ICSB World Conference 2000 Title: An SME in the Land of the Giants: The Case of Benefon Authors John Rice, Queensland University of Technology, Australia Mark Shadur, Queensland University of Technology, Australia

Summary

This paper investigates the potential role of SMEs in technologically driven industries through an investigation of the business strategy of Benefon, a medium sized producer of mobile telephone terminals (handsets) that is based in Salo, Finland. It notes that SMEs in regions or industries dominated by larger firms can choose to either integrate themselves into the knowledge and business network that the presence of the larger firm creates, or they can choose a competive strategy. SMEs, though, tend to have a more limited portfolio of knowledge and business resources than their larger peers and this tends to restrict their strategic options. It was this situation that caused major problems at Benefon.

The Land of the Giants

The tales of Gulliver’s Travels [1] have captured their readers’ imagination for centuries. Indeed, the stories have been adapted for the screen many times, though interestingly the tale always told in the film version is that of Gulliver’s first adventure, as recounted by Jonathan Swift in 1726. In “A Voyage to Lilliput” the locals measures six inches high by Gulliver’s reckoning. On this tiny island Gulliver was able to influence affairs of state by, among other achievements, single-handedly vanquishing the attacking forces from neighbouring island of Blefescu. The rather less told of Gulliver’s Voyages was his second, to the peninsula of Brobdingnag. Here the Lilliputian proportions were similar, though in reverse. Gulliver became a plaything here to the Brobdingnag giants. While his counsel was, for a time, sought in Lilliput, in Brobdingnag Gulliver was a plaything used to amuse the masses.

Swift’s satirical observations of the Age of Reason in eighteenth century Britain may at first seem to offer little in the way of relevance for SMEs in the twenty first century. Like all literary classics, though, Gulliver’s Travels contains some timeless truths – one of which is that (relative) size does matter. Larger firms always have more industrial and commercial influence than smaller firms. Increasingly technologically driven industries in information technology, communications and biotechnology are dominated by large multinational firms. Where SMEs chose to become involved in these industries, relationships between these large dominant players and the SMEs inevitably develop. The development of a better understanding of the way in which these large and smaller firms relate is thus timely and relevant.

SMEs in High Technology Networks

The importance of SMEs in high technology production internationally is increasing. Some authors [2] for example, have noted the growth in the number and importance of SMEs in the UK electronics industry. Others [3] have noted that the strategic outsourcing of manufacturing by large firms has benefits for all involved: allowing the creation of knowledge efficiencies and competence focus in the outsourcing firm and production and knowledge development opportunities in the contract recipient firm. Trends have certainly been evident that larger high technology firms have tended to fragment their production processes in response to a number of external stimuli, including loss of control of the labour process, growth in innovation uncertainty [4] and a growing trend toward technology licensing [5]. These networks have developed “technological systems” comprising sets of coordinated elements or agents operating in a particular area within a particular set of environmental or institutional arrangements [6]. In the model presented by these authors, a clear specification of the relative role of SMEs emerges.

The role of the entrepreneur or technological champion in all industries is the provision of vision and innovative resource allocation through the strategic weighing of risk and potential reward. In high technology industries this role is heightened and broadened as firms search the most promising technological and market option while dealing with increasingly complex knowledge resources. A diversity of knowledge champions within a network allows large and small firms to develop a portfolio of potential products or services that may perhaps be incompatible or mutually competitive. Within a single firm, the decision to promote competitive technologies may be seen as wasteful or inefficient, though this may not be the case within a diversified knowledge network.

Knowledge networks in high technology industries have often taken form within “clusters”, geographical groupings of firms utilising similar or supportive knowledge resources. The fact that these clusters have emerged in industries that have traditionally pioneered the exchange of information electronically (note, for example, Silicon Valley, California or Route 128, Massachusetts) illustrates the fact that knowledge tends to be “sticky” [7], and the transfer of tacit knowledge between individual who are physically present to one another is an important aspect of the innovation process.

For SMEs, this too has implications. Large firms can employ a range of geographical sites and often have extensive resources to overcome the tyranny of distance (travel, communications technology etcetera). This may not be the case for SMEs, who are thus often left with more limited choices in the development of their knowledge alliances.

As SMEs increase their operational presence in industries, the question arises as to what strategic relationship between SMEs and larger firms is most appropriate. There have been a number of articles that have assessed the different strategies adopted by these firms in relation to their larger peers in the same or related industries. It has been proposed [8], for example, that collaboration between SMEs and other firms allows a degree of knowledge focus to occur at all firms involved, facilitating the development of new technologies and products. This focus needs to be directed by strong entrepreneurial leadership in SMEs where capital and other resources are scarce to ensure that market opportunities and innovative processes are achieved to deliver products and services for customers [9].

Indeed, if there is a consensus developing in the literature with regards to potentially profitable business strategies for SMEs in industries dominated by larger firms, it relates to the development of collaborative or network relationships. The benefits that such approaches are said to provide include flexible, smart and responsive organisational forms for SMEs [10]. The same author notes that the development of collaborative knowledge or production relationships between SMEs and large firms can stabilise the SME as a participant in its chosen industry.

The focus on the collaborative or cooperative model that has dominated industry practice raises a further question: what of those SMEs who choose to compete directly with larger firms in the same or similar markets? There is an evident need for entrepreneurial skill and the development of a differentiated product or service, though the former of these two concepts tends to be a little elusive and the latter has costs of its own.

In fact, there are no purely collaborative or competitive strategies, and all firms operate on a continuum between these extremes. An important consideration is the establishment of a strategic position is the knowledge stock employed by the firm.

Where the knowledge stock employed by a firm is standardised and openly available, network relationships make clear sense. Differentiation tends to be difficult to achieve and hard to defend. On the other hand, network relationships between SMEs and large firms solidify market and industry presence and provide access to economies of scale that often work against SMEs.

Standardised industries often employ network knowledge management more generally in any case, thus further enhancing the drive towards network relationships in manufacturing and production. The industry examined here, the mobile phone terminal (handset) manufacturing industry, draws on knowledge and competencies from consumer electronics, data communications, signal processing and data processing sectors to name but a few. Large and successful players require a myriad of alliances with other large, medium and small firms to provide the required knowledge for competitiveness. In such industries, it is difficult for SMEs to achieve success on their own.

The markets investigated in this case employ open knowledge architecture. The NMT 450 and GSM 900 standards that are explored later in this paper are open to all producers of terminal equipment. In some respects, this tends to favour fragmentation of industry production as componentry tends to become modular in nature, with inherent economies of scale flowing to those firms who can develop large research and production facilities. SMEs who choose to adopt more competitive strategies tend to be successful where they have a differentiated product that can be defended from rival entry. This may be through customer loyalty, market segment or niche dominance or through legal mechanisms protecting some patent or product knowledge.

This paper looks briefly at the employment of collaborative strategic relationships in two Nordic mobile telephone sector companies and in more detail at the strategy of a medium size firm that has taken a competitive approach to the market and its competitors.

Nordic Mobile Telephone Manufacturing

When talking of the remarkable success of Nordic mobile terminal or handset producers, Nokia of Finland and Ericsson of Sweden are most often discussed. These two firms have come to dominate the world industry for

terminals and they also have broad market presence in the related industry infrastructure segments (base stations, switches) of mobile telephony.

The Nordic environment is internationally unique in the provision of a supportive home market from which these firms have developed. Finland has the highest mobile telephone penetration in the world at 58% of the population, followed by Norway at 48% and Sweden at 46% [11].

This world leadership in mobile penetration has created great impetus to growth for the local industry. There has been much research into the causes of these high penetration rates, and these have been said to include the early adoption of a regional analogue standard (the NMT 450 standard) which in turn created economies of scale of production and strong positive network externalities if the form of support of regional roaming. Further, national governments in the Nordic region have actively and successfully encouraged the development of high technology sectors through a range of positive government policies like the establishment of science and technology parks, technology development centres and national funding bodies to support research and development.

The development of the common market in Europe has also provided a strong spur to the development of the mobile telephone industry. The removal of most trade barriers within the European Union (EU) opened a market of almost 300 million consumers to Nordic terminal producers. The EU was also a catalyst for the development and deployment of the GSM digital standard, for which Nokia and Ericsson became lead producers and whose international adoption has tended to drive much of their market success. The original GSM group was originally designed as a cooperative, open and pan-European initiative and the EU, in 1986, reserved frequency blocks in the 900 MHz throughout the region for future mobile telephone development.

By 1997, European producers had come to dominate all areas of GSM equipment manufacture. Ericsson, Siemens, Nokia and Alcatel, all European multinationals, had between them 93% of the market for switching devices, 41% of the market for base stations (where Motorola had a stronger market presence) and 78% of the market for terminals [12]. As the GSM standard itself became dominant internationally, these suppliers leveraged their strength in home markets to build a strong market presence worldwide.

A number of environmental factors related to national and European market and policy factors thus assisted the development of mobile telephony in the Nordic region.

In this supportive, though competitive, environment, a number of small and medium enterprises have emerged as central to the industry’s development.

One strategy is well illustrated by a firm like Elcoteq, a Finnish manufacturer of electronic sub-assemblies utilised by firms like Nokia and Ericsson, have seen sales grow from 18.5 million Euros (equivalent) in 1992 to 394.5 million Euros in 1998. In 1998, Nokia and Ericsson accounted for 82% of Elcoteq’s sales [13]. Similarly, another Finnish firm, JOT Automation, has grown strongly in cooperation with both Nokia and Ericsson. This firm has provided contract assembly services to both firms.

The strategy adopted by these two firms in relation to Nokia and Ericsson is illustrative of the collaborative network relationship often discussed in the literature. The growth of these former SMEs has indeed been leveraged to the growth of the larger firms as they have grown from a very small base to provide a range of necessary non-core operational services for their larger partners.

Another strategy is illustrated by the case under investigation here, Benefon. Benefon employs around 280 personnel. It is a medium sized producer of mobile telephone terminals with production and research facilities located in the city of Salo on the southern coast of Finland. A former Nokia employee, Jorma Niemenen, who still heads it, established the firm in 1988.

Salo is an important city in the rapidly growing Finnish electronics and telecommunications cluster. Nokia has a large research and development facility in the city and a large number of small and medium sized firms that provide a range of production and research services to Nokia are also located there. The decision to locate in this region by Benefon took into account these factors, allowing the firm to harness some of the knowledge development processes that the presence of this myriad of large and small firms created.

To characterise Benefon’s business strategy, the firm has operated in peripheral competition to Nokia and Ericsson. It has tended to produce terminals for the NMT 450 and NMT 900 mobile telecommunications

standards while Nokia and Ericsson have increasingly shifted their product ranges to GSM and US standards compliant equipment.

The NMT 450 and NMT 900 standards were pioneered in the Nordic countries and the first services were available in October 1981 [14]. The NMT 450 standard has proved itself serviceable and resilient in the most difficult of operational climates and is particularly well suited to deployment in developing countries with low mobile penetration rates and/or operational densities, due to the low number of base stations required for coverage of a given area in comparison to other analogue and digital standards. NMT 450 systems have thus been deployed in Russia, the Baltic States, Indonesia and Thailand (among others) and it was in these markets that Benefon found the majority of its customer base.

Being a small player in the mobile terminal market allowed Benefon to seek niche markets, while its larger competitors focused on developing terminals and network infrastructure for the GSM digital standard that was being deployed throughout Europe from 1991 and soon after in over 60 national markets by more than 100 operators [13]. Benefon’s market success in the developing nations’ NMT markets diverted its resources from developing products for the GSM standard. While it introduced eleven terminal models for NMT standards between 1989 and 1997, the GSM marketplace exploded in Europe and elsewhere. It was not until 1997 that the firm introduced the “Benefon Gamma”, its first GSM terminal.

During this time, Ericsson and Nokia were cementing their presence in the terminal market through the development of a range of innovative and high quality GSM terminals. Nokia, especially, operated within a most munificent home market, with Finns being the leading users of mobile services in the world throughout the 1990s.

It is perhaps worth a brief explanation as to why the Finnish home market was so favourable to Nokia (and potentially, to Benefon). Finland is one of the only international markets that expressly forbids the subsidisation of terminals by operators. Perversely, this has been a big plus for Nokia as Finnish consumers have been very demanding in their expectations of terminal quality. In markets where terminals can be had for a nominal sum when bundled with a contractual obligation for network access, consumers have been less concerned with terminal quality.

Further, as terminal sales increased in Finland, there was a lower requirement for operators to seek higher rates for network access to recoup their initial terminal subsidies (as has been the case in most other markets). Thus Finnish consumers tended to use their mobile terminals more than other comparably sized markets, thus increasing their individual and aggregate utility derived from the network and creating the positive network externalities that drove a virtuous cycle of demand growth.

In most respects, the NMT focused strategy adopted by Benefon negated this home market advantage. As the GSM stndard was further adopted throughout the European Union, Benefon’s NMT production strategy further negated the benefits available through the open state of European terminal markets.

Emergent Problems in the NMT Standard

The decision to introduce the GSM Gamma marked a clear change of direction for Benefon. This change was necessitated by some unforseen (though perhaps not unforeseeable) consequences of its niche market strategy.

In 1991 Estonia became the first of the former Soviet Republics to secede from the Soviet Union. Other Republics soon followed. For a period in the mid 1990s it seemed that the region would prosper under the new, liberal economic arrangements that were introduced, though in fact the entire region, and most especially Russia, had begun an inexorable slide into economic chaos. By 1997 major economic problems had emerged. Not surprisingly, one of the hardest hit sectors of the Russian economy was the market for mobile telephone services and products.

In a statement to the Helsinki Stock Exchange in November 1998, the Benefon CEO Jorma Niemenen noted that:

The result outlook for the second half of this year has worsened because of the effects of the economic crisis of Russia, and it is now obvious that the second half results will stay in the red.

Asian economies, too, where Benefon was selling its NMT equipment, began to face economic uncertainty in late 1997. The NMT standard had been widely deployed in both Indonesia and Thailand, two of the worst hit nations in the economic crisis that hit the region and again, the demand for NMT terminals suffered.

In the home market of the NMT standards, operators by 1997 had broadly deployed GSM 900 networks on most urban areas, again reducing the demand for NMT terminals. Consumers tended to prefer the operability, clarity and extra services that GSM provided, ensuring further reduced demand for NMT equipment in the Nordic countries.

All of these factors caused sever financial problems for Benefon. In 1998, sales dropped sharply and the financial result went into the red for the first time since 1988.

Benefon Sales and Profits 1988-1998

400000

FIM

300000 200000

Sales

100000

Profit

0 -100000 Year Data Source: Nordic Accounting Network, 1999.

Benefon was faced with some difficult strategic decisions in late 1997. The decision to enter into more direct competition with Nokia, Ericsson and other GSM terminal manufacturers marked a clear change of direction for the firm. In some respects, though, it was the only choice available to Benefon as its previously chosen market segment (NMT) was rapidly decaying in all key markets, while the GSM market was achieving great market success in Europe, Australasia and key Asian markets (China, Hong Kong, Singapore). This change of strategy,

to move to direct competition in GSM terminals against Nokia, Ericsson and others, again required Benefon to establish a differentiated product range.

Strategic Responses – Innovations in GSM Products

Benefon’s first GSM equipment was released in 1997. The firm had a clear reputation at home and abroad for producing reliable, high quality and tough terminals. The technical challenges confronting Benefon in producing GSM equipment was limited as GSM was an open standard without the requirement of licensing expensive patents and intellectual property rights (IPRs).

Benefon sought to differentiate its products from those of its competitors in key areas. In Finland, where terminal equipment is almost ubiquitous among the young, the Short Messaging Service (SMS) feature of mobile telephones is popular. Traditionally, the input of text with a numeric keyboard is a lengthy and frustrating task. Benefon introduced technology developed in the United States into its range of phones (the T9 text input system), becoming the first of the Nordic trio to introduce this feature. The Benefon “Io” terminal that was introduced in 1998 also incorporated a large display screen, a feature designed to further the utility of SMS messaging.

Benefon also sought to produce terminals for niche markets within the GSM standard that were not being filled by larger competitors. Two examples here have been the “More Phone”, a terminal designed for elderly and disabled users with a large “SOS” button to call for assistance. Emergency service personnel can then be guided to the user through GPS locationing technology installed in the phone.

Another example has been the “Benefon Esc”, released in late 1999, that incorporates a map display and GPS technology with a GSM terminal. Again, the market for this product will be limited, though a significant niche market will be all that is required for relative success for a firm of Benefon’s size.

Cooperation with Operators

Another example of innovative design can be illustrated by Benefon’s cooperation with Vaasan Läänin Puhelin (VLP), the Vaasa local telephone provider. Vaasa is a city in central western Finland on the coast of the Gulf of Bothnia. The firm wished to introduce a mobile telephone service in their area, though as the three national GSM 900 operators had existing licenses to deliver services on the GSM 900 spectrum, the firm was required to develop a local mobile network utilising the GSM 1800 spectrum.

Terminals were thus required to be constructed that were able to operate on both the GSM 900 and GSM 1800 standards. Many terminal producers manufacture such equipment, though when VLP sought agreements with one of the three Finnish GSM 900 operators to allow their customers use of GSM 900 networks elsewhere in Finland, they met with resistance.

Existing operators were reluctant to allow national roaming for VLP customers as it would tend to deteriorate their market position. If they undertook such agreements, small, local GSM 1800 networks could be established throughout Finland, and most especially in the larger cities, for local calls that would reduce both customer numbers and customer usage of the main mobile operators’ services.

VLP first approached Nokia, then Ericsson, with a novel solution. They proposed that these firms manufacture GSM 900/1800 dual band equipment with dual SIM cards, allowing customers to switch to the Vaasa local network when in Vaasa and another operator when travelling outside Vaasa. Nokia and Ericsson both, in turn, refused.

There are two explanations for this, both of which are illustrative of a potential strength for Benefon. First, the market in Finland was seen to be small (VLP expects about 12,000–20,000 consumers to use the service). In some respects, production runs of this size are uneconomic for the larger firms. Secondly, and more importantly, Nokia and Ericsson have strong strategic alliances with the Finnish national mobile operators (Sonera, Radiolinja and Telia). They were both reluctant to jeopardise these relationships by producing equipment that provided strategic opportunities for the operators’ competitors.

Neither of these considerations impacted upon Benefon. Their sales in the Nordic countries were limited and most of their products were exported, thus they had fairly limited relationships with the Finnish national mobile operators. Further, small production runs of the size demanded by VLP were economic for Benefon.

Thus Benefon and VLP concluded a supply agreement, with the first terminals delivered prior to Christmas, 1999. There is great potential for this product in export markets where there are two or more mobile operators internationally as the terminals will allow users to chose between different operators who often have different pricing plans and special offers.

Conclusions

In pursuing a competitive strategy in mobile telephones and producing products in similar market segments as its larger rivals, Benefon was making a strong strategic statement. It showed that it believed that it could deliver products for a segment of the overall terminal market at a better price/quality mix than its competitors.

The open and stable knowledge architecture of the NMT and GSM standards investigated in this paper provided both opportunities and threats for Benefon. The open technological standard facilitated market entry and allowed the firm to produce compliant equipment, though it also assisted industry fragmentation that allowed its larger competitors to develop large economies of scale.

Strong knowledge networks in mobile telephony have indeed developed in Finland and elsewhere in the Nordic region, though the choice of Benefon to develop products for a fairly stable and established standard (NMT) placed them at the periphery of much technological development. Further, the adoption of a competitive strategy in relation to the larger Nordic firms further sealed the firm at the periphery of the knowledge environment that was developing.

Strong growth in sales and profits until 1998 illustrated that the firm’s substantial internal knowledge competencies were sufficient to provide profitability in the short term. Innovations in producing high quality and reliable equipment for the NMT 450 networks developed for the firm a strong share of a significant niche market. The collapse of world markets for NMT 450 equipment was beyond the control of Benefon, though with the

benefit of hindsight, the firm’s decision to produce equipment for markets predominantly located in developing economies added a degree of strategic risk for the firm that was clearly avoidable. While the niche positioning within a peripheral segment of the terminal market provided a defensible market position for a time, success here was at the expense of servicing a highly risky geographical market segment. It was this risk that drove the problems that beset Benefon in 1998.

Perhaps Benefon’s key strategic error was that it did not diversify into GSM equipment earlier. By the mid1990s, the explosion in GSM markets in Europe was becoming evident. New GSM operators were also being established in high-growth markets like China from 1994. While the GSM terminal market was highly competitive and difficult to enter, it also provided the highest potential for growth and a leveraging of existing firm competencies. Benefon’s change of strategy since 1998 has begun to deliver some results. While still making a loss, Benefon’s sales have begun to improve. Sales of GSM equipment are becoming significant for the firm, and this is reducing the risks from the deterioration of the NMT markets.

A clear lesson to emerge from this case is that SMEs must take care in utilising all possible environmental advantages available to them whether they be in the form of knowledge and technological competencies or network or market access. The development of a strategy that marginalises the firms from these potential advantages tends to produce poorer longer term results than would otherwise be possible.

It should be noted that Benefon have done well in developing a niche market strategy thus far, though the fact remains that those firms in Sweden and Finland who have chosen to collaborate and perhaps integrate with Nokia and Ericsson have achieved far better financial and growth results. The capital, knowledge and labour employed by firms such as Benefon, Elcoteq and JOT Automation in the mid-1980s were similar. It is clear that those other SMEs have met with far more success than Benefon.

SMEs should thus carefully assess where on the continuum between pure competition and pure collaboration, with regards to large firms in similar industries, that they locate themselves. All strategic positions have potential risks and rewards and the assessment of this portfolio of costs and benefits should be carefully undertaken.

In assessing this positioning an assessment of the presence of local knowledge networks should be undertaken. Firms operating in the mobile telephone industry in the Nordic region have access to a range of network opportunities if they chose to utilise a collaborative strategy with larger firms that may not be available if a competitive strategy is adopted.

References 1.

Swift, J. (1987) Gulliver’s Travels. Penguin Classics. Third Edition. (First printed in 1726).

2.

Jones-Evans, D. & Westhead, P. (1996) “The high technology small firm sector in the UK”. International Journal of Entrepreneurial Behaviour and Research. 2(1): 15-35.

3.

Kumar, R. & Vanelli, A. (1987) “Strategic subcontracting for efficient disaggregated manufacturing”. International Journal of Production Research. 25(12): 1715-28.

4.

Shutt, J. & Whittington, R. (1987) “Fragmentation strategies and the rise of small units: Cases from the North-West”. Regional Studies. 21: 13-23.

5.

Dodgson, M. & Rothwell, R. (1991) “Technology strategies in small firms”. Journal of General Management. 17(1): 45-55.

6.

Karlsson, C. & Åhlström, P. (1997) “A lean and global smaller firm?”. International Journal of Operations and Production Management. 17(10): 940-952.

7.

Carlsson, B & Stankiewicz, R. (1995) “On the nature, function and composition of technological systems” in Carlsson, B. (1995) (ed). Technological Systems and Economic Performance: The Case of Factory Automation. Kluwer Academic, Dordrecht/Boston/London.

8.

D. (1998) “Entrepreneurial context and behaviour and context in SMEs: An investigation of two contrasting manufacturing firms”. International Journal of Entrepreneurial Behaviour and Research. 4(2): 88-100.

9.

Zeffane, R. (1995) “The widening scope of inter-organizational networking: economic, sectoral and social dimensions”. Leadership and Organizational Development Journal. 16(4): 26-33.

10. Nokia (1998) Annual Report. Nokia Oy, Espoo. 11. Bekkers, R. and Smits, J. (1999) Mobile telecommunications: standards, regulation, and applications. Boston: Artech House. 12. Merita (1999) Merita Nordbanken Equities Research, Helsinki. 13. Bekkers, R. and Smits, J. (1999) Mobile telecommunications: standards, regulation, and applications. Boston: Artech House.