Who Needs the Chaebol Anyway?

Korea's midsize companies are finally coming into their own

Just five years ago, Dongyang Mechatronics Corp. looked as though it might be headed for the scrap heap. The Asian economic crisis had already eaten into demand for Dongyang's auto parts and hydraulic gear when Daewoo Group -- which bought 70% of Dongyang's production -- collapsed. Despite efforts by the government and creditors to keep Daewoo units running until they found buyers, about a third of Dongyang's 900 employees lost their jobs, and sales tumbled 37%. "Everything had to change, from business strategy to factory operation," says Cho Byung Ho, Dongyang's founder and CEO.

So Cho rolled up his sleeves and started a difficult restructuring. He shut businesses that built incineration plants and greenhouses to focus on his core products. Then he ordered his sales staff to drum up new customers. Today, sales to former Daewoo companies represent just 12% of Dongyang's total. And roughly half of the company's estimated $189 million in sales this year will be to overseas clients such as General Motors (GM ), Volkswagen, and Hitachi, Cho says, up from just 3% in 1997. Indeed, GM, which buys some $3 million worth of windshield-wiper systems monthly from Dongyang, in April named the company its Supplier of the Year. The transition was painful, says Cho, "but as a result, the company has become healthier and more agile."

Dongyang is one of dozens of midsize companies helping to change the landscape of Korea Inc. For years, the country's economy was dominated by about 20 chaebol, or large industrial conglomerates. Midsize companies were far less dynamic and often saw their chief role as chaebol suppliers. But with a tidal wave of disgust at the financial shenanigans and shoddy corporate governance at the conglomerates, midsize companies may become drivers of the 21st century Korean economy. Execs have realized that simply supplying the chaebol and local consumers won't work for the long term, so they're cutting deals with multinationals and have started cultivating their own brands abroad. "These companies show the potential to emerge as another locomotive of growth for the Korean economy and fill the hole created by the failure of some of the chaebol," says Yang Ho Chull, managing director at Morgan Stanley (MWD ) in Seoul.

They're already doing so. While there are no precise statistics on the health of Korea's midsize companies, the top 20 chaebol accounted for just 38.6% of the total sales of the country's non-financial companies in 2002, down from 45.0% in 1998. "Industrial reshaping is taking place fairly quickly in Korea," says Rhee Namuh, chief executive of hedge-fund company Rhee Capital Advisors. Korea is likely to see double-digit export growth this year, he adds, "and smaller niche players are contributing to that."

Most of the midsize leaders had to learn some tough lessons before finding their way. Cosmetics maker AmorePacific Corp., for instance, tried to follow the footsteps of the chaebol, expanding into electronics, advertising, and financial services. But when Estée Lauder, L'Oréal, and Chanel began to unseat its brands at Korean department stores, AmorePacific managers refocused their business on health and beauty -- cutting the number of affiliates to 6 today from 23 in 1991, and slashing the workforce to 4,500 from 12,500. At the same time, AmorePacific brass knew they needed to expand overseas to grow. So in 1997, they started a push into France, and by last year, the company's Lolita Lempicka perfume commanded 2.6% of the tough French fragrance market -- making it the fourth-biggest seller in the country. Now, the company is launching a line of skin-care products in the U.S. and hopes to increase overseas sales to $150 million by 2005, from $60 million last year. "Global growth is the key to our future success," says Baek Jeong Gy, senior vice-president for corporate strategy at the company.

Other midsize companies have focused on improving the quality of their products. Hankook Tire Co. has set aside 5% of its annual sales to invest in technology and new production facilities in recent years. And it has opened research and development centers in the U.S., Germany, and China, plus six overseas sales offices, to increase quality and woo foreign buyers. Those initiatives have paid off as customers such as Ford (F ) Volkswagen, Mitsubishi Motors, and Volvo have all signed new contracts or increased their orders from Hankook, boosting exports by 20%, to $456 million, in the first half of this year. And the company's shipments of high-margin, high-performance tires leaped 44%, to 1 million units. That helped lift six-month net profit by 123%, to $54.2 million on sales of $722 million, up 14%.

Like businesses worldwide, Korea's midsize companies are also looking to China. Hankook has become the largest tire supplier for passenger cars there, with a 20% share of the market. This year, its tire production on the mainland is expected to grow by 11%, to $124 million. AmorePacific is marketing its Laneige brand cosmetics through 30 leading department stores in China this year and hopes to increase sales by 45%, to $16 million. Dongyang is running a hydraulic-cylinder plant at Shandong and plans to open an auto-parts plant elsewhere in China. Instant-noodle maker Nongshim Co., which has 74% of the Korean market, expects China sales to rise by at least 50% this year, to more than $30 million.

True, for every success story, there's another midsize company that continues to struggle. But President Roh Moo Hyun is trying to help by cracking down on chaebol that unfairly squeeze smaller suppliers. And Roh has earmarked $4.7 billion this year to finance technological innovation at small- and medium-size companies. "The government is trying to help midsize companies to keep innovating for growth and achieve a long-overdue balance with the chaebol," says Park Joon Kyeong, a senior economist at the Korea Development Institute, a state-funded think tank. The transformation is still a work in progress, but if these pioneers can show the way for their peers, Korea's midsize companies may soon rival the chaebol as the country's economic engine.

By Moon Ihlwan in Seoul

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