Are Nokia's Supply Issues Temporary?

Jun.11.13 | About: Nokia Corporation (NOK)

Last year, when the new line of Nokia's (NYSE:NOK) Windows Phone 8 devices hit the market, they were "sold out" almost immediately. Many people (including me) praised the company for selling off its phones so quickly. Once the quarter was over and the company announced its earnings, we found out that the reason it was able to sell off phones so quickly was because it was having supply issues. Even though the company promised to solve its supply issues, the progress made so far isn't that satisfactory. Currently, Nokia's cheaper smartphone Lumia 521 (sold through T-Mobile and Wal-Mart) has reportedly "sold out" in many locations, and we don't know if this is due to supply issues or too much demand; however, many people suspect that the company is having supply issues again.

As the company fails to produce enough phones for the consumers, it is leaving a lot of money on the table, which gets grabbed by the competition. After all, the smartphone market is a rapidly changing market and consumers of this market aren't the most patient people in the world. Hungry to make a sale, many sales associates will refer potential buyers to the next available phone if the phone they are looking for isn't readily available. As a result, Nokia's present and future business gets hurt. The company's present business gets hurt, because it fails to make a sale it could have made. Its future business gets hurt, because every phone sold is actually a marketing product for future sales. When people buy a product, if they are happy with the product, they are more likely to stay loyal to the producer of the product next time they buy a similar product. Furthermore, people are more likely to advertise a product to their friends if they are happy with it. If someone goes to a store to buy a Nokia Lumia but sees that it is out of stock, he or she is likely to buy a phone from competition and possibly stick with the competition until he or she is not happy with that company anymore.

I've been following Nokia for a long time and I remember the days the company didn't have any supply issues. In fact, Nokia used to be king of production and distribution. The company could distribute and sell its phones in places that are hardly visible on a map. I remember the days when Nokia would announce a phone, and it would be sold in 75 countries on the next day. Now, what are some of the possible reasons Nokia might be seeing supply issues right now?

1) Nokia might be "learning" how to build a smartphone. While the company has a lot of experience with feature phones, it is somewhat a newcomer as a high-end and medium-end smartphone producer. It is very possible that Nokia is still in the learning stage and the company is still trying to figure out how to effectively produce these phones in large numbers. After all, building a smartphone will be a lot more complex than building a feature phone and it may require a different skill-set as well.

2) The problem might lie with one or more of the companies in Nokia's supply chain. It is very possible that some of the companies providing Nokia with parts aren't really performing that well, and the company suffers as a result of this.

3) It is possible that Nokia is producing many smartphones in small quantities on purpose because the company doesn't believe that it can sell a lot of copies. Perhaps the company doesn't want to risk investing a huge sum on producing a large number of phones and not be able to sell enough of these phones to recuperate its investment.

4) There may be shortage of a material that is crucial for producing a Nokia smartphone.

I think the real answer lies with Nokia's restructuring efforts. Between 2010 and now, Nokia has implemented some changes in its production capacity, and I blame these changes for the company's supply problems. I also believe that the supply problems will be solved soon enough as the company's production changes take effect.

In 2011, Nokia had 8 production facilities around the world. In Cluj, Romania, Nokia used to produce higher end feature phones and low-end smartphones, and this production facility was closed in 2011. Furthermore, Nokia closed down another production plant which was located in Salo, Finland in 2012. This plant was also responsible for smartphones, and it mostly focused on Software and sales package customization. Two more plants, one in Komarom, Hungary and another in Reynosa, Mexico saw product shifts and focus changes as some of their assembly lines were moved to the factories in China and Republic of Korea. In summary, out of the 8 existing production plants in 2010, 2 plants were closed (Romania and Finland), 2 plants went through significant product changes (Mexico and Hungary) and 2 plants received updates in order to produce a higher volume of smartphones (China and Republic of Korea). Basically, 75% of all Nokia production plans went through major changes.

In addition, Nokia just opened a production facility Vietnam. This is a large project that was announced by the company two years ago. By moving most of the production to Asia, Nokia is making sure that it stays as close to its supply chain as possible, because most of Nokia's suppliers are in Southeast Asia. Furthermore, the company is cutting production costs and building affordable phones for most of the world population (keep in mind that Nokia also has a number of production facilities that serve Nokia Siemens Networks, and these are located in Germany, Russia, China, Finland and India).

In the last annual 20-F form, Nokia states:

We consider the production capacity of our manufacturing facilities to be sufficient to meet the requirements of our devices and networks infrastructure business (page 81).

By "sufficient" the company might mean quality, quantity or both, but it is not clearly stated in the section.

It looks like most of Nokia's supply issues are caused by the plant closings and product shuffling. Once the company "gets used to" the new production situation, most of the supply issues should be gone.

Restructuring is almost always messy. It always takes a lot of time, effort and resources. The resources and effort needed in order to complete a restructuring effort successfully increases exponentially if we are talking about a multinational corporation with complex line of products. Slowly but surely, Nokia is getting there. I know that many investors would have liked it more if Nokia's turnaround had been quicker, but facts are facts. As the company's turnaround takes a longer time, this allows investors a longer opportunity to buy the company's shares at cheap prices.

Disclosure: I am long NOK. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.