by Linda Yueh
Nokia and BlackBerry phones are good illustrations of Schumpeter’s ‘creative destruction’. Nokia was once worth $150 billion but was eventually sold for just $7 billion. How did all of this market value disappear?
For Finland’s Nokia it was the culmination of a rapid rise and fall. It introduced its first mobile phone in 1987 and by 1998 had overtaken Motorola to become the global market leader in handset sales. In 2005 it sold its billionth phone. Its peak was probably in 2007. By then its share of the global handset market had reached 40 per cent, including nearly half the smartphone market at the time, and its market capitalization hit $150 billion. Before its sale, its global market share had fallen to just 15 per cent, and this was mainly accounted for by its range of cheaper phones. Its share of the global smartphone market had plummeted to just 3 per cent.
A similar story of boom and bust describes the Canadian firm Research in Motion (RIM). Back in 2003 it launched the BlackBerry. By allowing people to email easily from their phones, its popularity grew quickly and its secure network was favoured by businesses and governments. The addictive nature of the phone led to it being nicknamed ‘CrackBerry’. By the middle of 2008, the company was valued at around $70 billion.
The subsequent decline was steep and the landing hard. Just a decade after its founding, RIM reported losses of $1 billion that meant cutting 40 per cent of its global workforce. Haemorrhaging cash and sitting on a stockpile of unsold handsets valued at $930 million, it was bought out by a consortium led by Toronto-based private equity group Fairfax Financial in 2013. The price was just $4.9 billion. Together, Nokia and RIM have seen roughly $200 billion evaporate. How?
In 2007 Steve Jobs walked onto the stage at the Moscone Center in San Francisco, pulled an iPhone from his pocket and talked of a revolutionary product that was going to change everything. The rest, as they say, is history. Apple’s take-off, along with Google’s Android system, has mirrored the decline at Nokia and RIM.
So where did Nokia and RIM go wrong? Were they just the latest victims of ‘creative destruction’ in the digital age?
They weren’t the first. In January 2012, after over 130 years of operations, Kodak filed for bankruptcy. The American company had once sold over 90 per cent of all film in the US and its little yellow boxes could be seen all around the world. Its death knell sounded simply because it was out-innovated in the very technology it had pioneered for over a century.
Ironically, Kodak had developed a prototype for the digital camera in 1975. But by the time it became apparent that it would be a game changer, it was too late. Japan’s Canon and Fuji had already established a decisive lead in the digital camera market.
Kodak’s is not an atypical story. A large incumbent company, successful for decades, finds it difficult to adapt to new technologies while it makes good profits in the traditional business areas. It is then left adrift once the whole industry has shifted for good. The lesson is, adapt or die.
Is this also true of Nokia and RIM? Nokia was innovative in hardware and was the dominant force at the outset of the smartphone market. However, Apple, and then Android, saw the value of software. Touch-screen technology changed the way people used their phones and both had app stores that were easy to use.
Perhaps Nokia showed a lack of urgency. In the early days of the iPhone era, the drop-off in global market share was gradual rather than abrupt, and Nokia was able to retain its position as the market leader. BlackBerry’s problem was that it catered primarily for business users and was left stranded when, with the advent of social media, innovation in the mobile phones market became strongly consumer-led. RIM failed to respond to the consumerization of IT.
In today’s high-technology era, consumers expect constant innovation and are quick to punish the products that fall behind. The pace of creative destruction has quickened and brands are no longer as resilient as they once were.
This is evident from the increase in stock market churn over the past few decades. In 1958 the average tenure of the companies listed on the S&P 500 was sixty-one years. By 1980, this had fallen to twenty-five years, and is now down to eighteen years. If the trend continues, three-quarters of the firms currently listed on the S&P 500 will be replaced by 2027.41
Apple and Samsung
What about the disrupter Apple? Could US technology giant Apple’s empire fall? Apple has made bumper profits from international sales. In 2017, it was the most valuable traded company in the world in history. And what about Korea’s Samsung, the market leader in the global smartphone market?
Japan’s Sony is a cautionary tale. During the 1980s and early 1990s, Sony was the Apple of its day. The company was synonymous with quality in the electronics industry. In 1979 it launched the iconic Walkman. Even when cheaper personal stereos flooded the market, the demand for Walkmans remained high because people trusted the brand. During the 1990s it teamed up with the Dutch electronics giant Philips to perfect the compact disc media format, but that was probably its peak.
When Apple launched its iPod in October 2001, Sony was criticized for being slow off the mark in the MP3 market. Since then its fortunes have been all downhill. The stock of the company had been downgraded to junk status due to its severe challenges to improve sales and profitability, while its core businesses are subject to obsolescence and rapid changes in technology.
It is very premature to forecast the eventual decline of Apple, but Sony, Kodak, Nokia and RIM exemplify the potential force of creative destruction. It’s been over a decade since the first iPhones started flying off the shelves. Apple, along with Samsung, has been at the vanguard of the smartphone revolution. The two companies dominate the global smartphone market. But there are signs that worldwide growth in smartphone sales is beginning to slow, and new competitors are emerging, notably from China. What might that mean for these two smartphone giants?
There are indications of market saturation in the world’s developed markets, while stronger growth has been found in developing and emerging economies such as China. According to the International Data Company, half of smartphone sales around the world are below $100, excluding sales taxes. Prices have fallen as smartphone technology becomes standardized and a swathe of manufacturers target the budget end of the market. In developed markets, customers are becoming more price-sensitive and a bit less brand-orientated. Wiko, a French start-up that is majority owned by a Chinese firm, sells some of its phones for less than that $100 benchmark. It has quickly claimed a share of the French market and has set its sights on the rest of Europe.
Consumers are also benefiting from rapid improvements in standard technology, so a cheap price does not necessarily mean low quality. In 2012 less than half of all smartphones priced at $80 or less had a processor faster than 1 gigahertz. A couple of years later, nine out of ten at this price did. Budget smartphones have also followed the trend of larger screen sizes.
Then there are the new competitors from China. After Samsung and Apple, the next three biggest smartphone makers are all from China. They are eating into Samsung’s world market share, which has fallen from one-third to around one-fifth. For Apple, two-thirds of its sales are outside the US, and in those markets the iPhone is facing considerable competition from cheaper brands.
And there are many of them. There are 6,000 handset manufacturers in Shenzhen alone. Once a fishing village close to Hong Kong, it’s now a massive tech hub rivalling Silicon Valley in California. This area produces the majority of the mobile phones in the country, and China produces more than half of the 2.5 billion phones sold around the world annually.
In light of this competition, what might happen to the smartphone pioneers Apple and Samsung in the coming years and how might they adapt to the maturing market and growth in manufacturers of cheaper smartphones?
The iPhone generates the biggest portion of Apple’s total revenues. It’s an expensive product. With Google’s Android operating system used in nearly three-quarters of all smartphones, the iPhone is looking increasingly
like a luxury and niche brand. Apple has never been an out-and-out hardware company and might respond by developing its complementary software and services. iTunes has about a billion subscribers, and with its acquisition of Beats Music, Apple has made a foray into the video and music streaming business. It has also developed a mobile wallet, working with MasterCard and Visa.
Samsung manufactures smartphones at a range of prices, but is coming under intense competition from manufacturers of cheap phones. It has started branching out into what it calls ‘wearable tech’ through a range of smartwatches. Apple too has launched a smartwatch. However, the uptake of wearables has been slow. It is perhaps too early to say whether smartclothing, smartglasses or smartwatches will come to challenge or even replace the smartphone.
There is also scope for smartphones to become even smarter. The recent trend to increase screen sizes could lead to flexible screens or built-in projectors. Augmented reality may encourage people to live their lives through their smartphone screens by allowing us to interact in real time with our surroundings.
Battery developments have so far failed to keep pace with the power demands of more sophisticated devices. It is ironic that as our mobile technology becomes more advanced, we need more regular access to a wall socket.
Figuring out the next innovation, though, will undoubtedly matter for these two, especially as there’s immediate competition on their heels. The world’s third largest mobile handset maker, Chinese firm Huawei, has launched a big screen smartphone, a phablet (phone + tablet), with an eye to challenging Samsung and Apple in the global smartphone market. In Schumpeter’s theory, how these companies manage the ‘creative destruction’ process matters not just for them, but also for their home economies. Schumpeter viewed the rise and fall of companies as the source of economic growth. As entrepreneurs create new companies and innovative products, the economy prospers along with them. Whereas standard models of the economy assigned no role to individual firms except as homogeneous producers of widgets, Schumpeter gave entrepreneurs the biggest role in explaining how innovation comes about and boosts the growth of an economy.
China’s innovation challenge
China is the major economy currently facing the considerable challenge of becoming an innovator. Is it possible for ‘Made in China’ to become ‘Designed in China’? Japan made that transformation, but many more countries have failed than have succeeded.
In the 1980s movie Back to the Future, Michael J. Fox’s character Marty McFly travelled back in time to the 1950s. He met a scientist who demanded proof that he was from the future. Even though Doc Brown scoffed at the idea of an actor (Ronald Reagan) as the US president, Marty managed to convince him. But Doc’s incredulity was further stretched when Marty says that in the future Japan will make ‘all the best stuff’. In Doc’s time, ‘Made in Japan’ was synonymous with products that were cheap and of low quality.
In roughly thirty years, Japan came to rival the United States and was the world’s second-largest economy. Japanese manufacturing was transformed from producing low-cost goods into launching world-beating companies such as Toyota. Now that China has overtaken Japan economically, could its companies become the next global competitors? Just as one company can overtake another, so one country can overtake another too.
Innovation, of course, takes many forms. But there’s one thing in common: talent. It’s what Joseph Schumpeter pointed out, which is that innovation comes from innovators. Can China produce the next Steve Jobs, for instance? Will there be innovators that transform the way that we live through their inventions and ingenuity? The answer to the question of Chinese innovativeness goes beyond manufacturing and into all areas of society, including the creative industries.
The Chinese government is actively investing in innovation. R&D spending has increased rapidly. China is predicted to surpass even US R&D spending in the coming years. Of course, it’s not just what is spent or the number of patents filed that determines innovation. It’s how useful these inventions are. And that data does not yet exist for China.
To complicate matters, much manufacturing now involves global supply chains. For instance, half of China’s exports are made by foreign-invested enterprises, so it’s multinational companies that are producing in China as well as domestic firms. Harvard economist Dani Rodrik estimated that the value of Chinese exports suggests that they come from a country with a much higher per capita income. Does that mean that China produces innovative exports or is it a place for global assembly?
A case study is Huawei. The giant telecoms equipment firm was founded in Shenzhen in 1987 by Ren Zhengfei. It imported telecoms equipment from nearby Hong Kong, just across the then Chinese border. It now makes the networks that power the internet and mobile phone networks around the world. Huawei products are used by companies such as Vodafone since they make the USB dongles that provide mobile internet connections. As mentioned above, it has also entered the smartphone market. Ren could be one of Schumpeter’s entrepreneurs since he transformed his business from being just an importer of telecoms equipment into the world’s largest telecommunications company, one that invests heavily in R&D and technological innovation.
Huawei faces specific challenges as telecoms and tech can engender suspicion of industrial espionage. Ren’s stint in the Chinese army is a cause for concern in the US and other places such as Australia. It adds to suspicion that he works with the Chinese government. Huawei denies all the allegations made against the firm, but it is still banned from bidding for US government contracts.
Ren Zhengfei even based Huawei’s sprawling campus on Silicon Valley. The green, open environment is designed to encourage innovation and collaboration, and there are on-site basketball courts and ping-pong tables, which is unusual in China. Graduates say that Huawei is a prestigious place to work. Ambitious young engineers want to be part of a global, innovative company and they even call themselves Huawei-ren or Huawei people, the Chinese version of Googlers.
However, there are numerous obstacles faced by Chinese non-state companies like Huawei. It was only in the late 1980s that consumer markets developed in China as the centrally planned economy was liberalized and private firms emerged. State-owned companies still dominate key sectors of the economy and bank credit. As a private firm, Huawei could not rely on government policy that promoted Chinese-foreign joint ventures to gain technology and know-how. Instead, the company innovated and undercut competitors to gain market share.
Another difference in the Chinese attitude towards innovation is that firms like Huawei innovate to serve a market need. In other words, they don’t create something entirely new and then look for a market for it. For instance, Huawei developed an ‘anechoic’ chamber that eliminates echo so they can test for interference from their antennae or handsets. It’s one of only a few such chambers in the world and it is designed to fill a need and where they have a competitive advantage from their massive amounts of data. As Huawei operates in 150 countries and over one-third of the world’s population uses their products, they have a great deal of data with which to test and then fine-tune and improve their products.
But the next stage still needs to be invention, which is well recognized in China. Tech companies like Huawei spend around 10 per cent of their revenue on R&D, which is in the same league as the biggest global innovators. Half of Huawei’s 150,000 employees work in R&D and it holds over 50,000 patents, making it one of the top five patent filers worldwide. Of course, spending on R&D doesn’t necessarily translate into an innovative product. Around a quarter of Chinese patents are in product design, which is viewed as less innovative than a new product, but it is a category of innovation recognized by Schumpeter, who saw the value of improving the quality of an existing good. In the US, the figure is much lower, less than 10 per cent.
Huawei is also working on cutting-edge research. In competition with Silicon Valley, the company is developing a universal translator to enable people to converse in different languages using
software that will translate context and not just words. Research is being undertaken on artificial intelligence that can even interpret jokes, which are among the hardest things to translate. For instance, how would the following joke be translated?
English: Why did the chicken cross the road? To get to the other side.
Chinese: How do you get an elephant into a refrigerator? You open the door, and put it in.
The Chinese elephant plays the same role as the chicken in the joke.
Huawei’s next strategic move was to make its name known not just to industry insiders, but to the 7 billion people around the world. It became the first Chinese company to make it into Interbrand’s top 100 global brands. Huawei believes it can take on the market leaders because its innovation is centred on customer needs. But can it get global customers to choose its smartphones over Samsung’s and Apple’s? If Huawei succeeds, that would point to whether China can make that difficult leap from imitator to innovator. And that could help China become a prosperous nation.
The thing about history is that it rarely repeats itself. One advantage that Chinese firms have over Japan is that their home market has more than a billion people, so they start with the advantage of scale. Scale gives Chinese companies a leg up because they have a billion consumers to sell to, so they can test new products and services without leaving Chinese borders and facing foreign competition. A downside, though, is that it is possible to become a very large Chinese firm without facing global competition. Although nothing is ever guaranteed, it is possible that China will be the source of the next global giants.
That is precisely the aim of the ‘going global’ policy. China’s Alibaba Group is the world’s largest online retailer. Few may have heard of it before its IPO on the New York Stock Exchange since the company operates predominantly in China. But, as with other Chinese companies that are coming of age, Alibaba has become a multinational company. If Alibaba truly breaks into overseas markets, that is precisely where China would like to see its firms succeed. If ‘Made in China’ continues to be viewed as low quality, then it will not sell well to consumers around the world. But if Chinese brands become synonymous with being the best in the world, that would also mark China’s transition into a country that can produce innovation.