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The Problem With Huawei’s Great Earnings

Latest Electronics Products On Display At The CEATEC ExhibitionLatest Electronics Products On Display At The CEATEC Exhibition
A Huawei phone.Photograph by Kiyoshi Ota — Bloomberg via Getty Images

Maybe for dramatic effect, Huawei, the Chinese telecommunications with $61 billion in sales, releases its annual financial results in two steps.

The company already said revenue jumped 35% to $61 billion in 2015, on the strength of a soaring smartphone business (108 million devices sold in the year). But smartphones are being commoditized across the world, begging the question of how much money Huawei made selling them and its core telecommunications equipment used by carriers across most of the world.

Today Huawei released its full figures for the year and said net profit rose 33% to $5.7 billion, seemingly good news.

A little deeper down in the financial statements, however, lies a bigger concern: gross margin fell by two and a half percentage points, to 41.7%, due to increased R&D spending and the “rapid growth of consumer business”—smartphones “contributing greater share of total revenue.” Smartphones drive about a third of total revenues, while sixty percent comes from selling equipment to carriers.

Huawei is now the world’s third largest smartphone maker, behind Apple (AAPL) and Samsung (SSNLF) after overtaking Lenovo during the year. Its shipments grew 44% last year, double the growth rate of Apple and the Chinese startup Xiaomi, according to IDC.

Bryan Ma, an IDC analyst, estimates that Huawei’s smartphone average selling price rose by $30 during the year to $204, as the company shifted out of low-end devices, the opposite of Samsung, which is expanding smartphones in the mid-price range. “Huawei is the exact opposite. They are trying to claw themselves out of the low-end, low-margin into the higher range with you’d think beefier margins.”

So why the margin fall?

It’s likely because of the incentives Huawei provides retailers in China to sell its phones are among the most generous, Ma says. “As we talk to distributors and retailers in China, they were very excited about carrying Huawei products because felt they could make the most money off them,” Ma says.

Marketing those new phones likely dented margins too. Huawei, like Samsung, spends heavily on global advertising.

So Huawei’s rise to global smartphone leader has come with costs, the kind you don’t hear about when top market share charts are released.