If the smartphone market were merely a “gadget” market, this wouldn’t matter. Apple still has tremendous scale, and as its devoted fans often observe, it still arguably makes the best smartphones in the world. As a result, Apple is still the dominant player in the “premium” segment of the market, winning the hearts, minds, and wallets of rich consumers who have $600 to spend on a phone (or, more relevantly, carriers who will subsidize their phones).

The smartphone market isn’t just a gadget market. It’s also a platform market. (Third-party companies build products and services that are built on smartphones.) And platform markets tend to standardize around the platform with the most market share, because it’s easier and cheaper to build products and services for only one platform. Thus, in smartphones, platform market share matters.

Also, the “premium” segment of the smartphone market, the one Apple dominates, is already maturing rapidly.

More than 1 billion people worldwide now have smartphones.

These “golden 1 billion,” not coincidentally, are the people who have most of the world’s money. The next 6 billion smartphone buyers, meanwhile, don’t have much money. So, for them, the price of their smartphone is going to be extremely important.

And, as yet, Apple doesn’t offer low-priced smartphones that these folks can afford.

Kai-Fu Lee, a former Googler who now runs startup incubator Innovation Works in China, described the key dynamics of China’s exploding smartphone market in a recent LinkedIn post.

The Chinese smartphone market is growing spectacularly quickly: From an installed base of about 50 million phones last year to a staggering 500 million by the end of next year.

Android’s running away with the game.

Importantly, this explosive growth was triggered in part by the launch of affordable $100-$200 Android smartphones.

As in other areas of the world, Apple is a premium brand in China. But most Chinese can’t afford to shell out $500 for a phone. And the Chinese wireless carrier business is not built around subsidies, the way the U.S. and European carrier businesses are.

So even though Apple is enjoying huge growth in China, it’s missing out on the truly explosive growth segment of the market: Mainstream Chinese consumers.

Kai Fu Lee explains:

Originally, China’s market developed more slowly because of two reasons. First, usable 3G networks took much longer to develop than other countries.  Second, there are few subsidies in China, so users had to pay one or two month’s salary for an iPhone or Android.  These inhibited the growth.

But both issues have changed.  Broadband wireless is now over 58%, and smart phone prices have dropped to about $100 for an acceptable Android phone, and about $200 for a full-featured Android phone. Smart phones are now spreading like wildfire.

About a year ago, there were less than 50M users, basically affluent or tech savvy users who were willing to pay $500 for a phone and $30 a month for 3G.  But now, students, young white collar, and even blue collar workers are swarming into the smart phone market!

The same thing is happening in India, another vast and burgeoning smartphone market. In India, though, Apple isn’t even a strong “premium” brand, because it doesn’t have the distribution system it has in China. Samsung and other Android vendors are cleaning up in India, while Apple tries to figure out how to sell $500 phones to people who don’t make that much money in a month.

Apple’s dominance of the “premium” segment of the smartphone market has allowed it to become the most profitable company in the world.

But the “premium” segment of the market is maturing, and the next phase of explosive market growth is going to come from lower-priced phones.

As Apple surrenders more and more market share to Android, meanwhile, it risks becoming an “also-ran” development platform. If that happens, the value of Apple’s “ecosystem” will drop, and even the company’s position in the premium segment might become threatened.

Apple isn’t helpless here, but it also can’t have everything.

Apple will soon have to choose between:

1) its extraordinarily high profit margin, or

2) its global market share

If Apple wants to defend, much less grow, its market share relative to Android, it’s going to have to offer low-priced phones.

If it offers low-priced phones, however, its profit margin will almost certainly drop.

Defending market share is much more important to the company’s long-term value than maintaining a particular profit margin, so this shouldn’t be a tough decision for Apple. But it may cause some angst among the company’s investors.