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Insight: How Samsung is beating Apple in China

Samsung Electronics' Galaxy S4 (L) and Apple's iPhone 5 are seen in this picture illustration taken in Seoul May 13, 2013. REUTERS/Kim Hong-
Samsung Electronics' Galaxy S4 (L) and Apple's iPhone 5 are seen in this picture illustration taken in Seoul May 13, 2013. REUTERS/Kim Hong-

By Melanie Lee and Miyoung Kim

GUANGZHOU, China/SEOUL (Reuters) - Apple Chief Executive Tim Cook believes that "over the arc of time" China is a huge opportunity for his pathbreaking company. But time looks to be on the side of rival Samsung Electronics Co Ltd, which has been around far longer and penetrated much deeper into the world's most populous country.

Apple Inc this week said its revenue in Greater China, which also includes Hong Kong and Taiwan, slumped 43 percent to $4.65 billion from the previous quarter. That was also 14 percent lower from the year-ago quarter. Sales were weighed down by a sharp drop in revenues from Hong Kong. "It's not totally clear why that occurred," Cook said on a conference call with analysts.

Neither is it totally clear what Apple's strategy is to deal with Samsung - not to mention a host of smaller, nimbler Chinese challengers.

Today, in the war for what both sides acknowledge is the 21st century's most important market, Samsung is whipping its American rival. The South Korean giant now has a 19 percent share of the $80 billion smartphone market in China, a market expected to surge to $117 billion by 2017, according to International Data Corp (IDC). That's 10 percentage points ahead of Apple, which has fallen to 5th in terms of China market share.

Cook said Apple planned to double the number of its retail stores over the next two years - it currently has 8 flagship stores in China and 3 in Hong Kong. But, he added, Apple will invest in distribution "very cautiously because we want to do it with great quality."

Samsung, with a longer history in China, now has three times the number of retail stores as Apple, and has been more aggressive in courting consumers and creating partnerships with phone operators. It also appears to be in better position, over an arc of time, to fend off the growing assault of homegrown competitors such as Lenovo Group Ltd, Huawei Technologies Co Ltd and ZTE Corp, former company executives, analysts and industry sources say.

Apple declined requests for comment for this article.

VARIED MODELS

Samsung's history and corporate culture could hardly be more different than Apple's, the iconic Silicon Valley start-up founded by Steve Jobs and Steve Wozniak in 1976. Lee Byung-Chull started Samsung in 1938 as a noodle and sugar maker. It grew over the decades into an industrial powerhouse, or chaebol as Koreans call the family owned conglomerates that dominate the nation's economy and are run with military-like discipline.

Apple, by contrast, became the epitome of Californian cool, an image the company revels in. That hip image translates in China - its stores are routinely packed - but hasn't been enough to overcome the more entrenched Samsung.

A stuffy electronics bazaar in the southern Chinese city of Shenzhen illustrates part of the reason why.

Samsung Galaxys and Apple iPhones of different generations sit side by side, glinting under bright display lights as vendors call out to get customers' attention. With its varied models, Samsung smartphones outnumber iPhones at least four to one.

While Apple releases only one smartphone a year, priced at the premium end of the market, Samsung brings out multiple models annually with different specifications and at different price points in China.

And those models, analysts say, are loaded with features tailored specifically for the local market: apps such POCO.cn, the most popular photo sharing site in China, or the two slots for SIM cards (Apple offers one), which allows service from multiple cell carriers, either at home or abroad.

"The Chinese just love features. They want their phone to have 50 different things that they're never going to use," said Michael Clendenin, managing director of technology consultancy RedTech Advisors. "Apple just doesn't play that game. Unfortunately, if you want to hit the mainstream market in China, and you want a lot of market share percentage points, you have to offer the Swiss army knife of cellphones."

"SETTING THE PACE"

Analysts believe Samsung's increasing strength in China is a critical reason behind its rival's possible intention to introduce globally a new and cheaper iPhone model, as well as one with bigger screens - a staple of Samsung's offerings.

Said a Samsung executive with experience in China: "We definitely think we're setting the pace there. They are having to respond to us."

Most audaciously, Samsung has gone after Apple not simply by offering lower priced smartphones, but by attacking its rival directly in the pricier end of the market. "We put a lot of emphasis on the high end market in China," co-CEO J.K. Shin told Reuters in an interview.

Samsung launched a China-only luxury smartphone together with China Telecom marketed by actor Jackie Chan that retails for about 12,000 yuan ($2,000). The flip phone, named "heart to the world," is encased in a slim black and rose gold metal body. The sleek look - called "da qi" (elegantly grand) - is coveted by Chinese when they shop for cars, sofas or phones.

"There are a lot of 'VVIP's' in China, and for them we launched luxury phones promoted by Jackie Chan. This helps target niche customers and build brand equity," said Lee Young-hee, executive vice president of Samsung's mobile business.

While Samsung won't sell millions of these smartphones, the creation of the phone in conjunction with a carrier reinforces Samsung's willingness to go local - and tap into niche markets.

"The key point is that Samsung consistently adapts to the local market," said TZ Wong, a Singapore-based technology analyst with IDC.

Apple's latest mobile operating system offers links to popular Chinese applications like Sina's microblogging platform Weibo, but the application itself must be downloaded onto the phone. On all of Samsung's entries, it's already there.

"People know intellectually that Samsung is from Korea, but when it comes to the messaging there is always a local face," Wong said.

RETAIL PRESENCE

Samsung opened its first office in China in 1985 in Beijing - an era in which it was all but inconceivable that Apple and Samsung would end up in one of the world's most intense corporate grudge matches. Like other South Korean chaebols, Samsung was a first mover in China, using the market primarily as a base to produce electronics for the world.

In contrast, Apple's big push in China came only recently, with the advent of the smartphone age roughly five years ago.

The early entry gave Samsung an undeniable edge, and it adapted fast to a rapidly changing environment. By the mid-1990s, with the economy booming, Samsung made the strategic decision to treat the Chinese market not just as a production base, but to start marketing to China higher-priced electronics, said Nomura researcher Choi Chang-hee, who wrote a history of Samsung's experience in China.

That shift has meant Samsung's retail presence in China far outstrips Apple's. Aside from selling via the distribution outlets of the three major telecom carriers, Samsung also has a strong retail presence through its partners Gome Electrical Appliances and Suning Commerce Group, as well as its own "Experience" stores and small retailers all over the country.

Apple works through the same channels, but its relatively late entry means it has a significantly smaller presence. Samsung, for example, has more than 200 official distributors and resellers in Guangzhou province, while Apple lists 95.

Over the last two decades, Samsung has also taken pains to build relationships with Chinese government officials and -perhaps more critically - the three major telecom carriers.

The notion of the importance of connections - or "guanxi" - in China is occasionally overrated in business. Not, according to Samsung's Shin, in this case. "It's our core policy to keep friendly relationships with the operators," he said. In China, each carrier uses a different technology and that requires Samsung "to tweak our smartphones to their request."

"It's not easy," Shin said, "but we do this to be more operator friendly."

Contrast that with the ongoing negotiations Apple has had with China Mobile, the largest cellphone operator. For years the two sides have been unable to come to an agreement on revenue sharing, effectively precluding Apple from hundreds of millions of potential customers.

SCRUTINY FROM THE TOP

Samsung's reach extends higher than just the CEOs of the top state-owned telecom companies. Top executives have met each of the last several Chinese leaders, most recently Xi Jinping, who spent time in April with vice chairman Jay Y. Lee, son of K.H. Lee, Samsung Electronics chairman.

"What surprised me most," said Lee later, "was that they (Chinese leadership) know very well about Samsung. They even have a group studying us."

The Chinese government has also made clear it's well aware of Apple - though not always in a good way. In April, state media bashed Apple for its "arrogance," protesting among other things that its current 1-year service warranty was insufficient. Apple initially dismissed those criticisms, but Cook later apologized to Chinese consumers.

Samsung's success in China has its roots, one former executive said, in a previous obsession for the company: its desire not to replicate the mistakes made by Japanese rivals.

"Samsung spent a lot of time benchmarking Sony, Toshiba and Panasonic," said Mark Newman, who spent six years in Samsung's global strategy group and is now an industry analyst at Sanford C. Bernstein in Hong Kong.

"One of the things that came out of that is the realization that the insular approach has its drawbacks, and so Samsung has made an effort over the last 10 years to be much more global."

This strategy of decentralization is plainly evident in China, he said, home now to more Samsung employees than any country outside South Korea.

FIGHTING HIGH AND LOW

Samsung now leads in both low-end and high-end segments in China, according to IDC, and its logic of going after both ends of the market is straightforward. In China, where the average wage is roughly $640 per month, many users looking to upgrade from feature phones to smartphones cannot afford Apple.

By bracketing the market with multiple models, Samsung can breed deep relationships with customers, many of whom, market research shows, trade up to more expensive models as they get older. Playing high and low also positions Samsung to fend off the intensifying competition from Chinese firms such as Lenovo and Huawei and literally hundreds of smaller local players.

"That's where the next battle for Samsung will be fought," said Newman. "We'll have to see if Apple does introduce a new, cheaper model for China - and the world."

(Writing by Bill Powell, Editing by Bill Tarrant and Ian Geoghegan)

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