Services, instead of hardware, are expected to drive industry as it enters second decade
By Betsy Morris
Nearly a decade after taking off, the smartphone is at a turning point.
Advances in hardware have become incremental, and growth in handset sales has largely stalled. But the development of software and services on the phone is booming, driven largely by advances in artificial intelligence, expanding what the devices are capable of and making them increasingly indispensable.
The change is roiling the industry. Slowing growth has intensified a market share war in China and has pitted Huawei Technologies Co. -- the world's third largest smartphone maker -- more directly against market leaders Apple Inc. and Samsung Electronics globally.
It also is a major reason behind chip giant Qualcomm Inc.'s pending purchase of NXP Semiconductors NV for $39 billion, as it looks to diversify beyond supplying chips for smartphones. And it is the reason Apple -- famed for its hardware -- is boasting about growth in its services.
After Apple unveiled the iPhone a decade ago this week, global sales of smartphones soared for years, with unit shipments, for instance, growing as fast as 75.8% in 2010 from the year before. But shipment growth had slowed to 10% by 2015 and is expected to have increased by 0.6% in 2016, according to International Data Corp. Rival research firm Gartner Inc. estimates higher sales growth of 4.5% in 2016, compared with 14.4% in 2015, but projects that sales of premium smartphones such as the iPhone and Samsung's Galaxy S series will fall 1.1%.
Several factors are sapping the smartphone market's momentum. With 1.45 billion smartphones sold world-wide in 2016, according to IDC, much of the global market is saturated. In the U.S., wireless carriers lately have moved away from offering subsidies in exchange for signing long-term contracts to requiring customers to pay full price, which begins at $649 for a new iPhone 7. So consumers are waiting longer to replace their smartphones: Citigroup estimated the handset replacement rate lengthened to 31.2 months by third quarter last year from below 24 months in 2011.
And while phone makers lately have added features like second camera lenses and waterproofing, few analysts expect major new hardware advances that could drive sales growth beyond single digits in the foreseeable future.
"The question is: can there be something else to get sales going again," said analyst Gene Munster, who recently left Piper Jaffray to start a venture-capital firm. Some features that could juice demand are still likely years away, such as truly foldable glass displays that would allow a phone-tablet combination to fit in your pocket, or a dramatic improvement in augmented reality that would take it beyond rudimentary games and into practical uses like figuring out if a chair you want to buy would fit into your living room.
While hardware advances have been less exciting, software is changing at head-spinning rates, driven by advances in how computers process giant amounts of data using artificial-intelligence techniques. Those have enabled big leaps in vision and speech-recognition software that have led, among other things, to much improved versions of virtual assistants such as Apple's Siri, Amazon.com Inc.'s Alexa, and Alphabet Inc.'s Google Assistant.
Amazon's Echo speaker, which uses Alexa, and Snap Inc.'s new Spectacles, camera-bearing sunglasses, are examples of what Benedict Evans, partner at venture-capital firm Andreessen Horowitz, calls "frictionless computing" -- easy-to-use devices that unite applications with hardware beyond smartphones.
Ben Schachter, senior analyst at Macquarie Capital, says: "Our view is the next big innovation will be from outside the device -- from the software." He expects increasing use of such software to meet entertainment, health-care, home innovation and automotive needs.
Though Apple touted its newly launched iPhone 7 on its last earnings call in October, the star was its services business, which includes Apple Pay and the App Store. Services revenue grew 24% from a year earlier to $6.3 billion during the latest quarter -- still only about 22% the amount from the iPhone, but iPhone revenue fell 13%. Chief Executive Tim Cook said the services business has nearly doubled in the past four years, on track to be the size of a Fortune 100 company in the current fiscal year, which ends in September.
A lot of Apple's smartphone success has resulted from its control of both its hardware and its software. Now Google is emulating that. The company for years focused its mobile efforts on developing free Android operating system software, which runs 85% of global smartphones shipped each year. But in October it launched its own Pixel phone.
For other hardware companies, the battle for market share is getting increasingly intense as the pie grows more slowly. Huawei, which doubled revenue in the past five years, wants to be the No. 1 smartphone maker in five years and is competing at the high-end of the market. It introduced its pricey Mate 9 phone (costing $776 in Europe) last month in Germany. The company also launched Honor 6X, aimed at millennials in the U.S. and at a more affordable starting price of $249, to positive reviews at the Consumer Electronics Show in Las Vegas last week.
"The smartphone is changing. It is becoming the control device" for home speakers or television when one can't find the remote, said Raj Talluri, senior vice president of product management at Qualcomm. "The phone becomes the hub."
Write to Betsy Morris at email@example.com
(END) Dow Jones Newswires
January 12, 2017 02:48 ET (07:48 GMT)
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