Samsung Electronics Co Ltd's Profit Squeeze Continues

Just like last quarter, Samsung is getting squeezed from both ends of the smartphone market. One notable difference this time around is that Apple has now officially entered the market for larger phones and phablets.

The South Korean conglomerate has just released third-quarter earnings guidance in order to brace investors for shrinking profits. Samsung's operating profits are expected to drop by 60% this quarter, which is even worse than most analysts were expecting.

All about mobile
As Samsung has risen to the top of the smartphone market by unit volumes during the past few years, its mobile division has become the largest contributor to the company's operating profit -- 70% of operating income for the first half of 2014, up modestly from 68% throughout 2013. The flip side is that any troubles in the mobile business will disproportionately weigh on Samsung's consolidated results.

Samsung says its smartphone volumes were up "marginally amid intense competition," and operating profits were hurt by marketing expenses, aggressive promotions, and falling prices. On top of that, high-end models, which are more profitable, comprise a smaller portion of the product mix. The company is also cutting prices on older phones to clear out inventory.

Low-cost Chinese smartphone OEMs continue to grab share at the low-end, while Apple is attacking the company at the high-end. This isn't a new storyline, but rather a continuation of one that's been developing for the past year.

Xiaomi released its latest Mi4 in August; it sells for less than half the price of the Galaxy S5, and offers comparable specs. In the second quarter, the Chinese challenger overtook Samsung's market share in China for the first time. Xiaomi's 14% share narrowly beat Samsung's 12%.

East and West
Samsung has tried its best to fend off commoditization, but the reality within the Android camp is that there is very little loyalty among smartphone brands. Just because users are loyal to the platform doesn't mean they're loyal to Samsung.

If we take a step back to look at all of Asia, a recent ScientiaMobile report highlights the differences in preferences between Western consumers and Asian consumers.

Source: ScientiaMobile. Data shown for Q2.

While Apple is far more popular with Westerners, larger phones, like Samsung's Galaxy Note series and HTC's One, are much more popular in Asia. That undescores the opportunities that Apple has ahead of it with the iPhone 6 and 6 Plus, which launch in China on October 17. Samsung's mobile prospects are getting worse before they get better.

Other victims of mobile fallout
As a multinational conglomerate, Samsung has a lot of moving, interconnected parts. Its component businesses are also closely tied to its mobile segment, and these divisions are also suffering. Samsung says its OLED panel business saw shipments and profits decline in connection with weaker demand for mobile devices.

The company also has a System LSI segment, which manufactures mobile application processors for other companies, as well as things like image sensors. This business was also down from mobile fallout. Apple's partial shift to Taiwan Semiconductor for A8 chip production is also hurting Samsung's foundry business.

The next big thing?
Samsung expects "uncertainty" in its mobile segment to continue into the fourth quarter, even as unit volumes should increase seasonally. Samsung seems to have taken criticisms about material choice and copycat designs to heart, as it prepares new smartphone models "featuring new materials and innovative designs."

Samsung's next big thing might not be that big -- in terms of sales.

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Evan Niu, CFA owns shares of Apple. 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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