Is an Android Price War Getting Under Way?

In the market for a high-end Android phone? Well, you're in luck – the phones are cheaper than they've ever been, and the discounts might just amount to the first shots in an overdue price war. That's bad news for Motorola (NYSE: MOT  ) and other Android manufacturers ... but chances are that Google (Nasdaq: GOOG  ) isn't quite so heartbroken.

Why Android is a profit machine …
Thus far, Android has been a godsend for its three biggest phone manufacturers: Motorola, Samsung, and HTC. Not only is the mobile operating system keeping these companies from being laid to waste in the smartphone market by the juggernaut known as Apple's (Nasdaq: AAPL  ) iPhone, but it's also doing wonders for the profit margins and average selling prices produced by their phone businesses. Last quarter, thanks to sales of the Droid X, Droid 2, and other Android models, Motorola reported a cell-phone ASP of $223, up nearly 80% from the $124 reported a year earlier. Even more importantly, booming Android sales allowed Motorola's phone division to go from a $183 million non-GAAP operating loss in the year-ago period to a $3 million operating profit.

High-end Android phones are often sold by the Motorolas and Samsungs of the world to carriers for more than $500 (before the carriers sell them to consumers at highly subsidized prices). And with teardowns of these phones usually showing that they cost less than $200 to manufacture, we can assume that they're earning a pretty penny for the manufacturers, even after you factor in other expenses such as marketing and R&D.

... and why it won't last
But can investors expect these enormous profit margins to last? Normally, for a hardware manufacturer to keep its gross margins at the levels that Android manufacturers are apparently seeing for high-end devices, its products need to be highly differentiated. That simply doesn't seem to be the case for phones such as the Droid X, HTC's EVO, and Samsung's Galaxy S. When it comes to core features such as a phone's display size, processing power, memory, and camera(s), there's very little to give any individual Android vendor a real edge. Sure, manufacturers have developed custom user interfaces for their Android phones, but from all indications, very few users see them as a big selling point.

Backing up the notion that high-end Android phones are steering very close to commodity status is the way in which the market share of leading manufacturers is constantly in flux. A year ago, HTC was easily the biggest Android vendor in the United States. But following the runaway success of the original Droid with Verizon (NYSE: VZ  ) , Motorola stole HTC's crown. Now, after a big summer push in which versions of the Galaxy S were rolled out by all four major American carriers, Gartner is reporting that Samsung has displaced Motorola as the U.S. market leader.

Also adding to the notion that Android manufacturers can't differentiate themselves is the way in which the most popular/hyped Android phone has been changing almost every month. First, the Droid was seen by gadget enthusiasts as the must-have Android phone. Then it was HTC's Droid Incredible. Then it was the EVO. Then the Droid X arrived. Then Samsung stole headlines with its Galaxy S barrage. And now HTC's Desire HD and Samsung's forthcoming Nexus S are generating the most buzz. Is your head spinning? Good; it should be.

Signs of trouble
If the struggles of the PC industry are any guide, a lack of major differentiation will inevitably produce serious price competition and dwindling margins. We might have recently gotten a sign of things to come for Android, with Amazon.com, Best Buy, and other retailers offering phones such as the Droid X and Samsung Captivate for free with a contract, rather than the $199 that they typically go for.

Sure, it's the holiday season, and retailers often provide discounts on popular items to get consumers to visit their stores and websites. But when the discounts are this steep, and this widespread, chances are that price cuts from suppliers have something to do with them. After all, Radio Shack is trying to reel in customers by offering a discount on the 16GB iPhone 4, but (no doubt thanks to Apple's historically tough stance on pricing) it's still charging $149 for the device.

And speaking of the iPhone, if it turns out that those never-ending rumors about AT&T (NYSE: T  ) losing exclusivity in early 2011 prove true, then that can't help but worsen any Android price war that breaks out. If high-end Android vendors have to contend with direct competition from Apple for the dollars of Verizon subscribers (and perhaps also Sprint and T-Mobile subscribers), then their natural response is going to be to try to undercut Apple in terms of price.

Motorola's loss is Google's gain
If the salad days of Android manufacturers are about to end, you can count on it being bad news for Motorola's shares. Profits from Android phone sales are the only thing keeping the Mobile Devices division from again being a giant cash sinkhole. But for Google? Cheaper Android phones have to be music to its ears. Less costly hardware should translate into a higher smartphone market share for Android, and that translates into more mobile advertising revenue for Big G.

Qualcomm (Nasdaq: QCOM  ) , meanwhile, is a company that stands to both gain and lose from a price war. On one hand, the royalties that Qualcomm gets for individual Android phone sales will go down as prices decline. But on the other hand, sales of the costly Snapdragon processors that power many Android devices will get a boost, and the company's total royalties might still increase on account of Android phones' taking more share from Research In Motion's (Nasdaq: RIMM  ) BlackBerrys and inexpensive "feature phones."

The economics of Planet Android are bound to see some gut-wrenching changes over the next couple of years. With limited product differentiation, it's probably just a matter of time before the Android phone business looks a lot like the PC industry, with a big chunk of the profits going to the operating-system provider and chip companies, and hardware manufacturers forced to live in a world of thin margins and frequent price wars.

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Fool contributor Eric Jhonsa thought that getting a Droid Incredible made him the coolest kid on the block. Then he saw a Droid X a week later. He has no position in any of the companies mentioned. Best Buy and Google are Motley Fool Inside Value recommendations. Google is a Motley Fool Rule Breakers pick. Apple, Amazon.com, and Best Buy are Motley Fool Stock Advisor selections. Motley Fool Options has recommended buying calls on Best Buy. The Fool owns shares of Apple, Best Buy, Google, and Qualcomm. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


Read/Post Comments (9) | Recommend This Article (4)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On December 12, 2010, at 3:33 PM, pbodal1 wrote:

    The age of doubters never ends.....one year back..this same press was participating in Motorola's funeral...."Motorola is dead....the mobile devices division is going to shut down....", obituaries were already written about how Motorola Mobile Devices went from being the "darling" of the masses to extinction....Motorola's dead....etc...etc....

    Then we had the next set of doubters...."Android" huh ? How was Motorola going to differentiate from "other" vendors since all of them have the same "Android" stuff....

    Once the "Droid" was a hit..oh well...its a one trick pony wonder.....Motorola cannot sustain the momentum....live this while it lasts.....then came the Droid X....oh but HTC also has a competitor phone...the EVO.....

    Bottomline is....none of these doubters can ever come to a sane conclusion that there is prosperity for all companies to participate and make profits in the smartphone space.....Apple / Motorola /Samsung / LG...etc...all of them can churn profits......

    When you publish articles....do not expect readers to be naive enough to buy into what you say....publish articles explaining how any business made their way up and what it is doing to at least be competitive....

    Your thoughts show that the facts you bring up are a one sided biased perspective and presenting it to the world....it would help if you knew what is Motorola going to do to improve on its products and deliver even better than what they did before....if you do not know what they are doing...it would be good to do some research instead of writing obituaries of a business which is seriously on the upswing......

    Thanks.....

  • Report this Comment On December 12, 2010, at 3:52 PM, Henry3Dogg wrote:

    Android was always going to end in a cut-throat fight between vendors.

    But I'm confused by your comment

    "If high-end Android vendors have to contend with direct competition from Apple for the dollars of Verizon subscribers ... then their natural response is going to be to try to undercut Apple in terms of price"

    They always were cheaper, otherwise they wouldn't have sold any!

  • Report this Comment On December 12, 2010, at 4:45 PM, fatmonk wrote:

    @Eric, Excellent.

    -- Android makers can create a custom Android OS for each phone. Update will be nightmare for many users.

  • Report this Comment On December 12, 2010, at 4:59 PM, TMFRhino wrote:

    Henry3dogg,

    I think you'll see less selling at the $200 price point (post subsidies). The next Droid incarnation is much less appealing selling at $300 (with $100 mail in rebate to get it down to $200) when the iPhone is selling for the same price.

    -Eric

  • Report this Comment On December 12, 2010, at 5:26 PM, sapiska wrote:

    You forgot to mention the ZTE Blade (Orange San Francisco) phone, which is the cheapest Android phone so far. It has 480x800 pixel AMOLED-screen, 5 Mpix camera, GPS, etc. and it costs around $150 - unlocked. You can get it for free with contract. The specification is quite identical to Samsung Galaxy S.

    Huawei is also making very cheap Android phones. This means that Motorola is gone 2011, it mobile phone unit will not see the year 2012. The same destiny will face the SonyEricsson too. LG is out too. Maybe HTC can make rivaling phones, but not with big profit. Samsung will switch to Bada if they want to survive.

    These Chinese vendors are bad news for Google too. They have started to replace the Google services in China market with their own or some other service provider, like Microsoft Bing and started making 100% Google-free phones.

    You have to have your own OS which you can control to be profitable. For example Nokia Corporation has been profitable all the time with profit margin >10% and it will gain a lot when its worst competitors have hung themselves to Android and will see that they cannot compete anymore profitable with price.

  • Report this Comment On December 12, 2010, at 9:23 PM, EquityBull wrote:

    Android will take a HUGE hit once iPhone is on Verizon. I own BOTH an iPhone 4G on ATT and a Droid X on Verizon (call me crazy but I need both as a developer plus I'm a gadget junkie).

    There is no comparison between the two. Hands down apple is far better in almost every way. It is more stable, cleaner, slicker, not clunkly like the droid, has a better screen by far and so much more.

    The only advantage droid has is the easy integration with google products like gmail, calendar, voice, etc. Those features (which I use) are super easy to setup on the Droid (just enter your login on setup) and work fantastic. If you are not a heavy google product user then I can see no advantage at all for the Droid product.

    Google has built the next best OS to apple but that is what it is. The next best. I'm long both Apple and Google stock. Think both companies have incredible businesses and futures but if I was google I'd fear the coming pain as Apple makes its way to Verizon.

  • Report this Comment On December 12, 2010, at 9:38 PM, Henry3Dogg wrote:

    @TMFRhino

    But that not the price that tbe telco pays Apple, LG, Samsung, etc. They're already undercutting to get the telcos to push phones that the users don't want.

  • Report this Comment On December 12, 2010, at 10:05 PM, srimox wrote:

    I agree that smartphones are a booming technology that is sure to make money, but why place money on the performance of a specific manufacturer or carrier? I know of an investment that will profit from the growht of ALL of these companies because they provide something neccesary to the existence of smartphones. This stock is American Towers (AMT), which builds cellular towers around the world, but their main business being in the US. These towers are leased out to the cellphone service providers so they can place antennas on them. Cellphone service providers need them to supply service, and with 4G and all these new smartphones more and more service is needed. That means a lot of new business for AMT, and their stock could boom. I wrote a whole article about AMT on my blog and am reccomending it as a buy. Feel free to read my article by clicking this link: http://teenstockadvisor.wordpress.com/2010/11/30/...

  • Report this Comment On December 13, 2010, at 9:44 AM, TMFRhino wrote:

    Hey Henry,

    I think it's more of, say you're Samsung/MOT and you're selling top-line phones to carriers at ~$500. If you can get the carrier to subsidize it down to $200, and your bill of materials is $200ish, even after marketing, etc., that's pretty good margins. However, if the $200 price point is less attractive, you'll instead get a lower price from carriers, or having to move away from that flagship phone, margins take a good hit.

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