Huawei vs Samsung: Rivers of Blood

on July 25, 2016

Huawei flat-lines, passes advantage to Samsung 
The first indications for the smartphone market in Q2 16A are pointing to a loss of momentum for Huawei, Vivo, and Oppo. It will put a crimp in their plans to continue their rapid growth in 2016. Huawei is of particular note as it has very aggressive plans to become No. 1 in smartphones indicating it needs to employ a different strategy to continue gaining market share.

The net result is Huawei is no longer closing the gap on Samsung and its global ambitions are grinding to a halt. Huawei is now a comfortable No. 2 but I see it only making margins of 2-4% in the best instance. In order to earn better margins, it must become the No. 1 in terms of volume and outsell its closest rival by a factor of more than 2 to 1. It is this volume advantage that allows Samsung to earn 10-12% margins on Android devices which I think is sustainable for as long as it can maintain that volume advantage. This will be very difficult to achieve which is why I think Huawei is also working on differentiating its products through software and services.

I see three areas of development:

First: user experience. The aim is to lift the user experience on Huawei phones above other Android makers and thereby achieve differentiation. The user experience in developed markets is already reasonably well defined but RFM research finds that, in China, almost everyone struggles as 90% of users have low-quality stock Android. Only Xiaomi has developed a unique user experience but unfortunately, this has done nothing to help its poor profitability. Hence, I think Huawei will have to do something very special to achieve a price premium for its products which is unlikely to last long as good ideas will quickly be copied.

Second: proprietary operating system. I think Huawei is also building a complete alternative to Android where it would have full control of both hardware and software. This would give it the freedom to fully optimise the software to run with its silicon (HiSilicon) as well as to develop its own suite of services without having to put Google as the default. The problem is that outside of China and Africa, the Google ecosystem dominates Android to the point where it is almost impossible to sell an Android device without Google Play on it. Google uses this demand for Google Play to require handset makers put its services front and centre on their devices as well as precluding them from making devices based on other versions of Android. Hence, while this status quo exists, the Huawei version of Android is very unlikely to see the light of day outside of China.

Third: services. This is the Holy Grail because, if Huawei can develop a suite of Digital Life services millions of users love, it will be able to charge a significant premium for its devices. Unfortunately, this is by far the most difficult thing to do as one has to both build great services and then convince users to use them. Furthermore, in both China and overseas, there are bigger and stronger companies already dominating in the services space. I find it encouraging Huawei has understood and committed to differentiating in software as this represents its best chance of fulfilling its strategy without a substantial bloodletting for all Android handset makers. I think China represents Huawei’s best chance as it is in China where the most improvement in the user experience is needed and this is Huawei’s home market. I also see the possibility of a tie-in with Baidu, Tencent or even China Mobile as possibilities as these companies have very nascent, if any, verticalization strategies for their services. However, this won’t help in developed markets and Huawei must do everything it can to develop the appeal and attractiveness of its Honor brand.

These strategies will be difficult given the dominance of the Google ecosystem in these markets but I see cracks in Google’s position that might just give Huawei a chance. Huawei’s commitment to this strategy will be sorely tested as it is going to be a long and hard road and handsets could easily lose a lot of money before everything comes right. For the moment, the advantage has passed back to Samsung, who is also capitalising on the popularity of the Galaxy S7 to extend its lead in terms of profitability. This is why Samsung rests alongside Microsoft and Baidu as my top picks for 2016.