Apple Lowers Dependence On Samsung To Exert Greater Control Over Supply Chain

The general public may have been treated to an interesting courtroom drama, but the Apple-Samsung battle seems to be heating up behind the scenes as well. Having recently won a $1.05 billion patent infringement ruling against Samsung (PINK:SSNLF) in the U.S., Apple (NASDAQ:AAPL) seems to be gradually reducing its dependence on the Korean electronic giant for the supply of iPhone and iPad parts as well. Not only has Apple reportedly been increasing its memory chipset orders from other manufacturers such as Hynix but also been diversifying its display suppliers by roping in rivals such as LG and Sharp in order to decrease its exposure to Samsung and foster greater supply-chain competition. ^[1]

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Samsung’s conflict of interest

While the move is being seen by many as prompted by the ongoing patent litigation between the companies, we believe that this is more a response to Samsung’s growing smartphone sales which could lead to a conflict of interest for the company in the coming years. The past year has seen Samsung gain a lot of smartphone market share. Its market share has doubled to more than 36% in Q2 2011 from about 18% during the same period last year.

With Samsung’s smartphone sales growing at a rapid pace and the company acting as its own supplier in many cases, it could pose an interesting dilemma for Samsung if it were forced to choose between Apple and itself in case of a supply shortage at its factories. This seems to be the primary reason why Apple is increasingly feeling the need to diversify vendors as it would mitigate the risk of Samsung prioritizing the supply of its own parts over Apple’s.

In fact, considering that Apple is Samsung’s chief rival in the smartphone market, it doesn’t even need the excuse of a supply shortage to cut Apple off at the source. The ongoing patent dispute only gives Samsung more reason to use its advantageous supply-chain position to Apple’s detriment. Samsung is currently the sole supplier of microprocessors used in the iPhone and the iPad and its components make up a significant 26% of the iPhone’s total costs. ^[2]

Diversification hedges the supply risk

Additionally, Apple needs to secure supplies for its products, the demand for which seems to be touching new highs every year. The launch of iPhone 5 is expected to be the company’s biggest ever product refresh cycle while the iPad continues to rule the tablet roost with a lion’s share of the nascent and rapidly growing market. With demand expected to remain strong, it makes sense for Apple to diversify and lessen exposure to any one supplier. Finding additional suppliers is essential for it affords Apple more choices and gives it greater control over its supply chain, especially at a time when burgeoning demand for mobile devices puts the supply side at a greater risk of not meeting demand.

Of particular interest to Apple could be the ongoing discussions about a potential deal between Foxconn and Sharp that would help Sharp compete better and give Apple an opportunity to decrease its dependence on Samsung. (see Foxconn-Sharp Deal Will Give Apple Greater Control Over Its Supply Chain) Fostering higher competition in the supply chain will give Apple greater bargaining power and help it control the cost of supplies, thereby supporting its profit margins in the longer term. As the smartphone market gets commoditized over time, we expect Apple’s iPhone margins to fall but a greater supply chain control could mitigate the risk to an extent.

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1. Apple Cuts Samsung Reliance, WSJ, September 7th, 2012 [↩]
2. Analysis: Friend and foe; Samsung, Apple won’t want to damage parts deal, Reuters, August 27th, 2012 [↩]