SMARTPHONES: Smartphone Price Wars Claim More Suppliers

Bottom line: The failure of 2 major touch-screen technology manufacturers in Guangdong is the latest sign of trouble in China’s overheated smartphone sector, with similar new closures likely to accelerate in the next few months.

Two more smartphone component suppliers go bust

China’s smartphone wars are taking an unexpected twist, with suppliers to some of the nation’s top brands emerging as the first victims of a prolonged battle for market share. I had previously expected at least one or two small- to mid-sized brands would bow out of the market by the end of this year, though we have yet to see any such developments.

Instead the inevitable shake-out appears to be starting in the supply chain, with media reporting that 2 major smartphone part suppliers have gone bankrupt in southern Guangdong province where much of the manufacturing takes place. (Chinese article) The insolvency of these 2 major suppliers, one in the boomtown of Shenzhen and another in the nearby city of Huizhou, comes just a couple of weeks after the bankruptcy of a major supplier of metal casings for smartphones sold by Huawei and ZTE (HKEx: 763; Shenzhen: 000063).

China’s smartphone market has become a hotbed for cut-throat competition over the last 2 years, with dozens of companies entering the crowded space. Current players jockeying for sales run the range from big names like Huawei and Lenovo (HKEx: 941), to smaller newcomers like OnePlus and even unlikely entrants like air conditioner specialist Gree (Shenzhen: 000651) and construction equipment maker Sany (Shanghai: 600031).

All of those companies are under huge pressure to lower their costs to remain competitive, and they’re passing that pressure on to their suppliers. The latest reports say that 2 of those companies, both makers of touch screens and related technology, have halted production due to cash flow problems. The reports say the 2 companies had a combined 1.6 billion yuan ($250 million) in unpaid bills and other debt when they stopped production.

Ripple Effect

The reports don’t specify any customers, but say the 2 companies’ closure has created major headaches for hundreds of other companies in China’s complex supply chain that churns out hundreds of millions of smartphones each quarter. These particular closures come after metal casings maker Fosunny also halted production at its factory in Shenzhen for similar reasons earlier this month. (previous post)

This is almost certainly a case of “Where there’s smoke there’s fire”, and I suspect some other smaller companies in the supply chain have quietly closed their doors or are on the brink of doing so. The suppliers aren’t the only ones feeling the pressure. Former smartphone sensation Xiaomi has been in the headlines several times in the last 2 months for a switcharoo scandal that saw it substitute domestically made screens in some of its models after promising imported ones from Taiwan and Japan in earlier marketing materials. (previous post)

These kinds of closures tend to have a domino effect, since many companies become insolvent themselves after their major customers go bankrupt. At the same time, such bankruptcies create big headaches for brands like Huawei and ZTE, which must suddenly scramble to find new suppliers when some of their existing ones go out of business. This kind of chaos is likely to affect the smallest brands first, since the shrinking number of remaining parts suppliers and manufacturers are likely to abandon the smaller names to focus on their bigger customers like Huawei and ZTE.

All of this isn’t hugely unexpected, and a machine’s engine often exhibits this kind of problem before the entire machine itself breaks down. I do expect these growing reports of company closures in the supply chain will probably accelerate in the last 2 months of the year, putting further pressure on the many brands still crowded in the market. As that happens we can probably expect to see the exit of 1-2 small to mid-sized brands in the first half of 2016, a year that could finally see the arrival of a major sector shakeout.

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