No Dip in Smartphones

By MARK VEVERKA | MORE ARTICLES BY AUTHOR

The hot segment of the consumer electronics business shows no signs of getting caught in the economic slump.

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THANK GOODNESS FOR SMARTPHONES and the mobile Internet. They are the rare tech products with the ability to power through the peaks and valleys of this dubious economic recovery. Folks just seem willing to purchase smartphones, despite tightened budgets and underemployment.

As a category, smartphones have been seeing higher adoption rates since the 2007 launch of Apple's iPhone, and they are expected to account for 20% of all mobile handsets by year end. Smartphone unit sales grew 15% in the second quarter. That advance wasn't as robust as the first quarter's 21%—an all-time high—but still represented a double-digit gain, notes technology analyst Bill Whyman of ISI Group, an investment-research firm. Whyman increased his 2010 projection of growth in unit sales of smartphones by three percentage points, to 15%-16%, based on their resilient first-half performance.

Mobile handsets are starting to affect the personal-computer market, as some people use them, rather than laptops, for mobile web-browsing and other tasks. And their rapid proliferation also is contributing to the mounting pressure to double the country's broadband spectrum, Whyman notes. Despite the industry's growth trajectory, it seems inconceivable that there is room at the top for all of the handset makers, causing each to push its engineers and designers to stay relevant in the face of constant innovation.

APPLE'S (ticker: AAPL) iPhone and Google's (GOOG) Android operating system are the early favorites to dominate the category. (ISI hardware analyst Abhey Lamba rates Apple a Buy with a 320 price target, versus about 250 last week.) But that doesn't mean others, including handset stalwarts Nokia (NOK) and Motorola (MOT) are sitting idle. Unfortunately for most of them, there are six major smartphone operating-system platforms, which is "too many," Whyman argues. The market is bifurcating between high-end, or "super" smartphones, such as the iPhone and Research In Motion's (RIMM) BlackBerry models, and "feature" smartphones. Nokia, which is still No. 1 in total market share, saw its smartphone unit sales grow 44%, year-over-year, during the second quarter, to a record 59 million. But the stiff competition is causing Nokia and others to cut prices and squeeze margins, according to Whyman. Nokia's brass has told investors that its sequential asking-price decline has been driven primarily by price pressure, particularly in high-end smartphones.

Handset manufacturers such as Motorola and HTC (2498.Taiwan), which have embraced the Android operating system, continue to chip away at Nokia. Motorola, in particular, has enjoyed "dramatic" increases in asking prices, thanks to the introduction of new Droids.

An important factor that leads to lower asking prices is a stronger U.S. dollar. Average handset prices were down 5.8% in the second quarter from the level in the previous quarter, and down 8.4% from the year-earlier level, Whyman says. But most of the price drop across all manufacturers can be attributed to foreign-exchange swings, he says.

As prices drop, so do profits. In the second quarter, the average profit per handset plunged 16%, to about $6—about $6.40 in constant currency. "Because everyone wants to be in smartphones, [the] competition is predictably driving down profits," Whyman notes. "Yet, in the end, the bulk of the profits end up with Apple." Little surprise there.