Should Samsung Embrace Emerging Markets With Low-End Galaxy Smartphones?

Samsung (NASDAQOTH: SSNLF) is generating a lot of buzz these days with its high-end Galaxy Note 4, Galaxy Alpha, and Galaxy Note Edge smartphones. However, many tech investors aren't paying much attention to the Galaxy S Duos, its line of low-end Galaxy devices designed for emerging markets.

Samsung launched the Galaxy S Duos line two years ago. The key feature is that it can run two SIM cards simultaneously for voice calls, compared to its other dual-sim devices that require the user to manually switch between the two. The latest model in the line, the Galaxy S Duos 3, was launched in emerging markets in early September for roughly $120 to $130.

Samsung's Galaxy S Duos 3. Source: Samsung

The Galaxy S Duos 3 -- along with the Galaxy Core II, Galaxy Ace 4, Galaxy Star 2, and Galaxy Young 2 -- all represent Samsung's push to expand its Galaxy brand into low-end markets. While this might seem like a sound strategy to reach more users, it could also undermine the premium appeal of its high-end Galaxy devices and wreck its margins.

Why emerging markets are a blessing and a curse
IDC expects mature smartphone markets to only post 4.9% year-over-year growth in 2014, while emerging markets are set to soar 32.4%. Mature market users will also only account for 26.5% of the market, compared to 73.5% from emerging markets. Research firm Mediacells also forecasts that China and India will account for half a billion smartphone shipments this year.

While that sounds like a great new market opportunity, established smartphone makers face two major hurdles entering these markets -- a race to the bottom in pricing, and modified versions of Android (like Xiaomi's MIUI) which replace Google (NASDAQ: GOOG) (NASDAQ: GOOGL) Play with local app stores. That's why Google recently launched its Android One smartphone initiative in India -- to guarantee that its services would be bundled with low-cost smartphones across the country.

Meanwhile, hardware makers in China and India accustomed to high margins from developed markets must accept lower margins in emerging ones, with the hope that higher sales volume can offset lower profits per unit. For some companies, like Microsoft (NASDAQ: BBRY) and BlackBerry (NASDAQ: BBRY), emerging markets represent the only way to avoid being crushed by iOS and Android devices.

So why is Samsung expanding into emerging markets?
In the past, Samsung wasn't extremely concerned about low-end markets, since its high-end Galaxy S devices fared well against its Android competitors and Apple (NASDAQ: AAPL).

But over the past year, Xiaomi, Huawei, and other Chinese rivals turned the tables on Samsung by launching comparably powered devices at less than half the price. They spent less on marketing, released devices in smaller batches to inflate demand, and accepted razor-thin margins to gain market share. Sticking to those strategies, Xiaomi dethroned Samsung as the top smartphone maker in China in August.

Xiaomi's Redmi 1s. Source: Xiaomi

That unrelenting pressure caused Samsung's global market share to decline from 32% to 25% between the second quarters of 2013 and 2014, according to IDC. As a result, Samsung's quarterly operating profit has fallen year over year for three consecutive quarters, and it also warned of a fourth decline earlier this month. The company now expects its mobile division, its largest business, to post a 60% plunge in operating profit when it reports earnings on Oct. 30.

To address this problem, Samsung is expanding into emerging markets and selling handsets at lower margins, in hopes that higher sales growth will offset its problems in developed markets.

Not as easy as it looks
Unfortunately for Samsung, the Chinese and Indian smartphone markets are so saturated with cheap smartphones that the average price for an unlocked device now hovers between $100 and $150. Moreover, Chinese competitors are hitting hard with more powerful devices, like Xiaomi's Redmi 1S, which only cost slightly more.

Sources: Company and industry websites. *Based on e-commerce sites and official announcements.

As you can tell, that low-end market is being flooded by similar devices. Samsung's strategy in this market is to leverage its Galaxy branding to sell its devices, but that's a risky strategy which could cheapen the brand and discourage status symbol seekers from buying high-end Galaxy devices.

Samsung's expansion of its Galaxy brand into low-end markets shows that it is losing its competitive edge against Apple and its cheaper Chinese rivals.

Moreover, Samsung will likely have to lower the prices of these low-end Galaxy phones to gain any market share at all against competing devices. That approach would cause more damage to its bottom line and tarnish the premium appeal, which could trap the tech giant in a nasty negative feedback loop.