Can Samsung Squeeze Apple Inc. (AAPL) Where It Hurts?

Perhaps Tim Cook’s best-known claim to fame is that he constructed what’s widely regarded as the best supply chain in the world for Apple Inc. (NASDAQ:AAPL). Market researcher Gartner Inc (NYSE:IT) even ranks companies based on supply chain prowess, and Apple takes the cake by a long shot. The Mac maker’s composite score in the 2012 rankings put it ahead of McDonald’s Corporation (NYSE:MCD), one of the largest fast food chains in the world, as well as the largest retailer in the world, Wal-Mart Stores, Inc. (NYSE:WMT). Apple outscored rival Samsung by nearly three-fold.

Apple Inc. (NASDAQ:AAPL) is known for making billions of dollars of inventory component prepayments to secure supply, a figure that currently stands at $3.6 billion.

Source: SEC filings. Calendar quarters shown.

Can Samsung squeeze Apple’s supply chain?

Main squeeze
One of Samsung’s biggest strengths in the battle for smartphone dominance has been its vertical integration, an infrastructure it built as an Apple Inc. (NASDAQ:AAPL) supplier itself. The South Korean conglomerate sources the majority of its components internally, everything from applications processors to memory to displays. That’s given it cost advantages and it also contributes to the operational efficiency that facilitates Samsung’s “fast follower” strategy, where it can quickly replicate a rival’s offering with breathtaking agility.

apple-moneyHowever, as the company has risen to become the largest smartphone vendor in the world by volume, its need for crucial ingredients has similarly increased. That’s put a strain on its ability to source from within, and Samsung has now increasingly begun tapping third-party vendors — many of which have relationships with Apple Inc. (NASDAQ:AAPL).

That includes companies like Sharp, which provides LCD panels to Apple. Samsung has also been tapping QUALCOMM, Inc. (NASDAQ:QCOM) more, including in its newest Galaxy S4. Samsung and Apple Inc. (NASDAQ:AAPL) primarily tap Qualcomm for different chips, though: Samsung uses Snapdragon processors while Apple only purchases basebands. Some analysts think that using Snapdragons could adversely affect Samsung’s image of having differentiated hardware (like its Exynos chips), since a wide range of OEMs use Snapdragons.

That notion deserves more context. Samsung’s Exynos chips use standard cores licensed from ARM Holdings plc (ADR) (NASDAQ:ARMH); the latest Exynos 5 family uses ARM Cortex-A15 cores. Qualcomm, on the other hand, licenses an ARM instruction set and makes its “Krait” cores from scratch, meaning Snapdragons are more differentiated. It just so happens that everyone uses them, so they’ve become the standard. Samsung was also reportedly facing challenges in power consumption with its Exynos 5 Octa. Qualcomm is happy to play both sides, though, and has overcome its supply constraints of yesteryear that were related to Taiwan Semiconductor Mfg. Co. Ltd. (ADR) (NYSE:TSM).

An estimated 80% of Galaxy S4 component profits are generated within Samsung’s own divisions, so the vast majority of Samsung’s ingredients still be produced internally. As Samsung continues to push its own internal limits, it will find itself competing more directly with Apple Inc. (NASDAQ:AAPL) for component supply.
It’s a good thing that Apple has those prepayments.

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Fool contributor Evan Niu, CFA, owns shares of Apple and Qualcomm. The Motley Fool recommends Apple and McDonald’s. The Motley Fool owns shares of Apple, McDonald’s, and Qualcomm.

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