Smartphones: Mobile Maturity

sagawa

The global mobile phone installed base has decelerated sharply this decade to roughly 3% annual growth, a pace that may be sustainable for a few more years. In this context, demand for new phones is already overwhelmingly driven by replacement activity. Steady increases in Asian replacement, and an iPhone related pop in N. America, have seen phone sales rebounding recently, but we expect future global replacement rates to deteriorate particularly given the market shift toward emerging economies. The recent trend toward annual trade in plans could partly offset replacement declines in some markets, but will increase the supply of 1-2 year old used devices, threatening the trade-in economics in time. We also expect new mobile phone ASPs to tilt lower, tempering the expected 3% CAGR in units to less than 0.5% growth in industry revenues. What growth there is will come from low end smartphones, with basic feature phones falling from 34% of total unit sales to near zero by 2020. With this dynamic and a concurrent damping of product differentiation, we expect ambitious Chinese and Indian brands (Huawei, Xiaomi, Lenovo, Micromax, Spice, etc.) to benefit to the detriment of the companies that currently dominate the premium smartphone market (AAPL, Samsung, LG).

Mobile phones are a mature market. In 2012, after decades of double digit growth, the global base of mobile phones abruptly decelerated, falling sharply from 16% to 3.1% in just 4 years. With most countries already showing near ubiquitous phone ownership and less than 1% annual growth in their adult population, future installed base growth will likely have to come from the less penetrated and faster growing emerging economies in Africa and Asia. All in, we expect the total global installed base of mobile phones to grow at a slowing 3.0% CAGR through 2020.

Replacement drives phone sales. The percentage of phones sold needed to satisfy the growth of the user base has fallen precipitously over the past few years, from more than 30% in 2011 to less than 9% in 2014. As the global base appears very unlikely to reaccelerate, future demand for mobile phones will come overwhelmingly from existing users replacing their devices. Replacement rates vary wildly by region, with ~50% of North American’s upgrading their phones in a given year compared to less than 25% in Africa. Moreover, replacement rates also vary year to year with changing market conditions – North American replacement rates jumped 680bp in 2014, not coincidentally the same year as the iPhone 6 introduction. Chinese replacement bumped up 340bp in 2013 and has remained elevated since.

Used market may crowd out some replacement. The shift from carrier subsidies to installment purchase plans in the US is an obvious negative for replacement demand. To counter this, AAPL introduced its own installment plan with the twist of an annual trade-in. Carriers have mimicked this approach, leading many observers to predict further acceleration in replacement. We are skeptical. First, few consumers have opted for similar programs that have been offered. Second, the economics of a trade-in program depend on a robust market for used phones. If the trade-in plans are successful in driving replacement, they will also boost the supply of used phones, pressuring prices and destroying plan economics. Used premium smartphone sales are currently ~19% of the new device market – lower secondary market prices would also squeeze out demand at the lower end of the premium segment.

Little to no growth in new phone sales. With replacement rates in N. America, Asia and Middle East/Africa at all-time highs, it is difficult to expect the current 4%+ unit growth as sustainable. We believe that the market will settle in to 2.5-3% annual growth over the next few years, as network advances make mobile service realistic in parts of Africa and Asia and as the world adult population continues to expand ~1.25%/yr. With the market growth overwhelmingly driven by low income populations, with the pressure from the expanding used device market, and with less effective product differentiation, we anticipate global ASPs falling ~2% per year, yielding industry sales growth of ~0.5%.

Shift to smartphones and 3G/4G is still meaningful. Smartphones were about 2/3rds of mobile phones sold in 2014, a share that is rising very rapidly. With quality smartphones available below $100 and an active second hand market, we expect sales of feature phones to fall off precipitously, allowing nearly 9.3%/yr unit growth in smartphones, almost all of it coming from the low end segment. Factoring in falling ASPs tempers this to a 2.1% CAGR. Along with the shift to smartphones, the next 5 years will also see carriers phasing out 2G networks, still serving ~60% of global subs, in favor of the more spectral efficient 3G/4G standards.

Less differentiation. Smartphones are becoming more homogenous, as the factors that were once the biggest points of differentiation – e.g. screen size and resolution, processing power, camera quality, app availability, etc. – generate diminishing returns. The platforms and OEMs have strived to fill the gap with new capabilities, such as mobile payments, 3D Touch, Google Now, edge displays, etc., but it is not clear that these technologies have resonated enough with consumers to drive purchase decisions.

The rise of Chinese brands. 2015 has seen Chinese brands Huawei, Xiaomi, Lenovo and Vivo break out, consolidating domestic share and moving aggressively into international markets. With growth centered on emerging markets and value-priced smartphones, we anticipate a dramatic shift in global market share toward these vendors and away from established brands like Samsung, HTC, LG, Nokia, Blackberry and others. The Chinese may be joined by even newer Indian vendors, like Micromax and Spice, competing at even more aggressive price points.

Little growth available for AAPL. Consensus projects AAPL FY15 revenue growth of 28%, driven by the wild success of the iPhone 6. While management frames its success as share gains, the data suggests that much of this growth may have come from pulling replacement forward. N. American replacement jumped 680bp to 53.9% of the installed base in 2014, with a further increase to 54.8% estimated for 2015. After 6 months of sales, AAPL announced that 20% of its base consisted of upgraded iPhone 6s, with CIRP estimating that 40% of the US base had upgraded. These figures are far ahead of market upgrade trends, and given the preponderance of iPhones in the used market (also included in the installed base), there is likely FAR less upgrade runway than many presume. The premium smartphone market is likely nearing long term stasis, bad news for AAPL which depends upon it for growth.

Component suppliers still have room. While the maturation of the premium segment is unequivocally bad for smartphone component vendors, growth is still available in lower tiers for 3G/4G focused players. We see opportunities for SoC vendor QCOM, and sensor players like INVN and SYNA, and a broader market for GOOG’s services bundled with its Android platform.

Please see our published research page for the full note.

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