Special report: Can Samsung change with the tech times?

By @ibtimes on

Only a handful of reporters were at Samsung's booth at the Consumer Electronics Show in Las Vegas earlier this month when Jay Y. Lee dropped by.

They had been tipped that the sheltered heir to the Samsung business empire was about to make his first public appearance since his father named him one of the new presidents of the conglomerate's flagship, Samsung Electronics, in December.

Most of the Korean media contingent eagerly awaiting his appearance at the show had been diverted to another news conference. They didn't miss much. Jay Lee's remarks were brief and bland. He mainly wanted to make it clear his ambition was to be a chip off the old (and equally aloof) block.

I'm trying very hard to learn his challenging attitude and personalize it, said Jay Lee, 42, the only son of Samsung Group Chairman Lee Kun-hee. The chairman has this DNA that just won't let him be seen being beaten, said the boyish-looking Lee, wearing rimless spectacles and a business suit with an open collar.

His father's formula has helped turn Samsung into a top global brand over the past decade or so, boasting a market value of $143 billion, bigger than Intel and Hewlett Packard and equal to the combined value of Sony Corp, Nokia, Toshiba and Panasonic Corp.

Yet that's still less than half of Apple's $320 billion market value.

Samsung, which has had better net earnings than any other global tech firm except Microsoft and IBM over the past decade, is set to report its lowest profit in six quarters when it issues December quarter corporate results on Friday, although 2010 will be another record profit year.

The outlook for this year and beyond is unclear as global technology firms grapple with weak demand and falling prices for memory chips and flat screens, and new players enter the market for smartphones and tablets.

Successful business leaders are very good storytellers, it is often said, and the industry is looking for a new narrative from Samsung, as it passes the generational torch while trying to evolve into a more innovative and content-driven company.

Jay Lee, who graduated from the Seoul National University with a degree in East Asian history, has an MBA from Japan's Keio University and studied for a doctorate at Harvard, is deferring to his elders for now. But eventually Samsung will be his story to tell.

He is taking over at a pivotal point for Samsung Electronics, the world's biggest maker of flat screens and memory chips, the second-biggest mobile phone maker behind Nokia and a core holding in any emerging market portfolio.

His company faces the challenge of moving beyond being a hardware company, clever at copying ideas, to becoming more creative, better adept at software, at a time when consumer gadgets are getting smarter all the time. In short, it faces a management challenge.

In a statement to Reuters, Samsung Group said its strong performance during the aftermath of the global financial crisis has proved the value of its management model.

Samsung's management is based on a complementary relationship between the founding family and professional managers. On the one hand, Chairman Lee Kun-hee provides long-term business visions and the basis for sustainability. On the other, professional managers bring to bear their day-to-day management skills without being unduly pressured by short-term and quarterly results.

Samsung had the biggest booth, the thinnest products, and by some accounts, the best buzz at the annual Las Vegas show. But the stars of this Las Vegas extravaganza, which drew a record 140,000 technology enthusiasts, were the tablet computers. More than 30 tablets were announced over the two-day show, and while Samsung's Galaxy Tab was one of the precious few actually in stores, all the new players pointed to Apple's iPad as the one to chase.

To catch up, Samsung has vowed to inject some Silicon Valley culture into the ranks of its salarymen.

Does Samsung want to be Apple? Probably not, says Lee Seung-woo, an analyst at Shinyoung Securities in Seoul. I think they'll continue to pursue their strategy of being the fast executioner. They'll be the first you'll see in the market with a copycat product when there's a new opportunity, like a tablet market. Being an innovator and creating a new market requires lots of risk and I don't think Samsung is ready yet to take that level of risk.

And yet big business is fraught with risk in South Korea, where the public seems to have a love/hate relationship with the family conglomerates, or chaebol, that have long dominated the economy.

REWARDING INNOVATION

Lee Kun-hee's visit to Samsung's new headquarters in Seoul on December 1 was his first since he reinstated himself as chairman last March, and two weeks after elevating his son to a president's position.

He had stepped down after receiving a three-year suspended jail sentence for tax evasion and breach of trust in 2008. South Korean President Lee Myung-bak later pardoned him, saying he was too important to the nation to be behind bars.

What's good for Samsung is good for South Korea, Kun-hee might well argue. His conglomerate after all accounts for around 20 percent of the country's exports and a big chunk of its GDP. Yet he is constantly exhorting his employees to act as if the company was on the verge of extinction, warning them Samsung products could all be obsolete in 10 years if they don't keep up with the times. Change everything but your wife and children, he is fond of saying.

The elder Lee had come to Samsung Group's new headquarters -- three office towers housing 10,000 employees in Seoul -- to bestow year-end promotions and awards, including to Galaxy S smartphone designer, Lee Sung-sik.

Sung-sik, in fact, epitomized the qualities Samsung has long been known for -- a fast executioner who gets something quickly to market. Samsung sold 10 million Galaxy S units in just six months after a June launch, tripling its share of the smartphone market to almost 10 percent, though still trailing Nokia, Apple and RIM's Blackberry.

But Sung-sik's story also illustrates Samsung's essential challenge -- it only developed the Galaxy after Apple took the market by storm with its latest iPhone early last year.

Thanks to iPhone, we've been to hell, said a senior executive at Samsung who did not want to be identified because he is not authorized to speak to the media. We had more than 1 trillion won of (telecoms) profit in the first quarter (of 2010), but saw it halved the following quarter simply because we didn't have attractive smartphone lineups. We couldn't give anything to our distributors when they were asking for models to stop iPhone.

Samsung's TV business has unveiled a new business slogan, Samsung creates and others follow but it's the other way around for other products. The Galaxy S is an imitation iPhone that runs on Google's Android operating system. And the Galaxy Tab is basically just a bigger version of its smartphone.

Samsung has yet to come up with the kind of original, iconic, market-leading products that powered rival brands such as Apple's i-series or Sony's Walkman. Nor has it taken the kind of initiatives in software that Google and Apple did to thwart Microsoft.

If they want to pursue an innovation strategy then they can master the connected home as they already are in almost every household, said Francisco Jeronimo of market intelligence firm IDC. They need to create services that connect and explore the different products. That's what Apple is trying to do with a service like Apple TV.

Samsung Group plans to spend 12.1 trillion won ($10.7 billion) this year on research and development, up from 10.6 trillion won last year and 8.8 trillion the year before.

The new investment is targeted at achieving global market dominance of Samsung's m major businesses, the group said in its 2011 investment plan. Samsung will hire 25,000 new workers this year, also a record.

What is not clear is how much of that will be spent on reshaping the business to add more content, on its TVs for instance, in a market where flat screens will all be offering the same features and only the cheapest producers will win in a race to the bottom.

In its statement to Reuters, Samsung said the latest fruit of its investment in research and innovation is its leadership in LED TVs and 3D TVs, products that created a new market even during the 2008-2009 global recession and brought about a paradigm shift.

Samsung's history is filled with such shifts.

THREE STARS

Jay Lee's grandfather Lee Byung-chull started Samsung or Three Stars in 1938 as a small trading company in Daegu city in the southeast of the country, dealing in groceries and making noodles. He expanded into insurance, securities, print media and retail as South Korea slowly rebuilt after World War II and the Japanese occupation.

Byung-chull set up Samsung Electronics in 1969, producing black and white TVs that he supposedly learned how to make by tearing apart a Sony. But it was his third son, Lee Kun-hee, who suggested Samsung acquire a Korean semiconductor firm. Though viewed as a huge risk in a market dominated by Japanese companies, the operation grew to become the worlds top memory chip-making business.

Samsung started its rise as a global brand after Byung-chull's death in 1987 when Kun-hee took the reins of the chaebol. Fond of sports cars, he made his only notable business failure with Samsung Motor. It was eventually sold to Renault during the Asian financial crisis at a significant loss.

The rapid expansion of Samsung and other chaebol was greatly aided by the country's dictators between 1960 and 1992, who directed banks to give them easy credit, regardless of the viability of their projects, and provided an enabling regulatory environment. They looked for businessmen who could deliver signature projects in record time. What mattered then was whom a businessman knew.

The chaebols borrowed so much in this cozy environment that eight of them collapsed in the Asian financial crisis and the rest were left wobbling. The IMF crisis that ushered in sweeping economic reforms, coupled with a more democratic system, has largely dismantled this old nexus. But as recent cases show, the creative book-keeping and payola scandals of yesteryear remain a problem.

Samsung Group shrugged off its car debacle and emerged otherwise unscathed after the Asian financial crisis. It consolidated around Samsung Electronics, which by 2005 had overtaken Sony as the world's most popular consumer electronics brand.

Now it will be the mission of the third star of the family, Jay Lee, to lead the next stage of Samsung's evolution in the fiercely competitive and ever-shifting consumer electronics industry as it battles declining margins on its core products.

Samsung's shares have risen a stunning 33 percent over the past three months to record highs, despite last quarter's profit decline, with investors heartened by Kun-hee's moves toward a generational shift in leadership and betting the change may spur growth.

By some measures, its shares are undervalued. According to an analysis by Thomson Reuters StarMine using a quantitative model, Samsung shares have an intrinsic value of 1.2 million won, well above the 999,000 won it was trading at on Wednesday.

A seamless shift in the company's leadership is certainly important to foreign investors who own half the shares of the company, and who might expect that the old Korean adage about the average lifespan of family fortunes -- shirtsleeves to shirtsleeves in three generations -- will not apply in the case of this family conglomerate.

BATTLE FOR SMART

Jay Lee's promotion as one of a dozen new presidents at Samsung Electronics came only a year after he was named to the newly created position of Chief Operating Officer. His 69-year-old father has said repeatedly Samsung needs young and nimble talent to deal with fast-changing markets. This has been unsettling in South Korea's Confucian corporate culture, where seniority is revered.

In last month's shakeup, the average age of Samsung's presidents was lowered by 2.1 years. In the following days, a rash of hair-dye jobs swept the offices at the new headquarters in Seoul, and hardly a grey head could be seen, said one executive who asked to be unidentified because he is not authorized to talk to the media.

With the latest promotions and his mantra about perpetual crisis, Kun-hee is clearly trying to prepare his younger corporate warriors, including his son, for the coming battles over smart products.

Despite questions around its culture of innovation, analysts believe Samsung is one of the best placed companies to deliver something fresh and exciting to rival Apple, particularly its ability to provide in-home convergence offerings with internet TVs, smartphones and tablets.

But to capture the imagination of the public in the way the iPhone or iPad have done, Samsung will need to take risks and produce something unique that has a true Wow! factor and be first to market, said Tim Shepherd, an analyst at Canalys, a technology-focused research house.

Samsung does want to be seen as an innovator, but it's primary strategy thus far in the mobile device markets is to focus on the speedy delivery of competitive products.

Samsung uses Google's Android operating system across a range of devices, including its smartphone, and was the earliest to ship it on a tablet. But soon many others will also have Android-driven phones and tablets on the market. Differentiation will be a challenge.

It has been difficult for companies to build differentiation in software on PCs outside of Apple, said Ross Rubin, an analyst at market research house NPD. Samsung needs to send a stronger message around where it sees Android versus its own operating systems like Bada.

Bada, which means ocean in Korean, is at the heart of Samsung's drive to develop new revenue sources from its own Samsung App store and create synergies with its TV and tablets' business. Samsung's Bada operating system (OS) is also aimed at sharply boosting its market share in the booming smartphone market and compete with Apple, Google's Android and Nokia's Symbian platform.

Achieving this ambition won't exactly be bada bing, bada boom (the slang term popularized on The Sopranos TV series for something that happens effortlessly).

Bada's only edge right now, according to tech analysts, is that it improves networking and gaming on other platforms, a kind of helper OS.

Bada's open-source platform mainly supports Samsung's low- to mid-end smartphones. But Samsung is using the Android-powered Galaxy lineup to challenge Apple.

Bada, analysts say, faces an uphill battle competing as an independent platform against the likes of Apple and Android.

It will be easy for Samsung to transform its TVs, fridges and appliance businesses, but phones require really hard work, said Robert Jakobsen, senior analyst at Denmark-based Jyske Bank, and the only one among dozens of analysts that follow Samsung Electronics with a sell rating on the company.

Samsung's success so far in the smartphone market is based on Android, but that's an (operating system) that everybody can copy and is copying They need to innovate and add value. If they cant, price is the only feature left, which could mean lower margins.

Samsung does want to break out of the high-sales, low-margin business model and emulating Apple with its 40-percent margin on iPhone sales or Microsoft's 70 percent-profit margin from Windows.

What we dream of is creating great content, and that will lead to more sales of our devices and downloads of our applications, said Lee Hoo-soo, executive vice president and head of Samsung's mobile software development. We want to see more of this virtuous circle.

Samsung is pinning some of those hopes on the Galaxy S, which hit 10 million units of sales in January. Samsung expects smartphone sales will more than double this year to at least 50 million handsets as it rolls out its Galaxy lineup.

The company is also putting its money where its ambitions lie with those eye-popping investment plans. It is targeting 50 trillion won ($43.33 billion) in sales in 2020 from new growth businesses, including healthcare and renewable energy.

Samsung Electronics aims to rank among the global top 10 companies in 2020 with $400 billion in revenue, Samsung Group Vice Chairman Choi Gee-sung has said.

As part of Samsungs 10-year plan to develop next-generation growth engines, Samsung Electronics recently purchased a stake in diagnostic ultrasound maker Medison and acquired display technology firm Liquavista, the statement to Reuters said.

SUCCESSION PLANNING

For the past year as COO, Jay Lee has been overseeing Samsung's eight operating divisions, working with a dozen presidents who report to his mentor and the CEO, Choi Gee-sung, who turns 60 next week and whose pitch-black hair looks every bit as dark as Jay Lee's.

Jay Lee's fast rise to president, after just one year as COO, has raised eyebrows about his readiness to take the reins of Asia's most valuable company.

In the statement to Reuters, Samsung stressed he will continue in a supporting role to the CEO. While his position has been elevated from executive vice president, he will focus largely on coordination of Samsung Electronics' diverse business and providing a leadership role in the company's investments.

Jay Lee makes it clear he's not wearing the mantle of authority just yet. Chairman will continue to be in charge and I still have lots of things to learn and feel enormous responsibility already, the media-shy Lee told a local newspaper in brief remarks after he was stopped on his way out of the office.

Neither Jay Lee nor his father were made available for this report.

Jay Lee's one foray into a new venture was not fortuitous. He ran Samsung's Internet business during the dot com boom in 2000 and the firm chalked up some 20 billion won in losses before the company was folded.

Those who have met him say the divorced father of two is a personable, even charismatic individual. At the Las Vegas show, he spent most of his time in the Samsung hospitality suite wooing major customers.

Promoting Jay Lee is one thing. Positioning him to control ownership within Samsung's labyrinthine chaebol structure -- and wield power over a company with 174,000 staff in 66 countries -- is quite another.

The elder Lee's conviction three years ago stemmed from allegations by civic groups and the company's estranged chief lawyer that he had managed a political slush fund, and had helped his son buy shares of Samsung Group subsidiaries at unfairly low prices in a scheme to hand over control of the conglomerate to him.

Prosecutors were unable to prove either of those charges. But after that whole controversy, Kun-hee is likely to take a more subtle approach to restructuring Samsung as he transfers ownership to his three children, the third generation of the Three Stars company.

The restructuring will begin with companies where Jay Lee is the top shareholder, analysts say. He owns 25 percent of unlisted amusement park operator Everland, which is at the crux of a spiderweb of crossholdings among companies in the Samsung chaebol. Some companies will be listed, others will be merged to simplify the structure.

Samsung Group has also elevated Kun-hee's daughter, Lee Boo-jin, as president of Hotel Shilla and Everland.

The strength of the chaebol has always been their ability to make these kinds of decisions -- act quickly and move money around when the company is in trouble without fussing with a board or shareholders.

But the conglomerates have long been criticized for their enormous economic power, hierarchical and sometimes opaque governance, and dubious wealth transfers among family members.

The fact that Samsung depends heavily on Chairman Lee is a poisoned chalice, said Kim Sun-woong, head of shareholder activist group Center for Good Corporate Governance.

Group companies can't make their own independent decision and they have to follow what the chairman says. If you think about Samsung without Lee, it is difficult to imagine that its management, which has become so used to the influence of Lee, will be able to run Samsung independently and efficiently.

Back in Las Vegas, Jay Lee strolled over to the booths of his Japanese rivals after chatting with the Korean reporters. He was especially interested in the 3D televisions that can be viewed without those goofy glasses. Samsung doesn't offer one, at least yet.

He then donned some stereoscopic spectacles and sat down to watch Panasonic's 3D, along with Choi, the Samsung vice chairman, and the TV chief, B.K. Yoon. They can only hope he will see Samsung's future in such dimension and high definition.

(Additional reporting by Jungyoun Park and Hyunjoo Jin in Seoul and Tarmo Virki in Helsinki)

(Editing by Bill Tarrant)

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