Atop the Electronics World, Samsung Now Chasing Innovation

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Shin Jong-Kyun, CEO of Samsung Electronics Co., launches a new range of Galaxy Gear 2 and Gear Fit wearable devices and the Galaxy S5 smartphone during the 2014 Mobile World Congress in Barcelona. Close

Shin Jong-Kyun, CEO of Samsung Electronics Co., launches a new range of Galaxy Gear 2... Read More

Photographer: Angel Navarette/Bloomberg

Shin Jong-Kyun, CEO of Samsung Electronics Co., launches a new range of Galaxy Gear 2 and Gear Fit wearable devices and the Galaxy S5 smartphone during the 2014 Mobile World Congress in Barcelona.

When 10 of Samsung Electronics' top executives met in Shanghai last December, they weren't there to celebrate the company's dominance in the gadget world. They convened to map out how the South Korean tech giant can survive the onslaught from a multiplying number of low-cost competitors — many of which are located just outside the meeting room's walls in China.

"Where they are today is great,” says Jenny Lee, a managing partner at technology investment firm GGV Capital in Shanghai, who dined with Samsung's management while they were in town. "But they are paranoid.”

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Paranoid because Samsung may have outgrown the formula that led it to the top of the consumer electronics business. The company owes much of its success to its mastery of what's known in the tech industry as "fast following." By owning each piece of hardware development from start to finish and then ruthlessly designing scores of products that cater to whatever is hip among users, Samsung has been able to catch up to and even surpass the companies it was chasing.

Now that it's ahead of the pack in many parts of the industry, Samsung is trying to shed its copycat image and chart a path toward innovation. Last year, as rumors began to bubble up that Apple was working on a smartwatch, Samsung already had one ready to go. The Galaxy Gear wasn't a commercial success, but the move indicated that the Asian company would no longer wait for others to prove a market.

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Visitors walk past a Samsung Electronics Co. booth, in this photograph taken with a tilt-shift lens, at the World IT Show 2013 in Seoul, South Korea. Close

Visitors walk past a Samsung Electronics Co. booth, in this photograph taken with a... Read More

Photographer: SeongJoon Cho/Bloomberg

Visitors walk past a Samsung Electronics Co. booth, in this photograph taken with a tilt-shift lens, at the World IT Show 2013 in Seoul, South Korea.

Successful Transformers

Although rare, there are examples of fast followers that have transformed into innovators. Japanese automakers Mitsubishi, Nissan and Toyota started off by emulating what worked for Ford and other American car companies, including just-in-time production of parts, says William Stofega, an analyst at IDC. In a role reversal, U.S. automakers have spent much of the last decade trying to stem declines and catch up with Japanese innovations, such as hybrids and other fuel-efficient vehicles.

Sony, a Japanese company that Samsung had once chased after, went through a similar transition. Sony got its start in the wake of World War II by creating low-quality versions of tape recorders and other devices that had been invented elsewhere. It took nearly a decade for Sony to create the first mass-market transistor radio, which would be followed by other breakthroughs such as the Walkman and PlayStation. "Made in Japan," once a derisive term, became a source of pride for the country, thanks largely to one company's innovations.

“Sony started out by doing a lot of cheap junk, and was able to change and innovate and grow,” Stofega says. “Think about what Sony did right after the war and what they were able to produce, and then you think of something like PlayStation. Wow.”

The list of companies that have failed to make the leap is much longer. Zynga has been criticized in the video-game industry as a fast follower. When it found it couldn’t keep up with all the new Facebook and mobile games coming out, Zynga bought several developers but failed to churn out more hits on the scale of “FarmVille." The stock is down 57 percent from when it went public. Zynga declined to comment.

Practically since its inception, Microsoft has mixed fast following with experiments in new areas. The tried-and-true Microsoft model was to bundle its own versions of services similar to those offered by competitors and reduce the price, says Horace Dediu, who runs a mobile industry consulting firm called Asymco. “They have run out of really great markets to enter." Microsoft declined to comment.

Chairman Pushes Innovation

Samsung is in a similar position, and it knows it. Chairman Lee Kun Hee gave a speech to employees last year urging them to help identify “new businesses that Samsung’s future will hinge on” and again this year calling for "a bigger push for innovations, including in business structure, so that we can lead industry trends."

“Samsung is the 800-pound gorilla that works harder than a startup,” says Jay Eum, who helped start the company’s Silicon Valley venture-capital arm in 2003 before breaking off to co-found TransLink Capital. “Because they’re in a leadership position, they have to evolve. They realize that now, especially in the last two or three years, they don’t really have a roadmap to follow.”

Samsung declined to comment on the meeting in Shanghai or on rival companies. Samsung says about 25 percent of its workforce is dedicated to research and development, which results in thousands of new patents per year. The company touts about two dozen examples of products that were industry firsts, such as "the world's first MP3 player phone" and "the world's first 55-inch OLED TV."

"Samsung has always been an innovator and has led the development of core technologies and products over many years," the company says in an e-mailed statement. "We contest the idea that Samsung is simply a fast follower. Samsung’s success in the fast-evolving and competitive technology industry came from our commitment to R&D, innovations in products and designs, in-house engineering and manufacturing as well as convergence capability across smart devices."

The rise of Samsung’s global brand has only come in the last decade or so. In 1993, the chairman gathered his lieutenants for a meeting in Frankfurt where he laid out a plan to transform the electronics company into a maker of high-quality hardware. Samsung still makes lower-priced products to get the budget-conscious consumer hooked on its brand, but it began manufacturing full-featured gizmos that sometimes exceeded what rivals' devices could do. The strategy took time to execute, but now Samsung is No. 1 worldwide in TVs and smartphones, No. 2 in tablets, and targeting the top spot in appliances by next year.

A Glimpse of the Smartphone Future

Samsung's success with smartphones was due in part to the company's dominion in chipmaking, where it's considered an innovator, says Dediu. As one of the biggest component vendors to Apple and other hardware makers, Samsung got an early glimpse at the smartphone revolution and decided it was time to take the leap in 2009, two years after the release of the iPhone, with the Galaxy line of touchscreen devices.

“They knew the writing was on the wall for dumb phones because of Apple’s success,” says Dediu, a former senior analyst for Nokia.

However, Apple claims Samsung got more than a glimpse. The Silicon Valley giant sued the company in 2011, claiming Samsung copied the iPhone and infringed on its patents. Apple won a $1 billion verdict in the first trial in the U.S. that was later reduced, and a second trial began yesterday.

Beyond the damages, the lawsuits against Samsung aren't helping the company's effort to change its image. And that, too, can cost Samsung since people often don't want to pay extra for a product that’s seen as a copycat, says Ross Rubin, the principal analyst at consulting firm Reticle Research. A brand that's perceived as innovative "helps justify pricing premiums,” he says.

That's not the only pressure Samsung is facing in smartphones. The market is now flooded with devices that all roughly look the same. So how do you distinguish yourself? Software — but that's a problem for Samsung, which has built the majority of its electronics business on top of operating systems made by another company: Google. Samsung makes Android phones and tablets, Chromebook laptops and Google TV sets.

“If Samsung, for all of its massive power, cannot make software, they have zero future,” says Dediu. “Innovation today is something that involves a systems-wide approach. Fundamentally, I cannot see that happening unless Samsung goes into the software-and-services business. Software and services is where all the action is.”

While Samsung does develop add-on tools and applications for Android, such as the recently unveiled radio streaming service Milk Music and the corporate-security system Knox, its effort to create a smartphone operating system called Tizen is behind schedule. Samsung doesn’t create highly acclaimed software like Apple or even Xiaomi, the $10 billion upstart that sells Android-modified phones that are popular in China. That puts Samsung's products at risk of being commoditized, according to Dediu.

"Someone will make something comparable at a lower price, particularly in China,” he says.

Chinese Competition

Like Samsung, Chinese tech companies have developed a reputation for copying. Huawei started as a knockoff of Cisco Systems, says Lee, the venture capitalist from Shanghai. Huawei quickly expanded beyond telecom equipment to mobile, becoming the third-largest smartphone maker today behind only Samsung and Apple, according to research firm IDC. Meanwhile, computer maker Lenovo ranks fourth in smartphones. Talk about fast followers. Huawei said it spends more than 10 percent of annual revenue on R&D. Lenovo declined to comment.

All of this has given Samsung a greater sense of urgency to gamble on new markets, such as smartwatches. Despite its disappointing start, the company is marching on with the release of three more watches on April 11. One of them, the Gear Fit, is an exercise-focused wristband that’s getting favorable reviews. All of the new watches run some flavor of homemade software that’s not from Google. Meanwhile, Apple has yet to release its iWatch.

It's this kind of innovation that "ultimately pays benefits for companies,” says Rubin. “The fitness band is a differentiated product. It’s an innovative product. It has a curved glass screen.”

Although the smartwatch is a work in progress, there's already evidence that Samsung’s more aggressive innovation strategy is working. The company was a marginal player in PCs when it came out as an early supporter of Google’s fledgling desktop operating system. But Chromebooks, especially those made by Samsung, are gaining steam and starting to give Microsoft a run for its money. (Microsoft says Windows computers come in more flavors, offer better productivity software and are more functional than Chromebooks when used offline.) Samsung was also one of the first TV manufacturers to incorporate Internet features throughout its product line, which is resonating with consumers, Rubin says.

And despite the phablet's clumsy name, the bigger smartphones have been a hit, particularly in Asia where the larger screens make it easier to input text in local languages and to replace a PC for many functions, says Stofega, the IDC analyst. Innovations in stylus technology pioneered by Samsung have helped the company to extend its lead while rivals start to catch onto the trend, he says.

Of all phones and tablets running Apple's iOS or Android, phablets account for 7 percent, according to a recent study by mobile research firm Flurry. The latest Samsung Note phablet has an eye-popping 5.7-inch screen. The flagship Galaxy S5 has a 5.1-inch screen. That has analysts calling for Apple to increase the display size on the iPhone, which is currently at 4 inches. Apple declined to comment.

If Apple does come out with a new smartphone later this year that resembles Samsung's phablets, it will be a symbolic victory for the Korean company that's eager to distance itself from its old image.

“They want to win,” Stofega says. “They don’t want to come in second place. They want to be perceived as a company that’s moving forward, and a company that’s paying attention and generating new ideas.”

—With assistance from Jungah Lee in Seoul

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