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What
goes up must come down. That principle seems to be coming true for
Samsung Electronics, the world’s top cellphone maker, whose profit is
falling in part because of pressure from its price-cutting rivals in
China.
Samsung, a South Korean company, said last week that profit in the last quarter was expected to be 25 percent lower than in the period a year earlier.
Among
other factors, Samsung blamed intense competition from Chinese
manufacturers for the decline. Companies like Xiaomi and Huawei have
quickly increased market share in China over the last year with the help
of handsets they sell at a break-even price.
Chinese
companies have swooped into many other industries, including personal
computers and solar energy, to produce products less expensively. This
strategy has traditionally been used after a market matures, at which
point the Chinese companies find a way to make and sell products nearly
at cost, building market share and eating into the profit of the
incumbents.
Investors and analysts are now wondering whether Samsung will choose to cut prices or push innovation harder in order to fight back.
“How
does Samsung compete against players that price at cost?” said Adnaan
Ahmad, an analyst for Berenberg Bank in London, in a research note.
“Investors should question where the growth is.”
Samsung’s
response to its predicament could shape the entire smartphone market.
If Samsung aggressively cuts prices to improve sales, it could pressure
other competitors like Nokia, HTC and Motorola Mobility to lower prices,
too. That could lead to lower-quality products or even slimmer margins
for the smartphone business as a whole. Already, in many recent
financial quarters, only Samsung and Apple have made a profit from smartphones.
The
low-end market is not Samsung’s only worry. At the high end, its main
rival is Apple, which has continued to improve iPhone sales. T. Michael
Walkley, a Canaccord Genuity analyst, said Apple could find even more
success if the company releases phones with larger screens this year, as
is widely expected.
Samsung
has shown no signs that it wants to go down the price-cutting path. It
declined to make an executive available for an interview, but in a
written statement, the company said it would continue to compete through
a diverse set of products that fulfill consumer needs.
“We
also will strengthen our product competitiveness by reinforcing our
premium brand reputation, powerful product lineup and cutting-edge
technology,” the company said.
In
other words, Samsung, at least for now, plans to keep doing what it is
already doing: offering a large variety of mobile products at a wide
range of prices.
But it remains unclear whether that will be enough.
Ben
Bajarin, a consumer technology analyst for Creative Strategies, said
the competitive dynamic among devices running Google’s Android system,
like most of Samsung’s and the inexpensive handsets made by Chinese
manufacturers, was starting to shift.
Because
all Android smartphones work similarly, he said, hardware does not make
a device stand out. Software and Internet services, like video
streaming or messaging, will set the devices apart.
Xiaomi, the rising Chinese electronics brand,
is a chief example of that. The company makes several models of Android
smartphones, including handsets that have many of the same features as
top phones from Apple and Samsung, but cost less than half the price.
But
the hardware and low price are just a small part of what gives Xiaomi
its advantage. To lure customers and keep them loyal, the company offers
a special version of Android, called Miui. Fans can help design Miui by
giving feedback online, and the company releases a new version of the
operating system every Friday to keep fans excited.
Xiaomi’s
business model is unique among Android phone vendors. It sells phone
models for about the same amount it costs to buy and assemble the
materials. But it sells the phones for up to a year and a half, giving
time for the components’ price to fall. Xiaomi also makes money from
selling apps, games, special Android themes and Internet services.
Making money off Internet services will be Xiaomi’s core business strategy, the company has said.
“Cellphones are really just like PCs were 20 years ago,” Lin Bin, one of Xiaomi’s founders, said at a business conference
last year. “They generated big profit margins in the beginning. But
those margins are in the single digits now. The same thing is beginning
to happen to smartphones. So rather than focus on devices where margins
will decline, we’re focusing on services.”
But
Samsung’s smartphone business is still reliant on selling hardware.
While the company also offers specially customized versions of the
Android system for its smartphones and tablets, its software has been
widely panned by reviewers and customers. And in Internet services like
maps and online messaging, Samsung is virtually irrelevant.
Samsung
has been working with Intel and other companies on a new mobile
operating system called Tizen. But Mr. Ahmad of Berenberg predicted
Tizen would fail as other competing software systems have before, like
Palm’s WebOS and BlackBerry’s latest software system, BlackBerry 10.
In the end, he said, the company will probably resort to cutting its prices, sacrificing profit margins even more.
“Samsung
has had a knack historically of playing the price game if its market
share is under any pressure,” Mr. Ahmad said. “Why should history not
repeat itself for its high-end portfolio?”
Apple,
too, makes most of its profit from selling hardware, but it does not
share Samsung’s problems, Mr. Bajarin said. To stand out and keep
customers loyal, Apple offers operating systems and Internet services
that run only on Apple hardware.
A
Samsung customer, by contrast, can always switch to an Android phone
made by another company, log in to Google services and have basically
the same phone. And if you can buy some other Android phone more cheaply
than a Samsung device, why not?
“That’s
really the difficult part for them,” Mr. Bajarin said. “Their customers
are actually Google’s, they’re not necessarily theirs.”
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