In December, I explained why I thought a price war is about to erupt among wireless carriers in the U.S., and how Apple (AAPL) could be collateral damage as the cheap phones associated with these new plans put Apple's iPhone margins under significant pressure. Recent research makes me even more concerned about the direction of smartphone economics -- at least from a shareholder's perspective. (From a buyer's perspective, the world is going to keep getting better!)
The MIT Technology Review recently ran an article on the low-end smartphone industry in China, and the developments there should give any investor pause. The article reveals that hundreds of small Chinese companies are turning out millions of Android-based smartphones annually, with retail prices often below $100. This segment exploded in 2011, when simple and cheap off-the-shelf chipsets became available from Taiwanese semiconductor companies such as MediaTek and Spreadtrum (SPRD). With the phone predesigned and a free copy of Android loaded up, cheap Chinese labor can produce thousands a day for a cost of around $40. The chipsets themselves cost between $5 and $10. Even well-known names such as Lenovo and Huawei are entering this market with "midrange" phones at the $200 price point.
To those of you with a bit of grey in your hair, this should sound very familiar. Michael Dell, the billionaire in the news today (who is trying to take his company private), exploited exactly the same phenomenon 20 years ago to completely disrupt the personal computer industry. In the 1980s, PCs were still relatively highly engineered and expensive pieces of hardware. However, with inexpensive standard chips from Intel (INTC), inexpensive standard supporting chipsets from a variety of suppliers, such as LSI Logic, and inexpensive standard software from Microsoft (MSFT), any kid could build a computer in his dorm room. Michael Dell and Ted Waitt -- who founded Gateway 2000 at the University of Iowa around the same time -- figured out that the cheap computers were "good enough" for most needs and could be sold directly to consumers via advertising and mail fulfillment. The rest is history, as they say.
Anyone who dismisses the $10 smartphone chipset as "low quality" and "only for the low-end Chinese market" is missing the point. In fact, they are missing the single biggest and important development in the smartphone market. Dell and Gateway PCs were "junk" in the beginning. They worked, but had little in the way of corporate support. However, over time, the parts and software got ever more reliable, the low price point attracted ever more buyers, and Dell and others could layer on the customer support, customizability, and other features that turned them into real companies that ate the lunch of Compaq, IBM (IBM), and 100 other competitors.
Mediatek may be a joke today, but that chipset will keep getting better and better, and the price is not going to increase. Google (GOOG) will keep perfecting Android -- it is already the most popular smartphone OS in the world, and the price is unlikely to go up much. The smartphone is going to get commoditized, and it will happen on a global basis. Recent data from IDC has Apple iOS market share around 15%, based on phone shipments, while Android is around 75%.
The old saying is, if you are not growing you are shrinking -- and Blackberry can tell you what happens when other competitors gain dominant market share. Apple is not going to zero like the Blackberry did, but any Apple shareholder must ask what is likely to happen to Apple's gross margins when the dominant phone OS -- which is a functional equivalent to Apple's product -- can be bought on a device selling for below $100. As the quality of the devices improve relentlessly year after year, Apple will become increasingly more challenged to hold pricing.
If you don't think the Chinese can destroy the economics of an industry with quality product and cheap pricing, I suggest you study the solar panel industry.
History rhymes. The smartphone is nothing more than a handheld PC with a wireless communication capability. What happened in the PC business that enabled Michael Dell to amass a multi-billion fortune by "piling them high and selling them cheap" is in store for the smartphone market. The when and how remain to be seen, but ignore this at your own peril.
(I'd like to tip my hat to my business school friend Kurt Hattendorf, who sits at the edge of the world in Chang Mai, Thailand, yet sends me some of the most important information I read each week, such as the MIT piece!)