for 100 years I discovered that neither narrow focus nor diversification into unrelated industries pays off.

Analysts might take the view that investors can always diversify their own risk (that is, buy shares in different focused companies) but from a company’s perspective the ability to reduce industry-specific risks and make best use of their resources is the way forward. Drifting too far from the core, however, imposes co-ordination costs outweighing the advantages.

On balance, Nokia’s strategy seems to be on the right track. It is also encouraging that the new CEO lists “engaging and understanding employees” as his number one priority. According to my study of century champions this is part and parcel of successful strategy execution.

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