STATE OF SAMSUNG
Samsung’s operating profits are falling off a cliff. Over the past year, their quarterly profits have plummeted from just over $10 billion down to just $490 million. This represents a 95% cliff dive within just a matter of a year and it’s the lowest number that Samsung has reported since 2009.
Normally, this would be indicative of a failing company like Nokia or Yahoo who’s numbers are down across the board but that’s not quite the case with Samsung. Take their top-line numbers for example.
This too is down for Samsung from $240 billion per year to $200 billion per year, but that’s a much more modest drop of about 16% as opposed to 95%. A similar story can be seen with their smartphone shipments as well. While they have been slowly bleeding dominance and sales, nothing drastic has unfolded within the past 12 to 24 months.
This puts Samsung in a really weird situation where they’re not exactly losing relevance but they are losing profitability. It’s easy to write this off as just a market downturn but when we peel back the layers, it becomes clear that Samsung is facing a much larger crisis due to the era of peak smartphone. So, join me as we dive deeper into Samsung’s existential crisis and their struggle to remain profitable.
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ALL IN
A simple Google search would tell you that the primary culprit behind Samsung’s dwindling profits is the memory chip market. If you didn’t know, Samsung is not just a big memory chip producer, they are the biggest memory chip producer. This title definitely sounds impressive on paper but Samsung actually had to make massive sacrifices to get here like overbetting on the chip market. You see, one of the ways that Samsung was able to beat the competition and rise to the top was simply outspending the competition.
In fact, they’ve been doing this for decades dating as far back as 1997. This year, Samsung opened up a $1.3 billion memory chip fab in Austin TX. Over the next 14 years, this would grow to being a $9 billion investment which is not only one of the largest chip investments in the world, but one of the largest foreign investments the US has ever seen. This sort of spending is what allowed Samsung to catch up to and overtake the competition but this is also a very dangerous game because there is no moat when it comes to internal components.
You see, most end consumers don’t care or even know what brand of chips is going into their smartphones computers, and cars. So, there’s virtually no brand loyalty and companies like Apple just go with whoever is offering the best performance and price at the time. Over the past decade, this has very much been Samsung but it doesn’t take long to fall behind within the chip industry.
Moore’s law may or may not be dead but one thing is for sure, chips are still advancing extremely fast. Even stagnating for a year or two could destroy the lead that took decades to build. So, year after year, these chip producers are having to invest more and more. Really, all of this is just one massive game of chicken.
Fortunately, Samsung hasn’t dropped the ball when it comes to R&D, they’ve actually been doing the exact opposite, they’ve been stepping up to the plate. But, this has simply led to ridiculous investments. Just earlier this year, Samsung announced that they would be investing, wait for it, $228 billion to build the world’s largest chip facility.
Let me put this in perspective. That’s more than Apple has spent on R&D across the entire company since the launch of the iPhone itself. It’s hard to find data about Apple’s R&D spending throughout the 80s and 90s but it’s very likely that $228 billion is more than Apple has spent on R&D throughout their entire history.
This honestly isn’t that surprising given that $228 billion is enough money to buy out a Fortune 50 company cash. And Samsung is looking to spend this much money on an industry that they could lose at any time within just a matter of 2 years. This is no doubt a gutsy bet but when you take a closer look at the company's internals, it starts to become more clear why Samsung is basically betting it all. It’s likely that Samsung feels that they have no other choice.
This is probably a bit confusing because most of us see Samsung as a giant conglomerate with strongholds in dozens of industries. They make everything from smartphones, chips, monitors, laptops, and TVs to refrigerators, dishwashers, washing machines, and who knows what else. But, while they do indeed have their hands in every business you can think of, almost 60% of their profits came from just one sector: semiconductors. So, it’s not surprising why Samsung is willing to make such a massive gamble in chip fabrication.
It’s their bread and butter and they can’t afford to lose. But, one thing they’re forgetting is that just because they stay on top of the chip industry doesn't mean that they’ll actually stay on top overall. Let me explain.
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VOLATILITY STRIKES
If large amounts of capital and a lack of a moat weren’t bad enough, another major pitfall of the chip industry is that it’s one of the most cyclical industries in the world, and the pandemic simply exacerbated this effect. I think we all remember how tech was a bit hard to come by back in 2020 and 2021.
PS5s and graphics cards were basically impossible to come by. Often times you had to pay 2-3 times the price just to buy these gadgets and it wasn’t just tech products either. Anything that even slightly had to do with chips was extremely hard to come by including cars and even refrigerators which often had waiting times in the 6-12 month range. As such, all of these products naturally rocketed in price.
Most people just figured that these price increases were due to high inflation but a lot of it just had to do with the global chip shortage. You see when the pandemic hit, most chip fabricators either pulled back or completely shut down temporarily due to covid restrictions and general uncertainty. At the same time, the demand for these products went through the roof.
Everyone was staying at home meaning that they were more dependent on electronics than ever. Moreover, they weren’t spending any money on vacations or eating out or any of that, so they were able to spend a lot more on tech. This led to this extreme situation where there was no supply and massive demand leading to ridiculous revenue and profit margins for chip makers. Many chip makers including Samsung assumed that this was simply the new norm for the modern hybrid economy but it hasn’t quite played out that way.
In fact, prices for tech products are very much falling off a cliff as supply and demand have more or less normalized. Take Tesla prices for example. In the peak of the chip shortage in late 2021 and early 2022, Model X prices reached as high as $108,000. But, over the past 18 months, prices have almost halved down to $63,000. This is great for consumers as some prices are finally returning to reality but for Samsung, this is a nightmare.
In fact, normalizing supply and demand has led to DRAM prices plummeting by 53% year over year. And experts don’t think the pain is over either, so we could very well by looking at a 60% plus price drop before things finally stabilize. Given that 60% of Samsung’s profits were coming from chips, it’s no wonder why their bottom line has been obliterated.
The reality is that profits from their chip business have not only gone down, they’ve actually become negative. In fact, over the first 6 months of 2023, Samsung took a $7 billion loss on their chip business. Samsung is of course trying to cut production to prop up prices as much as they can but unfortunately, demand is falling even faster.
You see, it’s not just prices that have been plummeting, demand has also been plummeting as companies and consumers have become much more conservative with tech spending due to high inflation and recession fears. Not to mention, most people just got a bunch of new tech over the past few years so they don’t exactly feel the need to upgrade which brings us to a bigger question: Will Samsung ever recover?
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ERA OF PEAK SMARTPHONE
Normally, the answer would just be yes. Eventually, when the chip industry enters another boom cycle, Samsung should naturally recover. But, here’s an interesting point to consider: not all of the chip industry is getting destroyed. In fact, certain sectors within the chip industry are doing better than ever specifically AI.
I don’t even need to explain this, I mean, just take a look at Nvidia’s stock graph, it’s vertical. Granted the stock market is very much being irrational with Nvidia but it’s not like Nvidia’s doing bad fundamentally either. In fact, they just posted their largest quarterly profit of all time coming in at $6 billion.
Of course, Nvidia is an exception case that has largely benefited from the AI boom. Everyone focused on traditional chip-making like Samsung, TSMC, AMD, and Intel have seen their margins get obliterated, but this brings up a larger question: where exactly does Samsung fit within the era of peak smartphone.
While it’s true that Samsung has made massive advancements with mobile chips and memory over the past 15 years, a lot of their success is actually just thanks to the success of the smartphone industry at large.
This was great in the early to mid-2010s when smartphone sales were exploding, but over the past 5 years, smartphone sales have started to fall quite noticeably. And the more time that passes, the more likely it feels that smartphones are destined for the same fate as PCs.
As PC sales started to fall, manufacturers naturally started competing on price. Of course, there were some exceptions like Apple and some higher-end product lines from Dell and Asus. But, for the most part, the PC industry became a race to the bottom, and profit margins edged closer and closer to 0.
Many reputable manufacturers like Sony and Toshiba actually just exited the business altogether. And many of the survivors like Dell and HP started focusing on other parts of their business like the cloud and servers. They simply kept around their laptops and PCs as a way to maintain their brand presence as opposed to drive massive profits.
This same thing is starting to happen with smartphone brands as well. In early 2021, for example, LG left the smartphone business after losing money for 23 consecutive quarters. The same thing happened to HTC, Microsoft, and Nokia as well. Heck, even Apple isn’t immune. In fact, that’s why they stopped reporting iPhone sales 5 years ago. And with how disappointing the iPhone 15 is, who knows how bad sales will be.
But, with that being said, Apple will do just fine because they’ve shifted their focus to monetizing the use of the iPhone as opposed to the purchase of the iPhone. The same, however, cannot be said about Samsung. Samsung phones run Android meaning that it’s mainly Google that profits from the use of Samsung’s 2 billion phones.
Samsung is still very much dependent on the sales of their own smartphones and other smartphones for which they make internal components. And as smartphones become more and more commoditized, this business will become less and less viable. This isn’t to say that Samsung is on the brink of collapse or something but the point is that this isn’t just a downturn for Samsung.
Rather it’s very much a test regarding whether Samsung can grow and evolve past smartphones. Can they capitalize on the AI trend? Can they shift to monetizing the use of Samsung phones? Can they reduce their dependency on smartphone components?
These are the concerns that Samsung will have to address in the coming years if they want to grow past the era of peak smartphones. Will Samsung be able to make this jump or will they end up like the next IBM? Only time will tell.
