Huawei vs Samsung – Rivers of blood pt. VII.

Samsung margins unlikely to recover from Huawei’s predations.

• Samsung’s handset margins are unlikely to recover anytime soon thanks to a resurgent Huawei, but as ever in Android, it is Google that will reap the real benefit.
• I have written a long series (see here) concerning the competitive dynamics between Samsung and Huawei where my opinion has long been that Samsung’s superior profitability in smartphones is almost entirely tied to its market leadership.
• Android smartphones have long been devoid of profitability with everyone except Samsung eking out a wretched existence with 2% – 4% operating margins in the best instance.
• The one exception has been Samsung which has routinely made 9% – 14% from its handset business over the last 5 years.
• My position has long been that this superior profitability is tied to the fact that it has outsold its closest rival for leadership by a factor of more than 2 to 1 for a long period of time.
• This gives Samsung a volume advantage (exactly as Nokia had in its glory years) over which to spread its fixed costs and therefore higher profitability even in a brutally competitive market.
• However, since Q1 2017 we have seen Huawei chip away at this volume advantage such that in Q4 18, Samsung sold just 1.2 smartphones compared to Huawei’s 1.
• This appears to have had a substantial impact on Samsung’s profitability as Q4 18 handset margins were down to 6.8% from 13.6% in Q4 2017.
• Q2 18, Q3 18 and Q4 18 have seen margins decline from between 16% to 30% indicating structural shifts within the business.
• The slowing smartphone market has certainly not helped, but I think that the real issue here is that the volume advantage that Samsung has relied on for several years has now slipped away.
• While Huawei is breathing down its neck, I do not think that margins are coming back and that brutal competition will now ravage the profitability of Samsung as well as everyone else.
• The real beneficiary here is not Huawei (other than the revenue increase) as to start making good money from smartphones, it will need to outsell Samsung by a similar margin (i.e. 2 to 1) and it is pretty far from doing that.
• As usual in these situations, the real beneficiary is Google which benefits substantially from the brutal competition between the commoditised Android handset makers.
• These companies seek to endlessly push better and better hardware down to lower price points in order to gain share.
• The net result is better-specified handsets achieving higher penetration, resulting in more usage and more traffic going to Google’s servers.
• This results in higher advertising revenues for Google and it is here where the profits of the Android handset industry are now largely to be found.
• Google owns the ecosystem that runs on these devices and as a result, is the biggest reason why users choose an Android device over an iOS device.
• While Google holds the preference of the smartphone buyer, the Android handset makers are unlikely to be able to achieve much differentiation and therefore, they will make very little money.
• I would prefer Google over any Android handset maker.