A Korean giant confronts the crisis

Samsung Group Chairman Lee Kun Hee defies easy characterization. As South Korean chaebol chairmen go, he's as autocratic as any. Yet last November, he authored a book, Look Around the World and Think, that reads like a New Age tract urging Koreans to shape their own destinies during times of upheaval. He spends weeks on end holed up at his palatial home in central Seoul mapping out the grand contours of long-term strategy. Then suddenly he's obsessing about details, browbeating managers over squeaky washing machines, or test-driving a prototype of Samsung's new SM5 sedan.

The chairman--no one at Samsung ever calls him Mr. Lee--has used these tactics to reach a level of influence that no U.S. chief executive could ever match. Koreans shop at Samsung department stores, operate Samsung PCs, stroll through Samsung art galleries, chat on Samsung mobile phones, have operations at Samsung hospitals, and live in houses built by Samsung construction equipment. Many of the companies selling these products and services barely break even, yet Lee has added steadily to this sprawl, thanks to abundant loans from foreign and local banks that have regarded Samsung as the bluest of Korean blue chips. And inside the group, Samsung Electronics, the world's dominant memory chip maker, has bankrolled other Samsung businesses with its cash, and even guaranteed $4.5 billion of their debt.

CASH CRUNCH. It's an astonishing achievement. Yet not even a dynamo like Lee can reverse the effects of the Asian crisis and a slump in the global chip business. Both events have conspired to deprive Samsung of what it needs most--ready cash to prop up profitless companies, service billions in debt, and embark on imperial adventures like the new auto business. As a result, Lee faces a choice--change Samsung radically through restructuring, or run the risk of fatally weakening his group, especially the core chipmaking business. How he and his lieutenants tackle this task could well set the tone for all of Korea Inc.'s restructuring.

Lee would not speak with BUSINESS WEEK, but five of his senior executives did. What emerges from these interviews is a willingness to change that no one would have thought possible at Samsung just a year ago. Still, no bold plan has emerged to reinvent Samsung completely. That, say analysts, would involve laying off 20% of the workforce of 230,000, and selling off autos, petrochemicals, aerospace, and other laggards to focus on memory chips, liquid-crystal displays (LCDs), telecom equipment, and financial services.

Dire developments in the Asian economy may yet drive Samsung to take such drastic steps. For now, group executives are still adjusting to the idea that the heady days of breakneck expansion are over. "We are realizing that financial resources are very scarce," says Hwang Young Key, senior managing director and a member of Lee's powerful executive staff. "This is a very tough lesson for us." Group earnings, which plummeted 80%, to $67 million on sales of $90 billion in 1996, may even fall into a loss when Samsung releases its 1997 results in late March.

The major problem is debt--oceans and oceans of it, $23.4 billion owed to domestic and overseas banks. That's 267% of equity, and it's getting hugely expensive to service now that local interest rates have skyrocketed and banks are balking at making more loans.

Executives now spend their days obsessing about ways to cut spending and increase cash in order to shrink debt to about 150% of equity. In deals valued at some $600 million, Sweden's Volvo has agreed to buy Samsung's construction-equipment business, and U.S.-based Clark Material Handling Co. will absorb its forklift division. Samsung is cutting global investments by 30%, selling some $300 million in real estate and other assets, and shelving projects such as a 102-story skyscraper it had planned in Seoul. Goldman Sachs is looking for other buyers, and petrochemicals may go--provided Samsung can get better than a fire-sale price.

Meanwhile, to inspire the troops, senior managers have taken a 10% pay cut. Lee himself has agreed to donate $70 million from his $2 billion fortune and most of his $6 million salary to company coffers. Workers can no longer count on such perks as preschool tuition. At headquarters, the thermostat is now set so low that execs wear thermal underwear.

All of this is quite a comeuppance for a company that has been a standout among the chaebol. The Hyundai Group may be the biggest in terms of assets, but Samsung has always viewed itself as a cut above the rest. Its technological prowess is unrivaled, and many of its top executives boast fancy degrees from top U.S. universities. By paying its people well, it has managed to keep Korea's militant unions out of its factories. Three years after Lee took over from his father in 1987, Samsung became the world leader in memory chip production. It has also become a powerhouse in LCDs and in financial services.

The keystone of this empire is now in a dangerously exposed position. At the Samsung Electronics research and manufacturing complex in Yongin City and nearby Suwon City, workers in neatly pressed company jumpsuits make everything from washing machines to notebook PCs to digital televisions.

The division's real strength, however, lies in dynamic random-access memory, the chips used in personal computers, while other products add very little to the bottom line. In chips, Samsung boasts a world-leading 17% market share. It already has investments in place to pump out next-generation, 256-megabit chips when they are expected to be in high demand early next century. "We make the most advanced memory chips in the business," says Hwang Chang Gyu, a senior vice-president who has a doctorate from Stanford University. That's boastful, but others agree. Mighty Intel Corp. bought 10% of a Samsung memory chip plant in Texas last year to lock up a supply of chips as it forges ahead with its microprocessor business.

Yet this star division now suffers from the vagaries of the commodity chip business. When the price of 16-megabit chips collapsed in 1996, it dragged down Samsung Electronics profits 93%, to $194 million, vs. $2.8 billion in 1995. The unit probably didn't do much better last year. Lee wants to diversify into higher-margin microprocessors, application-specific chips, and other logic chips used in everything from dishwashers to car-navigation systems. Such diversification would moderate the savage swings in profits that afflict the business.

But moving up the food chain is going to take scads of cash, which at the moment is scarce. Interest expense on debt at Samsung Electronics Co., the core chip division, may jump from $492 million in 1997 to $688 million this year. It is laboring under $6 billion in dollar-denominated debt, which is much harder to pay off with depreciated won.

To stretch the budget, Samsung Electronics is cutting capital spending by 24%. That's understandable, but potentially dangerous. Analysts say the cutbacks could force Samsung to lose some of its market share in the next generation of chips. Samsung will keep spending on research but not be able to move into next-generation production ahead of its rivals as it has in the past. "Samsung Electronics is still king," says Daewoo Securities Co. analyst Jeon Byeong Seo. "But it's a king without much money."

INTEL INSIDE? Small wonder that Samsung has started talks with Intel about a cash infusion at this critical juncture. Although both sides are keeping mum, the betting is that Intel will pony up $500 million for an equity stake in Samsung to ensure there are no supply problems in high-end memory chips when demand for its Pentium II microprocessor rises sharply at yearend.

That's a boon for Intel, but a potential lifesaver for Samsung. Samsung Electronics probably wouldn't be in such a fix if it had not served as the in-house cash machine for other units. When chips reaped windfall profits back in 1994 and 1995, insiders say, profits flowed into projects of questionable value. Some of that money, for instance, went into a shopping mall at Samsung headquarters that had the misfortune of opening just as the economy went into a free fall.

Another chunk may have helped a Samsung construction company win a contract to build part of the Petronas Towers in Kuala Lumpur. "They wanted the public-relations value of saying they helped build the tallest building in the world," says a former executive: "They took some money from Samsung Electronics, even though they knew they were going to take a $20 million loss before they started shoveling." A public-relations officer at Samsung construction says Samsung Electronics had nothing to do with Petronas Towers, and that the construction division actually made a profit on the contract.

The biggest potential blunder was the creation of Samsung's auto division, which got 21% of its paid-in capital from Samsung Electronics. The 1994 decision by Lee to jump into autos and challenge a well-entrenched Hyundai baffled analysts. Now, four years and $1.8 billion later, Samsung Motors Inc. is rolling out its first car, an $8,500 sedan based on the Nissan Maxima--just when the bottom has fallen out of the Korean car market.

Yet Samsung Motors still has a first-year sales target of $687 million. The idea is to sell 70,000 cars in Korea and 10,000 cars overseas. Samsung Motors director Oh Heung Jin insists the company can prosper as an exporter to such emerging markets as China, Chile, Peru, and Turkey and thinks it will break even by 2002. "We have never been just looking at the domestic market," he says. "We are thinking in much broader terms." Analysts think if Samsung Motors does reach its sales goals, interest costs will consume more than a third of revenues and that it will be impossible to break even by 2002.

Such grim scenarios probably drove Samsung executives last fall to sound out Ford Motor Co. about an alliance. The speculation is that Ford might consider taking as much as a 50% stake in Samsung Motors but would certainly insist on taking the lead. "It would behoove us to have management control," says James T. Tessada, representative director and president of Ford Motor Co. of Korea. If a deal goes through, Samsung and Ford may also absorb some of Kia Motors Corp., which went bust last year. But no outside auto company has ever succeeded in calling the shots in a joint venture with a Korean company.

Nor has any chaebol ever succeeded in achieving a dramatic restructuring. Lee certainly grasps the magnitude of the problems. The burning question is whether he's able to abandon the old ways of doing business. When Lee was a student at Tokyo's prestigious Waseda University in the mid-'60s, he became enamored with Japan's keiretsu, close-knit webs of companies cemented by equity ties, investments, and other business relationships.

"CHANGE EVERYTHING..." These days, Japan has big problems of its own. And Samsung managers say they no longer want to be South Korea's version of Mitsubishi Corp. A better model might be General Electric Co., where operating units that aren't leaders don't survive and where managers are held to exacting performance standards. Lee is friendly with GE chief Jack Welch. And since 1993, the chairman has exhorted his troops to "change everything but your wife and children."

Yet it's hard to tell how much of Samsung's management style has changed and whether Lee can stop being a one-man show. His 150-member executive staff at the Samsung Group still reports directly to him and micromanages every facet of Samsung companies, from investment decisions to salary levels and new-product launches. "They have all the power," says one vice-president with a big Samsung unit. Perhaps that made sense when Samsung was at the takeoff stage. But it doesn't now that it must react with lightning speed to rival product launches, changing market conditions, and technological breakthroughs across myriad industries.

If any of the chaebol can turn themselves around, Samsung can. But it will require dropping a decades-long tradition of growth at any cost. Should Lee manage to remake Samsung, he can make his mark as the chairman that took this proud company to the next step, and led the way in reforming Korea's economy. But to do that, Lee will have to repudiate decades of corporate practice--and doubtless reinvent a part of himself as well.

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