Cheaper than China.

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Samsung's Future Runs Through Indonesia

Adam Minter is a Bloomberg View columnist. He is the author of “Junkyard Planet: Travels in the Billion-Dollar Trash Trade.”
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Samsung, the world's biggest manufacturer of smartphones, has a growing problem in the world's biggest smartphone market. The company has seen a 53 percent decline in units shipped to China so far this year compared to the same period a year ago. After a long reign as China's most popular phone producer, it has now slipped to fourth.

There's plenty Samsung can do to try to stage a reversal in China, from developing new products to improving its marketing. But it may have identified a shortcut for a turnaround -- one that runs through Indonesia.

Samsung’s current struggles in China are due in part to its failure to anticipate recent changes in the country's economy and smartphone market. According to IDC, a market research firm, overall Chinese smartphone shipments contracted 4.3 percent year-on-year last quarter, their first decline in six years. Yet this contraction was accompanied by a revealing trend: During the same period, Apple’s shipments increased more than 60 percent. The explanation for this apparent paradox is that China’s smartphone market has matured and now more closely resembles that of the United States than it does that of, say, Vietnam. Chinese consumers are looking for bargains, or iPhones, and not much in between.

Samsung, which prospered for years in China by selling cheap phones, faces an additional problem: Over the last two years, China's market has become crowded with low-cost Chinese manufacturers like Xiaomi that offer fully featured phones with cutting edge (and copycat) designs at discount prices. Those companies have been eating away at Samsung's low-end market share.

Samsung's fate, in other words, won't just turn on whether it develops enticing products -- the company is also going to have to find a way to lower its production costs if it hopes to remain competitive. And that will likely require moving its manufacturing somewhere outside of China, where private sector manufacturing wages grew 13.5 percent in 2013 after increasing 16.9 percent in 2014.

That's where Indonesia comes in. According to a report last week in the Wall Street Journal, Samsung opened a smartphone assembly plant there earlier this year that's capable of producing 1.5 million units per month. It would seem to be a smart investment. Thanks to its population of 250 million -- the largest in Southeast Asia -- and its under-developed economy, Indonesia's labor costs are less than half those paid in China. And it seems that gap will only widen in the years ahead: According to a Bloomberg Intelligence report, Indonesians are predicted to earn an average wage of $0.79 per hour in 2018, while Chinese workers will average $4.79.

Samsung's newfound proximity to Indonesia's domestic market will also be an advantage in the years ahead. The country has the world’s seventh largest population of smartphone subscribers, and by 2018, it’s expected to have the fourth largest, according to a report by eMarketer, a market research firm focused on digital commerce. Being closer to the growing Indonesian market makes it easier to quickly adapt to changing local tastes. (This is the basis of the nascent “next-shoring” movement.)

Samsung isn't the only manufacturer looking to set up shop beyond China. Among its competitors, Foxconn (Apple’s contract manufacturer of choice) has set up shop in the company's fastest growing market, Vietnam (where average wages are expected to be a comparatively expensive $3.16 per hour in 2018). Samsung has also set up significant operations in Vietnam, including a $5 billion assembly plant that exports most of its production.

But Foxconn has not managed to branch out to Indonesia. The company has entered negotiations to get a foothold in the country, but the Indonesian government claims Foxconn is demanding too many concessions, including free or discounted land, and import protections from the types of low-end phones it would like to sell in Indonesia (at least initially). And it is true that the Indonesian government hasn't made it easy for foreign manufacturers; it has generally seemed more interested in protecting its own manufacturers than coddling foreign newcomers. In 2013 it imposed a 20 percent tax on imported phones, and this year it started requiring manufacturers of 4G handsets to source 40 percent of their components from local suppliers. That’s especially difficult for a big multinational.

Samsung wisely chose to manufacture in Indonesia anyway. In doing so it has gained a chance to replicate its prior low-wage, down-market successes in Indonesia, and elsewhere in Asia. Of course, there’s no guarantee that it will succeed, especially against its low-cost Indonesian and Chinese competition. But by gaining early access to Indonesian labor, there's good reason to think it has gained a leg up on its competitors.

This column does not necessarily reflect the opinion of Bloomberg View's editorial board or Bloomberg LP, its owners and investors.

To contact the author on this story:
Adam Minter at aminter@bloomberg.net

To contact the editor on this story:
Cameron Abadi at cabadi2@bloomberg.net