How Ericsson will manage slowdown in radio market by cutting cost

Ericsson 5G radio prototype
Patrick Filkins, analyst at TBR, says telecom network and software maker Ericsson will weather a downturn in the radio market by targeting cost reductions.

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While Ericsson is funneling investment to growth initiatives such as cloud, media, OSS/BSS, NFV / SDN, Internet of Things (IoT), the technology company is structured to deliver the majority of its growth and profitability from building networks, a business in decline. Total revenue declined 10.8 percent year-to-year, driven by across-the-board revenue declines in Ericsson’s subsegments. Ericsson’s Networks segment was impacted particularly hard, declining 14.1 percent as the traditional RAN market is in structural decline.

Ericsson recognizes the broader radio market will continue to decline over the next couple years ahead of commercial 5G deployments, which will enable it to sell next-generation radio access hardware at scale. In the meantime, Ericsson announced expanded cost cuts that will enable it to achieve an annual operating expense run rate of SEK53 billion ($6.2 billion) by H2 2017. Ericsson’s 2015 total Opex was SEK64 billion. To achieve this, Ericsson will reduce R&D tied to IP research, an area ripe for pruning as it ramps up its partnership with Cisco. The cost reductions are achievable, but Ericsson will also need to accelerate headcount reductions.

Enabling digital transformation is a strategic imperative as Ericsson’s core RAN business will continue to decline

Ericsson is pursuing engagements around IT, mainly OSS/BSS, cloud and NFV, media service providers and a select group of alternative industries (e.g., transportation, utilities, public safety, etc.). Positioning itself as the preeminent digital transformation partner will enable Ericsson to drive new sales as it attempts to offset a decline in its core RAN business, as investment in 3G and LTE macro base stations is post-peak.

Ericsson is well-positioned to capture a leading share of digital engagements supported by its existing mobile payment, OSS/BSS, media portfolio and new investment in OTT enablement. In April Ericsson launched its Unified Delivery Network (UDN), a global content distribution network (G-CDN), which enables operators to combine and scale the delivery of video content and OTT services.

Ericsson notes China Telecom, Telstra and Far EasTone Telecommunications have joined, while non-telecom participants include Twentieth Century Fox and Paramount Pictures, among others. Though forthcoming 5G deployments will improve sales as Ericsson will scale and support 5G RAN deployments, 5G RAN investment will provide lower volume in comparison to previous cycles of 3G and LTE investment, challenging long-term growth and marking efforts to grow its digital business a strategic priority.

Ericsson is expanding its optical services headcount by acquiring Abentel

In July Ericsson announced its intent to acquire Abengoa subsidiary Abentel, a provider of fiber services. Abentel’s 500 employees will join Ericsson’s Business Unit – Network Services. Ericsson will leverage Abentel’s workforce to support ongoing contracts, including a recent win with Vodafone India to manage its optical network across 10 circles, and expand its existing network rollout (NRO) and maintenance businesses.

Ericsson is prepping its services organization to help service providers launch gigabit networks over the coming years. Ericsson will absorb Abentel’s existing contracts when the acquisition closes in 3Q16. While Ericsson will continue to abstain from developing its own optical hardware, it is investing to grow its complementary optical services business through a mix of organic investment and acquisitions. Pursuing a services-only play allows Ericsson to leverage its service heritage and capture growth in new domains.

By Patrick Filkins, analyst at TBR