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Old guard defies smartphone turmoil with deeper pockets

Samsung is in the ascendant again as the real contest shifts to profit and innovation, disadvantaging the new players

The smartphone market is not being turned on its head after all. Last year, all the talk was of the rise of Xiaomi and the decline of the established leaders. Now, we see Samsung consolidating its leadership despite its recent troubles, and the Chinese vendors with the strongest growth are the old names – Huawei and Lenovo, rather than Oppo and Vivo.

The Chinese handset makers will continue to grow their collective share, even if the individual players’ shares fluctuate. The size of their home market is key, and local suppliers now occupy the whole top five, according to Strategy Analytics. But as the Chinese home market slows and India becomes a bigger source of volume growth, Indian vendors will also be more visible in the cut-price melting pot.

But there are two more important battles, in terms of company value, and ones in which the majority of suppliers will be unable to compete. One is for profit, rather than unit sales, and here, Samsung and Apple continue their tug-of-war to the virtual exclusion of all others, though the more enterprise-focused players like Lenovo and Huawei are also starting to take a greater share of the spoils. Apple’s share of smartphone profits may fall below its 92% peak, of mid-2015, this year, but it will still be out of all proportion to its unit market share.

That level of profitability gives Apple an advantage in the second key battle, to invest in the ‘next big thing’. Whether that is a dramatically new smartphone experience or an entirely new product category, major vendors will need to come up with these innovations to sustain growth and move beyond the handset price war. The short term reactions of stock analysts often give the impression that a high growth, low margin firm like Xiaomi is threatening the old guard, but in terms of future growth and new markets, they are unable to do so.

Apple can spend its vast profits and cash on R&D and acquisitions to support its innate advantage of a culture focused on innovation and user experience. It has not traditionally been a big R&D investor, but it is now under intense pressure to up the pace of change. In 2015, it entered the global top 20 in terms of R&D spending (and was number seven in hi-tech), with an outlay of $6bn, a record.

Such activities are both to support the iPhone’s services and capabilities, and to move into new areas. The latter has, recently, seen poor results, such as the Apple Watch and Apple TV, but there are high hopes for other directions like extending the AI-driven Siri into new environments like the smart home, and in the longer term, the supposed Apple car.

The company’s recent $200m purchase of start-up Turi was the latest addition to the program to incorporate artificial intelligence into the renowned Apple experience and keep ahead of mobile platforms from Samsung, Google and others. Turi offers tools for developers to embed machine learning into applications which automatically scale and tune. Use cases for the technology include product recommendations, sentiment analysis and churn prediction.

Apple CEO Tim Cook has identified AI as a key way to improve the customer experience of the firm’s devices and software – and of course, it is vital for Apple to continue to lead in user experience and keep customers as addicted to its home, auto and IoT offerings as they are to its phones. It seems likely that Turi’s ability to analyze sentiment could be harnessed to improve Siri’s intelligence and responsiveness, extending it beyond the start-up’s current fairly basic applications.

On the company’s most recent earnings call, Cook said: “These experiences become more powerful and intuitive as we continue our long history of enriching our products through advanced artificial intelligence. We have focused our AI efforts on the features that best enhance the customer experience.”

On the same call, analysts asked how much of Apple’s increased R&D spending (4.4% of its revenue up from 3.2%) was for bold new products? “There is quite a bit of investment in products and services that are not current currently shipping,” Cook said. “You can look at the growth rate and conclude that there is a lot of stuff that we’re doing beyond the current products.”

Samsung spends considerably more on R&D than Apple – $14.1bn last year, which made it the second biggest investor in the world after Volkswagen – but of course a lot of that is related to its chip manufacturing business, in which it has been developing new processes.

The area on which Samsung has resolved to focus more resources, mobile software platforms, is the one where it lags well behind Apple. It has evolved a more differentiated user experience than its initial, generically Android-based mobile platforms, and has some advanced applications in payments and other areas, but its real strength still lies in hardware – so capturing public imagination with a brand new form factor will be critical, but very difficult (the brief love affair with wearables has virtually ended at this stage in their evolution, for instance).

For now, though, its Galaxy family, which suffered market share losses and technical hitches last year, is in the ascendant again, putting new pressure on the challengers like Xiaomi, and on Apple itself. While Apple has seen a string of bad news, including this week’s news that retailer Target had sold 20% fewer iPhones in the second quarter, Samsung’s shares surged to a new high on Wednesday – reflecting a 30% rise in the stock this year, compared to Apple’s 4% – because of the strength of the latest Galaxy models.

The latest Galaxy Note phablet, the Note 7, is now available and, as analysts Lee Jae Yun of Yuanta Securities told Bloomberg: “The Note 7 is expected to outsell its predecessor and Samsung will be able to keep that spirit alive at least until early next year, because the upcoming iPhones won’t likely offer big surprises this time around.”

Meanwhile, Lenovo’s CEO Yang Yuanqing says its lossmaking smartphone business, much of it based on the acquisition of Motorola Mobility from Google, will turn the corner in the next fiscal year. Once again, this will be based on a focus on profits (higher end devices and integration with the enterprise PC activities, rather than volumes) and on reaping the returns on investment in R&D and on marketing, especially in the US and China.

The world’s largest PC maker says premium products, such as its upcoming smartphone with advanced augmented reality capabilities will stabilize the division in the second half of the year.

“I hope we can completely turn around the business in the next fiscal year,” Yang Yuanqing told analysts on a call. “Integrating the mobile business needs time, it took several years for us to integrate the PC business … but writing down Motorola is never an option.”

Lenovo beat estimates with its first quarter profit, up 64% year-on-year to $173m, though that was mainly achieved with cost cutting and asset sales. Sales were down 6.2% to $10.06bn and smartphone demand was sluggish.

Having cut its cost base, Lenovo acknowledges that its challenge now is to expand internationally, since its Chinese home market is both slowing and shifting into a pricing bloodbath, while investing in key new technologies such as cloud computing, AI and robotics.

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