Consumer electronics companies love people who swear by their flagship products.
These premium devices carry a hefty price tag that juices revenues, and they have a higher profit margin built in, too. And when the product happens to be an “it” device, that margin can be pushed even higher. Smartphones like Apple’s (AAPL) iPhone 5 and Samsung’s (SSNLF) Galaxy S4 are prime examples of flagship products that have a huge impact on their respective companies’ bottom line.
When the market starts to get saturated, other manufacturers catch up and mid-range products become good enough for most consumers. Commoditization can take the shine off pretty fast. And that shift seems to be starting in the smartphone market.
What happens when even entry-level products (the ones for consumers who couldn’t afford the “it” device) are so close to the leading flagships in features, design and quality that they’re more than good enough? Consumers have a moment of realization. The cheap stuff is “good enough,” so why pay two or three times more?
That spells trouble for the companies that have grown comfortable as the “it” supplier. At that point, sales tend to spread out across a greater range of competitors and flagship devices tend to become the realm of professionals or hardcore users instead of the general population.
When this happens, the makers of flagship devices tend to go downmarket in an attempt to retain market share and/or start slashing prices on their premium products. Both options usually mean giving up those fat profit margins amid hope that selling more of the cheaper devices will preserve their revenue and earnings.
It doesn’t always turn out that way, though.
Thinks TVs for example. Sony (SNE) used to pretty much own the premium TV market. But as other manufacturers who had once been mid-range or off-brand bargains caught up, consumers decided they were good enough that there was no point in paying extra for a Sony TV. Samsung, Vizio, LG and others became increasingly popular with buyers, Sony started slashing prices on its high-end TVs and releasing cheaper sets — to the point where it was losing money on every TV it sold — in a desperate attempt to maintain its market dominance.
Apple has also seen this effect (albeit to a less damaging degree) with some of its products. After owning the tablet market for several years, cheaper 7-inch models running Google’s (GOOG) Android started catching on with consumers who had previously snubbed tablets designed anywhere but Cupertino. Apple was forced to respond with its own cheaper tablet, the iPad Mini, accepting lower profit margins.
And once upon a time, the company’s 17-inch MacBook Pro — with aluminum body and massive display — was coveted by many as a status computer. But as Apple’s 13-inch MacBook Pro went slightly downmarket to gain market share (allowing status seekers a much lower cost of entry) and Windows PC makers churned out big-screen laptops at half the 17-inch MacBook Pro’s $2,500 starting price, demand eroded. Rather than accept lower prices for the super-sized laptop, Apple ditched its iconic 17-inch MacBook Pro in 2011.
There are signs that we’re reaching this stage in the smartphone market. Samsung and Apple control 100% of smartphone industry profits, but the market is quickly becoming more competitive. Smartphone makers including BlackBerry (BBRY), Nokia (NOK), LG, Sony and HTC have released models that narrow the quality and functionality gap. The smartphones don’t only function well, they look good too (design is always a big deal with consumer electronics). HTC’s One is frequently cited by reviewers as being one of the most beautifully designed phones available.
Apple’s stock started its long slide after numbers for last fall’s iPhone 5 launch showed slowing demand. It was a record weekend, but only a modest increase over the previous year’s iPhone 4S launch.
Now alarm bells are ringing over the Galaxy S4. Samsung’s flagship launched with a great deal of hype, hit the 10 million milestone within a month and now appears to have slowed. Samsung has announced variants on the phone, including colored cases, a ruggedized version and one with an optical zoom lens tacked on — as well as a smaller, cheaper version — in an attempt to keep sales volume up. However, investors punished the stock after learning of the sales data, knocking $12 billion off the company’s market cap on Friday.
The current smartphone market of early adopters is becoming saturated. Mass-market growth is beginning and this segment is being driven by consumers who value function, reliability and affordability over logos and a (decreasing) technical edge. An article in BGR pegs the low-cost smartphone market (under $250) as the growth area, expected to account for nearly half the global smartphone sales by 2018.
Apple is reportedly scrambling to prep a low-cost iPhone, while Samsung is actually quite well covered already — besides its Galaxy flagship, the company sells more than 100 different mobile phones in the U.S. alone. But for both companies, a shift to lower-cost models, combined with increased competition, is going to put pressure on profit margins.
Apple and Samsung both lean heavily on smartphones as profit centers (Business Insider figures the iPhone generates nearly two-thirds of Apple’s profit, while Forbes says mobile is responsible for a similar chunk of Samsung’s profits). When demand was high for premium-priced flagship smartphones, Apple could get away with a 68% margin to drive that profit.
But if we are entering the stage where most smartphones are “good enough,” and mid- to low-range devices begin to take off, the juicy profits of Apple and Samsung are in serious jeopardy.
As of this writing, Brad Moon did not hold a position in any of the aforementioned securities.