The pending wave of consolidation in the US cellular carrier business spells doom for many handset makers, especially the big three, which are going to see their margins pounded and market shares eroded.
ANALYSIS: Number portability and desire to go wireless has helped the handset makers quite a bit in recent times. Nokia and Sony Ericsson, both managed to reverse their fortunes and post profits. Good times are not going to last forever. Why? Because of the mergers which are set to sweep the mobile phone business in the US.
When AT&T Wireless and Cingular merge their operations, or one of the many combinations we have postulated happen, the power axis within the industry is going to shift from handset makers, to the service providers. For the longest time, handset makers have been the decision makers, choosing what features to include in their mobile terminals, ignoring the wishes of carriers who are more in touch with the end customers. This near autonomy allowed the M.E.N (Motorola, Ericsson and Nokia) to charge premium for their devices, which were subsidized by service providers on behalf of their customers. That domination is coming to an end.
Ten years ago the top three – Motorola, Ericsson, and Nokia accounted for about 85 percent of all phones sold. Today while the overall handset market has quadrupled to about 450 million handsets, the share of the big three has declined to 55 percent of the total pie. Why because new comers have muscled in by flooding the market with low-cost phones. Samsung, which five years ago was not even in the business now accounts for 9.9 percent of the overall market. Sharp and LG Electronics, relative new comers to the phone business (they started selling phones only three years ago) have carved up about 5 percent of the market each.
The main reason: the phones have become fairly standardized. A phone is made up of four basic sections- a radio chip which receives and sends phone calls, a base band chip that converts voice signals into digital signals, a processor that controls functions such as the keypad and the screen, and other chips like memory. Over last five years these four basic parts have become standardized. And as a result their prices have fallen drastically. In 1999 the innards of the phone cost roughly $100 bucks a phone, and now that number is down to about $40 a phone, and falling.
With six radio chipset makers, four operating systems companies, and half a dozen middleware and DSP providers, the barriers to entry in the wireless handset business have been lowered. This is a perfect in for anyone from little Taiwanese start-ups to consumer electronics giants like Samsung, LG and NEC a chance to enter the business. For carriers, this is good news.
“Small companies will do whatever we want them to do,” Rod Nelson, chief technology officer at AT&T Wireless told me during a casual chat a little while ago. If you read this statement, carefully, it is the future of the handset business. Consider the Cingular-AT&T merger. With over 35 million customers, the company would be so big that it will dictate the terms on handset features, pricing and even margins. And more than anything, the carriers can brand their handsets, and not give any premiums to the big brands. Bye Bye Nokia, Hello, Mr. No Name Chinese handset maker.
Those looking for precedent should analyze the handset portfolio of Verizon Wireless. It is dominated by three companies ? Samsung, LG and Audiovox. No Sony Ericsson and only a couple of Nokia handsets. Elsewhere, Vodafone, clearly the largest mobile phone company on the planet has handsets from guys like Sagem, Samsung, Sharp and Panasonic. Nokia and Motorola are also offered, but their percentage as offerings is decreasing. I suspect that the new comers offer better margins to Vodafone and are more receptive to the needs of Vodafone.
Michael Raynor and Clay Christensen in their The Innovator’s Solution define this commoditization as a process that makes highly lucrative, ‘differentiated and proprietary product into a commodity.’ “Large established and extremely successful companies have become too good for their own good,” Raynor told me in a phone conversation. “Argument is Intel is going to give me a faster chip, I am going to take it, but I am not going to pay for it. That is called commoditization. Intel understands that their ability to charge premium prices on processors is falling because they are overshooting what consumers can use. Nokia is facing that challenge in their business.”
“Modularity had a profound impact on industry structure because it enables independent, non integrated organizations to sell, buy and assemble components and subsystems,” they write in The Innovators Solution. “When that happens, companies mix and match components from best-of-breed suppliers in order to respond conveniently to the specific needs of individual customers.”
LG Electronics and Samsung are two classic examples. These companies had little presence in the handset business ten years ago, but today they are in the top five. LG aims to become the #3 provider in the planet, while Samsung is on its way to the top. Why? Because they are applying the hard learned lessons from the DRAM/Memory chip business to handsets now. They did not make the memory chip; they made it cheaper and better. Ditto for Cell phones! Let someone else come-up with technologies (processors, radios and all that cute stuff), and find a way to package it that it meets the needs of your customers. Lower costs and higher volumes would make-up.
Wait till the Chinese get into the act: this would make life tougher for the big three. This is a market for the M.E.N to lose. Carriers are too glad to see their monopoly fade. “It is at the low-end of the market we are seeing a lot of commoditization,” says Neil Starker, analyst with In-Stat/MDR, a research group that tracks the handset business. He believes that it is at the very low end of the market, “where there is a lot of action.? Expect these no-name players of today to become mobile phone giants of tomorrow. “Five years ago Samsung was nowhere,” reminds Starker, “and look where they are now.” You will not hear Wall Street talk about this. They are too busy celebrating the recent good earnings of Nokia and SNE. Have they forgotten that it is really calm before the storm?