Meitu leaves the dancefloor – and the brutal smartphone OEM crunch begins

The brutality of the dance marathon. Still from They Shoot Horses, Don’t They? © Palomar Pictures 1969

“They shoot horses, don’t they?” asks the beautiful woman near the end of the film of the same name, as she and her partner consider their hopeless struggle to stay awake in a dance marathon – one of the US Depression’s little entertainments, where you could win a prize, and more importantly get food, if you could only stay on your feet.

The modern form of the dance marathon is the smartphone business. The latest to take one to the head is Meitu. It’s a Chinese smartphone company which previously attracted some attention for its “beauty shot” selfie system (and some more attention for its data-grabbing ways). The reason you probably haven’t heard of it is because it’s pretty small on a global scale: since launching in 2013, it has sold a total of just 3.5m smartphones. That’s about 0.7m per year. Apple sells about that many per day in a slow quarter.

Now, though, Meitu is interesting for a different reason: it’s an early casualty of the coming smartphone crunch. The whole business is in a recession, and small players are going to get squeezed out.

Meitu put up the white flag on Monday with an announcement in which it says that it will licence its brand to Xiaomi: “the Board has determined that it is in the Group’s interests to operate this business by way of cooperating with a partner with the scale and reach of Xiaomi.” Why? Because as it explains further down its note to the stock exchange, its net loss for the second half of 2018 will be way bigger than its first-half loss, which was RMB127.4m (US$18.4m). In fact the full-year loss could hit around RMB1bn ($144m) – up from 2017's RMB197m ($28.4m). The reasons are simple: it sold fewer phones. And: “Given the intensity of competition of the smartphone market that has further accelerated in the second half of 2018, it appears that our smartphone business is no longer profitable.”

Meitu isn’t the first (remember BlackBerry? Moved to a very similar licensing model back in late 2016) but it’s definitely not going to be the last. Most people don’t follow smartphone sales closely, so here’s some news: the smartphone business is officially in recession, with sales numbers down year-on-year for four quarters in a row, and it’s expected that sales for Q4 (which we’re in now, running to the end of December) will be down annually too, marking yet another year of lower sales.

Time to see the shrink

What happens when a market shrinks? The smaller players get squeezed out, because their losses become unsustainable as they lose scale. We’ve seen this in the PC market, where a number of Japanese companies have exited the market (Sony) or effectively handed the business over to a more successful one (Fujitsu, with Lenovo).

For the past few years China has been a cauldron of smartphone OEMs trying to break through, or just break even.. Quarterly sales there regularly exceed 100 million – but along with most other regions, they’ve dipped in the past few quarters.

This has put a lot of pressure on smaller players. And there are a lot of them. Counterpoint Research’s breakdown of profits in the smartphone industry for Q2 2018 (the most recent available as I write) reckons that Apple grabbed 62% of all profits, while Samsung, Huawei, OPPO, vivo and Xiaomi grabbed 17%, 8%, 5%, 4% and 3% respectively. I’ll help: that means the top six OEMs took 99% of available profit.

That remaining 1% of profit? Shared out among more than 600 brands. But how much is 1%? Well, if Samsung’s 17% was 2.67trn won, or $2.4bn, then 1% is $141m. Shared evenly among 600 brands, that would be $230,000 each. You know of course that it isn’t shared evenly. Some are doing OK, and some are losing money, such as Meitu, above, or HTC (though it can barely be called a smartphone OEM these days), or ZTE (which was hobbled by a ban from the US for breaking an embargo on exporting equipment to Iran – a ban that it agreed to observe and then, amazingly, breached). And this is before we think about the many, many other tiny brands being made in China.

It’s hard to make money in the smartphone business, particularly because if you’re not Apple, then you’re making an Android device, which means you’re competing with 600+ brands all running the same basic software. There’s a great deal more variety about the OS in China; the open-source Android is just a base layer, onto which lots more is larded (Xiaomi in particular has carved out its niche there through its MIUI OS). But even so, competition tends to boil down either to price (customers prefer it lower; vendors, higher) or brand.

And the general story remains: to stay in the dance, you have to have stamina. That means the ability to withstand losses (Xiaomi’s huge venture capital injection helped there) or having a supportive partner (Huawei’s phone network business was hugely profitable long before its smartphones) and/or good distribution.

Stop the music, I can’t dance any more

The reality is that only the strong are going to survive this. The PC market is long past its peak, which came in mid-2011, and the big six companies (Lenovo, HP, Dell, Apple, Asus and Acer) are taking more and more share as former rivals fall away, unable to keep moving to the music of loss.

The mass smartphone market, despite being about 30 years younger than its PC sibling, seems to be heading the same way. It’s hard to imagine we’ll see the heady growth of 2010 – nearly doubling year-on-year! – again. There aren’t any new continents to conquer; even India has been showing signs of slowing down.

Percentage growth figures for the worldwide smartphone market. Sources: IDC, Gartner, Counterpoint, Strategy Analytics. The latter says the market has declined for four quarters; the others don’t, but still think things are bad.

Thus smartphone OEMs from Samsung and Apple on down are trying to figure out how to manage a static or declining market, where people are hanging on to their phones longer. In Samsung’s case, it makes more and more models, and pushes them in newer countries.

In Apple’s case, the answer is to raise prices so that you get more from those people who buy less often, while building a services theme (Apple Music, iCloud) around them and offering add-on hardware (Watch, AirPods) that can provide mid-upgrade add-ons.

Some Chinese brands are going to come out of this well: Huawei is powering ahead, and vivo/OPPO/OnePlus (effectively all same company) look assured, as does Xiaomi, after a serious stutter in 2016.

But not Gionee, once China’s fifth-biggest smartphone maker, which on 29 November revealed it owes US$2.45bn to banks, suppliers, and advertising agencies; it’s basically gone. Its CEO says he lost about $150m gambling — perhaps with the company’s money, he’s not sure. The company’s been losing money since 2013, he said. Off the floor with you!

But ZTE, TCL, Lenovo (caught holding Motorola when the music stopped, and still unable to make it turn a profit – despite its 2014 claims it would quickly have it profitable, Motorola’s still burning money, as it has done through its life) – they all look troubled. Their best hope now is that some of the other 600-odd brands will give up, like Meitu, and license their brands to them, which might give them the chance of surviving, at least for a few more quarters, in the hope that someone else will stop dancing first.

But abject, subjugated survival is hardly a wonderful way of life for any business. They shoot horses, don’t they? For some smartphone OEMs, that might look like the easy way out in the next couple of years, as they pray for someone else to please, just please, drop out first.

(Edited on 29 November to add the too-good-to-miss Gionee story.)