How Apple’s Business Model Burned Samsung

on September 26, 2014

I have been amused by Samsung’s current TV ads saying they were first to market with a smartphone over 5 inches and staking claim to being the one who blazed the trail and showed the market there was demand for larger smartphones. In a recent interview with Bloomberg, Google Chairman Eric Schmidt reinforced this idea when he was asked about Apple’s success with the iPhone 6 and he stated:

“I’ll tell you what I think,” Schmidt said. “Samsung had these products a year ago.”

Bloomberg reporter Stephanie Ruhle quickly pointed out, however, that Samsung’s Galaxy device launches failed to spark the fervor witnessed at Apple Stores around the world, where customers eagerly lined up to wait overnight — in some cases, days — to be among the first iPhone 6 owners. Apple later announced first weekend sales hit a record 10 million iPhone 6 and 6 Plus units.

The question was again rebuffed, with Schmidt repeating, “I think Samsung had the products a year ago, that’s what I think.”

I am not sure how long Schmidt or Samsung have been following Apple’s business model but being first is not always a good thing. In fact, Apple’s strategy is basically centered around not being first — letting others do the R&D and early market development and then coming in with their own version and besting any similar product with design, applications and services. I saw this first hand in the late 1990’s. At the time, I was doing a consulting project for a company called Diamond Multimedia. Although they were mostly doing PC based media products, they had a skunk works project on what was one of the early MP3 players. I realized when I saw this product it had the potential of replacing Sony’s Walkman but was concerned with the actual design of the product and especially how difficult it was to get music into the MP3 player itself.

Of course, Steve Jobs saw the early MP3 players and realized the same thing I did and that this represented the future of portable music players. However, he did not just create a competing hardware product. He spent the next two years working with the record labels and designing a very easy way to purchase and then listen to music on what became the iPod. This basic business model has been replicated ever since. They did not invent the smartphone. They made it better and, along with an ecosystem of apps and services, delivered a ground breaking product that revolutionized the cell phone market.

Apple did not invent the tablet. Again I saw this first hand. In 1991, I was asked by Microsoft to consult on what was their first pen-based tablet. In 2000, I again worked on Bill Gates’ second attempt at a tablet. But these tablets had terrible UIs and could not get the software community to back it. The bottom line is, in both cases, the technology was not there to create a tablet that could be easy to use and was touch, not pen-based. As we know, 20 years later Apple put the pieces together to create the iPad and finally brought the tablet to the masses.

History is repeating itself again. But this time to the chagrin of Samsung and Google. Samsung was first with a phablet and I am pretty sure Apple is willing to thank them for blazing the trail and doing the market research for them. It is true Apple resisted doing larger iPhones for a long time based on the fact Steve Jobs truly believed people wanted to use them with one hand and that drove their designs through 2013. However, Samsung’s Note phablet, while not a huge success in terms of driving mass industry adoption, showed Apple there was legitimate interest in a 5.5″-5.7″ smartphone in China and parts of Asia, as well as in other parts of the world. By the way, we are still predicting the mix of smartphones Apple will sell will be 65% iPhone 6 vs 35% iPhone 6 plus even though early demand seems strong for the 6 Plus.

To say there was pent up demand for an iPhone with larger screens would be an understatement. One of the things I found out when talking to people waiting in lines for the new iPhones at Apple Stores is many of those who bought the Samsung Note 3 did so because it was the only one out there with this size screen. But now that Apple had one with basically the same size screen, they were going to switch to Apple. I also talked with someone familiar with Samsung’s own research on what prompted people to buy a Note 3 thinking it might be the pen or the larger screen. Interestingly, what they found is that many people, especially in Asia, believe bigger is better and that the Galaxy Note in their mind was a premium product. Now that Apple has one of their own, it too will be viewed as a premium product in all of these markets and there is no doubt Apple is going to capitalize on this fact in a big way.

Apple’s entering the phablet space with a premium competitor is going to have a major impact on Samsung’s fortunes. Samsung has already shown a serious loss in profits from their smartphone business last quarter and have already hinted to the street this quarter will be negative as well. We estimate Apple will sell around 63 million iPhone 6 and 6 Plus models in Q4 and if you add the sales of iPhone 5’s to the mix that are still selling well in certain countries, they could sell around 70 million iPhones during the holiday quarter. If this is true, imagine how it will negatively impact Samsung during this same time period.

In an article in the Korea Times last week, they point out Samsung is seeing the handwriting on the wall for their premium business. The article says:

To ride on the market changes, Samsung is paying more attention to the low end smartphone segment to entice more clients in populous emerging markets, including India.

I don’t expect Samsung or any of the Android smartphone vendors to actually get out of the phablet business. However, the Android vendors who until September had this market all to themselves now have to deal with Apple, a ferocious competitor. Given the cycle of cell phone contracts, I suspect demand for the iPhone 6 will be at record numbers well through most of 2015 and this will continue to contribute to Samsung’s woes, at least with their premium models. Apple is very grateful for the role Samsung trailblazed, although I am not sure it is wise to do ads about this fact.