The significant increase in smartphone demand is leading to intense battles for market share. While market share is a key parameter for evaluating the performance of smartphone manufacturers, the ability to cash in on sales remains the most important consideration for determining a company’s financial health in the long term.

Over the past few years, several handset manufacturers, especially regional players from Asia, have entered the global smartphone market and been offering devices at low price points. As a result, they are giving stiff competition to incumbents like Sony, HTC, Microsoft (formerly Nokia), BlackBerry and Samsung. With this intense rivalry in the smartphone market, albeit not in the high-priced handset category, incumbents have been reducing their product prices to maintain their market share. However, this strategy has not augured well for the industry as price drops have led to lower earnings. This is evident from Samsung’s earnings for the past few quarters, with the company’s mobile business division struggling to maintain profit growth. In contrast, Apple has opted against this strategy and instead continued to focus on aspects like marketing, new product launches and entry into new markets in a bid to improve its bottom line. This approach has played out well for the company, enabling it to sustain income growth.

In fact, the earnings of Apple and Samsung for the quarter ended December 2014 show some surprising results. During this period, Apple registered a massive profit after tax of $18 billion, with a year-on-year growth of 37.88 per cent. These staggering profits have been on account of the huge sales of newly launched products like the iPhone 6 and iPhone 6 Plus, as well as the high demand from the Greater China region, which had previously been a low-sales market for the company.

On the other hand, Samsung’s mobile business division reported a decline in net profits on a yearly basis for five consecutive quarters. The division’s net income declined by 64 per cent year on year to $1.8 billion for the quarter ended December 2014.

This fall in Samsung’s profits has been attributed to the decrease in smartphone and tablet sales for the quarter ended December 2014. Intense competition from regional players in the low- to mid-price handset segment and from Apple, Sony and HTC in the premium segment has been the key reason for this decline.

Apple’s unique business model

Most smartphone manufacturers currently follow a business model of building the handset’s hardware and incorporating Google’s operating system (OS), Android. By doing this, companies do not have to bother about supporting software issues and providing regular firmware and software updates. Instead, they can focus on improving their hardware. This model was working wonders for manufacturers, with the growing demand for smartphones resulting in rising profits. But with a larger number of companies in the market, this model has come under pressure as it is leading to the commoditisation of smartphones.

Apple, on the other hand, has been following a different business model. It not only manufactures the handset but also develops the entire supporting ecosystem (including the applications store) for its device. While this has increased the company’s capital and operational expenditure, it has also led to huge gains on account of customer loyalty and the brand value that it has established over the years. All the applications, software and features embedded in Apple’s products are interconnected and ensure seamless access, enhancing the user experience with offerings across the ecosystem. Hence, Apple is often able to offer its customers a higher value than manufacturers using the Android OS, though the difference has diminished over the past few years. This allows Apple to differentiate its products and offerings from those of its competitors.

The December 2014 quarterly results indicate that Apple has attracted many Android users to its ecosystem. The company’s new smartphone, iPhone 6, features a much larger screen, which seems to have appealed to customers in the Asian market, particularly China. With a 70 per cent increase in Apple’s net sales in Greater China, the region has become the third largest after the US and Europe in terms of sales. In fact, according to data research firm Canalys, Apple was the biggest vendor in China in terms of shipments during October-December 2014. The growing popularity and rate of iPhone adoption in the region is beneficial for Apple as this market offers a huge untapped potential. This augurs well for the company as it is likely to witness a slowdown in sales in the US and Europe due to saturation in these markets and longer replacement cycles.

Xiaomi’s growing threat

Xiaomi, a Chinese smartphone manufacturer, seems to have taken a different route altogether and is reportedly selling more smartphones in China than Apple or Samsung. Within four years of starting operations, it has gained a significant market share and become the third largest vendor globally. Instead of calling itself a smartphone vendor, Xiaomi says it is a service provider and an internet company. Its strategy is to earn income from the services offered to users rather than just from handset sales, and the company’s “Just for fans” slogan reiterates this approach. Xiaomi attempts to engage with customers through online social forums and feedback support, and incorporates user suggestions in its decision-making processes.

Despite this approach, however, the company, like Apple, currently earns most of its revenue from the sale of handsets. Though Xiaomi has not revealed its earnings, it reportedly made a profit of Chinese Yuan 485.77 million in 2013, while its operating profit margin stood at less than 2 per cent. During the same period, Apple and Samsung had operating profit margins of 28.7 per cent and 18 per cent respectively. Although Xiaomi is yet to achieve economies of scale like Samsung and Apple, its strategy of selling high quality smartphones at significantly lower prices will not generate adequate income, while the add-on services and offerings will take time to yield returns. Consequently, the company is expected to operate on thin margins for some time to come.

Xiaomi’s strategy of selling smartphones at low prices has triggered a new price war, with many Asian handset manufacturers competing only on price points. Given the rising brand affinity for its handsets, however, Xiaomi is expecting a surge in sales, especially with its focus on international markets. Higher volumes will allow the company to improve its operating margins, though these will continue to remain minuscule in comparison to the incumbents’ in the short term.

Future outlook

After seeing the entry of companies with disruptive business models fuelling the aggressive smartphone battle, the incumbents are restructuring their business strategies. Samsung, for instance, will now be using new raw materials and designs in its premium models to compete more effectively. The company is also looking to reduce the number of its products in the market by 25-30 per cent. However, these plans could be hampered by the ambitious strategy employed by Chinese manufacturers and the growing success of Apple and other incumbents in the global market.

Apple, meanwhile, will continue to make inroads into the underpenetrated Asian market to improve and diversify its revenue base, though maintaining its current margins would be a tough task. Xiaomi, on the other hand, is now pushing itself on the international stage with a focus on building brand loyalty and customer engagement. Going forward, the market position of these three manufacturers – Samsung, Apple and Xiaomi – over the next few years will define the dynamics of the smartphone industry