Qualcomm's Premium Smartphone Chip Problem

Wireless chip giant Qualcomm (NASDAQ: QCOM) is the leading vendor of smartphone applications processors and cellular baseband processors (these components are often -- though not always -- integrated into a single chip). According to research firm Strategy Analytics, Qualcomm had a 42% revenue share of the smartphone applications processor market in the first half of 2017.

A significant part of Qualcomm's success in the smartphone applications processor market has been a result of its strategy of building a broad portfolio of processors with feature sets and cost structures tailored to everything from $100 smartphones all the way to $800-plus flagship phones.

One problem that Qualcomm faces in the premium portion of the market -- a part of the market that highly values chip performance and features -- is that the most successful high-end smartphone makers are stepping up their efforts to design their own chips.

The situation

Apple (NASDAQ: AAPL), the most successful vendor of high-end smartphones, has designed its own applications processors for many years. Every iPhone shipping today includes an applications processor that was developed internally by Apple.

It's unlikely that Apple is ever going to switch away from using internally designed processors to a third-party chip in the iPhone.

Chinese smartphone vendor Huawei, which is now the third-largest smartphone vendor by shipment volume, also uses its own applications processors exclusively in its high-end smartphones.

Samsung (NASDAQOTH: SSNLF), which is the world's largest smartphone vendor by shipment volume, uses internally designed processors (sold under the Exynos brand) as well as Qualcomm processors for its flagship Galaxy S and Galaxy Note smartphone lines.

Over the years, though, Samsung's Exynos processors have become increasingly competitive with Qualcomm's best across the board. In fact, in some ways, Samsung's top mobile processors have actually surpassed Qualcomm's.

Take, for example, Qualcomm's recently announced Snapdragon 845 and Samsung's upcoming Exynos 9810. The Exynos 9810 supports 4K video capture at 120 frames per second, while the Snapdragon 845 supports 4K video capture at only 60 frames per second.

The Exynos 9810 could also include a substantially more powerful CPU subsystem than the one in the Snapdragon 845.

And, finally, the Exynos 9810 seems to have a more powerful (at least on paper) integrated LTE modem, capable of upload speeds of 200 megabits per second, which is quite a bit higher than the 150 megabits per second upload speeds that the Snapdragon 845's integrated modem is capable of.

I wouldn't be surprised if, over the long term, Samsung were to entirely eliminate Qualcomm from its high-end Galaxy S and Note smartphones.

Considering that Samsung's Galaxy S and Note smartphone lines ship in substantial volumes (not quite flagship iPhone volumes, but they're probably, collectively, the highest volume Android flagship devices on the market), such an eventual loss could really hurt Qualcomm's high-end smartphone chip business.

Qualcomm's course of action

Ultimately, Qualcomm's long-term strategy will need to be multifaceted. It has to continue to invest heavily in high-end applications processors in a bid to power flagship smartphones from smaller smartphone makers that don't have the resources or the business justification to build their own chips.

Qualcomm is also going to need to double down in trying to gain share in high-end (but not premium flagship), mid-range, and low-end smartphones. The processor average selling price in those segments is lower than it is in the premium market, but the shipment volumes are potentially higher.

On top of that, Qualcomm is working aggressively to capture additional content share in smartphones by building things like RF front end chips, fingerprint scanners, 3D sensing modules, and more. Qualcomm will probably need to double down there and try to enable low-end, mid-range, and high-end smartphone makers to put out devices that can compete with premium devices.

Qualcomm should also enjoy a revenue boost from the additional components that it'll be supplying to a large volume of phones.

In other words, if Qualcomm is getting shut out of the premium smartphone market, it should try its best to disrupt it from the bottom up.

In addition to these smartphone-related actions, Qualcomm is, of course, trying to diversify beyond the smartphone chip business. That's why the company announced its intent to buy NXP Semiconductors, and that's why the company is going after new areas like Windows-based PCs and data centers.

Qualcomm's position in the premium smartphone processor market is hardly enviable, and that's just one of many reasons that I'm a fan of Qualcomm's simply accepting the takeover offer that it received late last year from Broadcom. Qualcomm's board rejected the offer, but Broadcom has approached Qualcomm investors directly.

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Ashraf Eassa owns shares of Qualcomm. The Motley Fool owns shares of and recommends Apple. The Motley Fool owns shares of Qualcomm and has the following options: long January 2020 $150 calls on Apple and short January 2020 $155 calls on Apple. The Motley Fool recommends NXP Semiconductors. The Motley Fool has a disclosure policy.