The smartphone in your pocket embodies today's cutting-edge technology. It is also a product of a global supply chain decidedly old-school in the way it shares rewards.
Two brands, Apple and Samsung, scoop over 100 per cent of the profit pool (the other brands are losing money, giving them negative profit share). Despite all the commotion around their new product launches, they represent only one-third of total smartphone volume. Most consumers can't afford them, so they buy standard products at $100 or even $50. These devices (and Apple iPhones too) are assembled in Chinese factories at negligible profit. Despite China dominating production, its brands together receive only 17 per cent of the industry's $300 billion in revenue, about half that of what Apple and Samsung each pocket. A few other foreign suppliers making semiconductors and other components quietly make huge profits off every smartphone sold.
With 1.2 billion devices sold annually, practically the entire human adult population owns a smartphone, or soon will. Like generic medicines, the ubiquitous device is a stunning example of the democratisation of affordable technology. It is also, from a Marxist perspective, a scourge of winner-take-all capitalist imperialism.
That such a large and important industry is so asymmetrical, with so few winners, raises questions. Why can just a few companies make such extravagant profits while no-one else can? Why are Chinese companies pursuing their profitless existence? How do they survive? And what does Beijing think about all this?
Apple and Samsung are profitable because their prices are higher. Scale helps but is no guarantee of continued success: Nokia once owned the market, and blew it. Because everyone uses the same components and design concepts, the product differences are subtle. The Chinese phones are catching up quickly and eventually the smartphone, like the PC, may 'commoditise'. Consumers pay mostly for the brand, a lazy habit reinforced by Apple and Samsung's vast advertising budgets. For now, they are runaway winners, but their profit margins and market share will erode. They might stumble, as many have before.
The prospect of Apple or Samsung tripping up keeps Chinese companies in the game. The biggest have grown to dominate their home market and have ambitions overseas. Some, like Xiaomi, are genuinely innovative. The Chinese rulemanufacturing too. Still, despite working so hard, they scrape out only a 2-3 per cent margin, at best. The domestic market is abloodbath; everyone aspires to the big league and to outlast the others, ensuring a slow, painful shakeout of the 100 Chinese players. Exports are more profitable, so lesser-known firms are shipping to India and Africa in amazing quantities, tens of millions of units per year.
It has been observed by trade economists that China captures little value in the total price of an iPhone, with most of the wealth going to Apple itself and other foreigner corporations. Naturally this irks Beijing, all the more so because Chinese consumers love Apple's brand, a fetish ridiculed by the state media. There is a not-so-subtle campaign to wean local consumers from foreign wares. Samsung, facing a 'China storm', already manufactures in Vietnam. In recent times Apple, generating 60 per cent of its incremental growth from China, has been attacked and its service and its security questioned. Beijing has also been slow to certify Apple for its Chinese carriers.
The main alternative to Apple is a phone running Google's free Android operating system. Android runs 80 per cent of all smartphones and is rampant in emerging markets. Chinese consumers and manufacturers have settled quickly for Android too, but Google's dominance doesn't sit well with Beijing. It plans an indigenous 'patriotic' alternative called the China Operating System.
China may also target lucrative foreign parts suppliers, as it did in cars. Three-quarters of a Chinese-made smartphone's cost are components made by foreign companies, some of which are dominant and outrageously profitable. Beijing's greatest test of wills is against the powerful US semiconductor maker Qualcomm, which earns half its revenues in China. True to form, the chip business is close to a duopoly: Qualcomm and Taiwan's Mediatek dominate. China has its own semiconductor ambitions and is trying to build up a homegrown chip-maker with Intel's help to rival the pair. Qualcomm demands an average 3 per cent IP royalty on the price of every smartphone (even those running MediaTek chips), and more from some Chinese companies. Obviously, with 1-2 per cent profit margins, such a levy would destroy them. So Beijing has blocked all Chinese smartphone makers from paying, while condemning Qualcomm for monopolistic behaviour and for ripping China off: 'You're making money in China and you're hurting China. We won't allow that to happen.'
Qualcomm's lockhold on wireless technology has annoyed many, not just Beijing. Qualcomm has repeatedly tangled with both competitors and customers, and it has a separate ongoing dispute with Huawei over cross-licenses. Beijing uses roughcounter-tactics, especially against IP owners. Effectively, Beijing is shielding its companies from some IP costs that Apple and Samsung are paying.
For now, this policy is creating a segregated marketplace: a royalty-lite zone in China, another in emerging markets where IP enforcement is impossible, and another in developed countries where Qualcomm might block infringing Chinese phones with import injunctions. Because they want to export to the US and EU, some Chinese firms are now building up their own patents. Lenovo bought Motorola for that reason. Elsewhere, however, Chinese brands could overrun the world market, hiding behind Beijing's industrial policy bastion. They will face other challenges but if they succeed the global landscape will look very different within three to five years.
What we see in the smartphone industry is another example of Beijing quietly pressing the scales in favour of its companies, 'leveling the playing field.' The smartphone is likely to be with us for many years. China is determined to be a big part of that future.
Originally published by The Lowy Institute publication The Interpreter. Republished with permission.