“The global average sales price of Chinese branded smartphones stayed at a level of about RMB 1,700 during the course of 2016,” said Wu. “By the end of 2017, the global average sales price of Chinese branded smartphones is estimated to climb to around RMB 2,000. Facing rising costs and mounting competitive pressure, Chinese smartphone makers will eventually abandon their favorite strategy of selling high specs devices at extremely affordable prices.”

Starting in the second half of 2016, numerous Chinese brands broke from the tradition of offering high performance products at low prices. The deviation from the usual pricing scheme was first noticed among flagship devices such as Huawei’s P9 and Gionee’s M6. The pattern of a general price increase became more apparent as affordable brands including Xiaomi and Meizu also followed suit.

“By raising prices, Chinese brands are at risk of losing consumer demand for their products,” said Wu. “At the same time, maintaining profitability has become a struggle as the market is now more competitive than ever. Therefore, the price hike may be the last resort for some Chinese smartphone makers and an indication of a coming industry consolidation.”

Prices of key smartphone components have been going up steadily since the second half of 2016 and this trend is directly responsible for the price increases in the end device market. TrendForce’s data show that panels for smartphone displays have been on a price upswing for more than three consecutive quarters.

Mobile memory solutions have also experienced the same uptrend since the fourth quarter of last year and will continue to do so. Despite this first quarter being the traditional off season, the market supply of mobile storage components remain tight owing to a shortage of NAND Flash. In sum, production costs for smartphones are expected to keep going up.

Wu pointed out that the recent sharp rise in component prices is most threatening to the more than 30 Chinese brands that sell Android devices. “Because of the lack of product differentiation among the Chinese makers of Android phones, carrying out aggressive pricing and being undercut by rivals have been unavoidable in the competition. However, costs of components are now so high that the already slim product margins are being squeezed out.”

Chinese yuan has been rising against the U.S. dollar from the second quarter of 2016 onward and this impacts the Chinese smartphone makers by compounding the problem of component costs. “Most Chinese brands rely on imports of panels and semiconductor chips, so the rising yuan is further driving up the cost of purchasing,” said Wu. “It is also worth mentioning that only a few major Chinese brands are able to successfully expand into overseas markets. Many others have IP issues that prevent them from selling their products abroad. This problem also negates the advantage of lowering the yuan against the dollar.”

Labor constitutes a significant portion of the ballooning smartphone cost structure. The recent increases in salaries of engineers and technical personnel in both the R&D and the manufacturing end of the operation have also led to large cost increases for Chinese brands. Looking ahead, China’s will continue to face a domestic inflation problem that translates to wage increases across industries. This will be another difficult challenge for the country’s smartphone companies to deal with as they try to turn a profit.

Generally, Chinese brands have no option in the short term except for raising prices to boost margins. Wu noted that many of them are actively promoting their flagship devices that have substantial price premiums. Increasing the share of flagship models in their total sales will have an effect of pushing up the average sales price.

“Production volumes of low-end models that are priced below RMB 1,000 are expected to decrease due to the cost pressure,” said Wu. “Moreover, high shipment growth will become a thing of the past for Chinese smartphone makers. There is also a strong indication that some smaller and uncompetitive Chinese brands will be acquired by larger ones in the future.”