Sunday, August 28, 2011 2 comments ++[ CLICK TO COMMENT ]++

Mobile phone market dynamics

A couple of weeks ago, asymco produced a comprehensive chart plotting the volume by price metrics for various smartphone manufacturers. I thought it was an insightful chart that illustrated the competitive positioning of all the major competitors (for which Asymco has data or can make an estimate). I thought I would add some notes highlighting my interpretation of the various segments of the smartphone market, and raise a couple of key issues for smartphone investors.

In the chart below, I have marked up the chart with the traditional, high-volume/low-price to low-volume/high-price, segmentation. As common in business, nothing ever fits perfectly so the classifications are just ideas. Asymco's charts are in line with my classification except for Sony Ericsson, which should be moved further to the left since it is a low-volume/high-price manufacturer.

Sorry about the small font on the axis labels. Click for a larger chart but the font is still too small. Hopefully it doesn't detract from the main observations.



The most insightful observation, especially for those that don't follow mobile phones, is how much of an outlier Apple is. Apple has very high average selling price (ASP) that is nowhere near the competitors. It is truly taking advantage of premium pricing and competitors appear to be unable to attack its pricing.

The shaded area shows operating profit so the bigger the surface area, the better. Apple completely dominates the operating profit category. In fact, many of the volume suppliers are posting losses or close to posting losses (these results are only the quarter two and are not necessarily refelective of the full year). Apple's operating profit per phone is almost as high as the average selling price of any of the competitor!

The chart also clearly illustrates that the biggest volume manufacturers (wide bars) are Samsung and Nokia. Both of them have very low ASP with Samsung averaging around $130 and Nokia around $100 (hard to tell the numbers accurately from the chart :( ). Nokia has the lowest ASP on the chart and started posting a loss recently but it has historically been the lowest cost producer.

Looking at the chart, if you were a contrarian, you would probably be bearish on Apple and bullish on Samsung or Nokia—hence why I'm seriously interested in Nokia. There are reasons Apple's profitability is so high but it looks unsustainable when you look at the rest of the industry (then again, I have been doubtful of Apple for a while and been completely wrong).

Will Apple Move Downstream?

One big question making the rounds is whether Apple will move downstream and introduce a mid-end phone. This could have dramatic consequences for smartphone investors. So far, Apple has only sold top-of-the-line premium phones. You can see that in the chart above with Apple's ASP (average selling price) well above $600, whereas no one else even comes close.

It'll be interesting to see what Apple does. It can increase sales, while accepting lower margins, by going into the mid-end market. However, that may cannibalize its high-end sales or tarnish its brand slightly (especially if its mid-end products aren't as competitive as its competitors' offerings). Apple has several different lines for its iPod product but I believe that is not comparable to the iPhone (iPod competition is more limited compared to the smartphone competition).

Apple won't move into the low-end market, so I wonder if someone will end up owning that space or if it will be a highly competitive market with low profits. The only way one can win that space is by being the lowest cost producer. The low-end market also has the highest growth potential although per unit profitability will be low. Most of the non-phone-owning population in the world, who are mostly in poor countries, can only afford low-end phones.

Overcapacity in the Industry?

More ominous for investors perhaps is the thought that this may an industry with persistent near-term overcapacity. I am bringing up the overcapacity possibility because there are numerous large players—Sony Ericsson, Motorola, Nokia, LG—posting losses (at least for this quarter; this is not necessarily the case over the full-year). Furthermore, they are posting losses in an industry that is growing and is somewhat developed (i.e. not in a start-up phase).

There are numerous other, tiny, no-name, companies (mostly from China and India), who are expanding into the low-end market and may be posting losses as well. I'm not sure about these profitability of these companies.

The question is whether some of these companies will exit the market, or at least cut production. It's too early to say for sure but if there is overcapacity, this is not a good industry to be in. It could resemble auto manufacters in the 1930's/1940's, who were in a growing market (so you would think it would be good for all), but if you didn't pick the few that survived, all the others dissapeared.

Future Thoughts

I'm not too knowledgeable about the mobile phone market but since I started researching it an year ago, I would say that we have seen two distinct phases of wealth creation (for shareholders) in the industry (Note that the phases are different if you look at it from a technological or social perspective. For instance, the underlying technology may shift but you may not see a shift from a shareholder profitability or company "moat" perspective. I am also ignoring the very early days of mobile phone commercialization in the 80's and early 90's.)

The first phase generated big profits for the early entrants such as Motorola, Palm, Nokia, and RIM. Motorola and Palm failed to maintain their success into the next phase.

The second phase—it probably ended about an year ago—appears to involve large profits for the premium manufacturer (Apple) and a few large volume manufacturers (Nokia, RIM and Samsung). It's too early to say since profits (and share prices) lag monumental shifts in the industry but Nokia and RIM are struggling to maintain their dominance and there is a chance of them also ending up as an "also-ran."

Slowly, the third phase, which appears to coincide with the shift from feature phones to smartphones, is emerging. It's too early to say what will happen but we are noticing some shifts. In particular, it appears that past winners such as Nokia and RIM are rapidly losing market share and profits. Although other suppliers are gaining market share, it's unclear to me that they are seeing consumerate increase in profits (the only exception might be Samsung.)

It remains to be seen who will end up dominating the current phase. What I wonder is whether the mid to low-end manufacturers will see eroding profits, even though sales increase, due to heavy competition and overcapacity. There is also a trend towards lower ASP due to improving technology (although it will probably stabilize temporarily during the shift to smartphones due to their higher prices and higher value proposition (i.e. not a voice phone anymore; more of what was once called a PDA.)) Will we see the big volume sellers with low cost production, which have traditionally been companies like Nokia and Samsung, able to earn a decent profit at lower ASP?

Barring some drastic change in the industry landscape, my feeling is that companies like Nokia only have a shot at surviving if they become the lost cost producer in the low to mid-end space. Believe it or not, this has historically been Nokia's market positioning so it just needs to adapt and produce low-cost phones using the Windows Phone architecture. Driving down Windows Phone costs—I am including the software and hardware—below, say, $75 will be key. Samsung, which is an amazingly well-run company these days, will also likely focus on the mass-market.

Companies like RIM (Research In Motion) will have to focus on the higher-end market. They don't have the volume to produce cheap phones. RIM does sell a lot of consumer phones outside North America but I believe their position will be difficult to defend once Windows Phone and Android smartphones are released a lower price points with similar features. RIM has a lock on corporate enterprise users defended by a noticeable moat (encrypted e-mail, easier-to-use enterprise back-end software, phone focus on corporate productivity tools such as e-mail rather than on consumer needs such as photos). Apart from Apple, RIM is probably the only one that maintain a high ASP (due to its strong relationship with corporate customers.)

How Will the Industry Evolve?

A big question in my mind has to do with the industry evolution. What will the mobile phone market resemble? Is it going to be similar to a pure consumer electronics industry (e.g. television)? Or will it be something like autos? Or is it going to be like the retail industry?

What I am getting at is, are we going to end up with only 3 or 4 major manufacturers, or will there always be almost 10 decently-sized companies?

Will there be distinct separation between low-end, mid-end, and high-end phone suppliers (e.g. fashion & retail)? Or will there be a blurred line (e.g. PCs)?

Of utmost importance to investors is how the market segments end up looking because the profit picture is not going to remain the same. For instance, Apple earns the vast majority of profits in the industry even though it is clearly a high-price/low-volume producer. Yet, in many consumer-focused industries, the biggest (aggregate) profits tend to go to the mass-market producer. Such mass-market-focused companies may have a low price and a low profit margin, but they tend to create way more wealth. Think about Wal-mart (WMT) vs Saks Fifth Avenue (SAK); or Toyota (TM) vs Ferrari (division of Fiat I believe); or with consumer PCs in the 90's, Dell vs Compaq/IBM. Of course, this is not always true if the higher-priced brand has strong market positioning (e.g. Nike vs no-name shoes; or Coca-Cola vs no-name pop). But I do think the greatest aggregate profit in mobile phones will be made by the low to mid-market manufacturer. I say so because the vast majority of the world's population can't afford a smartphone over $200.

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2 Response to Mobile phone market dynamics

August 31, 2011 at 2:04 AM

Hey, just came across this as I was researching for a whitepaper. Love it! The graph is very nice, its given me some interesting ideas to create my own graphs which deal with multiple areas within a segment (Finances, Usage etc.) If possible, can you tell me how you learnt to make graphs like these? I would like to know if there are other possibilities as well!

Thanks, will come back here :)
Neeraj.

Sivaram Velauthapillai
August 31, 2011 at 9:59 AM

Hi Neeraj,

The original graph was created by Horace Dediu at asymco.com. You should go over there and find out how he created the graphs.

As for my modifications, I just used the latest PowerPoint to add the elements.

Hope that helps.

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