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Five ways Samsung can overhaul its ailing smartphone business

Profits tumbled a stunning 74 percent in Samsung's mobile business in the third quarter, and tough times may continue. Here's what Samsung can do to turn things around.

Samsung's devices tend to look alike, including the variants of its Galaxy S5 line. Josh Miller/CNET

It's time for a little change in Samsung's mobile business.

The South Korean company on Wednesday reported its lowest operating profits since the second quarter of 2011 and said third-quarter income in its mobile business tumbled 74 percent from the previous year. It also warned that conditions would remain tough in smartphones as competition heats up toward the end of the year.

At the same time, market researchers International Data Corp. and Strategy Analytics said Samsung's global smartphone market share dropped to less than 24 percent of shipments in the third quarter from nearly a third of all units a year earlier. It's being hurt by competition with Apple's new iPhone 6 and 6 Plus smartphones at the high end and cheap devices from Chinese and Indian vendors at the low end.

In an effort to halt the freefall, Samsung said it plans to "fundamentally reform" its product lineup and "significantly enhance product competitiveness for each price tier." It plans to use new materials and technologies, such as metal frames and flexible displays, to set its devices apart from rivals. And Samsung will work on differentiated designs and software and use the same components in its mid- and low-end phones to bring down its costs.

That doesn't mean Samsung will be scrapping devices already in its pipeline. Instead, it will think more strategically about what it's developing in the future to make sure it has differentiated products for all price points.

"Although our mobile communications business is undergoing a challenging period, we will use this situation as an opportunity to thoroughly improve our business fundamentals and further strengthen our competitive advantages in order to continue to lead the market and sustain growth," Hyun-Joon Kim, senior vice president of Samsung's mobile communications business, said Wednesday in the company's earnings call with analysts.

Its planned actions are headed in the right direction, market watchers say, but they may not be enough. Here are some other steps Samsung could take to turn things around in mobile:

1. Cut back on the number of models

Samsung wants to provide a wide range of devices to appeal to every consumer possible. Its smartphones touch all different screen sizes and prices, and that's something that has helped it become the biggest mobile phone vendor in the world. But it has gone a little overboard. It's one thing to give consumers choice; it's something else entirely to create so many models that both retailers and consumers have difficulty telling them apart.

For its flagship Galaxy S line, Samsung not only offers the Galaxy S5 but also sells five other variants: The rugged Galaxy S5 Active and Galaxy S5 Sport; a scaled down, cheaper Galaxy S5 Mini; the Galaxy K Zoom, which has a better camera; and the Galaxy S5 LTE-Advanced for higher Internet speeds. The variants all have more limited distribution than the S5 (the K Zoom for instance, is not available in the US), but that doesn't make things less confused.

And that list doesn't even take into account the Note phablet line or Samsung's new metal Galaxy Alpha devices, or its other Android and Windows Phones devices. On Thursday, Samsung introduced two new devices, the Galaxy A3 and A5, despite its vow to streamline its offerings. The all-metal smartphones, a shift from Samsung's recent designs, fulfill its promise to change the materials used in its products.

Samsung gets some benefits from offering so many devices, including name recognition and scale for purchasing components (many of which it builds in-house). But for more specialized products, such as the Note Edge, which has a screen that curves around the side, it means increased cost for making device-specific parts.

Samsung said that it will expand its "new product development strategy of focusing on streamlined strategic models for each price category to enhance product and cost competitiveness."

It doesn't need to go as extreme as Apple, which offers only a couple new -- and very pricey -- smartphones a year and doesn't care about its market share. But getting rid of some variants would serve Samsung well. Odds are, they wouldn't be missed by consumers.

2. Partner more closely with local companies in key markets such as China and India

Samsung got an early lead in emerging markets, but in the second quarter, it ceded its position as the No. 1 smartphone vendor in China and India to local handset makers Xiaomi and Micromax, respectively.

Upstarts such as Xiaomi are rising up. In the recently ended third quarter, the Chinese vendor became the world's third largest smartphone maker after Samsung and Apple, according to IDC.

"Key to its success was the launch of its Mi4 smartphone in August, which was positioned as a high-end alternative to the status quo," IDC said. "What remains to be seen is how quickly the company can move beyond its home territories to drive volumes higher."

The local companies have risen quickly for a few reasons. First, they know what matters most to consumers in their countries (because after all, most of their employees are also locals). They also know how best to sell to those buyers, a process that's often different from mature regions such as North America. In China, for instance, many smartphones are sold online through e-commerce sites, and Xiaomi, for one, has benefited from its flash-sale model where it offers only a limited number of devices for a short period of time.

Samsung has long counted on carriers to push its phones, and in the past couple years, it has tried to go up against Apple's store model in the US by partnering with Best Buy on But to sell in China and other areas, it needs to shift its strategy, something that Samsung acknowledges.

An executive said on Samsung's earnings call that because the percentage of sales made online and through other channels is increasing, Samsung is not only operating its own Samsung-branded online stores for handsets in 10 countries (including the US, China and South Korea) but is also "partnering with a major online retailer in the major markets."

Another benefit of local handset makers is in many instances, they also offer services specific to the region. In China, where certain Google-made apps won't work, Xiaomi offers its own versions of the software or partners with local companies to create such programs.

Samsung has been trying to build its software prowess for years, but it continues to struggle. And it said during its earnings call that it's "already leveraging all of the Samsung local companies that we have around the world to develop local content and local services." It also said it plans to expand its localized offerings. Still, it needs to pick up the pace.

3. Focus more on software and services

When Samsung needs a hit, it leans on its core strength: Hardware. Samsung has long been at the forefront of the mobile market when it comes to cramming tech into its devices. Its phones tend to use the fastest processors and brightest screens, as well as incorporate novel, high-tech features such as curved displays.

But simply using new materials, as it has vowed to do, isn't enough to keep consumers coming back. It's the software and services, along with the hardware, that helps make loyal users.

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"Materials appeal to the kind of person who really appreciates good design and high quality workmanship, but that kind of person also wants the same principles applied to software as well," Jackdaw Research chief analyst Jan Dawson said. "The version of Android Samsung runs could be more polished and attractive."

Samsung has made a big investment in software, hiring hundreds of new engineers and even starting entirely new operations, such as its Media Solutions Center. The problem is most of the efforts have fallen flat with consumers.

Many of Samsung's gee-whiz software features in the past -- eye scrolling, a translation tool, and a Group Play app that lets users share photos and other items with friends in close range -- haven't worked as well as promised. And the company has pared back many of its home-built applications and services in favor of those from partners such as Google. Few Samsung-built apps now come preloaded on its latest smartphones, and it's overhauling its Galaxy Apps store.

Google's Android and Apple's iOS software have evolved over the past couple years, but the design of Samsung's TouchWiz layer on top of Android hasn't changed much. Consumers don't necessarily want more Samsung software and services on their devices, but what they do want is a smooth, seamless experience. Samsung may need to buy a company with that expertise or turn to even more partners to accomplish its aims.

4. Figure out its end goal

When it comes to growth, the low end is where it's at. But that's also where competition is harshest. Samsung said that more than 50 percent of its smartphone units will come from the low end in 2015. In the third quarter, the company's profits tumbled in part because it sold more cheap smartphones than pricey devices. It also said it plans to go head-to-head with its rivals in inexpensive phones.

Samsung has some tough choices ahead, as CNET has noted before. It has to decide just what it's willing to give up to succeed in the emerging markets and just what success there means: profitability or market share. It can go the path of Apple by keeping its device prices steady but sacrificing its No. 1 position. Or it can load lower-end devices with high-end specs and cut prices to gain share at the cost of razor-thin margins.

The Xiaomi Mi 4's blockbuster sales have hurt Samsung. CNET

Samsung also has to attack the lower end without hurting its brand as a high-end vendor. It could do that by creating a new brand just for cheap devices in places like China and India. That would allow it to keep Samsung synonymous with high-end devices but still address the lower end of the market. But it also could present problems of its own. Samsung spends a lot of money on marketing its name. A new, non-Samsung brand wouldn't benefit from any of that.

Companies such as Xiaomi and fellow Chinese vendor Huawei are willing to sacrifice profits -- or even outright lose money -- to gain customers. The companies believe they'll make money once their volumes increase and component costs decline, so they price high-end devices cheaply.

In China, for instance, Xiaomi puts high-end specs in its phones but sells them for mid- or low-end prices. The company has been in the smartphone industry for only four years, but it has already surpassed Samsung in the world's biggest phone market with devices such as the $154 Redmi Note or the $322 Mi 4. By comparison, Samsung's Galaxy S5 flagship phone, which has specs similar to the Mi 4, retails for about $650 without a contract.

Samsung executive Kim said that the company will make its mid- and low-end smartphones more competitive by using different displays and materials, as well as upgrading the cameras and differentiating its user interface. It also will make its devices more competitive price-wise, though that likely will hurt margins in the near term.

In the third quarter, Samsung's profit margin tumbled to about 7 percent from 20 percent, its lowest since the beginning of 2009, according to the Wall Street Journal. Samsung still aims to keep its margins at a double-digit rate, Kim said.

There are concerns Samsung won't succeed at maintaining such margins. "We remain doubtful about the company's ability to recapture significant momentum in the budget market, given that Chinese players such as Xiaomi and Lenovo have been increasing their dominance in the sub-$300 segment by offering products with high-end specifications at value prices," said research firm Trefis.

5. Move faster but don't panic

Samsung prides itself on how quickly it can roll out products. Its first smartwatch, the Galaxy Gear, came together in about a year. By comparison, Apple has been working on its smartwatch, named the Apple Watch, for more than three years and won't start selling it until sometime in 2015.

But Samsung also admitted on Wednesday that it was too slow in responding to upcoming, low-cost vendors in China and other emerging markets. "Our responses to these rapid shifts in competitive landscape were not quick enough to avoid recent weak earnings results," said Robert Yi, Samsung senior vice president of investor relations.

Samsung knows almost better than anyone what can happen when a giant moves too slowly. After all, it was the biggest beneficiary of the sluggishness of BlackBerry, Nokia and Motorola Mobility. All missed the huge consumer shift to smartphones. Samsung did not, something that allowed it to overtake Nokia as the world's biggest handset vendor in early 2012.

But a knee-jerk reaction by Samsung could result in dozens of new devices and an even more scattershot approach. It also could mean even more marketing spending and lower prices, furthering weighing down on profits. All of those actions could actually have worse results than simply doing nothing.