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In Smartphone Market, It’s Luxury or Rock Bottom

For Apple Inc. and Xiaomi, the Chinese smartphone maker often described as the “Apple of China,” it is the best of times. For most of the companies’ competitors, not so much.

In December, Xiaomi became the world’s most valuable tech startup, worth $46 billion. And last week’s blowout quarterly results for Apple were credited to just about everything—from consumers’ lust for big phones to Chief Executive Tim Cook ’s steady hand on the tiller—except for the most important factor of all.

Apple and Xiaomi’s successes reflect the world’s growing income inequality.

Take a look at the chart accompanying this article. It shows the average selling price for smartphones from Apple, Xiaomi and all makers of Android-based phones. It succinctly captures a trend that has damaged the fortunes of just about every smartphone maker other than Apple, Xiaomi and a couple of other companies at the low end of the market: a hollowing out of demand for smartphones priced in the middle range.

The falling price of the average Android phone is driven by supply and demand, of course. As smartphone components become ever-cheaper, devices by Xiaomi, Coolpad Group , Vivo and countless no-name Chinese manufacturers whose wares are rebranded and sold throughout the developing world, keep driving down the price at which a smartphone is “good enough” for most users.

Xiaomi is masterful at this game, and its online-only sales and narrow range of products allow it to sell its phones at rock-bottom prices, says ABI Research analyst Nick Spencer. (Xiaomi also has curated a massive user community that serves as a powerful marketing engine.) This has forced competitors to react.

In the most recent quarter, profits of Samsung Electronics ’ mobile division plunged 62% from a year earlier, leading the South Korean company to declare that it would attempt to sell less-expensive phones, just like Xiaomi. Chinese mobile giant Huawei Technologies, meanwhile, is going in the opposite direction, and will attempt to sell only high-end phones.

But these trends don’t explain the fortunes of Apple, which did the seemingly impossible last quarter—that is, sell more phones, but at a higher average price, than in previous quarters.

Only one kind of product behaves like that: a luxury good.

By maintaining its own walled garden of services, with a huge selection of apps that are often better-implemented than on Android, Apple has sufficiently differentiated itself from the mass of Android phones to charge consumers on average two to three times as much as they would pay for a comparable Android device.

In China, Apple has become the luxury brand most frequently given as a gift, ahead of Louis Vuitton, Gucci and Chanel, according to a survey released last week by Hurun Report, which tracks luxury goods in China.

As the market for smartphones matures, they have come to resemble any other consumer good. A recent piece in The Wall Street Journal on America’s “two tier” economy outlined the way that makers of everything from homes to groceries are responding to the hollowing out of America’s middle class: They are moving either to the high or the low end of their respective markets. The same thing is happening to phones.

The twist here is that smartphones are sold all over the world, and this split market is hardly just a product of what’s happening in the US. Indeed, Xiaomi doesn’t even sell its wares outside of Asia. But just as a growing class of global rich is creating a demand for the highest-end phones—made by Apple—so, too, is a growing middle class creating demand for phones made by Xiaomi and its ilk.

“Middle class” is by nature a relative term. To be part of the world’s richest 1%, you need make just $34,000 a year, Foreign Policy noted in 2012.

Xiaomi’s best-selling phone, the Redmi, sells for about $100 in India, where someone purchasing his first Xiaomi phone certainly qualifies as well off by the standards of his countrymen, who make on average about $600 a year.

It’s no mistake that the low end of the smartphone market appeals to both ever-poorer Americans and ever-richer citizens of the developing world, when you consider that many economists agree their fates are linked. Outsourcing and, to a lesser extent, automation have depressed the wages of the American middle class even as they increased them everywhere else.

Thus, the commoditization of smartphones has led to price trends which highlight the fact that there have always been two distinct markets for smartphones: A luxury market, and everyone else.

Predictably, distribution of profits between these two markets mirrors the distribution of wealth between the buyers of these goods. Analyst Horace Dediu estimates that in the past quarter, Apple captured about 90% of all profits in the mobile market. The world’s top 10% control 87% of the world’s wealth, according to economist Justin Wolfers.

If current macroeconomic trends continue, two things will happen. The first is that, as long as it can maintain its luxury brand, Apple should continue to show strong revenue, if not growth. Analysts say there are about 350 million iPhones in use in the world, which means Apple has already captured nearly 5% of the world’s population.

The second thing that will happen is that the average selling price of Android phones will continue to drop, as manufacturers battle each other to offer the most value at the lowest price. The good news in this fight is that hundreds of millions of people gaining access to the cheap but serviceable smartphones made by Xiaomi is hardly a Dickensian outcome.</p>