As 2008 draws to a close, handset vendors find themselves with a choice to make: Get more involved with the services market and thrive, or stay hardware-focused and wither on the vine.
The popularity of the Apple iPhone, despite the introductory price of US$499 for the 4GB version in 2007, gave vendors a respite from the steady fall in average handset prices. Here, at last, was a device segment that could be not only a reliable source of revenue growth, but also a way of increasing a vendor’s operating margins.
That is still true, but only to a certain extent.
In developed regions – Western Europe, North America and Japan – growth in the value generated by smartphones is expected to be sharp in the next five years, making up for the decline of the nonsmartphone market. In emerging markets, growth will continue to be driven by devices other than smartphones.
The smartphone market will see double-digit annual growth until 2013, according to Informa Telecoms & Media forecasts. The value of devices other than smartphones is expected to register almost zero annual growth until 2011, partly because of the aggressive migration of subscribers in developed markets to smartphones, with an adoption level exceeding 60% in 2011. After that year, the value of nonsmartphone sales will start to grow again, but this time it will be driven by the take-up of 3G and 3.5G services in emerging markets, such as China and India.
The value of the global smartphone market will grow from almost US$39 billion in 2007 to more than US$95 billion, or 47% of the total value of the handset market, in 2013, Informa says. This impressive potential is encouraging device vendors to prepare strategies to tap into the market. A number of vendors are increasing their involvement in open mobile-terminal software, which is central to the development of smartphone devices. Open source will play an essential role in bringing smartphones to the mass market. A number of mobile-open-source foundations have been created in the past two years, including the Symbian Foundation, the Open Handset Alliance and the LiMo Foundation. Virtually all OEMs and the leading operators are actively working within these organizations and preparing themselves to compete strongly in this market segment.
But the growth in the value of the smartphone market will only just make up for the sharp decline in nonsmartphone revenues in the developed countries. The growth in the value of mobile handset sales is expected to drop to zero by 2010 and could decline shortly thereafter. In these regions, vendors will have to create new opportunities if they want to maintain revenue growth. The creation of ecosystems bundling handset sales and associated services (e.g. S60-Ovi, iPhone-iTunes, Android-Google) is a trend that will help vendors to sustain revenue growth.
Handset sales in developed markets are reaching saturation, leading to increasing competition among handset OEMs. The price war will only intensify, since new entrants, such as Apple and Google, are putting more pressure on competitors to reduce their prices, mainly for feature phones and smartphones. With average selling prices of feature phones and smartphones falling, several leading vendors are looking for new ways of controlling handset-manufacturing costs to maintain margins.
With that in mind, vendors have already shifted the majority of production to low-labor-cost regions, such as China, Taiwan, India, Vietnam and Eastern Europe, and now they have to play their only remaining card: lowering the amount they pay for chipsets and terminal software.
Device vendors have traditionally relied on customized chipsets to power their products. Now that modem chips are becoming a commodity, and vendors are adopting off-the-shelf technology, price competition is expected to increase significantly, requiring suppliers to generate significant economies of scale.
The mobile handset industry is also turning its interest to open source, a community-based approach that promises vendors a reduction in or the elimination of royalties related to terminal software and will also help them lower the cost of maintaining commoditized software, because, under open-source rules, the cost is shared among all members of the community rather than being borne by a single vendor.
Despite all these efforts, OEMs will find it hard to maintain feature-phone and smartphone margins, because of the growing competition in these market segments as different types of vendors, including incumbent OEMs, consumer-electronics makers, PC vendors and Internet-content providers, seek their share of the mobile handset market. Overall, the mobile handset market will undergo some radical changes and will be controlled less and less by the top five vendors, which hold an impressive 85% market share.
Informa forecasts that ASPs will stabilize at US$123-130 and average margins will continue to decline sharply. Vendors will need to control costs or face losing market share. This situation will push the market toward a period of strong consolidation within the next five years at every level of the value chain, including chipset manufacturers and OEMs.
It is becoming clear that, in developed markets, handset vendors can no longer rely on mobile phone sales to sustain growth. They will have to look at other opportunities, such as getting involved in creating content and offering services. The trend is already happening, with a number of device vendors, including Nokia, Apple and Sony Ericsson, seeking to create end-to-end ecosystems linking their devices to services they offer. Not only will this move enable them to differentiate themselves by offering users an enhanced experience, but it will also create new revenue opportunities for them by either delivering their own services or teaming up with mobile operators to deliver these services.
This development indicates that the industry is entering a new era, in which product differentiation will shift from hardware to software. Vendors that have prepared themselves for this radical change will find themselves in a better position than those that continue to differentiate their products on the basis of hardware.