An economic analysis on Samsung

Samsung, one of the world’s leading electronic companies have been in the IT industry from 1938 till today (Samsung, 2013). Originated from Korea and now is expanding worldwide. Samsung specializes in digital appliances ranging from smartphones and televisions to microwaves and refrigerators, memory, semi-conductors and system integration (Samsung, 2013).

Samsung's Long Run Production

Samsung is currently in the long run where all of its factors of production are variables and can be subjected to change. Samsung has achieved economies of scale as they are financially very stable and strong which means they have enough capital to invest in more inputs to further increase in production. Also, they have large plants and factories around the world to accommodate their production and where they produce their own memory chips and flat screen sectors thus they are able to decrease their unit production costs instead of importing or outsourcing the spare parts from other suppliers states the senior executive of Samsung Electronics (Kim, 2009). The biggest plant that Samsung owns is the Gumi plant located at their homeland, Korea which produces 400 million phones, in other words 12 phones per second (Grobart, 2013) and in an addition to that they have many a new plant in X’ian, capital of Shaanxi, China (People’s Daily Online, 2013) and Vietnam (Lee, H.S., 2013) to accommodate the high demand in the industry.

Samsung has the potential to achieve economies of scope with its AMOLED display which is a high quality slim display with clearer images and is less power consumption compared to traditional screens. With assistance from Samsung Mobile Display which at the moment carries the most resources and Samsung Electronics with the potential to drive the phones, they are able to expand the market for AMOLED display (Lee, H.S., 2013). “Mobile phones with AMOLED display are only holding 5-percent market share due to the higher cost” said Lee Ka-Keun, an analyst at IBK securities (Lee, H.S., 2013). Since Samsung has planned to invest $18 billion in memory chips and display (Lee, J., 2013), they are financially able to raise capital for investment easily as compared to small firms thus they are achieving economies of scale. In addition to that, Samsung owns large machines and high amount of labor to produce their smartphones and other electronic goods. They have the financial capability to support these costs whereas a smaller producer has to borrow money from the bank in order to carry production out as labor and rent costs can be very high and with that interest is charged so their input costs will be way higher than Samsung’s.

Not only that, Samsung also has its own system integration such as the Android OS and as a result of that they do not need to purchase an OS and this is able to reduce their input costs as well unlike HTC who do not own their own OS as they are considered small producers of the smartphone industry, (Schuermans, 2012) they have to bare costs such as licensing and operating fees in order to own the Android OS.

Recently, Samsung decides to switch the raw materials used in producing Samsung Galaxy phones in which plastic is being replaced with metal (Lee, H.S., 2013). The reason why it was replaced is because metal brings a more prestige and higher class value in terms of outlook and feel which is why Steve Jobs insisted all iPhones to be made with metal to bring a futuristic feel to its customers (Lee, H.S., 2013). This implementation is only subjected to Samsung Galaxy premium smartphones (Lee, H.S., 2013) as it is a luxury good and since the elasticity of demand for Samsung Galaxy premium smartphones are slightly inelastic, price is not the main purchase criterion for customers. Thus they are able to transfer the increase in production costs to the customers since metal is more expensive than plastic.

Government Intervention in Malaysia 

Despite Samsung smartphones flying off the shelves of many IT stores around the world, the Malaysian government isn’t taking the opportunity to implement tax to increase its revenue but instead is giving subsidies. This is a conditional subsidy which is a RM200 rebate and is subjected to customers who are 21-30 years old and with a monthly income of less than RM3000 (Krishnan, 2013). This subsidy was put in place is to offer the youngsters an easy access of information through the smartphones (The Star Online, 2013).

 

Since the Law of Demand is affected by two effects; one of which being the income effect where when price falls, the individual’s real income increases to which they are able to purchase more. Thus when subsidy is given to consumers, price decreases and they are now able to purchase the smartphones. Due to the financial constraint as their monthly income is less than RM3000 and most smartphones range from RM 400 – RM 3000, smartphones can be viewed as a luxury item to this group of people. As a result of that, the elasticity of demand for smartphones for the target group is highly elastic.

Unfortunately, the subsidies allocated are subjected to a price cap of RM500 which means consumers can only purchase smartphones which are priced RM500 and below (Krishnan, 2013). As a result of this, the supply curve shifts rightward, taking opportunity of the gain revenue from the subsidy as shown in Figure 1.1.  S1 represents the RM200 subsidy given by the government. After the rightward shift, price of an average smartphone (P), decreases by RM200 down to (P1). 

Figure 1.1

After complaints from the community, the government decides to remove the price cap of RM500 (The Star Online, 2013) which gives the opportunity to the consumers to purchase other smartphones of a higher price and this shifts the demand curve rightward and thus price increases back to P as when they purchase phones at a higher price, the rebate value is not as high of a reduction as compared to purchasing a phone cheaper or of RM500 as shown in Figure 1.2.

Figure 1.2

So what determines Samsung’s high demand?

It is now a trend to own a smartphone where worldwide smartphone usage is expected to reach 1.4 billion this year (Pramis, 2013) with 57% of the market share is dominated by Samsung (Pramis, 2013). Since everyone is demanding for smartphones, why Samsung? It is shown that Samsung’s demand for smartphone increased up to 23% for early 2013 (Etherington, 2013). This was from the sales of Samsung S3 and Samsung Galaxy Note II smartphones (Etherington, 2013). The most desirable phone among Samsung handsets was the S3 holding 69% of overall demand and Samsung Galaxy Note II of 23% of all Samsung consumer’s interest (Etherington, 2013). It can be seen that smartphone users now are leaning towards getting a “phablet”, with 27% reported to prefer their phone screen to be at least 5-inches (Etherington, 2013). The increase in demand could be because users now prefer a larger screen mobile device which explains in the decrease in interest by 21% in Apple smartphones (Etherington, 2013). Also, Samsung users are loyal to their brand in which it brings in positive effects where smartphone users would only purchase Samsung smartphones and no other brand. Samsung currently holds the top spot in brand loyalty for smartphones reported by Brand Keys (Tode, 2013).

What is the smartphone industry market structure like? & where does Samsung stand?

Since there are only a handful of firms dominating the smartphone industry such as Samsung, Apple, HTC, Nokia, Blackberry and et cetera, the smartphone industry could be seen as an oligopoly with Samsung being the dominant firm in the industry since it holds 57% of the market share (Pramis, 2013). In most oligopoly cases, there are high barriers to entry mainly caused by high scale production or the strong branding of the dominant firms (Blink and Dorton, 2008) ; Samsung and Apple. In 2008, barriers of entry to the market was lowered as Android was launched to provide a free platform for other firms to enter the industry as Android is an operating system (Schuerman, 2012) which allows one to download and use applications which is one of the main features of the smartphone. Despite the barriers of entry being lowered, competition among firms are high especially the small firms trying to compete with large firms such as Samsung and Apple as they have achieved economies of scale and build strong brand loyalty and recognition.

The key element in all oligopolies is that there is interdependence. This is different from perfect competition and monopolistic competition where all the firms are too small in the market and thus they are unable to influence the market as how oligopoly is able to. A few numbers of large firms dominating the industry takes careful notice of what other firms are doing as interdependence tends to make firms collide to abstain from surprises and unexpected outcomes (Blink and Dorton, 2008).  If all the firms act as a monopoly, they can maximize the industry’s profits (Blink and Dorton, 2008). However there are situations where firms compete vigorously to gain greater market share such as Samsung and Apple.

Since Samsung and Apple compete with each other head to head at all times, a tacit collusion emerges as competitors may charge the same price (Blink and Dorton, 2008). In this case, the firms act as a monopoly where they become the price makers and make monopoly profits and these profits are shared according to the market share (Blink and Dorton, 2008). Samsung being the dominant firm gets the larger share of profits while Apple not too far behind shares the remaining with the other smaller firms such as HTC, Nokia and Blackberry.

Figure 1.3

 Figure 1.3 shows the abnormal profits earned by the firms in the industry. Since all the firms are in an oligopoly industry, there are only a few firms to compete with and thus all firms are able to make supernormal profits as shown.

Figure 1.4

But since some firms have a bigger market share compared to others, the profits are split according to the market shares. The demand curve shifts to the left due to other firms competing to obtain the market demand and profits thus Samsung's supernormal profits are highlighted in the purple area as shown in Figure 1.4. As more and more firms enter the industry, the demand curve will continue to shift to the left and this it will subsequently reduce the firm's supernormal profits.

How will Samsung stay at the top of the pyramid of the oligopoly market?

Samsung has to keep watch of its competitors at all times as new inventions and smartphones are released almost semi-annually. Since Samsung has achieved economies of scale and is already their own producers for most of their raw materials and supplies such as memory card and screen displays, they are able to achieve a bigger profit margin and can thus sustain the bigger market share of the industry. But Samsung has to take caution as barriers of entry has lowered and other smaller firms such as HTC rising up, Samsung has to make sure to invent new goods that will capture the demands of the consumers and avoid them from being Galaxy-fatigue (bored of Samsung smartphones) in order to increase their profit margins.

References

Samsung (2013) History Available from: http://www.samsung.com/my/aboutsamsung/corporateprofile/history.html [Accessed 17 October 2013]

Kim, Y.C. (2009) Samsung is now the big surprise [blog]. 26 October. Available from: http://www.koreatimes.co.kr/www/news/biz/2013/08/127_54263.html [Accessed 17 October 2013]

Schuermans, S. (2012) The Apple and Samsung Profit Recipe [blog]. 5 December. Available from: http://www.visionmobile.com/blog/2012/12/the-apple-and-samsung-profit-recipe/# [Accessed 18 October 2013]

Lee, H.S. (2013) Samsung puts the metal case design on Galaxy [blog]. 30 March. Available from: http://english.etnews.com/device/2821262_1304.html [Accessed 18 October 2013]

Tode, C. (2013) Apple loses top spot in brand loyalty for smartphones and tablets [blog]. 7 February. Available from: http://www.mobilemarketer.com/cms/news/research/14741.html [Accessed 18 October 2013]

People’s Daily Online (2013) Samsung plant X’ian proceeding apace [online]. 19 July. Available from: http://english.peopledaily.com.cn/90778/8333523.html [Accessed 22 October 2013]

Lee, J. (2013) Samsung boosts capital spending as high end phone demand slows [online]. July 26. Available from: http://www.bloomberg.com/news/2013-07-25/samsung-misses-estimates-as-high-end-smartphones-near-saturation.html [Accessed 22 October 2013]

Etherington, D. (2013) Demand for Samsung jumps up to 23% for early 2013, iPhone interest down 21 points from the last quarter [blog]. 15 January. Available from: http://techcrunch.com/2013/01/15/demand-for-samsung-smartphones-jumps-to-23-for-early-2013-iphone-interest-down-21-points-from-last-quarter/ [Accessed 22 October 2013]

The Star Online (2013) Government lifts smartphone cap [online]. 22 April. Available from: http://www.thestar.com.my/News/Nation/2013/01/03/Government-lifts-smartphone-cap.aspx [Accessed 20 October 2013]

Krishnan, G. (2013) Fixing maximum price will ensure smartphone rebates reach target group [blog]. 1 January. Available from: http://www.themalaysiantimes.com.my/fixing-maximum-price-will-ensure-smartphone-rebates-reach-target-group/ [Accessed 20 October 2013]

Grobart, S. (2013) How Samsung became the world’s no.1 smartphone maker. [online]. 28 March. Available from: http://www.businessweek.com/articles/2013-03-28/how-samsung-became-the-worlds-no-dot-1-smartphone-maker [Accessed 22 October 2013]

Pramis, J. (2013) Worldwide smartphone usage will reach 1.4 billion this year [blog]. 7 February. Available from: http://www.digitaltrends.com/mobile/worldwide-smartphone-usage-will-reach-1-4-billion-2013/ [Accessed 22 October 2013]

Blink, J. and Dorton, I. (2008) Economics Oxford: Oxford University Press