LGE – Harsh reality

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Only volume can improve profitability.

  • LG’s latest moves show all the signs of a company that has come to terms with its commoditisation.
  • In many ways, LGE is currently better off than Samsung as it does not have the huge burden of expectations of high market share and profitability.
  • LG has been chugging along for years with mid-single digit smartphone market share and 2-4% margins.
  • Its devices have been commodities for a long time and its recent 10 year patent deal with Google (see here) is a sign that it has recognised and embraced that fact.
  • Underneath the surface of this deal is an arrangement where LG agrees not to compete with Google’s ecosystem on its devices.
  • For LG, losing the ecosystem is not a problem as it has no margins to protect, but for Samsung it has been a disaster.
  • Consequently, any preferential treatment that LG gets from Google as a result of this arrangement is a plus.
  • Now that it has accepted commoditisation, LG is looking for ways to maximise its profitability.
  • This is why I suspect that it will reduce the number of devices that it releases in 2015E.
  • Almost all of the profit in the mobile phone industry are made by one or two models and as devices commoditise users find it harder and harder to tell the difference between different devices.
  • This makes it increasingly pointless to make 2 devices that are almost indistinguishable as far as users are concerned.
  • Consequently, I suspect that only one of the LG G3 and LG G3 Pro will see a G4 version.
  • This will reduce R&D costs and is unlikely to reduce overall volume meaningfully giving a lift to profitability.
  • The problem remains that while LG is streamlining its cost base, the Android market continues to get more and more competitive meaning that any savings are likely to be eaten up in price declines.
  • Hence, I very much doubt that LG’s position will improve next year unless it can benefit from Samsung’s problems and take some share.
  • This would benefit margins through scale benefits and is the only way that I can see margins going up in 2015E.
  • I continue to think that the only beneficiary from the current situation in Android is Google whose ecosystem registers more traffic as more capable handsets are put into user’s hands at lower prices.
  • Google remains the only place to invest within the Android ecosystem.

RICHARD WINDSOR

Richard is founder, owner of research company, Radio Free Mobile. He has 16 years of experience working in sell side equity research. During his 11 year tenure at Nomura Securities, he focused on the equity coverage of the Global Technology sector.

Blog Comments

Reducing the number of SKUs would certainly make sense, but PC market is full of companies which have been steadfastly refusing to take that step. It seems commodity tech companies are reluctant to give up any niche. (The variety of diaper brands and models suggest this is not unique to tech.) Why do you think smartphone market will evolve differently?

I dont think that Diapers are a commodity because there is still dfferentiation to be had when it comes to performance. PCs are and thats the way that the handset market is going. The landscape of players is very similar.