ERASMUS SCHOOL OF ECONOMICS
Product Variety and
Innovation
A Comparison of Apple and Samsung
Wessel van Rietschoten
17-7-2014
Abstract: This research compares the amount of patents obtained by Apple and Samsung
with the amount of phones these companies introduce to the market. This data will be
combined with existing theories on horizontal and vertical product variety and patent thickets
to see if the observed data can be explained by existing models. This research shows that
the difference in product variety between the two companies can be explained using a
vertical product variety model. A connection between vertical product variety and innovation
can be found through the design cost of adding lower quality product types. Companies
owning many patents may have to incur less cost in order to design additional products.
However these results are not robust and further research is necessary.
1 Table of contents
Table of contents
Table of contents ........................................................................................................ 1
Introduction ................................................................................................................. 2
Apple and Samsung........................................................................................................... 2
Patents .............................................................................................................................. 2
Product variety ................................................................................................................... 3
Current research ................................................................................................................ 3
Theoretical Framework ............................................................................................... 5
Horizontal product variety model ........................................................................................ 5
Vertical product variety model ............................................................................................ 6
Additional product variety theories ..................................................................................... 8
Patent thickets and cross licensing ...................................................................................10
Methodology ............................................................................................................. 12
Data .......................................................................................................................... 13
Results...................................................................................................................... 15
Conclusion ................................................................................................................ 18
Discussion / Limitations ............................................................................................ 20
References ............................................................................................................... 22
Appendix................................................................................................................... 24
2 Introduction
Introduction
Apple and Samsung
With the introduction of Apple’s first iPhone in 2007 a lot has changed on the
smartphone market. A new standard was set for mobile phones and competitors
were facing difficulties meeting these new standards. It lasted until 2009 before
Samsung developed a competing model, the Samsung Galaxy. With the introduction
of the Galaxy series Apple started losing market share to Samsung. This even led to
Samsung taking over a leading position in the market, forcing Apple to be second.
These two giants on the global smartphone market have clashed ever since. (Statista
Inc., 2014)
The success of the Samsung Galaxy was partly due to its similarity with the Apple’s
iPhone. Kristin Huguet, spokeswoman of Apple stated: “Samsung wilfully stole our
ideas and copied our products. We are fighting to defend the hard work that goes into
beloved products like the iPhone, which our employees devote their lives to
designing and delivering for our customers.” Lawsuit after lawsuits led to a patent war
unprecedented in business history. In separate trials in the year 2012 Apple had won
$930 million from Samsung because of patent infringement. However considering the
worldwide Smartphone market with a value of $330 billion Samsung can be seen as
the real winner. In the latest lawsuit at the beginning of 2014 a California jury
awarded Apple less than 10% of the compensation Apple had requested, partly
because also Apple had infringed Samsung’s patents with the creation of the iPhone
4 and 5. (Elias, 2014)
Patents
Clearly both Apple and Samsung spend a lot of money and effort on patenting their
new developments. According to the dictionary a patent is: a government authority or
license conferring a right or title for a set period, especially the sole right to exclude
others from making, using, or selling an invention. (Oxford University Press, 2014)
Thus in order to prevent competing companies from copying your inventions patents
are essential. Filing patents contributes to achieve and maintain a competitive
advantage over competing companies.
The number of patents a company owns gives a good indication of the
innovativeness of this company. Empirical research by Acs and Audretsch support
3 Introduction
the validity of patent counts as a measure of innovative activity (Acs & Audretsch,
1989). According to this theory companies with more patents are more innovative.
But does this theory hold for Apple and Samsung and their mobile phones?
Product variety
Although their mobile phones might look similar the amount of phones brought to the
market by Samsung and Apple differs significantly. Since the introduction of the
original iPhone by Apple, the company introduces one or two new models a year.
Samsung on the other hand has introduced over twenty phones per year for the last
three years (see appendix entry B and C). This difference is remarkable since both
companies are major players on the same market.
When it comes to product variety a distinction has to be made between horizontal
and vertical product variety. Horizontal product variety is when a firm offers multiple
versions of basically the same product. For example an automobile manufacturer
offering the same car in different colors. The product is the same, but the company is
attracting more customers since some people like blue cars while others might like
red cars. Horizontal differentiation is used by companies to attract customers with
different taste preferences while the price stays the same. Vertical product variety on
the other hand is used to differentiate between the willingness to pay for quality by
customers. In this case the automobile manufacturer will offer a basic car and one
with for example heated seats. Obviously the car with the heated seats is the better
one but some costumers will be willing to pay a premium for this and others won’t.
By using vertical differentiation companies try to reach more customers by offering
them a larger variety of quality for different prices. (Pepall, Richards, & Norman,
2014)
Current research
The aim of this research is to look for a possible relationship between the
innovativeness of Apple and Samsung’s mobile phones and the amount of product
variety observed. The main research question of this research is:
“Does more innovative activity lead to a larger product variety?”
To answer this question the following hypotheses are stated:
1) “More patents lead to more innovative activity.”
4 Introduction
2) “Innovative activity is reflected in the amount of horizontal product variety.”
3) “Innovative activity is reflected in the amount of vertical product variety.”
This research compares the amount of patents obtained by Apple and Samsung with
the amount of phones these companies introduce to the market. This data will be
combined with existing theories on product variety and patent thickets to see if the
observed data can be explained by existing models. This research shows that the
difference in product variety between Apple and Samsung can be explained using a
vertical product variety model. A connection between product variety and innovation
can be found through the designing cost of adding lower quality product types.
Companies owning many patents may have to incur less cost in order to design
these additional products. However these results are not robust and further research
is necessary.
5 Theoretical Framework
Theoretical Framework
Most firms sell more than one product in order to appeal to consumers with different
tastes. Apple’s latest iPhone 5S is available in three different colors: gold, silver, and
space gray. (Apple Inc., 2014) Essentially these phones are the same except for the
color. When a firm offers a variety of products in response to different consumer
tastes it is called horizontal product differentiation. The second option a firm has to
differentiate is vertical product differentiation. When a firm responds to differences in
consumer willingness to pay for quality of a product by offering different qualities of
the same product it is called vertical product differentiation. (Pepall, Richards, &
Norman, 2014) With the introduction of the cheaper iPhone 5C Apple started using
vertical product differentiation in 2013. Samsung makes extensive use of both types
of differentiation. Currently offering 21 different Galaxy models in a wide variety of
prices, colors and product features. (Samsung, 2014)
To determine the optimal amount of product differentiation for a company a model
has to be introduced. Since this research is about Samsung and Apple it is
reasonable to assume that a model based on monopolistic competition is in order.
Both companies produce similar but not yet perfectly substitutable products, are profit
maximizers and have a sufficiently large amount of market power, which are
indications of monopolistic competition. (Investopedia, 2014)
Horizontal product variety model
The basic model assumes that different consumers have different tastes. When a
monopolistic company offers a product, the product will be closer to some peoples
preferences then to others. The company sells its product for a certain price (p 1). The
consumers have their own reservation price (V). For any price above the reservation
price the consumer will not buy the product. The price the consumer is facing is the
price set by the company (p1) and additionally the cost of the product being different
from their optimal taste (t). The consumer is indifferent between buying and not
buying when 𝑝1 + 𝑡𝑥1 = 𝑉 which can be rewritten to: 𝑥1 =
𝑉− 𝑝1
𝑡
. The variable x1
represents the distance between the consumers optimal product and the product
offered on the market. Assuming that N consumers are evenly distributed on the
market, there will be 2x1N consumers willing to buy the product when the firm set
price p1. Substituting the first expression into the second results in 𝑄 (𝑝1 , 1) = 2𝑥1 𝑁 =
6 Theoretical Framework
2𝑁
𝑡
(𝑉 − 𝑝1 ) when the firm is selling one variant of the product. The highest price the
𝑡
firm can charge in order to reach all N consumers is given by 𝑝(𝑁, 1) = 𝑉 − 2 which
satisfies the buying decision of consumers with tastes farthest away from the product
offered.
Now in order to determine the optimal amount of products the firms cost have to be
added to the equation. Profit (π) of the firm depends on the revenues as stated in the
equation above but also on marginal production cost per unit sold (c) and fixed cost
associated with production (F). Combining this the profit equation of a firm selling one
product variant is: 𝜋 (𝑁, 1) = 𝑁[𝑝(𝑁, 1) − 𝑐] − 𝐹 = 𝑁 (𝑉 −
𝑡
2
− 𝑐) − 𝐹.
More generally when a firm sells n product variants (horizontal differentiation) instead
of one the rule becomes: 𝜋 (𝑁, 𝑛) = 𝑁 (𝑉 −
𝑡
2𝑛
− 𝑐) − 𝑛𝐹 this implies that when a firm
decides to sell one more product variant the profit will be: 𝜋 (𝑁, 𝑛 + 1) = 𝑁 (𝑉 −
𝑡
2(𝑛+1)
− 𝑐) − (𝑛 + 1)𝐹. Simplification of this formula results in a general rule, the
additional product variant increases profit if and only if 𝑛(𝑛 + 1) <
𝑡𝑁
2𝐹
.
According to the model horizontal product variety n increases when there are many
consumers (N is large) or when the fixed cost for increasing product variety are low
(F is small) or where consumers have strong and distinct tastes regarding products (t
is large). (Pepall, Richards, & Norman, 2014)
Vertical product variety model
With vertical product differentiation a company tries to target more consumers by
offering different qualities of the same product. Some people are willing to pay a
higher price for premium products, others aren’t. By offering the choice a larger part
of the market can be served. For a profit maximizing monopolist two conditions have
to be satisfied:
1. “For a given choice of quality, the marginal revenue from the last unit sold should
equal the marginal cost of making that unit at that quality”
7 Theoretical Framework
2. “For a given choice of quantity, the marginal revenue from increasing quality of
each unit of output should equal the additional (marginal) cost of increasing the
quality of that quantity output.”
When it comes to costs the model assumes that the cost of improving product quality
is a sunk cost, making production cost independent of the quality of the product. The
only cost rising with quality is the cost of designing the product.
By using vertical product variety the company targets to types of consumers. Type 1
consumers place a higher value on quality then type 2 consumers. These two types
of consumers (i) differ in surplus they get from buying the product with quality z at
price p: 𝑉𝑖 = 𝜃𝑖 (𝑧 − 𝑧𝑖 ) − 𝑃. 𝜃𝑖 is a measure of value that consumer i places on
quality. 𝑧𝑖 is the lower bound quality below which consumer i would not buy the
product any more. Although the company knows of the existence of these types of
consumers it cannot distinguish them.
The idea is that the company brings two product types to the market, a low price low
quality version and a high price high quality one. For consumer type 2 to buy the low
priced product the price has to be low enough for his low valuation of quality: 𝑝2 =
𝜃2 𝑧2 . Type 1 consumers should buy the higher quality product. In order to make this
happen the consumer surplus type 1 consumers get from buying the high quality
good have to be greater or equal to that what they would have got if they bought the
cheap low quality product: 𝜃1 (𝑧1 − 𝑧1 ) − 𝑝1 ≥ 𝜃1 (𝑧2 − 𝑧1 ) − 𝑝2 . Besides the surplus
from buying the high quality product has to be greater or equal to 0: 𝜃1 (𝑧1 − 𝑧1 ) −
𝑝1 ≥ 0. Combining these equations results in a formula for the price of the high
quality product: 𝑝1 ≤ 𝜃1 𝑧1 − (𝜃1 − 𝜃2 )𝑧2. This formula states that the maximum price a
company can ask for its high quality product is greater when the difference is greater
between the two type of consumers (𝜃1 − 𝜃2 ). Also the prices increase when all
consumers value quality more.
Now that is established how different qualities of products have to be priced the profit
for the firm can be calculated. Assuming that there are 𝑁𝑖 consumers of each type
and as discussed before costs are independent from quality, the profit function is:
∏ = 𝑁1 𝜃1 𝑧1 − (𝑁1 𝜃1 − (𝑁1 + 𝑁2 )𝜃2 )𝑧2. From this equation it becomes clear that profit
increases in 𝑧1 , meaning that the company should set the quality of its high quality
8 Theoretical Framework
product as high as possible. For the lower quality product 𝑧2 it is depending on the
second part of the equation.
In the case that there are less consumers of type 1 buying the high quality product
then consumers of type 1 and 2 buying the low quality product: 𝑁1 𝜃1 < (𝑁1 + 𝑁2 )𝜃2 .
The second part of the equation will be positive, resulting in a positive effect of 𝑧2 on
the company’s profit. In this case 𝑧2 should be equal to 𝑧1 meaning that the firm only
sells one, high quality product. When 𝑁1 𝜃1 > (𝑁1 + 𝑁2 )𝜃2 the company’s profit
decreases in 𝑧2 creating an incentive for the firm to offer two different qualities.
If the company only offers one high quality product the price has to be: 𝑝∗ = 𝜃2 𝑧 in
order to sell to both types of consumers. When a company differentiates between
high and low quality the price for the high quality product is given by: 𝑝1∗ = 𝜃1 (𝑧 − 𝑧1 ).
The low quality good has to be priced: 𝑝2∗ =
𝜃2 𝜃1 𝑧1
𝜃1 −𝜃2
. This results in 𝑝1∗ > 𝑝∗ > 𝑝2∗ which
means that a company with different qualities can charge a higher price to type 1
consumers but has to charge a lower price to reach type 2 consumers. This means
that offering two quality differentiated products is only profitable when there are
sufficiently many type 1 consumers as compared to type 2. (Pepall, Richards, &
Norman, 2014)
Additional product variety theories
For completeness other models on product variety from recent literature have to be
discussed. Managing product variety has become more and more important in recent
literature. Kamalini Ramdas argues in his literature review on product variety that any
organization has to make four key decisions in variety creation: dimension of variety,
product architecture, degree of customization and timing. His framework for a firm’s
variety-related decisions is graphically represented in appendix entry A. Most
interesting is the process of variety creation. The dimension of variety chosen by a
firm must be of value to the customer, and it has to contribute to its competitive
advantage. Besides a firm must use synergies across products to keep the cost of
producing a larger variety of products low. The second decision on product variety is
product architecture. When a firm chooses for a modular architecture it allows for
differentiation in the specific components. On the other hand an integral architecture
may increase product integrity but takes away the option to differentiate on
components. The third decision faced by the firm is the degree of customization.
9 Theoretical Framework
Generally the firm has to base its decision on what the market values and the firm’s
own internal and supply chain capabilities. Customization may vary from letting
consumers build their own device (high level of customization) to offering a standard
product with predetermined specifications (low level of customization). Lastly timing is
crucial in the variety creation process. Product life cycles together with product
announcements and introduction dates can be crucial for the success of a product.
(Ramdas, 2003)
Another research by Kevin Lancaster concludes that most product variety models
agree on three points. Firstly that scale economies are a major determinant for
product variety. When scale economies arise production cost of large volumes
decrease, this leads to less product variation. Secondly the perception of the
products by the consumers is important. When consumers perceive different, similar
goods as close to perfect substitutes the amount of product variation decreases. If
these goods are not seen as substitutes product variation increases. Lastly the
higher the level of competition on a market, the more product variety. In a market with
little to no competition there is little or no product variety. (Lancaster, 1990)
An article published in 2004 by Pil and Holweg links product variety to order
fulfillment strategies. This study on automobile industry aimed to find a link between
external variety (variety offered to the consumers) and internal variety (variety
involved in making the product). For many years forecast-driven order fulfillment
strategies were considered to be the best strategy. The production process is driven
by an sales forecast, causing stable capacity and good use of economies of scale.
On the downside it has low flexibility, high inventories and forecast errors might lead
to obsolete inventory. Relatively new is the build to costumer order fulfillment
strategies. This strategy leads to more customized products and lower inventories.
But since it is demand driven capacity use might vary significantly. Currently a hybrid
form of both forecast and order driven systems is observed in many companies.
Crucial for managers is to consider if their current order fulfillment strategy is
sufficient for the products they offer. Some products don’t need customization or can
be adjusted by the costumer himself, for these products forecast-driven systems
might be the best strategy. For products that do need customization order-driven
systems are often more effective. Precursor in build to order strategies is computer
manufacturer Dell, offering customers the option to select different qualities of
10 Theoretical Framework
computer parts to build their own customized PC. This extreme form of customization
can grant a competitive advantage which is interesting for other companies who are
developing their product variety strategy. (Pil & Holweg, 2004)
Patent thickets and cross licensing
To be able to connect product variety and innovation also literature on innovation and
patents have to be reviewed. As mentioned before patents are an accepted way of
measuring a company’s innovative activity. However the added value of the patent
system itself is up for discussion. A study by Boldrin and Levine advocates the case
against patents. Their study is in favor of abolishing the current patent system since
there is no empirical evidence that patents increase innovation nor productivity.
(Boldrin & Levine, 2013)
If patents are not contributing to more innovation or productivity, why are they
observed and valued so much in real life? The most obvious reason of course is the
protection of its intellectual property by a company. However with complex
technologies one patent doesn’t cover the complete product. Research on patent
thickets by James Bessen gives a possible explanation for the large amount of
patents observed at companies dealing with complex technologies. Patent thickets
are large overlapping sets of patent rights in order to force competitors into crosslicensing. In his research Bessen explains a model which explains strategic patenting
when a single technology involves a large number of patents. When the costs of
patenting are low, firms will build large portfolios of patents. Since these complex
technologies require a large amount of patents, building a patent thicket serves a
company well. If not they but their competitor achieve a drastic innovation, they will
get part of the rent since their competitor most likely needs to cross-license one or
more of their patents. “Patents serve to subsidize the losers of innovation races (paid
by the winners), especially if those losers are large patent holders in mature
industries.” (Bessen, 2013)
An earlier study on patent thickets acknowledges the same phenomena of firms
having difficulties commercializing their innovations because of patent infringements
caused by patent thickets of competing companies. Under the current system of
strong patent rights, patent thickets are not only used to capture part of the rents of
the drastic innovation from the competitors. They can also be used to increase
11 Theoretical Framework
transaction cost, create hold up problems and even block innovations of competitors.
These issues make it harder to bring an innovation to the market and gives firms an
incentive to build a large portfolio of patents, to protect themselves against
innovations from other firms. (Shaprio, 2001)
12 Methodology
Methodology
In order to carry out this research data has been collected. A list with Samsung
Galaxy phones and Apple iPhones was composed using data from both companies
websites. This list was used to form an overview on how many phones both
companies have introduced since 2009.
To match the amount of phones introduces per year to the amount of patent filed per
year data has been collected on patents obtained per year using the website of the
United States Patent and Trademark Office. (US Patent and Trademark Office, 2014)
By searching on a yearly interval from 2009 onwards together with the assignee
name of the company (see appendix entry D for the specific search terms used).
The amount of patents obtained by Apple and Samsung per year is companywide, so
this also includes patents from other business activities. Since this research is about
the mobile phone department of both companies the overall number of patents is an
overestimation of the amount of patents obtained by the phone department. In order
to correct for this a data source on the number of mobile device patents in the United
States in 2011, by leading company is used (see appendix entry E). (Statista Inc.,
2011) Comparing the total amount of patents filed in 2011 with the amount of mobile
device patents from the source gives an indication of the percentage of patents the
companies issue for their mobile phone departments. The same percentage will be
used to correct the total amounts of patents in the other years to get a more accurate
estimation of patents obtained for mobile phones per year.
After the data is presented, the theories as explained in the theoretical framework will
be used to explain the observed data. By combining the theories on product variety
and patent strategies with the collected data this research aims to explain the
observed situation at Samsung and Apple.
13 Data
Data
As described in the methodology data on the amount of phone introductions per year
by Apple and Samsung is gathered. Table 1 shows the amount of phones per year
per company. As can be seen just by looking at the amount of phones introduced
over the last five years there is a big difference in product variety between Apple and
Samsung. Note that every iPhone at introduction data was made available with
different storage capacities. This can be considered a form of product variety but are
left out of this research for simplicity. Because Samsung Galaxy phones provide the
option for an external SD data card, comparing on this feature is challenging.
Year
Apple iPhone
Samsung Galaxy
2009
1
2
2010
1
6
2011
1
21
2012
1
24
2013
2
29
Total
6
82
Table 1: Introduced phones per company per year.
For the same years the amount of patents obtained by the companies is represented
in Table 2. The amounts of patents corrected for use in mobile devices are based on
data on 2011. In 2011 Apple used approximately 43% (
831−477
831
≈ 0.4259) of their
patents for their mobile phone department. By Samsung around 35% (
2346−1592
2346
≈
0.3482) of the patents involve mobile technology. These percentages are used to
calculate the other years.
Year
Apple (Phones)
Samsung (Phones)
2009
825 (352*)
3578 (1246*)
2010
1037 (442*)
3120 (1087*)
2011
831 (477)
2346 (1529)
2012
652 (278*)
1345 (468*)
2013
117 (50*)
257 (90*)
Total
3462 (1475*)
10646 (3707*)
14 Data
Table 2: Patents obtained per company per year. *Corrected amount of patents used
for mobile device as part of total amount of patents using percentage from 2011 data.
Figure 1 is a graphical representation of Table 1 and 2. Combining the amounts of
phones introduced with the amounts of patents obtained per year by Apple and
Samsung in one graph.
1800
35
30
1400
25
1200
1000
20
800
15
600
10
400
Phones Introduced
Mobile device patents
1600
5
200
0
0
2009
2010
2011
Year
2012
2013
Apple Mobile Device Patents
Samsung Mobile Device Patens
Apple iPhones
Samsung Galaxy Phones
Figure 1: Graphical representation of the amounts of patents obtained and phones
introduced by Apple and Samsung per year.
Figure 1 clearly shows two very different product variety strategies. Apple on one
hand introduces very little different phones per year. Samsung on the other has
introduced over twenty types of phones for the last three years. Also the amount of
patents obtained by both companies is differs significantly. Samsung issues more
than double the amount of patents for their mobile devices as Apple for most of the
years.
15 Results
Results
From the data two big differences between Apple and Samsung are observed.
Samsung introduces a lot more different phones per year and issues more patents.
Following previous literature patents can be seen as a measure of innovative activity,
(Acs & Audretsch, 1989) which means that Samsung has more innovations because
of the larger amount of patents obtained. So the larger amount of products brought to
the market by Samsung might be explained because their innovative activity is larger.
However this reasoning assumes that the products introduced by Samsung are all
innovations. By looking at the list of phones introduced by Samsung (see appendix
entry B) can be seen that this assumption might be incorrect. Samsung Galaxy S
phones are considered their most innovative models. For example after the
introduction of their innovative Galaxy S4, Samsung also introduced a S4 Zoom, S4
Active and S4 Mini. These models are modifications of the original S4, no pure
innovations.
Product variety strategies might explain the larger amount of phones introduced by
Samsung. According to the horizontal product variety model the market size, fixed
cost of making additional product types and the distribution of tastes on the market
determine the optimal strategy for a firm. Since Apple and Samsung serve the same
global market it is reasonable to assume that market size is the same for both firms.
The same logic applies for the taste distribution on the market, if they serve the same
market this will also be equal. So the difference in product variety has to be explained
by a difference in fixed cost of making additional products types.
For simplicity we assume the production process of Apple and Samsung to be
similar. Which is a sound assumption since they develop similar products in similar
production countries. Apple even used parts produced by Samsung in their iPhones
for a long time, making the production process for some parts even identical.
(Cunningham, 2013) Interestingly the variable manufacturing costs of the parts of a
Samsung Galaxy S5 are $256 which is $50 higher than those for an iPhone 5s.
However this only displays the cost of manufacturing the phone parts. Software,
licensing and royalty payments are not included. (Ranger, 2014) When it comes to
retail price Apple’s iPhone 5s is most expensive, $649. (Apple Inc., 2014) Samsung’s
Galaxy S5 has a retail price of only $592 (Amazon, 2014). A phone that is cheaper to
16 Results
make and is selling at a higher price, does Apple simply has a higher profit margin or
do they incur more cost in licensing and royalty payments?
Apple’s profit margin indeed is a lot higher than Samsung’s, with a margin of 40%
Apple’s profit per iPhone 5s sold is $260. Samsung only has a 16% profit margin per
Galaxy phone sold, for the S5 this means $95 per phone. (Reuters, 2014)
Straightforward calculations show that for a iPhone 5s after deducting manufacturing
cost and profit margin $649 – $206 – $260 = $183 is left unaccounted for. The same
calculations for the Galaxy S5 show $592 – $256 – $95 = $241 of costs that are not
yet explained.
These remaining fixed cost can amongst others be explained by the costs a firm has
to incur in (cross-)licensing patents. Intuitively it is reasonable that these costs are
higher for Samsung than for Apple. Samsung issues a lot more patents and besides
has to pay large amounts in patent infringements lawsuits. The reason for Samsung
to issue a lot of patents can be explained with the theory on patent thickets.
Samsung protecting itself from drastic innovations by competitors by trying to gain a
part of the rent by forcing that competitor to cross-license their patents. With success,
as mentioned before Apple had to settle their lawsuit because they infringed
Samsung’s patents in the creation of the iPhone 4 and 5.
According to the model on horizontal product variety higher fixed costs involved with
additional product types leads to lower product variety. Following this reasoning
Samsung should have less product variety because they incur more fixed costs on
licensing, which is not in line with the data observed.
In the vertical product variety model the difference between the products offered is in
quality and price. As mentioned before Samsung offers one high quality model and
for every of these there are 2 or more lower budget models. Assuming that Samsung
uses vertical product variety because it offers different qualities of products for
different prices is more in line with the data observed. In order to explain why
Samsung chooses to do this and Apple does not, the model offers two options. When
it comes to costs the vertical product variety model assumes all costs sunk, meaning
they should not matter to the decision making. The only cost that does influence the
decision making is the designing cost of the additional quality product. A second
explanation given by the model is the amount of type 1 and type 2 consumers. When
17 Results
there are fewer type 1 consumers buying the high quality good than type 1 and 2
consumers buying the lower quality (𝑁1 𝜃1 < (𝑁1 + 𝑁2 )𝜃2 ) the company cannot profit
from offering different qualities. This might explain why Apple only sells one high
quality product, however it does not explain why Samsung does offer different
qualities. Assumed is that Apple and Samsung do serve the same market and the
same consumers. This assumption implies that 𝑁1 & 𝑁2 are the same for both
companies, which should mean that they both should get to the same optimum of
vertical product variety. Another issue with the vertical product variety model is the
price. Samsung offers high and lower quality products which according to the model
should mean that their high quality product is higher priced than when offering just
one quality. This is not observed in the data, Apple although they only offer one high
quality product charges the highest price.
Another more obvious explanation for the observed difference in product variety at
Apple and Samsung is the difference in profit margin on their phones. Because
iPhones have a high profit margin Apple doesn’t have to sell as many phones to
make a large profit. Samsung on the other hand has lower profit margins on their
phones, in order to be profitable for the company they thus have to sell a lot of
phones. By introducing more types of phones with slightly different features and price
categories Samsung succeeds in expanding their sales and generating more
revenue.
18 Conclusion
Conclusion
The main research question in this paper was: “Does more innovative activity lead to
a larger product variety?” After analyzing data on Samsung and Apple together with
theories on product variety and patent thickets the conclusion can be drawn that the
research question cannot be confirmed.
The first hypothesis stated that “more patents lead to more innovative activity”.
Although some literature suggests that patents do accurately reflect a company’s
innovative actives, in the case of Apple and Samsung this does not hold. The data
has shown that Samsung owns and issues a lot more patents per year than Apple.
However since the introduction of the iPhone and the first Galaxy there hasn’t been
any more drastic innovation coming from either of the two firms, indicating that all
these patent do not lead to innovations per se. A more reasonable explanation for the
large amount of patents hold by Samsung comes from the theory on patent thickets.
The desire of firms to hold large amount of patents, is a form of protecting from
innovation by competitors. By forcing competitors to cross-license when they are
trying to commercialize an innovation, a company can capture part of the rents
coming from this innovation.
The second hypothesis was: “Innovative activity is reflected in the amount of
horizontal product variety.” Because the first hypothesis could not be confirmed, it is
hard to prove or disprove this statement with the available data. Horizontal product
variety models suggest that the amount of product variety depends on the market
size, fixed cost of making additional product types and the distribution of tastes. The
market size and taste distribution is assumed equal since both companies serve the
global mobile telecom market. So the link between innovative activity and product
variety should be found in the fixed cost of making additional product types. Theory
predicts that higher fixed costs leads to less horizontal product variety. Higher fixed
costs and more product variety for Samsung contradict this horizontal product variety
model. Based on this can be concluded that the difference observed between
Samsung and Apple cannot be explained with the use of horizontal product variety
models.
The last hypothesis was: “Innovative activity is reflected in the amount of vertical
product variety.” The data has shown that Samsung does use vertical product variety
19 Conclusion
because they offer different quality products for different prices. Apple only offers one
high quality product. However if this difference can be explained by innovative activity
as the hypothesis suggest is doubtful. The model assumes all cost to be sunk when
evaluating the use of vertical product variety. The only cost that has to be considered
is the designing cost of the additional quality product. It could be that these cost for
Samsung are lower since they own a lot more patents. Because of their large patent
ticket it might be less costly for Samsung to design a new product because they can
use one of the patents they already own instead of buying or developing a new one.
Another explanation offered by the model is a difference in type 1 and 2 consumers
for both companies. When relaxing the assumption of both companies serving
exactly the same market and consumers this is a reasonable explanation for the
observed difference in product variety between the two companies. However this
explanation does not provide a connection with innovative activity.
Getting back to the main research question, larger product variety is not just caused
by more innovative activity. This research shows that Samsung and Apple have very
different product variety strategies. Samsung has a lot of vertical product variety in
their mobile phone department, Apple very little. The most logical explanation for this
is the profit margins both companies have on their phones. Since Apple targets the
premium market and gets high profit margins, they have no incentive to introduce
other lower priced models. These might even negatively affect their high end
reputation. Samsung on the other hand has lower profit margins, meaning they have
to sell more devices to reach the same profit levels as Apple. By introducing a large
variety of phones, Samsung aims to satisfy a larger part of the market in order to sell
more phones. This explains most of the difference in product variety between the two
companies.
The only link this paper shows between innovative activity in the amount of patents a
company has and its product variety is through the designing cost of adding lower
quality and lower priced products. When a company owns a lot of patents, less cost
might have to be incurred to design an additional product quality. However this
explains the data observed, no hard evidence is found. Besides the amount of
patents a company issues has become more of a strategy because of patent thickets
rather than it represents innovative activity.
20 Discussion / Limitations
Discussion / Limitations
Trying to explain phenomena observed in real life with theoretical models is always a
challenging task. Assumptions have to be made in order to fit the model into the data.
The first assumption made in this research was about the quantity of patents
obtained by a firm as a reflector of innovative activity. Although there is literature to
support this assumption (Acs & Audretsch, 1989), this is somehow outdated and can
be challenged. Since Apple and Samsung develop complicated high tech products, it
is more reasonable to assume that the theories on patent thickets apply to these
companies. Following these theories as explained before, patenting can be more of a
strategic move rather than that it reflects innovative activity. Though this takes away
of the validity of current research, it does present an interesting field for further
research.
The second assumption made in this research is about the model on both horizontal
and vertical product variety. The model shows that product variety is determined by
market size, fixed costs of developing additional products and the distribution of
tastes on the market. Current research assumes market size and taste distribution on
the market to be the same for both Apple and Samsung since they both sell to the
same global market. This assumption is reasonable but target markets are not
considered. Apple deliberately choses to only serve the upper end of the market, with
high quality and high priced product. Samsung aims to target a larger part of the
market by making one high and model and some lower priced models, with slightly
different features. So the total market might be the same for both companies, Apple
strategically made a choice to serve a smaller part of this market. This is not reflected
in the model as used in current research although it can explain the product variety
observed. However questions could be raised as why Apple does not offer even
more higher priced, high end models of their iPhones. This could be a way for them
to target a larger part of the market without losing their premium status. Instead they
introduced a budget model last year, which is still priced high compared with
Samsung phones. Further research on the marketing strategies of Apple and
Samsung is needed to shed more light on this topic.
Another drawback of this research is the lack of real evidence on the main result. A
relation between the amount of patents held by a firm and the designing cost of
producing lower quality product types is argued. This seems reasonably within the
21 Discussion / Limitations
assumptions of this research. But this research is about just two companies, making
it difficult to generalize this result. Besides there is no evidence on the magnitude and
strength of this relation. It is questionable if this relation will hold when the
assumptions of this research are released. To see if this relation is valid additional
research has to be done, including more companies. Also omitted variables have to
be considered, as it might be that the observed relation is caused by other factors.
Since there is little known about this topic, more research might reveal valuable
insights. Making this an interesting field of study for further research.
The biggest limitation of this research is the amount of company data and information
available on Apple and Samsung. For obvious reasons both companies are not
providing much data and information on their strategies. An improvement for this
research would be to get an insight within both companies. To know about their
strategic decisions regarding licensing and product variety. With this information the
validity of this research would increase since less or no assumptions have to be
made. Most interestingly would be to know whether or not Samsung and Apple
include the amount of patents hold by their company in their decision making on
product variety.
22 References
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24 Appendix
Appendix
Entry A:
Entry B:
List of Samsung Galaxy Series with introduction dates:
June 2009 - Galaxy
November 2009 - Galaxy Spica
July 2010 - Galaxy 3
Augustus 2010 - Galaxy 5, Galaxy U
October 2010 - Galaxy 551, Galaxy K
February 2011 - Galaxy Ace, Galaxy Fit, Galaxy SL
25 Appendix
March 2011 – Galaxy Gio, Galaxy Mini
April 2011 – Galaxy Prevail, Galaxy Pro, Galaxy Neo
May 2011 – Galaxy SII
Jun 2011 – Exhibit 4G, Galaxy Z
Aug 2011 – Galaxy S Plus, Galaxy R, Galaxy W, Galaxy M, Galaxy Y, Galaxy
Precedent, Galaxy XCover
October 2011 - Galaxy Note, Galaxy Stratosphere
November 2011 – Galaxy Nexus
January 2012 – Galaxy Y Pro Duos, Galaxy Ace Plus
February 2012 – Galaxy Ace 2, Galaxy Mini 2, Galaxy Y DUOS, Galaxy Beam
March 2012 – Galaxy Rugby Smart, Galaxy Pocket
April 2012 – Galaxy Rugby, Galaxy S Advance
May 2012 – Galaxy SIII, Galaxy Appeal, Galaxy Ch@t
July 2012 – Galaxy Stellar
Augustus 2012 – Galaxy S Duos
September 2012 – Galaxy Pocket Duos, Galaxy Victory 4G LTE, Galaxy Reverb,
Galaxy Note II, Galaxy S Relay 4 G, Galaxy Rush
October 2012 – Galaxy Express, Galaxy Rugby Pro
November 2012 – Galaxy S III Mini
January 2013 – Galaxy Pocket Plus, Galaxy S II Plus, Galaxy Grand
March 2013 – Galaxy Young, XCover 2
April 2013 – Galaxy S4, Galaxy Frame, Galaxy Mega
May 2013 – Galaxy Win, Galaxy Y Plus, Galaxy Core, Galaxy Star
June 2013 – Galaxy Pocket Neo, Galaxy S4 Zoom, Galaxy S4 Active, Galaxy S4 Mini
26 Appendix
September 2013 – Galaxy Note 3
October 2013 – Galaxy Ace 3, Galaxy Core Plus, Galaxy Light, Galaxy Trend Lite,
Galaxy Round, Galaxy Express 2, Galaxy Star Pro
November 2013 – Galaxy Grand 2
December 2013 - Galaxy Trend Plus, Galaxy S Duos 2, Galaxy J, Galaxy Win Pro
January 2014 – Galaxy Grand Neo, Galaxy Note 3 Neo
April 2014 – Galaxy S5
Entry C:
List of Apple IPhones with introduction dates:
29 June 2007 – IPhone
11 July 2008 – IPhone 3G
19 June 2009 – IPhone 3GS
24 July 2010 – IPhone 4
14 October 2011 – IPhone 4S
21 September 2012 – IPhone 5
20 September 2013 – IPhone 5S and IPhone 5C
Entry D:
Search terms used on US Patents and Trademark Office:
AN/"Samsung Electronics Co, Ltd" AND APD/20090101->20100101
AN/"Samsung Electronics Co, Ltd" AND APD/20100101->20110101
AN/"Samsung Electronics Co, Ltd" AND APD/20110101->20120101
AN/"Samsung Electronics Co, Ltd" AND APD/20120101->20130101
AN/"Apple Inc" AND APD/20090101->20100101
27 Appendix
AN/"Apple Inc" AND APD/20100101->20110101
AN/"Apple Inc" AND APD/20110101->20120101
AN/"Apple Inc" AND APD/20120101->20101301
Entry E:
Mobile device patents in 2011, by leading company
Number of mobile device patents in the United States in 2011, by leading
company
Number of mobile device patents
values
RIM
3134.00
Nokia
2655.00
Microsoft
2594.00
Qualcomm
2593.00
ATT
1867.00
Samsung
1529.00
IBM
1073.00
Sony
1055.00
Motorola Solutions
1019.00
HP
892.00
Intel
806.00
Motorola-Mobility
706.00
Alcatel-Lucent
680.00
Yahoo
665.00
Broadcom
513.00
Apple
477.00
Cisco
452.00
Ericsson
415.00
Verizon
353.00
Google
317.00