Nokia announced its Q1 results today, showing a year-on-year decline in profits and a decline in average selling price (ASP). However, it managed to increase overall sales slightly, grow device unit shipments (up 21 percent to 91.1m) and add another percentage point to its market share (now 36%). It also saw relative stability in its gross margin, which fell less than expected from about 34% to approximately 33%.

At a macro-level, the performance of the handset industry is being governed by two factors at the moment: an increasing proportion of sales are coming from emerging markets and the high-end of the market is becoming more competitive than ever. At the top-end, mobile telecoms companies are also finding they are increasingly faced with competitive overlap from the consumer electronics markets.

It’s a challenging time for everyone and Nokia seems to be doing a good job of managing these issues.

There are several factors I’ll be looking at long-term to evaluate Nokia’s prospects. Firstly, does it make sense for Nokia to continue expanding its market share in emerging markets, where devices typically have lower ASPs? If it does, it will probably have to lower prices further and engage in a price war with local vendors and its global competitors. This could lead to further margin declines, even if bottom line sales and profits increase.

However, Nokia has a number of things in its favour. Despite investor concern over competitors’ ability to undercut the Finnish company in emerging markets, it’s worth remembering that quite apart from anything else, Nokia’s volumes dwarf those of even its closest rival. Its units volumes were double those of Motorola in Q1 2007 (Motorola shipped about 45m devices compared to more than 90m at Nokia).

No company in the mobile industry is better placed to control its supply costs and take the lead on pricing. Nokia has invested aggresively in local manufacturing capabilities in key growth markets like India and China.

The real story with Nokia’s emerging markets prospects, however, is about brand and customer loyalty. How much is Nokia willing to invest to capture market share among the 4 billion people it estimates will be using mobiles by 2010, almost half of which will start using mobile devices for the first time in the next 3 years? How much is it worth to the Finnish company to ensure customers have their first mobile experience with a Nokia product?

There are some 850m Nokia handsets in use worldwide. If Nokia can continue to maintain its position as the benchmark for ease-of-use, this existing customer base could become one of its most valuable assets, tying in a new generation of emerging markets customers to the ‘Nokia experience’. Given the benefits this has delivered for Nokia in the past in developed countries, it may be more appropriate to consider lower margins and falling ASPs in the same way investors treat subscriber acquisition costs in the network operator community – an investment in future revenues.

There are signs this is already occuring. Sales in China jumped 43.4 percent year-on-year, but they weren’t just confined to low-end devices. China is Nokia’s fastest growing market for ‘multimedia’ devices such as the high-end N-Series range. Latin America is experiencing similar growth in these higher margin sales.

If Nokia can establish the dominance of its brand in these regions, it should be able to gradually increase ASPs as their economies grow, mobile devices become the terminals of choice for internet access and network build-out increases.

Looking at developed markets and the top-end of Nokia’s device portfolio, I see the company facing a key inflexion point. The launch of the N95 ‘multimedia computer’ is a real test of the company’s medium-term strategy. Will it be able to convince customers that their mobile phone can really be their primary MP3 player, handheld gaming console, GPS and digital camera – as well as maintaining the simplicity of the voice and text experience?

At the same time, Nokia is transitioning its business model from one based almost entirely around hardware, to a new approach where it also plays a much greater role in the software and services experience. The N95 includes the GPS software it acquired when it bought Gate5 and Nokia is also launching its own music downloads store.

Initial reviews of the N95 have been very favourable and the Finnish company is sparing no expense with its marketing campaign. The N95 is everywhere in the UK at the moment. Clearly the company is aiming for a blockbuster launch which will cause a major shift in customer’s expectations of what a mobile phone can do.

It is also ramping up the pace of innovation and the marketing efforts of its enterprise unit, with major campaigns underway for E65 and E61i. There is also the forthcoming E90, the first of a next generation communicator line.

Nokia will face tough competition in both high-end consumer and enterprise sales. Motorola’s Q1 performance was dismal, allowing its competitors a relatively easy ride. However, Motorola has demonstrated in the past it has the product development expertise to executive impressive turnarounds – witness the RAZR – and a resurgent Motorola could have an impact on Nokia.

Sony Ericsson, due to report results tomorrow, is also expanding rapidly. Of all the major handset manufacturers, Sony Ericsson has demonstrated the best performance in winning high-end customers and convincing users to try new features like photography and music playback. It’s 2006 average selling price of about USD 190 is far ahead of Nokia and Motorola’s approx. USD 120 level.

In the short term, Nokia’s prospects are all about execution. If it delivers its key product launches on-time and with effective marketing and supply management, the outlook for the rest of the year will be really quite positive. Looking further out, much will depend on how effectively it manages the competitive threat from Sony Ericsson, Samsung and Motorola – as well as countering the emerging threats from consumer electronics players like Apple and business specialists like Palm.

In the long-term, Nokia will need to demonstrate its ability to manage two distinct business propositions: rapidly expanding emerging markets and mature, highly competitive developed markets. Ultimate success depends on its ability to address both these opportunities and find a way to weave them into a single brand strategy based on loyalty to the Nokia experience of simplicity and convenient integration.

This research note is based on my television interview today for BBC World Business report. Nokia’s Global Director of Retail Marketing, Cliff Crosbie, is a keynote speaker at our MEX conference in London on 2nd – 3rd May 2007.