It's time for Samsung's next act

January 28, 2013: 9:28 AM ET

World domination? Check. Now the electronics giant must step out of its comfort zone and not simply focus on increasing market share.

121114110240-samsung-galaxy-s3-gallery-horizontalFORTUNE -- It's been a very good year for Samsung Electronics. Late last week the Korean hardware giant announced that its fourth-quarter profit rose a whopping 76% from the year before, mainly due to strong sales of its popular Galaxy line of smartphones. Overall, the company shipped an estimated 213 million smartphones in 2012, the largest amount ever shipped by a single vendor in one year, according to a new report from research firm Strategy Analytics. Samsung now owns 30% of the global smartphone market, ahead of archrival Apple's  19% share.

But while Samsung has clearly achieved world domination, it will have to move fast to hold on to that title. That means churning out even more hardware innovations and delivering software services that will make its devices stickier with consumers.

In developed markets like North America, growth in smartphone sales is already waning. "Global shipment growth slowed from 64% in 2011 to 43% in 2012 as penetration of smartphones began to mature in developed regions such as North America and Western Europe," Neil Shah, a senior analyst with Strategy Analytics, wrote in the company's recent report. In other markets, an influx of cheaper devices—many of them also built on Google's (GOOG) Android operating system—could threaten Samsung. The company issued its own not-so-subtle warning of slowing demand when it announced earnings last week. In a press release, Samsung said the "furious growth spurt seen in the global smartphone market last year is expected to be pacified by intensifying price competition compounded by a slew of new products."

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Because many of these new products also run on Android, Samsung will need to do more to differentiate itself from the pack. It's already proven that it can innovate and mass-produce hardware on an unprecedented scale—the company makes many of its smartphones' building blocks, from high-end screens to quad-core processors. It's also poured millions of dollars into a remarkably successful ad campaign that knocks Apple (AAPL) in its own backyard (the U.S. market). But what it hasn't done is prove that it can compete on the software ecosystem front, where Apple and Google's content services, app stores and operating systems rule. It comes down to this: If consumers associate Samsung with crucial services like music or mapping, they're more likely to see their shiny piece of hardware as more valuable than another, possibly cheaper shiny piece of hardware.

If the company was serious about competing in the software battle—whether it chooses to build on top of Android or promote its own operating system—then it would probably need to increase its presence and investment in the Silicon Valley, where a large pool of mobile software talent now resides. It appears to be doing just that—finally. In December Samsung announced it is building out a 1.1-million-square-foot R&D center in San Jose. It also plans to open a new startups incubator in Palo Alto, and is expected to unveil more details about its "vision for accelerating innovative ideas and start-ups in Silicon Valley" next month.

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To be fair, Samsung already has some software offerings, like Music Hub, a cloud-based music service. But it's not clear how much of a priority such efforts have been in the past. It also has its own smartphone platform, Bada, but sales of phones powered by its homegrown OS pale in comparison to its Android-powered line of Galaxy smartphones. Many analysts wonder if there is room for a third mobile operating system at all.

Of course, customers are also looking to Samsung to keep delivering on the hardware front. It has become known for bringing out big, dazzling screens and technologies such as near field communication, which lets two phones "beam" photos when pressed together. But while Samsung needs to keep upping the ante on the latest and greatest hardware specs, it also needs to start making some big—and possibly uncomfortable—bets in software. The rewards may not be immediate, but if Samsung wants to hang on to the crown well beyond 2012, it doesn't have much choice.

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About This Author
Michal Lev-Ram
Michal Lev-Ram
Writer, Fortune

Based in Silicon Valley, Michal Lev-Ram covers enterprise and mobile technologies for FORTUNE. Prior to joining FORTUNE, she wrote for CNNMoney, Fast Company, Popular Science and other business and technology publications. She was also a staff writer at Business 2.0 and holds a B.A. in journalism from San Francisco State University.

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