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Samsung and Apple Inc. Vs. the Commoditization of the Smartphone


Cheap devices under a variety of brand names are about to take over the market, but Apple Inc. has already survived the same trend in personal computers.

"Commoditization" is a long word but a simple concept. You know you've encountered it when you walk down the cereal isle, and discover four different brands of corn flakes. Or when you're shopping for a new television at Best Buy (NYSE:BBY), and find yourself staring at 50 indistinguishable black sets, all playing the same Pixar film. It's when there ceases to be any noticeable difference between competing products, except perhaps the price tag.

The smartphone industry is commoditizing. Innovation made kings out of Apple Inc. (NASDAQ:AAPL) and Samsung Electronics (OTCMKTS:SSNLF), but these days the creative well is getting a little drier. Visit any AT&T (NYSE:T) or Verizon (NYSE:VZ) store and you'll see a row of 5-inch Android smartphones, a shorter row of current and previous-generation iPhones, and few differences between any of them. LTE data is now standard, along with high-resolution displays. Screen sizes have converged in the 4- to 5-inch range, and faster hardware means that any of these devices will fly through normal tasks. Android has regularly "adopted" the better features of iOS, and Apple has returned the favor; with the introduction of iOS 7 this fall, these two operating systems will look and feel more similar than ever.

In this environment, it's hard to differentiate new products. Apple and Samsung have both seen customers move towards older (and cheaper) models. One out of every five iPhones sold in the second quarter was an iPhone 4 – a three-year-old handset. When it was released in 2011, the iPhone 4s grabbed 90% of total iPhone sales; a year later, the iPhone 5 took only 70%. Samsung doesn't break its numbers down, but IDC reported "renewed interest" in the aging Galaxy S3 last quarter, while disappointing S4 sales weighed on the company's stock.

Meanwhile a slew of competitors, including Sony (NYSE:SNE), LG (KRX:066570), HTC (TPE:2498), Huawei (SHE:002502), and Lenovo (HKG:0992), have launched well-received devices in the last year. Some are little more than copies of Samsung's Galaxy line – itself a copy of the iPhone, according to Apple – but with the advantage of a lower price. Brands unheard of in the West, like Yulong, have taken off overseas by offering cheaper (but still perfectly capable) smartphones, and growth in the industry is increasingly focused at the low end.

The result is falling prices. IDC estimates that the average smartphone sells for $375 today, down from $450 a year and a half ago. When reporting its second quarter earnings, Samsung warned of growing competition and lower average selling prices looking forward. For its part, Apple has seen prices fall from $655 in the first half of 2011, to $630 for the same period in 2012, to $597 this year.

Smartphones have become "good enough," much like the personal computer a decade ago. Then it was HP (NYSE:HPQ) and Dell (NASDAQ:DELL) who led the market, and rather than give up any market share, they chased prices lower at the expense of profitability. The result was a steady erosion of value in their PC divisions. Aside from Apple and Samsung, the smartphone industry isn't profitable, and a race to the bottom is the last thing either company should want.

Nevertheless, a Samsung employee recently told ETNews that, disappointed with the Galaxy S4, the company's new strategy "is to maximize the market share with a number of small hit models, not one single mega hit model." This is the traditional Samsung approach, and the one it takes with television sets, in which it boasts a strong, popular brand, that only earns operating margins of 3%. Samsung's mobile division, on the other hand, brings in margins of 18%, and provides a majority of the company's profits. That's a long way to fall.

Apple has been encouraged to do something similar and release a low-priced version of the iPhone. I've said in the past that this would be a mistake, and I'd go even further and argue that older models of the iPhone should be discontinued; they're competing directly with the current generation. Apple not only survived the commoditization of PCs but thrived because it maintained a premium brand and a simple lineup (and having a proprietary operating system didn't hurt). Samsung may be abandoning the "mega hit model," but Apple knows firsthand that innovation and cachet are the only ways to keep high margins in a commoditized market – and you don't get either of those things with a sprawling product line.

The days may be over when a single smartphone could inspire universal lust. That's not a bad thing for consumers, who will get the option of paying less, and it doesn't have to be a bad thing for Apple and Samsung. If they embrace a more diverse industry, they have a good chance of succeeding in it; a larger pie can feed everyone. Trying to eat the whole thing would be a terrible mistake.

See also:

Three Late-Year Catalysts for Google, Apple, Amazon, and Microsoft

If Android Is So Hot, Why Are Samsung, HTC, and Motorola Struggling?

Google Inc Handles a Security Hole in the Worst Way
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