Friday, 17 June 2011

What's Next for RIM?

Several people have asked for my thoughts on RIM's financial troubles.  A computing platform runs on momentum.  When the platform's growing, there's a virtuous circle between the growth of the customer base, the introduction of new products, and the arrival of new developers.  Each one reinforces the others, and it produces strong, resilient growth.  Look at Apple's current expansion for a great example.

But if that momentum breaks, the same forces that help you grow can create a self-reinforcing decline.  The loss of customers reduces your resources, so you can't spend as much on new products, so developers are less excited, so you lose more customers, and so on.  I lived through those cycles at both Apple and Palm, and they are very difficult to reverse once they gather momentum.

Based on RIM's latest financial report, it looks to me like the company may have fallen into a declining pattern in North America.  Sales in the rest of the world seem to be doing better, which is masking the severity of the problem in the US.  It's hard to say any of this for sure, because RIM doesn't release all that much detail.  But here's what I think I am seeing in the numbers:

--As the chart below shows, sales were down compared to last quarter, only the second sequential revenue drop since fiscal 2006. 

Revenue per quarter (RIM fiscal quarters)

RIM pointed out that sales were up year over year.  They were, but...

--The year over year revenue increase was driven by a 67% increase in sales outside North America.  If you look only at North America, sales were down about 18% year over year.  (RIM didn't announce that number, but you can back it out from the reported increase in international sales compared to total sales). 

In other words, RIM is growing strongly outside North America, but declining sharply in North America.

The most disturbing thing about the revenue decline is that it came in the quarter when RIM shipped the PlayBook.  That should have increased revenue.  The fact that North American revenue dropped anyway means the decline in North American BlackBerry smartphone sales was even worse than it seems.  Edit: I did a back-of-the-envelope estimate of the revenue from PlayBook, and BlackBerry smartphone sales in North America must be down by well over 20% year over year. 

--Device gross margins are down to 28%, a drop of three points from the quarter before.  I suspect this is another sign of the mix shift away from North America -- RIM's sales in the rest of the world tend to be lower-cost units sold to young people, and those devices would have lower margins.  It may also mean that RIM has been cutting prices in an unsuccessful effort to prop up sales in North America.

Company and hardware gross margins (RIM fiscal quarters)

As you can see from the chart, RIM's overall corporate margins (the blue line) did not drop as much as its hardware margins.  That's because the company had a big increase in services revenue.  Perhaps the service revenue from those international customers is better than the device revenue.  Unfortunately, RIM doesn't release enough data to let me dig into that.

--Average sales revenue per device dropped $20, to $279.  That is an all-time low.  This may be due to the shift to international sales.  It may also be due to price-cutting in North America.  I am astounded that average revenue per unit sold dropped in the quarter when the (relatively expensive) PlayBook shipped.

Average revenue per device sold (RIM fiscal quarters)

--The shoe that hasn't dropped yet is channel inventory.  RIM told us it had shipped 500,000 PlayBooks, but it didn't say how many of them have sold through to customers.  It's easy to have one good quarter when you load the channel, but what matters is the sales in the next two quarters.

We also do not know how many BlackBerry units are sitting around in the channel.  But one thing is certain, every time RIM's executives talk about how great their upcoming products will be, it gets a little bit harder to sell through those existing devices.

Netting it out, the sales pattern in North America looks disturbing.  Pricing actions in North America don't appear to be increasing sales, and the PlayBook has not rescued the company.  The silver lining for RIM is that its international sales are growing.  But North America is half of RIM's revenue, so it has to be fixed if the company is to go back to rapid growth.

What happens next?

To restore momentum in a faltering platform, you need a hit product.  Can RIM generate one?  The company says it will accelerate the introduction of new products, which sounds sensible in the abstract, but if it's possible to develop products faster, why didn't RIM do it before?  And considering RIM's history of shipping buggy devices, I tremble at what its products might look like if they were developed even faster.

RIM says it is going to do layoffs, which is probably necessary given the drop in revenue.  But I wonder where the cuts will come from, and how big they will be.  Do you lower staffing in North America, so you can focus more on the fast-growing international markets?  If so, you may blow your chances of ever recovering the North American half of your business.  Do you cut R&D?  If so, I don't know how you get products to market faster.  Do you focus on being a youth messaging phone?  If so, how do you prevent Apple's new iMessage service from eating your lunch?  Or do you try to do an across-the-board haircut of a certain percent of employees in every department?  I went through some of those at Apple.  They are easy for management to implement, but their net impact is fewer people trying to do the same work, and doing it poorly.

Meanwhile, there will be a morale problem at RIM.  Ideally, you should announce layoffs on the same day you conduct them, so employees don't waste time worrying about whether they will keep their jobs.  Instead RIM pre-announced the layoffs, which probably mollified investors but which will distract every person in the company for the next quarter while they prep their resumes.  I have lived through that sort of uncertainty, and it is a productivity-killer.

The other hit to morale is going to be RIM's announcement that it will buy back up to 5% of its shares.  At current market value, that is about $900 million in cash that could have gone into R&D or marketing or price cuts but will instead be used to prop up the stock price.  If you're a RIM employee, the combination of layoffs plus stock buyback seems to say that management thinks the stock price is more important than the work you're doing.

What is the plan?  You can't cut your way to broad growth; you have to cut and then focus on some key initiatives.  Apple is a good example to keep in mind.  It was in far, far worse shape than RIM, and came back very successfully.  RIM can too.  But Apple slaughtered huge numbers of projects and teams so it could focus on brand advertising, the iMac, and eventually the iPod.  

So I'm waiting for RIM to tell me what its master plan is for restoring growth.  So far all management has said is that the layoffs will be a "streamlining exercise" rather than a reorganization (link).  That may imply an unwillingness to make hard choices, or it may just mean they are not yet willing to discuss their plans.  Either way, before we can evaluate RIM's prospects, I think we need to know more about what it's going to kill (if anything), and which initiatives it will focus on obsessively.

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