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CASE COMPANY
DESCRIPTION
Mobilé Inc.
The US Department of Justice ordered the boards of directors of the major mobile handset
manufacturers to dismiss and replace their top management due to years of cartel-like behaviour.
Investigations found that the companies’ directors had agreed amongst themselves in secret
banquets on issues such as deliberately stagnating technology development plans, pricing the
handsets artificially high, and other key matters that had set the companies in exactly the same
financial and operational position. Finally, the board of directors has understood the serious nature
of this situation and hired you to compete against the other restructured companies.
The core operations of the companies operating in the mobile handset manufacturing industry
consist of research and development, production and marketing. Sales revenues in the previous
financial year were a bit more than 1 billion dollars. Due to collusion, profitability has been good,
and the companies are also generating sufficient amounts of cash. This is a good starting point
since it is likely that the increased competition and rapid technological evolution over the next years
will tax both profitability and cash.
BACKGROUND
HISTORY OF THE INDUSTRY
The first international cellular mobile telephone network, NMT, was introduced in 1981. At the time,
the transportable mobile phones were heavy and huge. Towards the end of the 80’s actual hand
portables came into the market and the era of the mobile phones industry began.
Many of the mobile communications companies have evolved from multi-industry companies as a
result of the recession in the end of the 80's and the beginning of the 90’s, when the downward spin
of the economy slowed down the general economic growth for a couple of years. Despite the
economic slowdown, heavy investments in R&D were made in the telecommunications sector. With
the birth of a second generation (2G) of mobile telephones, the telecommunications business
started to emerge from other business’ shadow, and on July 1st, 1991, the world's first genuine
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GSM call was placed by the prime minister of Finland, Harri Holkeri, to the mayor of Helsinki to
discuss the price of Baltic herring. GSM’s American counterpart, CDMA, is the world’s second most
common mobile phone standard, covering a third of the world’ s mobile phone subscribers. The
constant development of mobile phones in the 90’s made the devices smaller and lighter, their
technical design more complex, and increased the number of available functions. FOMA, the first
3G (third generation) network was launched in Japan in 2001 by NTT DoCoMo. The new
technology made possible the transfer of voice data and non-voice data. This paved the way for
data-based mobile services and started to transform the whole industry. By 2009 it had become
clear that the overwhelming growth of data traffic could not be sustained with the existing
technology and industry started looking for new data-optimized technologies. The first 4G networks
were launched by Sprint in the US and TeliaSonera in Scandinavia.
PRESENT DAY
Currently the companies have an annual sales revenue of about 1,2 billion USD and due to
relatively large R&D investments the companies’ handset businesses have developed favourably.
Appealing and customer-driven designs have been named as some of the key success factors in
the business.
The companies sell their products in the U.S., Asia, and Europe. Production and R&D have
historically been located in Atlanta (GA), but recently the companies have also started building
plants in Asia. Some years ago, the possibility to begin production in Europe was investigated as
well. It became clear that the more complicated and inflexible labour laws in Europe would make the
operations difficult and expensive.
To ensure flexibility in R&D and production, the companies have also actively negotiated
agreements for subcontracting parts of their production and R&D.
FUTURE CHALLENGES
The pace of change in the industry has been rapid and great expectations have been set for new
technologies. The overall trend is towards increased mobility with tested communication speeds of
the 5G technology at 100 megabits per second in metropolitan areas and improved support for
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device-to-device communication. The overall growth potential of the industry is good, but
development can vary heavily from one market to another.
The biggest challenge for a mobile handset manufacturer may be keeping up with technological
evolution since R&D requires continuous large investments. Phones have already long been much
more than just devices for talking.
It seems that not everything can be developed in-house and therefore partners for technology
licensing are needed. The growth in the global markets will probably create momentum for
establishing more production facilities at least in Asia.
As the mobile industry evolves into new applications and services, co-operation among industry
players has intensified, facilitating a faster adoption of mobile services as well as market growth for
the entire mobile industry.
OPERATIONS
PRODUCTION
Characteristic to high-tech companies, production is complicated and high costs are incurred in the
beginning phases of the production of new models. This, combined with short product life-cycles,
forces the companies to adapt the production process to manufacture a new product model as soon
as possible, in pursuit of low costs. Eventually, as the company becomes more acquainted with a
specific technology, production cost per unit will fall with the learning curve effect. It should be kept
in mind that when subcontracting production, the learning curve effect is foregone. On the other
hand, since adding new in-house manufacturing capacity comes into effect with delay, the extra
capacity from contract manufacturing can become very useful. Also, sometimes the contractors can
provide the devices with significantly smaller costs.
The company is running just in time production process and there are no finished goods inventories.
If the initial demand estimation is too high, the production department will automatically decrease
the production volumes according to the actual demand. There is an additional 5-10% cost on top of
the regular cost due to the production re-adjustment. More importantly, if the initial demand
estimation is too low, the production department is not able to increase the production during the
period and the company will encounter lost sales due to insufficient delivery capacity.
SALES AND MARKETING
The companies have traditionally operated only in the U.S. market. Over the last years, sales
networks have been established in Asia and Europe as well. Marketing plays a significant role in
promoting the brand and communicating to consumers about the product. Marketing is particularly
important in the U.S. and Europe. In Asia the effect of promotion is less but still considerable.
Typical marketing spending in the industry is 3-5% of Sales revenue.
R&D
R&D is extremely important for IT - and other high-tech companies, because of the dynamic nature
of the industry. Consumers continuously demand new products and the margins from old products
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decline rapidly due to tight competition.
The companies have a choice of performing their own R&D or outsourcing the process by
purchasing technology licenses for the technologies and their related features. The first step of the
R&D process is to develop the base technology upon which up to ten technology-specific product
features can be added. There is one notable difference between in-house R&D and technology
licenses: when R&D is performed internally, the benefits are available in the next period. If R&D is
outsourced, the new technology/feature is available immediately.
The cost of in-house R&D is lower when the process is a gradual one, comparing to a lump-sum
investment. Technology licensing fees are one-time payments. The cost of which will decrease as
the technology ages. A typical company in the industry spends as much as 10% of Sales revenue
on R&D.
It should be noted that R&D expenditure will not be capitalised on the balance sheet. That is, all
R&D expenses are considered as operating expenses and as such R&D investments may cause
substantial fluctuations to the companies’ P&L.
TECHNOLOGIES
So far, the companies have been manufacturing Technology 1 mobile handsets. New mobile
networks are developed constantly, and these will require new technology handsets. Therefore,
steps should be taken to begin developing new technologies. R&D of new technologies may require
relatively large investments, but it is crucial to secure a prosperous future for the company.
It should be mentioned that the technologies are dependent on the networks in which they operate
in. Thus, a Technology 2 phone cannot operate in Technology 1 network infrastructure.
You should monitor the network coverage forecasts on the demand-page before you plan your R&D
as it indicates when the various technologies are economically viable to be introduced.
FEATURES
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The underlying technology for mobile handsets is not very different from one company to another,
so product differentiation is done with product features. These may be, for example, design, cover,
screen size, processor speed, specific applications, etc. In the simulation you decide about the
number of features. Minimum number of features is one and maximum is ten for each technology.
Product features have different effects on demand in different market areas.
TRANSPORTATION AND LOGISTICS
Transportation to export markets is handled by an independent freight company and the cost of the
service cannot be influenced by the teams. The total logistics cost per unit is transportation cost +
tariff. There is no logistics cost involved when the good is manufactured and sold in the same area.
INTERNATIONAL TAXATION
International taxation and transfer pricing are sensitive issues. The companies have created a
system that allows some flexibility, but the ultimate purpose is to even out the cost-impact of the
R&D expenditure. R&D functions are located in connection to the production facilities and the costs
are allocated on the profit and loss statements with the following principles:
Let’s assume that we have 10 plants in the US and 2 plants in Asia, i.e., 12 plants in total. Our total R&D
expenditure for the period is 200 mUSD. Respectively, 10/12 x 200 mUSD is allocated to the US P&L and
2/12 x 200 mUSD is allocated to the Asian P&L.
While determining transfer prices, multipliers (between 1 and 2) are applied to the direct variable
cost of production. In practice this means that the direct variable cost of production can be multiplied
with a number between 1 and 2 and the outcome is the transfer price. When used wisely, these
multipliers can also be used to benefit from differences in corporate tax rates in different areas. At a
minimum, the company should use the multipliers to take benefit from any accumulated losses that
may have been created.
FINANCE
In addition to income financing, the companies can obtain financing from equity investors and
lending institutions. The companies are listed on the stock exchange, enabling effective equity
financing by issuing shares. Shareholders expect a return on the equity invested in the form of
dividends and capital gains.
Over the past few years, the industry has been in a rapid growth phase, and shareholders have not
been able to enjoy large dividends. On the other hand, the increase in share price has been
remarkable and the companies have outperformed the Nasdaq Composite Index over the last
couple of years.
You can reward your investors in the form of dividends or share repurchases. Share issues and
buybacks are made according to the market valuation at the beginning of the round.
Lending institutions provide short- and long-term loans with an interest rate depending on the
company's financial condition. Short-term debt is considered to be the last resort, i.e., emergency
funding, and it always carries a premium over the long-term loan rates.
You can also transfer funds between different countries by internal loans (International Treasury
Management). You may want to use internal loans if you have accumulated substantial cash
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reserves in Asia or Europe that can be repatriated and distributed to the owners, or if for instance
you need to finance some plant investments in Asia.
MARKET AREAS
USA
USA is the local market of Mobilé and at the same time its largest market. The USA is generally
known to be a leader in high-tech industries but in the wireless sector the leadership is not that clear
due to the multitude of different network technologies. Product features are currently less
appreciated than in Europe, but advertising appears to have a good response.
Demand is expected to grow steadily about 5-10% p.a. at least for the next 2-3 years. There seems
to be no reason why growth should stop even after that. According to some of the least conservative
estimates, in a few years with the introduction of new technologies, growth in demand may show
peaks of up to 15-20% p.a.
EUROPE
The companies have been exporting products to Europe for a couple of years. Production facilities
will not be established in Europe because of the high labour costs.
The market growth is expected to be about 10% p.a. and demand is expected to grow steadily for
several years to come. This market appears to be the most responsive to product features currently.
ASIA
It is predicted that the highest growth potential is in fact in Asia. Currently the market grows at 20%
p.a., but long-term growth prospects are hard to make.
The market is quite polarized between high-spenders who always want to have the latest
technologies and late adopters who are happy with their old devices. But on average it seems that
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consumers are currently less responsive to new technologies and features than their counterparts in
USA and Europe. Also, the average responsiveness to prices is higher than elsewhere.
MEASURES OF PERFORMANCE
The primary objective of the firm is to maximize the value to its shareholders. In this case the
returns to shareholders are measured by a term called cumulative shareholder return. It takes into
consideration both the dividends paid as well as the share price development over time. This ratio is
then annualized to portray an annual performance of the company. Share price correlates well with
the profitability and growth of the company. Dividends are considered to earn 8-9% annual
shareholder return after they have been paid out of the company.
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