South Korean chipmaker SK Hynix (OTC: HXSCL) recently announced that it will produce more CMOS image sensors to address the growing demand from smartphone makers. The decision was surprising for two reasons: SK Hynix mainly produces memory chips, and Sony (NYSE:SNE) and Samsung (OTC: SSNLF) already dominate the CMOS image sensor market.

Sony's Exmor sensors controlled 48% of the market last year, according to Techno System Research, and its top customers include Apple (NASDAQ:AAPL) and Huawei. Samsung, which launched its own ISOCELL sensors last year, holds a 21% share.

Four smartphones being use to take pictures of a coast.

Image source: Getty Images.

SK Hynix converted part of its DRAM production facilities in Icheon, Gyeonggi Province into a production center for its new Black Pearl CMOS image sensors. It's already supplying three types of image sensors to smartphone manufacturers, and it will start mass production on a fourth sensor later this month.

The smartphone market is heavily saturated, but SK Hynix expects the average number of cameras per smartphone to rise from 3.2 in 2019 to 3.9 in 2020. Smartphone makers are also expected to install pricier sensors in higher-quality cameras to attract shoppers.

However, SK Hynix's entrance into the image sensor market could cause problems for Sony, which relied on robust sales of image sensors to offset the weakness of its other businesses over the past year. Let's see how much that business matters to Sony, and if SK Hynix's entrance will throttle its growth.

How much do image sensors matter to Sony?

Sony's imaging and sensing solutions (I&SS) revenue rose 22% annually in the first three quarters of 2019 and accounted for 13% of its top line. The unit's operating profit soared 63% and accounted for 25% of its operating income.

That growth partly offset declining revenue at its gaming business, which faces slower hardware and software sales ahead of the PS5 launch in late 2020; and its consumer electronics business, which is struggling with soft sales of TVs and mobile devices.

Sony raised its full-year guidance for the I&SS unit last quarter. It lifted its revenue growth forecast from 18% to 24%, and its operating profit growth forecast from 39% to 60%. It attributed that rosy revision to "higher-than-expected" sales of sensors for mobile devices and an improved product mix.

The growth of the I&SS business should help Sony tread water until the PS5 arrives and turns the gaming business into its core growth engine again. However, SK Hynix's sudden entrance into the image sensor market could pull some customers away.

Why is SK Hynix a dangerous rival?

Last December, Sony stated that it couldn't meet customer demand for its image sensors even as it ran its plants around the clock.

A close-up of a camera lens.

Image source: Getty Images.

Sony already more than doubled the unit's capex throughout 2019 to boost its capacity, but semiconductor chief Terushi Shimizu admitted that the investments still weren't matching market demand. Sony will open a new semiconductor plant in Nagasaki in April 2021, but it could come online too late to fend off fresh competition from SK Hynix and Samsung.

SK Hynix is the second-largest manufacturer of DRAM in the world. DRAM prices have been in a cyclical slump over the past two years, but they're expected to gradually rebound later this year. SK Hynix can't ramp up DRAM production until those prices rise, since flooding the market with new chips would drive down prices again.

That's why SK Hynix is using part of its DRAM plants to produce CMOS image sensors instead. SK Hynix already has the infrastructure to produce those chips at a rapid rate, and it can simply divert some resources away from DRAM production to satisfy market demand. Samsung, the world's top DRAM chipmaker, is also adopting a similar strategy.

Sony still has a "best in breed" reputation in image sensors, but impatient OEMs could place orders from SK Hynix or Samsung instead. Moreover, a fresh supply of image sensors could cause a supply glut and drive down market prices.

Should Sony investors be worried?

It's unlikely that SK Hynix will crack Sony and Samsung's near-duopoly in image sensors anytime soon. The pent-up market demand also suggests there's plenty of room for all three companies to sell their image sensors without trampling each other. However, investors should still keep an eye on SK Hynix and Samsung's latest moves, since both companies have the scale and market clout to challenge Sony's strongest business.