The Simple Reason Samsung Smartphones Can't Compete With the Apple iPhone

The smartphone market is still growing strong in 2014. In the second quarter, unit sales increased 23% to 295.3 million.

Although most of that growth is coming from low-end devices sold in emerging markets, Apple (AAPL -0.69%) -- a company that makes exclusively high-end devices -- was able to increase iPhone sales 12.7% last quarter. Still not as much as the overall market, but enough to maintain nearly 12% market share.

Comparatively, Samsung (NASDAQOTH: SSNLF), which sells smartphones at nearly every price point, saw its smartphone sales fall 3.9% year over year. As a result, its market share declined to 25.2% from 32.3%.

So, why is Apple able to sell more high-end smartphones despite most of the growth supposedly coming from low-end devices? And if Samsung is making low-end and mid-range devices, the prime areas of market growth, why aren't its sales increasing?

Apple makes really good phones
The simple reason Apple is selling more smartphones is because it makes the best smartphones. The latest iPhone is consistently ranked as the best smartphone by critics, while Samsung's Galaxy S models have started falling from the No. 2 spot over the last two years.

While it's one thing to make really good phones, it's another to make really good phones that people want. Smartphones are just as much a fashion as they are a utility, and Apple's brand is very fashionable.

The appeal of Apple is evidenced in its 41.9% share of U.S. smartphone subscribers. That number has continued to climb in a market that many consider already saturated on the high end. Smartphones accounted for 70% of the mobile market as of the end of May.

Most people who can afford an iPhone will buy an iPhone. That's even true in China, where about 80% of smartphones sold for more than $500 are iPhones. For everyone else, price is one of the biggest differentiating factors when making a decision regarding which smartphone to buy.

Samsung is in a race to the bottom, and it's losing
Samsung is one of two smartphone makers that actually turns a significant profit selling hardware. The other is Apple. But Samsung is seeing its sales decline largely due to the fact that it still thinks it should be able to earn a nice profit on its handsets while its competitors are willing to settle for less.

The landscape of Android phone makers is much different than just a couple years ago. Samsung no longer makes the best Android phones, and Chinese OEMs are selling phones comparable to Samsung's high-end devices for half the price. With Android limiting Samsung's ability to differentiate its products through software, and Chinese manufacturers able to quickly clone Samsung's hardware capabilities, Samsung is in a race to the bottom.

Chinese OEMs have come on strong over the last couple years. Huawei has ascended to the third-largest smartphone OEM since launching its consumer business in 2011. Xiaomi is now the fifth-largest. Lenovo, after acquiring Motorola Mobile, is in between.

These companies are dominating Samsung in the mid-range and low-end, and they're still just getting started. Huawei recently announced plans to shift its focus to more consumer-facing products. Xiaomi plans to expand to South America and Europe in the near future. And Lenovo has yet to fully capitalize on its recent acquisition of Motorola Mobile.

All is not lost for Samsung. It's actually well-positioned to win among those companies racing to the bottom. Fool contributor Ashraf Eassa notes Samsung has the advantages of economies of scale, vertical integration, and a well-known brand. Ashraf goes on to say, however, that if Samsung wants to stabilize its margins, it needs to find a way to differentiate itself like Apple does. Despite several efforts to differentiate its smartphones, Samsung has been unsuccessful.

Differentiation leads to success
Apple's iPhone differentiates itself through its OS, its unique hardware capabilities, its retail experience, and its brand. Most Samsung phones are differentiated from their competitors on price, and Samsung isn't on the good side of that equation. Samsung is losing sales to Apple on the high end, and it's losing to the Chinese OEMs on the low end. It still dominates the market, but if it doesn't change course, it won't be long until another Android OEM leapfrogs it.

Meanwhile, Apple will continue to chug along, slowly gaining sales as soon as people can afford it. And once someone buys an iPhone, as most of you know, they usually keep buying iPhones.