Samsung's dire earnings preview should scare every smartphone maker

Samsung expects to post a massive drop in both sales and profit for the second quarter. The way Samsung spins it, that’s bad news for Apple, HTC, Xiaomi, and every other smartphone maker, not just the Korean electronics giant itself.

The world’s largest smartphone maker expects to rake in $7.1 billion in profits for the second quarter — still a huge chunk of money, but 24.5% less than the same period last year. This is the company’s third consecutive quarterly decline. Facing such blistering results, Samsung released a rare statement Tuesday morning explaining its crummy earnings forecast.

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Analysts have long forecast smartphone market saturation, suggesting manufacturers will struggle to maintain sustainable growth across the developed world. Those conditions appear to be materializing in China and parts of Europe, where Samsung said it faced intense competition amid lower demand. Many of its mid- and low-end phones sat unsold as the increasingly crowded markets remained content with their current devices.

Research firm IDC predicts worldwide smartphone growth will drop from roughly 39% (in 2013) to 23% (in 2014) — a slowdown that will affect Samsung as well as other smartphone vendors.

“Most importantly to Samsung, the market is continuing to push toward a wide range of low-cost Android handsets,” Ryan Reith, IDC’s research director for mobile devices, told VentureBeat. These device use “components that are roughly a year or so old, but they create a ‘good enough’ experience for the consumer.”

While Samsung has a lot of low-end products, it’s facing increased competition in regions like China, India, Indonesia, Russia, and Brazil — the markets driving that 23% global industry growth.

“Apple will feel these same challenges, but [it hasn’t] aimed to compete heavily in these low-cost markets,” said Reith.

Samsung expects some relief next quarter, calling the second quarter “a seasonally weak period for smartphone demand in China.” Samsung also predicts coming demand for 4G LTE products will help compensate for China’s current dissatisfaction with 3G devices. The company didn’t outline a specific plan for growth in Europe, where it commands 40% of the smartphone market.

Consumers worldwide have demonstrated an appetite for increasingly larger smartphones, but Samsung warned that those “phablet” devices are cannibalizing tablet sales. That’s bad news for companies that make both smartphones and tablets, especially iPad-maker Apple, which is expected to release an iPhone with a larger screen soon.

As more companies compete for fewer smartphone buyers across developed markets, they’ll have to introduce substantial innovations to maintain good growth trajectories. Smaller versions of flagship devices aren’t going to cut it.

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But Samsung is particularly challenged because it is “misjudging” its ability to earn revenue from the devices it sells, Forrester analyst Frank Gillett told VentureBeat.

“The challenge for Samsung is to differentiate from smartphone producers [that] are just focused on the hardware, and add truly engaging customer elements with online services, the way Google and Apple do,” said Gillett. “Samsung is also faced with companies like Xiaomi [which] are innovating new business models that make money other than from the handset hardware.”

Samsung also highlighted the strong value of the Korean won, marketing expenditures, and weakness in its display business (another victim of weak smartphone demand) as reasons for its poor second-quarter performance. We’ve included the company’s complete statement below.

The earnings forecast is the result of the strong Korean currency throughout the second quarter as it appreciated against the dollar, euro and most emerging market currencies.

The company also witnessed a slowdown in the overall smartphone market growth and saw increased competition in the Chinese and some European markets. And this led to higher inventories for the medium- and low-end smartphones.

The second quarter is a seasonally weak period for smartphone demand in China. Samsung also saw an increase in inventory due to price competition and a weaker demand for 3G products ahead of the expected growth of 4G LTE products in the Chinese market. Weaker demand in the second quarter also led to increased inventory in Europe, where Samsung has a 40 percent market share approximately.

In the case of tablets, sales were sluggish due to a longer replacement cycle than that of smartphones, which is usually between two to three years. In addition, higher shipments of 5-to-6 inch large screen smartphones replaced demands for 7-to-8 inch tablets.

With the release of new smartphone devices in the second quarter, Samsung launched various promotions to reduce existing inventories in sales channels and this increased the company’s marketing expenditure compared to the previous quarter.

The weak demand for smartphones also affected the System LSI and the display businesses that provide key components and screen technologies.

The company cautiously expects a more positive outlook in the third quarter with the coming release of its new smartphone lineup. Samsung does not expect any major marketing expenditure to occur in the upcoming quarter.

Samsung expects stronger smartphone sales and this will have a positive impact on the company’s display panel businesses. In the memory business, following stable market conditions in the first half, seasonal increase in demand in the third quarter is expected to drive stronger earnings growth.

Samsung will continue to expand its B2B businesses and looks forward to exceeding consumers’ expectations by offering the most innovative wearable devices, smart home appliances, and Internet of Things (IoT) devices.