The Samsung Way

It thrives in low-margin consumer electronics. It favors hardware over software. It's still a conglomerate that makes everything itself. Can Samsung keep defying conventional wisdom?

A black-suited Agent Smith sprints down a city street. As he is felled by an acrobatic kung fu kick from Trinity, the camera pulls back to show the action taking place inside a giant, floating Samsung TV. The screen rotates, revealing that the set is just three inches thick. "You cannot escape the Samsung 40-inch LCD flat-panel TV," intones the baritone voice of actor Laurence Fishburne. "Welcome to the new dimension."

The ad, now appearing in many U.S. theaters showing The Matrix: Reloaded, has an element of truth: Whether you're a consumer in America, Europe, or Asia, it's getting pretty darn hard to escape anything made by Samsung Electronics Co. Take the U.S. alone. Stroll the aisles of Best Buy (BBY ) Co. electronics stores, and stylish Samsung high-definition TVs, phones, plasma displays, and digital music and video players are everywhere. Log on to the home pages of USA Today (GCI ) CNN (AOL ) and other heavily trafficked sites, and Samsung's ads are first to pop out. You see its blue elliptical logo emblazoned on Olympic scoreboards. And expect more Matrix tie-ins: Samsung is selling a wireless phone just like the one Keanu Reeves uses to transport himself in the movie. Samsung will be even more visible in this fall's sequel, The Matrix: Revolutions.

Samsung's Matrix moment is the latest step in its reincarnation as one of the world's coolest brands. Its success in a blizzard of digital gadgets and in chips has wowed consumers and scared rivals around the world. The achievement is all the more remarkable considering that just six years ago, Samsung was financially crippled, its brand associated with cheap, me-too TVs and microwaves.

Now the company seems to be entering a new dimension. Its feature-jammed gadgets are racking up design awards, and the company is rapidly muscling its way to the top of consumer-brand awareness surveys. Samsung thinks the moment is fast arriving when it can unseat Sony Corp. as the most valuable electronics brand and the most important shaper of digital trends. "We believe we can be No. 1," says Samsung America Chief Executive Oh Dong Jin. Its rivals are taking the challenge seriously. "I ask for a report on what Samsung is doing every week," says Sony President Kunitake Ando.

A few measures of Samsung's progress: It has become the biggest maker of digital mobile phones using code division multiple access (CDMA) technology -- and while it still lags No. 2 Motorola (MOT ) Inc. in handsets sold, it has just passed it in overall global revenues. A year ago, you'd have been hard pressed to find a Samsung high-definition TV in the U.S. Now, Samsung is the best-selling brand in TVs priced at $3,000 and above -- a mantle long held by Sony and Mitsubishi Corp. In the new market for digital music players, Samsung's three-year-old Yepp is behind only the Rio of Japan's D&M Holdings Inc. and Apple Computer (AAPL ) Inc.'s iPod. Samsung has blown past Micron Technology (MU ), Infineon Technologies (IFX ), and Hynix Semiconductor in dynamic random-access memory (DRAM) chips -- used in all PCs -- and is gaining on Intel (INTC ) in the market for flash memory, used in digital cameras, music players, and handsets. In 2002, with most of techdom reeling, Samsung earned $5.9 billion on sales of $33.8 billion.

Can the good times last? That's a serious question, since Samsung is challenging basic New Economy dogma. In high tech, the assumption is that developing proprietary software and content gives you higher margins and a long lead time over rivals. Yet Samsung defiantly refuses to enter the software business. It's wedded to hardware and betting it can thrive in a period of relentless deflation for the industry. Rather than outsource manufacturing, the company sinks billions into huge new factories. Instead of bearing down on a few "core competencies," Samsung remains diversified and vertically integrated -- Samsung chips and displays go into its own digital products. "If we get out of manufacturing," says CEO and Vice Chairman Yun Jong Yong, "we will lose."

Yet the industrial history of the past two decades suggests that this model does not work in the long run. The hazard -- as many Japanese, U.S., and European companies learned in the 1980s and '90s -- is that Samsung must keep investing heavily in R&D and new factories across numerous product lines. Samsung has sunk $19 billion over five years into new chip facilities. Rivals can buy similar technologies from other vendors without tying up capital or making long-term commitments. What's more, the life cycle of much hardware is brutally short and subject to relentless commoditization. The average price of a TV set has dropped 30% in five years; a DVD player goes for less than a quarter. The Chinese keep driving prices ever lower, leveraging supercheap wages and engineering talent. Meanwhile, the Japanese are building their own Chinese factories to lower costs. No wonder Samsung exited the low-margin market for TV sets 27 inches and under.

Faced with these perils, Samsung needs a constant stream of well-timed hits to stay on top. Even Sony has stumbled in this race: It now depends on PlayStation to support a consumer-electronics business whose glory days seem behind it. Other legendary hardware makers -- Apple, Motorola, Ericsson (ERICY ) -- have learned the perils of the hardware way.

Investors got a sharp reminder of the risks Samsung is running when the company announced first-quarter results. In a tough environment, Samsung racked up the biggest market-share gain of any company in handsets, from 9.3% to 10.5%. Yet it had to lower prices to get there, and memory-chip prices also hit the bottom line. The result was a drop in first-quarter profits of 41%, to $942 million, on sales of $8 billion. Second-quarter profits could drop further, analysts say, hurt by lower sales in Korea's slumping economy -- and in China and other Asian countries struck by the SARS epidemic. Controversy also flared in May when Samsung Electronics agreed to invest a further $93 million in a troubled credit-card affiliate. Many critics believe Samsung should divest the unit but that it is propping it up under orders of its parent, Samsung Group. Concern over corporate governance is the big reason Samsung continues to trade at a discount to its global peers. Even though it's regarded as one of the most transparent emerging-market companies anywhere, Korea's history of corporate scandals means many foreigners will always suspect its numbers.

If the earnings continue to soften, plenty of investors around the world will stand to lose. Samsung is the most widely held emerging-market stock, with $41 billion in market capitalization, and foreigners hold more than half its shares. Over the past five years, the shares have risen more than tenfold, to a recent $273. But concerns over 2003's earnings have driven the shares off their recent high this year.

The challenges are huge, but so are Samsung's strengths. It is used to big swings: Nearly half its profits come from memory chips, a notoriously cyclical business. Even in the weak first quarter, Samsung earned more than any U.S. tech company other than Microsoft, IBM, and Cisco. Meanwhile, Sony lost $940 million in this year's first three months and chip rivals Micron, Infineon, and Hynix lost a combined $1.88 billion. In cell phones, Samsung has kept its average selling price at $191, compared with $154 for Nokia (NOK ) and $147 for Motorola, according to Technology Business Research. What's more, since 1997 its debt has shrunk from an unsustainable $10.8 billion to $1.4 billion, leaving Samsung in a healthy net cash position. And its net margins have risen from 0.4% to 12%.

Driving this success is CEO Yun, a career company man who took over in the dark days of 1997. Yun and his boss, Samsung Group Chairman Lee Kun Hee, grasped that the electronics industry's shift from analog to digital, making many technologies accessible, would leave industry leadership up for grabs. "In the analog era, it was difficult for a latecomer to catch up," Yun says. But in the digital era, "if you are two months late, you're dead. So speed and intelligence are what matter, and the winners haven't yet been determined."

Samsung's strategy to win is pretty basic, but it's executing it with ferocious drive over a remarkably broad conglomerate. To streamline, Yun cut 24,000 workers and sold $2 billion in noncore businesses when he took over.

Samsung managers who have worked for big competitors say they go through far fewer layers of bureaucracy to win approval for new products, budgets, and marketing plans, speeding up their ability to seize opportunities. In a recent speech, Sony Chairman Nobuyuki Idei noted Samsung's "aggressive restructuring" and said: "To survive as a global player, we too have to change."

Second, Samsung often forces its own units to compete with outsiders to get the best solution. In the liquid-crystal-display business, Samsung buys half of its color filters from Sumitomo Chemical Co. of Japan and sources the other half internally, pitting the two teams against each other. "They really press these departments to compete," says Sumitomo President Hiromasa Yonekura.

The next step is to customize as much as possible. Even in memory chips, the ultimate commodity, Samsung commands prices that are 17% above the industry average. A key reason is that 60% of its memory devices are custom-made for products like Dell servers, Microsoft Xbox game consoles, and even Nokia's cell phones. "Samsung is one of a handful of companies you can count on to bridge the technical and consumer experiences and bring them successfully to market," says Will Poole, Senior Vice President at Microsoft's Windows Client Business, which works with the Koreans.

The final ingredient is speed. Samsung says it takes an average of five months to go from new product concept to rollout, compared to 14 months six years ago. After Samsung persuaded T-Mobile, the German-U.S. cell-phone carrier, to market a new camera-phone last April, for example, it quickly assembled 80 designers and engineers from its chip, telecom, display, computing, and manufacturing operations. In four months, they had a prototype for the V205, which has an innovative lens that swivels 270 degrees and transmits photos wirelessly. Then Samsung flew 30 engineers to Seattle to field-test the phone on T-Mobile's servers and networks. By November, the phones were rolling out of the Korean plant. Since then, Samsung has sold 300,000 V205s a month at $350 each. Park Sang Jin, executive vice-president for mobile communications, estimates the turnaround time is half what Japanese rivals would require. "Samsung has managed to get all its best companies globally to pull in the same direction, something Toshiba, Motorola, and Sony have faced big challenges in doing," says Allen Delattre, director of Accenture (ACN ) Ltd. high-tech practice.

Samsung can also use South Korea as a test market. Some 70% of the country's homes are wired for broadband. Twenty percent of the population buys a new cell phone every seven months. Samsung already sells a phone in Korea that allows users to download and view up to 30 minutes of video and watch live TV for a fixed monthly fee. Samsung is selling 100,000 video-on-demand phones a month in Korea at $583 each. Verizon plans to introduce them in three U.S. cities this fall.

This year alone, Samsung will launch 95 new products in the U.S., including 42 new TVs. Motorola plans to introduce a dozen new cell-phone models, says Technology Business Research Inc. analyst Chris Foster. Samsung will launch 20. Nokia also is a whiz at snapping out new models. But most are based on two or three platforms, or basic designs. The 130 models Samsung will introduce globally this year are based on 78 platforms. Whereas Motorola completely changes its product line every 12 to 18 months, Foster says, Samsung refreshes its lineup every nine months. Samsung has already introduced the first voice-activated phones, handsets with MP3 players, and digital camera phones that send photos over global system for mobile (GSM) communications networks.

Samsung has been just as fast in digital TVs. It became the first to market projection TVs using new chips from Texas Instruments (TXN ) Inc. that employed digital-light processing (DLP). DLP chips contain 1.3 million micromirrors that flip at high speeds to create a sharper picture. TI had given Japanese companies the technology early in 1999, but they never figured out how to make the sets economically. Samsung entered the scene in late 2001, and already has seven DLP projection sets starting at $3,400 that have become the hottest-selling sets in their price range. "They'll get a product to market a lot faster than their counterparts," says George Danko, Best Buy's senior vice-president for consumer electronics.

Samsung hopes all this is just a warm-up for its bid to dominate the digital home. For years, Philips, Sony, and Apple have been developing home appliances, from handheld computers to intelligent refrigerators, that talk to each other and adapt to consumers' personal needs. Infrastructure bottlenecks and a lack of uniform standards got in the way.

Now, many analysts predict that digital appliances will take off within five years. By then, as many as 40% of U.S. households should be wired for high-speed Internet access, and digital TVs, home appliances, and networking devices will be much more affordable. Samsung is showing a version of its networked home in Seoul's Tower Palace apartment complex, where 2,400 families can operate appliances from washing machines to air conditioners by tapping on a wireless "Web pad" device, which doubles as a portable flat-screen TV.

It's a grandiose dream. But if the digital home becomes reality, Samsung has a chance. "They've got the products, a growing reputation as the innovator, and production lines to back that up," says In-Stat/MDR consumer-electronics analyst Cindy Wolf. With nearly $7 billion in cash, Samsung has plenty to spend on R&D, factories, and marketing.

Samsung Electronics' ascent is an unlikely tale. The company was left with huge debt following the 1997 Korean financial crisis, a crash in memory-chip prices, and a $700 million write-off after an ill-advised takeover of AST Technologies, a U.S. maker of PCs. Its subsidiaries paid little heed to profits and focused on breaking production and sales records -- even if much of the output ended up unsold in warehouses.

A jovial toastmaster at company dinners but a tough-as-nails boss when he wants results, Yun shuttered Samsung's TV factories for two months until old inventory cleared. Yun also decreed Samsung would sell only high-end goods. Many cellular operators resisted. "Carriers didn't buy our story," says telecom exec Park. "They wanted lower prices all the time. At some point, we had to say no to them."

A top priority was straightening out the business in the U.S., where "we were in a desperate position," recalls Samsung America chief Oh, appointed in early 2001. "We had a lot of gadgets. But they had nowhere to go." Samsung lured Peter Skaryznski from AT&T (T ) to run handset sales, and Peter Weedfald, who worked at ViewSonic Corp. and ComputerWorld magazine, to head marketing.

Yun brought new blood to Seoul, too. One recruit was Eric B. Kim, 48, who moved to the U.S. from Korea at age 13 and worked at various tech companies. Kim was named executive vice-president of global marketing in 1999. With his Korean rusty, Kim made his first big presentation to 400 managers in English. Sensing Kim would be resented, Yun declared: "Some of you may want to put Mr. Kim on top of a tree and then shake him down. If anybody tries that, I will kill you!"

The first coup in the U.S. came in 1997 when Sprint PCS Group began selling Samsung handsets. Sprint's service was based on CDMA, and Samsung had an early lead in the standard due to an alliance in Korea with Qualcomm (QCOM ) Inc. Samsung's SCH-3500, a silver, clamshell-shaped model priced at $149, was an instant hit. Soon, Samsung was world leader in CDMA phones. Under Weedfald, Samsung also pulled its appliances off the shelves of Wal-Mart and Target and negotiated deals with higher-end chains like Best Buy and Circuit City.

Samsung's status in chips and displays, which can make up 90% of the cost of most digital devices, gives it an edge in handsets and other products. Besides dominating DRAM chips, Samsung leads in static random access memory and controls 55% of the $2 billion market for NAND flash memory, a technology mainly used in removable cards that store large music and color-image files. With portable digital appliances expected to skyrocket, analysts predict NAND flash sales will soar to $7 billion by 2005, overtaking the more established market for NOR flash, which is embedded onto PCs, dominated by Intel and Advanced Micro Devices (AMD ).

The company's breadth in displays gives it a similar advantage. It leads in thin-film LCDs, which are becoming the favored format for PCs, normal-size TVs, and all mobile devices. Samsung predicts a factory being built in Tangjung, Korea, that will produce LCD sheets as big as a queen-size mattress will help to halve prices of large-screen LCD TVs by 2005. Samsung also aims to be No. 1 in plasma and projection displays.

If Samsung has a major flaw, it may be its lack of software and content. Samsung has no plans to branch out into music, movies, and games, as Sony and Apple have done. Sony figures that subscription-to-content will provide a more lucrative source of revenue. Samsung's execs remain convinced they're better off collaborating with content and software providers. They say this strategy offers customers more choices than Nokia, which uses its own software.

Yun has heard tech gurus, publications, and even Samsung execs warn him to forsake the vertical model. His response: Samsung needs it all. "Everyone can get the same technology now," he says. "But that doesn't mean they can make an advanced product." Stay at the forefront of core technologies and master the manufacturing, Yun believes, and you control your future. Many tech companies have tried that strategy and failed. Samsung is betting billions it can overcome the odds.

Corrections and Clarifications In "The Samsung way" (Cover Story, June 16), one of the charts understated the company's operating profits. Samsung earned $110 million in its digital-appliances business and $320 million in digital media.

By Cliff Edwards in Ridgefield Park, N.J., Moon Ihlwan in Seoul, and Pete Engardio in Suwon

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