Samsung's Awful Position: Losing Both the High and Low End

With cheaper manufacturers stealing market share on the low end and market saturation on the high end, Samsung is expecting its second consecutive quarter of falling profit.

Apr 10, 2014 at 2:00PM

Samsung's (NASDAQOTH:SSNLF) spectacular run of profit growth may be coming to an end. The world's largest maker of smartphones and televisions expects its second consecutive quarter of declining profit, sending some alarm bells ringing for analysts. The company is suffering from increased competition from cheaper manufacturers, such as new entrant Lenovo (NASDAQOTH:LNVGY) on the one hand, and saturation in the higher end market on the other. As such, commentators believe the company will be forced to implement a number of cost-cutting initiatives, in addition to working on lower-cost smartphones.

Cheaper competitors
Let's take a quick look at the numbers before moving on to what's weighing on these results. The world's largest technology firm by sales is projecting first-quarter operating profit at $7.9 billion. This figure is down 4.3% year over year for the second quarter in a row of declining profit. Sales were more or less flat, inching up 0.25% year over year.

The decline in sales growth is partly due to the emergence of low-cost smartphones from Chinese manufacturers aimed at emerging markets, which are still seeing very strong demand for cheap smartphones and tablets. Lenovo, for example, has made it clear the company is serious about disrupting the smartphone market with its acquisition of Motorola, giving it an established brand to develop and expand. With the A526 smartphone launching for less than $160 in India, the company is hoping to acquire a market share of around 5% in Asia's third-largest economy.

So, what does this mean for Samsung? Basically, the company will have to embark on an aggressive cost-cutting mission in order to prop up earnings, as margins are dropping across the industry. This means reducing manufacturing costs as well as marketing spend. Additionally, the company has lowered the price of its new flagship phone, the Galaxy S5, by about 10% compared to the previous model, as a response to lower prices across the industry. Now favoring design and features above hardware innovation, this back-to-basics approach of price competitiveness is expected to boost the top line in the coming quarters.

Top-end saturation
The other problem faced by Samsung is an increasingly saturated market in the more developed economies where higher-end smartphones generally see the greatest demand. Most people in the West who want a high-end smartphone generally already have one, so companies face limited growth potential compared to the lower end of smart devices. But some analysts believe that slowing sales are also due to a lack of innovation from market leaders Samsung and Apple (NASDAQ:AAPL).

Apple is facing many of the same problems as Samsung in its smartphone division. Samsung's American competitor is now looking to challenge it in its home field, namely the 5-inch screen arena. The iPhone 6 is likely to have a considerably larger screen size than its predecessor, with Apple finally recognizing the popularity of larger screens and the low-priced Android phablets. Reports indicate that Apple will be releasing a 4.7-inch smartphone as well as a 5.5-inch phablet this year, as well as scaling back its marketing spending to rein in margin contraction.

The bottom line
Samsung's expected second consecutive quarter of declining profits underscores the fact that the smartphone market is changing. Some years ago, growth was mostly fueled by high-end devices in the developed world. Now, with growth drying up in the high-end segment, cheaper Chinese manufacturers are cornering the market in faster-growing emerging economies, and stealing market share away from traditional players like Samsung and Apple. As such, these companies will have to find ways to cut costs, as well as maintain their market share by catering to the low-cost, large-screen market.

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Daniel James has no position in any stocks mentioned. The Motley Fool recommends Apple. The Motley Fool owns shares of Apple. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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