I've been asked in comments on this blog who will win the "mobile war".
I use two analytical tools to answer this question: (1) history (2) value chain analysis.
History shows that operators are very important and hence very powerful in this market. That makes sense on many levels. They control what phones you get to buy, they decide the pricing and they decide frequently how you can use the phone. This is because the networks are expensive to build and maintain and there is an implicit bargain struck that the user and device should conform to the operator.
Value chain analysis tells me that as networks are not good enough, tight integration of the business models of the phone vendors and the operators is necessary to climb up the trajectory toward good enough as quickly as possible.
Therefore, given the distribution of value/bargaining power in the chain, it’s reasonable to assume that it’s operators who will decide which platforms win/lose and to what degree.
That simply means that no single platform can win a disproportionate share because it would threaten the balance of control the operators require. So talk of “dominance” of one platform or another is hyperbole. The most likely scenario is an even distribution of share between 4 or 5 competitors, so I expect iPhone and Android to get 20% share each.
This is not “fair” or economical or efficient, but it’s the way it’s going to be for a long time. If you're a fan, don't despair. In a few years, it still means hundreds of millions of units a year for each platform.
If you want to dream or hope for a more efficient outcome, you’ll have to look outside the cellular network model. I.e. think how iPod/iPad and Android tablets will evolve into communications products.
I did not include all vendors for various good reasons. The first survey (market share) did include an "others" category that made the volume data complete, but in the financial data sets, I chose to include the top 7 vendors that make up 80% of device volumes.
One noteworthy vendor that was not included was HTC. HTC is an important vendor for several reasons:
it's a pioneer in smartphones having made the first Windows Mobile devices and the first Android devices
at one point it sold 80% of all Windows Mobile devices
even if it did not brand its devices, it was the name behind many re-branded or white-label operator branded phones
it has a brand of its own today and is expanding its reach
HTC has been around building devices since 2001 and so it would be a pity to exclude them from any analysis of the effect of iPhone on the market or any discussion on the effect of smartphone disruption on feature phones.
The challenge with HTC was that historically their branded devices and white label devices were not reported by the company separately. This matters because white label devices are valued differently. Typically these devices are not marketed by the original manufacturer so SG&A is not applied to their cost base. Operating margins, ASPs and hence profitability is not directly comparable with other OEMs.
But HTC has recently changed its reporting. Thanks to a reader I discovered that, since 2008, HTC has been listing its ASP and Operating Margin making direct comparisons possible. I still don't have all the data, but enough to add HTC to the analysis.
So, here are the 5 industry performance criteria, now with eight vendors listed.
Volumes
Note that HTC volumes start in 2008.
The volume of units HTC sold has been increasing at about the rate of market growth.
As a result, HTC's share has not increased as dramatically as those of the other smartphone entrants.
Sales
A similar story in the sales picture. Although a consistent performer, the growth has not matched that of RIM and Apple.
ASP
The pricing story is also a mixed one. Although HTC lies between RIM and Apple in price, the erosion is more consistent with RIM and the rest of the industry.
Margin
The margin story is also not as positive as one might expect. The margins for HTC started out above Apple and RIM but have dropped to closer to industry average. This is not what one might expect from an exclusive smartphone vendor.
Earnings
The share of earnings has remained unchanged at 5% over the period of iPhone presence. It's perhaps a credit to HTC that they did maintain their position in the market with the massive change that has come to pass.
However, here we also have to ask if HTC is riding a disruptive wave.
When I wrote the last series, my definition of “loser” was a company that had faced a long series of operating losses and has no viable software assets of its own, making it vulnerable to Android (and Windows Mobile). Motorola first, Sony Ericsson second and LG now coming into the picture. Nokia is not a loser in this sense since it has remained profitable and does maintain an investment in software. Same with RIM and Samsung (now with Bada). When/if they do have the near death experience, they might opt for the Android lifeline (flimsy as it is).
However HTC does not fit the mold of either "winner" or "loser". It's the Goldilocks company, not too hot, not too cold.
But I would add that HTC is not an example of a winner because of its adoption of Android. HTC’s dependence on Windows Mobile made their move to Android the most desperate of all. Unlike the larger OEMs, who had their low end devices to fall back on, they are completely dependent on a smartphone OS vendor. When WinMo was showing the first signs of crisis in 2007, they were the first to flee to Android (think of why they would risk the wrath of Microsoft for something so fragile as Android in 07). They are also trying hard to escape the dependence by building up their own UI (SenseUI) and I would not be surprised if they move to their own OS in the future. Being associated with Android does not confirm them as "winners" but in fact, shows their vulnerability.
What does this all say about Android?
Again here my thesis is that Google chose to sustain the industry rather than try to upend it. I don't judge their motives, but the fact is that with Android, Google is not in a position to disrupt telecom. There were high hopes dashed with the Nexus One and hearts broken with net neutrality and now there are patent wars to be fought. Android, with its licensees, is still at the mercy of operators.
The mobile phone market is intertwined with the telecommunications industry which is vast and there are numerous competitors which are much more dynamic and better capitalized than the moribund PC or music player vendors. It’s also a regulated and fragmented global market with 1.2 billion units and 5 billion consumers—far greater than any of the markets Apple played in for its first 30 years.
Nevertheless, the iPhone has had a huge impact on the industry. To show just how much of an impact, I dove in and pulled over 500 data points on three years’ financial performance of seven competitors responsible for 80 percent of units being shipped today. The time frame covers the iPhone’s participation in the market so it allows for “before-and-after” comparisons.
Now I turn my attention to draw a bottom line from all the data above, namely the operating earnings (EBIT or Earnings before Interest and Taxation).
The first chart shows the EBIT from the top seven vendors of mobile phones since the quarter when the iPhone launched. I annotated Nokia and Apple's bars to give perspective.
The total available profits in the industry dipped to a bit under $4 billion at the trough of the recession, and have recovered to nearly $6 billion in the holiday quarter last year. However, not all vendors are profitable. As you might expect from looking at the operating margins, Motorola and Sony Ericsson have been generating losses for most of this time period. They have both reached profitability in the last quarter, though at very low levels and after having lost a large part of their sales. LG has turned negative this past quarter after being a modest earner for some time. Samsung has maintained a fairly even consistency in its profit capture, though with its expanding market share, it seems to have come at the cost of pricing.
Finally, looking at the pure smartphone vendors RIM and Apple, the picture is nothing short of astonishing. This before-and-after share-of-available-profit chart shows that the two entrants went from about 7% profit share to 65% in three years.
Apple in particular is capturing about half of the available profits with three percent of the units. It dwarfs all the other vendors, more than double the nearest (Nokia). All that in three years and with the added burdens of only three models, a recession and limited distribution.
What does it all mean?
Here are my conclusions, enumerated:
The lack of a real response. The recurring theme in this series of articles has been that giant multinational incumbents in a vast and rapidly growing industry, enjoying all the advantages that size and incumbency, have had their profits taken from them. And they don't seem to have put up much of a fight.
It's all wealth transfer. Note the total amount of profit available has not increased markedly; this is not about incumbents growing the pie. Two thirds of what should have rightly been theirs moved from the incumbent shareholders to the entrant shareholders.
Speed. This shift of profit occurred over an unprecedentedly short period of time. Three years is no more than two product cycles in the industry and it's an order of magnitude faster than what happened historically to other industries.
Disruption is the diagnosis here. The incumbents were caught in the headlights. Disruptive innovation leads to asymmetric competition and this is what we just witnessed. History has shown that the shift of profits is usually the last stage of disruption and is usually irreversible because the change in business models cannot happen at the rate of change of profit transfer.
Which leads me to one final point.
When analyzing the potential for challengers to the new winners, the most cited is Android. Can Android affect this redistribution of profit once again? And to whom?
If Android is to become the dominant platform, does it depend on the success of its licensees? Who are these licensees and what are the chances that they will be able to align their businesses to what Android offers (a new revenue model based on services and advertising).
One problem I see is that Google is making a bet on those same vendors who are now squeezed in the middle of that last pie chart: Samsung, LG, Motorola and Sony Ericsson. Nokia, Apple and RIM will certainly not take the OS over what they already have as it dilutes their differentiation and margins. That means Android is aligned with the biggest losers in the industry.
So how likely are these disrupted ex-giants to recover and take Android forward? My bet: slim to none. Android does not offer more than a lifeline. It is not a foundation for long-term profitability as it presumes the profits accrue to the network and possibly to Google. Profit evaporation out of devices to Google may be a possibility at some time in the future, but only if the devices don't need too much attention to remain competitive. But because they're still not good enough (and they won't be for years to come), it's certain that attention to detail is what will be most important to stay abreast of Apple.[1]
So here we have the real challenge to Android: partnership with defeated incumbents whose ability to build profitable and differentiated products is hamstrung by the licensing model and whose incentives to move up the steep trajectory of necessary improvements are limited.
In other words, Android's licensees won't have the profits or the motivation to spend on R&D so as to make exceptionally competitive products at a time when being competitive is what matters most.
[1]: I would argue the same lack of symmetry with licensed software vendor Microsoft is what led the the failure of the same incumbents to make a dent in the industry with Windows Mobile [2003 to 2010].
As of the end of the second quarter, Samsung’s global smartphone share was 4.8 percent, according to IDC. But LG’s presence was negligible.
[Update] From early 2009,
LG, the third-biggest phone maker, will produce about 50 models that run Windows over the next five years, said Scott Rockfeld, a director in Microsoft’s mobile business. Seoul-based LG will use the software as its primary program for smart phones, devices that can send e-mail and browse the Web.
After ASP, Sales, and Unit Volumes we look at the three year history of operating margins for the seven most significant mobile phone vendors (Nokia, Samsung, LG, Motorola, Sony Ericsson, RIM and Apple).
The following chart shows the OM from mobile phone sales. These figures are as reported by the companies with the exception of Samsung and Apple. Samsung reports OM for its telecommunications unit as a whole and we have to assume that it's largely accurate for mobile phones. Apple does not report margins for its iPhone but it's possible to estimate gross margin percent for the iPhone and then subtract its overall OPEX as percent of sales. This assumes that OPEX is allocated to the iPhone in proportion to sales, which is the best assumption we can make at this time.
The data shows that the iPhone has been considerably more profitable, due mostly to a high ASP, than other vendors. Motorola and Sony Ericsson have been "underwater" with respect to margin for much of the time period, with LG recently dipping into the red.
Nokia's margin erosion is a source of significant angst but note that it has just reached Samsung's historic level (around 10%). LG, long seen as an up-and-coming vendor who took over the number three spot from Motorola is shown to have done so with moderate-to-low profit margins.
Overall, the phone incumbents have an unweighted average operating margin of 4.5%, down from 8.6% three years ago. In contrast, RIM and Apple have an average OM of 34%, up from 24%. In other words, profitability has halved for the volume leaders while it has increased nearly by half for the entrants.
This goes a long way toward explaining the "smartphone gap" which is being filled by Android. As vendors see their unit growth, ASP and operating margins under pressure from low end disruptors, there is a tendency to flee to the high end that smartphones represent. Android offers an irresistible siren's song.
Japan and Korea have further 3G reach but use it significantly less.
His findings support notions that Android and iPhone are controlling data use in the US. The iPhone's current exclusive home, AT&T, and Android-favorite Verizon both make up 75 percent of American data use
Is there any surprise that in the country where the iPhone and Android are most popular there is the highest data usage even though it has one of the poorest mobile data infrastructures in the developed world?
What does that say about the importance of the device (and not the network) to the adoption of data services.
There are implications about the relative power shift between operators and device vendors. Within the mobile value chain, as mobile data overtakes mobile voice, the economics and value propositions will shift. The motivation of participants will begin to diverge and a schism will occur.
Many consider June 2007 to have been a pivotal moment in the history of mobile phones. Apple's entry with the iPhone has re-defined the market in many ways. However, there was a smartphone market before then. About 28 million smartphones shipped the quarter when Apple launched out of an overall phone market of 265 million. Apple's entry with 270k phones was a drop in the bucket.
I thought it would be instructive to chart what happened between that quarter, exactly three years ago and today. I collected the data from IDC, Gartner and Canalys and company reports to paint a few pictures.
First, the market shares (by units) of the top mobile vendors, Q207 vs. Q210. I highlighted the smartphone vendors by separating their wedges from the pie. Note that I also separated Nokia's smartphones from Nokia's regular phones as two separated wedges--Nokia ex-SP for no smartphones and Nokia SP as their "converged" units. I did the same with "other".
The first thing to note (beside the large increase in smartphone share) is that "other" non-smartphones are a huge part of the pie. At 20%, the share of "other" is now equal to the share of Samsung. Other consists of a group of mostly low cost Chinese vendors. The growth of the low end "other" went from 35 million units in Q207 to 65 million in the last quarter. It's this competition that is driving profit out of the core businesses of Nokia, Samsung and LG and forcing a flight to smartphones (more about this later).
The second thing to notice is that Motorola and Sony-Ericsson are highly visible victims of the last three years. Sony Ericsson shipped 25 million devices in Q207 and only 11 million three years later going from 9% share to 3%, on par with RIM and Apple. Motorola did even worse, shipping 35.5 million in Q207 and a mere 8.3 million last quarter, losing 10 out its 13 points of share.
Viewing the overall units market, one can see the gouge in units that the recession took out. The following graph shows three years of volumes by the top vendors with the smartphones separated at the top (Nokia SP, RIM, Apple, HTC and Other SP--everything above the grey band are smartphones).
However, separating out the smartphones, one can see their volume increased with barely a ripple during the recession. Although Nokia retains the top share spot, the entrants have jointly grown much faster. I have annotated a few of the competitors' volumes with the actual values.
One thing to note is that "other smartphones" has traditionally consisted of Windows Mobile licensees but that is quickly shifting now to Android. I also had only fragments of data for Samsung and Motorola, so their bands are incomplete. However, one could note how minimal their participation has been in the market. LG has been practically absent from this market. For these latecomers to smartphones, it's clear what Android offers: a chance to stay in the game.
Thanks to Android, T-Mobile tripled its smartphone user base in one year. Evidence again of a secular shift to smartphones and the value of Android as gap-filler for Apple's inability/unwillingness to satisfy demand.
Only sell-through (i.e. not exact numbers that companies report as sold, i.e. excluding inventory in the channel)
Other includes Symbian devices not sold by Nokia, Microsoft Windows Mobile and various Linux, WebOS
iOS includes only phones, no iPads, no iPod touch, similarly Android includes only phones
Some of these numbers are approximate as they are based on partial data (Canalys does not publish complete share data and some must be interpolated)
Data used to build charts:
Overall the market grew 64% last Q, with Apple maintaining share y/y even though transitioning to a new model and draining channel during several weeks. Android continued to experience over 8x growth which is phenomenal. Share was taken mostly from incumbent Nokia (-7), Microsoft (-4) and RIM (-3), though bear in mind that the whole pie grew by nearly 70%.
[Updated]
Canalys OS share data has become available and I've updated the charts and table.
• No other manufacturer can claim nearly the loyalty of iPhone owners. RIM BlackBerry owners see a touch-screen device as the antithesis of their hard keyboards. However, even in this category, 23 percent of respondents plan to buy an Apple iPhone. We see similar results with all other mobile phone owners. In fact, 36 percent of Google-branded Android phone owners say they plan to buy an iPhone, surpassing the 32 percent of Google-branded phone owners who intend to buy another Android phone.
The Droid X comes loaded with several nonstandard applications for Google’s Android, most of which cannot be removed. Among the phone’s so-called junkware is a Blockbuster video app and a demo for an Electronic Arts game called Need for Speed: Shift.
