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Samsung raises stakes in global smartphone battle

Samsung's new Galaxy S III phone.

Bebeto Matthews/AP

Once a week, executives from every Samsung Electronics Co. Ltd. national headquarters around the world get together on a conference call to discuss inventory. The call covers all regions and all Samsung products, from cameras to televisions to dishwashers.

The conference call, like almost everything else the company does, is part of Samsung's obsession with controlling its supply chain – an obsession that is starting to pay off in a market in which it was a just a minor player only four years ago: smartphones.

As Research In Motion Ltd. continues its downward spiral – it will almost certainly report its first quarterly operating loss in eight years on Thursday – much of the narrative has been about how the Waterloo, Ont., company was outgunned by Apple Inc. With far less attention, Samsung, as the world's top maker of Android phones, has also done significant damage to RIM and to the popularity of its once-dominant BlackBerry.

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For all the growth in the smartphone market over the past three years, only two companies are currently generating any kind of meaningful profit from the devices. Apple, of course, is the leader, keeping 73 per cent of all handset industry profit in the first quarter of this year, despite having only 9 per cent of handset market share, according to Canaccord Genuity research. Samsung is the other. According to Canaccord, the electronics giant generated 26 per cent of all handset industry profits during the same quarter.

Of every dollar of profit in the cellphone industry, Apple and Samsung keep 99 cents. Everyone else, it seems, is losing money or fighting for scraps – even companies that, like RIM, once generated large profits from selling handsets.

Samsung did it by recognizing a shift in the market that RIM was slow to grasp.

After the iPhone's launch in 2007, consumers began to favour touch-screen phones that were far more than messaging devices, on which they could play music and video and surf the Web with ease.

"Samsung committed early to the [touch-screen] category," said Kaan Yigit, president of Solutions Research Group. "RIM was too vested in its own category. ... It bet on its own horse. That's why incumbents get hammered when the winds change."

As it positions itself as Apple's only serious competitor, Samsung's smartphone division is getting ready for what will be perhaps the most critical summer in its history. Not only is the company releasing its highest-end smartphone to date – and spending millions to promote it during the Olympic Games – it is also locked in a high-stakes legal battle with Apple that threatens to halt its market momentum just as it starts to pick up. Indeed, just this week, Apple managed to convince a U.S. judge to issue an injunction halting the sales of Samsung's flagship tablet in the country – an ominous sign.

Samsung's success – even though it may prove to be very temporary in the fast-moving world of mobile devices – is a rarity among companies that build phones and tablets running on Google's Android operating system. Because Android is essentially free, dozens of manufacturers have adopted it, creating a glut in the marketplace and driving margins down.

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But Samsung has so far managed to leverage its massive manufacturing infrastructure to keep its costs under control. Whereas many of its competitors have to go elsewhere for components, Samsung builds almost every part of its smartphones in-house.

"We don't have to rely on others for the core components, and that allows us to have control over the product," Mr. Politeski says. "Consumers have a choice, and market share doesn't lie."

Still, Samsung faces a host of challenges. In addition to the myriad companies offering competing Android devices – including Motorola Mobility, which was recently purchased by Google – a slew of Windows-based phones are due out in the coming year.

In addition, Samsung and the Android operating system face a series of lawsuits that could threaten the company's very presence in the market.

In the coming weeks, consumers will face an onslaught of Samsung advertising, in large part because the company has paid millions to sponsor the London Olympics, and plans a blitz during the games to promote its new Galaxy S III smartphone, released in Canada on Wednesday.

But for all Samsung's Olympic advertising, its flagship Android smartphone isn't all that much of an improvement over some of the other high-end Android devices that have hit the market in recent months. And yet Samsung remains not only the biggest Android smartphone maker, but the biggest overall smartphone maker in the world.

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Samsung Group, the massive conglomerate that includes the electronics division, is sprawling – composed of some 80 different businesses that operate in areas ranging from construction to shipbuilding.

It is Samsung's size that is perhaps most responsible for its ability to generate profit in the smartphone market. Unlike many of its competitors, the company makes most of the parts that go into its phones – from memory chips to screens. In fact, Samsung manufactures components for many of its competitors. If you're holding an Apple mobile device in your hand, chances are some part of the hardware was built by Samsung.

"Creating a virtuous circle, the company's success in the smartphone market enhances the competitiveness of its semiconductor and display divisions," Woori Investment and Securities analyst Young Park said in a recent note. "In turn, the strengthened semiconductor and display divisions [enable] the company to provide the best-available smartphones at each price level."

That ability to produce components in-house allows Samsung to micromanage its supply chain, keep costs low and, as a result, make money off its smartphone sales. The control over hardware also partly offsets Samsung's reliance on an outside source – Google – for its software.

Like almost all Android-based phone makers, Samsung chose Google's operating system because it is cheap to use and has a vibrant app developer ecosystem. Increasingly, developers have chosen to design software only for the two or three leading smartphone platforms – Apple's iOS and Google's Android being by far the two most popular. That trend has seriously hurt companies such as RIM and Nokia, which for years opted to develop their own proprietary smartphone operating systems.

At the beginning we thought there were a couple of ways we could go," said Paul Brannen, Samsung's Canadian vice-president for mobile. "We could build our own operating system, but you look at the downfall of companies that haven't embraced apps. You look at what operating systems apps are co-developed for – they're developed for iOS and Android."

Nonetheless, the decision to go with Android means Samsung now competes with Motorola, HTC and many other smartphone players that offer essentially the same software experience on their phones (although most Android handset makers try to at least tweak the version of the operating system to make it look unique).

As such, Samsung has tried to differentiate itself by following in Apple's footsteps and creating a brick-and-mortar retail store all to itself. Recently, the company began working on a Samsung store in British Columbia, possibly the first of several in Canada.

The standalone store, located at the Metropolis shopping centre in Burnaby, is in many ways a progression of Samsung's retail strategy. Already, the company has deals with many of its carrier partners to build Samsung-only display tables at those carriers' stores. Dubbed "Galaxy Headquarters," those displays are meant to immediately distinguish Samsung's devices from myriad other smartphones and tablets that also run on Android.

So far, the strategy seems to be working. In 2011, Samsung posted year-over-year smartphone sales growth of 278 per cent. But the company has yet to prove it can unseat Apple as the most profitable name in the business. That's why this summer will be critical for both companies.

Samsung's new high-end phones hit the all-important U.S. market in the second half of this month. Realistically, the company will have only a short window to generate traction before Apple is expected to unveil the newest version of the iPhone, which will undoubtedly cause a frenzy among consumers.

But the Samsung phone's U.S. debut might be over before it begins. Currently, Apple and Samsung are caught in a brutal legal battle, with Apple accusing Samsung of copying the design of its products. As part of that battle, Apple is seeking an injunction to stop the selling of the Galaxy phone in the U.S.

Such an injunction, if approved, couldn't come at a worse time for Samsung, which is tying the release of the Galaxy to the start of the London Olympics. But in addition to the Apple lawsuit, the Android operating system itself is the subject of myriad intellectual property lawsuits, the outcome of which will have a major impact on all companies that rely on the operating system.

As such, the company so obsessed with controlling the production of its devices could see its fortunes determined by judges and juries. Where Samsung stands at the end of this summer will go a long way toward determining whether it can one day dethrone Apple as the most profitable smartphone maker in the world.

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