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When BlackBerry (NASDAQ: BBRY ) posted a loss of $4.4 billion in its third quarter -- primarily driven by unsold inventory -- the investing community began to question the proficiency of its management. In its most recent quarter, however, that loss narrowed to $423 million.
Optimists believe that the financial improvement will continue in the coming quarters. But there is reason to believe that BlackBerry's prospective turnaround won't be easy to execute.
BlackBerry's management has done a commendable job in restructuring its operations. By shifting its cost structure to variable pay and reducing its exposure to fixed costs, the company was able to lower its operating expenses by 51% in its fourth quarter, sequentially.
The smartphone giant signed a five-year contract with Foxconn in December to outsource the production of its smartphones. This move will reduce BlackBerry's exposure to its bleeding manufacturing arm and shift its cost structure to variable pay, a move that in theory should drive its operating costs lower.
On the operational side, BlackBerry linked up with several e-commerce distribution channels across the globe and introduced lucrative discount deals to offload its inventory. And in a bid to boost its exposure to emerging markets, the company slashed its Z10 prices by 60% under a limited-period offer in India.
These efforts, however, were not enough to support its sliding top line; BlackBerry's fourth quarter revenue was down 18%, sequentially, and plunged 64% on a year-on-year basis.
The biggest threat to BlackBerry's financial recovery is posed by competitive offerings from Apple (NASDAQ: AAPL ) and Samsung (NASDAQOTH: SSNLF ) . For instance, Apple reintroduced its iPhone 4 earlier this year at a competitive price tag of $330 in developing markets such as India. Plus, it has introduced trial offers in emerging markets to lure first-time buyers.
Samsung, on the other hand, launched two new smartphones in emerging markets earlier this year -- Galaxy Grand 2 and Grand Neo -- both priced very close to BlackBerry's Z10. Moreover, these devices house Snapdragon 400 processors, which are relatively faster than the OMAP 4470 processors equipped in the Z10 available in emerging markets. Therefore, there isn't any performance incentive to buy the Z10 over Samsung's latest.
More importantly, the eagerly awaited Galaxy S5, HTC One M8 and iPhone 6 will make it harder for BlackBerry to sell its Z30 devices at elevated price points. BlackBerry will have to price its products more competitively, thereby putting a strain on its margins.
Investors should note that a shift to a variable cost structure has its limitations. Fixed costs are constant, recurring expenses, whereas variable costs fluctuate proportionally with the company's output. It makes sense for a struggling company to adopt a variable cost structure.
As illustrated in the chart above, however, the same variable cost structure can work against a growing company. The breakeven point is pushed back, and growing companies begin to hemorrhage cash.
This essentially means that BlackBerry will have to restructure its costs once its unit sales increase. But this shift won't occur anytime soon, since BlackBerry's recent deal with Foxconn lasts till 2018.
Words of caution
The latest BlackBerry Z3 is reportedly manufactured by Foxconn, which means that profits generated from the device will be split equally between both parties. Since the Z3 is a budget-friendly, $200 device, it's doubtful that shared profits will be enough to boost BlackBerry's operating income substantially.
BlackBerry should continue to benefit from outsourced production over the short-term period. But if its unit sales grow substantially, the variable costing structure will limit the smartphone maker's bottom-line growth.
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