Global Economics

Samsung's High Design, Lower Profit Cell Phone Strategy


Count on Samsung Electronics executives to put a brave face on it when they announce their smallest quarterly operating profit in nearly three years on July 14.

Analysts expect Samsung to report operating profits of about $1.35 billion in the three months to June. That's a better earnings performance than key global rivals, but underscores the problems the South Korean national champion is having in two critical markets: flash memory chips and liquid crystal panels. Samsung execs concede as much, though they think the earnings stall is pretty much over.

"We are doing okay," says Samsung Senior Vice-President Chu Woo Sik. "We've gone past the bottom and the second half looks much brighter."

Samsung, of course, is still a killer innovator and the most profitable information technology player in Asia. And Samsung investors can take some comfort in the fact that rival LG.Philips LCD, a key competitor in the liquid crystal display panel business, recently posted a record quarterly net loss of $340 million (see BusinessWeek.com, 7/11/06, “LG.Philips LCD Swings to Loss in 2Q”).

MOBILE SLIDE. Samsung is still making money from its LCD unit, thanks to its focus on hot-selling big flatscreen TVs. The profit margin from flash chips, used for MP3 music players, digital cameras, and other mobile gadgets, will be just below 30%, far below the approximately 40% of the end of last year. That's not sensational, but hardly a disaster, either.

The far bigger worry is Samsung's slide in the global mobile-phone arena, which used to be a money-spinner. Two years ago, Samsung looked as if it had a shot at displacing Motorola (MOT) as the world's No. 2 handset maker just after Nokia. (NOK) Now, the Korean company is a distant No. 3 and analysts don't expect it to catch up to Motorola anytime soon.

The reason: Samsung is missing-in-action in critical emerging markets such as India for the fast growing market in low-end handsets. Since the late '90s, Samsung has tried to establish itself as a high-end player and ultra-cool brand by focusing on stylish, feature-packed products. The plan worked, but the company seems to have missed the big market shift to less expensive phones in recent years. "Samsung is a victim of its own success," says technology analyst Daniel Kim at Merrill Lynch in Seoul

OLD PARADIGM. The focus on high-end products allowed hard-charging Samsung to emerge out of nowhere as a trend-setter. In the past several years, it led a switch to color from black and white screens and became the first to make phones double as MP3 players and mobile TVs. It also introduced the clamshell design and kept rolling out camera phones with increasingly high resolution.

The gambit is no longer working. With cell phone saturation in the developed world, the big growth comes in emerging markets where first-time users still abound. "I like Samsung because of the speed with which it responds to changing business environments, but when it comes to phones, the company still lives in the old paradigm," says Ahn Young Hoe, chief investment officer at fund manager KTB Asset Management in Seoul. "It certainly risks diminishing market share."

Already there are signs Samsung is losing out. The consensus among analysts is that in the second quarter of this year, Samsung won't be able to match its first-quarter sales of 29 million phones. Worse, its profit margin is set to slip back closer to the 8% it posted in the fourth quarter of last year from 10% in January to March of this year. Compare this to the margin of 17% a year earlier.

RIVALS RISING. Samsung maintains it is not neglecting the entry-level markets. However, "our priority is in maintaining our brand image as a maker of premium products with leading-edge technologies," says Executive Vice-President Kim Woon Sub, a key figure for charting Samsung's business strategy. "Our basic business approach is clear: we won't compromise profits for the sake of a bigger market share. Even in the entry markets, our focus will be the premium segment."

Execs argue that Samsung should be able to keep its standing in the industry without competing with Nokia or Motorola for phones costing $50 or less. In the first quarter of this year, for example, Samsung's phone unit sales rose 18% from a year earlier, they point out. The trouble is, rivals' sales grew at much faster pace. Nokia's sales jumped 40% to 75.1 million phones during the period and Motorola's 61% to 46.1 million.

A bigger problem lies in profitability. Although Samsung limited its marketing efforts largely to mid- to high-end phones, its operational income dropped 45% to $486 million in the first three months of this year. In contrast, Nokia and Motorola posted income increases of 32% to $1.34 billion and 60% to $702 million respectively in the period.

RAZR MARGINS. The numbers underscore the need for the Korean company to lower costs. One method could be outsourcing manufacturing and globalizing the sources of components to include suppliers in Taiwan, China, and India, where costs are lower than Korea. Yet a spokeswoman at Samsung says her company had no plans to outsource the production of phones for the sake of cutting costs because that would make it hard for the company to control quality.

Instead, Samsung's answer is to roll out a profusion of fancy new models that execs hope will drive both sales and earnings. Last month, it unveiled three ultra-thin phones to tap the runaway success of Motorola's thin clamshell RAZR.

"The biggest differentiating factor these days is design," Chu said, noting that mobile carriers have been slow to migrate to next-generation networks (see BusinessWeek.com, 7/17/06, “A Chat with Nokia's Alastair Curtis”).

STILL SLIMMING. In an attempt to beat the U.S. rival in its own going-slim game, Samsung last month in Europe started selling the X820 model which is just 6.9 mm thick against 14 mm for RAZR. The bar-shaped phone sports a two megapixel camera and a case of fiberglass-infused plastic.

This month it is launching in Asia and Europe the clamshell D830, with a 9.9 mm-thick magnesium body, and the D900 slider phone that is 12.9 mm thick. Joining them in Europe is a new slim smartphone with a QWERTY keypad, the SGH-i320, to compete with Motorola's Q (see BusinessWeek.com, 7/11/06, “Motorola's Quirky New Smartphone”). Samsung is negotiating with a U.S. carrier to bring them all here soon.

Eventually Samsung hopes its focus on handsets with cutting-edge features such as 3.5G services and mobile TV will pay off. London-based researcher Informa Telecoms & Media forecasts the TV broadcasting market could be worth $8.4 billion by 2010.

"We are well placed to take the lead once mobile television and high-speed wireless Internet service become widespread," says Chu. Maybe, but Samsung will first have to make sure it won't be outgunned by its rivals because it missed the boom in low-end handsets for emerging markets.


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