The Top 3 handset makers should be worried about Apple

Phil GoldsteinOne of the most far-reaching (and yet unsurprising) stories of the third-quarter earnings season was Apple (NASDAQ:AAPL) vaulting past BlackBerry maker Research In Motion (NASDAQ:RIMM) to become the world's No. 4 handset maker in the third quarter, according to research firms IDC and Strategy Analytics. This, coupled with RIM's surge that pushed Motorola (NYSE:MOT) out of the Top 5 in April,  should give the Top 3 handset makers--Nokia (NYSE:NOK), Samsung and LG--great pause. It also heralds a new era of unpredictability among the world's largest handset vendors.

The most obvious conclusion to draw from Apple and RIM's startling rise is that companies that can churn out smartphones on a massive scale are going to have all of the momentum in the months and years ahead. I think it also means that companies like Nokia, Samsung and LG that have relied on large shipments of low- and mid-tier devices are going to have to nimbly adapt to a world where smartphones make up a larger share of the overall handset base. 

To be clear, smartphones still are a minority. Smartphone shipments reached 77.1 million in the quarter, up 78 percent from the year-ago period, according to Strategy Analytics--but the firm noted that smartphones made up 23.5 percent of the 327 million total handsets shipped in the quarter.

In this environment, companies with well-defined smartphone strategies will thrive. Apple and RIM likely will put even more pressure on the margins of the world's Top 3 handset makers. 

IDC analyst Ramon Llamas said each of the Top 3 vendors has its own problems to deal with and strategy to focus on. However, he said what will determine their fate is how agile they are in adapting to a market more focused on smartphones. Since almost every handset maker is trying to capture large margins at the high end of the market, he said, that makes it even more imperative to be nimble, since margins will be under pressure. However, he noted, shifting strategies takes time. "At what point in the learning curve are you? At what point in the R&D curve are you?" he said. "It's not going to be an automatic where it's, 'I have a smartphone, let me look at my beautiful double-digit margins.'"

It is a bit of a Catch-22 for the Top 3 vendors, Startegy Analytics analyst Neil Shah said. They have to achieve high margins and profitability now to dump revenue back into R&D, which will help them stay ahead of the smaller, smartphone-focused competitors. Otherwise, he said, "they won't have the spending power to beat Apple or other Android vendors like HTC in the future," he said.

All of this is not to say that the Top 3 are doomed. "Due to the greater scale these players have and financial power they have, they should be able to bounce back if they quickly realign their portfolios in the high-end segment and arrest their decline in profitability," Shah said.

Nokia has an opportunity to capitalize with MeeGo early next year, Llamas said. Likewise, Samsung has achieved a great deal of success with is Galaxy S Android phones, but must follow through with more mass-market devices. LG is trying to dig itself out of a hole on the back of its Optimus Android phones, and could also find success with LTE handsets. However, the danger for LG, in particular, Llamas said, is that since it is already so far behind on smartphones, it will have to move even more quickly to catch up, which may be difficult to do.

The bottom line seems to be that for the Top 3, their position and stature will depend entirely on their ability to stay ahead of the curve on smartphones. The market is more in flux now than ever before, and in the coming years, I can easily imagine the likes of HTC, ZTE or Huawei crashing into the top 5.

The handset order, stagnant for so long, is rapidly changing. Nokia, Samsung and LG can't afford to sit still. --Phil