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China's Rising Star Might be Why Samsung is Struggling

Last week, Samsung  (NASDAQOTH: SSNLF  ) CFO Lee Sang-hoon warned that the Korean tech giant's upcoming earnings report would not "look too good." Management offered nothing in the way of an explanation, but given the company's dependence on profits from its mobile division, weak handset sales may be to blame.

If Samsung's handset business is indeed struggling, it could be due to the growth of one of its major competitors. Earlier this week, China's Xiaomi said that its handset sales for the first half of 2014 were up a whopping 271% from the same period of last year.

Xiaomi's rapid growth may even challenge Apple (NASDAQ: AAPL  ) as it looks for growth in emerging markets.

Xiaomi: China's rising star
Xiaomi was founded just four years ago, but it has attracted some big-name executives -- most notably Google's Hugo Barra --, and has taken the Chinese handset market by storm. Kantar Worldpanel reported that Xiaomi in April sold more smartphones than Samsung -- this is notable, as Samsung has been the top-selling smartphone vendor in China in recent quarters.

Xiaomi's success has largely been a byproduct of its budget handsets: Its flagship Mi3 is a high-end smartphone that retails for roughly $300 in China. To Chinese consumers, with an average family income of only a few thousand U.S. dollars, Xiaomi's devices are understandably attractive.

Poaching Samsung's customers
As TechCrunch noted, many of Xiaomi's customers are first-time smartphone buyers, but almost a quarter were former Samsung handset owners. Like Samsung, Xiaomi's smartphones use the Android operating system.

Xiaomi's version of Android is heavily modified, but that's not particularly relevant. Few Chinese consumers actually use the official Google Play -- the majority of Chinese Android apps are downloaded through third-party app stores.

Apple looks to China for growth
With its monopoly on the iOS operating system, Apple is less likely than Samsung to lose customer to Xiaomi, in China or anywhere else.

But Xiaomi is still a competitive threat to Apple's emerging-market ambitions. Although the Cupertino-based company has a firm grip on developed economies such as the U.S. and Japan, analysts have looked to China and other markets to provide incremental iPhone demand.

To a large extent, that has happened. Last quarter, Apple sold more iPhones than analysts had anticipated, mostly due to record emerging-market demand. In China, for example, Apple's revenue increased 5% sequentially, and company management noted that revenue from the BRIC countries collectively was at an all-time high.

Investors may be tempted to write off Xiaomi's phones as low-end budget devices, stepping stones for Chinese customers who will one day (if they can afford it) purchase Apple's iPhone. In reality, Xiaomi's phones are fairly high end -- the Mi 3, for example, has specs comparable to Apple's top-of-the-line iPhone 5s.

If Xiaomi can continue to capture first-time Chinese smartphone buyers, Apple may have a difficult time prying them away. As Xiaomi expands into other emerging markets, it could prove to be a major competitive threat.

Investors should be mindful of Xiaomi
Unfortunately, Xiaomi is a private company, leaving investors unable to take advantage of its rapid growth. Yet shareholders in the space, particularly Apple and Samsung investors, should be mindful of Xiaomi's rapid expansion.

When it comes to China, and emerging markets more broadly, Xiaomi could prove to be a major thorn in the side for these two tech majors.

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  • Report this Comment On July 03, 2014, at 12:17 PM, chastenruin wrote:

    The S3 sold more than both the S4 and the S5 based on current projections. They are getting killed on the flagship phones.

    On emerging markets, its a high volume, low margin game and if they arent moving volume they are taking losses.

    It's really hard for Samsung to differentiate themselves in both markets. In emerging markets, they have to compete on price, in flagship markets they have to compete with every other Android manufacturer to try and cobble together a phone that competes against Apple's iOS and ecosystem.

    Samsung should consider going full Tizen and flooding emerging markets with better phones at a loss to claw market share and build an ecosystem for Tizen users to begin purchasing apps and content and bringing in developers to fill up the store.

    Then Samsung needs to bite the bullet and bring Tizen to the flagship market with an entirely new phone line that represents their best effort to compete toe-to-toe with Apple. And do the same thing on price in order to claw market share in that premium space for Tizen to continue to attract developers to a paying user base.

    Samsung is at a real disadvantage in the respect they dont make money from app and content sales and really dont have full control over hardware/software integration with Android and they sacrifice their ability to chart their hardware development path and integration of the OS into their other consumer electronics devices because they dont have control over the OS. They are Google's bitch, essentially. They need to start exerting some control over their own destiny and take the money that they are leaving on the table for Google and Amazon to make up in App/Content sales.

  • Report this Comment On July 03, 2014, at 12:37 PM, zippero wrote:

    Regardless of who the leader du jour of the commoditized, profitless Android market is at any given moment, whether Samsung or Xiaomi, the Android market at large remains commoditized and profitless and will always stay like that, just like the Windows PC makers of today remain commoditized and profitless and will never recover from that either. Whether Windows OS or Android OS, the fact that these OS's are widely distributed across every Windows PC and Android smartphone maker on earth GUARANTEES these markets will all be commoditized in the end, because they all have nothing to differentiate themselves from each other except price. It's basic economics 101. With commoditization comes not only falling prices but also declining quality, as price wars ensure cheaper, lower quality components get used to achieve lower bills of materials. Tim Cook was right: Android = junk! and the junkification/commoditization of Android is an inexorable, relentless process. Samsung could look to Tizen, but even there Samsung messed up by sharing Tizen with all the Chinese Android OEMs, and these Chinese will undercut Samsung on Tizen phones just as they're undercutting Samsung on Android phones. 5 years ago, Samung took the expedient route of adopting Android instead of developing its own proprietary OS, and Samsung's mobile division won't even be around 3 years from now due to this lack of long term thinking.

  • Report this Comment On July 03, 2014, at 1:05 PM, GaryDMN wrote:

    Losing Apple as a customer has to hurt, since they lost billions in revenue.

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Sam Mattera

Sam has a love of all things finance. He writes about tech stocks and consumer goods.

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