Samsung - lede

Samsung

Giant in Transition

By | Updated July 24, 2014

In South Korea, when people talk about big business, they mean big: sales of the five largest companies are roughly equivalent to two-thirds of South Korea’s gross domestic product. None of them is bigger than Samsung, a collection of more than 70 companies whose revenues are about equal to a quarter of GDP, a scale that has led some to refer to South Korea as “the Republic of Samsung.” Like the country’s other family-run, government-supported conglomerates known as chaebol, Samsung has grown by fast following, a strategy that has made it the world’s largest electronics company by revenue and South Korea the world’s eighth-largest exporter. Samsung in 2011 became the leader in smartphone sales, setting off a titanic series of patent fights with Apple. Samsung is trying to shake that copycat image at the same time that it and other chaebol are facing generational transitions. The question younger leaders face is whether the web of government, corporate and cultural ties that made the chaebol dominant will help or hinder innovation.

The Situation

Lee Kun Hee, Samsung’s chairman and South Korea’s richest man, underwent emergency surgery in May after suffering a heart attack. Lee, who turned 72 in January, engineered the company’s push into mobile phones, which account for 76 percent of operating income. But now it’s facing tougher competition: Chinese rivals with cheaper, feature-packed devices like Xiaomi are gaining in emerging markets, while Apple is boosting iPhone sales through a partnership with China Mobile. A slump in Samsung’s mobile phone sales contributed to a 9.9 percent decline in the company’s stock in 2013. But the shares rebounded in the weeks after Lee’s surgery, as investors speculated that he might hand over control to his only son, Lee Jae Yong, vice chairman since 2012. With the chairmen of many chaebol aging and scions facing large inheritance-tax bills, the conglomerates are under pressure from the government to simplify their tangled systems of cross-shareholding to protect the rights of minority owners, a step seen as likely to free up capital.

The Background

Lee Kun Hee became chairman of Samsung in 1987 upon the death of his father, founder Lee Byung Chull. Samsung began with 40 employees in 1938, exporting rice, dried fish, noodles and produce before diversifying into insurance, sugar, paper, textiles, property development, and electronics and appliances. In the 1960s, dictator Park Chung Hee turned to the chaebol to spur export growth: Companies such as Samsung and Hyundai were protected by steep tariffs and encouraged through government financing to branch out and develop heavy industry, chemicals, shipbuilding and construction.  The strategy led to rapid export growth but backfired in the 1997-98 Asian financial crisis, when the huge, debt-laden chaebols helped trigger a spate of bank failures. Many trace Samsung’s rise in electronics to the day Lee made a bonfire out of shoddy handsets and proclaimed the slogan of “Quality First.” The company went on to become the world’s largest manufacturer of smartphones, TVs and memory chips, and Lee became the country’s richest man, worth an estimated $11 billionIn the convoluted world of chaebol, Lee’s family has been able to retain control of Samsung while owning a combined stake estimated at less than 2 percent of shares.

The Argument

While the chaebol helped make South Korea an economic success story, many politicians and investors argue that the system is a cultural relic poorly suited to the 21st-century economy. The shares of chaebol-linked companies trade at lower multiples of earnings than their peers in the U.S., Europe or Japan (a phenomenon called the Korea discount) because of concerns over cronyism and cross-ownership. Park Geun Hye, the current president and the daughter of Park Chung Hee, has clamped down on deals in which chaebol steer business to companies controlled by friends or relatives, and has banned further cross-holding of shares. The sheer size of Samsung and other giants raises concern they’ll leave no room for the small ventures seen as engines of innovation in other countries. Younger, Western-educated chaebol executives promise to make their companies nimbler. Even so, the immense political clout of the chaebols may make them resistant to change. In 2008, Lee was convicted of evading taxes on about $5 billion, only to receive a presidential pardon a year later.  Despite Park’s push on corporate governance, she, like her father, looks to them to drive growth. In August, Park met with Lee and the heads of nine other chaebol to encourage them to increase investment, promising that regulations would not get in their way.

The Reference Shelf

  • A profile by Bloomberg Businessweek of Samsung and Lee Kun Hee.
  • This Bloomberg News article sorts through the complexities of chaebol ownership in light of the expected generational transition — the chaebol “timebomb.”
  • A Vanity Fair article on the patent war between Apple and Samsung.
  • In 2010, the Economist surveyed “Korea’s Industrial Giants,” with a focus on Samsung.
  • A book, in Korean, called “The Samsung Way,” by two business management professors at Seoul National University based on a Harvard Business Review paper. Publication of an English translation is scheduled for August.

(First published on May 29, 2014)

To contact the writer of this QuickTake:

Jungah Lee in Seoul at jlee1361@bloomberg.net

 

To contact the editor of this QuickTake:

John O'Neil at joneil18@bloomberg.net