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Samsung (OTC:SSNLF) and Apple (NASDAQ:AAPL) are facing the challenge of increasing competition in the Chinese market from the leading local players such as Lenovo (OTCPK:LNVGY), Huawei, Xiamoi and ZTE (OTCPK:ZTCOF). The Chinese market is witnessing explosive growth with 53 million cell phones being shipped in the previous quarter, a 64% year-over-year increase. In such an environment, everyone wins on paper but the real fight is for market share. For both Apple and Samsung, their early-mover advantage is eroding. According to IHS iSuppli, Samsung's market share in China fell from 20% in 2011 to 14.2% in 2012, while Apple's share dropped from 10% to 7.9% in the same period. On the other hand Lenovo, whose growth is astounding versus the shifting background of the PC market, has increased its share in the smartphone market from 5% to 10% and both Huawei and ZTE are now ahead of Apple with a market share of approximately 9% each. These dynamics demand a response from Samsung and Apple.

According to recent reports by China's state news agency Xinhua, Samsung has decided to invest $1.7 billion over the next five years at a plant located in Jiangsu province in East China. The investment will go to the city of Kunshan, one of China's IT hubs. The money will be used to buy equipment, develop a research institute and a workshop. The company's plant in Kunshan was established in 2008 and since then, Samsung has invested $81 million in the city. The current plan will therefore be a significant step forward.

As the Chinese middle class emerges we are seeing more local pride - some would call it nationalism - creep into consumer buying patterns. Local investment, therefore, becomes a very important business development strategy for international players. And the execution of the local Chinese manufacturers is causing these shifts to occur, in my opinion, faster than anyone anticipated.

While Lenovo is beating analysts' estimates by earning record revenues ($9.36 billion) and profits ($204.9 million), Huawei - according to IDC - has become the third-biggest player in the global smartphone market, behind Samsung and Apple and ahead of Sony and its local rival ZTE. For the first time ever, we find that two Chinese firms are among the world's top five smartphone manufacturers. Both Huawei and ZTE have clearly capitalized on the downfall of Nokia and HTC in the last couple of years. This also shows the important role the emerging markets are playing in the global mobile market as the Chinese phones are primarily sold in China and Asia Pacific. So, between price, local pride and being able to compete at all levels of the market - from flagship phones to the lowliest entry-level one - it is a becoming increasingly difficult landscape for foreign players to make headway. One misstep and one of these companies will be there to capitalize.

However Samsung knows this fight is also global and while its market share in China may stabilize at lower levels, it has to step up its game around the world as well like in the U.S. In fact, Samsung recently announced a $100 million "catalyst fund" for further investment in the U.S to pump its $1 billion research and venture capital fund called Samsung Ventures America Fund. It has a big task ahead of it, however as Apple literally owns the very lucrative U.S. market. Moreover, Young Sohn, the company's famed chief strategy officer, will be spearheading a new Samsung Strategy and Innovation Center, which will have offices in California, South Korea, and Israel. Samsung clearly knows that increasing levels of research and development are crucial for survival in the market. More so when its biggest rival Apple spent more than $1 billion in its previous quarter over R&D.

IDC Market Share

Q4 through Dec- 2011/12

2011

2012

Samsung

22.5%

29.0%

Apple

23.0%

21.8%

Huawei

3.5%

4.9%

Sony

3.9%

4.5%

ZTE

4.0%

4.3%

Samsung is coming close to owning one-third of the global market, exploiting its ability to move quickly into rapidly expanding markets. However, both Huawei and ZTE, an expert in making low-cost, high-quality devices, are putting pressure on Samsung's margins. While Samsung has reported a 76% increase in its quarterly profits, the company's profit margin in the mobile phones arena has fallen sequentially from 18.8% to 17.4%. This is perhaps the biggest impact of Chinese smartphone vendors as Samsung's margins are likely to fall even further in the coming quarters. For the Chinese market however, despite its billion dollar investment program, analysts still believe that Samsung's leadership crown will be taken over by Lenovo in the current year.

In the last six months, Guggenheim China Technology ETF (NYSEARCA:CQQQ), in which the Lenovo Group is the third-biggest holding, has been up by 17.8%. This is an excellent vehicle to play this rise in Chinese smartphone makers. The easy money in smartphones has been made and Apple captured the lion's share of it with Samsung grabbing most of the rest. The next phase will be dominated by those that can pick at those margins and incrementally widen their own.

EWY

CQQQ

Stock 6M

3.34%

17.80%

P/E

9

15

Beta

1.59

1.52

Yield

0.61

1.76

Market Cap

$2.79B

$19.09M

Fund Flows

+$470.55M

-$3.14M

Source: Samsung And Apple Will Lose The Cheap Smartphone War