Why 2014 Was A Challenging Year For Samsung’s Smartphone Business

Samsung Electronics (PINK:SSNLF), one of the world’s largest electronics companies, had a difficult 2014. The company’s once rapidly growing smartphone division has been under significant pressure due to lackluster sales of its flagship Galaxy S5 handset, the launch of Apple’s large-screen iPhones and intense price competition from Chinese vendors. As of Q3 2014, Samsung’s smartphone market share fell to around 24% from around 32% a year ago. ((Gartner Says Sales of Smartphones Grew 20 Percent in Third Quarter of 2014, Gartner, December 2014)) Revenues from the mobile division have declined by around 18.5% year-over-year for the first 9 months of 2014, while operating margins have fallen from around 19% to about 15%, on the back of higher marketing and promotional costs and lower average selling prices. ^[1] The division has dragged down Samsung’s overall performance, with the company reporting a 30% decline in operating profits during the first 9 months of this year. We believe that things could remain challenging for the foreseeable future, given that the company’s traditional strengths of marketing and manufacturing are unlikely to compensate for its lack of product differentiation, in a smartphone market that is contending with slowing growth and higher competition.

Trefis has a $1,170 price estimate for Samsung, which is slightly ahead of the current market price. The mobile division accounts for about half the company’s revenues and close to 25% of the company’s value, according to our estimates.

See Our Complete Analysis For Samsung Here

Tepid Response To New Premium Products: The smartphone market tends to be somewhat perception driven, and it is important for a company to have a high-end flagship device that can excite customers while bringing in volumes and profits. A hit flagship product also helps to bolster a company’s brand image and positioning. While Samsung achieved success with its Galaxy S3 and S4 handsets, the response to its latest flagship device – the Galaxy S5 has been disappointing. The device has failed to kindle the interest of customers, who view it as an incremental upgrade to the Galaxy S4. Samsung is reported to have sold just 12 million units of the S5 during the three-month period following its release, compared to the 16 million units that the Galaxy S4 sold during the same period. ^[2] Additionally, Samsung’s share of the premium smartphone market will be impacted by the launch of Apple’s (NASDAQ:AAPL) large-screen iPhone 6 and 6 Plus models. Customers in the market for a premium large screen smartphone could veer towards the software differentiation, ecosystem and user experience that an Apple device would offer. While Samsung has also launched other premium handsets such as the Galaxy Alpha,  a device that sports a metal frame and premium finish, and the Galaxy Note 4, a high-end phablet device, we do not see these new launches bringing in the volumes, since the Android smartphone industry as a whole has been gravitating towards larger screens and more premium build-quality.

Slowing High-End Smartphone Market: The high end of the smartphone market is becoming increasingly saturated, with smartphone penetration in markets such as North America and Western Europe recording (or approaching) 50% penetration. ^[3] While the U.S. market has been exhibiting growth, the Western European smartphone market has declined for 3 consecutive quarters this year. Customers also appear to be less likely to upgrade their handsets frequently, given that the smartphone paradigm has been largely set and functionality based innovation has been plateauing. While there remains room for high-end growth in emerging markets such as China and India, it is possible that much of this growth will be captured by Apple, which enjoys a strong brand cachet and aspirational value among customers in emerging markets. For instance, in China, Apple dominates the high end of the market, with about 80% of handsets sold in the $500+ price range being iPhones. ^[4]

Chinese Vendors Squeezing Margins At The Low End: Samsung is also facing the heat in the low and medium end of the market, which still offers scope for volume growth. Chinese players like Xiaomi have been increasing their dominance in the sub-$300 segment by offering products with high-end specifications at value prices, backed up by a clever go-to-market strategy that eschews traditional advertising and retail channels, in favor of social media and online sales. As of Q3, Xiaomi’s global smartphone market share more than doubled year-on-year to over 5%. It is becoming increasingly clear that consumers are less likely to pay a premium for Samsung’s phones since they lack the brand cachet and meaningful hardware and software differentiation to distinguish themselves from the myriad Android handsets in the market. Samsung lost its leading spot in China to Xiaomi during Q2, and during Q3, the company saw its smartphone shipments to China decline by around 28%. ^[1] Although Samsung remains the smartphone leader in India – one of the world’s fastest growing markets – it has been ceding share to local vendors. According to IDC, global smartphone shipments growth is expected to moderate from over 25% in 2014 to just about a 9.8% CAGR for the 2014–2018 period, and we believe that competition could intensify further as vendors chase the slowing growth. ^[5] Samsung will have to beef up the specifications of its low-end handsets (potentially endangering the sales of its high-end models) or cut prices further, hurting margins either way.

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1. Financial Highlights, Samsung [↩] [↩]
2. Samsung Galaxy S5 said not selling as well as S4, CNET, November 2014 [↩]
3. Worldwide Smartphone Usage to Grow 25% in 2014, Emarketer, November 2014 [↩]
4. Of the 27% of Chinese phones that cost >$500, 80% are Apples, Fortune, March 2014 [↩]
5. Worldwide Smartphone Growth Forecast to Slow from a Boil to a Simmer as Prices Drop and Markets Mature, IDC, December 2014 [↩]