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Smartphones Are King — Sorry, Nokia

If you love your smartphone, you’re not alone. According to research firm Gartner, sales of smartphones surpassed the sales of feature phones for the first time ever in the second quarter.

While this is good news for companies like Apple (AAPL), it’s ominous for companies that still rely heavily on old-school feature phones. A prime example: Nokia (NOK).

Only 10 years ago Nokia was enjoying 40% annual growth, while the Nokia 1100 cell phone was everywhere. The company sold some 200 million of them. Last quarter, though, the company saw its mobile phone sales drop from 83 million last year to 61 million this year. That’s not a new trend either, as Nokia also lost its crown as the world’s biggest mobile phone seller to Samsung (SSNLF) last year, after 14 years at the top.

Of course, many U.S. consumers may well have forgotten that Nokia sells anything but smartphones. After all, the company has been pushing its Lumia line of Microsoft’s (MSFT) Windows Phone devices hard. That’s because there’s a big difference between feature phones and smartphones, and it’s not just the functionality. For the manufacturer, there can be a massive difference in profit margin.

Just consider this: Nokia just released a new feature phone for emerging markets — a followup to that best-selling 1100. And it comes with an unheard of (for that segment) 29% profit margin. But the Nokia 105 has two problems: At a $20 price tag, even if Nokia sells boatloads of these things (Gigaom’s Kevin C, Tofel thinks it could end up being hundreds of millions) and even with a 29% profit margin, we’re not talking big bucks here.

If Nokia repeats the success of the 1100 and moves 200 million 105s, that’s around $1.1 billion in profit. Plus, it’s going to be spread over many quarters and flies in the face of the stats that show feature phone sales worldwide beginning to wind down in favor of cheap smartphones.

That’s why, long-term, Nokia’s survival is going to be about smartphones.

After abandoning its own Symbian platform, Nokia tied its smartphone fortunes to the Windows Phone mobile platform. The first Lumias were released at the end of 2011, but it was the Windows Phone 8 launch last fall that saw the Lumia line begin to gain traction. The result was Windows Phone pushing a struggling BlackBerry (BBRY) and its new BB10 out of third place worldwide.

With a 3.3% worldwide market share, the Windows Phone now seems to be cementing its spot as the alternative to Apple’s iOS and Google’s (GOOG) Android. Nokia — as Microsoft’s primary Windows Phone hardware partner,with an estimated 80% of those Windows Phone devices — stands to benefit from the platform’s success.

There are a number of Lumia smartphones now on the market, the latest being the 1020 with its monster 41 MP camera. The flagship Windows 8 Lumia phones have been bringing Nokia a profit margin somewhere in the 50% range, and sales of the devices hit 7.4 million in Q2, up 32% over the previous quarter.

The question, though, is whether Windows Phone market share (and therefore Lumia sales) will plateau any time soon. Because with sales of all its other phones on the decline, Nokia needs those smartphone numbers to increase.

Historically, there’s been room for the third place mobile OS to take a big chunk of the market. At one point in 2009, for example, third-place iOS had a 18% share. In March 2011, third place BlackBerry OS was at 16% world wide. If Windows Phone could climb to even a 10% share — bringing Nokia along for the ride — that would mean 30 million Lumias a quarter, a point at which Nokia starts looking a whole lot better.

However, when it comes to smartphones, “history” is too short to see trends. And in the past two years, we’ve seen the market dramatically shift, with Android completely dominating at nearly 80% of sales, iOS taking 13% and third place reduced to a minor 3.7%.

Even if BlackBerry is eliminated altogether and other contenders like Firefox OS fail to catch on with consumers, it’s entirely possible that Android and iOS will soak up the majority of the windfall, leaving Windows Phone — and Nokia — languishing near current levels.

That Android domination is a primary reason why many analysts questioned Nokia’s decision to go with Windows over Android in the first place. Nokia’s Stephen Elop explained to The Guardian that his company expected Samsung to dominate the Android smartphone market. Rather than compete directly and likely be marginalized in the Android space, Nokia wanted to be that vital third option to carriers in both platform and manufacturer.

The argument makes some sense, but it’s not enough to quell calls for Nokia to adopt Android if it wants to survive.

Personally, I think Nokia should stick it out with Windows Phone. Any switch at this point would reek of desperation/

Besides, no matter how you slice it, Nokia has a challenging future. While the Lumia/Windows Phone uptick is a good sign — at least in the short term — the declining market for feature phones doesn’t bode well for the company, even if it can squeeze bigger profit margins from the devices.

The 90% decrease in NOK share price since those glory days when it first won the crown as “world’s biggest cellphone maker” reflects just how big of an uphill climb the company is facing.

As of this writing, Brad Moon did not hold a position in any of the aforementioned securities.

Article printed from InvestorPlace Media,

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