Samsung's mobile marketing lead for the country, Sitthichoke Nopchinabutr, also provided a surprise and hinted that the company might turn on Google and focus primarily on Windows Phone. About 15 to 20 phones based on Android, Bada and Windows Phone would ship in 2011, but the majority of them would use the Microsoft OS. For every 50 Windows devices, 24 would be Android models and just five would use the in-house Bada OS.
Gartner released sell-through data for the handset market. In the release appears an estimate of total Android 3Q Smartphone sales (20.5 million). Combining this with what some of the vendors have reported in terms of units sold, we can estimate the share of Android by vendors.
Note that this is a rough estimate. We don't have data on Sony Ericsson's smartphone units sold and we don't know the mix of HTC's Windows Mobile vs. Android. I'm also assuming LG as part of Others. The data from Gartner is claimed to be sell-through whereas vendors report sell-in so there is more roughness about each vendor.
Regardless of these potential sources of error, it's a very safe bet that Samsung and HTC are the largest Android vendors by a fairly large margin.
It's perhaps noteworthy that both are also committed Windows Phone vendors. According to pdadb.net here is the count of Windows Phone SKUs by vendor:
HTC 12
LG 5
Samsung 2
Dell 2
Toshiba 1
Motorola is keeping its Windows Phone options open, leaving "Others" as the only likely exclusive Android vendors.
Today's chart: the percent of smartphones as part of the total phones sold for three vendors vendors that have traditionally sold a large portion of voice-oriented phones.
As these vendors switch to a higher mix of smartphones, their distribution network will ensure a continuing surge in overall smartphone penetration.
Most of Samsung's increase has come in the last two quarters. Note also the rate of growth in Nokia's mix. Motorola and Samsung owe it all to Android.
There is some confusion with the latest Canalys teaser press release. The implication is that Apple has lost smartphone platform share due to the Android surge.
Using the published data, it's easy to see that Apple has continued to increase share in both smartphones and handsets as a whole.
I used green bars to represent quarterly share of smartphones and blue bars to represent quarterly share of all phones.
I used orange line to show trailing four quarters (TTM) share in regular phones and red for smartphones.
Here are the Q2 to Q3 changes in share for the vendors whose data is published:
Nokia 38.4% to 32.7%
Motorola 4.32% to 4.7%
Samsung 5.11% to 9.71%
RIM 18% to 15%
Apple 13.5% to 17.4%
HTC 8.65% to 8.41%
Other 12% to 12%
Sequentially, Nokia lost 5.6% of share, Samsung gained 4.6%, RIM lost 3% and Apple gained 4%, Motorola, HTC and Other remained largely unchanged.
One of the most hotly debated subjects in the mobile phone business is the importance of market share. It's also a topic of lore in the PC industry. Briefly the two arguments are:
Market share matters more because it drives network effects which ultimately drive competition out of the market, creating the opportunity for monopoly rents.
Profit share matters more because profit is the only fuel that can drive innovation. Any macro downturn or shift in strategy can cause a company to cease investing in unprofitable projects.
The old disruptor's adage: "Be hungry for profits and patient for growth" is challenged by the equally disruptive: "Grow share with lower prices in exchange for new revenue sources."
There are many rich anecdotes to support each strategy, but how about some data? Fortunately we have some: the market and profit shares for vendors covering 80% of the world's largest technology market over a three year period. The vendors are a good proxy for the market, the time frame is long enough to cover seasonality and anomalies and the market is very big (over 1.2 billion devices) and very broad (world-wide).
The only question is how to measure success. One measure is how various strategies benefit the asset owners, i.e. the share holders. Benefit to society, employees and consumers are very difficult to measure. But share holder benefit is easily obtained by measuring change in share prices.
So, here are two charts:
The percent change in market share vs. percent change in share price for the top mobile phone vendors.
The percent change in profit share vs. percent change in share price for the same vendors. (see note 1 for time frame discussion).
I showed the R-squared value of the correlations. (See note 2 regarding LG and Samsung). At r-squared of 0.36 share price is not well correlated to market share while at 0.76 it is rather well correlated to profit share. To a financial analyst this would seem obvious. After all, share price reflects the present value of future cash flows which are clearly coupled to profit and hence to profit share growth. However, as many technology observers would point out, market share determined the success of Microsoft and Google, and to some degree Nokia.
High market share can cause competitors to be starved of components or ecosystem developers. At the same time, high profit share can cause competitors to be starved of capital.
What does this analysis add to the argument? Note that this data covers a hardware business. Is hardware relevant? It does not scale as rapidly and has a short shelf life. It's also notoriously difficult to distribute. However, outside of the service revenues for cellular voice and data, device hardware is the only pool of money that has any material dimension in the industry. It's also the pool of money with the highest margin in the industry. For the time being and the foreseeable future, hardware is the only business model worth anything in mobile computing.
The data shows that in this particular but substantial market profit share is closely correlated to shareholder value creation. It also shows that profit loss is closely correlated with shareholder destruction. The dominant data comes from Apple and Nokia, which appear to be polar opposites in performance on both measures.
In other articles I've shown how profits have shifted from incumbents to entrants in the smartphone disruption. This shift has resulted in direct benefit and loss to the owners of the two asset classes. To suggest that market share alone is a determinant of "success" in the device market must exclude the effect on shareholders and, ultimately, the management and employees of the companies concerned. The virtuous/vicious cycles will be fed by the profit variable more than any other.
I don't think the market share argument holds water in this market and this data supports my belief. It may be that as value shifts over time away from hardware the benefit will shift as well, but business models alternatives to hardware have not emerged after ten years of experimentation. If anything, the idea of selling hardware as a way of capturing service revenue was pioneered by RIM and perfected by Apple. Nothing I've seen so far is challenging this model. Whoever attempts to siphon the device pool of money (which has remained fairly constant over the smartphone disruption) needs to solve system-wide problems like the dependence on the network and the life-cycle of portable electronics.
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Notes:
The dates when performance was sampled are are July 1 2007 to July 1 2010. The latest quarter (3Q10) has not been included in this data as it has not been fully reported. The data will be updated with the latest quarter as soon as it's possible.
For many competitors the share price is dependent on more than performance in the mobile phone market. In particular, LG, Samsung, Motorola and Apple have diversified product lines which affect their share prices. Two of those companies (LG and Samsung) are conglomerates and their share performance is dominated by businesses other than mobile so I did not include their data in the correlation measure (though their place on the chart is shown). Motorola and Apple's stock prices were, to a very large extent, driven by their mobile phone performance over the same period so their data is included in the correlation analysis. The other vendors have been primarily focused on mobile phones.
I don't write product reviews and I don't pass judgement on individual products but I do own and test various products. For example I have the Android powered Samsung Galaxy 5 (GT-I5500) and the experience is, in my opinion, better than for recent Symbian phones but not as smooth as for Apple's products.
But that's not what this article is about.
It's about the price. The price for the Samsung is one third that of the iPhone 4 (both devices unlocked and sold in Europe with a 23% VAT). It was also purchased in a department store with as much hassle as buying a pair of gloves.
When it comes to the product, it may be a fair trade-off: one third the price for one third the product. The specs are not only worse but the whole experience is rougher and cruder. But that "one third the product" may be just good enough for a large population of users who are now satisfied even with "one tenth the product". The price point should be evaluated as a valid threat.
But Apple can respond. It's not like this is asymmetric competition. As the iPod shows, Apple can make money with low end products. Easily. Is this entry price point (€200 unlocked) something Apple should cover? My answer would be an unqualified yes.
For operator distribution, the subsidized price combined with a high-end offering is by far the best marketing mix (price, promotion, positioning, etc.) However, for non-operator distribution, a lower spec unlocked device sold through tens of thousands of points of purchase (like the iPod, and soon, iPad) makes a lot of sense from a platform point of view.
These two channels are often in conflict due to subsidy and exclusivity clauses. This conflict makes the decision to ignore the non-operator channel compelling. The economics for the operator channel are always going to trump the non-operator channel. But as the platform expands across geographies and income segments not covered by the operator-subsidized channel, these populations will need to be addressed.
So this is the inherent strategic tension for the iPhone franchise: Whether to use the iPhone brand to enable ubiquitous mobile computing outside operator channels, or use iPod/iPad as a complementary but separate brand to engage in an orthogonal attack.
I suspect the decision has been made. We will observe the consequences next year.
I plotted the vendors on share of market and share of profit axes in two different points in time: Q2 2007 and Q2 2010. I further broke the chart into four quadrants as shown:
I chose to label the quadrants to indicate the possible categorization of the companies.
Dominant: large market share and large profit share
Star: low market share with large profit share
Fading: high market share with low profit
Marginal: low market share and low profit
It's interesting to note the shift over the time period of the eight vendors. Whereas Nokia moved from Dominant to Fading, only Apple rose from Marginal to Star. The Marginal players dispersed their placement with Samsung moving laterally toward Nokia while RIM followed in the Apple trajectory and increased profit share while maintaining relatively low share.
Thinking about motion around these two dimensions could be reduced to a vector model. If each vendor is represented by an arrow showing direction and distance moved, we can compare each vendor vs. a symmetric competitor which might account for the loss or gain of share.
The vectors can be paired as follows:
Although the data does not contain all market participants, the shifts in share are quite closely conserved with the vector magnitude (arrow length) and angle (direction) paired. Note how Nokia and Apple swapped Profit without too much impact in Units volume. Similarly, RIM and Sony Ericsson traded profits and volumes quite symmetrically. Samsung also took volume while Motorola lost it. HTC and LG did not change positions dramatically.
Finally, moving all vectors to the same origin leads to this view of share gain/loss over three years in two dimensions:
It becomes quite easy to see who the winners and losers are and by how much.
This model is only an observation of the shifts in market power and is not conclusive about where share was gained or lost, however there is compelling symmetry which also matches the intuition of observers.
A quick update on the analysis of mobile phone profits. If the available profit[1] (i.e. excluding losses) were summed and each vendor's profit were measured as a percent of this total, this chart would tell the story of the last three years:
Note that profit share has mostly shifted from Nokia to Apple, though Sony Ericsson and LG were also casualties and Motorola has not had anything to lose.
Some assume that the future belongs to the Koreans but we see that the relatively small amount of profit that Samsung has (less than RIM actually) has not changed much. HTC is also shown to be a steady performer but not having displaced much from competitors.
Will Android change this picture? As I've argued before, Android is most attractive to the unprofitable and the strategically constrained. Can having undifferentiated new products change this? As Nokia is unlikely to license Android, and RIM seems very unlikely and Apple is out of the picture, the only possible contenders are Samsung, LG, HTC, Motorola and Sony Ericsson.
Motorola and Sony Ericsson have both returned to profitability but with a very small volume Android strategy. However the incumbents fielding Android are really facing a far more sinister threat: the smaller local brands in China (e.g. ZTE) and emerging markets.
On profitability, the smaller challengers are unlikely to make a large impact, but they will constrain the profits of other licensees. The distribution of phones on a global scale is challenging without a brand, and brands are very expensive to build. It's still possible over a longer timer frame that a small brand like HTC can emerge on a global stage. But in terms of profit capture, challengers will mostly "steal" from the already constrained big brands running with Android.
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[1] Profit is not the only measure of success and can sometimes be a deceptive indicator. For this reason I look at a longer time frame so that anomalies, seasonality and business cycles are smoothed over. As flawed as it is as a measure, the most important reason to pay attention to profit is that it's the only fuel for growth in the long term. Companies that are consistently unprofitable (e.g. Motorola) face diminishing degrees of strategic freedom further lubricating a downward slope toward financial distress.
Verizon, unfortunately, is also what ruins the phone. Or, rather, what it’s forced Samsung to do to the phone, which you could sum up in a word: Bing. Bing is the default—and only—search engine on the Fascinate. A Google Android phone. In the search widget, in the browser, when you press the search button. Bing. No, you can’t change it. There’s no setting for it, and the Google Search widget that you can snag from the Market is blocked (or at least very carefully hidden). Being unwittingly forced into Verizon and Bing’s conjugal relationship is infuriating on its own, but the implementation also feels like the sloppy hack that it is.
Android is “open”, but who it’s open for, primarily, are the carriers. (Somehow I doubt we’ll see any Windows Phone 7 devices where Google is the one and only search option.)
The primary defense of Google's Android strategy is that it's beneficial in driving traffic to Google's services/properties. This is by no means a certainty. To the contrary, it seems likely that the Android experience will be defined by operator back-room deals.
Coupling a lack of control over the platform, the revenue streams, the user experience, the potential banishment of AdMob from iOS and an attack on Google's brand, Android is currently winning the war with Google.
However, my money long term remains with Google. They can and will eventually beat Android. Perhaps with Chrome.
[Footnote: if anyone wonders why Verizon, Google's best friend in mobile, is gutting Android, you need to remember an exclusive five-year deal Microsoft struck with the carrier to provide search and advertising services on the phone. Microsoft was rumored to pay $500 million for the opportunity.]
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].
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.
