According to a report in The InvestorSamsung (NASDAQOTH:SSNLF), which is widely believed to be the most capable manufacturer of advanced organic light-emitting diode (OLED) displays for smartphone applications, will supply Apple (NASDAQ:AAPL) with between 180 million and 200 million OLED displays for next year's iPhone lineup

"Improved yield rates at Samsung's A3 panel production lines are being cited as the main reason behind the display maker's decision to increase supplies to Apple next year," the report said. 

Apple's iPhone X.

Image source: Apple.

Yield rate is a figure that indicates the percentage of the displays manufactured that are viable. For example, if Samsung produces 100 displays and only 60 of those displays work as intended, the yield rate is 60%. 

Per the report, the yield rate of OLED displays on Samsung's A3 production line "was around 60%," but is now solidly north of 80%.

Here's what that means for Samsung and Apple. 

Higher yields, better costs and supply

Manufacturing yields affect both manufacturing costs and supply. 

The impact to manufacturing costs is easy to understand: If Samsung manufactures 100 panels and only 60 of them work, then the average manufacturing cost per working panel is the cost of manufacturing 100 panels divided by 60. 

If that number is higher -- let's say, 80 of the 100 work -- then the effective cost per working panel is the cost of manufacturing 100 panels divided by 80. In that case, the effective manufacturing cost per panel is substantially lower. 

Depending on the supply agreement Samsung has with Apple, this could translate into better profits for Samsung (since its cost structure would improve) or potentially lower prices for Apple -- which is said to be paying a pretty penny for the OLED displays found in this year's iPhone X -- at roughly similar levels of profit per panel to Samsung. 

There's also the fact that supply will improve with higher yields. Notice in the article, The Investor says that Samsung had considered investing more in its A5 lines to meet Apple's demand but thanks to the improved yield rates at the A3 line, it ultimately didn't have to. 

For a given amount of capacity that's put into place -- think factory space and the complex and expensive equipment used in the display production lines -- a higher yield rate means more working product, which means higher effective capacity. 

Of course, relatively low yield rates can be offset by putting into place a lot more manufacturing capacity, but this is problematic for two reasons: 

  1. Eventually yield rates will go up, and as they do, the manufacturer risks suffering from an oversupply of panels. This would either bring prices down per unit sold or force the manufacturer to cut back production, lowering factory utilization rates and ultimately profit margins. 
  2. Building extra manufacturing capacity doesn't happen overnight; the manufacturing company would have to be fully aware of the low yield rates and have a low amount of confidence in its ability to improve yield rates to get the ball rolling on additional capacity in time to meet customer demand. 

I think Samsung's dramatically improved yield rates for OLED displays will allow Apple to be more confident in its adoption of OLED technology across its 2018 product lineup. This benefits Apple because Apple's OLED displays are simply better than its LCDs, which leads to improved product competitiveness, and it benefits Samsung because it'll be able to sell a lot of OLEDs to Apple at good profit margins.

Ashraf Eassa has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Apple. The Motley Fool has the following options: long January 2020 $150 calls on Apple and short January 2020 $155 calls on Apple. The Motley Fool has a disclosure policy.