PC Makers Look To Invade the Handset Market
By Carlo Longino, Wed Oct 08 20:15:00 GMT 2003

The handset market has seen a number of new entrants over the last few years, but the major manufacturers have been able to repel most of their assaults on the western market. In addition to a number of Asian ODMs and manufacturers looking outside their home regions, a number of PC and electronics companies are eyeing mobile phones as their next target. Can companies like HP, Dell, or even Apple make a dent?

As the mobile market continues to grow, more and more companies are looking to get a piece of the pie. A number of companies have entered the market in the last few years, like Danger or Neonode, and several companies have expanded outside their traditional geographic or technological areas, such as Palm and Handspring, HTC, or even Samsung.

But the most recent movement sees PC manufacturers like HP and Dell, buoyed by their success in the PDA arena, looking to handsets. A Dell exec earlier this year said the company's next-generation Axim Pocket PC PDA would include both Wi-Fi and GSM/GPRS or CDMA connectivity, and that the company would also likely release a Microsoft Smartphone-powered handset. HP went shopping for smartphone quotes from a number of Asian OEMs including HTC, Compal, and Mitac earlier this year. And rumors of an Apple "iPhone," once pretty frequent, continue to pop up from time to time.

The PC market has seen a long and precipitous decline in selling prices and margins marked by the commoditization of hardware -- something traditional handset powers are keen to avoid, particularly as their own average selling prices erode, pressuring margins. Can top-tier handset makers avoid this, and can these PC makers succeed in the market?

Dell's entry into the PDA market provides a recent example. In less than a year since the introduction of their Axim Pocket PCs, the company has become the number-four PDA maker in the world, grabbing almost 7% of the market in the second quarter, according to IDG, and selling roughly 1 in every 6 Pocket PCs by my calculations, through a strategy of offering feature-packed devices at low prices. This is something they'd look to do with phones as well, but the dynamics of the PDA market are very different from the handset market, and may not pan out as well as they'd hope.

Nobody subsidizes PDAs, like carriers do phones, so people are used to paying much higher prices for them. A person who wouldn't think much of shelling out $400 or $500 for a PDA likely won't do that for a phone, when they're used to getting a carrier-subsidized device for less than half that. And your average Joe Public certainly won't be interested. There will be tremendous pressure on any new entrant to the market to drive down prices, particularly if they pursue a direct-sales model, like Dell has made its bread and butter, and try to leave out the carriers and their subsidies.

This puts a squeeze on margins. One of the main reasons for companies like Dell and Nokia's success in their respective fields are their abilities to leverage economies of scale. But that's a strategy that depends on volume, and it's doubtful that any new entrant will be able to quickly develop the kind of volume necessary to compete. Whatever a new entrant builds, a market leader can build more cheaply, and in turn, sell more cheaply, to stave off competition, if need be.

But they likely won't have to. Device makers and carriers enjoy a symbiotic, if sometimes strained, relationship. For all the talking carriers do about manufacturers' unwillingness to customize handsets, they also realize that their users are interested in name-brand phones, and will wait for them or pay a premium for them. On the other side, device makers rely on the carriers to subsidize mid- and high-end handsets. This is where new entrants will struggle -- developing relationships with the carriers and securing the necessary subsidies.

Entrenched incumbent device makers can use these relationships, as well as their pricing power to hurt margins. While investors like to look at margins as a key metric, a company like Nokia or Motorola that's selling millions of phones can absorb a small dip much more easily than a new entrant selling just thousands of phones.

Keeping healthy margins is essential, and as those margins shrink, sales volume becomes more and more important. Costs can only be shrunk so much, and its highly doubtful a new entrant to the market will be able to shrink them enough to disregard subsidies and still generate healthy margins, particularly when incumbents hold so many trump cards.