There hasn’t been much to cheer about on Wall Street lately when it comes to Android manufacturers' earnings. HTC and Motorola have both issued relatively disappointing quarterly results for long enough to annoy the investment community. In the case of Motorola, the big GOOG has come to their rescue anyway. Motorola didn’t even hold a conference call to discuss its latest quarter (because of the Google deal, it said). They’re getting assimilated into the Google unless something goes haywire with the merger. But HTC is still an almost perfect pure play on the Android smartphone market. Yeah, they support Windows Phone too, but almost all the volume is on Android right now, and I think it’s a safe be that this will continue to be the case in 2012.
Neither Motorola or HTC seem to be performing very well. Motorola can’t seem to get enough volume shipped to make a profit on phones, while HTC’s profitability has slipped considerably. The latest quarterly forecast from the Taiwanese giant is for an operating margin of only 7.5 percent.
So what does all this mean to investors and consumers?
I think investors need to keep in mind that Android vendors don’t have much ability to differentiate on software. Especially with the release of ICS, the features and capabilities of the OS are much improved and there is less of a need for vendors to mess around with something that is already very good.
This leaves vendors to compete on hardware. And even there, it’s a challenge. Most of the volume is for the same old sheet-of-glass form factor that we’ve all grown to love since the launch of the iPhone back in 2007. So we watch vendors compete on gigahertz, megapixels, screen resolution, size, milliAmp hours, and so on.
And of course they compete on price. All of the big Android vendors make good hardware, and carriers are naturally interested in reducing the subsidies on these small computers. Especially those who also get stung by the massive subsidies that are applied to iPhones. The iPhone 4S, for example, is believed to cost carriers more $600, meaning there is a massive $400 subsidy for a device that fetches the carrier a two-year contract. (Something Sprint alluded to in its earnings call Wednesday.) Apple makes the money. Carriers just help them do it. So the Android vendor community is under immense pressure to cut costs, and this means fewer dollars of profit on the latest phones.
Making matters worse for HTC and Motorola (and others) is the necessity to fight against Samsung, a vertically integrated vendor who just so happens to make its own screens, memory and the exynos processors. (Along with being more diversified in the electronics space.) Vertical integration often allows vendors to produce at a lower price, or at least the illusion of lower price depending on internal corporate accounting.
My belief is that we’ve moved past the big innovative period in the smartphone market. RIM got things interesting with the QWERTY-focused BlackBerry lineup. Then iPhone changed the game entirely, and finally Android brought in some much needed competition and, of course, openness.
The hardware battle is now all about cost. The Android vendors are probably not the best way to play the trend. In a war, people on both sides of the fight die. But it’s the arms dealers that make money.
My good friend Ed Zabitsky from ACI Research, and co-host of Mobile Nations Stock Talk has been educating me on exactly what’s happening within this supply chain. I find it fascinating. We’ll definitely be talking about this in the next live podcast.
So does this mean most Android vendors are doomed? No, of course not. It just means that people who compete on hardware are likely destined to earn the kind of margins that PC vendors make. There’s always a profit to be made by someone even if it’s thin. So long as there is demand for Android smartphones, there will be enough companies who can get by on slim margins to make them. The stock market will value these companies the way they should be valued in the long run.
Should consumers worry? Nope. Not any more than they worry about PC box makers disappearing. There are always enough competitors to supply our needs.
Chris Umiastowski is a former sell-side equity analyst at Orion Securities and TD Securities. Before that, he was an engineer for Nortel Networks. Chris is co-host of the Mobile Nations Stock Talk podcast.