Consumer electronics giant Samsung has taken some lumps after discontinuing its Galaxy Note 7 smartphone amid ongoing reports of combusting batteries — and the firm’s recovery may be hampered by the fierce competition in the Android ecosystem.
Samsung reported it will lose more than 3 trillion won, or $2.6 billion, in operating profit from the fourth quarter of this year through the first quarter of 2017 due to the decision to discontinue the device.
The Galaxy Note 7 went on sale August 19, and reports of batteries smoking and catching on fire soon followed. Samsung moved quickly to recall the phones with an announcement on September 2, but then a number of the replacements were reported to also catch fire. On October 11 — less than eight weeks after the Galaxy Note 7’s introduction to the market — Samsung said it would end production and discontinue the smartphone completely. What’s still unclear is the exact cause of the malfunctions; Samsung is giving customers a fireproof box to return the devices.
“This recall is a disaster for Samsung, but ultimately this is a rare event,” says David Hsu, a management professor at Wharton. “Samsung had a premium priced product and built a reputation for innovation. This is a huge setback for the brand, but ultimately the company did the right thing.”
Samsung maintains the No. 7 position on Interbrand’s top global brand listing for 2016, and analysts expect the company will bounce back from this episode. However, Samsung’s recovery could rest on whether consumers will continue to pay a premium for its devices. The stakes are high. According to a Canaccord Genuity research note in August, Apple accounted for 75% of the smartphone industry’s profits in the second quarter. Samsung accounted for the rest.
“This is a huge setback for the brand, but ultimately the company did the right thing.”–David Hsu
What remains to be seen is whether Samsung can maintain its position as the premium smartphone maker in the Android ecosystem or whether consumers will ditch the company for lower-priced rivals such as Huawei, Lenovo and Xiaomi, or switch to Apple. Another big worry for Samsung: Google on October 4 launched the Pixel and Pixel XL, two smartphones that are being billed as premium devices enabled by artificial intelligence.
The Google launch could be Samsung’s biggest threat. Samsung said in a statement that it can “normalize its mobile business by expanding sales of flagship models such as the Galaxy S7 and Galaxy S7 Edge.” But Google’s Pixel and Apple’s iPhone 7 are going to make those efforts difficult, analysts say.
Kartik Hosanagar, a professor of operations, information and decisions at Wharton, says Samsung’s issues with the Galaxy Note 7 will provide a window for players like Lenovo, Google and Korea-rival LG to get ahead. “This is an opening for other Android manufacturers, and I don’t see the benefits spilling over to Apple. Android users are not going to ditch the entire platform over this,” he says.
According to Wharton marketing professor Peter Fader, Apple is likely to get a short-term boost for its iPhone 7 Plus. “Apple will benefit in the short run with people who were buying the Note 7 because of the size and features, but then switch to the big iPhone 7,” he says.
Ironically, the one smartphone rival rooting for Samsung’s recovery may be Apple, says Wharton operations, information and decisions professor Eric Clemons. “It was better for Apple to fight with Samsung and a host of smaller, weaker competitors than it will be for Apple to compete with a fully integrated Pixel-Android-Google-YouTube device,” he says.
Splitting Android’s Profit Pie
According to Clemons, Samsung’s issues with the Galaxy Note 7 are perfectly timed to benefit Google and its latest foray into the hardware business. Google, the company behind the Android platform, has historically worked with hardware partners to develop Android smartphones. As the primary premium device maker for Android, Samsung was Google’s largest partner.
“Why leave any profits for anyone else? [The Pixel] allows Google to bring all the Android profits back in house.”–Eric Clemons
Now that Google has its Pixel smartphones starting at a premium price of $649, it is positioned to compete with Samsung. “This is great for Google,” notes Clemons. “Samsung was starting to act as if they could have some independence, and as if they did not have to follow all 100+ pages of the restrictive Google Mobile Application Distribution Agreement. Google can now afford to slap Samsung around and let Pixel occupy the high end space of Android devices. Why leave any profits for anyone else? This allows Google to bring all the Android profits back in house.”
Indeed, Google at its Pixel launch touted hardware and software integration with its artificial intelligence technology at the core of the device. “This is the right time to be involved in hardware and software,” said Rick Osterloh, head of Google’s hardware unit, at an October 4 press conference. “Bringing hardware and software together allows us to leverage years of experience in machine learning and AI. We’re in it for the long run.”
Google CEO Sundar Pichai said the differentiator for the company’s Pixel device and hardware strategy will be its Google Assistant. “Our goal is to make a personal Google to reach individual users,” said Pichai. “This is about getting our assistant in the hands of users.”
The issue for Google’s Pixel, which is being exclusively offered through Verizon in the U.S., is that the company doesn’t have the retail footprint to easily compete with Samsung or other smartphone players, says Hosanagar, who also adds that there’s a channel conflict with partners.
“Google launched Pixel phones that are priced at the same levels as Samsung and Apple,” he notes. “What are Google’s hurdles with being a high-end player? Google struggles with distribution because it doesn’t have stores. Plus, there’s the conflict of interest in convincing other manufacturers to adopt Android while competing with them. So I don’t think this will be an opening for Google.”
Hsu and Fader say that Google’s pricing for the Pixel may blunt any damage for Samsung. Both were surprised Google went for premium price points given the company’s history of being more value-oriented with its Nexus line of smartphones.
Meanwhile, Hsu points out that the larger concern may be smaller Chinese rivals, which were already squeezing Samsung’s profit margins on smartphones. “For sure, the Samsung issues are going to make consumers more willing to experiment with less premium devices,” says Hsu. “It’s a pretty fine line between a premium Android product and a lower priced one.”
Fader says that Samsung’s competition outside of Google’s Pixel may not dent the company too much. Why? The smartphone industry has hit a mature stage with slower innovation at the moment. “It’s amazing how quickly this market has locked itself in. With all these models there isn’t much that’s dynamic,” says Fader. “We used to hear of the next iPhone killer, but no one has come close.”
Google’s Pixel effort replicates much of Apple’s playbook of vertical integration. With the Pixel, Google designed the hardware, integrated the software and added features such as full-resolution photo backup to its private cloud infrastructure. Hsu notes that the Samsung Galaxy Note 7 problems may arise in part from a horizontal approach to the smartphone supply chain. Samsung makes its own chips and displays, but depends on others for parts. Apple controls most of its own hardware components in the iPhone. “It’s not even clear Samsung has diagnosed the problem yet,” says Hsu.
At the very least, the Samsung-led Android ecosystem will have to highlight its testing and safety processes throughout the supply chain. “This is a wake-up call for the entire industry,” says Hsu. “The horizontal model will have to be evaluated in terms of quality control and the integration of hardware and software. It only takes one disaster to get people to think about the supply chain and partners as devices become more sophisticated.”
“With all these models there isn’t much that’s dynamic. We used to hear of the next iPhone killer, but no one has come close.”–Peter Fader
The question remains whether Samsung can rebound from the Galaxy Note 7 debacle. Clemons points out that a number of companies have recovered from high-profile recalls, including stalwarts such as Johnson & Johnson, Ford and Toyota.
“Of course Samsung can recover. No one died or was injured, unlike the Lockheed L-1011 or McDonnell Douglas DC-10 disasters,” says Clemons. “There was no cover up. There was an immediate acknowledgement of responsibility and a full recall. Think about the McNeil [Laboratories] Tylenol disaster and how well it was handled. Johnson & Johnson fully recovered. Think of how poorly the exploding Ford Pinto was handled, and Ford also recovered. Samsung will ditch this model, come up with a newer model, and be fine.”
Also bolstering Samsung is that beyond Google, there are no other companies offering higher-end Android devices. Clemons notes that Huawei and Lenovo make solid phones, but they don’t have the cachet or style of Apple or Samsung.
Meanwhile, there weren’t any big disasters associated with the Note 7 fires. “In the short run, it’s a shame that Samsung put devices in people’s homes and they caught on fire. And Samsung could have handled communication better,” says Fader. “There will be some jokes, but in the big picture this event will be inconsequential two to three years from now.”
Hsu says that the one issue for Samsung’s brand will be its inability to get its customers replacement devices. “One aspect that sets this recall apart is that we’ve all become so dependent on the smartphone. Even if we’re without it for a day, we feel it.”