The world’s largest smartphone maker today saw its stock fall by 6.2 percent after banks downgraded the stock on concerns that Samsung Electronics (005930:KS) may make only several billion dollars this year, as opposed to a kajillion.
Sales of the company’s flagship Galaxy S4 have slowed, say analysts. In the meantime, Samsung is readying smaller and more stripped-down versions of its popular smartphones. These less-expensive models will probably perform well in developing markets, but the profits earned on them will be smaller.
To understand what’s going on here, it’s important to remember two things. First, the global smartphone market does not resemble the one in the U.S., where phones are subsidized by the carriers. The actual price of a GS4 or iPhone is north of $600, but carriers will sell you one for $199 because they more than make up the difference in monthly charges over the two years on your contract. Everywhere else, you pay full freight, but you don’t have multi-year contracts.
The second thing is that most of the growth in smartphones is not going to happen in the U.S. “We’re getting to the end of the first phase of the growth in smartphones, particularly in the U.S.” says Benedict Evans of Enders Analysis. “Everyone who wants one has gotten one.” China, India, and other huge-but-developing nations will be responsible for new sales. That means it’s vital for smartphone makers such as Samsung (and Apple (AAPL) and the others) to make phones that will sell in Shaanxi Province, not just on the corner of Fifth Avenue and 58th Street.
According to the Gartner Group, a market researcher, sales of smartphones were relatively flat in the first quarter of 2013, while sales in Asia rose 6.4 percent. China specifically saw its mobile-phone sales go up 7.5 percent. It now accounts for nearly 26 percent of all mobile sales, up two percentage points since the same period last year.
If you’re going to be competitive in markets like China, you have to drop the cost of what you’re selling—partly because global consumers are extremely price-sensitive, with no carrier subsidies to cushion the blow, and partly because Chinese manufacturers will build something cheaper if you don’t. That’s going to cause profit margins to shrink. “Samsung makes less profit than Apple, per phone. Chinese manufacturers make even less,” says Asymco analyst Horace Dediu. “Is that 20 percent margin going to evaporate?”
As Samsung has been to Nokia (NOK), Motorola (GOOG), and Sony Ericsson—moving faster, making things cheaper—so, too, may Chinese makers such as Huawei and Lenovo (992:HK) be to Samsung. Samsung can still make high-end flagship models that garner the majority of press and attention, but the mid-and-low end of the market will ultimately become commodified and taken over by low-cost manufacturers. But then, Samsung knows this. That’s why it’s pouring billions of dollars into such higher-margin businesses as health care and solar power: The water is rising and the company is seeking higher ground.