Samsung slips back in battle of smartphones

It seems like only last week that Samsung was seen as the indomitable giant of the consumer technology space, the company that basically owned all the profits in the Android business and, above all, the firm that took on Apple in the smartphone game and ate the iPhone's proverbial lunch. As the flagship Galaxy S series of smartphones became ubiquitous, there was no shortage of breathless coverage showering the Korean behemoth with plaudits, confidently declaring that it had stolen Apple's innovation crown.

And then, as suddenly as an elaborate house of cards comes tumbling down, Samsung’s golden era appears to be over.

Its last quarterly results, released at the end of July, showed an alarming slump in revenues, despite the launch of the higher- margin Galaxy S5 – a 25 per cent drop in operating profit from the year-ago quarter, down to $7.02 billion. It warned that the second half of 2014 would be “a challenge”.

“Samsung expects to see its sales of mobile devices increase with the rollout of flagship products and new models, but profitability may suffer due to a heated race over price and product specifications,” the company said.

That would be bad enough, but last week brought a fresh hint that the current woes are harbingers of long-term crisis. In China, soon to be the largest smartphone market on the planet, the Korean corporation was overtaken by the local upstart, Xiaomi, the rising star of consumer electronics.

Furthermore, the news that Samsung and Apple have agreed to a global truce of sorts in their protracted game of legal whack-a-mole over patent infringements, bringing an end to their interminable courtroom battles outside of the US, would seem to be a bit of a bonus.

However it is in the US courts that the Korean company has suffered some of its most bruising reversals, most notably the billion-dollar fine imposed in 2012, since reduced. In that context, however, the agreement appears to be setting up a final battle to decide the war.

Heated race

So, how did Samsung get to this point? Well, there’s a pretty blatant clue in that quarterly results statement – “profitability may suffer due to a heated race over price and product specifications”. That’s what’s known as “a race to the bottom” and the “winner” of such races is rarely in a healthy state by the finish line, because to come out on top you have to exhaust your physical reserves (or, say, product margins) to fend off lean rivals.

The reason Samsung is in that race and not, say, the far less populous race in which Apple finds itself, creaming off the vast majority of smartphone profits at the high end of the market, is because it is not in control of the entire smartphone “stack”.

Most normal people’s eyes glaze over with talk of platforms and stacks and vertical integration or horizontal strategies, but understanding Samsung’s shortcomings in these areas is key to understanding the problems it faces.

By relying on Google for the Android operating system for its smartphones, Samsung finds itself incapable of differentiating its offerings through software or retaining users through its own app eco- system. It took on Apple by undercutting the iPhone on price and above all through a humongous marketing machine (an astonishing $14 billion marketing spend last year, the biggest marketing budget by any company ever and nearly five times Coca-Cola's spending). Now, Xiaomi, for instance, is undercutting Samsung in pretty much the same way in China.

In many ways, the smartphone sector is beginning to replicate the PC era, with Google playing the role of Microsoft as the operating system provider and Samsung finding itself in the role of a Hewlett Packard or a Dell.

While Apple's zeal for tight vertical control was seen as a bizarre idiosyncrasy in the PC era, the Mac was consistently profitable after Steve Jobs returned to the company in 1997, and now the iPhone is in a more comfortable position than the Mac ever was. That vertical control means higher-quality products and the ability to sell devices on the basis of tightly integrated software and hardware. Samsung's efforts to mimic that strategy with the Tizen operating system appear doomed to fail – Tizen was recently delayed yet again.

Samsung would appear to boast far too many advantages for the company to end up following the ignominious path forged by Dell, but ultimately, Samsung’s situation proves that there’s no summit to stand atop of when you’re in a race to the bottom.