Samsung reports huge drop in profits
Last week Samsung announced its latest financial results, and it was not a pretty picture at all. In fact, it was so bad that in its Q3 2014 earnings release, Samsung Electronics reported its operating profits were 4.06 trillion won (£2.4 billion) which was a 60% drop over the previous year, while its mobile division suffered even worse with a massive 74% drop in profits. This rapid decline is almost as impressive as Samsung’s rise to stardom in the first place.
Despite slight growth in shipments, earnings declined QoQ as ASP decreased due to weak smartphone product mix and sales decrease put pressure on the cost structure – Samsung earnings release
Industry analysts have frequently criticised Apple’s reliance on a very small product mix (the iPhone accounts for more than 50% of the company’s profits), but Samsung is now in exactly the same situation because its Galaxy lineup generates the lion’s share of its mobile revenue. The situation is not expected to get much better in the fourth quarter for Samsung. The outlook for Apple is much brighter, as it typically sees its strongest performance in the run up to the holidays and is currently enjoying a very successful quarter – with an 11.3% increase in mobile profits led largely by two new iPhones that have so far achieved record sales.
Samsung’s rise to the top
In the past few years, Samsung has ascended to become the world’s most popular smartphone manufacturer (by market share), and with that accolade has also generated enormous profits from its IT and Mobile division. While being accused of copying Apple’s wildly successful device strategy with a number of high end premium devices, Samsung has enjoyed the boom mainly thanks to its Galaxy S and Note smartphones that have tempted buyers with huge screens and impressive-sounding features like quad-core processors . Samsung has mainly relied on its ever-larger screen sizes to differentiate against Apple, who until recently held out releasing a larger screened phone.
Samsung was also an early adopter of Android, which certainly helped catapult its products to the forefront of the attention surrounding that mobile operating system. Recently however, there have been signs of friction with Google – Samsung has even resorted to its own mobile OS called Tizen on several of its niche products such as the latest Galaxy Gear smart watch.
Samsung’s sales driven by low margin products
In the company’s press release, Samsung noted its smartphone sales in the past quarter were “driven by mid to low-end products”, which unfortunately is where most of the profits are not generated. Samsung’s other products such as its Galaxy Tab S tablet experienced an increase in units shipped, but this still wasn’t sufficient to offset the small margins from its feature phones and middle-tier smartphones. Besides smartphones, Samsung’s display panel division (which also provides screens to other companies) also took a sharp hit in profits due to “weak demand for OLED screens”.
Samsung is now relying heavily on its semi-conductor division (which, incidentally, manufacturers a sizeable proportion of Apple’s latest ARM-based A8 and A8X CPUs, which are used in both iPhones and the iPad Air 2) – which has now posted a larger profit (£1.3 billion) than the mobile division for the first time since 2011.
The fact that Samsung’s profits have been hit dramatically shouldn’t come as much of a surprise, as Samsung previously issued profit warnings stemming from lukewarm sales of the Galaxy S5. Even in the premium segment where Samsung has traditionally performed well, it is now under attack from the roaring success of Apple’s latest iPhone 6 and iPhone 6 Plus.
What is to blame for Samsung’s dip in profitability?
As already mentioned, Samsung is under pressure from Apple at the high-end, and cheap Android licensees in the low and mid-tier smartphone segments, especially companies from China such as Xiaomi – undoubtedly this year’s rising star that has shot up into the world’s top vendors for handset unit shipments.
The most pressing problem for all of the Android licensees, including Samsung, is that smartphone sales have been massively eroded in emerging markets where they have dominated more recently. Consumers are increasingly switching to Asian brands that are starting to rival Samsung in terms of features and build quality, and that often sell for much less.
Huawei, Lenovo and of course Xiaomi are the main culprits giving the established players a run for their money, but it’s Xiaomi that show the most promise. In the chart below, Xiaomi has now moved from the “Others” category into third place behind Apple (previously held by Huawei), giving you an idea of how rapidly the global smartphone landscape is changing.
Samsung also suffers on its average selling price, due to the fact that it often heavily discounts its smartphones and gives away tablets with its phones. Apple on the other hand commands a premium price and consistently managed to achieve nearly 40% profit margin on just about every device it ships. And with almost no revenue yet from the emerging category of wearables and smart watches, Samsung Mobile, just like Apple, still relies on its flagship smartphones to generate the majority of its revenue.
Can Samsung turn things around?
Much like Blackberry and Nokia, Samsung is finding that once you lose the crown, it’s not easy to regain in a cutthroat market with intense competition from all sides. Can’t Samsung just aim to make better phones like Blackberry and Nokia tried? Both companies took that approach to turn things around but still failed to make a real comeback.
Samsung’s reliance on Android may also hinder its efforts to differentiate from competitors like HTC and LG. On the surface, Samsung’s phones have a unique interface (its own TouchWiz UI layer built atop Android), but many consumers prefer standard Android without the vendor customisations (which has the downside of restricting Android updates) – and underneath it’s all just the same as Android anyway. This means there is little room to stand out from the crowd – with everybody on the same operating system it’s often only hardware features and design that can make an impact – Samsung has demonstrated its expertise in CPU design and particularly high resolution displays but unfortunately isn’t perceived as a luxury brand by many.
With the chief of Android (Andy Rubin) recently announcing his departure to a tech startup and Android’s raison d’etre being to support Google’s advertising business, Samsung may face an increasingly hard time achieving what it wants by sticking with Android.
Samsung is however hedging its bets with its own smartphone OS Tizen, but developing and maintaining a mobile operating system is extremely challenging and very expensive – it remains to be seen whether Samsung really has the will to go down that route for its most popular products and at the same time snub Google.
So, what should Samsung do? As they have already realised, they should focus on fewer products that make more of an impact – as opposed to the scatter gun approach of dozens of designs and sizes. Samsung also needs to stop adding unnecessary features to its smartphones that nobody actually wants (such as the heart-rate sensor on the back of some phones) and instead create simpler, more elegant products that use the best technology available – such as its superb OLED screens.
Samsung does in fact make some excellent devices that have proved massively popular in the past. If they can find a way to differentiate their designs and features from the competition, using their best of breed in-house technology, they might stand a chance of reversing the trend of declining sales.
Let us know in the comments what you think Samsung can do about falling sales. Should it focus on better products, or a smaller range of smartphones? Can anything be done to counteract the Chinese Android manufacturers?