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How the smart went out of the Samsung phone

It was in 2010 that Lee Kun-hee, chairman of the Samsung group, warned that South Korea's most famous company risked becoming a "corner shop". In fact, at the time of his premonition, Samsung Electronics, by far the most profitable company in the sprawling empire, was on the verge of a golden streak.

It cemented its place as the world's biggest technology company by sales, and as Asia's most valuable brand, ahead of Japan's Toyota, no less. It went on to become the first South Korean company to reach a market capitalisation of $200bn. Yet now, as 72-year-old Mr Lee lies gravely ill in a hospital bed following a heart attack, his paranoia looks almost prescient.

Samsung Electronics is certainly no corner shop. It continues to dominate the country's corporate landscape to an uncomfortable degree. Yet its problems are manifold and its horizons darkening. Last month it reported third-quarter profits down 60 per cent as margins on smartphones withered. Now, as it prepares for life after Mr Lee, who will be succeeded by his son, Lee Jae-yong, there is talk of a wholesale revamp. As if to rub salt in the wound, the market capitalisation of arch-rival Apple, whose third-quarter results were as rosy as Samsung's were funereal, this week touched $700bn, more than four times that of the South Korean company today.

What has gone wrong? Paradoxically, most of Samsung's problems are down to its smartphones, the product for which it has become world renowned. At the premium end of the market, where handsets cost upwards of $500, its once-spirited challenge to Apple with its Galaxy smartphones has faded. The US company's more stylish products command a higher premium and occupy an app-rich ecosystem that has proved far easier to turn into cash. Despite huge spending on marketing, Samsung has never managed to persuade consumers that its brand is as desirable as Apple's. Nor is its generic Android operating system as easy to tailor as the proprietary iOS system. To top it all, Apple is now offering larger-screen phones, cancelling out Samsung's biggest differentiating feature.

At the cheaper end of the market, too, Samsung's advantages are fast evaporating. A crop of Chinese companies based in the fiercely competitive Shenzhen cluster, including Huawei, Xiaomi, Lenovo and ZTE, is robbing Samsung of both volume and pricing power. In the second quarter of 2013, Samsung accounted for more than 32 per cent of global smartphone sales, according to research company IDC. By the third quarter of this year, that had shrivelled to less than 24 per cent. "Samsung is being squeezed at both ends," says Benedict Evans, a partner at venture capital firm Andreessen Horowitz.

At home, Samsung finds itself under pressure of a different kind. Many South Koreans take great pride in the company's achievements. There is, however, also resentment at the dominance of the chaebol conglomerates, which are seen to have benefited from government largesse and to have prospered by squeezing the little guy. Official policy is slowly catching up with public anger. From next year, a tax on retained earnings is likely to come into force. Other measures will cajole big companies into distributing more of their profits in wages and dividends.

One might conclude that Samsung's best days are behind it. Certainly, the transition to the third generation of Lee family control will be testing. The group is in the process of an upheaval that some put down to an attempt by the family to reduce inheritance tax. That may be so, but spin-offs could also result in a simpler, more investor-friendly structure.

On the operational front, too, the position may not be quite as grim as it appears. The company has culled its smartphone range, a strategy that should bring economies of scale as well as simplification. Samsung makes more than 320m smartphones a year and has a market share nearly five times that of Xiaomi, its nearest Chinese rival. That means it ought to be able to go head-to-head on price, particularly as it steps up its already big manufacturing operations in low-cost Vietnam.

Mark Newman, an analyst at Bernstein Research, says the worst could even be over for Samsung's handset business. He also predicts that the massive semiconductor division is entering a golden era of its own. According to his reckoning, it is worth paying current depressed prices for Samsung shares for access to the semiconductor business alone. If he is right, that would mean the market has marked down the smartphone business to zero, surely an overreaction. Even the corner shop of Mr Lee's nightmares is worth more than that.

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