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Why Apple Is Not in the Volume Business

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The smartphone industry is growing like mad, but profits remain elusive for most players.

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The smartphone industry is growing really, really fast.

But it's also a mess.

Really?

On Tuesday, research firm IDC busted out its third-quarter industry numbers, reporting that the smartphone industry grew by an impressive 39.9%. Year-over-year, Android units were up 51.3%.

Google's (NASDAQ:GOOG) dominant Android operating system crossed past 80% market share for the first time ever, while Apple's (NASDAQ:AAPL) 26% gain in unit sales resulted in a drop to 12.9% from 14.4% a year ago.

Microsoft's (NASDAQ:MSFT) underdog Windows Phone grew by 156% year-over-year, bringing its market share to 3.6%, up from 2.0% last year, but slightly down from 3.7% in the second quarter.

Forty Percent Growth? So Where's the Mess?

Well, let's take a look at the major smartphone makers' recent earnings reports:

LG (KRX:066570): LG reported a 24% year-over-year increase in smartphone sales, with a 31% quarter-over-quarter improvement in LTE sales. However, profitability "declined due to increase in marketing expense for G2 and decrease in ASP as a result of intensified competition."

For the fourth quarter, it said "overall market competition will be intensified due to handset makers diversifying their portfolio in order to gain market share."

Motorola (owned by Google): Sales fell 34% year-over-year, and the unit posted an operating loss of $248 million.

BlackBerry (NASDAQ:BBRY): Revenues fell 45% last quarter, with a loss from continuing operations of $248 million.

HTC (TPE:2498): Posted a 33% drop in revenues and a NT$3.5 billion operating loss.

Samsung (OTCMKTS:SSNLF): While not doing poorly, Samsung said that sales of its high-end models flattened out, and that its growth is now led by lower-priced mass-market models.

Nokia (NYSE:NOK): Nokia is doing better with its Windows Phone-powered Lumia devices than I ever imagined but, like BlackBerry, still only has a small fraction of its former market share. I'm actually looking forward to seeing what Microsoft does after it completes the acquisition of Nokia's phone unit, because it is definitely putting up a fight.

Lenovo (OTCMKTS:LNVGY): Interestingly enough, Lenovo is hanging tough. Last quarter, it reported not only outstanding growth in smartphones, but showed "steadily improving profitability" in its Mobile Internet and Digital Home segment, which includes smartphones.

So overall, I think we can conclude the industry is in rough shape, with a few bright spots here and there -- namely the Chinese players like Huawei (SHE:002502) and ZTE (SHE:000063) that are moving big units in emerging markets.

What's the Culprit?

Simple -- there are too many darn phones out there.

The IDC report included some very interesting nuggets of information on pricing. First, average selling prices for smartphones were down 12.5% year-over-year. That's not terribly disturbing, as pricing on consumer electronics products goes down over time.

However, ASPs for large-screen smartphones, a.k.a. phablets, dropped by a whopping 22.8%, which takes the shine off the 600% unit growth they saw in the quarter.

Where Does Apple Fit In?

If the 5C had been a super-cheap phone, maybe Apple could have grown iPhone units by 50-60% (assuming no supply constraints), but Apple is not playing the market-share game. If it were, there's no way the new iPad mini with Retina display would have been priced at $399, a $70 premium to last year's model.

It wants to protect its brand and its profit margins and will sacrifice current growth and market share to get there.

Last quarter, its iPhone ASP fell by just 6.5% -- which is incredible relative to the 22.8% drop seen in phablets.

The moment Apple tries to compete on price and specifications is the moment it stops being Apple and starts becoming just another company slugging it out in the smartphone death match which, as shown above, is getting pretty brutal.

And if it's this rough at 40% market growth, what about when it gets to 30% or 20%?

So Is Anyone Making Money Here?

You're darn right people are making money off phablets, but it's not the above names. The real beneficiaries are the giant mobile advertising players like Google, Facebook (NASDAQ:FB), and Twitter (NASDAQ:TWTR). The smartphone boom is putting more and more people on the mobile Internet, and that means more eyeballs and clicks on mobile ads.

Twitter is now getting over 70% of its ad revenues from mobile. For Facebook, that figure is 49%.

This would not be happening if the smartphone industry hadn't advanced so far with Internet access speeds, and screen size and quality.

Is Apple's Strategy Better?

Over the long term, who really knows? But for now, it seems like it's the least worst way to operate, and that makes it the best.

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