Ericsson Cost-Cutting Plan Ends at R&D Department's Doorstep

(Bloomberg) -- The last shakeup in the phone-equipment industry crushed profit margins at Ericsson AB and many of the Swedish manufacturer’s peers didn’t survive. As the next upheaval takes shape, its new chief executive officer says he’s ready.

Borje Ekholm witnessed firsthand as an Ericsson board member the damage wrought by Chinese-led price wars. Ten months in as CEO at the Swedish wireless network maker, he foresees another wave of new rivals with the shift to networks run by software. Ekholm is resisting pressure to deepen cuts beyond the 10 billion kronor ($1.19 billion) already planned as he invests in research and development to guard Ericsson’s market position against further erosion.

“There will be other entrants coming. It always happens when you change models,” Ekholm said in an interview in London. “In no way can I jeopardize the investments in R&D, because that’s the way for us to protect the future.”

Ekholm, who stepped off the board into the top executive job to bring down Ericsson’s ballooning costs and revamp its strategy, is now preparing the company for the next phase of investment by carriers in fifth-generation mobile technology and services. The former McKinsey consultant gave himself breathing room on mid-term profit targets this month as he sets the company up to compete over the long run.

The next disruption wave will come as a consequence of mobile networks increasingly being based on software rather than hardware, Ekholm predicts. This so-called virtualization will probably also bring new rivals, from small startups to large-scale tech companies, because the barriers to entry are lower than with network gear.

“We should assume that,” Ekholm said. “If you stretch your imagination you could see anyone doing it.”

Fundamental Change

Ericsson is one of three major vendors left following a wave of consolidation that last year saw its Finnish rival Nokia Oyj swallowing up Alcatel-Lucent, making the French vendor the latest victim of increased competition from China’s Huawei Technologies Co. Ltd. and ZTE Corp. Their ascent over the past 15 years “fundamentally changed the industry,” Ekholm said, and a string of telecom pioneers, such as Siemens AG, Nortel Networks Corp. and Motorola Inc. exited the scene, leaving Nokia, Ericsson and Huawei in a three-way battle for dominance.

Ericsson’s response to mounting competition and contracting spending from carriers was to broaden its offering to lure new customers from industries such as broadcasting and utilities. Parts of that strategy are now being rolled back by Ekholm, who is considering a sale of Ericsson’s media unit to focus on the company’s core networks business.

Ericsson “needed to change,” Ekholm said about the state of the company when he took over in January. “We as a board as well as in the company tried to fight back by going into new areas, and that’s perfectly credible. Then we can look at it now and say we didn’t achieve the desired results.”

Last week, Ericsson laid out new targets for performance in 2020, including aiming for a gross margin of 37 percent to 39 percent by introducing more cost-efficient technology and reducing spending by 10 billion kronor next year. Ekholm asked investors for more time, pushing back an operating-margin target of 12 percent by two years, to after 2020. The shares declined after the announcement, which also prompted activist investor Christer Gardell at Cevian Capital to reiterate that Ericsson needs to cut costs faster and deeper.

“It was unfortunate that the company adjusted the target so soon, especially considering Ericsson’s weak history when it comes to taking responsibility for results and delivering on targets,” Gardell said in an email.

While it’s good to create targets based on conservative assumptions, companies should set out more aggressive plans when it proves more challenging to reach them, Gardell said. “We believe that Ericsson’s ambition should be to deliver on the targets ahead of schedule, and we see that as possible.”

Ekholm said Ericsson probably needs to bring its gross margin above the current target to sustain the necessary investments in research and development.

The closely-watched margin “probably has to be more than 40 percent long-term,” he said. And while “there could possibly be potential” to cut more costs to get there, changing the strategy of boosting research capability is a line in the sand that Ekholm, whose company hired some 1,000 engineers in the three months through September, said he won’t cross. “If I would have to sacrifice R&D investments to fulfill a goal, that would be the wrong goal to have.”

--With assistance from Nejra Cehic and Veronica Ek

To contact the reporter on this story: Niclas Rolander in Stockholm at nrolander@bloomberg.net.

To contact the editors responsible for this story: Anthony Palazzo at apalazzo@bloomberg.net, Rebecca Penty, Kim Robert McLaughlin

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