Why Apple, Samsung's phones sit atop piles of cash (FAQ)

It's tough being in the mobile-phone business, if your name isn't Apple or Samsung. CNET looks at how the two swallowed up nearly all of the industry's profits.

Apple's iPhone 4S.
Apple's iPhone 4S helped the company swallow up 80 percent of the industry's profit. Josh Lowensohn/CNET

When it comes to making money in the smartphone business, Apple and Samsung have a license to print money, while everyone else is holding a hat out for handouts.

Apple and Samsung accounted for 95 percent of the industry's profits in the fourth quarter -- with Apple generating 80 percent by itself -- as the rest of the players struggle for the scraps. Canaccord Genuity analyst Mike Walkley said yesterday that their percentage could rise even higher in the first quarter.

Just five years ago, Nokia and Research In Motion -- two companies now desperately looking for a comeback -- were the ones gobbling up the industry's profits. The radical change in leadership illustrates the rapid shifts in the business, which is even more dependent than ever on consumer tastes and technical trends. Titans today are paupers the next.

So what happened? CNET puts on its financial cap and explains how two companies can eat up an entire industry's profit, and what that may mean for some of the players down the line.

Wait, so Apple and Samsung stole everyone else's profits?
Not exactly. Apple and Samsung were the most successful companies at selling handsets in the fourth quarter, particularly high-margin smartphones, so they were both able to record a healthy profit. The demand for their smartphones meant less demand and lower sales of rival phones made by the likes of HTC or Motorola, which translates into lower profits.

Besides Apple and Samsung, no other major handset manufacturer recorded a significant profit. Some actually posted losses for the period. And ultimately, it was really Apple that accounted for most of the profits, with its unique level of success.

How did Apple make so much money on its iPhone?
Apple was the real profit machine in the fourth quarter. That's thanks to its iPhone 4S, which commands the highest average selling price in the industry. The average selling price isn't the price consumers pay for their iPhone, which ranges between $199.99 and $399.99, based on the memory size. The price of the device is estimated to be roughly $300 to $400 more -- an expense that the carrier covers in exchange for the consumer signing a two-year contract.

While carriers pay similar subsidies to the other handset vendors, they aren't nearly as high as Apple's payment. That's why a lot of the wireless carriers reported weaker results in the fourth quarter; they had to pay out huge subsidies to cover the large number of iPhones activated in the period.

Obviously, Apple generates more profits with each additional iPhone it sells. And it has sold a lot. The company is estimated to have sold 31 million iPhones in the fourth quarter , according to a J.P. Morgan research note issued today. Walkley said the iPhone outsold every other smartphone in AT&T and Sprint Nextel's lineups combined, and it was on par with every other Android smartphone combined sold by Verizon Wireless.

The iPhone's superior ability to turn a profit is illustrated by Apple's market share. Despite only nabbing 45 percent of total handset sales in the fourth quarter, it controlled 80 percent of the profits.

And Samsung?
Samsung is a distant second, but it can still boast of healthy profit. One large reason is the success of its flagship Galaxy S II line, which has been able to stand out in a crowd of so-called superphones running on Google's Android platform.

Despite its claims of a premium phone, Samsung doesn't command the kind of premium that Apple can get away with. The company instead leans on its own manufacturing capabilities and massive reach to ensure a profit.

It helps that a lot of the components found in a smartphone - from the display to the processor -- are made in-house.

Beyond the Galaxy S II, Samsung has been good at creating smartphones for different levels of consumers, from its flagship line down to more affordable models for the prepaid wireless carriers. The company's size and scale helps the company profitably serve each customer segment, something few others can emulate.

What happened to everyone else?
The fourth quarter happened to be a time of flux for several companies. Nokia was in the early stages of rolling out its Lumia Windows Phones. HTC had already warned that competition was starting to take its toll on its business. Sony was in the middle of taking full control of the smartphone business from Ericsson. Motorola Mobility was awaiting its acquisition by Google. LG was working through its own turnaround. Research In Motion, meanwhile, continued to cede its share, as people abandoned BlackBerrys.

The phenomenal success of the iPhone 4S in the period basically wiped out any hopes that any other smartphone would make a real impact with consumers. Companies were more reliant on lower-cost -- and less profitable -- feature phones.

Why is it so hard to make money in this business?
In general, it's fairly tough to make money in the handset business. Yes, the high-end flagship smartphone tends to do well. But unlike Apple, which has its limited iPhone line, the other handset vendors have large portfolios of products catering to different kinds of consumers.

The amount of research-and-development resources devoted to so many phones -- when so few end up being hits -- means a lot of risks taken that don't pay off. With the market so crowded, and pressure to keep packing in more expensive components constantly rising, vendors are under the gun to deliver, despite slimming profits.

In addition, the companies face competition from Huawei and ZTE, which offer smartphones with improving specs at a lower cost. Walkley noted that both companies were around breakeven and didn't factor into the share of the industry's profits.

Some analysts question whether Android players beyond Samsung can compete in the smartphone market. The last few quarters have seen most of the Android supporters -- HTC, Motorola, and LG -- dealing with continued struggles.

"The rich get richer, and the smaller guys struggle for relevancy," Walkley said.

Can the profit share shift back?
It's possible. The fourth quarter represented the launch of a new iPhone, which gave Apple a large onetime boost. With the iPhone hype settling, there's room for other handset vendors to increase their own profits.

Nokia, for instance, has a chance with its Lumia smartphones launching around the world. In the United States, the Lumia 900 will launch with AT&T on April 8, and the carrier is promising a big launch.

HTC, meanwhile, has managed to win back some excitement for its line of One smartphones, particularly the One X.

What happens, if nothing changes?
If things don't change, a few of the companies won't be around in a few years. These are businesses that are in it to make money, and if profits can't be had, the industry will see either consolidation or companies waving a white flag.

Google is already acquiring Motorola. RIM's chief executive, Thorsten Heins, opened the door to a possible acquisition, though he stressed that he would prefer to go it alone.

With profits hard to come by, don't be surprised, if those end up being just the first of many indications that bigger industry shakeups are at hand.

 

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