Starting a New Smartphone Company - Breakeven AnalysisResearch Paper

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Smartphone Start-Up

This paper examines the possibility of a new smartphone start-up company. The focus is on understanding the dynamics of the industry, because it is from that understanding that the company can derive strategy. Then, an analysis will be required to understand whether the company will be profitable, or more specifically what it will take to be profitable, and whether that is feasible or not. It is determined through the course of analysis that profitability is possible, though it will be difficult, due to the changing nature of the industry. Key growth markets are entering maturity, something that has resulted in a more challenging environment for a start-up than any other company that has a significant share in the market today. However, there are still some relatively young companies, mostly in China, that are having success in this industry and whose experience can provide insights -- if not hard financial data -- upon which a reasonable analysis of profitability can be based.

Introduction

Starting a new smartphone company -- from scratch -- is probably not the brightest idea in the world. The industry is highly competitive, and the learning curve on the technology side is very high. Your benchmarks are not going to be Apple, Samsung or those sorts of companies. Even well-capitalized companies with high levels of technological skill (HTC, Nokia, Motorola among others) have found it impossible to match the technological leadership of Samsung and Apple. Blackberry is barely even in the industry any more, and they were once the leaders.

Your benchmarks are going to be the companies that are entering the business today, with the business models that make that possible. In essence, the only way into this industry, unless you're playing a child's game of make believe, is to start at the low end, and build share by offering cheap phones to people who cannot afford the world's premium models, but instead are in the value segment. That's usually people in the developing world, which is why these companies come from those same regions. The technology for lower-end models is cheap and easy to acquire. Xiaomi is probably the biggest success story, but there are several other companies in China that have followed this pathway into the business (Chinese Smartphones.com, 2014).

Ethical Worldview

The product will be made under normal conditions for smartphones in China. The job of this company is to make money, and that will be done within the context of whatever laws are in place. That means that while we will not engage in bribery, we are also going to work with the subcontractors that deliver what we need in terms of quality and price. We are not going to be the police of the Chinese labor system -- our job is making and selling phones. The consumers have demonstrated quite clearly that they do not care too much about ethical issues when shopping for phones, so there is no financial advantage to be gained from taking a different ethical stance than our competitors take.

Implications

There are several implications of entering the smartphone business. First, there should be a discussion of the prevailing industry characteristics, as they are critical to understanding the financial ramifications of starting a new smartphone company. First, this is a highly competitive industry. At the high end, you would need to attract the best talent in the world away from Samsung or Apple -- good luck with that. It might have been possible to start at the top, leapfrogging the leaders, back in 2009 or 2010, but today even big money companies that are trying to do this cannot accomplish the task. A start-up with no brand isn't going to get the talent needed to realize that vision, and needs to build itself up, similar to how Huawei has done this over the course of several years. This is what makes the low end attractive. The technology for lower-end models is usually 1-3 years old, available off the shelf. A new company in this segment, therefore, has a relatively flat learning curve, and is mostly in the assembly and marketing business. The design aspects are going to be derivative, and that is simply not the most important part of the value chain for this start-up.

Thus, the focus is on finding two things. The first is an efficient supply chain, and the second is finding a market. More or less, the key to the latter is the former. There are no meaningful gaps in the smartphone market. Consumers generally opt for the best phone that they can afford. Thus, there is a fair bit of room -- and competition -- at the low end, where barriers to entry are low. Low barriers means a high level of competition, and with all companies seeking to succeed with a high volume/low margin strategy at the low end, being able to offer value is essential to success.

A good example of how to enter and grow rapidly in this business is Xiaomi, which is the largest OEM in China, the world's largest smartphone market. The Xiaomi flagship, the Mi4, is derivative of both the iPhone and the Galaxy, but the company undercuts both by half. It has a few specs that are better, but mostly it runs like an older version of those phones -- but not that much older. Essentially, the Mi4 is a very good phone at half the price of the industry-leading phones. This makes it incredibly attractive to buyers. Further, Xiaomi has surrounded its main lines with tablets, an app store and the otherwise full suite of services and products, just like the biggest companies (Amadeo, 2014). This has helped it to market itself as a value premium brand -- something that has allowed it to overcome its poor starting position as a brand nobody had ever heard of. While those ancillary services provide revenue, they also serve to make the entire product offering better, and it is recommended that any company serious about making an impact in the smartphone business have a similar "value premium" approach. Other Chinese upstarts are taking the same pathway to success, recognizing that a large segment of the market wants good features, but does not necessarily need to pay for the full range of premium features. Both Oppo and OnePlus are building on this strategy, for example (Seifert, 2014).

Aside from the phone, there are the service and distribution aspects that need to be paid attention to. How the phones are sold, distributed and serviced are of course all elements of the value chain. These need to be conceptualized in order to cost out those different elements. First, most start-ups are focused on Asia markets. They need to sell volume, quickly, in order to build their business, because margins are slender on derivative, commoditized phones. There's a reason all the new manufacturers come from China -- they make phones cheap and they have a huge market. India has people, but not the same manufacturing capacity. Russia, especially with the weak ruble, might be a place to start, but ultimately China is hard to beat as a proving ground. So the start-up has to look at the cost of assembling a phone, and marketing that phone in China. Why not the U.S. Even the best companies in China have had difficulty breaking into the American market. Apple and Samsung dominate this market -- their shares total 70.9% of the American market together, leaving little room for upstarts, with less than 30% of the market dedicated to anything other than the highest-end phones (Ausick, 2015). This compares with the worldwide market, where those companies hold a collective 42.9%, leaving much more room in lower rungs of the market for new entrants. It is worth noting that the only low-end phone among the top five manufacturers is the oldest and most diversified -- Huawei, with 5.2% of the global market. Xiaomi is the #6, leading a large peloton of smaller brands fighting for 40% of the world's share (IDC, 2015).

The industry is in a state of maturity, which is a condition significantly different from that in which any of the major industry players arose. The history of the industry is one of rapid change. Blackberry and Palm were the initial smartphones, or prototypes thereof, and they were aimed at the corporate market. Apple's first iPhone was really the first smartphone aimed at the consumer market, and it was a tremendous success. Among the followers, HTC first and then Samsung, were able to close the gap on Apple's technological leadership. The smartphone market was a race to the top, with the high-end phones being the big sellers, and sales focused in major economies.

In more recent years, the major markets have remained focused on high-end smartphones, with only around 30% of market share in the U.S. For example available for anything but the latest models. The U.S. market is showing signs of maturing, but short product life cycles are a factor in… [END OF PREVIEW]

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