The mobile handset clone wars have arrived

The last earnings report from Apple was good on many fronts. While I was concerned with the dip in sales everywhere outside of the iPhone, Apple’s iPhone sales showed great promise, both in terms of unit sales and average selling price. But I believe this is a blip. Downward pressure on margins will continue on Apple, Samsung and elsewhere. The mobile space’s clone wars are now beginning.

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The last earnings report from Apple was good on many fronts. While I was concerned with the dip in sales everywhere outside of the iPhone, Apple’s iPhone sales showed great promise, both in terms of unit sales and average selling price. But I believe this is a blip. Downward pressure on margins will continue on Apple, Samsung and elsewhere. The mobile space’s clone wars are now beginning.

The personal computer market started in the mid-1980s with Apple as a leading player. I received my first Macintosh, a Mac SE, when I entered college and another when I left. Apple’s strategy then was similar to the strategy it has in mobile handsets today. It was the sole manufacturer of Apple devices and it created both the hardware and software, controlling its entire ecosystem.

But IBM was the dominant player, with its PC becoming synonymous with personal computing. IBM had a different strategy because it outsourced its operating system to Microsoft, who subsequently went own to dominate the PC market. And IBM allowed other hardware manufacturers to produce PC clones, that is personal computers using the IBM hardware standard but manufactured by another OEM.

In retrospect, both Apple and IBM made critical strategic errors and they soon lost control of the market as the clone wars began. Here’s how the New York Times described it in 1988:

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THE Clone Wars have begun again, and if you’re confused about which side to support, you’re not alone. The announcement last week by the Clone chieftans that they were banding together against the International Business Machines Corporation is bound to cause consternation among people trying to decide which computer to buy.

Clones are copies of the original I.B.M. PC, XT and AT personal computers. On the surface, the so-called Gang of Nine – the clone makers AST Research, Compaq, Epson, Hewlett-Packard, NEC, Olivetti, Tandy, Wyse and Zenith – seemed to intend their announcement to bring calm to the industry by settling on new standards that extends the old, thumbing their noses at I.B.M in the process.

Upon deeper reflection, though, the new standard appears to open the clone makers to many the same criticisms that they have made so forcefully of I.B.M: that nobody needs it yet and that users will wind up having to buy new equipment and software.

[…]

It appears that the market will continue to be divided, with I.B.M. and its loyal customers going one way and everyone else going the other.

IBM lost this war. Eventually it exited the PC market altogether. But Apple’s market share plunged as the clones produced a gazillion units at ridiculously low prices, all using a Microsoft Windows operating system and Intel Microchip platform whose documents were compatible across machines, with a largely compatible set of peripheral equipment. This gave the PC clone market a network effect based on document and peripheral compatibility that proved fatal to Apple, who could not compete on price.

Fast-forward to 2014 and we see a similar dynamic now in play. Apple plays the same role it did in the PC market. Samsung arguably plays the IBM role, while Google hopes to play the Microsoft role, the caveat being that Google uses an open-source operating system that it gives away, making it closer to Unix, a PC-compatible OS, than Microsoft in terms of market dynamics.

What I have been saying here is that as the mobile market becomes saturated the industry will be increasingly driven by the conversion of price-sensitive buyers in developed and emerging markets from feature phones or no phones to smartphones. Your grandmother will get a smartphone. And the emerging middle class in emerging markets will get smartphones, sometimes skipping landlines altogether. This, by the way, is the reason everyone is excited about Alibaba. The key here is that the incremental sales will increasingly come from price-sensitive buyers of phones. And that means lower average selling price and lower margins.

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We have seen this in the trend for Apple’s margins over the past two years. But last quarter seemed to be a break from the downward margin pressure. I think the pressure will continue, particularly because Android continues to take share, giving it a Wintel-style dominance.

In that vein, struggling handset maker Blackberry is launching a cheapie handset in Indonesia, where it still has large market share. The phone goes on sale Thursday for the equivalent of almost $200 – not a bad deal for an unsubsidized smartphone. But Blackberry is on its deathbed and $200 is not cheap enough.

However, now Motorola is also launching a cheap handset. And get this: Motorola are selling this device for $129 with no contract – worldwide. That’s right. This is a handset that is $129 unsubsidized that anyone in the US or Europe can buy. Now, I use a 2-year old Samsung Galaxy 3. My backup phone is my previous model, a Samsung Nexus S, which was released four years ago as a top-of-the-line handset: Tri-band UMTS, 1-Ghz single core processor, 512MB RAM,1500 mAh battery, 800×480 display, 5MP camera. It’s a totally usable phone but lacking some horsepower.

The Galaxy Nexus, the Nexus phone that was released after the Nexus S in 2011 is the right comparison for this new Motorola phone. LTE, 1.2-Ghz dual-core processor, 1GB RAM,1850 mAh battery, 1280×720 display, 5MP Camera. Your mother would love this phone. And so would anyone with a feature phone or no phone in an emerging market or developed market.

Specs on the new Motorola Moto E:

  • 4.3-inch qHD (540 x 960) 256 PPI display with Corning Gorilla Glass
  • 1.2 GHz dual-core Qualcomm Snapdragon 200 processor
  • 1 GB RAM
  • 4 GB Internal Storage + microSD slot
  • 5 MP camera on the back (no front-side camera)
  • 1980 mAH battery
  • Dual SIM slots supporting 3G (Global GSM version)
  • FM Radio
  • Android 4.4.2 KitKat

This phone is the equivalent of the Galaxy Nexus, what was a top-of-the-line phone two years ago. Actually, it’s better. And it’s selling for $129.

This is where the mobile handset market is headed. At some point people are going to stop upgrading phones to the top-of-the-line and realize they can get away with a $129 cheapie handset, unsubsidized. Last summer, I wrote about the unbundling of the handset subsidy and the coming mobile price war. I said T-Mobile’s new contract plan that unbundled handset subsidies would be a big win for consumers and would spark a war in telecom and among handset makers.

I also wrote that “we could be looking at the end of the subsidized mobile handset model. I expect this chase to continue. What we are likely to see over the next few years therefore is a move away from contract plans that only make sense because of handset subsidies; if you get rid of the handset subsidy and have people pay directly for their handset, then people have no reason to go under contract. The more people that move to this unsubsidized model, the more price sensitive potential handset customers will be. That means downward pressure on handset prices and margins, which will be the most negative for Apple. Yes, many people will still be willing to pay $499 for an iPhone if they go on an instalment plan. But that price will be more transparent, making people much more likely to trade down.”

The Motorola Moto E at an unsubsidized $129 marks the beginning of the mobile handset clone wars. And it will destroy margins. Both Apple and Samsung will feel the most pressure as they have the largest share and the largest profits. But the clone makers like LG, HTC and the rest will also feel pressure. Some will exit the business altogether. This is a big win for consumers though. We are about to see very good phones at very good prices.

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