Nokia is having a hard time transitioning to smartphonesThey're called "feature phones," which sounds nice enough. The term refers to the clam-shell or candybar phones still making up two-thirds of the global mobile-phone market, but quickly shrinking. In the age of the iPhone and Android smartphones, building your future on the feature phone is a long-term strategy that's, well, not so smart.

And that's Nokia's (NOK) problem. The company was a huge player in the heyday of the feature phone, so it should have had a strong head start. With a global reach that other phone makers can only envy -- 44% market share -- and the brand recognition that comes along with it, Nokia's still having a hard time transitioning to smartphones.

Innovation Trumps Existing Market Share

The problem is that, with smartphones, existing market share takes a back seat to innovation. Phone makers live or die according to how new and dazzling their operating systems are. Despite Nokia's work on upgrading its Symbian operating system for smartphones, it still lags the two leaders, Apple (AAPL) and Google (GOOG).

The current version of Symbian underwhelmed buyers, leading Nokia to lower its revenue guidance for the current quarter. But it's not going to stop there. As Dawn Kawamoto wrote, a new version due out in early 2011 will be more like Apple's iPhone OS. Which is good, except that six months is an eternity in the smartphone industry, and by then Apple and Google will be working on next-generation innovations in their own mobile software.

Needham analyst Charlie Wolf wrote recently,
Nokia's problem is that the Symbian operating system, the platform on which Nokia phones run, is a generation behind the iPhone and Android smartphone operating systems. With Nokia's heritage in low-cost, volume manufacturing, not software development, it's unlikely the company will ever catch up with the companies that are redefining this market.
It remains to be seen what Symbian can do to catch up with iPhone and Google's Android OS-based smartphones. There's always the option of joining the Android bandwagon, as Motorola (MOT) and HTC have, but the problem there is a lack of differentiation from those companies.

Nokia Needs a Plan

During the rise of smartphones in North America, Nokia has still thrived on feature-phone sales because of their popularity in emerging economies, but that isn't going to last for long. So Nokia had better have a plan for the growing smartphone market, and it doesn't, really. Coasting on its longtime global market share won't work anymore. That 44% share mentioned above? Down from 49% in only 12 months.

Nokia's stock closed at $8.90 Monday, only 50 cents above its March 2009 low. The stock is worth less than a quarter of its value in late 2007, when it briefly traded above $40 a share.

According to a Gartner survey, feature phone shipments are still growing, but slowly. In the first quarter of 2010, they increased by only 4% in industrialized nations and 20% in emerging economies. Smartphones grew 38% in industrialized economies and 69% in emerging economies. Companies like Nokia that thrive on mobile phone sales in emerging economies are finding their market shrinking. By 2013, Daiwa Securities estimates, most of the phones shipped in those countries will be smartphones.

More Threats in Store

And the attack of the smartphones isn't the only threat facing Nokia. Its strength is in the middle of the market, between smartphones and the lowest-cost phones, but that's not a good place to be right now, either. Even as more customers upgrade to smartphones with better Web access, non-branded companies are attacking the low end of the market. Nokia saw its share of mobile-phone sales in China, for example, fall to 29% last quarter from 39% two years ago, as non-branded phones have eaten up more of the market.

More and more, customers don't buy phones for the hardware -- which are all taking on the same features -- and more on what happens inside the phone. And then there's the battle to win over developers to build apps. Even a company like Palm, which created a respected mobile platform with webOS, suffered because it lacked the flood of new apps that greeted the iPhone.

It will be a slow decline for Nokia unless it has a compelling smartphone offering. But this market seems to belong to the early movers, and Nokia isn't one of them.

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