Unforgiven: The consequences of profit failure in mobile phones

In June of last year I wrote a post titled “Does the phone market forgive failure?” It was written on the eve of Nokia’s Q2 2011 report highlighting the historic consequences of a dip into negative operating margins for a phone vendor.

I listed 13 phone vendors who were either merged, liquidated or acquired. There are no examples of vendors who recovered from a position of loss making.

I was prompted to follow-up by a note Charter Equity Research analyst Edward Snyder wrote illustrating the effect of negative operating margins on phone vendors. I took his illustration and expanded it with additional data.

Since my post in June last year Sony Ericsson and Motorola were acquired making the victims list total 14 companies, with Nokia, LG and RIM having joined the “endangered species list”. If the pattern repeats, then RIM and Nokia are in early phases of what promises to be an extended period of pain followed by an exit.

What the analysis does not answer is when a vendor loses its independence after beginning loss making. Motorola took 20 quarters; Sony Ericsson 14, Ericsson 8 and Siemens only 7. We cannot tell if or when LG, which is still operating after 8 and Nokia, which is now in its fourth and RIM, now in its second quarter post-loss, will lose independence.

The rumors swirling around RIM and LG are centered around exits and some suggest Nokia will follow. Many also argue that these companies will recover. The conditions they each face are different in details but broadly they are the same. Earlier last decade the exits were prompted by loss of brand value and subsequent loss of distribution. This decade disruption brought upon by mobile computing brings with it new business models centered on ecosystems and value captured through software and services.

Until and unless these endangered companies solve the dilemma of having the wrong business model at the wrong time, the chances are that they will not be forgiven for market failure.

  • mjuarez

    Very interesting graph.  One thing you could argue is that the phone makers that lasted longer, had huge parent companies behind them, willing to take losses for at least a few quarters, if not a few years, while deciding whether to exit the business or not.  LG, Sony-Ericsson, Siemens, even Motorola, all had huge parent companies, in which phones were merely a division. 

    The companies where phones are a much bigger percentage of revenue, e.g. Nokia and RIM, face the most danger.  There’s no safety net, so to speak.  No parent to hit up for more cash.  I’m expecting that, within the year, both Nokia and RIM will have found an exit of sorts, either getting bought out, exiting the industry, or somehow “transforming” themselves into something that does not compete with the iOS/Android juggernaut.

    • Nokia could always get into the paper manufacturing business, or maybe even start making… Oh, I don’t know… rubber boots perhaps? 🙂

    • RobDK

      One can argue that Nokia DOES have a parent: Microsoft!

      MS is bailing out Nokia’s smartphone division to the tune of $250M per quarter for the foreseeable future.

      • David Avraamides

        And still they suffered a $1.2B loss in Q1. That platform support payment from MS is like using a small bucket to bail a sinking ship.

  • mc

    Does similar data exist for the PC market? A lot of vendors went under in the 80s and 90s. You would suspect there would be a pattern amongst markets defined by technological generations and disruption.

  • kankerot

    SE, LG, Siemens had large parent companies subsidising losses.
    Nokia and Motorola are similar in that they have a handset and Network division.
    RIM stands alone as a pure play handset provider.

    It made sense for Sony to take control over SE as Ericsson focused back on telecoms equipment which it controls about 35%+ of the market.

    Motorola split into two separate divisions was always about making it more enticing for takeover.

    LG has no clear strategy they seem to be Samsung-lite but can sustain their phone businsess as long as the parent company feels its necessary to remain in mobile.

    Nokia success or failure now depends on MS and specifically Windows 8 in the short term. Longer term without its own ecosystem Nokia future is uncertain.

    • capnbob67

      Nokia-Seimens networks is no longer a profit center either.

  • Steve Weller

    It would be interesting to add another axis to the graph that includes cash on hand at the time of the first loss, to see if that had a positive or negative effect on longevity.

    • Andrew Condon

      Good idea – you could do that with line thickness instead of another axis (a la Charles Minard’s famous map).

  • obarthelemy

    Indeed. I’m sure the case of multi-market conglomerates cannot be extrapolated to 100% mobile companies such as RIM, and, broadly speaking, Nokia.

    • capnbob67

      Not 100% but this is only looking at their mobile divisions. Synergies seem light for the conglomaerates and the only real difference I can see is the portfolio management choice for them vs. the all or nothing POV from the pure plays.

  • Jambani

    Horace,                                                                                                                                                                                                                                                                                                  Has your estimate for number of iPhones sold for fiscal Q2 2012 changed at all after hearing the number of activations at AT&T and Verizon in the past week??

    • echo

      yes i am also curious if apple will report lower
      iPhone sales than excepted it would be
      interesting to get Horace take on the decreasing
      subsidies carriers are providing which extend the upgrade
      cycle to the user

      • Tom

        Don’t treat rumors as fact. iPhone prices are completely unchanged on AT&T, Verizon and Sprint. In fact, Apple even convinced a string of regional carriers to offer the iPhone for $50 less than the big carriers.

        As for the future, if US carriers decrease their subsidies, Apple will most likely lower the wholesale price so consumers will still pay the same.

      • I have not seen any evidence of decreased subsidies. If there are decreases then the price of the iPhone should reflect that. It has not happened prior to this quarter. We shall see if it did happen this quarter. (I doubt it and my forecast assumes average revenue per iPhone of $656, inline with $659 of the previous quarter.)

      • The subsidy thing seems a bit confused in the media. At least one of the reports I saw seemed to be saying not that iPhone subsidies, per se, were dropping now, so much as early upgrade programs were being terminated, and the analyst was assuming that a lot of users were upgrading iPhones every year, and would be forced to move to a two-year cycle, thus lowering the sales rate this year because a lot of the sales are upgrade units.

        Longer term, I think he was also arguing that the actual subsidy amount would come down, but I don’t think that can happen unless the iPhone stops being the “must have” phone on all the carriers. Certainly the new AT&T data suggests just the opposite: something like 60% of *all* phone sales were iPhones, and over 75% of the smartphones.

        Another dimension in the subsidy/pricing topic is whether Apple will need to maintain their current $600+ unlocked price for iPhones — I think at some point in the next 2-3 years there will be less need to upgrade the hardware, and software features will dominate, with a consequent decrease in hardware component costs similar to that seen in the current iPhone 4 and 3GS models.

        There’s probably no need to make the display any higher density, nor much larger physically. The CPU/GPU chip is now approaching gaming console territory, which is probably more than anyone but hardcore gamers needs. The radio will move to LTE, but there’s not a clear next step beyond that. About all I can see is better battery life and maybe better screen visibility in sunlight as hardware areas that most users would find compelling.

        The hardware will have become “good enough”, and Apple will then need to maintain its lead via software. Software isn’t free, of course, but it’s a lot cheaper per-unit than the hardware, I expect. As I recall, Apple’s R&D expense ratio is actually very low, for the industry.

      • Name99

        Remember that what you see in the media is carrier whining, devoted to trying to drag Apple down (because the carriers hate Apple), and with zero connection to reality. (And reported by idiot journalists who parrot press releases as “reporting”).

        If the carriers hated subsidies so much, they could perfectly easily provide non-subsidized phones as an option. They’ve not been willing to do that, which rather makes you go “hmm”

      • Agree – generally poor reporting.  In 2009 and especially 2010, the last year of AT&T’s iPhone exclusivity, AT&T allowed many of their subscribers, and particularly iPhone owners, to upgrade at the fully discounted price, at around the 12 month mark.  I actually upgraded from a 3GS to a 4 at the 11 month mark. That practice stopped in early 2011, with fully discounted upgrades only allowed between 18 and 24 months.

        Verizon also ended its 1-year upgrade policy just before iPhone arrived at the carrier.

        In terms of future hardware, there’s still much to do to make phones easier and quicker to use for more jobs. Phones can also still improve their hardware for better reception, better ability to handle liquids, better ability to survive a drop, and better tactile feedback.

      • JohnDoey

        The only hint of truth in what you are saying is that a $0 3GS has a lower subsidy than any previous iPhone. However, 4S is apparently by far the most popular iPhone, and iPhone sales increase 2x per year, so the money is always up, up, up.

    • I had adjusted iPhones earlier to 35.4 million because of the relatively early timing of Chinese New Year this year (January 23) vs. previous year (February 3).

      • silverlining2

        You are slipping. 35.1 million sold in 1Q12. Any ideas on how to fix the Euro?

  • Westechm

    I don’t believe that the Google purchase of Motorola has yet been executed, so it is too soon to list the deal as done.  I wonder why the delay?

    Motorola is carrying the legal battle for Google, using primarily their FRAND patents.  Their success with this approach is very speculative.  Could it be that Google is waiting for the outcome os this before closing the deal?

    Just a conjecture.

    • capnbob67

      Probably to give them time to part it out so they can avoid putting all that garbage on their books. That or to give them time to work out what the hell to do with them after the shotgun wedding at the barrel of mr Jha’a patent suit gun.
      Front the start they said it would take forever to close. Of course the way the market has moved and their inability to make money from Android (vs what they make from iOS in mobile) may make them think that a more focused strategy leveraging Moto as the in house maker and relying on Chinese brands to pick up the low end and Asia that delivers profits and better customers might be the better way to go. Last year it seemed that the pile em high, sell em cheap model must succeed but it seems far less clear now. Lots of their original partners are in trouble (SE, LG, HTC), Samsung will probably fork It anyway, so why not rely on Huawei and ZTE and future low cost OEMs?

    • I think part of the holdup is that Chinese regulators haven’t approved the deal yet.

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  • Although iPhone growth and iPhone disruption has been rapid, I think that the iPhone is about to take both to a whole different level. This has been disguised by the U.S. Teleco’s smaller, post-holiday sales numbers. What we should be focusing on is Apple’s complete domination of the three U.S. carriers that it is on.

    Here’s what we know:

    – Sprint doesn’t break out its numbers but after only 7 months (September 2011 to March 2012) the iPhone is expected to out sell all other smart phones combined.

    – Verizon has only offered the iPhone for 13 months (February 2011 to March 2012) but the iPhone already outsells all other Verizon smart phones. And remember, this is the home of the “Droid”.

    – AT&T has been selling the iPhone since its inception in the summer of 2007, so one would expect their iPhone percentages to be high. And they are. 78% of all AT&T smart phones sold were iPhones.

    – But get this. 60% of ALL phones sold by AT&T were iPhones. SIXTY PERCENT!

    Add to this the fact that several regional carriers are now selling the iPhone and T-Mobile has all but said that they would sell their soul to acquire the iPhone and several patterns seem to be emerging:

    1) The iPhone takes in 80% of the industries’ profits.
    2) The iPhone is on fewer carriers than Android.
    3) When the iPhone is finally distributed by a carrier, it quickly comes to dominate that carrier.
    4) Apple is rapidly expanding its carrier base in the U.S. and across Europe, China and elsewhere.

    Why am I discussing all of this in an article related to whether Nokia (and RIM) can recover from their current predicaments? I am discussing all of this because I believe that iPhone domination is rapidly increasing and that its concurrent pattern of disruption is about to increase too. This means that those who are in distress are going to receive more downward market pressure and less time than ever to do anything about it.

    Should we be talking about whether Nokia and RIM are going to be losing their independence or should we, rather, be talking about how soon that will be happening?

    • “But get this. 60% of ALL phones sold by AT&T were iPhones. SIXTY PERCENT!”

      Is this the first time that iPhones have accounted for a majority of ALL phones sold on a particular carrier? Tim Cook’s comment that “all phones will one day be smartphones” is right on the money…

      • ChKen

        He stole that from Horace.

    • I’d be careful about reading too much from the US situation when looking at the rest of the world. There seem to be areas where the iPhone and Android are both available, and the ratios are very different than in the US.

      In the US, you’re pretty much forced to buy into a $2000 contract to have any smartphone (though maybe this is changing a bit), so the difference between a “free” Android phone and a $199 iPhone 4S may not seem that big, while in the foreign prepaid market, a $50 knock-off low-end Android may look very attractive versus a couple hundred dollars for even the 3GS. If you can’t afford it, it’s not “good enough”…, and a low-end Android is still probably a lot more useful than prior feature phones.

      I think there’s a potential low-end market, at least, though whether there are any decent margins there is an open question; I expect Huawei and ZTE will be gunning for that market too. Microsoft has talked about moving into lower-priced phones, and if they can make the software experience substantially better on roughly the same-cost hardware as the cheap Androids, they might be able to claim a enough of a premium to make a go of it, especially if the low-end Androids fragment in enough directions to lose any cohesive app market.

      The other big question is whether Apple will get into that same low-end market using older/cheaper designs. If they can keep app compatibility (except for high-end graphics-intensive games), they might wind up playing well at the low end in a couple years. The key issue may turn out to be the display/touchscreen component, which I suspect Apple won’t compromise as much as the Android makers have.

      • “…in the foreign prepaid market, a $50 knock-off low-end Android may look very attractive versus a couple hundred dollars for even the 3GS…” -Walter Milliken

        An excellent point.

        However, even in that scenario, the purchasers of iPhones are far more likely to be purchasers of Apps and content – and therefore supporters of developers content creators – than are the low price Android purchasers.

        So in the areas where there are subsidies, the iPhone may become dominant in market share as well as profit share.

        And in the areas where there are no subsidies, Android phones may continue to enjoy more market share but the phones will be forced into a low cost ghetto which will starve Android manufacturers and developers of profits.

      • I generally agree, though if these types of phones get any kind of user base, there may also be low-end developers (I’m thinking college students and the like) who will be willing to develop apps for *any* return greater than zero. These will not be quality apps, probably, but if they can actually do any kind of useful job, there may still be a bit of an ecosystem.

        I suspect the manufacturers will actually be in a worse position than low-end developers, since the entry cost for programming these devices is very low, unlike R&D and component costs for building the phones. And if the labor is otherwise going unused, the opportunity cost is zero. While these same developers might want to sell apps for the more profitable iPhone (or higher end Android or Windows phones), the required entry costs go up by the device price (for testing), and the competition is much worse — both higher quality apps and more developers joining the gold rush.

        Overall, I’d expect the users in this low-end ghetto model would want to migrate out of it, if there is opportunity and the incremental costs are matched with higher utility. It might well turn out to be a “starter” market, like US high school students and used cars. This might be especially true if possession of *any* smartphone economically benefits the user, giving them the ability to move upscale. That’s a very speculative notion, though….

      • JohnDoey

        It’s iPods again. Plain and simple. Tech people say “MP3 player market” (smartphone market) and consumers ignore all that and it iPods and iPhones.

        Apple just spent 5 straight years teaching the world what an iPhone is and what it does and even how to use it. The “smartphone” CANNOT compete with that. Consumers simply do not care. They want iPhones. Only nerds seek out the generic crap.

      • “The other big question is whether Apple will get into that same low-end market using older/cheaper designs.” 

        You can get a “free” 3GS right now.. so Apple’s already in that market. They’re not developing cheaper handsets, they just demote previous years’ version. Smart – they’re amortizing the cost of tooling (for a new model) over 3-4 years which is probably why (not counting the first gen) a new form factor only comes up every other iteration.

  • JohnDoey

    These companies are already names from the distant past for me. They don’t even have a roadmap that is interesting. How will I suffer if I never buy an LG phone? Not at all.

    All of the tech companies other than Apple now make iPhone parts. That is what they are good at: making parts. It is appropriate. Apple is good at putting them together into something that is — gasp — functional. LG is not developing that skill.

  • ChKen

    Motorola got spun off from its parent, and I believe got a cash infusion as a parting gift, so that probably delayed its demise/acquisition timeline.

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