IPhone Widget Makers Are Turning the Tables
(Bloomberg View) -- Best Buy won't be selling the full-price iPhone X and iPhone 8 -- the most expensive models Apple has ever made -- because customers have complained that, with the retail company's markup, the smartphones were too expensive. Now, the store chain will only offer them on installment plans. Clearly, iPhones have reached some kind of psychological threshold beyond which their price is not just high but outrageous -- but it's not about Apple's greed: Smartphones are getting more expensive globally and across the entire price range.
Smartphone makers aren't happy about it. But it's getting harder for them to maintain their profit margins because -- contrary to conventional wisdom about electronics prices following a downward trajectory -- components are getting costlier. There's not enough competition in the manufacturing of intricate, essential smartphone parts. Entry barriers, both technological and investment-related ones, are high. So it's natural for component producers to try to capture more value. The trend may be similar to that in the automotive industry, where there are indications that the balance of market power is shifting toward component suppliers.
According to the market research firm GfK, which tracks retail sale prices, sales volume growth this year is outpacing unit sales growth everywhere except in the Middle East, Africa and the wealthier Asian countries. Even in China and India, where price was assumed to be the defining factor of demand, phones are getting more expensive.
This trend ostensibly follows improvements in smartphone performance and the introduction of attractive new features: better cameras, higher-resolution and increasingly bezel-free displays, faster processors, more memory. These improvements have long ceased to matter to the average consumer, though. Processors used in phones two years ago handle modern apps just as well; the same goes for the rest of the specs. Gadget reviewers are the only people who can spot the difference. There's only one area in which most consumers would like to see improvements -- battery life, and that has been stagnant for years. Phones and their features have become commoditized. As manufacturers try to stay ahead of the pack, though, they're forced to buy increasingly complex and pricey components. As a result, the manufacturing cost increases relative to the price customers are willing to pay -- even for iPhones, which traditionally command a price premium thanks to Apple's devoted fan base.
The research firm Trendforce reported back in March that the price of components -- specifically, mobile memory and storage chips, as well as AMOLED displays (the kind Apple finally used in the iPhone X after many Android device makers adopted them years ago) -- were putting pressure on phone manufacturers' margins. For Apple, that's a nuisance but not the end of the world: Facing disappointing iPhone 8 and iPhone 8 Plus sales, the company pins its hopes on the iPhone X, which is more innovative but less profitable. It'll still make plenty of money. For China's budget smartphone producers, however, it's a threat to their business model based on premium features at lower prices.
In the automotive industry, component producers now enjoy higher valuations than automakers. Though some analysts argue that this is an accident, it could also be a sign that conventional wisdom about famous brands being more important than skill at making obscure widgets is being challenged. The modern widget is exceedingly hard to make at the level required by the likes of Apple -- and generally by a low-growth, bitterly competitive smartphone market. Relationships with big smartphone manufacturers can still make or break component producers, but the resulting shakeout can only make top-of-the-range components more expensive.
In a market like this, making many of one's own components, as Samsung does, becomes increasingly important. It is no accident that Samsung's gross profit margin in the quarter that ended in June reached 46.9 percent compared with Apple's 38.5 percent, though the Korean company lacks Apple's prowess at selling lucrative content and services. Just two years ago, Apple was slightly more profitable than Samsung. The lesson here is simple: Manufacturing matters. Increasingly, it's no longer the unloved stepchild in a world dominated by big brands.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Leonid Bershidsky is a Bloomberg View columnist. He was the founding editor of the Russian business daily Vedomosti and founded the opinion website Slon.ru.
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