Ericsson Ups R&D Spend to Put 5G Squeeze on Rivals

Slowly but surely, Ericsson is hammering its business back into shape. While it still has a long way to go to achieve its target of a 10% operating margin in 2020, it edged into profitable territory for the first time in nearly two years in its recent second quarter. (See Ericsson Back in Profit After Fierce Cuts & 5G Action.)

What should encourage investors is that Ericsson AB (Nasdaq: ERIC) is not simply hacking away at deadweight to restore margins, with no real plan for growth. Spending on research and development rose to 9.8 billion Swedish kronor ($1.1 billion) in the second quarter, from around SEK8 billion ($900 million) a year earlier. And that R&D commitment appears to have fueled margin improvements this year.

"We will continue to increase investments because we see it contributing to gross margins and growth in network sales for the first time since 2015," says Helena Norrman, Ericsson's chief marketing officer, during an interview with Light Reading.

Perhaps the most surprising aspect of Ericsson's recent set of results was this sharp sales improvement. After reporting a 9% year-on-year drop in revenues in the first quarter, Ericsson said they were down just 1% in the second. In the networks business, which accounts for nearly two-thirds of total business, sales rose 2%. That performance followed a 9.5% sales decline in the first quarter and marked the first time the networks business has grown since the final quarter of 2015, as Norrman indicates. (See Ericsson Takes Giant Leap Toward Profitability.)

Given Ericsson's forecast of a 2% decline in the radio access network (RAN) market this year, the rate of growth suggests Ericsson is currently outdoing its chief rivals. Norrman says it is too early to figure out if Ericsson has increased its market share. But she attributes some recent successes -- with Ericsson replacing Nokia Corp. (NYSE: NOK), Huawei Technologies Co. Ltd. and ZTE Corp. (Shenzhen: 000063; Hong Kong: 0763) in several network deals -- to its renewed R&D commitments. (See Ericsson Beefs Up With Telefónica Argentina as Huawei Goes Hungry and DT Ditches Nokia From Its German Radio Access Network.)

"We see it happening increasingly," she says. "The portfolio is stronger now than a year ago, and that leads to better momentum in discussions with customers."

Margins have naturally risen as Ericsson slashes costs while boosting sales. Its entire headcount has fallen by 20,500 since the end of 2016, leaving it with about 108,000 employees (including contractors) today. The annual "run rate" for operating expenses has fallen by SEK10 billion ($1.1 billion) over that period. But Ericsson's latest products, and particularly the Ericsson Radio System that now accounts for 84% of all RAN sales, also appear to be more profitable than older goods.

"It is about technology leadership and cost leadership," says Norrman. "When you invest you get better products and more cost-efficient products."

Ericsson is understood to have offered some extremely competitive prices to edge out rivals in recent network deals. And with previous management talk of a market-share push in China, there was some concern about the likely impact of this activity on margins. Yet the company's latest earnings report shows the gross margin at the networks business has risen to 38.8%, from 34.4% a year earlier, with the operating margin ticking up from 3.4% to 3.5% over the same period. So have these more cost-efficient products allowed Ericsson to be price competitive without hurting profitability? (See Ericsson in China: Dangerous Liaisons?)

"Let's not go into pricing, but they definitely contribute to the strength in gross margins," says Norrman.

— Iain Morris, International Editor, Light Reading

This is an edited version of a story that was originally published on Telco Transformation's sister site, Light Reading. To see the full story, click here.