Thursday, 25 September 2014

Nokia, BlackBerry left behind amid untold disruption of the smartphone revolution

As I was completing my previous IP Finance posting on alleged royalty stacking in smartphones, last week, it occurred to me I should also write more generally about the massive disruptions in the mobile phone industry resulting from technological changes, new business models and market entry by Apple with its iPhone and many others using the Android operating system. Former market leaders have fallen and consequently exited the market with handset division divestitures by Nokia, Ericsson and Motorola. Challengers are succeeding on the basis of highly-standardized and readily available hardware and software platforms. These are employed by all comers as if they were commodities, but are rich in IP including standard-essential and other technologies which are costly to develop. This is paid for downstream in a variety of ways including: merchant product prices for chips; patent licensing fees for standard-essential patents and the other patents needed to implement the radio communication protocols and various user features consumers expect all smartphones to have; and advertising and apps spending to Google in the case of Android. The following article on all this was first published in mobile industry trade publication FierceWireless Europe.

Nokia, BlackBerry left behind amid untold disruption of the smartphone revolution

It is remarkable how dramatically and rapidly the fortunes of so many mobile handset vendors have turned with the advance of smartphones. Their marketplace was transformed by Apple's iPhone starting in 2007 and a succession of Android-based smartphone newcomers since 2008.
This has greatly expanded the size of the handset market with global revenues doubling in the last six years, as consumers substitute more expensive smartphones for their feature phones and basic phones. Yet changes have devastated most of the leading incumbent handset vendors.
Former leaders Nokia, Ericsson and Motorola have exited by divesting their handset divisions, and BlackBerry has struggled to survive following its precipitous market share decline, as business models and competitive cost structures have changed. Samsung Electronics is the only incumbent that has really flourished, while LG Electronics has also advanced and HTC has wavered.
How the mighty have fallen

Strategic strengths became liabilities

Seemingly strong brands, product distribution, patent ownership, vertical and horizontal integration with chips, networks and manufacturing have been insufficient to ensure survival, let alone success. The market leavers once had these attributes in spades. For example, Nokia had it all with approaching 50 per cent market share in smartphones and 40 per cent in mobile phones in general up until 2007. It ranked highly in global consumer brand ratings, dominated distribution in Europe and in many other nations worldwide. A cumulative $60 billion spent on R&D funded one of the very strongest patent portfolios and it could exploit various synergies with its network equipment division and in-house baseband modem development capabilities.
Business models and the basis for success in smartphones and mobile phones in general have been revolutionized. Costly supporting and complementary operations soon become major burdens when incumbents were wrong-footed in the market and lost the cash flows required to support all that, while also needing to do things differently. Instead, low costs and much greater reliance on technologies from others are the keys to success for most of the many recent market entrants.
They are exploiting platforms which are open, widely available and cheap to adopt. Apple is something of an exception, having created much of its own ecosystem, but it is also entirely dependent on others for radio technologies and manufacturing. Samsung uniquely remains highly integrated, but also employs outside technology including Android and Qualcomm's baseband chips in many cases.

Challengers rising high
What made the smartphone revolution possible
Smartphones, or at least the precursor to what we regard as such today, have existed for more than decade with Nokia's Communicators from around the dawn of the new millennium and the first cellular BlackBerry in 2002. But these were only niche devices and network service constraints severely limited utility beyond messaging. A combination of many technological advances has made modern smartphones the enormous success they are today. These include much faster networks, as 4G LTE today is 1,000 times faster than 2G GPRS introduced around 2000; fast and yet low-powered application, graphic and digital signal processors; much improved display technology; revolutionary improvements in operating systems and user interfaces; better battery performance; and an extending ecosystem with apps stores and mobile-oriented content.
Smartphone market entry barriers are now relatively low with standardized and openly available technology platforms. Smartphone vendors can capitalize on extensive published standards, market-leading merchant (i.e. off-the-shelf) chips and reference designs provided by these suppliers, and contract manufacturing. Addressable markets have grown to include hundreds of operators and several billions of consumers. Average selling prices, at around $275 for smartphones versus $175 for handsets in general, generate substantial revenues while strong downward pricing trends are maximizing smartphone penetration growth.
Just rewards
Handsome rewards including profits are available to those market leaders that can build a sustainable edge. According to Credit Suisse, handset manufacturer operating profits since 2007 have tripled to $51 billion on $326 billion revenues in 2013. Reportedly, these are overwhelmingly shared between Apple and Samsung, with others making small profits or losses.
Much of the costly R&D and standardization work required to create the platforms smartphone manufacturers employ is still being borne by network equipment vendors like the diversified former handset leaders above. These are increasingly dependent on technology licensing to help fund ongoing R&D. Similarly, specialized technology vendors such as Qualcomm and InterDigital have business models which are largely dependent on licensing fees. Microsoft also generates income this way as well, licensing its patents to Android device makers. In addition, Google, which provides the Android smartphone platform and its Play app store, generates income from these in various other ways including advertising charges.
It is incorrectly alleged that stacked royalty costs prevent the other smartphone manufacturers from making profits and cause other harms. Evidence does not show that high royalties are paid or that royalty charges undermine profits. Manufacturers that could negotiate the lowest royalty rates through cross licensing, due to owning most standard-essential and other patents, have taken the greatest competitive pounding by Apple, Samsung and various other new entrants selling Android devices. The former lost money because they had obsolete and uncompetitive strategies. Low profits for many newcomers are a function of the open and "commoditized" nature of the business with low barriers to entry, including the standardized and merchandized platforms everybody uses. This makes product differentiation and high-margin pricing difficult to achieve.
It is not possible to determine true profitability on handsets because many manufacturers are reluctant to disclose them, and businesses are mixed with the manufacture and sale of other products and services. Some manufacturers are still benefitting from being in both the handset and network equipment markets. For example, Huawei and ZTE have reported strong profit growth recently. This is due to the boom in LTE network investments, but smartphones are important complements to these companies. Rising star Xiaomi, with a low-cost, Internet-based distribution model, does not formally disclose profits but was reported last year as making a 10 per cent margin.

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