iPhone power: Why Apple wins the smartphone war

Overwhelmed by the iPhone effect and unable yet to match the Apple gadget on features, prospects seem bleak for many smartphone makers. Android as an army may have a rapidly growing slice of the market, but the speed of its advance is no more than smoke and mirrors -- there's no future if handset manufacturers can't see the money. Meanwhile Apple has entered the top five handset makers list for the first time, with 90 percent annual growth.

I'm not convinced Android's fragmented market is pouring profit into handset maker's coffers -- though it doesn't cost them anything to install on their devices.

Mythically open

Carriers also enjoy the openness they enjoy with the Google OS -- they can activate and block whatever features they like, making for some confusion for consumers.

[This story is from Computerworld's Apple Holic blog. Follow on Twitter or subscribe via RSS to make sure you don't miss a beat.]

Despite the claims of Android openness, the only end users who can truly enjoy that sensation are the ones with the technical skill required to jailbreak their device to activate features not necessarily embraced by the carrier or manufacturer.

What this means is that for most of us, Android is only just as open as the iPhone -- you only get to do what you want with either device when you jailbreak them.

It's time to move away from this "open" hype. Really. The hubbub around 'Open' Android reminds me of the scene in 'Monty Python, Life of Brian' in which the mother of Brian yells at a crowd, "He's not the Messiah, he's just a very naughty boy." In the interests of humor, click on the image below and you'll reach the YouTube clip (warning, there's a moment of nudity).

Screen_shot_2010-10-28_at_18_31_05.jpg

Android is not the smartphone messiah. There's also trouble ahead.

Jumpin' Java

Google currently stands accused of directly copying Oracle's Java code within Android. So far as I can tell, Oracle seems to be gathering ever more compelling evidence to support its position.

While Google calls the accusation "baseless", what will happen if it loses the case? Will Oracle then be in a position to sue device makers?

At least device makers -- who are increasingly beginning to recognize that they are not software developers -- can compete by deploying the free OS.

So what?

Google's Android business dispenses with the troublesome and expensive process of hardware production and support and goes straight to the high profit virtual center of smartphone evolution: ads, location data, user data and personalization.

The reason the OS is freely-licensed is because Google knows there's no money in the heavily subsidized and highly competitive mobile handset market. And the OS makes a land-grab for where the future virtual economy sits. Handset makers just provide the hardware.

Where's the money?

But is there any money to be made creating hardware for a deeply competitive market?

Look to Nokia's disappointing financials. Look at Sony Ericcsson, RIM. Palm couldn't survive alone and sold itself into HP.

This morning we learn that LG Electronics has posted record mobile phone segment losses in its second successive quarter of making losses. It lost $270 million in Q3, double the previous loss. Sales in the US and Europe fell.

In response LG recently introduced the Android-powered Optimus One smartphone. The company also plans to offer Windows Phone 7 devices and a 'premium' smartphone's set to ship next year.

This characterizes the situation: Handset manufacturers are scrambling to produce highly-featured devices. But this is posing another problem -- component supply.

Apple's annual report, released last night, tells us that company management anticipates component price hikes.

"The Company expects its gross margin percentage to decrease in future periods compared to levels achieved during 2010 and anticipates gross margin levels of about 36% in the first quarter of 2011. This expected decline is largely due to a higher mix of new and innovative products that have higher cost structures and deliver greater value to customers, and expected and potential future component cost and other cost increases," the report said.

With numerous firms chasing finite supply, component prices can only rise. Supply and demand indicates that when lots of people want the same thing and there's insufficient supply, prices rise.

Strategy Analytics will later today publish its Q3 2010 Global Handset Vendor Market Share report. This will doubtless show rapid increases in Android market share, but will also show that component constraints have begun to bite.

In a statement provided to me, Strategy Analytics' Director, Wireless Device Strategies (WDS), Neil Mawston, takes this position:

"We think there is still plenty of profit in mobile hardware, you just have to dig harder for it nowadays. If you hit a seam of gold, like Apple in premium smartphones, then profits boom. If you miss a seam of gold, like LG in premium smartphones, then profits quickly fade," he said.

"Some software and services are semi-commoditizing, because Google is trying to push their prices toward zero. For example, the OS is mostly free, search is free, maps are free, amateur video is free, and so on. Google wants to draw in eyeballs with low-cost software and services, and then reap profits with targeted adverts.

"Apple wants to lock in users with proprietary software and services, and then reap profits with high-value hardware and high-value adverts," he added, contrasting the two business models of the former allies.

Intense competition; component cost price hikes; and rapid technology advancement makes this an incredibly challenging market.

Components -- feel the squeeze

But with a growing slice of the smartphone business, Apple is in a much stronger position than most, and it has a business model on which it can sustain itself.

There's another advantage: Apple makes just one basic handset. This is an advantage because it means the company can fill huge component orders, sometimes months in advance.

While Android's share may match or exceed it as a mass, manufacturers depending on the OS are actually signing a warrant toward future consolidation.

That's because they cannot match the block purchase savings of Apple's iPhone, and don't get the same slice of after-market revenue Apple enjoys. Google gets that.

Component-based market pressures emerged before with the iPod (currently owning 70 percent of the MP3 player market). Competing firms produced some good-looking devices, but could never quite match the iPod range on features, mind-share or profit margin.

(I say profit margin, rather than price. It doesn't matter if you sell something cheaper than others if you can't make a profit on the sale. That's not business. That's charity).

The smartphone wars are far from over. Expect further casualties. And look forward to iPhone 5, and the looming Verizon iPhone, too. (And take a look at this report for a sense of how complex things will become when Verizon offers the phone).

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