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Two Bears, Revisited

One of the more annoying aspects of the late great PC area was how review sites treated Macs: for all intents and purposes, they were just another PC. Consider this CNET review of the 2007 MacBook Pro:1

The good: Updated CPUs and graphics without an updated price; LED-backlit display for better battery life; 802.11n support.

The bad: Minimal configuration options; only 90 days of toll-free technical support; still no media card reader.

Or this PC Mag review of the 2006 Macbook:

PROS: Core 2 Duo upgrade completes the laptop line. Only one inch thick. Excellent performance. iSight Camera. More hard drive options. Front Row interface and remote.

CONS: DVD burner doesn’t come standard.

Conspicuous by its absence is OS X, and the fact that these were the only laptops that ran it. Sure, configuration options or media card readers may be important, but if I cared that my computer ran OS X then none of the cons – including price – mattered. Yet review after review, lost in their analysis of hardware speeds and feeds, ignored the fundamental differentiation provided by software, making their conclusions narrowly correct and broadly useless.

Sadly, things haven’t improved; indeed, as Apple has become one of the largest companies in the world, largely because of the iPhone, the obtuseness has spread to analysis. Consider this from Strategy Analytics (emphasis mine):

Samsung and Apple together accounted for almost half of all smartphones shipped worldwide in 2013. Large marketing budgets, extensive distribution channels and attractive product portfolios have enabled Samsung and Apple to maintain their grip on the smartphone industry. However, there is clearly now more competition coming from the second-tier smartphone brands. Huawei, LG and Lenovo each grew their smartphone shipments around two times faster than the global industry average and captured a combined 14 percent marketshare. Huawei is expanding swiftly in Europe, while LG’s Optimus range is proving popular in Latin America, and Lenovo’s Android models are selling at competitive price-points across China. Samsung and Apple will need to fight hard to hold off these and other hungry challengers during 2014.

The problem with lumping Samsung and Apple together, particularly in the last sentence, is that they face two markedly different challenges: saturation for Apple, and differentiation for Samsung. After all, only iPhones run iOS, while those “hungry challengers” run Android.

I wrote about these differences in one of the first articles I posted on Stratechery, Two Bears:

Bear Argument #1 is the imminent collapse of the iPhone in the face of significantly lower-cost alternatives…Bear Arguments #1 rests on the assumption that the iPhone is competing on hardware, and is therefore susceptible to lower-cost alternatives. However, the iPhone is not simply a device. Rather, it’s a ticket into an ecosystem

Bear Argument #2 is the end of growth for the iPhone…In this case, the iPhone has saturated the high end, and while current iPhone users replace their iPhones, their overall numbers don’t increase significantly…

The iPhone faces little threat in the differentiated high-end of the market. Suggesting this market is limited in size is fair; counting the days until customers flee for cheap phones is silly.

That’s not to say that Bear Argument #1 is invalid; in fact, it’s the Bear Argument for Samsung. There is precious little that differentiates high-end Android from low-end Android…and not only are low-end devices increasingly “good enough,” they’re also impossibly cheap.

Indeed, over the last two weeks both Apple and Samsung have had worrisome earnings reports, but for very different reasons: namely, both bear arguments are coming true.

Samsung is being challenged by lower-cost competitors; the company’s average price per phone fell by $30 last year, and its share of >$400 phones slipped from 40 percent to 21 percent. This kept up Samsung’s volume – they now account for one in three smartphone sales – but the result was their first profit decline in nine quarters.

Apple had the exact opposite problem: the iPhone’s average selling price jumped from $577 to $636 quarter-over-quarter, and was only down $6 year-over year. Apple also increased its share of the >$400 market from 35 percent to 65 percent. Growth, though, was meager: a mere 7%, despite the addition of NTT DoCoMo and a much earlier China launch for the iPhones 5S and 5C as compared to the iPhone 5. According to Tim Cook, this was compounded by stricter upgrade policies amongst North American carriers.

There isn’t much that Apple can do. The market is clearly – and predictably – bifurcating between customers who care about differentiation and those who care about price; the 5S is dominating the former, the 5C was targeted at a middle ground that is disappearing, and Apple will never make a phone cheap enough for the latter.2

Still, growth primarily matters for its impact on AAPL the stock.3 The iPhone as a platform is in fine shape: the iPhone is increasing its dominance of high end customers, and its those high end customers who dominate usage. More importantly, they aren’t going anywhere. User experience is a sustainable differentiator in consumer markets, and any analysis that ignores iOS and Apple’s integrated approach as a differentiator is as useless as a Macbook review that ignores OS X.

Samsung is a different story. They have no meaningful software-based differentiation, and have seen the iPhone’s increased distribution eat into their high-end sales. A larger-screen iPhone would likely erode these sales further. Meanwhile, Samsung has to deal with Chinese Android-based manufacturers driving down prices not only in China, but, particularly now in the form of Lenovo, globally. Lenovo is crushing the traditional PC OEMs with both superior cost structures and superior R&D; at first glance there’s no reason to expect any different result in smartphones.

Still, Samsung has a much more integrated and impressive supply chain than any of the PC dinosaurs that Lenovo surpassed over the last decade, and they have a dominant position when it comes to distribution and carrier relationships especially, a complication that makes the smartphone market much different from the PC market. It will be fascinating to see the degree to which these strengths overcome Samsung’s lack of product-based differentiation.4

  1. I just searched for a year at random, but long-time observers know these examples are hardly unique
  2. There is, though, one obvious area for growth: high end customers for whom the top priority is screen size. I have been banging the large-screen iPhone drum for quite some time now, likely because I live in Asia. As I noted a couple of weeks ago:

    Anecdotally speaking, I don’t know a single person who doesn’t long for a larger iPhone, but I know plenty who switched to Android for this reason.

    Remember, large-screen phones have significantly higher average selling prices; even if >4.5″ is a small part of the market, it’s all high-end, and if Apple wants iPhone growth it ought not leave any high-end stone unturned.

  3. The stock market is not an awards show; prices are about future earnings, and skepticism about Apple’s profit upside in light of the law of large numbers is warranted
  4. Samsung’s fate will be the true ultimatum on Stephen Elop’s decision to go with Windows Phone. I’ve argued strongly that Nokia should have gone with Android and leveraged their supply chain and carrier relationships. If Samsung continues to do well in the face of Lenovo and other Chinese manufacturers then that strengthens my case that Nokia could have succeeded as well