After 11 Years and 8.5 Billion Phones, Smartphone Growth Has Run Out

What comes next?

In 2017 the world shipped 1.472 billion smartphones, 1 million fewer than the year before.

This industry, which takes in nearly $480 billion a year from handset sales alone, had grown for more than a decade straight. This was the first time it stopped. China's market also posted its first full-year decline last year.

Back in 2007, when smartphones were just taking off, only 15 million of America's 250 million mobile phone users carried one. Apple's total revenue then was under $40 billion — less than it now books in a single quarter. Tencent and Google had been public for three years, and along with Amazon and Alibaba they were services you used on a computer.

Today the smartphone is a business worth $478.7 billion a year, second only to cars within manufacturing. That figure would rank 26th on a list of global GDP, above Thailand and Iran.

Six of the world's ten most valuable companies are tied to the smartphone: Apple, Google, Amazon, Tencent, Alibaba and Facebook. Smartphones spread the mobile internet, and gave everyone the chance to use those services anywhere, at any hour.

No other product works this way: everyone has to buy one, it isn't cheap, and people keep replacing it.

Every business is run in order to grow. When growth can't be sustained, the trouble starts.

People point to the emerging markets of Southeast Asia, and to Central and Eastern Europe, as the new growth. But those markets are small to begin with. Once a giant market stalls, their gains can't fill the hole.

Smartphones have come far enough that people won't and can't give them up. But for the manufacturers, and for the suppliers who serve them, this is a big deal.

Why phones sell badly is simple: everyone has one, and there's little reason to replace it

At least half the world's mobile phone users are now on smartphones. In North America and Europe, smartphone use has passed 70%. China has about 700 million smartphone users, and 96% of the people there who use the internet use a smartphone.

In the US, a high-end phone like an iPhone or a Samsung Galaxy changes hands three or four times before it is scrapped. Every year phone makers repeat the same few words at their launch events: the camera, the speed, the resolution.

Each year does bring something new, but never enough to force an upgrade. On an 8,000-yuan iPhone X, a 4,000-yuan iPhone 6 or a 2,000-yuan Android phone, the apps people use most are the same.

The independent research firm Asymco built a model from Apple's disclosed sales figures and its count of activated devices, and estimated that one in every three Apple devices out there is in "retirement." From that number it worked out the average life of an Apple device. The figure has gone from one year when the iPhone launched to four years and three months.

The curve is the one population growth follows: roughly exponential at first, slower as saturation sets in, flat once maturity arrives. Phones have reached old age.

IDC research director Jeronimo said: "People have phones, they know what they're using and what features they want, and they're not in a rush to go to the store (to buy a new one)."

Since 2014 people have held on to their phones longer. In the US the replacement cycle has stretched from 23 months in 2014 to 31 months now, and the data firm BayStreet expects 33 months next year.

One study found the three main reasons people replace a phone are a cracked screen, a worn-out battery, and the maker dropping software support.

Carolina Milanesi, principal analyst at the US research firm Creative Strategies, argues that the biggest driver of smartphone sales over the past decade was the screen getting bigger. The megapixel race and dual cameras lifted sales only for a while, and features like waterproofing did essentially nothing.

As more old devices pile up in the market, app developers have to support them and tune for them, or lose a large share of users.

That makes a vicious circle. New phones do have noticeably faster processors, but almost no app requires a new phone, so even fewer people buy one for the sake of an app.

Words like AR and VR have not created enough desire to buy. Facing a market that has stopped growing, the makers are looking elsewhere for answers.

As sales fall, phone makers sell dearer phones to protect their margins

Data from Canalys shows China shipped 459 million smartphones in 2017, 4% fewer than in 2016 — the first full-year drop the Chinese market has ever recorded.

But the phones cost more. GfK recorded a 14.4% rise in China's 2017 smartphone revenue, at an average selling price of 2,250 yuan, up 295 yuan on the year.

Across the price bands, models between 2,500 and 4,000 yuan and models above 4,000 yuan gained the most share; every other band lost. In the 1,999-2,999 yuan band, OPPO's R9s and vivo's X9 held the top two monthly sales spots for more than half a year.

The R11, released in the second half of last year, pushed OPPO's sales share of the 2,999-3,999 yuan segment from 19% in May to 44% by the end of July.

Samsung, whose sales and reputation both suffered from the exploding batteries, priced last year's S8 at 5,688 yuan, 800 yuan above the S7. The Chinese Note 8 went up 1,000 yuan to 6,988 yuan, its top configuration close to the price of an iPhone X.

Behind the increases: memory chips, screens and other components got much more expensive, and the offline channel wants a bigger cut. Raising prices is how the makers hold their gross margins.

The trend will probably continue. GfK expects China's phone sales to fall from 469 million units to 449 million in 2018, while revenue rises 7.1%, to 1.09 trillion yuan.

It is the same worldwide. According to IDC, the global average selling price rose from $282 in 2016 to $288 in 2017, and should keep climbing to $317 over the next four years.

Apple raised prices hardest. In the fourth quarter of last year, the iPhone X made the average user spend $178 more. It also gave Apple a record profit in a quarter when unit sales fell: net income of $20 billion.

The operating system makes switching brands harder and harder for Chinese Android users, and easier and easier for everyone else

On working across devices, Android now looks more and more like iOS. Google has a single account system, so a Sony, Samsung, Google or LG phone is much the same, and texts, call logs, photos and apps all sync between devices through Android's own backup and restore.

None of which has much to do with users in China.

Because of various restrictions, Chinese phone makers all run Android and follow its update schedule, yet many Android features do not work in the country. So the makers write their own versions of the system, with their own interfaces and account systems, hoping the differences will keep users. Xiaomi's MIUI, Huawei's EMUI.

There are ways to move data from one maker's phone to another's, but most go through third-party backup software, and the process is a chore.

Overseas, where Google keeps firm control, phone makers are turning into the HP, Dell and Lenovo of the PC era: the machines differ in design and in a few hardware features, but Windows and Office work the same on all of them. Android is now the same.

That is part of why Chinese makers want new markets abroad. Outside China, though, hardware is all they can really sell — internet services and app stores stay in Google's hands.

The business Xiaomi described years ago is the one every phone maker is now picking up

In 2011, Lei Jun said Xiaomi was a mobile internet company that would make its money from internet services, with hardware earning only a thin margin.

Reuters reported that Xiaomi's internet services brought in about $560 million in 2015, just over half of Lei Jun's $1 billion target.

Internet services means app stores, ads inside the system and its software, co-published games. They may not earn much yet, but with phone sales falling and new users hard to find, the makers have to try.

What they control best is the app store on their own phones.

In 2016 only about 30% of smartphone users used the store that came with the phone, and nearly 60% chose a third-party store. By the first half of 2017 the makers' own stores had passed the third-party ones, reaching 50.3%.

The chance of profit is why the makers run their own. Abroad, the Google Play store earns most of the money in Android: it carries app ads and takes a 30% cut of paid apps and games.

So the makers also work to keep third-party stores from taking what is left. Using their control of the system, they stop users from uninstalling the built-in store or installing a rival one. That breeds disputes with the third-party store operators.

In 2015, for instance, Anzhi Market sued Huawei for unfair competition and asked for 500,000 yuan. Tencent sued OPPO for unfair competition too, and has won a pre-trial injunction ordering OPPO to stop the infringement.

In internet services the makers have a better model to copy: Apple.

In the fourth quarter of last year, one of the growth stories in Apple's results was exactly this pair of internet services — the App Store and Apple Music brought in $8.5 billion, 18% more than a year earlier.

Apple even shoots its own shows. Xiaomi has not paid production teams directly, but it put $300 million into iQiyi in 2014. iQiyi recently filed its prospectus; Xiaomi holds 8.4%.

When a market stops growing, small brands' users drift to the big ones

In the fourth quarter of 2017 the five largest smartphone makers in the world — Samsung, Apple, Huawei, Xiaomi and OPPO — all held more of the market than a year earlier, taking about 5.2% of it from the companies ranked behind them.

The pattern is sharper in China, where sales are also falling. GfK data shows the top five Chinese brands went from 60% of the market at the end of the third quarter of 2015 to 83% at the end of 2017.

Over the same stretch, brands ranked sixth to tenth fell from 27% combined to 10%. Meizu, Gionee and Samsung all shipped fewer phones last year than the year before. The small makers are harder and harder to notice.

And just below Xiaomi, which sells on the order of 50 million units, sits Meizu at 20 million. Nothing occupies the gap between them, and nothing has for three years.

Lenovo had the Motorola brand to work with. But it kept reorganizing the phone business and the team, the product line was a jumble, and last year Lenovo sold 1.79 million phones in China — effectively gone from the market.

360 came briefly back into view on a run of alarming news. Mentioned alongside it lately is Smartisan, another brand people keep bringing up and forgetting, and whose sales figures have never been clear. Rumor had 360 and Smartisan merging; Luo Yonghao denied it quickly.

As competition gets harder, makers want more of the supply chain

What matters most in the phone business is being different — better software, a better brand, or the hardware itself. Android makers' software now differs less and less. Differentiation has moved to the hardware.

Most of the money in phones now goes to the channel and the supply chain. The fiercer the competition over products, the more the makers want to control what is upstream. Chips are the key link.

Apple has gone furthest in designing its own.

It bought the chipmaker P.A. Semi in 2008 and put its first in-house chip, the A4, in the original iPad two years later. Its A-series processors have since left Qualcomm and Intel, firms that do nothing but this, behind. Apple has extended the work to GPUs, co-processors and Bluetooth chips.

Samsung and Huawei are among the few phone makers after Apple to design their own chips. Samsung does not merely use them; chips are one of its pillar businesses. Between April and June last year, on the strength of semiconductors, Samsung's operating profit passed Apple's for the first time, the highest of any company in the world. Samsung has also decided to spin off its foundry business, aiming within five years to be the world's second-largest contract chipmaker behind TSMC.

Xiaomi puts its own processor in a small number of phones. Last year's Pinecone phone carried the first of them, the Surge S1.

Even vivo, long better known for marketing and always reluctant to talk about performance or new technology, is now rushing to use new parts. At CES in January it showed an engineering prototype with an under-display fingerprint sensor from Synaptics, the identification-technology firm — the device it later released as the vivo X20 Plus UD.

Its front holds only the front camera and the screen, with none of the iPhone X's forehead. With the fingerprint sensor moved into the display, the chin where the sensor used to sit became screen too.

vivo's staff said at the time that the company was working with several fingerprint suppliers at once, Qualcomm and Goodix among them; Goodix, the Chinese firm, put in the most people and the most R&D, but Synaptics was still first to a shipping product.

Any new technology carries risk until it has survived mass production on the order of 100,000 units. vivo's under-display fingerprint had low yields and high costs.

At MWC last month vivo showed the Apex, a concept phone with the same under-display fingerprint reading, over a larger area. Its front camera pops up and hides inside the body when unused, so the face of the phone is nothing but screen, with bezels of 1.8 millimeters on the left, right and top. Among the crowd of Android phones copying the iPhone X's notch, it does look different.

Chip companies are either merging or looking somewhere else

As phone makers move upstream, some suppliers merge and others, pushed to the margins, go into different industries.

Nvidia and Intel both wanted the phone processor business once.

By 2011 Nvidia held most of the desktop graphics card market, and it began selling phone chips, producing the dual-core Tegra 2 during the shift from single-core phones to dual-core. Qualcomm at that point was still a baseband supplier.

But Nvidia fell behind Qualcomm and the others in the work that followed. Once the Snapdragon 8 series arrived it had no opening left. It gave up the low-margin mobile market and turned to graphics processors, cars and supercomputing.

Intel had also long wanted to build chips for smart handheld devices, and paid heavy subsidies to get there. After losses in the billions, it quit the market.

In 2017 Intel spent nearly all its cash reserve — $15.3 billion — to buy Mobileye, the Israeli self-driving supplier, and allied with BMW to develop autonomous driving together.

Those still standing are talking mergers. Broadcom's bid for Qualcomm, worth as much as $140 billion, has been in negotiation for months and has drawn in American regulators.

A merger would make the chip market's monopoly tighter still. If MediaTek does not change course, it could well disappear in this round of competition. After a few exits and mergers, phone makers will have two or three suppliers to choose from.

With too little profit to share, more and more stores sell only one brand

On money made in the Subor and BBK years, OPPO has advertised through celebrities since it sold MP3 players. It signed Leonardo DiCaprio for its first phone in 2011; later faces have included Yang Mi, Yang Yang, Li Yifeng and TFBoys.

But that is not the main reason OPPO — and vivo, its relative by ownership — became two of China's three best-selling phone brands in recent years. The fast-spreading offline stores are.

No third Chinese company has done what OPPO and vivo did from 2013 on: pushing franchised agency shops into towns and villages, from 50,000 outlets to more than 200,000 in three years.

Even so, in mid-2016 stores selling a single brand were only about level with the carrier shops and phone chains that stock many brands at once.

By September 2017, single-brand stores had twice the share of the retail channel that the other chains did. In a year and a half, the makers' leverage over the channel rose fast. OPPO and vivo also sent their provincial agents in China to India to build local sales channels on contract.

Offline channels are not charities. A franchisee recommends OPPO or vivo because that is how it makes money. China Securities Journal reported that around 2016 a salesperson took roughly 100 yuan on every OPPO phone sold. More than 20% of OPPO's sales revenue is generally thought to go to the stores, the staff, the provincial agents and the rest of the chain.

Canalys analyst He Tianhua told QDaily that, whether for brand positioning or for margins, the makers are quite likely to cut subsidies to "street-side stores" with fewer than five outlets and to stalls in phone markets.

Whether the subsidies inside China will shrink or stop is unclear, but in India OPPO and vivo have already begun.

India's The Economic Times reported that the two together held about 17% of the Indian smartphone market early this year, and that they have cut the profit share they hand local retailers by more than 40%, angering neighborhood shops and phone chains.

By OPPO's own account it has more than 10,000 exclusive stores, which bring in 10% of company revenue, and 250,000 outlets counting the smaller authorized storefronts. But the early rush left its brand management thin and shallow, and all of that now has to change.

In the rebuild, resources will go to mid-size and large stores. GfK's analysts think that means location, fit-out and floor space will all be held to flagship standards. Under the new policy, small and mid-size retailers will take the hit.

5G is called the next source of growth, but even the people writing the standard can't name a reason you have to use it

5G was the hottest word at this year's Mobile World Congress. Siemens, Huawei, Intel, Qualcomm — nearly every exhibitor was showing 5G technology and products built on it, in the internet of things, autonomous driving, connected cars.

None of it has a direct connection to the smartphone. Even so, 5G is treated as the smartphone's next source of growth: carriers usually subsidize a new generation, and that is what the makers are counting on.

A GfK report says China plans to start commercial 5G by the end of 2019. A year after China issued its 4G licenses, 4G phone sales exploded, from under 5 million units in July 2014 to 15 million that October. 5G could repeat that cycle, the report says, or even compress it.

But 4G sales exploded because a huge number of China Mobile's 2G users needed to move up, and 4G was what finally put the mobile internet in their hands. At the end of June 2014 China Mobile had just over 10 million 4G users; by the end of that October, more than 50 million.

Between 4G and 5G there is no such gulf. In the GSMA's own view of 5G, everything apart from VR, AR, the internet of things and self-driving cars — real-time calls, remote collaboration and the rest — already works on 4G, or even 3G.

Personal computers spread through the 1980s and carried more than 20 years of prosperity, during which Apple and Microsoft grew large, Bill Gates became the youngest man ever to be the richest, and the internet that came with the computer took shape and peaked in 2000.

When that bubble burst in 2000, the smartphone took over, grew fast for another dozen years and pushed the information society along. The computer market was still growing then, but people knew computers too well by that point; owning one was no longer something to be happy about for long.

Now smartphone growth has stopped, and no technology or product can be found to take the baton. The phone itself, like the television and the computer before it, has turned into an everyday appliance.

The ceiling everyone has talked about for years has finally been reached.

These technologies and products brought society enormous progress, and they changed how people live and work completely. But as businesses they get less and less attractive.

Cover image/Christian Research Service, 1ZOOM.Me