Why Apple Is Best Positioned In Smartphones, In One Chart

By on Nov 30, 2015 in Mobile Design | 0 comments

Summary

Apple is currently the most successful smartphone producer in terms of mobile device profits.

In this article, I provide a single chart that summarizes Apple’s advantages relative to its main competitors.

I conclude that Apple’s advantages are unlikely to be disrupted by any industry developments in the near term (the next few years).

Smartphones remain the most important mobile device in the world, with 355 million units shipped in Q3 alone, according to IDC. Apple (NASDAQ:AAPL) doesn’t ship the most phones, but is generally regarded as capturing the most profit in the industry, which is probably the most important metric that can be applied in evaluating competitive success. In this article, I take up the problem of evaluating Apple’s competitive position going forward. I show in a single chart that Apple continues to have numerous advantages over its competitors.

Source: Apple

Rack and Stack

Back in my systems engineering days, I spent a lot of time evaluating competing vendors for subcontracts on systems or components. I would present my findings in a summary table that listed the key metrics and values for each competing vendor. Usually, I would color code the table entries according to a simple red/yellow/green grouping to reflect low/medium/high performance. This was the “rack and stack” chart.

The rack and stack chart is very compact, but a lot of thought goes into the selection of criteria and their evaluation for each of the competitors. My thinking about competitiveness in smartphones is necessarily conditioned by my views of the structural changes within the industry and the rise of ARM architecture to dominance in smartphone processors or systems on chip (SOCs). These trends are reflected in the fact that all three of the top tier smartphone manufacturers, Apple, Samsung (OTC:SSNLF) and Huawei, all design their own custom SOCs based on ARM architecture.

If a company is on the wrong side of the paradigm shift away from commodity processors and to custom ARM SOCs, I do count that against the company. This is reflected in various metrics I describe below. And there are other criteria as well, including financial strength, the ability to engineer and market the complete smartphone and the appeal of the mobile ecosystem.

Here are the criteria:

SOC Engineering: Does the company currently design its SOCs for its own smartphones? Commodity suppliers of SOCs qualify as a yes, but get a yellow rating for not building complete smartphones.

Uses ARM Architecture: I continue to regard ARM as having no technical advantage compared to other architectures such as Intel (NASDAQ:INTC) Architecture (IA). The only advantage I see is in cost, but this is a powerful advantage that I don’t see Intel being able to overcome. Intel’s inability to achieve significant penetration in the smartphone market, despite years of trying, its inability to achieve profitability in its mobile business, and its use of contra revenue to compensate all indicate to me that IA is fundamentally cost disadvantaged compared to ARM.

Has Modem Capability: This is the ability to integrate a cellular modem onto the silicon of the SOC. LTE modem integration gets a green rating, while 3G or less gets a yellow.

Control of OS and SOC Design: The ability to control the engineering of both the mobile operating system and the SOC confers synergies that are otherwise unavailable. Knowledge of the design properties of the SOC allows OS designers to optimize the OS for the SOC, and vice versa.

Company Profitability: Net income for 2015 Q3. Less than $3 billion gets a red rating, $3-$10 billion a yellow, $10 billion or above a green.

Cash Less Debt: Total cash and marketable securities minus short- and long-term debt as of the end of calendar 2015 Q3. Below $20 billion is red, $20-100 billion is yellow, and above $100 billion is green.

Retail Presence: Partly this reflects whether the company makes or markets a smartphone rather than just selling components. But even within the group of smartphone makers, most of these are mostly dependent on online retailing and have relatively few physical stores. These get a yellow rating.

OS Ecosystem: This mostly pertains to whether the company has created its own mobile operating system. Doing this affords numerous monetization advantages through on-line app and content stores and other services including streaming music and video. Most importantly, the architect of the mobile OS tends to be the driving force for the entire ecosystem, even if the company doesn’t build its own devices.

The following table summarizes my take on Apple and its major competitors.

(click to enlarge)

Some footnotes and general comments. The financial results for Huawei are taken from its Financial Highlights page for the entire year 2014. Huawei is not publicly traded and doesn’t file quarterly reports, so this was the best I could do.

Generally, if a company doesn’t build the total smartphone, that’s viewed as a negative, and this is reflected in the ratings for Intel (NASDAQ:INTC) and Qualcomm (NASDAQ:QCOM). Building the total smartphone doesn’t guarantee success (witness Microsoft (NASDAQ:MSFT)), but it’s a prevailing characteristic of the successful smartphone companies. Being vertically integrated usually means higher profitability.

On the modem rating for Samsung and Huawei, I kind of gave them the benefit of the doubt given recent announcements of the Samsung Exynos 8 series and the Huawei Kirin 950. Both are announced but not yet shipping, but expected to ship by early next year. They could have been yellow, but appear further along than Intel, which isn’t expected to ship an integrated LTE modem until SoFIA smartphone SOC production is brought in house for 14 nm next year.

Disruption Potential

The predominantly green ratings for Apple certainly reflects my view of Apple’s competitive position. It’s a judgment call, and I’m sure there are plenty who would disagree with my assessments or the criteria I’ve chosen. But taking issue with the assessment has to be reconciled with Apple’s current smartphone profitability. In other words, if you believe that Apple is not the strongest competitor in the smartphone industry, then why is it taking 94% of the industry profit? I’d like to see anyone try to make that reconciliation.

However, just because Apple is currently the top dog doesn’t mean that it can’t be disrupted by some development in the future. Any assessment of Apple’s future competitiveness should include some assessment of the disruption potential. Here’s mine.

Various Apple competitors have already embraced the custom SOC paradigm. Others are looking at ways to adapt this paradigm to their business models. Google’s rumored interest in finding a custom SOC partner probably reflects the realization that Google needs to move beyond its current commodity device model.

I see such partnerships as the key potential disruptors of Apple’s current smartphone preeminence. The likely partners are Google (NASDAQ:GOOG) (NASDAQ:GOOGL) and Qualcomm, and Microsoft and Intel. In fact, I believe that the demands of the smartphone market are so compelling that partnerships such as these are almost inevitable.

So the real question is how effective will these partnerships be in competing with Apple. These partnerships suffer from two key disadvantages. First and foremost, the collaboration between the companies is unlikely to be as efficient and productive as what Apple has achieved in a single company.

Secondly, the collaborations have to occur in the context of an existing commodity framework that the partner companies have so far been unwilling to dispense with. This means that the products of any partnerships will be competing with other commodity devices as well as with Apple. This will tend to dilute the competitive impact of the partnerships on Apple.

This is already a fundamental problem for Microsoft, where its Microsoft branded products (Lumia, Surface) are not just competing with Apple, but with the host of commodity devices that also run Microsoft provided operating systems.

And finally, any partnership between Microsoft and Intel in smartphones would almost certainly employ Intel Architecture processors. This would provide better compatibility with existing Windows software, but come at a higher cost for the SOC. Windows phones with Intel Inside are probably the only hope for Microsoft in smartphones, but these will appeal primarily to Windows diehards.

Investor Takeaway

In short, although the potential partnerships afford some improvement in competitiveness relative to Apple, they don’t achieve what Apple has been able to achieve within a single business entity. This may ultimately lead to some further consolidation within the smartphone industry, but a combination of, say, Microsoft and Intel, or Google and Qualcomm, is probably more than three years in the future. Primarily, this is because the players involved aren’t really convinced that they can make the commodity model work to their advantage.

The main chink in Apple’s armor is in modems. I suspect that Apple is probably working on this. Companies like Apple do these kinds of rack and stack assessments versus their competition all the time. I doubt that the modem issue is something that Apple has overlooked.

Apple has been hiring communications engineers, but it’s unclear whether they have the critical mass to build their own modem. As I’ve discussed elsewhere, Apple will probably continue to rely on Qualcomm modems, and may elect to license Qualcomm designs for future SOCs. This would probably be the path of least resistance.

I believe that closing the modem gap is likely for Apple, and that this will essentially cancel the improved competitiveness of future partnerships among Apple’s competitors. Given that prospects are good for Apple to continue to take the lion’s share of smartphone industry profits, I consider Apple a buy.

Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.

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