The iPhone and the limits of brand

11 Feb 2014

The global smartphone market expanded almost 40% last year, as lower-cost models fueled strong demand in emerging marketing. Sales in China, for example, doubled.

As demand goes mass market, prices are plummeting. The average selling price of a smartphone fell 13% to $337 last year. IDC expects the average price to reach $265 in 2017. Markets like China and India are quickly moving toward the point where sub-$150 smartphones make up the majority of shipments, according to an IDC research note.

In Asia the average smartphone price is forecast to drop from $262 to $215 in three years. In Europe the fall is predicted to be much steeper – 38% -- while in the highly subsidized US, prices actually are expected to rise from $531 to $567 (almost double the European level in 2017).

The big question is how will the top-tier makers – such as Apple and Samsung -- fare as low-cost vendors from China and India gain market share and continue to squeeze prices and consequently margins?

Sales growth is forecast to slow to 18-20% over the next few years, with shipments reaching 1.7 billion in 2017. Certainly, most of that growth will be fed by the low-cost makers. Canalys research director for China Nicole Peng says most the growth in China is at the low end -- $200 devices -- while the high-end market is stable.

Impact on top tier

My reading is that demand for high-end devices has at best peaked and in most markets will continue to shrink. Lenovo’s planned purchase of Motorola Mobility is a clear signal of how commoditized the smartphone market is becoming.

It’s hard not to see the drop in iPhone’s market share to 15% last year from 20% in 2012 as a trend for the future. Of the top five makers, its 13% growth in shipments was by far the weakest. Samsung by comparison shipped 43% more smartphones in 2013, Huawei 68% more, LG 81% and Lenovo 91%.

The iPhone’s gross margins have held up surprisingly well – currently at about 50%. They have fluctuated between 44% and 59% over the past five years. Meanwhile, Samsung’s have been in the high teens – barely a third of the iPhone.

Samsung obviously has anticipated the strong demand beyond the high-end and has continued to expand its range. Canalys’ Peng says it actively targets the low-end and midrange. “It has adjusted specs to bring down costs, such as offering a big screen but with a lower resolution. This has enabled the company to bring down the price gap to say $50 for a $350 midrange device.”

For Apple she says it will be more difficult. “It has been working hard to protect its high premium, but it needs to change. It has an inspiring brand image. Some people like the cutting-edge features Apple can bring. If they can continue this, price is not seen as a problem.”

Peng says Apple needs to demonstrate it can still bring out leading-edge technology. “People expect more from Apple.” Perhaps its rumored iPhone 6 phablet will do the trick.

The fact that it upgrades just once a year means it’s getting left behind in many aspects. A friend’s six-year-old drove home that point recently when walking past the Apple store with iPhone 5S signage in Hong Kong’s IFC Mall, he asked “why doesn’t Apple have anything new yet?”

Apple’s success is based on selling aspirational devices to consumers who can justify forking out over $700 for a phone. (Okay in subsidized market the cost is hidden, but the total cost of ownership is actually much higher for those who can figure out the maths).

Given the huge range of low-cost options with high specs from top-tier component makers, the number opting to pay the iPhone premium is likely to fall. Lenovo, Huawei, ZTE, Xiaomi, Yulong (Coolpad), Oppo and Micromax all offer smartphones with comparable specs for less than half the price of an iPhone 5S.

Looking again at the China market, iPhone had just a 6% market share in Q4 and ranked fifth after Samsung (21%), Lenovo (13%), Coolpad (11%) and Huawei, according to Canalys. Xiaomi was sixth. It will be interesting to see how its share fares now that China Mobile is selling iPhones.

New brands like Xiaomi, Coolpad and Oppo are making a lot of noise in China with savvy marketing campaigns. Outside of China, Huawei has announced a sponsorship deal with Arsenal football club while ZTE has a similar arrangement with the Houston Rockets basketball team as the official smartphone for the team.

“Huawei is doing heavy recruiting and is moving in the right direction in how it markets to make its brand more desirable,” Peng says. She notes that newcomers can’t get it right in one or even two or three product launches.

With some of these firms now moving to their third- and fourth-generation models, they’re not just getting the specs right but also the user experience and marketing. Consumers in China have realized this. Those in overseas markets will do the same over time.

The question for Apple will be how important is brand in the face of the low cost alternative, which is attractive to most consumers. But Apple has never targeted the masses. With the iPhone accounting for 55% of Apple’s revenue, the answer will be top of mind for its shareholders.

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