smartphone

Morgan Stanley's Web 2.0 update came out yesterday and it's full of nice charts. Here is one:

Note that the expectation for smartphones to overtake all PCs (including netbooks) will happen when smartphones sell more than 450 million units per year.

In 2013 nearly 650 million smartphones are forecast to be shipped.

My estimate for the iPhone in that year is 180 million. That would give iPhone (excluding iPad and iPod) about 28% share. The last quarterly figure is around 17%.

Perhaps 180 million iPhones per year will be defined as failure by those who consider over 80% share as a threshold for success but I still think it will be a healthy business.

Even assuming a cut in ASP to about $350, Apple will still be able to get about $62 billion in sales from phones (a bigger number than 2009 total sales for the whole company).

I would also add that by the end of 2013 Apple will have sold about 470 million iPhones. Though many will be out of use by then, the installed base will not be small (I'd guess about 300 million). Including all iOS devices, 500 million is a credible estimated audience for developers.

It's entirely possible that Android variants, offshoots and forks will add up to a bigger number by then, but to pre-emptively declare the platform "war" won because the also-ran Apple will only have half a billion users seems disingenuous.

When I applied the modularity dichotomy to smartphone operating system there were several implications that came to light. One was the question of whether the market has reached the point where products were "good enough" and the speed of innovation became less important than price. Another was: will integrated vendors be able to hold on to a healthy share of growth against non-consumption?

Now I bring up another implication of modularity: the concept of "law of conservation of modularity".

Clayton Christensen illustrated this as follows[1]:

If you are writing a software application to run on top of a platform, are you permitted to modify the platform to make your application run better?

If the platform is interdependent, changing it could cause unintended side-effects and you will not be allowed to make them. If the platform is modular, changes are possible and you will have access to the code.

The reason is not not political. It's that in the case of interdependence, the application has to be suboptimized and conform itself to the platform so that the platform could remain optimized (to its goals). The platform needs to remain optimized is because it needs to keep improving (since it's not good enough).

In the case of modularity, the application can be optimized and the platform can conform itself to the application because the application needs to keep improving while the platform is good enough and does not.

Conformability is what constrains up-market progress.

This also holds in hardware architecture. This was plainly evident in the WinTel era. During that time the microprocessor and the operating systems had a proprietary and interdependent architecture even while Dell’s product has a modular architecture.

So the microprocessor wasn’t good enough. That meant that the desktop computer had to have a modular architecture to conform itself in order to allow this to be optimized because the line widths on the circuit were not good enough.

This is what is meant by conservation of modularity: one side or the other of an value chain boundary needs to be modular and conformable to allow what’s not good enough to be optimized. The key question is what's not good enough: the device or the platform (the whole or part?)

How does this apply today in the post-PC era?

If you think about it in a hardware context, because historically the microprocessor had not been good enough, then its architecture inside was proprietary and optimized and that meant that the computer's architecture had to be modular and conformable to allow the microprocessor to be optimized. But in a little mobile computer like the smartphone, it’s the device itself that’s not good enough, and you therefore cannot have a one-size-fits-all Intel processor inside of a BlackBerry or iPhone, but instead, the processor itself has to be modular and conformable so that it has on it only the functionality that the BlackBerry needs and none of the functionality that it doesn't need (hence the ARM modular architecture is dominant). So again, one side or the other needs to be modular and conformable to optimize what’s not good enough.

Now today (and, I believe for some time to come) in smartphones, or in any situation where logic gets embedded in a system it’s the device itself that is not yet good enough and, therefore, you cannot back off the frontier of what’s technologically possible. It has to be optimized with a proprietary interdependent architecture. That means that the processor and the operating system inside of a Smartphone has to be modular and conformable to allow that to be optimized.

In order for you to believe otherwise you have to convince yourself that smartphones, as a system, have reached the limit of what is technologically possible.

[1] The source is a presentation by Clayton Christensen at  Open Source Business Conference in 2004

When mobile platforms are discussed, the conversation frequently turns to market share battles between Android and iOS. I've pointed out before that the problem with this reasoning is that market share in a market that's growing at 90% is a false measure of performance.

The more important measure is how much of the non-smartphone market is being taken by smartphones and how fast the whole phone market is growing. Competition with non-consumption is very different from platform warfare.

But even when discussing the rivalry between current platforms, the Blackberry and Symbian are often overlooked as contenders. Windows Phone and iOS come in and out of discussion only on the basis of press releases. The truth is however that Symbian, Windows, Blackberry are not going to disappear anytime soon.  Why is that?

The reason is that when you stop framing the market as rivalry between platforms, you see that many buying decisions are driven by specific device value propositions or jobs that the products are hired to do. For many years smartphones were purchased because they had the best cameras or the best keyboards and users never downloaded any apps or even used data plans.

Later, smartphones were purchased because they allowed for browsing and gameplay. Very rarely did buyers opt for "iOS" or "Symbian". Most buyers don't even know what these words mean. Phones are rarely advertised according to their platforms. (As an aside, the mention of Windows in a PC ad is made possible by Microsoft funding, the same as "Intel Inside." So for platform recognition, someone needs to fund the promotion and that implies some revenue to justify it.)

To illustrate, consider the Blackberry: A product that continues to grow despite a completely different basis of competition from the large screen touch competitors. It comes down to being good at some very specific jobs. RIM continues to grow in certain markets like Latin America and the Middle East on the basis of BBM (RIM’s sales outside the U.S. climbed 94 percent last quarter from a year earlier.)

“A 15-year-old boy who likes a 15-year-old girl, sends her a BBM and he’s able to measure how important he is to her based on the speed of response after the letter turns to an R,” meaning it’s been read, he says. “No one else runs an end-to- end service plan like we do. That’s killer and is why it’s almost a social phenomenon.”

or

BBM is also popular in socially conservative Saudi Arabia where its speed -- messages are typically sent in less than two seconds, according to Morgan Keegan -- has made it a way for teenagers to communicate in a country where religious police bar unmarried couples from meeting in public.

You could argue that the other platforms also allow for free messaging (through free texting apps) but the combination of a low cost device, a data plan and attention to detail (like Message Read notification) gives the Blackberry an edge.

The general purpose smartphone that Google and Microsoft and Apple promote is still not the prevailing view of mobile usage for most buyers. One could also argue that many if not most Nokia smartphones are still being "hired" to do feature phone jobs.

The fact that all these devices are classified as smart and therefore competing misses the point that they are hired for different things.

The latest mobile phone estimates from Gartner made a startling claim that "Others" vendors increased share from 16% a year ago to 33%. Doubling share in a year is possible if you're at 1% share but to double from a base of 16% is sounding improbable. They allege that the "Others" now sell more phones than Nokia. And Others don't even include ZTE and Huawei, the prototypical low end challengers.

They emphasize this point in their discussion and state that the incumbent vendors are being pressured by these low end entrants. They go on to explain that the same set of vendors will probably use Android to enter the smartphone space.

To illustrate, the growth of individual companies is shown here (all phones).

Also puzzling is that ZTE and Huawei did not share in this boom. They barely beat market growth and were growing at half of "Others". Until recently ZTE and Huawei were themselves Others, so the new vendors are truly unbranded "white box" vendors.

To put it in perspective, their year-on-year growth is astronomical: 176%, selling 87 million more phones this third quarter than last year's. This is equivalent to saying that a new company was born in the last year and has already become the second largest in the world. The growth in volumes is higher than the total units Samsung sold!

Mind the gap

Extraordinary claims require extraordinary evidence. Can we check what other analysts estimated and do some form of validation of the claims?

Yes we can.

IDC reports the same data and they only reported 340.5 million phones sold (vs. Gartner's 417 million). Excluding ZTE and Huawei the total share for "Others" in IDC would be about 20%.

20% share vs. 33% share is a big gap.

IDC and Gartner both agree on smartphones, so the difference is even more glaring when you consider the "non-smart" comparisons:

Non-smart phones:

Total Market: millions of units sold____	3Q2009______		3Q2010
Gartner	268		337
IDC	244		260

For added emphasis, I added a comparison of last year's quarter. Last year the Gartner total estimate was about 10% higher than IDC. This year they are 30% higher.

How could the difference in the total phones sold be so big: 77 million phones?

If Gartner is right, how could IDC miss 77 million phones. If IDC is right how did Gartner conjure up 77 million phones in one quarter? That number is nearly as big as all the smartphones sold (81 million). This is not within any margin of error for whatever sampling method they use.

Perhaps they need to clarify this because until they do, neither is credible.

--

Note: My own models are built from individual company public reports. The only data I depend on from IDC and/or Gartner is this total market size which allows me to back out what the "Others" are doing. If the total market estimates disagree so much, I'll be forced to throw out the "Others" all together.

None of this should come as major surprises, but Gartner's data allows for a bit more granular detail in the overall view of the market. Here are new points derived from Gartner's sell-through data:

• The smartphone market is growing at nearly 100% (96%).

• The overall market is growing at 35%.
• The non-smartphone market is growing at 25%.
• Android grew at 1,340% y/y. iOS grew at 92%, Symbian at 61% and RIM at 40%.
• Platform market shares (below) shows a more even distribution of platform volumes between four main platforms:

• Non-branded mobile phones grew to 33% of the market, with 141% unit growth. This is an alarming figure for the low-end of the market. The unbranded market excludes ZTE and Hauwei which grew below the overall market growth (9.8%, 27% respectively). The implications were most dire for Motorola (-36% units growth), Sony Ericsson (-23%) and LG (-14%). Nokia grew but, at 3.5%, well below market growth.
• In 3Q 2009 41 million smartphones were sold. In 3Q 2010 80.5 million were sold. If we were to split the growth among platforms, nearly half the growth was Android. 27% of the additions were Symbian and 16% were iOS. Only 8.3% of the growth was RIM devices.
• Windows Mobile and Linux were the only smartphone platforms to shrink volumes. However, even though the platform is deprecated, 2.2 million Windows Mobile devices were still sold last quarter -- more than Android sold a year earlier.

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.

Several readers pointed out that in my discussion on the market share of modular vs. inter-dependent market shares for smartphones, Nokia was incorrectly classified as having an inter-dependent software architecture since the Symbian platform is/was a modular component.

The problem is that the relationship between Symbian and Nokia is not that of independent modules. Nominally, the two are independent and mutually exclusive, but, in practice, Symbian has always been so heavily dependent and influenced by Nokia that it's never been possible to declare its governance fully independent.

I won't describe the full history since there are many other sources (good example here.) But I will point out that since Nokia licensed Symbian exclusively and Symbian obtained the vast bulk of license fees from Nokia, the relationship was one similar to a bilateral monopoly.

Nokia's bargaining power over Symbian was always high enough to affect its operations. "Ownership" does not only infer a formal control over equity, and many would agree that Nokia "owned" Symbian even when it held less than 50% of the equity. The relationship was so tight, that even though there were other members of the consortium with board seats, the licensing by Nokia's competitors was always very limited. The only significant non-Nokia revenue for Symbian came from Japan where Nokia did not have a presence.

After Symbian was effectively acquired by Nokia, the ownership became both de jure and de facto. The open sourcing of the Symbian code made it no less a Nokia operation than the open sourcing of Android makes it no less a Google operation.

So for all intents and purposes, the relationship between Symbian and Nokia makes Nokia's smartphone hardware inter-dependent on Symbian's software.

Now, given that the way the products are built in practice may be far from integrated, it would seem that Nokia's management captured the worst of both worlds: Modular implementation of an inter-dependent business. Nokia captured all the downside of modularity (poor integration and polish) without any of the benefits (e.g. flexible supply chain or lower R&D.)

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.

Following-up on the profitability discussion for the top eight vendors, I built a chart to show estimated profit capture from smartphones, further dividing the vendors into inter-dependent (own OS) and modular (licensed OS)[1].

The areas shown represent total profits by vendor and architecture. The totals:

• Inter-dependent: $3.83 billion
• Modular: $0.59 billion

Most of the modular profits came from selling Android devices.

[1]  Samsung and Nokia profits from Smartphones are not directly available and are estimated.

If we look at the growth of smartphones independently from all phones, the category looks impressive:

Smartphones are now almost 24% of all phones, up from 10% three years ago.

What's also impressive is all participants in the market grew their volumes. The rising tide did lift all the boats.

For this reason it's somewhat perplexing to hear absolute statements about the imminent death of certain smartphone competitors. The non-smartphone market is still 76% of the total phone market. And it's the biggest and easiest target for all smartphone competitors. The data shows that, for the time being, calling the end for vendors or platforms in a market that's doubling every three years is premature.

But what I really want direct attention to here is a subset of the market: modular platforms.

If you recall from the modular vs. inter-dependent dichotomy discussion, modular architectures are a way to implement products by licensing core components rather than keeping an integrated development model. I stated that modularity tends to be the better approach when markets are mature/over-serving and inter-dependency is the better approach when markets are young and the products not-good-enough.

Looking at the chart above you should note that the market is growing extremely quickly so it's not "mature" in that sense, implying a healthy future for inter-dependent players.

So how are modular vendors faring at this stage of the market and what are the prospects of module suppliers (i.e.  mobile operating systems).

To help clarify, rather than looking at vendors individually I grouped them by architecture. I took the charts above and changed the colors so that modular vendors (in shades of brown) are represented separately from inter-dependent vendors (in shades of green).

When looking at the market this way we can make some important observations:

1. Even though the overall market grew, the share of the market held by modular architectures is smaller than that for inter-dependent. It's also not increasing. In 2008 modular players held 36%, in late 2010, they held 35%.
2. The suppliers to the modular market changed over the same period, so to a large extent they are fungible. During 2007, the vast bulk of the brown area above was using Windows Mobile. The vast bulk in 2010 is using Android.
3. The addressable market for Android is constrained to the modular market. Therefore the growth potential depends on whether that brown area increases dramatically relative to the green.
4. Vendors don't change architecture easily. My knowledge of the competitors makes me believe that none of the green players will change from Inter-dependent to modular, and even if they wanted to change  it's not a simple thing to do. Conversely, changing from modular to inter-dependent is enormously challenging. Company processes, competencies and priorities must change dramatically.

So what's the bottom line?

For an Android dominant future, several conditions must be met; one will need to believe all of these to be true:

• The addressable market for modular solutions will have to grow much faster than that of inter-dependent vendors. [The chart shows in-line growth--again due to the overall growth of the market. The green guys above won't just roll over.]
• The split of licenses between Android and Windows Phone within the addressable market must favor Android. [Again, this is unlikely as "politics" will interfere. (I won't even touch IP issues.)]
• The current modular vendors will not become inter-dependent or the current inter-dependent vendors will become modular. [Now why would they tear themselves apart if they are growing?]
• The profitability of Android vendors must be high enough to make modularity sustainable [more about this later.]

Talk of Android (or iOS) "domination" is still wishful thinking. With the acceptance of Windows Phone within the value chain (device vendors, operators, developers), the brown area above will be served by two very powerful and motivated competitors. Politics and lawsuits will add drag on growth. Established brands are important to consumers and new brands (like ZTE and Huawei) will have a hard time joining the top tiers with or without Android. Established integrated vendors like Nokia, RIM and Apple don't have modular DNA but do have massive distribution.

In the end, the real limitation is that the brown area itself is not going to get disproportionately large. Android is limited by its addressable market and that market is a lot smaller than the whole market.

Looking at the world through modular/inter-dependent lenses lets you see that mobile platform dynamics will not evolve as they did in the PC era. At least not for the foreseeable future.

[Wedge Partners analyst Brian Blair] also contends that Apple’s production forecasts suggest the company thinks it can sell 100 million iPhones next year. “While a staggering number any way you look at it, our checks reflect full calendar 2010 builds in the 48-50 million unit range,” he writes. “While this number can change and adjust downward or upward  based on demand, we believe it is incredibly bullish that Apple feels it is possible that they could see nearly 100% year over year growth for iPhone in 2011 as this would mean that exiting 2011, Apple would have approximately 10% share in the global handset market.”

via Apple Can Sell 100M iPhones, 48M iPads in 2011, Analyst Says - Tech Trader Daily - Barrons.com.

Apple is, in my estimate, likely to sell at least 47 million iPhones in calendar 2010. (16 million in the current quarter, or 85% y/y growth).

The 100 million in 2011 estimate assumes 100% growth on average. Is it really "staggering" to forecast another year of triple digit growth?

The history of growth is one indicator. There the news is good: the product has been able to sustain that level of growth for three years.

The second indicator is room to grow. Apple largest competitor is smartphone non-consumption. This competitor holds 76% share, but is rapidly losing share. Consider the the following chart:

I've heard the mantra that smartphones are not for everybody and that the vast bulk of consumers will opt for voice-oriented phones indefinitely, especially in low-GPD/capita countries.

To this I point out that there are no technical obstacles to implementing smartphone technology in all price points nor that there are any constraints on distribution, network technology rollouts or shortage of capacity to produce these products for all current mobile users (5 billion at last count). I also believe that user demand for this level of product utility will shift rather more quickly than supply.

So, in my mind, the headroom looks pretty good as well.

Lastly there is the question of alternative platforms. I'll get to that shortly.