Apple-Samsung: How Far Is Too Far?

Apple Inc. (Nasdaq: AAPL) is reportedly cutting back on its purchases of Samsung Corp. memory chips in the wake of an ongoing patent battle between the two companies. This isn’t a big surprise, given the rancor between the consumer electronics giants.

At first glance, it looks as if Samsung will be the victim in this move. Apple is shipping iPhones and iPads as quickly as they can be built, and even in the low-margin memory business, volume is volume. Any cutback on Apple’s part will have a negative impact on Samsung. As long as memory is flush and prices are low, Apple has plenty of places to shop for memory chips.

But I think Apple and analysts watching the Apple-Samsung feud are missing the bigger picture. How far can any company -- even Apple -- go before alienating its suppliers?

In addition to memory chips, Samsung is the leading supplier of displays to Apple. Although recent reports suggest Apple is cementing its ties with LG Display, Samsung is the world’s biggest manufacturer of displays. Like memory, certain types of displays are in oversupply: active matrix LCD (AMLCD) prices have been in steady decline and display makers are scrambling to make a buck in display sales.

But Samsung is also a leader in the development of organic light-emitting diode (OLED) displays, a technology that will revolutionize the display market once prices come down. OLED uses less power than conventional displays; can be manufactured on paper-thin substrates; and can be used to make flexible screens. OLED TVs someday could take up no more space on a wall than a large poster. Is it feasible, by any stretch of the imagination, that Samsung would tell Apple to take a hike?

So far, there’s no indication that Apple is cutting back its display orders from Samsung. If it does, it will be another blow to the supplier -- at least for the short term. In addition to LG, Apple has a solid relationship with Sharp Electronics, a display maker now with close ties to Foxconn, Apple’s leading EMS provider. Any hiccup in display supplies to Apple will be short-lived.

So Apple is holding all the cards. Not only has it “beat” Samsung in the US courts, but it is likely one of Samsung’s biggest customers. Logic and self-preservation would dictate that Samsung take its lumps without protest.

There is also little chance that Apple will ultimately drive Samsung out of business. Samsung is a huge conglomerate, a major consumer electronics OEM in its own right, with $247.5 billion (in 2011) in revenue.

But the electronics market, as we have seen again and again, is highly cyclical. The DRAM market is the worst offender. Although DRAM has been flush, it seems, for years now, when demand spikes there is always a scramble for memory chips. Prices skyrocket and small customers -- even if they are “strategic” -- go to the end of the line when shortages strike.

The display market is beginning to look a lot like the DRAM market did not long ago. It is marked by wide spikes in supply and demand; corresponding swings in pricing; and is a key component in just about every electronics device. And that’s where I see a risk for Apple.

Displays have become the single most important component in many consumer goods. They aren't just nice to look at: touchscreens are a device's on/off switch and mouse and keyboard. It is the primary interface for most electronics devices. If, for some reason, display supply is disrupted to the extent HDDs were last year, what customers would get preferential treatment? The biggest customers, certainly. But the biggest customers that are also suing you? I have to wonder about that.

Ultimately, however, I think it will come down to a business decision, at least for Samsung. If losing Apple harms the business, Samsung, like any corporation, will consider its shareholders. It is highly unlikely any company, even Samsung, can afford to tell Apple to take a hike.