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Samsung Has a Big Problem

June 22, 2014 | About:

There seems to be this common misconception going around that Samsung's (SSNLF) Galaxy S5 has been "poorly received" because Samsung chose to stick with plastic rather than go with metal for its next-generation smartphone. While there are fairly vocal critics in the tech press of Samsung's design decision, the fact remains that Samsung's Galaxy S5 problem has never been -- nor will it ever be -- that it's made of plastic.

Surprise! The market for (plastic)smartphone cases is gigantic
This is a pretty informal observation, but how many smartphone users do you see using their smartphones without some sort of protective case? As an iPhone 5s user who doesn't put a case on his iPhone, I have friends and family constantly telling me that getting a protective case -- usually one made of plastic, mind you -- would be a good idea. Even Apple (NASDAQ:AAPL) itself advertises leather cases for its iPhone 5s.

So, given that a good chunk of smartphone users put cases around their phones, especially in the high end of the market, it would seem that the actual material the smartphone is made of isn't a first order of consideration when customers decide to buy a smartphone.

In fact, one could argue that Samsung, in going with a less expensive and more durable plastic casing, is making the economically prudent move by saving money on what consumersdon't care about, in order to include features that customers do care about (like a higher-megapixel camera, larger screen, removable battery, faster processor, and the like) while keeping margins intact.

A financial reality check

While the tech press has taken the opportunity to claim that Samsung is "struggling" to profit off its smartphones, nothing could be further from the truth. Does Samsung makes as much as, say, Apple does? Of course not, but it puts just about every other Android handset maker to financial shame. In fact, in the most recent quarter, Samsung's mobile group turned in a whopping $6.27 billion.

Source: Samsung.

How much did LG's mobile group make last quarter? Well, do the words "negative operating margin" ring any bells?

Source: LG.

HTC, which recently released a premium metal smartphone packing the latest and greatest specifications, saw gross margins of 21% in the most recent quarter and operating margin of negative-6.2%. Clearly, even with a premium metal smartphone, HTC can't bring in the revenues or the profits in the way Samsung can.

What's the Galaxy S5's problem, then?
The Galaxy S5 could be made of plastic or metal, but it wouldn't change the following facts:

  1. The smartphone market is shifting toward the low-end value space.
  2. The high end of the market is increasingly dominated by Apple, which has competitive advantages that go far beyond the hardware and specs.

Of course, some of the tech press will harp on the plastic Galaxy S5, but the fact is that Samsung should be optimizing its cost structure and delivering functional value and promoting its brand to drive sales. In fact, this is what Samsung has been doing, and it's a big part of the reason Samsung's mobile division is still wildly profitable while LG, HTC, and the like are in the red.

The Galaxy S5's problems are simply Apple and secular trends -- not the fact that it's made of plastic.

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