The Smartphone Shields Are Down

In China, phone makers are struggling as ownership shrinks

Illustration: Simon Abranowicz

Quarter after quarter, Xiaomi could do no wrong. Less than five years after its founding, the Beijing-based company became the No. 4 smartphone maker on earth, its well-built and relatively cheap devices trailing only Samsung Electronics, Apple, and Lenovo in global shipments. In 2014 the company shipped 57.7 million phones around the world, a more than 200 percent increase from the previous year. Xiaomi estimated its 2015 numbers would reach 80 million to 100 million phones. Then sales hit a wall.

On July 2, Xiaomi Chief Executive Officer Lei Jun said shipments in the first half of 2015 totaled 34.7 million phones, a growth rate of 33 percent over the first six months of 2014. Plenty of smartphone makers would be delighted with that kind of increase, but it was a shocking slowdown for a company used to posting triple-digit gains, especially because it spent much of 2015 expanding into India. The reason was one familiar to almost every other company selling smartphones: Xiaomi’s home market “is increasingly saturated,” according to Bloomberg Intelligence analysts Matthew Kanterman and John Butler. Xiaomi declined to comment.

Local and foreign companies alike have been dependent on steadily increasing demand in China, which accounts for about a third of the world’s 1.3 billion smartphones. But that pillar of growth had been eroding even before the Chinese stock market crash that wiped out almost $4 trillion in wealth in late June and early July. The total number of mobile phone users in China fell slightly in the second quarter (by about 1 million). From phone carriers to manufacturers to component makers, “slower smartphone growth is affecting everybody,” says Steven Pelayo, a technology analyst in Hong Kong with HSBC.

Much of the problem is simple math: Growth can’t keep rising forever in a market where most of the people who would want a smartphone already have one, especially as the country’s broader economic growth dips. But China’s leading phone carriers, state-owned China Mobile and China Unicom, are also part of the reason for ebbing demand. Both had kept phone prices artificially low for years until last summer, when the government ordered them to control their spending and slash customer subsidies. No. 1 China Mobile cut its annual subsidies from about $5.5 billion to $3.4 billion. China’s smartphone shipments shrank 4.3 percent in the first quarter of 2015, and market researcher IDC expects flat growth for the year.

Phone makers from outside China may be feeling more pain than Xiaomi. On July 7, Samsung announced a 4 percent drop in operating income in the second quarter, as sales of its Galaxy S6 smartphones, which the company had predicted would break records, fell short of analysts’ estimates. Rival HTC, which had warned in June that “weaker-than-forecast sales in China” would hurt its revenue, reported on July 6 a quarterly loss of $257 million. In June, Lenovo replaced the head of its mobile division after shipments fell 22 percent in the first quarter; the company declined to comment.

As the rest of the industry struggles, Apple has solidified its dominant position with affluent Chinese consumers. IPhones accounted for 87.5 percent of high-end phone sales in their first two quarters on the market, according to IDC, up from 55 percent after the 2013 launch of the iPhone 5S. Globally, smartphone shipment growth last year was about 28 percent, IDC says, but will barely top 10 percent this year largely because of China’s slowdown.

The average smartphone purchase price in China rose from $192 in the third quarter of 2014 to $263 in the first quarter of this year, “a reflection of the popularity of the iPhone 6 and 6 Plus,” says IDC analyst Bryan Ma. Still, Apple’s growing reliance on China isn’t always good news. On July 21 the company’s stock slid almost 7 percent after CEO Tim Cook announced third-quarter results that fell short of expectations. The biggest miss was in China, where iPhone shipments totaled 12.5 million, Bloomberg Intelligence says, about 2 million below IDC estimates. The stock market volatility in China “could create some speed bumps in the near term,” Cook said on an earnings call. But, he said, “we’re not changing anything.”

As business softens in China, contract manufacturers such as Taiwan’s Compal Electronics are trying to win orders from Micromax and other phone makers in India, but those emerging companies have been less willing to commit to a supplier than more established companies such as Sony and Nokia, says Steven Tseng, an analyst in Taipei with the brokerage Daiwa-Cathay Capital Markets. “I won’t say they are loyal customers,” Tseng says. “Those customers tend to shop around.”

To reduce the impact of the local slowdown, Xiaomi has begun working with Chinese appliance maker Midea Group on a smart air conditioner. Xiaomi may bring its smart air filter to India along with its phones, says Vice President Hugo Barra, and is also expanding beyond China and India, setting up shop in Brazil in July. Thailand, Vietnam, and Russia are coming within 12 months, Barra says, citing Indonesia as another focus. For now, though, Kanterman and Butler say, Xiaomi’s disappointing first-half results make the 2015 target of 100 million phones seem like “a stretch.”

The bottom line: Growth in China’s market of 400 million smartphone users has almost flattened, leaving manufacturers scrambling.

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