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Which size really matters? Market Share vs Profit Share

One of the most hotly debated subjects in the mobile phone business is the importance of market share. It’s also a topic of lore in the PC industry. Briefly the two arguments are:

  • Market share matters more because it drives network effects which ultimately drive competition out of the market, creating the opportunity for monopoly rents.
  • Profit share matters more because profit is the only fuel that can drive innovation. Any macro downturn or shift in strategy can cause a company to cease investing in unprofitable projects.

The old disruptor’s adage: “Be hungry for profits and patient for growth” is challenged by the equally disruptive: “Grow share with lower prices in exchange for new revenue sources.”

There are many rich anecdotes to support each strategy, but how about some data? Fortunately we have some: the market and profit shares for vendors covering 80% of the world’s largest technology market over a three year period. The vendors are a good proxy for the market, the time frame is long enough to cover seasonality and anomalies and the market is very big (over 1.2 billion devices) and very broad (world-wide).

The only question is how to measure success. One measure is how various strategies benefit the asset owners, i.e. the share holders. Benefit to society, employees and consumers are very difficult to measure. But share holder benefit is easily obtained by measuring change in share prices.

So, here are two charts:

  1. The percent change in market share vs. percent change in share price for the top mobile phone vendors.
  2. The percent change in profit share vs. percent change in share price for the same vendors. (see note 1 for time frame discussion).

I showed the R-squared value of the correlations. (See note 2 regarding LG and Samsung). At r-squared of 0.36 share price is not well correlated to market share while at 0.76 it is rather well correlated to profit share. To a financial analyst this would seem obvious. After all, share price reflects the present value of future cash flows which are clearly coupled to profit and hence to profit share growth. However, as many technology observers would point out, market share determined the success of Microsoft and Google, and to some degree Nokia.

High market share can cause competitors to be starved of components or ecosystem developers. At the same time, high profit share can cause competitors to be starved of capital.

What does this analysis add to the argument? Note that this data covers a hardware business. Is hardware relevant? It does not scale as rapidly and has a short shelf life. It’s also notoriously difficult to distribute. However, outside of the service revenues for cellular voice and data, device hardware is the only pool of money that has any material dimension in the industry. It’s also the pool of money with the highest margin in the industry. For the time being and the foreseeable future, hardware is the only business model worth anything in mobile computing.

The data shows that in this particular but substantial market profit share is closely correlated to shareholder value creation. It also shows that profit loss is closely correlated with shareholder destruction. The dominant data comes from Apple and Nokia, which appear to be polar opposites in performance on both measures.

In other articles I’ve shown how profits have shifted from incumbents to entrants in the smartphone disruption. This shift has resulted in direct benefit and loss to the owners of the two asset classes. To suggest that market share alone is a determinant of “success” in the device market must exclude the effect on shareholders and, ultimately, the management and employees of the companies concerned. The virtuous/vicious cycles will be fed by the profit variable more than any other.

I don’t think the market share argument holds water in this market and this data supports my belief. It may be that as value shifts over time away from hardware the benefit will shift as well, but business models alternatives to hardware have not emerged after ten years of experimentation. If anything, the idea of selling hardware as a way of capturing service revenue was pioneered by RIM and perfected by Apple. Nothing I’ve seen so far is challenging this model. Whoever attempts to siphon the device pool of money (which has remained fairly constant over the smartphone disruption) needs to solve system-wide problems like the dependence on the network and the life-cycle of portable electronics.

—-

Notes:

  1. The dates when performance was sampled are are July 1 2007 to July 1 2010. The latest quarter (3Q10) has not been included in this data as it has not been fully reported. The data will be updated with the latest quarter as soon as it’s possible.
  2. For many competitors the share price is dependent on more than performance in the mobile phone market. In particular, LG, Samsung, Motorola and Apple have diversified product lines which affect their share prices. Two of those companies (LG and Samsung) are conglomerates and their share performance is dominated by businesses other than mobile so I did not include their data in the correlation measure (though their place on the chart is shown). Motorola and Apple’s stock prices were, to a very large extent, driven by their mobile phone performance over the same period so their data is included in the correlation analysis. The other vendors have been primarily focused on mobile phones.
  • http://twitter.com/jtsd @jtsd

    What's interesting is that even Nokia acknowledges its scale/market share is only marginally relevant when considering smartphones (cf. 2009 20-F). Many smartphone SKUs actually ship at lower numbers than some competitiors with smaller portfolios.

  • AlleyGator

    Great job, Horace, but to properly focus on "incumbents", I think one has to compare Apples to Androids. I think you might need to change your starting date range from Jul 07 to sometime in '09. 2010 has been the year of the smartphone, and some real Apple competitors are emerging.

    Also, you're not going to be able to track the re-rise of Windows Phone 7 over the corpse of Win Mobile 6.X unless you restart the graph from somewhere more recently.

    • asymco

      All in due time. Short time sampling for share price observations are fraught with noise.

  • Gandhi

    "For the time being and the foreseeable future, hardware is the only business model worth anything in mobile computing."

    So what does that say about Android and WinPh7? I know Google reported blowout numbers, and claimed the mobile devices division is very profitable, but I have not seen any comments or analysis from blogs or analysts breaking out how profitable Android has been to Google in terms of solid numbers. Anyone know?

    • http://twitter.com/PaulMaxime @PaulMaxime

      Google actually reported mobile advertising revenue has reached a y/y run rate over $1B. They didn't speak about Android itself from that perspective.

      • asymco

        I suppose that mostly includes their AdMob business which mostly makes money on iPhone as a smartphone platform.

      • Gandhi

        Well, that is really my question. I want to know how much Google is making off Android versus iOS.

  • poru

    One advantage for a "new entrant" (epitomised by Apple in this sector) is the lack of legacy code and hardware to support. (The loser here would be MS which cannot seem to innovate successfully not only for technical reasons — supporting legacy code and apps — but also for corporate cultural reasons, where one division doesn't want to cede R&D or profit to another.) I've mentioned before here how hard it must be for OEMs, carriers, and developers to manage umpteen different models, two or three different OSes (and versions thereof), screen sizes, etc. New entrants who are thoughtful and careful can avoid all that.

  • http://twitter.com/_ChrisHarris @_ChrisHarris

    "High market share can cause competitors to be starved of components or ecosystem developers. At the same time, high profit share can cause competitors to be starved of capital."

    It's interesting to note how Apple's strategy with the iPhone has shifted with the iPad. The iPhone has been a high profit / low marketshare device. While (and this is stretching a bit) the iPad has marketshare / lower profits.
    Horace's point that competitors can be starved of components may be held out by the rumour that Apple have pre-bought the entire 9.7 inch display market. This has forced competitor to adopt the smaller 7 inch form factor.

    I wonder if (and the sales figures may support this- see adoption rates for new technology) that high marketshare strategy is more effective.

    • KRIS

      It has not shifted anywhere. Apple has just added the iPad. They do multiple things and they focus to all of them. That is amazing and that makes the Apple move very fast. They control all the key components what they need to make it happen. Also they have the cash to roll over any hiccups.

      • http://twitter.com/_ChrisHarris @_ChrisHarris

        Sorry, what I was implying was that they are trying a different strategy with the iPad than the iPhone. One that goes for market share rather than profit share.

        My point is that if the numbers continue as they are, the iPad could prove to be a bigger seller than the iPhone. This might indicate that going for market share may be more effective.

      • KRIS

        iPad has it easy now because Apple used the iPods and the iPhone to open the doors (kick in ;) ). It has taken over 9 years to talk with everybody (operators, resellers etc). So Apple can apply different tactic for the iPad. This was not possible 3-9 years ago because Apple did not have the contacts to do it. (Nokia has done that decades ago.) Now they sell Apple product everywhere. Also first the iPod and then the iPhone helped to do the critical mass. iPad does not have that burden. It relies for the same components as the iPod and iPhone (mostly). Apple TV is "iPod Touch with TV connection" and relies also to the same components as the others. This is one big part of why the iPad is immediately so succesful.

  • Priit

    Market share matters when you are unable to sell your goods by ourselves. THERE's the big difference between Apple and others. Apple at the biggest markets has online and brick&mortar stores, so Apple can go primarly after profit. (iPad currently is an anomaly though, here Apple is so scared of Android and/or thinks he must flood the US market at any cost to kill that or thinks good iPad market share which can be achieved right now helps iPhone too.)
    Others cannot go for profit, because they are dependent from resellers and distributors and those add FIXED markup to any stuff they sell and the mathemarics is simple – the more your stuff sells, the more your agent makes money. Again, the more you sell, the more shelf (and advertising) space you receive, the better you sell because of added visibility. Btw, that's why popular brands add lot of different products to extend their lineup – for example, only orange and tomato juice sell, other 20 juices are nothing more than shelf fillers.

  • famousringo

    As a consumer, I don't see it as market share vs. profit share. I see it as market control vs. value creation, each being a different path to profit.

    The market control path uses techniques like loss-leading and exclusive distribution to seize control of a market so that customers have little choice but to buy a box of widgets at a 100% markup.

    The value creation path is to buy a box of widgets at price X, add some special sauce, and sell it to the customer for 2X.

    Both companies earn the same profit, the difference here is that the customer is being enticed by the special sauce, rather than being compelled by market control. The special sauce creates value that the customer willingly pays for.

    Guess which path to profit I respect more?

  • Rob Scott

    Can you unpack and explain how this relates to todays post. Also how do you reconcile Apples' apparent profit maximization strategies with their not to make money stated goal:

    Jonathan Ive:

    “Apple’s goal isn’t to make money. Our goal is to design and develop and bring to market good products…We trust as a consequence of that, people will like them, and as another consequence we’ll make some money. But we’re really clear about what our goals are.”

    • http://twitter.com/_ChrisHarris @_ChrisHarris

      Yeah but you can bet Tim Cook doesn't think like that :)

      • KRIS

        Oh yes he does :D He is a company man ;)

      • KRIS

        He though makes sure that the money will come ;)

      • unhinged

        No, as an operations man, he makes sure that the money is _spent_ (and efficiently so).

      • asymco

        Tim Cook when he was CEO of Apple:

        "We believe that we're on the face of the Earth to make great products, and that's not changing. We're constantly focusing on innovating. We believe in the simple, not the complex. We believe that we need to own and control the primary technologies behind the products we make, and participate only in markets where we can make a significant contribution.

        We believe in saying no to thousands of projects so that we can really focus on the few that are truly important and meaningful to us. We believe in deep collaboration and cross-pollination of our groups, which allow us to innovate in a way that others cannot.

        And frankly, we don't settle for anything less than excellence in every group in the company, and we have the self-honesty to admit when we're wrong and the courage to change. And I think, regardless of who is in what job, those values are so embedded in this company that Apple will do extremely well."

    • asymco

      Jony is saying in his own way that their focus of making great products is going to make them a lot of money. It's the argument that if you really focus on quality, value and experience the money takes care of itself. Conversely if you obsess about profit you end up pleasing no-one. This is embodied in Jobs' own philosophy which has been detailed in many ways.

      • poru

        One of my favourite sayings (found I believe on 37signals.com a year ago) was by Walt Disney: "We don't make movies to make money. We make money to make movies." A lovely ambition.

    • kevin

      Steve Jobs was on the conference call today. He explained this very well; he said open doesn't always win; integrated beats fragmented; and "you're thinking like a hardware manufacturer who thinks software will take care of itself".

      It's worth downloading the transcript from SeekingAlpha.com once it's posted, or going to Apple.com later this evening to hear the call replayed.

      Steve talked about just everything we discuss here at Asymco, and left a lot of fruit for further thought and analysis. (Could he actually be lurking on his iPad?) There will be much to discuss in the days to come.

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  • OpenMind

    Actually I think Apple are working on both fronts: profit share and market share. Apple aims iPhone/Mac for profit share and iPad/iPod for market share. Look at the recent distribution deals (Walmart, Target, AT&T, Verizon, etc.) Apple have signed for iPad, it guns for market share and mind share. Jobs have learned the lesson of early '80s market share does matter. The beauty of Apple combined strategies is profit-share and market-share products have more than 80% components in common. At end of day, Apple iOS devices will both have big chunks of profit and market.

  • Anthony

    Apple's market share leadership is very clear to me: be a market leader in the high end or premium segments of the market–laptops over $1,000, Smartphone's over $400, and premium PMP's for example.
    If you were to recut this analysis with a view on Apple's market share in the highest priced laptops, PMP's and Smartphones, you'd find that Apple is a market leader both in share and profits. When it comes to the low end of the market, the don't play the market share game and there barely is a profit game to be played.
    And that's where the quotations of Ive, Jobs, and Cook make clear what they're doing and why they win so well. I humbly suggest.
    On the other hand, they play invert this model when it comes to software and content: they dominate the market share on apps and songs, but they don't extract margins here. This is an equally interesting story to tell: invoke rationale decision drivers when it comes to software and content (who can resist 99 cent songs and games for $1.49, when the risk is nearly zero?), while invoking emotional drivers when it comes to hardware purchase decisions for premium products. It's another level of genius that competitors aren't close to addressing

  • Jon

    Love your posts Horace. Very thought provoking. Share price reflects expected future cashflows as you have stated, however since you are comparing historical data you should include dividend payments (share price drops after a dividend is paid).
    Also, I wonder if percentage change in market share is a good measure? Does going from 10% to 20% market share have the same benefits as going from a 40% to 50% market share?

  • Niilo

    I like the fact you try to have a data-driven discussion of this industry, but I have several reservations about this analysis

    - As someone else stated above, then probably Total Shareholder Return would be a better value creation metric than stock price, but I think this is a bit of a nit as I believe (haven't checked) that Nokia is the only one in the sample to pay dividends
    - I am concerned that your use of market/profit shares means that (as all the shares in a market have to add up to 100%) the x-axis parameters are dependent on each other. Perhaps absolute volume or volume growth and absolute profit or profit growth would be better y.-axis variables but…
    - … however as you say in your post valuation is a DCF analysis of future free cash, strongly linked to profits, so you would anyway expect the market to reward higher profits
    - And finally, perhaps most seriously, I think you shouldn't bandy around r2 values without also talking about statistical significance. I haven't checked, but I suspect statistical significance in both cases to be quite low, but I unfortunately I don't have time to go check

    Overall I think these regression analyses are redundant as it seems pretty obvious to me that there is little point in having a high volume share if you are unable to extract at least an equivalent share of profits. I don't think you need to quote r2 to get buy-in that Protits Are Good.

    Would be interested in your comments.

    However, overall I still love your blog and the discussion in this post is great. I would comment that as long as the level of innovation required to win in this market remains high then overall volume share is secondary, but as soon as the pace of innovation slows, then volume share and scale and all that confrontation strategy thinking will once again count for a great deal. Pre-iPhone Nokia used to get around 60% of industry profits from only 40%of industry revenues.

    You have made many great posts on this subject;
    http://www.asymco.com/2010/09/13/when-will-the-smhttp://www.asymco.com/2010/09/28/correlating-inno

    There was another really good one I can't find now (market share increase vs. operating profit?)