A Tale of Two Smartphone Manufacturers

The financial analyst community has given Samsung a bit of a drubbing over its 2Q 2018 quarterly results. They certainly were not stellar. The company posted net profit of US$9.87 billion for the second quarter, a slight reduction from the US$9.88 billion reported for the same quarter last year, and down 5.5% from the previous quarter. Quarterly revenues were down 4% Year-over-Year (YoY) at US$52.29 billion. A day later, Apple reported its quarterly financial results…sales revenues increased 17% to US$53.26 billion while net profit increased 32% to US$11.51 billion YoY. Digging into the numbers continues to paint a picture of opposites. In the case of Apple, revenue from its iPhone business was up 29% YoY at US$29.9 billion, whereas Samsung’s mobile device business line generated US$22.67 billion in revenue, down 22%.

What is Samsung to do? There is no quick fix, especially once you take in the competitive factors. Samsung has approximately 22% of the overall handsets shipments market (as of 1Q 2018)[1], which places it in the number one position and effectively 1.65x Apple’s market share, which is currently in second place. However, once you take in the net profitability of Apple’s iPhone lineup, Apple becomes ascendant in the aggregate profit stakes. From ABI Research’s own teardown research, the bill of materials for a US$999 iPhone X is a mere US$280. Samsung does produce a number of low-, mid-, and high-tier handsets, which can be found in pretty much every country on the planet. The unlocked Retail Selling Price (RSP) of the Samsung Galaxy S9 is US$720. Samsung’s senior management, and its loyal customer base, is eagerly looking forward to the launch of the Galaxy Note 9. The Galaxy Note 9 may well provide a welcome boost to revenues (and hopefully profits) of Samsung, but it remains unclear how substantial it will be.

Samsung’s challenge is that it is being squeezed at both ends. Apple continues to corral a large percentage of the premium consumer and enterprise customers, especially in North America, where Apple has a 47% share of a very lucrative market. Remarkably, given the premium the iPhone X has over the “regular” iPhone 8 (25% more), the smartphone made significant contributions to boosting Apple’s Average Selling Price (ASP) to US$724. By comparison, Samsung’s ASP was US$220.

Samsung reported weaker than expected sales of its high-end models in the quarter, including the Galaxy S9, owing to strong competition in the premium market and the rising competition from other vendors’ flagship models. In the low- and mid-tier handset segments of the market, Samsung is seeing aggressive competition from Huawei (10.2% share), Xiaomi (6.6%) and OPPO/VIVO[2] (5.6%+5%). Huawei’s P20, Xiaomi’s Mi MIX 2, and OPPO’s Find X are very much going head to head with Samsung at high end. While these companies compete with Samsung in international markets, this competition is particularly fierce in China.

Another reality is that the boiler room conditions are only likely to get more difficult. Handset sales worldwide contracted in 2016 (-11.3%) and 2017 (-3%). Due to entirely new smartphone owners, handset sales have dwindled substantially, and replacement cycles for existing smartphone users have lengthened as smartphone features have matured. ABI Research forecasts that the overall handset market will grow from 1.66 billion in 2018 to 1.83 billion in 2023 (a Compound Annual Growth Rate [CAGR] of 2%) as 5G, bezel-less displays, and foldable screens stimulate replacement rates.

Samsung will no doubt be carrying out multiple management meetings to see how it can change its fortunes. The Galaxy S9 could be critiqued for not being very innovative (this depends on your view of Augmented Reality [AR] emojis, perhaps). The S10 will need to produce a winning hand of innovations, notably the rumored inclusion of 5G. It may not have been wise of Samsung to remove the “flat screen” version of its S series smartphones. Not everyone is a fan of the curved screen. Furthermore, more work needs to be done on the Bixby capabilities and integration. There are rumors that Samsung is working on a “foldable” smartphone due for launch in early 2019, coincidentally called the “X.” It may not be a financial hole-in-one, but it could become a long-term success story like the original Samsung Note (the inventor of the phablet). Samsung’s Gear smart watches have fared better than many other Android smartwatches, but Samsung will need to make sure sufficient Research and Development (R&D) funding is in place as the smart watch category is proving a strong revenue growth segment for Apple. Explicit numbers for Apple Watch sales were not released for 2Q 2018, but the overall category (Other Products) grew 37% YoY to US$3.74 billion.

Samsung will need to think hard about the extent of its handset portfolio. It may be prudent to trim its low-end and mid-tier handset models, to a greater or lesser degree, and it has spent the past quarter discontinuing production of older low-end models. These segments are only likely to come under increased pressure from Chinese and Indian handset manufacturers. While Samsung is beholden to the Android OS architecture, it needs to speed up the Operating System (OS) upgrade cycle for existing handset users and ensure its own OS augmentations (TouchWiz) really do enhance the end user experience. The Bixby button cannot be seen as an “orphaned” feature.

The final pillar of Apple’s revenue growth will be harder to emulate. Of Apple’s overall revenues, US$9.54 billion (17.9%) came from “Services” (i.e., digital content and services, AppleCare, Apple Pay, licensing). Apple has its own domesticated App Store to milk, and if rumors are true, it may launch an eSIM in future iPhones to offer always-on access to the store, which may be akin to the Amazon Kindle business model. Samsung does have a Near-Field Communication (NFC) based payment solution and can also harness licensing opportunities, but Google controls the Play Store. Samsung is using Tizen for its wearables, but fully disengaging from the Google Play Store may be almost impossible to contemplate.

Samsung should never be underestimated. Looking at the previous history of Samsung, the company has reached “glass ceilings” only to breakthrough them, but it needs to be wary of the fate that has befallen previous industry leaders in the handset market, most notably Nokia. In the meantime, there has been one solid pillar of revenue for Samsung—its semi-conductor division, especially its Memory and DRAM chipsets. Revenue for the group was up 25% YoY. Many of its smartphone competitors rely upon Samsung for their semi-conductor component, as they also do for Organic Light-Emitting Diode (OLED) display panels that are increasingly penetrating the smartphone market, most fervently (ironically) by Apple.

** Commentary for the Foresight based on recent BBC and CNBC TV interviews