The recession was supposed to impose a new era of frugality. But when it comes to mobile phones, consumers are still eager to open their wallets for the latest thing.
That's made the market for smart phones -- handheld devices that allow people to surf the Internet, check e-mail, play music and games, shoot photos and video, organize their calendars and, yes, make phone calls -- the hottest consumer battlefield around.
Score the latest round for Apple (AAPL, news, msgs), which sold a million of its new iPhone 3G S phones last weekend. In a bid to frugality, the company has cut the price on its older models, but who wants anything but the latest thing?
Before we declare a winner, however, consider this: Last week the Pre smart phone, from Palm (PALM, news, msgs) -- the company that started the craze years ago -- sold out on its release. And Research In Motion (RIMM, news, msgs), which makes the BlackBerry devices that are so popular with business users, saw sales leap an impressive 53% in its most recent quarter.
It's easier to figure out who's losing this war. Thus far, competing phone makers such as Nokia (NOK, news, msgs), Motorola (MOT, news, msgs) and Samsung haven't kept pace. And since smart phones are starting to compete with other gadgets, the makers of digital music players, GPS devices and handheld games, including Nintendo's (NTDOY, news, msgs) DS, could suffer.
Also on the winning side: Best Buy (BBY, news, msgs) and other companies that sell these phones head to head. "We think the summer is going to be huge, and we are fired up by it," says Scott Moore, the vice president of marketing for Best Buy Mobile.
No recession here
Moore had good reason to be cheery even before the new phones hit the market. Consumers have been buying smart phones throughout the recession.Consider:
- Mobile phones were the bright spot in Best Buy's February-April quarter. Driven by smart phones, mobile sales shot up by about 15%, compared with sluggish 1% sales growth overall.
- At Research In Motion, whose products include the popular BlackBerry Curve, sales leapt as smart-phone fans signed up for 3.8 million accounts, a 65% increase over the year before. Most of them were consumers, as opposed to business users, the company's traditional base. "I think we've demonstrated a lot of surging strength in the last two quarters, and I'm not seeing anyone here take their foot off the gas," co-chief James Balsillie said during the company's quarterly conference call with analysts.
- Worldwide during the first quarter, consumers bought 36.4 million smart phones, an increase of 12.7%. That's pretty striking when you consider that overall mobile-phone sales declined 8.6%, according to Gartner, a technology research company.
Smart phones now represent 13.5% of mobile-phone sales worldwide, Gartner says. And a recent survey by the Yankee Group concluded that 41% of people in North America want one.
Research In Motion plans to introduce a version of the BlackBerry called the Tour and is working on a new touch-screen model with a flip-out keyboard like Palm's Pre.
Nokia hopes to join in, too, rolling out models that should at least sell well abroad, and we may finally see more smart phones using the Android operating system made by Google (GOOG, news, msgs).
Research In Motion co-chief Balsillie expects sales this fall and holiday season to be "very, very strong."
The smart-phone allure
Why are smart phones hot at a time when consumers are otherwise turning frugal?Sure, there are fresh, cool features. The Pre's flip-out keyboard frees up space for a bigger screen and has an operating system that makes the phone more like a computer. Apple broke ground with a touch screen, and the latest iPhone sports a video camera and faster speeds.
But beyond the cool features, smart phones are a big hit for three basic reasons, analysts say:
They have badge value. This marketer's term means that when the phone gets strategically placed on the table at a meeting or during a meal, it sends a message: I'm hip.
"People want to be seen with the product," says Moore, of Best Buy Mobile. "It is statement about you."
At a time when we're worried about job security and our finances, the $2,400 or so it takes to fund a smart phone and a two-year contract may be a good deal on an ego boost.
They're the new Swiss army knife. Smart phones are consolidating several consumer electronics on one device, says Research In Motion's Balsillie. People can now do everything on them -- access the Web and play music and games -- while also staying in touch with friends and family.
That last part is key, especially with the growing popularity of social-networking tools such as Facebook, MySpace and Twitter, all reached easily via smart phones.
What's important for so many users is "the sense of being always connected," says Phil Goldstein, who follows the mobile-phone sector for FierceWireless, a Web site on the wireless industry. "It's having the ability to take the desktop Internet experience with you in your pocket because the browsers are becoming more sophisticated."
Their lower prices. It doesn't hurt, of course, that all this technology is getting cheaper. Apple dictates prices on smart phones -- and it keeps driving them down. In rolling out the new iPhone 3G S for $299, Apple cut prices on its older iPhone models to $99 and $199. William Blair analyst Anil Doradla says this will force competitors to bring down prices as well.
Carriers, meanwhile, are offering offer cheaper monthly service plans that bring costs down for new customers.
Investors have noticed the buzz, of course. Despite recent weakness, smart-phone stocks are up sharply for the year. So you have to be selective now.
Here's a deeper dive into the key players:
Apple
Apple has built a strong relationship with consumers by creating devices that are a breeze to use and look cool to boot. The newest iPhone is just another example. "Apple creates elegant products that are easy to use, and that is what is driving demand," says Ryan Jacob, the portfolio manager of the Jacob Internet Fund (JAMFX).Another key draw for consumers is the company's "app store." It offers a huge selection of small software applications, many for free, that allow iPhone users to perform nifty tricks, such as identifying a song by letting the phone listen to just a snippet. Collins Stewart analyst Ashok Kumar estimates there are 50,000 apps for the iPhone, compared with just 1,000 for BlackBerry smart phones.
A possible problem is that the iPhone works with only one carrier, AT&T. But Tim Cunningham of the Thornburg Core Growth Fund (THCGX) says the popularity of the iPhone allows Apple to get the best end of this exclusive deal. Consumers pay $99 to $299 for their iPhones, while AT&T pays Apple somewhere between $550 and $650 per unit.
Kumar has a $170-a-share price target on Apple stock, now around $137.
Research In Motion
A big plus for BlackBerry maker Research In Motion is that it has its own network to carry a lot of the e-mail and data traffic, taking much of the burden off partners like Verizon or AT&T, Cunningham says. Businesses also lean toward BlackBerry because it offers good security features.The company is also a pure play on smart phones because it doesn't sell regular phones or computers, and it has lots of models and partnerships with hundreds of carriers around the globe.
Its stock got ahead of itself because of investor hunger for smart-phone plays, and it's now pulling back from a recent peak above $85 a share. I'd wait to buy when it hits the mid-$60s.
Qualcomm
This communications chipset design company recently raised sales guidance for the year by 9%, citing continued strong demand for mobile phones. Thornburg's Cunningham says continuing increases in demand for smart phones will continue to help Qualcomm (QCOM, news, msgs).Qualcomm chips are used in most of the popular smart phones, and more-sophisticated phones and phone networks call for more chips -- and more-complex chips that carry higher profit margins.
Goldman Sachs analyst Simona Jankowski upped her rating on Qualcomm to a "buy," with a $53 price target, after the company announced it would take attractive royalties on chips used in a next generation of wireless technology called Long Term Evolution, which is being rolled out later this year.
Palm
Palm was an early leader in the handheld device space with the Pilot and later the Treo, then lost ground after a series of marketing blunders and product mishaps.Now, it is back in the game with the Pre, designed by Apple defectors who are working for Palm. The company's stock has taken off as a result, and it looks pricey compared with competitors', says Canaccord Adams analyst Peter Misek.
"While Palm has many successful product launches under its belt, we'd be wary of investing in a firm that has so much hinging on a single product release," agrees Morningstar analyst Joseph Beaulieu.
Nokia
Nokia is still the 800-pound gorilla in the global mobile-phone business, with a commanding 37% market share for handheld devices. But it's failed to make inroads into the U.S. smart-phone space.The company is also losing ground to Apple, Research In Motion and other competitors in the high-end smart-phone market, which carries larger profit margins. Nokia's global share of the high-end market eroded to 38% in 2008 from 50% in 2007, says Morningstar's Michael Hodel, one reason he thinks its "days of reaping massive returns on invested capital are numbered."
The wireless carriers
It's the snazzy phones that command the consumer's attention in smart phones, not the details of the wireless service plans, Thornburg's Cunningham says. That's why smart phones offer the juiciest profit margins in the game.Though AT&T (T, news, msgs), Verizon (VZ, news, msgs), Sprint Nextel (S, news, msgs) and other carriers are making a bundle, too, soon things will get trickier for them, cautions Jacob, of the Jacob Internet Fund. To broaden their reach and sign up customers, they'll have to start offering pre-pay plans and cheaper plans with usage caps. It could be hard to do that without sacrificing revenue by "cannibalizing" their current customer base now in unlimited plans.
At this point, I'd buy Apple and Qualcomm around current prices as long-term plays on smart phones.
Research in Motion is a solid pure play because it has so many models available via so many carriers. But I'd wait for more of a pullback to buy.
Be careful with Palm. The risk here is that it winds up remaining a one-product company if it can't replicate the Pre's recent success. And I'd steer clear of the carriers for now. They might open up the field for more people to buy smart phones by lowering prices but end up looking pretty dumb in the process.