This year's slowdown in mobile phone sales has triggered a wave of job losses and other retrenchment measures. But perhaps the most significant development was that announced in January by Ericsson.

The sector's third-biggest company said it was pulling out of handset manufacturing altogether and turning over the bulk of this part of its business to Flextronics, the Singapore-based outsourcing company. Most of the work has been shifted to low-cost countries in Asia.

Under the terms of the deal, said to be worth between $300m and $800m, Ericsson retained control of research, design, branding and marketing but handed responsibility for most other activities to Flextronics, which agreed to take over Ericsson's factories in Sweden, the UK, the US, Brazil and Malaysia, along with 4,200 employees.

The Singapore company is thus expected to handle much of the manufacturing for the newly-created Sony Ericsson joint venture when its products start to come on stream next year.

The move came two weeks after Motorola, the second-biggest vendor, said its hand-held division planned to increase its level of outsourcing from 20 per cent to 40 per cent over the next couple of years. Much of this work is being done by Flextronics and the Toronto- based Celestica.

In June, Philips said it would cease to be an independent maker of mobile handsets and would put these parts of its R&D and manufacturing activities into a partnership with China Electronics Corporation in which the latter would hold the controlling stake. And in July, Alcatel sold its one European handset factory to Flextronics, and said that this company would in future be responsible for all production for the European market.

License deals

Meanwhile, some manufacturers are making their technology available to their rivals. Motorola said in July that it would license 2.5G and 3G semiconductor and software technology to other manufacturers. Ericsson revealed in September that it had been licensing technology to other companies since the start of the year - including component specifications, printed circuit board layouts and software.

While some of these original equipment manufacturers (OEMs) have been using outsourcers for years, the pace and scale of developments over the past year indicate a sea-change in the way the industry does business. Many experts believe manufacturers will eventually come to operate in the same way as the makers of personal computers, which today play very little role in the manufacture or even the design of the products that bear their names. Instead, many leave this side of their business almost entirely to Far Eastern companies.

But others disagree. Market leader Nokia, which accounts for more than a third of all mobile phone sales, is resisting the outsourcing trend. While it does use outsourcers for items such as assemblies, it produces the actual handsets itself.

The plethora of outsourcing deals reflects changes in the reasons for using this approach. Initially, many vendors used outsourcers as a means of providing additional capacity in order to cope with the seemingly inexorable growth in world demand for mobile phones. At the same time, the growing pressure on margins as the industry became more competitive pushed them further towards outsourcing as a way to cut costs.

"Engineers and factories always come cheaper in Asia than in Europe," says Richard Fry, sales and marketing director at TTPCom, which sells software and chip designs for mobile phones. "The huge rise in the number of handsets produced has made it worthwhile to exploit this. A few years ago there were 10 companies making 50m phones a year between them. Now there are fewer than 10 making 500m a year."

In addition, the abrupt end of the growth cycle meant many companies which had geared themselves up to cope with a surging market suddenly found themselves with big unsold stocks.

Wolter Mannerfelt, vice president at consultants Booz Allen & Hamilton, argues the key advantage of outsourcing is that it gives a manufacturer the flexibility to ramp production up or down according to demand. "When you try to forecast volumes you are always wrong," he says. "You make too many or too few. But having your own factories makes you far too inflexible to cope with violent changes in the market."

Outsourcing, however, also entails risk. Companies must ensure the supply chain is organised so that it can react quickly to changes in requirements - otherwise they could face costly shortages or gluts. This is a particular danger with mobiles because of the shortening lifecycles of products. Booz Allen points out that Philips last year ran into problems operating its outsourced supply chains because of a shortage of flash memory chips, which threatened to disrupt production of 18m handsets.

Mark Paxman, principal consultant at PA Consulting, agrees. "In theory, outsourcing should be more efficient," he says. "The contractor is making products for several customers and several industry sectors. It should be able to shift manufacturing around and smooth demand. In practice, it can be more difficult."

Nokia says the disadvantages outweigh the gains. It maintains that possession of its own factories gives it the ability to turn production on or off as needed, as well as to control product quality and the supply chain.

Nokia sales

Ben Wood, senior analyst in mobile communications at the Gartner consultancy, says Nokia has a huge advantage over its rivals in terms of scale. But he also points to its "phenomenal" ability to control manufacturing processes. This was shown last month when the company said it had achieved a margin of 19 per cent on handset sales in the third quarter, at a time when most rivals are counting themselves lucky if they make money at all.

Nokia's rejection of the outsourcing trend partly reflects a divergence of views on how the market will develop, says Mr Wood. Motorola, for instance, justifies its move to license its technology to others on the grounds that mobile phones are becoming commodities. It says that, as in the PC industry, technology is becoming less important as a differentiator. Instead, value will be derived by competing on the basis of brand, distribution and style. "Nokia takes the opposite view," says Mr Wood. "It says handsets are not commodities, they are complex products."

He thinks it is too early to say which is right. But the commodity argument is much stronger at the low end of the market than at the high end, he says.

"There's much more complexity and innovation at the high end, especially as we move towards 3G," he says.

Neil McCartney is editor in chief of Wireless Internet, www.mmwirelessinternet.com