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Samsung (NASDAQOTH: SSNLF ) just issued preliminary results for its first quarter of the year. As the No. 2 mobile giant, just behind Apple (NASDAQ: AAPL ) , generating gargantuan amounts of profitability, Samsung has benefited quite handsomely from the mobile boom. However, as Apple suffered operating profit compression starting in 2012, Samsung bucked the trend -- until the most recent quarter.
Surprise! Smartphones are increasingly commoditized
Let's face it -- smartphones are, in general, destined to be a commodity. While today Apple and Samsung split the entirety of the mobile profit pie among each other, the truth is that the barrier to entry to build a smartphone or tablet device just isn't all that high. Anybody can buy top-quality components from a number suppliers (although Samsung does a lot in-house, giving it a margin edge), install a customized version of Android, and sell it.
Do a company's brand cachet, ability to market, and other intangibles matter? Of course -- just ask HTC how well its gorgeous HTC One sold. However, we live in a world today where phones that cost $199 to make can sell for north of $600. Surely there is some squeezing of these margins to be done (although Samsung is at far more risk of this, as Apple's iOS ecosystem is quite "sticky") for many smaller, opportunistic players.
Yes, it will happen
Apple may be a special case thanks to an incredible brand and a very sticky ecosystem (although that didn't save it from a significant gross margin decline following its 2012 peak), but if you look at the history of any consumer-electronics device -- flip phones, DVD players, HD-TVs, PCs, and more -- the margins for these businesses eventually become razor-thin. Just look at Samsung's consumer-electronics operating margins!
And so it begins for Samsung. In its preliminary earnings release, the company reported a slight year-over-year decline in operating profit from 8.8 trillion Korean won to 8.4 trillion (about 4.5%). This was on 53 trillion won worth of sales (roughly $51 billion USD) -- a fairly modest increase from 52.87 trillion won in the year-earlier period. What happens if revenue growth remains anemic or -- gasp! -- sees declines?
Is Apple similarly done?
Apple, as great as it is, isn't fully immune to the pressures in this market. However, unlike Samsung and the various Android handset vendors, Apple isn't just selling customers a phone -- it's selling them a brand and a software/media ecosystem. While just about anybody can sell an Android phone, only Apple can sell an iOS-based device with everything that goes along with it.
So, in reality, while Apple and Samsung both sell hardware, Apple is a software company that uses hardware as a delivery mechanism. Of course, Samsung would likely refute this and claim that it, too, is doing the exact same thing as Apple with all of the software it jams onto its phones, but there is a difference. Samsung's software often lacks the polish and user-centric finesse that Apple's does, opting for "more" and "bigger" features rather than carefully selected and highly tuned experiences. Samsung (and the other Android vendors) can tick the checkboxes, but many customers -- over 150 million of them in 2013 -- see right past that and hand over the "Apple tax."
Foolish bottom line
At the end of the day, Samsung is great at what it does -- producing a ton of smartphones across a wide range of price points and feature sets. Unfortunately, as well as Samsung does at this, there's plenty of room for Android players willing to live with less on the gross margin front ready and willing to disrupt that 8.4 trillion Korean won (or more, depending on the quarter) gravy train per quarter. And if history is any indication, they will.
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