Sony Ericsson

In June of last year I wrote a post titled "Does the phone market forgive failure?" It was written on the eve of Nokia's Q2 2011 report highlighting the historic consequences of a dip into negative operating margins for a phone vendor.

I listed 13 phone vendors who were either merged, liquidated or acquired. There are no examples of vendors who recovered from a position of loss making.

I was prompted to follow-up by a note Charter Equity Research analyst Edward Snyder wrote illustrating the effect of negative operating margins on phone vendors. I took his illustration and expanded it with additional data.

Since my post in June last year Sony Ericsson and Motorola were acquired making the victims list total 14 companies, with Nokia, LG and RIM having joined the "endangered species list". If the pattern repeats, then RIM and Nokia are in early phases of what promises to be an extended period of pain followed by an exit.

What the analysis does not answer is when a vendor loses its independence after beginning loss making. Motorola took 20 quarters; Sony Ericsson 14, Ericsson 8 and Siemens only 7. We cannot tell if or when LG, which is still operating after 8 and Nokia, which is now in its fourth and RIM, now in its second quarter post-loss, will lose independence.

The rumors swirling around RIM and LG are centered around exits and some suggest Nokia will follow. Many also argue that these companies will recover. The conditions they each face are different in details but broadly they are the same. Earlier last decade the exits were prompted by loss of brand value and subsequent loss of distribution. This decade disruption brought upon by mobile computing brings with it new business models centered on ecosystems and value captured through software and services.

Until and unless these endangered companies solve the dilemma of having the wrong business model at the wrong time, the chances are that they will not be forgiven for market failure.

The last time I did this comparison (Apple could buy the mobile phone industry | asymco) was in June after the end of the second quarter. The following chart is an updated look.

 

Here is a discussion of the changes since the last analysis:

• Sony Ericsson was valued through its acquisition by Sony. We did not have a way to value the enterprise before as it was not traded independently. Last June I estimated a 14x multiple on its trailing twelve months' profits and got $3.0 billion. Since then half the company changed hands for about €1.05 thus yielding a total company value of $2.8 billion. The enterprise value should be therefore slightly lower but I'll stick with the current transaction value as the EV.
• Motorola Mobility has entered into an agreement to be acquired by Google for $12.5 billion by Google. The company's enterprise value jumped as a result to about $8.6 billion.
• RIM's share price collapsed and it's now also trading at an EV of about 7.3 billion (Yahoo finance).
• Nokia's price has also dropped and it now has an EV of about $13 billion (Yahoo finance).
• HTC recently dropped significantly in price and is now worth about $15 billion EV. (Note that pricing of its equities is subject to suspended trading due to drop limits).
• LG's phone business is still losing money and it's still difficult to value. In November it was revealed that the company was seeking to raise $890 million in capital to fund new initiatives including smartphones. The share price fell by 14%. In June I suggested a nominal value for the phone business of $10 billion. I think that's very generous and with recent events I would place that value at $9 billion today.
• Samsung's fortunes have increased. In June I applied a 14x multiple to their trailing 12 months' operating earnings. Given overall discounting of the sector I applied a multiple of 13 today. That yields a business value of $78 billion. Interestingly, that is larger than the value of all other competitors apart from Apple. That also makes it six times more valuable than Nokia.
• Apple's cash and cash equivalents and investments grew by about $12 billion and were worth about $82 billion as of October.

In summary, in June Apple's cash was about 53% of the sum of competing phone vendor enterprise values. Today it's about 61%. Excluding Samsung, Apple could buy the industry and still have $25 billion left over. This makes the claim that "Apple could buy the industry" even more believable.

This analysis is mainly academic. It does not imply that any such transaction will take place. As the purchase of Motorola shows, control has a premium and individual buyers may be less "rational" than markets. What it does show however is that the entire industry is in a state of crisis. Valuations for phone companies are collapsing and two major brands (Motorola and Sony Ericsson) are being absorbed and could disappear.

At the same time entrants are arriving with completely different business models. Amazon, Facebook, Baidu, Alibaba are intent on selling phones or platforms to be valued as enablers for asymmetric business models rather than as phones. One could argue that what Apple itself sells is more than hardware and that its value-add "on top" of hardware is increasing. This is a sign of commoditization. Certainly the voice business is well beyond that point but it now appears that even the smartphone business is already in an advanced state of value compression.

All the while the overall market is growing. I had separately looked at the profit pool and concluded that the brands are suffering. Summing up the votes from stock markets, the sentiment is even worse. 2012 is looking more and more as a year of inevitable and dramatic industry change.

As shown in the yesterday's post, in the third quarter, overall mobile phone profitability declined. The eight vendors I use as a proxy showed a total net profit of $8.51 billion, down slightly from $8.57 billion and a drop of $9.01 billion in the first quarter.

Overall, the industry dropped by 1% sequentially but is still up 30% over last year and has a 20% compounded growth rate over a three year period.

• Nokia returned to profitability, though at $180 million it's only about 2% of the top eight.
• Motorola remained in the red with a small loss of $20 million, an improvement over the $90 million loss of the previous quarter. Motorola is being acquired by Google after an accumulated mobile operating loss of $4.69 billion since the beginning of 2007. It's unlikely we'll receive any updates on performance thereafter.
• Samsung had a great quarter with a sequential increase of 19% and year-on-year growth of 130%. The total profit amounted to 25% of the peer group.
• Sony Ericsson broke even with about $50 million in operating profit. Like Motorola its performance was barely break-even during the last four years and its also disappearing from our list of independent vendors as it becomes part of Sony.
• LG had its sixth consecutive quarterly loss and is now appealing to investors for more capital to continue operating as a smartphone vendor. Raising dilutive capital seems a radical approach and not one that inspires confidence.
• RIM had a sequential reduction in profit of 35% and y/y reduction of 30%. The company is exhibiting clear signs of decay and the stock market is valuing the company below book value.
• Apple profit dropped by 19% but grew 43% y/y during a transitional quarter. The growth remains 43% compounded over three years.
• HTC has a 1% sequential increase but a 78% y/y growth.

To illustrate the performance in terms of profit, pricing, volumes and margins, I developed the following chart. 

The solid areas representing profit are operating profit/phone in the vertical axis and volumes shipped in the horizontal. The blank areas above are the cost of goods sold per phone and the combined solid and blank represent the average revenue per phone.

Some of the areas are over-represented due to the lack of resolution available.

Using before-and-after pie charts for positive profits, we can see how the entrants (RIM, Apple and HTC) went from 6% of profits to over 73% four and a half years later.

I feel that this is somehow the end of an era. I've written before about the brutality of this market, listing 13 companies which were either merged or acquired or disappeared in the last decade. Now both Motorola and Sony Ericsson will soon be added to the list. On average, it's as if one phone vendor has disappeared every year for fifteen years.

And it's still not over. RIM is also becoming a going concern issue, and LG has a big question mark above it.

Of course, ZTE and Huawei and Lenovo are joining the list of competitors but I note that they are not focused on mobile phones. They are opportunistic phone vendors, depending on other businesses to compensate for the risks inherent in phone sales. It's interesting to note that neither Apple nor Samsung are pure phone plays.

In fact, of all the phone brands only RIM and HTC are exclusively phone-only companies. It may indicate something profound is happening. The notion that the development and marketing of phones as an activity independent of other business models may be coming to an end.

A few years ago, around the middle of the last decade, the mobile phone market was characterized by the rivalry between a few established vendors. These were Nokia, Samsung, LG, Motorola and Sony Ericsson. These incumbent companies had a broad portfolio of devices including smartphones and feature phones and basic phones. Many also sold networking equipment and were deeply engaged with their customers, network operators.

There was also a set of entrants who offered only smartphones.  They were quirky. HTC was a a prominent "ODM" or original design manufacturer who built phones for companies who added their brands and sold and supported the product. HTC made phones and PDAs for operator brands and for some large PC companies. It also began to sell phones under its own brand. RIM was also offering products that had evolved from pagers into email appliances with added voice capabilities. But RIM's products were not very good as phones. Voice was so poorly integrated that many people carried both a BlackBerry and a voice phone. Then there was Palm with something called a Treo which promised many things but did not quite deliver.

In 2007 something happened which changed the industry. It took a few years to even realize it was happening but by the time it was obvious, it had changed to such a degree that huge companies found themselves in financial distress. This chart illustrates the effect.

In a few short years the rivalry between incumbent handset makers has evolved into a rivalry between mobile platforms where the incumbents were caught in an increasingly unprofitable role of hardware integrators. Motorola is now being absorbed by a search company. Sony Ericsson is being absorbed into a consumer electronics company. Nokia is going through a potentially existential crisis and even abandoned its platform. Acquisition talk surrounds LG's phone efforts. Samsung is prosperous but sill at the mercy of its software suppliers. Even the entrants are starting to feel beleaguered. RIM, the oldest pure play smartphone company is trading below book value and has regressed in value to 2004 levels. Palm evaporated. A view into the changes is the rankings of the companies in terms of volumes, sales and profit as shown below.

How did large, powerful, smart companies let this happen?

It happened despite having a clear, front row view of the transition of the industry from mobile voice to mobile computing. The shift in the basis of competition from "connecting people" to "connecting people to data" ended up being a classic disruptive trap. Many will argue that it was the failing of individual managers. Perhaps, but how did they conspire to fail simultaneously?

When you see disruption happening, it's natural to seek out a cause, a pivotal magical "force" or event that enabled the weak to humble the strong--the proverbial sling that enabled David to defeat Goliath.

My hypothesis is that The Primary Cause for the shift of profits from Incumbents to Entrants has been the disruptive impact of a new input method. I illustrated this with the help of the January 2007 slide presented by Steve Jobs at the launch of iPhone.

Each new input method led to not just a disruption but new platforms and new business models. Each new "sling" victimized a set of historic companies. Mainframe and minicomputers, consumer electronics giants and now telecoms.

Just like David's sling, these technologies are not powerful in and of themselves, but rather, the way they are used makes them unpredictably sinister. The context of using capacitive touch on a handheld device rather than on a table-top makes it disruptive. Coupling it with high-speed mobile networks and powerful but efficient microprocessors made it into a force.

That is now ancient history. The consequences and repercussions are still being felt and weighed, but the smart money should be focusing on the next shift. From the time frame in the diagram above, it's clear that the cycle time between "Revolutionary User Interfaces" is shrinking. It's been five years since multi-touch. Is the next "RUI" already here? Is Siri the next RUI?

There are many things going for it:

1. It's not good enough
2. There are many smart people who are disappointed by it
3. Competitors are dismissive
4. It does not need a traditional, expensive smartphone to run but it uses a combination of local and cloud computing to solve the user's problem.
5. It is, in a word, asymmetric.

My disruptive hypothesis for Siri is that it shifts the competition from platforms positioned on a device to a "coupled" super-platform dependent on broadband and infrastructural computing.

Just after collecting enough data and observing patterns in it that give us clarity, It looks like things are about to change all over again.

 

Samsung no longer reports mobile phone shipments. The company's phone market performance reporting is limited to the following:

Shipment : High-20%↑YoY (low-20%↑QoQ)

ASP : Slight increase QoQ

As the company did not report volumes or ASP last quarter either, the QoQ (Quarter on Quarter) growth estimates are almost useless. The only fragment that might be useful is the "High-20% YoY" given that they did publish units for Q3 2010: 71.4 million. This leaves the question of what "High-20%" means. Here are some ranges and what the result would be:

• 92.1 million assuming 29% YoY growth
• 91.4 million assuming 28%
• 90.1 million assuming 27%

The "best guess" might be 91.4 million.

As the company also provides revenue for its mobile division (14.42 trillion Won) we can therefore estimate the average selling price: $142. Is this a slight increase? By a similar approach, last quarter's ASP was $139, and assuming exchange rates did not vary widely, this increase is small enough to be called "slight".

We also have a figure for the operating margin for the entire Telecom group (16.9%) which gives an operating profit of $2.2 billion.

The last piece of the puzzle is the number of smartphones Samsung shipped. Samsung said smartphones grew "more than 300%" year over year. That would imply 31.4 million. One estimate is from Strategy Analytics that suggests 27.8 but it's coupled to an overall volume estimate of 88 million (well below the 91.4 million estimated above). The Wall Street Journal published an estimate of 28 million.

I have no idea how to narrow down this estimate, but if we go with the one that claims the highest precision (27.8 million) we get an estimate of about 30.4% of Samsung's volumes being smartphones (what I call the "smartphone mix"). That is an interesting basis for comparing Samsung's smartphone business to other companies' smartphones. I prepared a graph showing how pricing is affected by the increasing mix of smartphones in vendor portfolios.

What the graph shows is the movement of prices as companies have increased their smartphone mix since Q1 2009. For example Sony Ericsson moved from 31% smartphones to 80% smartphones in about a year. Their ASP increased from $184 to $231. Some companies have not changed their mix. Apple, HTC and RIM have maintained 100% smartphones in their portfolios so their pricing has been consistently high ($650, $354 and $357 over last 12 months, respectively). Conversely, Nokia has struggled with its smartphone portfolio and as a result its pricing has remained stubbornly clustered below $100.

But the most interesting companies to watch are Samsung, Sony Ericsson and Motorola. You can see how their "vectors" or price migration point toward the sweet spot where HTC and RIM reside. Ideally, they would be very much better off with pricing in the $300 range.

Samsung is moving quite rapidly toward the sweet spot but the slope is not as steep as the others. That's may be because SE and Motorola have much smaller volumes but it's still an open question why, with an estimated 30% mix of smartphones, the pricing remains $60 lower than when Motorola was at the same mix or $40 lower than Se.

Some of the answer might be due to the number of "low end" smartphones (Bada?) that Samsung is selling or maybe their non-smartphone pricing is trending down a lot more rapidly.

Keep in mind that if we change the assumption of the number of smartphones to a lower number (i.e. below 27 million) then the trajectory of the Samsung line in the graph would increase and may match more closely the slope of the other two vendors.

I don't have any reason to believe that it's lower than 27 million but I don't have any reason to believe that it's above 27 million either. It's an estimate.

If we believe it then we have to say that with a near tripling of smartphone mix (from 11% to 30.4%), the company grew its overall units by 28% and its revenue by 39% and pricing by 17%. Profits also grew by 130%.

It would follow then that switching to a 100% smartphone mix would make a lot of sense.

Google's acquisition of Motorola is clearly designed to be an acquisition of Intellectual Property rather than an entry of Google into the phone business, but the impact on the business will be felt in many ways.

It is surely going to send some Android vendors scrambling. The situation is not without precedent however. The history of governance and ownership of Symbian shows how the licensing of platforms by licensor competitors leads to unintended consequences.

Symbian was formed to be governed in a way very similar to the original Android via the Open Handset Alliance. The company was owned by a consortium of phone vendors.[1] The shares were not equally distributed however with Nokia holding a larger share (though not a majority).

Although nominally involved in decision making, the smaller shareholders never felt entirely comfortable with the arrangement and over time some sold their shares and left the group even though they continued to license the OS.

Eventually Nokia ended up acquiring the company outright and open sourced the code. However, by then the product was obsolete and the only licensee was Nokia itself.

The lesson (and warning) was that a licensor that is also a licensee makes other licensees uncomfortable. The supplier is also a competitor. This is classic channel conflict and never ends well.

Open or not, with or without equity, these arrangements are always unworkable.

So Google's promise that

"This acquisition will not change our commitment to run Android as an open platform. Motorola will remain a licensee of Android and Android will remain open. We will run Motorola as a separate business. Many hardware partners have contributed to Android’s success and we look forward to continuing to work with all of them to deliver outstanding user experiences."

seems naive at best.

--

Notes:

1. Before its outright purchase by Nokia in December 2008, Symbian Ltd. was owned by Nokia (56.3%), Ericsson (15.6%), Sony Ericsson (13.1%), Matsushita (10.5%), and Samsung (4.5%). The company's founder shareholders were Psion, Nokia, Ericsson, Panasonic/ Matsushita and Motorola. Motorola sold its stake in the company to Psion and Nokia in September 2003. Psion's stake was bought by Nokia, Matsushita, Siemens AG and Sony Ericsson in July 2004.

Smartphones made up about 30% of global phone sales last quarter. That is a significant increase from 10% in Q4 of 2007.

From this perspective, iPhone obtained 5.6% share, Android 14.2%, Nokia Symbian 4.6%, RIM 3.6%, Bada 1.1% and Windows 0.4%.

The competition however still has 70.5%.

The chart to the right shows the challenge remaining and the progress being made.

The good news is that the non-smartphone market is not growing while the smartphone market is. In fact, the non-smart market has had a three year CAGR of 0% and a y/y growth of 1.0% and a sequential decline of 6%.

The non-smart portion of each branded vendor's business is pretty dismal:

• Nokia saw 17.57% decline y/y
• Samsung's non-smart business declined by 8.14%
• Sony Ericsson's dropped by a dramatic 80%
• LG's fell by 38.56%
• Motorola is the only one that grew y/y, by 17.86.

The reason all these brands fell is because the unbranded vendors took their place. "Other" non-smartphones grew by 43%. They have been sustaining growth at the rate of 57% compounded over three years.

The following chart shows the increasing share taken by the "other" vendors in non-smartphone units:

The non-smart business is so dismal for branded vendors that I've been assuming that they will cease to build such devices in the near future.

The trend is shown in the following chart which shows the percent of units for branded vendors which are smartphones.

Motorola, Sony Ericsson and Samsung are fleeing to smartphones as rapidly as they can. LG is following as quickly  as possible as well.

The only question remains with Nokia. While their smartphone business evaporates they've also made a commitment to the non-smartphone market and are thinking about "the next billion" users who, presumably, will not buy smartphones and will buy some variant of Nokia's Series 40.

Targeting the low end may be commendable, but the question they need to answer is why would those next billion buy anything other than a low cost smartphone? And if not, then what's so different about the next billion?

 

The major publicly traded phone vendors have all reported results for the second quarter. Based on the data available so far we can begin putting together a picture of the market.

The first picture I'll draw is usually the last: profitability. The following chart shows operating profit from the sale of mobile phones among the eight vendors I follow (Nokia, Samsung, LG, Sony-Ericsson, Motorola, HTC, Apple, RIM).

This quarter saw a slight sequential decline in overall profit for the sector, but four vendors did not manage a profit from selling phones. Nokia, Motorola, Sony-Ericsson and LG all saw losses. The other vendors split the slightly decreased pie with Apple getting two thirds of it (66.3%)

This share is up from 57% in Q1 and 50% in Q3 and Q4. Samsung's share went to 15%, though that's not a peak level historically. In Q1 2008 the company was at 21%. RIM was at 11%, a level in a range that has been unchanged for three years. Finally, HTC captured 7.4%, a new high and an increase from 6% since last quarter.  The profit share chart follows:

The ranking chart for profitability follows:

Finally, the "before-and-after" view of profit capture showing the change in profit share over a four year period.

 

The story remains largely unchanged from last quarter: Three companies which captured 11% of the profits before the modern smartphone era started (four years ago!) now capture 84% of the profits. Only one global brand phone vendor selling non-smart voice-oriented feature phones is still profitable however, as we shall see later, the only reason profits still exist for any vendor is due to the strength of their smartphone portfolio.

One of the details of Nokia's warning which did not get a lot of attention was the mention that profitability for the current quarter could not be guaranteed. That is to say that Nokia may make a loss, perhaps for the first time in more than a decade.

This may not be that newsworthy except for the strange fact that as far as I've been able to observe, any company in the mobile phone market that ended up losing money has never recovered its standing in terms of share or profit (i.e. AMP index value has never recovered).

Here is a list companies that have "hit the rocks" in terms of mobile phone profitability and their fates (in no particular order).

1. Alcatel of France. Sold its brand and operations to TCL Communications of China in 2004.
2. Siemens of Germany. Exited in 2005 through acquisition by BenQ of Taiwan.
3. BenQ of Taiwan. Mobile devices division declared bankruptcy in 2006.
4. Ericsson of Sweden. Exited by merging with Sony in 2001 even though third in volume share the prior year.
5. Sony of Japan.  Joined with Ericsson to form Sony Ericsson in 2001. Held less than 1% share prior to merger.
6. Motorola of the United States. Even though once the largest vendors, after a period of severe distress, Motorola spun off Motorola Mobility. Market value shows long-term viability still a concern.
7. Casio of Japan. Merged with NEC and Hitachi in 2010.
8. NEC of Japan. Merged phone units with Casio and Hitachi in 2010.
9. Hitachi of Japan. Merged phone units with NEC and Casio in 2010.
10. Fujitsu of Japan. Merged with Toshiba in 2010. Held 15 percent of Japanese market prior to merger.
11. Toshiba of Japan. Merged with Fujitsu in 2010. Held 4% share in Japan.
12. Palm of the United States. Sold to HP in 2010.
13. Handspring of the United States. Sold to Palm in 2003.

That makes 13 large phone brands that, in less than a decade, have either exited or lost independence after suffering crises of profitability.

As the following chart shows, at this time Motorola, Sony Ericsson and LG are still operating but have been dipping into the red.

The three suffered severe volume contractions in feature phones and have no differentiation in software or platform products which makes their position precarious.

This cursory survey shows that it's difficult to be optimistic once a company reaches a point of crisis. It's a curious outcome given that the market is so vast and growth is so robust.

But the fact is that because of the technology cycle time, rapid business model evolution and fairly low barriers to entry, there is great rivalry between competitors. Profitability is the canary in the coal mine. It causes a brand to be tarnished in the eyes of distributors who, because of sales cycle times, are extremely sensitive to obsolete inventory. A loss maker is seen as a maker of damaged goods.

It then turns off the tap of incentives, promotions and hence visibility in the eyes of consumers. It's a vicious cycle from which few (if any) can recover. Past greatness offers no succor.

And so, with Nokia about to join the list of loss-makers it's only natural to question its fate as an independent company.

It's time to review the mobile phone market at the end of the first quarter of 2011. Before I begin, I'd like to remind that this analysis will span multiple posts and that many details will be published separately due to time and space constraints. Data about platforms, sales, profitability and pricing will be posted separately.

All data sets and chart data will be available for interaction and download through Asymco Interactive when complete. You can purchase a license to Asymco Interactive anytime and you will have access to any new data sets for next 90 days so don't hesitate to pre-order the report.

The overall phone market grew at a compound rate of 9% over three years. The pattern of entrants focused on smartphones and mobile computing growing faster than the incumbents continues. The compound three year unit growth for the tracked vendors in descending order is:

1. Apple 122%
2. HTC 55%
3. RIM 50%
4. Samsung 15%
5. Other 14%
6. LG 0%
7. Nokia -2%
8. Sony Ericsson -29%
9. Motorola -30%

To give an idea of the split between smart and non smart, Nokia's smart business grew at 18% compounded while its non-smart units contracted at -6% rate.

In terms of y/y growth the market grew at 26% and the vendor ranking is:

1. HTC 194%
2. Apple 113%
3. Other 103%
4. ZTE 75%
5. RIM 42%
6. Motorola 13%
7. Samsung 9%
8. Nokia 1% (smart: 13%, non-smart -2.3%)
9. LG -10%
10. Sony Ericsson -23%

Sequentially, the growth rankings are:

1. Other 28%
2. Apple 15%
3. HTC 7%
4. RIM 5%
5. ZTE -10%
6. Nokia -12%
7. Samsung -13%
8. Motorola -18%
9. LG -20%
10. Sony Ericsson -28%

In terms of market share, the field is becoming more crowded.

The ranking of units shows a continuing relegation of Sony Ericsson and the increase of HTC to 7th spot. Apple reclaimed its fourth spot from ZTE.

As the number of vendors increases and the share of incumbents decreases it becomes harder to identify who is a "top tier" vendor or, in fact, what the tiers are.

It's pretty clear that on a unit basis there are nine vendors selling significant volumes. The other important observation is that vendors like ZTE are graduating from "other" while "other" is still growing, now at 25% of the market.

One of the most popular themes running through the mobile phone industry this year has been the unprecedented growth in Android adoption. I've argued that the adoption was initiated on the supply side by vendors and operators, but demand has certainly manifested itself.

Android is almost viral in the way it spreads. With no constraints on intellectual property, pricing, contracts, modification or terms of distribution, the incentives to push product out are phenomenal. It even works, mostly.

One hypothesis of the consequences of this viral adoption is that there will be a "commoditization" of smartphones with rapid price erosion to follow. This in turn might even lead to lower margins for Apple and RIM and most major vendors, including those selling Android itself.

In order to test this hypothesis, we need to look at what has been happening to prices. If prices have started tipping down at more than their usual rate then maybe commoditization is happening.

We can begin this test with the industry's canary in the coal mine: RIM. RIM has been struggling for growth in the very market where Android has been growing the fastest. Is RIM's pricing under pressure?

Interestingly, no. Their ASP (average selling price) decline, from an average of $350 to $310 in late 2009, came before the Android avalanche. During this year, the ASP has held steady, even rising in the last two quarters to $315 while Android activations reached 300k/day.

So I don't see a big problem with RIM, yet.

What about the industry as a whole? Can we see patterns that suggest imminent commoditization? Using the top 8 vendors (Nokia, Motorola, Samsung, Sony Ericsson, LG, RIM, Apple and HTC) and using volume-weighted ASP (total device sales divided by total units sold) we have the following chart:

Since the second half of 2007 the "industry ASP" (blue line) has actually increased. This is even though there was a huge recession in the middle of the time period.

This should be only slightly surprising. If you suspected that the iPhone may have a lot to do with that, you would be right. If you remove Apple from the mix, the second line (in orange) shows that the top vendors (ex-Apple) had some, but quite quite mild erosion (from an ASP of $133 to $129)[1].

This is far milder than what's been happening in the PC sector where prices are dropping catastrophically (According to NPD the average selling price of all Windows portable PCs has fallen from $659 in Oct. 2008 to $519 in Oct. 2009).

So Apple was a big contributor to the industry increasing its pricing power.[2] but even without Apple the industry has been holding on.

But is this just a lull?

Is Android going to stop the growth?

We can look at the pricing data one more way: If we separate the eight companies into two cohorts, the "diversified" vendors who sell both smartphones and regular phones vs. the "pure play" smartphone-only vendors, we get the following price history.

What is happening is that the diversified (Nokia, Samsung, LG, Sony Ericsson, Motorola) saw modest price declines (from $128 to $114) while the pure-players saw price appreciation (from $378 to $449). This is with the early impact of Android priced in. Unfortunately I don't have a chart showing non-smartphone prices in isolation, but I would be willing to bet it would be a significant negative slope.

In these two lines Android is not an independent variable. Android was adapted by some of the diversified vendors (all but Nokia), but in different ways. The thing is that Motorola and Sony Ericsson had great increases in ASP with Android. Among the pure-play vendors only HTC adopted Android and its performance is undistinguished vs. RIM which didn't.

So what, if anything, has Android done to pricing?

I argue that there is no evidence in the pricing data of a coming commoditization of smartphones. Android vendors were able to use the platform to move to higher pricing and the more they switched their portfolio to Android the more they got a better average price. At the same time those vendors who built smartphones without Android also saw strong price supports.

The only correlation with pricing power is whether you build smartphones or dumb phones. The more smartphones you build, the more price you can charge. This is regardless of platform.

The reason for this is that the smartphone market is growing so rapidly (90% y/y). There is limited direct competition between smartphones and a lot of competition between non-smartphones and smartphones--a battle smartphones are winning handily, irrespective of price. Smartphones seem to be what everyone wants.

So the real question that should be asked is:

Why do vendors bother making any dumb phones at all?

If you look at the third chart above you can see how attractive it must be for the diversified vendors to abandon the non-smart market to ZTE, Huawei et. al. Perhaps Nokia can still make a small profit there but to do so you need to run faster and faster toward extraordinarily low costs and prices. A point where phones cost less than everyday consumables. What keeps Samsung and LG in that game? Motorola and Sony Ericsson left once they hit profit warnings. Is that what it takes to drop what seems to be a loser business? I think not.

My bet is that by the end of 2012, it will be hard to find any branded phones which won't run a smartphone OS. Demand and supply of smartphones will race each other to overwhelm portfolio logic at the largest companies. The zero (visible) cost of Android will snowball this effect. What's even more provocative is that I believe the "others" will follow and abandon voice-oriented phones for smartphones almost immediately after the larger group.

So what have the Androids ever done for us?

I've long argued that the phone market should be studied as a whole because the competition is not between platforms but between smart and non-smart. Pricing is a leading indicator of what drives decision making inside vendors and it leads margin, and thence portfolio discussion. Android is expanding the market without crushing pricing. The margin expansion is what attracts more vendors and creates more demand. It's a virtuous cycle.

In a way, this is all good news--even for Apple. A world full of smartphone users is a better addressable market for iPhones than one filled with voice products. iPhone's traction was always in markets which had been seeded by some smartphones: the US with RIM and Europe with Symbian. Such a smartphone-soaked world will have better mobile broadband infrastructure, users with more demanding tastes and awareness of the value that a smart device can bring.

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[1] The effect of "other" vendors not among the 8 listed is a big unknown. It's been estimated that they now make up as much as 30% of total volumes and that they are beginning to ship significant volumes with Android. Without visibility into that part of the market, we should be cautious. However, the eight vendors sampled here are still a significant cohort and the conclusions still appear reliable.

[2] This industry had, until 2007 suffered from chronic price erosion. Each sustaining innovation drove a mild burst of pricing power but it never seemed to last. From color screens to bluetooth, to 2.5G to 3G to MMS, to cameras to music playback, each hardware advance was not enough to keep the erosion away. The tipping point seems to be the iPhone and the shift to software as the component that drives price power.