Unlike Apple, Motorola doesn't get it

By Robert Walberg

At what price success?

That's the question Wall Street is beginning to ask about Motorola (MOT, news, msgs), which CEO Ed Zander has tried to make the world's top provider of mobile handsets. To his credit, the company's share of the global market has climbed about 10 percentage points during the past two years to 23.3%.

Unfortunately, Motorola slashed prices to do it. Despite shipping a record 65.7 million handsets in the latest quarter -- a gain of 47% year over year and 22% since the previous quarter -- the handset division's operating profit plunged by 49% to $341 million. This isn't a surprise because electronics stores and phone companies have been heavily discounting the company's popular Razr phones for months.

Gaining market share with successful new products that beat the competition on technology or features is one thing, but doing it by slashing prices and gutting profit margins is quite another. Zander’s obsession with market share at the expense of profits and shareholder value could end up costing him his job.

"Our business remains solid, and we will continue to execute on our focused, strategic plan to create value for our shareholders," Zander said in a post-earnings-report conference call. The word "continue" erroneously suggests that Motorola management has been creating value for shareholders right along. In fact, the stock has fallen 23% since the end of September. Over three years, it has gained a mere 14.8%, far below the 24% rise in the Standard & Poor's 500 Index ($INX).

Apple's Jobs grasps what Zander doesn't

Maybe Zander could take a tip from Steve Jobs, the CEO of rival Apple (AAPL, news, msgs). Apple recently unveiled the highly anticipated iPhone, a new entry in the "smart" phone market in which Motorola competes with its Qphone. While Motorola has tried to win share with the disappointing Q by slashing prices -- you can get one for less than $100 -- Apple’s new phone will debut at prices of $499 and $599.

Though it's true that such a high price initially will limit the iPhone's growth, the unit should immediately help bolster Apple's profitability. Jobs understands that if you create a product that is technologically superior to the competition -- and looks cool on top of it -- consumers will pay a premium. Jobs also seems to realize that going after market share at the expense of profits is no way to create shareholder value. In case you're curious, Apple's stock has risen by 680% over the past three years.

Maybe it's unfair to compare Zander to Jobs because one is operating in the intensely competitive handset market while the other dominated the fractured digital-music space. But the truth is that managers in every industry must balance the desire for market-share gains with the need for sustained profitability and enhanced shareholder value. Zander puts too much emphasis on market share at the expense of profits, and there's no sign that focus will change significantly any time soon.

Streamlining not enough

Of course, Motorola acknowledged the disappointing margins and pledged to return them to double digits later this year. Zander even did what all managers do when profits disappoint because of choices they made: He announced that Motorola will cut 3,500 jobs. But not his, of course.

Wall Street likes to hear that sort of thing because it shows that management "gets it" and that by streamlining operations (a nice way of saying firing people) it will get profit growth back on track. Of course, in a few quarters management may simply decide that it didn’t cut deeply enough and announce another restructuring.

Zander doesn’t really get it -- at least not yet. Motorola remains committed to becoming No. 1 and plans to get there by selling inexpensive phones to Third World markets. Unless the phones can be made very cheaply, the margins will be slim and, as those sales become a greater percentage of overall sales, almost certainly will deteriorate. As long as sales are brisk enough, a slight drop in margins is acceptable. But as we saw in the latest quarter, record sales didn’t mean improved margins. It's difficult to comprehend how going after the low-end market will improve things.

Motorola’s stock is relatively cheap, especially when you back out all the cash the company is sitting on right now. The shares could bounce back up to the $20-to-$22 area over the next few months. Yet execution risks are relatively high, so don't expect the stock to keep pace with the overall market until management proves that it has a strategy for sustainable profit growth.

At the time of publication, clients of Robert Walberg owned shares of Motorola, but Walberg did not.