Tuesday, April 20, 2004

Changing Brand Dynamics in the Cellphone Industry

What kind of cellphone do you have? A lot of people would say "Sprint" or "Verizon", but those two companies don't make cellphones, they sell cellphone service contracts.

This change in consumer awareness is sending tremors throughout the cellphone industry as noted by an article in Businessweek. Essentially, the power of the "brand" is changing from the cellphone Original Equipment Manufacturer (OEM) such as Nokia, Motorola and Samsung to the distributors (Sprint, Verizon, Singular, etc.). As the leverage of the big-name brands decline, smaller cellphone OEMs such as Lucky Goldstar (LG) and eventually Chinese manufacturers will make inroads into the market. The result will be similar to what happened in the PC market: commoditization of the hardware and manufacturing for basic cellphone units. The effects of these changes are starting to be felt. Just this week cellphone market leader Nokia announced disappointing quarterly results and they are expected to lose between three and five percentage points of market share in 2004.

The commoditization of consumer electronics has been witnessed in other segments: PCs, digital still cameras, MP3 players and scanners. In each of these instances value has to be captured through means such as distribution (Dell in PCs), driving up the technology curve (Canon in digital cameras), styling (Apple in MP3) or embracing commoditization (HP in scanners). The cellphone industry will have to follow suit:
1. Distribution - As the Businessweek article notes, the major cellphone OEMs have taken note of the looming changes in consumer awareness and are becoming more flexible and willing to work with the distributors, who will see their influence continue to increase.

2. Drive for New Features - Standard cellphone designs are available from the chip manufacturers, such as Qualcomm and TI, allowing manufacturing companies without R&D or design (i.e. Chinese companies) to enter the market and compete solely on cost. With all phones at the low end being based on the same design and being sold based only on cost, the OEMs will have to drive more features, many of which can be seen on the market already: built in cameras, Global Positioning Systems (GPS), PDA functionality, internet access, games, etc.

Over time, the "standard" low-end cellphone will keep adding features, meaning the bar will keep being raised on what a "low end" phone is. Qualcomm and TI are already working on base designs that include many of the functions listed above, so OEMs will be driven to keep adding more features and services.

3. Styling - Many observers have already noted that the cellphone has become a fashion accessory for many demographic segments, mainly younger people. Different colors, "swappable" face plates and other features can make a phone a better seller than one with the exact same technical features. Samsung in particular seems to have done a good job in the styling department and this is an area that many of the majors are trying to address.

4. Embrace Commoditization - In order to compete against the upstart Chinese manufacturers such as Ningbo Bird and TCL, the major OEMs already doing things to drive down manufacturing costs. All the top OEMs, including Nokia, Motorola and Samsung already have plants in China and will be increasing production there to service not only international markets, but the quickly growing domestic Chinese market. In addition, most of the top OEMs outsource manufacturing altogether, with Nokia outsourcing 20% of its production and Motorola relying on companies such as Pantech in South Korea for several of its product lines.
I am modeling a lot of this based on what has happened in other consumer electronic segments, but there are some major differences that the cellphone market has that the other segments don't: different standards (GSM, CDMA, etc.), regulatory issues, and even some political issues. Overall, however, I think as this market matures there will be more similarities than differences with the other consumer electronics segments.

Update: Motorola just announced great earnings.. This was a combination of Mot getting their supply chain in order after they publicly stated severe problems late last year, plus Mot getting closer to the carriers since they have recognized where brand loyalty seems to be heading (plus strength in their other divisions, including semiconductor, which they are spinning off later this year).

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