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Can Samsung Save Its Smartphone Business After a 60% Drop in Profits?

By Leo Sun – Oct 10, 2014 at 10:00AM

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Samsung’s smartphone business is in serious trouble. Here’s how it can still save itself.

Samsung (NASDAQOTH: SSNLF) recently warned that its operating profit would plunge nearly 60% in the third quarter to 4.1 trillion won ($3.8 billion), while sales are expected to decline 20% to 47 trillion won ($44 billion).

That decline -- Samsung's fourth-consecutive quarterly operating income decline -- will also miss analysts' lowered projections. Analysts polled by Thomson Reuters expected Samsung's operating profit to fall 42% to 5.9 trillion won ($5.5 billion) on a 14% drop in revenue to 50.9 trillion won ($47.6 billion).

Source: Wikimedia Commons.

Samsung's mobile division, its largest business, has been crushed between Apple (AAPL 2.89%) in the high-end market and cheaper Chinese competitors like Xiaomi and Huawei in the midrange market. Between the second quarters of 2013 and 2014, Samsung's global market share dropped from 32% to 25%, according to IDC. IDC also reported that of the top five smartphone vendors in the world, Samsung alone reported a decline in global shipments in the second quarter. After this flurry of bad news, can Samsung still save its smartphone business? 

Why Samsung is dying
In August, Canalys reported that Xiaomi dethroned Samsung as the top smartphone vendor in China, which accounts for 37% of smartphone shipments. Xiaomi claimed 14% of the market, while Samsung, Lenovo, and Yulong controlled 12% each.

Xiaomi's strategy for beating Samsung was simple -- spend just 1% of revenue on marketing, rely on word of mouth advertising, manufacture phones in small batches to inflate demand, only sell phones through online retailers, and accept a smaller profit per unit to gain market share. Samsung -- which spends over 5% of revenue on marketing, manufactures phones in big batches, and tries to sell its phones at big margins -- couldn't fight back against Xiaomi's guerilla marketing tactics.

To make matters worse, other Chinese competitors, like Huawei, Oppo, and OnePlus, imitated Xiaomi's strategy and flooded the market with similar high-end devices with midrange price tags. OnePlus' One, for example, offers comparable specs to Samsung's Galaxy Note 4 for less than half the price.

Xiaomi's Mi 4 (L) and OnePlus' One (R). Source: Company websites.

In the U.S., Samsung isn't faring much better. According to comScore's August numbers, Apple still controls 42% of the U.S. market, compared to Samsung's 29%. Those numbers notably don't account for the launch of the iPhone 6 in September, which could tilt the scales further in Apple's favor.

Samsung now faces the same problem as Sony and HTC -- there's no cheaper alternative for an iPhone 6, but there are plenty of cheaper, comparable Android alternatives for a Galaxy S or Note handset.

How Samsung can save itself
Samsung has tried to solve these problems by tossing darts at every buzzworthy gadget that makes headlines, in a desperate effort to diversify its top line away from traditional smartphones. The company over the past year launched six smartwatches, introduced a modular wearable reference design for third-party manufacturers, unveiled a virtual reality headset, patented a design for smart glasses, and introduced the Note Edge, which features a curved display.

The Galaxy Note Edge. Source: Samsung.

But none of those tactics will save Samsung's core smartphone business. In my opinion, Samsung should consider these five strategies to get its smartphone business back on track.

  • Promote the "limited release" Galaxy Note Edge as a worldwide flagship phone, and price it competitively against the iPhone 6 Plus, regardless of margins.

  • Attract more developers to the Tizen OS by taking lighter cuts of app revenue than Google's 30% slice of Google Play sales.

  • If Tizen gets big enough, launch Tizen phones like the Samsung Z to break away from the rest of the Android market.

  • Reduce the number of low-end smartphones to protect its premium Galaxy branding.

  • Reduce the number of scattershot strategies (watches, VR, etc.) to protect its bottom line.

These strategies could help Samsung stand out in the high-end market with the Edge and in the midrange market with Tizen devices. If Samsung successfully replaces its Android devices with Tizen handsets, it could create an Apple-like unified hardware and software ecosystem, which would become the third largest mobile OS in the world.

A Foolish final thought
Samsung needs to make some bold moves to avoid becoming the next HTC. Its strategy of launching premium Android devices won't work in a market dominated by cheaper Android devices and the iPhone's dominance as a status symbol in emerging markets. The only choice Samsung has is to either swim forward -- by using the Note Edge and Tizen to carve out its own identity -- or to continue sinking.  

Leo Sun owns shares of Apple. The Motley Fool recommends Apple. The Motley Fool owns shares of Apple. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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