Hang up on Nokia

While Nokia still holds some 19 per cent of the mobile phone market worldwide, much of this comes from its dominance of so-called 'feature phones', the mobiles that have fewer bells and whistles than smart phones. The trouble is that feature phones can't command high prices, and so offer thin profit margins. Meanwhile, smartphones are taking more market share and this puts even more pressure on the prices of feature phones.

This was evident in Nokia's third-quarter results for 2011, which showed that sales from feature phones had plunged 39 per cent to €2.2bn (£1.88bn) partly as a result of price cuts to help drive sales. In turn, operating margins plunged to 2.4 per cent from 11.3 per cent in the previous year and operating profits dropped 84 per cent to €132m.

Needless to say, this wasn't the plan. Nokia's bosses want to gain traction in the smartphone market, but Nokia's lack of innovation – and its slow speed to market – has put it significantly behind its rivals. Apple's iOS-based phones, Android-based phones and RIM's Blackberrys – smartphones all – collectively account for 71 per cent of the global mobile market, so it's little surprise that Nokia's smartphone business remains loss-making, with accumulated losses of €59m for the first nine months of 2011. Analysts at RBS Research estimate that Nokia's smartphone market share has continued to slip in the latest trading quarter, to just 14.6 per cent from 16.4 per cent in the second quarter, despite reductions in average selling prices from €142 to €131.

To regain its footing, Nokia launched the highly-anticipated Lumia 800 and 700 phones – the first products of the Microsoft marriage – last week. While these mobiles look impressive, it will be tough for them to compete with the two operating systems – iOS and Android – that command most of the high-end smartphone market and have loyal customers. Moreover, the Microsoft platform is too richly specified to be priced cheaply, as it was originally built for PCs. So the new Nokia Lumia 800 is priced at €420 (£367), placing it in direct competition with Samsung's newly launched and award-winning Galaxy SII phone and Apple's iPhone 4S.

The phone will also have to win over Microsoft's critics. Microsoft's Windows operating system still accounts for just 5.6 per cent of the global mobile market, perhaps because it lacks the features of iOS and Android. For example, there is the issue of applications. The Windows OS has just 30,000 'apps' ready for download, compared with over 300,000 available on Android and more than 500,000 on iOS.

However, some respite may be garnered through Asha, a group of four low-end smartphones released alongside Lumia that are targeted at the world's emerging markets. These low-end smartphones will retail for between €60 and €115 each with the aim of helping Nokia retain its grip on emerging markets, which account for 61 per cent of its sales. That said, with rivals like Apple slashing prices of older models in a bid to gain traction in these markets, Nokia may find it hard to compete with the power of Apple brand.

Despite these concerns, shares in Nokia have started to rally, perhaps in anticipation of an improved performance as a result of the new phone launches. The shares are now trading at 32 times forecast underlying earnings for both 2011 and 2012, a punchy rating for a group that will report losses for 2011 and will struggle to grow revenue and profit in 2012 and 2013.