Apple Has a Samsung Problem

It seems that it wasn't all too long ago when Samsung was mocking smartphone leader Apple's lines in its "next big thing" campaign. Samsung is a formidable -- and highly profitable -- player in the smartphone business with the broadest product lineup in the market. But it should be clear from Apple's recent upward guidance revision after excellent first-weekend sales of the iPhone 5s/5c that Apple's still got it. In fact, Apple's gold iPhone 5s is proving so popular that Samsung has reacted by hyping up a Galaxy S IV "Gold Edition." While this launch shouldn't trouble Apple's shareholders, Samsung itself should. 

Do not underestimate Samsung
Apple is the clear innovator in the smartphone space. Its innovations include a robust mix of sensible design decisions and a robust software ecosystem that has millions hooked. Samsung, on the other hand, is a juggernaut that is interested in only one thing: flooding the market with devices until it strikes -- excuse the pun -- gold. This strategy has proven particularly successful for Samsung, whose electronics division has seen its net income just about double over the last year.

The problem for Apple is that Samsung controls just about everything in the smartphone supply chain, including chip manufacturing, DRAM, displays, and more, meaning that it can compete quite effectively on price. In fact, Samsung currently builds Apple's A-series processors. While Apple currently plays in the high end and differentiates on providing a (subjectively) superior product and an ecosystem that many love, Samsung can brute-force cover every single price point and niche without batting an eye and still enjoy robust profitability.

Will smartphones continue to be highly profitable longer term?
Another issue that I see is that while Apple continues to own the high end of the smartphone space, it seems that, sooner or later, the smartphone business will end up looking exactly like the PC business. Apple, interestingly enough, is far and away the most profitable player in that space, but it is much more a niche player there than a mainstream, ultra-high-volume player. The big concern is that if Apple wants to remain a major player in the smartphone space, it will have to start competing more aggressively on price, and it's not clear that the company would do well in such an environment.

Further, while many of Apple's competitors are quick to adopt the latest technologies in their devices (such as NFC, 802.11ac Wi-Fi, more than 1GB of RAM), Apple is doing its best to trickle these new features out slowly. This is likely an attempt to keep costs down and gross margins as high as possible in what seems to be a difficult environment on the gross-margin side of things for all of the players here. Apple's recent guidance revision for the quarter to $37 billion in sales and 37% gross margins (at the high end of the initially guided range) is nice, but remember that in the year-ago period, Apple's gross margin sat at a much prettier 40%.

Samsung seems better suited to a commodity smartphone world
Apple's products are excellent and are best-of-class at the high end, but the writing is on the wall for the high end: It's stagnant at best and set to decline at worst. Samsung may not bring a truly innovative device in the same way that Apple's laser-focused engineers are able to in their yearly product launches, but it can sure flood the market with devices for every niche and every price point. That's why, despite a deep admiration for Apple, it's a difficult stock to recommend, even if the world recognizes that Samsung's Galaxy S IV "Gold Edition" is a blatant rip-off of an appealing characteristic of Apple's gorgeous gold iPhone 5s. 

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Ashraf Eassa has no position in any stocks mentioned. The Motley Fool recommends Apple. The Motley Fool owns shares of Apple. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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