Earlier this month, Ericsson raised a few eyebrows with a warning that it might stop investing in Sony Ericsson, its handset partnership with Sony, if the business continues to disappoint.

"The message is clear. We will not make the same mistake again," spokesperson Ase Lindskog told Reuters of the less-than-year-old partnership. "We will not put any more capital into the joint venture if it does not show results."

The statement marks a stark turnaround from Ericsson's previous position. In the first quarter of this year, Sony Ericsson recorded revenues of 10.3 billion Swedish Krona (AU$2 billion), allowing the company to break even. In the second quarter, sales dropped to 8.8 billion Swedish Krona (AU$1.7 billion), resulting in a loss of 85 million Swedish Krona (AU$16 million). Kurt Hellstrom, Ericsson chief executive, had remained upbeat then.

"Although Sony Ericsson reports a loss for the quarter, we believe in the potential of this joint venture," he had said in a statement.

Then came the outburst which demonstrates the amount of pressure Ericsson has been under. Since 2001, the wireless equipment maker has been suffering heavy losses, resulting in aggressive cost-cutting measures. The company intends to slash its workforce to 65,000 by the end of 2003; from the 95,000 reported headcount in early 2001.

Mixed fortunes
Lindskog's comment bears historical reference. In 2000, Ericsson was the third-largest phone maker, shipping 10 percent of the global market. However, recent numbers from research firm Gartner Dataquest indicated that Sony Ericsson managed just 5.4 percent of the global market share in Q2 this year.

Last year's slowdown in cell phone sales hit Ericsson badly, alongside other handset manufacturers. Distribution channels were overstocked, leading to lower sales prices and volumes. In the three quarters leading up to the October 2001 tie-up with Sony, Ericsson's handset division had suffered an average operating loss of 4.8 billion Swedish Krona (AU$0.9 billion) per quarter.

Sony Ericsson's Q2 loss of 0.8 billion Swedish Krona (AU$155 million) may not look like much, but it may have been a case of the proverbial straw breaking the camel's back.

Dream team
In April, Ericsson began outsourcing its phone production to Singapore-based contract manufacturer Flextronics in a bid to reduce costs. That same month, Sony Corp and Ericsson agreed to merge their mobile handset operations. Half a year later, Sony Ericsson was born.

From the get-go, the two companies were touted as ideal bedmates. Katsumi Ihara from Sony was appointed president of Sony Ericsson, with Ericsson's Jan Wareby as executive vice president.

Wareby himself called the union a "dream team", a description that resonated through the media world. Indeed, Ericsson had limited presence in Japan, while Sony was having difficulties breaking into the European and US market. With the team-up, the two companies, Wareby said, complemented each other.

Furthermore, Sony's strength in consumer electronics and Ericsson's expertise in network infrastructure ensured synergies both vertically and horizontally.

Sony, with its marketing savvy, exerted a positive influence early on. In March, Sony Ericsson released the T68i, one of the first co-branded handsets. An upgrade of Ericsson's earlier T68, the T68i sported a fresh new paint job, eventually enjoying commercial success and boosting the company's bottomline.

Sony has also been actively cross-fertilizing the handset venture. The Sony Ericsson team announced in June that the upcoming camera-phone P800 would offer Sony's proprietary Memory Stick expansion card format. Sony Pictures, the producer of hit movies such as "Men In Black II" and "Spider-Man" would also port interactive content to Sony Ericsson cell phones.

The merged entity has set itself the aim of becoming the world market leader in "multimedia phones". This is ambitious given that Nokia, Motorola and Samsung--the top three handset makers--are all introducing high-end phones with digital imaging capabilities.

Zen and the art of infinite patience
Following the little tantrum from Ericsson, Sony has acted quickly to allay industry fears that the marriage may be fracturing.

"There has been concern about the venture, but Sony's and Ericsson's support and commitment have not changed," Sony president Kunitake Ando told reporters last week.

"We are now in the process of getting into one and trying to harmonize. Once we are back on the attack, then that would have substantial power," he added.

In other words, Ando is preaching patience--perfectly understandable given that Sony Ericsson has yet to release a pure joint product. Mobile phones have a development process of about two years, so the models released so far have been largely developed by either Sony or Ericsson. This also means the true Sony Ericsson mobile would probably be released only in 2003.

Looking ahead
A lot will rest on the market performance of the P800, which is due year-end. Although first conceived as a member of Ericsson's smart phone series, much joint development has gone into the P800. While it isn't a pure Sony Ericsson product, the P800 will be both a flagship and compass to how the venture will turn out.

Of course, it's easier for Sony to stay cool. The Japanese conglomerate has a considerably better financial record compared to Ericsson. For the June quarter, Sony raked in an operating profit of 51.87 billion yen (AU$786 million), thanks in part to the box-office success of the feature film Spider-Man.

The more critical question is how much longer Ericsson is able to hold out. In July, Moody's Investors Service downgraded the Swedish organization's debt to junk status. Hellstrom recently said on live television that, while he remained optimistic on the long-term prospects of the industry, it was impossible for him to say when the telco market would recover.

But will Ericsson hang up on the venture? Probably not.

In the long run, it makes sense for Sony to invest in cell phones. With convergence inevitable between phones, music players, gaming and imaging devices, Sony's considerable expertise in consumer electronics will come in handy.

Furthermore, there remains a great deal of optimism about Sony Ericsson products, both from the consumers and the analysts.

Should Ericsson decide to halt its investment in the venture, Sony may well buy over a larger stake in the 50-50 entity. This would put the Japanese company in the driving seat of the partnership, but, essentially, the handset operation and products will remain intact.

For all anyone knows, Ericsson may have only been bluffing; its threat mainly to spur Sony Ericsson into shaping up and meeting the challenges of a difficult market where the stakes are now higher.

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