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Are Smartphones Doomed to the Same Fate as Personal Computers?

BloombergBloomberg 5/05/2016 Adam Satariano and Ian King

The smartphone market has stopped defying gravity.

After almost a decade of turbocharged sales, the $423 billion industry can no longer count on consumers to robotically upgrade their handsets, putting at risk the fat margins and steady revenue growth long envied by the rest of the hardware sector.

Signs of a sputtering market have been brewing for months, but spilled into the open last week when Apple Inc. reported its first quarterly sales decline in 13 years. Chief Executive Officer Tim Cook acknowledged on April 26 that -- nine years after the iPhone’s game-changing debut -- the market had “stopped growing.” The next day, research firm Strategy Analytics reported a 3 percent drop in first-quarter smartphone shipments, the first decline ever.

“You couldn’t help but wonder how long the party could go,” said David Hsu, a management professor at the University of Pennsylvania’s Wharton School who tracks the market.

With consumers upgrading smartphones less often and first-time buyers harder to find, handset makers seem doomed to endure the same years-long sales decline as PC manufacturers. The industry has yet to identify and market the next big idea to take the place of smartphones, the way the iPhone and its ilk did when PCs fell from favor. The industry is hard at work developing everything from robots, cars and virtual-reality headsets to the grab-bag of connected gadgets and software known as the Internet of Things. Yet it may be years before many of these technologies enter the mainstream.

Before that happens, the industry could be in for some lean years. Already, companies that make mobile chips, sensors and other components are getting hit hard. Sony Corp. reported a quarterly loss Thursday on lower demand for image sensors. Display-maker Sharp Corp. of Japan, memory chip maker SK Hynix Inc. in South Korea and power-management component supplier Dialog Semiconductor Plc in Europe all warned of weakening demand.

Last week, shares of component and chip makers plunged. The carnage continued Monday when Murata Manufacturing Company, which supplies a range of equipment to Apple and other smartphone makers, plunged 13 percent in Tokyo after forecasting full-year profit would fall 13 percent.

“The end of the Apple super cycle is upon us,” said Neil Campling, an analyst at Aviate Global LLP, who expects smartphone makers to start squeezing component makers in an effort to shore up margins. “This is happening in the Samsung supply chain too.”

The industry says smartphone sales could revive. Executives point out that most smartphone owners use old technology that doesn’t deliver the benefits of high-speed data. Qualcomm Inc. notes that only 16 percent of handsets can access fourth-generation, or 4G LTE, connections. The chip maker also argues that because so many people use their phone all day, handsets wear out quickly and will still have to be replaced regularly.

None of that has stopped Qualcomm from rushing to diversify, however. With sales falling -- including a 19 percent dip last quarter -- the company is moving into drones, smart cars and homes. But though these “adjacent businesses” will generate more than $2.5 billion in sales this year, they’ll account for just 11 percent of total expected revenue. That in part explains why Qualcomm has lost a quarter of its market value in the past year, compared with a 2 percent decline for the IT sector as a whole.

For its part, Apple is trying to offset declining iPhone sales with such services as iCloud, Apple Music and the App Store. Profit margins are fatter on these businesses and revenue from them grew 20 percent in the second quarter. Still services account for just 12 percent of sales.

Like many tech companies, Apple is exploring the automobile industry, where new automated-driving features and advanced entertainment and information systems are creating new opportunities to sell components and software now commonplace in smartphones. Still, an Apple car is probably years away, and some analysts wonder if it will hit the streets at all. The shares have fallen 26 percent in the last 12 months.

Samsung, despite reporting solid sales of the Galaxy S7 last week, is looking beyond the smartphone, too. With investors expressing concerns about its next hit, the company is touting virtual-reality gadgets and pushing hard into the Internet of Things.

In October, Flextronics International Ltd., a long-time assembler of smartphones for companies including Blackberry and Motorola, struck a deal with Nike. To augment its business making car components, medical devices and FitBit Inc. wearable gadgets, the company has started making clothes and shoes, some of which could have technology weaved into them.

The most aggressive diversification won’t necessarily protect companies from their exposure to smartphones. Texas Instruments Inc.’s first-quarter revenue fell 4.5 percent despite growing demand for components from makers of cars, phone networks and industrial equipment. It doesn’t help that TI’s biggest customer is Apple, according to Bloomberg supply chain analysis.

It’s hard to imagine one single thing replacing the smartphone, said Neil Mawston, an analyst at Strategy Analytics. So companies must dabble widely, he said, in the Internet of Things, drones, consumer robots, wearables, smart homes, cars and offices. “That cocktail is the next big wave beyond phones, rather than one big new segment.”

Is that cocktail big enough to keep the party going? Mawston is skeptical. Consider the Internet of Things. Strategy Analytics says there will be five billion connected “things” by 2020, compared with four billion smartphones. But most of IoT devices will cost $1 or $2 and won’t need replacing for five to 10 years -- hardly a replacement for smartphones that cost hundreds of dollars and are replaced every two or three.

--With assistance from Jungah Lee To contact the reporters on this story: Adam Satariano in San Francisco at asatariano1@bloomberg.net, Ian King in San Francisco at ianking@bloomberg.net. To contact the editors responsible for this story: Jillian Ward at jward56@bloomberg.net, Alistair Barr

©2016 Bloomberg L.P.

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