Samsung Electronics <005930.KS>, the world's No.1 memory chipmaker, warned of weaker margins and profit growth after posting record quarterly earnings, as prices of chips and flat screens drop and smartphone competition grows.

Chairman Lee Kun-hee, 68, the country's richest and most influential businessman, faces a tough challenge to maintain the group's momentum as rivals, such as Sony Corp <6758.T>, catch up and the chip sector faces the prospect of oversupply if demand weakens.

Samsung's smaller rivals LG Display, Hynix and AU Optronics <2409.TW> have already warned prices of LCD and memory chips would fall in the third quarter.

It's going to be challenging period even for market leaders like Samsung because concerns are mounting over overall IT demand slowdown, said Kim Jae-dong, a fund manager at SEI Asset Korea.

Now the focus is moving to U.S. market where inventory is rising and demand is weakening. With worries of global economic slowdown only deepening, investors will be more sensitive to any negative news flow.

Samsung itself warned prices for its bread-and-butter memory chips business would fall in the second half due to supply growth outpacing demand pickup as concerns that China's tightening policy and the European debt crisis could hurt sales of PCs and other consumer goods.

In the handset arena, where Samsung is world No.2, the South Korean firm is being challenged by Apple in its home market, were the U.S. company has sold more than 800,000 iPhones this year.

Samsung trails Nokia in mobile phones, competes with Sony in flat-screen TVs, LG Display <034220.KS> in flat screens, and Toshiba <6502.T> and Hynix <000660.KS> in semiconductors.

Shares in Samsung, which has a market value of $113 billion, closed down 2.1 percent, versus a 0.65 percent decline in the broader index <.KS11>.

Samsung reported 5.01 trillion won ($4.23 billion) in operating profit in April-June, beating a consensus forecast for a 4.86 trillion won profit by 20 analysts from Thomson Reuters I/B/E/S.

The profit, in line with the median estimate of 5.0 trillion won given by Samsung early July, almost doubled from 2.67 trillion won a year earlier and topped the previous record of 4.4 trillion won in the first quarter.

Samsung said it would pay an interim dividend of 5,000 won versus 500 won a year ago, adding the jump in payout was due to a re-allocation of the total dividend for the full year.

With intensified competition throughout the digital media and mobile industries going forward, it may become a challenge to maintain current profitability levels, Samsung said in a statement. It said third quarter profit margins could be hurt by price competition in its handset and TV businesses.

Samsung is forecast to earn 19 trillion won in 2010 operating profit, according to Thomson Reuters I/B/E/S, up 74 percent from a year ago. That implies second-half profit would rise slightly to 9.58 trillion won from 9.4 trillion in the first half.

The company, three times bigger than rivals such as Sony and Nokia in market value, has renewed record profit every quarter since Lee returned as its chairman in March.

Since his return, Lee ordered a record investment of 18.2 trillion won to widen gap with its rivals such as Hynix, Toshiba and LG Display and announced massive $20.6 billion investment into new businesses such as health and green energy.

GALAXY VERSUS IPHONE

Lee sought to lift any complacency within the company by warning that Samsung's business model may have to change radically over a decade to compete with rapidly changing consumer tastes.

Last year executives voiced concerns about the company's smartphone product line after admitting they had been slow to see demand boom.

Apple has sold more than 16 million iPhones this year and its iPhone has become the mobile phone of choice in Seoul's financial district, Yeouido, by investment bankers and asset managers.

In June, Samsung launched its response to iPhone, Galaxy S. Samsung said it has sold half a million Galaxy phones in just a month, a record.

But Lee Jae-yong, the son of the chairman, who is also chief operating officer, will have to prove he can deliver an innovative and captivating product line like Apple's CEO Steve Jobs.

There has been some skepticism as to whether he can sustain the achievements of his father in memory chips, TVs and LCDs. The younger Lee's tenure overseeing Samsung's Internet business was not a success.

Samsung sold 63.8 mobile phones in the second quarter, down from 64.3 million units sold in the previous quarter, and telecom division margins slumped to 7.2 percent, as it boosted marketing spending in the absence of a strong model to claw back share in the lucrative smartphone market.

It fared better than domestic rival LG Electronics, which reported record 120 billion loss from phone sales last quarter to show a negative 3.5 percent margin, but worse than Nokia, whose phone division posted 9.5 percent EBIT margin.

The company is making a big bet on Galaxy S. The 4-inch touchscreen model is slightly wider and longer than iPhone 4, which has 3.5 inch display, and boasts similar user interface, with both 5 megapixel rear camera and video function.

BlackBerry maker Research in Motion and Microsoft Corp also plan to launch new smartphone operating systems.

(Additional reporting by Jungyoun Park, Kyungmin Suh, Chyen Yee Lee, Seo Jiwon; Editing by Jonathan Hopfner and Valerie Lee)

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