The picture on the right is the Xiaomi Mi4 smartphone.

The 16GB version sells in China at Rmb 1999 ($326), and the 64GB version at Rmb 2499.  By comparison, Apple’s iPhone 6 sells for Rmb 5288.

Unsurprisingly, Xiaomi is moving up the world sales league very fast.  In Q2, it jumped to 5.1% market share, from just 1.8% in Q2 2013.  In Q3, it reached 5.6% and seems likely to move higher as it begins to launch in India next month.

Nor is Xiaomi the only Chinese smartphone company enjoying success in the global market.  Analysts Strategy Analytics report that Chinese companies gained a 38% share in Q3 – more than Samsung (24.7%) and Apple (12.3%) combined.

Of course there will always be people who want, and can afford, cool phones such as Apple’s.  But will there always be people who want mid-market phones like Samsung’s?

Probably not, if one looks at what is happening to Samsung’s market share and profits:

• Its market share was down by nearly a third in Q3 to just 25%, versus its 35% in Q3 last year
• Its profits halved in Q3, as its smartphone margin halved to 7% from 15% over the past 10 quarters

And whilst Xiaomi is piling on the marketing pressure, China’s Lenovo is busy consolidating the market – with Motorola its latest acquisition.  Generally speaking, companies find it very difficult to fight back if market share crashes like this.  Cash begins to drain out of the company, and already Samsung executives have taken a 25% cut in H1 bonuses.

THE AFFORDABLE LUXURY MARKET IS DISAPPEARING
The problem is simple.  Samsung’s success was based on selling an affordable version of Apple’s luxury models.   But now, Xiaomi’s very different business model means it can do this profitably at half Samsung’s price.  Its marketing, for example, uses social media instead of expensive traditional advertising.  Overnight, therefore, Samsung’s niche in the smartphone market is disappearing.

And the problem is not just confined to smartphones.  A new report for Korea’s Institute for Industrial Economics and Trade forecasts that although Korea has strengths in certain high-end markets (like autos and memory chips):

“Korea is expected to lose out to China in the manufacturing of mobile phones, display screens, ships, machines, petrochemicals, steel and textiles.”

Essentially, therefore. its export-led success of the past decades has ended:

• It used to sell high margin petrochemicals and other products to China
• China would then undertake low-margin assembly work for export markets in the West
• But now China is moving up the value chain – as described last week – whilst Western markets are slowing fast

This paradigm shift has enormous implications across the entire Asian region.

For 20 years, companies across North and South East Asia have built successful businesses based on exports to China.  In petrochemicals, for example, many firms expect to sell half their production to China.

Now, all those exports are no longer needed.  And even worse, Chinese companies are now starting to supply a very wide range of products – from smartphones to PVC and PTA – into their own domestic markets, and more cheaply.

The conclusion is clear.  China’s move up the value chain is for real.  And the speed of its advance gives little time for companies outside China to change their business model.  Probably all they can do is to rush to the government for protection, and argue for duty barriers to be erected in order to preserve as many jobs as possible.

Samsung’s agony is thus just one high-profile example of the Cycle of Deflation in action