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Samsung, Apple and Vertical Integration

Posted on Thursday, May 15th 2008

We discussed Apple’s vertical integration thoughts in prior posts. I also did a Forbes column on the subject, looking into the Jobsian mind to cull what’s cookin’ …

The company that is perhaps the best positioned to compete in a vertically integrated convergence device world is Samsung. Let’s look at what’s going on at that camp.

Samsung said yesterday that it would pull out of the laptop market unless it triples its sales and increases its market share from 1.7% to 5.7%. Yesterday proved quite eventful with its CEO Yun Jong Yong retiring. His retirement follows the resignation of Chairman and co-CEO Lee Kun Hee just three weeks before on charges of tax evasion. The new CEO is Vice-Chairman Lee Yoon Woo, who led Samsung’s semiconductor business from 1996 to 2004.

Another major management change was the appointment of President Hwang Chang Gyu, head of the semiconductor business, as the CTO. Kwon Oh Hyun, who has was running the non-memory chip business will now head the semiconductor business. An interesting analysis of the management shuffle is available here. Another major development was Samsung joining hands with LG and an American company, Harris to develop a new standard for mobile TV broadcast.

Samsung Electronics Co., Ltd. On April 25 reported first quarter results that beat analyst estimates. Revenue grew 19% to 17.11 trillion won ($17.18 billion). Net income grew an amazing 37% to 2.19 trillion won ($2.2 billion), despite drop in semiconductor prices which was offset by flat-screen and mobile-phone earnings. Earlier coverage is available here and here.

The LCD Business revenue grew 53% to 4.34 trillion won and operating profit grew 10% q-o-q and 14-times y-o-y to a record 1.01 trillion won. The Telecommunication Business revenue grew 23% y-o-y to 5.55 trillion won and operating profit was 920 billion won, up 53% driven by favorable currency rates and reduction in marketing expenses. Its market share in cell phones is now 16%, up from 14% last year. Nokia’s share rose to 41% from 37% while Motorola’s share tumbled down to 10% from 18%.

The semiconductor business on the other hand was ridden by weak prices, over-emphasis on high-density products and seasonality driving down revenue 2% to 4.39 trillion won and operating profit down by 64% to 0.19 trillion won. The Digital Media Business had operating profit of 30 billion won on revenue of 1.83 trillion won. The Digital Appliance Division revenues were 820 billion won with operating profits of 20 billion won.

Of all these results, the most interesting one to me is their growing market share in cellular handsets. With a global channel, Samsung will definitely be a player as the market grows, and users upgrade to more capable devices. In fact, when it comes to emerging markets, Nokia and Samsung are much better positioned to cater than Apple and RIM, the market leaders in the high-end smartphone segment.

As Apple experiments with its new-found semiconductor identity, it would be interesting to see how Samsung plays its formidable cards in that domain.

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This premise is one of the most weakly supported you’ve made yet. You usually make logical arguments.

Today you state your premise, then lead us through detours … tax evasion management change … management change … management change .. then earnings reports in won without any USD references for comparison. Then one paragraph that restates the premise that Nokia and Samsung are better positioned with a global channel, and imply that means they’re “best positioned to compete in a vertically integrated convergence device world.”

You didn’t make the case. I don’t buy it. I just recently wrote 2 articles with a lot more meat on the phone that stated the exact opposite.

I just happen to agree that Samsung is shaping up to be a great international products company. They’re great at semiconductors, and have been doing surprisingly well in the “gadgets” category. They lack the industrial design expertise that Apple demonstrates for us on a regular basis. Neither do they have the software expertise that Apple developed since the time of the Apple II.

So besides all the talented engineers in both hardware and software reflected in these two observations, Apple has an extensible platform, that will be a competitive advantage against any and all comers for at least the next 5-10 years. If Apple continues to innovate at their current pace, then their lead will be extended into the foreseeable future and would last decades.

oh… the international sales channel… Let’s have this discussion again in another 6-12 months when the iPhone is for sale in 50+ countries and with 20-25 million units sold. They’ll probably hit 50 countries next month or soon thereafter. In a year, the reach of the iPhone will be even wider than the reach of the black market that has taken the phone to every corner of our globe at substantially elevated prices.

It is exactly at this point of connection that you imply a conclusion. Maybe that Apple’s stuff is too good and therefore will be too expensive for some markets.

Good design doesn’t necessarily make products more expensive. Good design can also make better products less expensive. It all depends on your design goals.

I see Apple building their iPhone franchise first. Then, it make sense that they will branch the iPhone into several variants that will cover the full spectrum of price points and needs in the mobile phone space as they have done previously with the iPods in the media player space.

It will be at that point that Apple will announce some kind of iPhone nano to expand their marketshare into lower price points. This will result in increased market penetration not only in North America, but also in the emerging world.

At this time, Apple will also be building the converged devices of which you refer. Samsung will also be giving a stab at such a device. The Apple device will dance circles around anything Samsung will be able to put out. Samsung will have to compete on price. Then economies of scale will give Apple an opportunity to continue lowering prices for far superior products. Apple will take almost all of the most profitable revenues from the mobile phone industry. The other players will be left fighting over the scraps of the far less profitable commodity cell phone business.

Where have we seen this before? Oh yeah… it was the iPod in the media player market. Granted that the media player market was in its’ infancy, when the ipod debuted.

Nokia and Samsung will fight valiantly to protect as much of their market as they can. These competitors have the resources ($$) and the desire to compete effectively, but they don’t have all the pieces in place to match up to all of Apple’s strengths.

These competitive advantages that Apple brings to the table have been developed over many years. Apple already has many pieces of technology that can be used synergistically in many interrelated markets. Apple has created an extensible platform that is more capable and more flexible than any that Microsoft or anyone else for that matter has ever offered to the world. The engineers at Apple have already demonstrated a remarkable ability to mold that platform into myriad successful and nicely profitable products and gadgets.

The other can try to replicate those skill sets, but doing so will take time. In the mean time, don’t expect Apple to stand still. If Apple has demonstrated an ability, it has been to innovate at a pace that puts them so far ahead of their competitors that the others have little or no chance of catching up.

I agree that Samsung has many positives in its’ favor; it will be a formidable rival. However, with all the strengths that Apple already has in place, it will be difficult for Samsung to claim the title of heir to the convergence device market.

The marketplace battles will become an interesting spectator sport. You have chosen 2 great opponents, and I would even throw Nokia into the mix. These three will be making sparks and fireworks for the next 5-10 years.

The quality of mobile phones and our expectations of their capabilities will evolve at a combustible pace. We will all benefit from the battle. The conclusions can already be inferred. Apple is holding a better hand in one metaphor. In another, Apple’s board position is much stronger. It’s not that their opponents have no chance to win; but Apple would have to make a bad move or stop innovating. At this point neither is likely. The Apple of today shows an amazing knack for learning from their mistakes, and there aren’t even many of those.

We’ll have better phones. Yes, Samsung will be in the ring for this fight, but they’ll be at a competitive disadvantage. I would rather be in Apple’s position or have their hand to play; whatever the metaphor you wish to use.

Give us some meat next time. Samsung’s channel advantage will disappear in the next 12 months. Then the advantage will go to Apple for technological and strategic reasons that have been developed for at least the past 10 years.

Realtosh Thursday, May 22, 2008 at 12:51 AM PT

Realtosh,

I agree with you that Samsung’s disadvantage is software, which is Apple’s biggest advantage over all its rivals.

I don’t agree on the Industrial Design point entirely. Frog Design and IDEO are for hire, and Samsung, if they decide to, can hire them.

On channel, I specifically mentioned the emerging market – where I don’t see Apple playing at all, except in the high end. Do you see Taxi Drivers in India and China using iPhones? I don’t.

Those volume markets are where Nokia and Samsung excel.

As for semiconductor capabilities, Samsung has vastly more expertise in that area.

All told, however, I agree that I would prefer to be in Apple’s shoes, just because it is playing in the most profitable “luxury” segment of the market.

But the dynamics of the market will also change over time, and Apple’s competitors will use “price” as a competitive weapon. I am pretty sure Samsung and Nokia will do that, and do it well.

Sramana Mitra Thursday, May 22, 2008 at 9:56 AM PT

I accept your point that Frog And IDEO are excellent design firms. They can assist any of the competitors in the outward appearance. They would say that they provide comprehensive design services. But even they don’t have the complete design talent that Apple has in house, with all of their IP and patents and can borrow from their other products in ways that others are restricted. But nonetheless I’ve been excited by many of their designs over the years.

Much of the design however is the interface. Apple excels at making the interface and the hardware work together harmoniously. There’s only so much that a contract design firm can do. Certainly many companies would benefit greatly from the services of these design firms. I agree they do excellent work.

However, if taking into consideration that some smart competitors would use the services of these contract design firms to improve their product; the overall team including in house talent plus design firms still work not work as well together and be able to produce the same quality of complete product design.

As to the point on pricing. The other will have to compete on price as you and I have both said. I agree that I’d rather have the more profitable segment of the market. Apple will still be able to dip down into the lower price points and take away market share with simple yet inexpensive product. Apple will be able to still maintain better margins even at the lower price points and still compete effectively. Apple will benefit from economies of scale that either Samsung and Nokia can also benefit from. Apple however streamlines their offerings to reduce component cost. They achieve similar or better economies of scale at fewer total units by having fewer models and through sharing of components across their product lines.

Plus Apple has shown that although they can design their entire portfolio to be able to get component cost synergies across their entire line and have a lower cost than competitors. At the moment, both Samsung and Nokia make many more units, so Apple’s cost would be higher, but watch that dynamic change as Apple ships many more phones. Plus Apple will sell many more units of any individual model that they manufacture to keep these costs down.

On top of these design synergies, the Apple brand carries a strong value proposition. Apple tends to have better build quality and better customer service experiences than their competitors. So, Apple can charge more for their product in a segment and still be able to compete with products from competitors they are selling for less. Ironically some of these competing products may actually cost more to manufacture than The Apple product because they often lack the design synergies.

That means Apple’s cost can be lower, while they can still command a brand premium if they choose. This is true when their competitors sell more total units of too many differing models. This becomes even more oppressive for competitors, when Apple units start to approach or surpass the production of their competitors.

The current mobile phone makers have gotten good at reducing their manufacturing costs. However their build quality over the years as deteriorated significantly. The opening for Apple is huge.

Either there is much hubris at these firms, or secretly they know that Apple is about to take their slice of cake away. For their sake, I hope their internal dialogue at the senior management level is a bit more honest with the reality of the situation. That way they have a fighting chance. If they keep thinking that Apple doesn’t have strong competitive advantage and work urgently to change that reality, they will lose their market position. By the time they finally wake up, Apple will have passed them by.

So, I agree that Samsung has much going for it. They have made remarkable strides over the last couple of decades. I wouldn’t bet against Apple though. They have a tough fight ahead. It will be a fun spectator sport. The quality of our phones will improve from this battle, all over the world.

Realtosh Thursday, May 22, 2008 at 10:53 AM PT

Look, Design is easy to copy. Look at the evolution of design-oriented industries, and you will see a continuous trend of the overall quality of design getting better over time. This includes laptops, phones, and also shoes, clothes, appliances. So I am not so hung up on design as Apple’s competitive advantage. It is an advantage, but not a sustainable one.

Chips will be a sustainable advantage. That is much harder to copy, and innovations can be patented. That’s why, I believe, Apple bought PA, and that’s why, I also believe, Samsung has an edge.

On software, similarly, Apple has the edge.

No one is betting against Apple, so you are preaching to the choir, btw.

Sramana Mitra Thursday, May 22, 2008 at 11:13 AM PT

Interesting points.

For Apple software is part of their design. Apple gets the interface done right, and they patent their IP, code and outward appearance of not just their iconic devices, but also the interface with which we interact with the devices. My idea of what design is comprehensive, like Apple’s

You’re right, Samsung will have strength in semiconductors.

You’re calling it right. Samsung will be one of the great brands of this century, as will Apple.

Nokia still has a chance; they’re starting from the top position. But as Motorola found out, you can’t rest on your laurels. If you’re not out there innovating and making your products obsolete, someone else will.

Realtosh Friday, May 23, 2008 at 8:06 AM PT

Another little tidbit that sheds more light on Samsung. It is well known that Apple uses numerous Samsung chips throughout their product lineup from the iPod on up.

Now it appears that Samsung will be following Nokia’s lead and using WebKit for their mobile browsing. The report actually mentions Safari, which would be an indication that Samsung licensed Safari from Apple as opposed to Nokia who are using WebKit, the open-source foundation of Safari. At the time it was reported that Apple worked with Nokia to adapt WebKit for Nokia’s use on its’ phones.

If this report about Samsung is also true, then it seems inevitable that the top 3 phone manufacturers will be using WebKit/Safari for their mobile internet browsing. Yes, I’m assuming that over the next 18 months Apple will grow their market share in the mobile space to move aggressively up the charts and pass Motorola. I don’t expect much from the Schaumburg firm, which is experiencing a spectacular melt-down. It seems that they never recovered from missing the digital revolution in the phone space. Motorola was the largest cell phone manufacturer during the era of analog phones. If only they worked to obsolete their own phones, then others like Nokia and Samsung, and now Apple, wouldn’t be doing it instead.

If true, this news of a critical mass of cell manufacturers coalescing around WebKit would tend to set up Safari or at least its’ foundation WebKit as the standard for mobile browsing.

Your observations as always are quite astute. Samsung excels at semiconductors/chips/electronics, while Apple is excelling at industrial design/human interface/software.

https://www.electronista.com/articles/08/05/28/samsung.l870/

Realtosh Wednesday, May 28, 2008 at 7:58 PM PT

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