Nokia made a bad call for 5G chips, scrambles to rectify situation

Nokia
Nokia has been regularly cutting costs the past few years, but perhaps it went too far in its R&D cuts. (Nokia)

On its recent third quarter 2019 earnings call, Nokia acknowledged that its 5G profit margins were dampened by the high cost of its “ReefShark” chipset. ReefShark is the brand name for Nokia’s mobile chipsets, which include its 5G products for the radio, the baseband and its massiveMIMO antennas.

On the earnings call, Nokia CEO Rajeev Suri said that when the company started working on 5G, it chose field programmable gate array (FPGA) silicon. A FPGA is an integrated circuit designed to be configured by a customer after manufacturing, providing a certain level of programmability. “They give you flexibility, they give you time-to-market advantage, but then they’re expensive,” said Suri, according to a Seeking Alpha transcript.

And apparently, that extra expense is cutting into Nokia’s profit margins in 5G. The company reported its Q3 2019 earnings last week and lowered its guidance for full year 2019 and 2020. Nokia’s stock is down nearly 30% since the beginning of 2019, and the company has suspended its dividend for the time being.

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“So, what we’re doing is, we’re moving to equity SoC-based products, which we’ll progressively start shipping during 2020,” Suri said. “To ensure that we execute on this fast and effectively, we are increasing investment in system on chip capabilities and moving aggressively to strengthen and diversify our supplier base.”

This week, Nokia acknowledged that it hired about 350 employees in Finland this year, and local media in Finland reported that a majority of those employees were hired to help speed Nokia’s custom 5G silicon work.

Sandro Tavares, Nokia’s global head of Mobile Networks Marketing, said the company had to make a choice a few years ago whether to use custom SoCs or FPGAs as the basis for its 5G products. He said FPGAs “put together the efficiency characteristics of an SoC but with the flexibility of being able to program via firmware.”

He said FPGAs seemed like a good choice at the time also because 5G standards were not fully defined and the FPGAs gave Nokia the ability to deliver solutions fast and with good performance. “But it has the flip side of cost and power consumption,” said Tavares. “FPGAs do cost more in unit price, and they do use more power. Now that things are pretty much set with Release 15 and 16, it’s good for us to get our SoCs.”

Custom SoC development can be a long process, taking two years or more. But Tavares said, “We have been working on the development for quite a while right now. We are now starting to ship the first products with our SoCs replacing some of the FPGAs.”

Cost savings versus R&D
 
The 2019 hires of 350 people in Finland are mostly dedicated to SoC development, confirmed Tavares. He said the company has about 16,000 people around the globe working on R&D. “We are repositioning our workforce to work on topics that are more critical for 5G development. We are hiring people in Finland and in other parts of the world and moving people from different programs to our 5G radio products.”

Since Nokia’s purchase of Alcatel Lucent in 2015, Suri has earned a reputation as a bit of a hatchet man, regularly boasting about cost cutting measures that often involve layoffs. But perhaps the company went too far with layoffs. On the Q3 call, Suri said “We also reduced our target to deliver €700 million in cost reductions in full year 2020 to €500 million. As I noted before, we believe there is a need to increase investments in 5G system on chip capabilities.”

Suri laid blame for the FPGA decision on a couple of factors. He said at the time of the decision, Nokia was dealing with the integration of Alcatel Lucent and FPGA seemed like the best choice for time-to-market to get in front of 5G. He also said, “one supplier let us down as well.”

Stefan Pongratz, senior director at the analyst firm Dell’Oro Group, said, “Nokia is honing-in specifically on these increased costs of the FPGA versus ASICs. That can explain part of the story. But if you take the overall business, there is more going on here than just FPGA migration.”

He said 5G is happening faster than expected, competition is fierce, and there’s been a need for increased R&D to deal with all the new complexity in the radio access network. “All those other factors are equally, if not more important,” he said. “Nokia also has to deal with consolidation of multiple platforms following the Alcatel Lucent merger.” He doesn’t think FPGAs, alone, account for Nokia’s need to adjust its operating margin down for 2020 by 4-5 percentage points.

In addition to scrambling to do its own SoC design, the telecom vendor is also now working with multiple suppliers, along with Intel. Suri said both of those actions were begun “a while ago.” But they won’t lower Nokia’s cost of its 5G products until probably early 2021.

Suri was asked bluntly on the earnings call why the company seemed to be missing the mark in terms of 5G leadership. Nokia has had three different people head up its mobile networks division during a four-year time frame. About nine months ago, it replaced the former head of mobile networks Marc Rouanne with Tommi Uitto.

“Tommi and his team have developed a comprehensive plan to ensure Nokia is competitive in 5G, and they are relentlessly executing against that plan,” said Suri. “Tommi is a strong leader, and he has my full support.”

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