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Samsung $uccess?Electronics: Burned by

WITH $176 BILLI0N in revenues in 2017, Samsung Electronics is the crown jewel of Samsung Group, with its mobile division contributing some 7 5 percent of the conglomerate's overall profits. The Samsung Group is one of the biggest conglomerates globally. In compari- son, the U.S. conglomerate General Electric had some

$ 150 billion in revenues, while the Tata group of India registered $I04 billion in the same year. Indeed, Sam- sung is the largest chaebol in South Korea, making up one-third of the entire stock market domestically, and it is the country's biggest exporter. Chaebols are family- owned multinational companies typical of South Korea, whose economy is dominated by a small num- ber of chaebols (including LG, Hyundai, Kia Motors, SK Group, and others).

As impressive as the achievements of the largest chaebol rn South Korea may sound, Samsung Elec- tronics is facing a host of challenges, creating a per- fect storm that calls into question Samsung's future viability. In recent years, the Korean conglomerate has been beset with crises, including:

. Leadership. Lee Kun-hee, Samsung's iconic chairman and long-time leader, remains incap acr' tated after a heart attack tn 2014. This situation is creating a leadership vacuum.

o Product recall. In 2016, Samsung's flagship phone, the Galaxy Note 7, was withdrawn from the market after some of the new phones spontane- ously exploded and caught on fire.

. Political scandal. In20I7,LeeJae-yong, the de-facto leader of Samsung (and son of Lee Kun-hee), was arrested and charged with bribery, embezzlement, and pedury in the wake of the scandal surrounding former South Korean President Park Geun-hye.

Before taking a closer look at the current chal- lenges, we need first to understand a bit of Sam- sung's storied history and its role in the South Korean economy.

An exploded Samsung Galaxy Note 7.

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In 1938, when the Western world was still recover- ing from the Great Depression and World War II was about to break out, Lee Byung-chul started a small trading company in Korea (at that time still under Japanese occupation). He named the trading company Samsung, which means three stars in Korean, symbol- rzing big, powerful, and numerous. Samsung started with just 40 employees and sold noodles and dried sea- food. It has since diversified into various industries, including electronics, chemicals, pharmaceuticals, shipbuilding, financial services, and construction. As a result, Samsung today is a widely diversified con- glomerate with over 80 standalone subsidiaries. The sprawling chaebol has 490,000 employees more than Apple, Google, and Microsoft combined. Not surpris- ingly, the huge enterprise exerts a powerful influence

Frank T. Rothaermel prepared this MiniCase from public sources. He gratefully acknowledges research assistance by Rahul Singh. This MiniCase is developed for the purpose of class discussion. It is not intended to be used for any kind of endorsement, source of data, or depiction of efficient or inefficient management. All opinions expressed, all errors and omissions are entirely the author's. Revised and updated: August 25, 2017 . @ Frank T. Rothaermel.

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504 i UINICASE 17 Samsung Electronics: Burned by Success?

on South Korea's economy, but also on its politics, media, and culture.

The rise of Samsung Electronics began in 1970 when it introduced its first consumer electronics prod- uct, a I}-inch black-and-white television. Although it was a latecomer, Samsung made a breathtaking ascent in consumer electronics. It is now leading a number of key electronics industries globally. For instance, since 1993, Samsung Electronics has been the world's larg- est producer of memory chips. The original iPhone even ran on chips made by Samsung. The company is also the largest television manufacturer in the world, as well as the largest manufacturer of LCD panels. Today, Samsung Electronics produces some 98 percent of all AMOLED screens (unlike LCD screens, AMOLED screens do not need backlight), used in computer moni- tors, TVs, phones, ca^rs, and elsewhere. Since 2012, Samsung has also been the world's largest phone man- ufacturer, replacing Nokia at the top spot. Its mobile devices contribute some 75 percent of the conglomer- ate's overall profits. In 2017, Samsung also overtook Intel as the largest chipmaker in the world.

The person credited for this ffemendous ascent to world leadership in consumer elecffonics is I-ee Kun-hee, the youngest son of the founder, who took over as chair of the conglomerate in 1987. Lee Kun-hee was trained in Western management principles, earning an MBA from George Washington University. To a cul- ture that deeply values seniority, he introduced merit- based pay and promotion. His strategic intent was to make Samsung a world leader in high-tech industries, including consumer electronics. To execute his strat- egy, Lee Kun-hee focused first on gaining market share by invading markets from the bottom up with lower-priced products at acceptable value. He hired Western managers and designers into leading posi- tions and sent homegrown talent to learn best busi- ness practices from other firms wherever they could be found. Lee Kun-hee also set up the Global Strate- gic Group to assist non-Korean MBAs and PhDs with a smooth transition into their positions in a largely homogenous cadre of Korean executives.

Pssitisnlng $am$$nS H**ctronics fcr Slchal Leadsr$hlp In the 1990s, Samsung's image, however, was still overshadowed by those of Sony, Motorola, and Nokia, the undisputed world leaders in consumer electronics

and mobile phones. During a 1993 trip, Lee Kun- hee saw firsthand how poorly Samsung's electronics were perceived in the United States and Europe, and he vowed to change that. Back in Korea, to show his disappointment and determination alike, he destroyed 150,000 new Samsung cell phones in a large bonfire in front of all 2,000 employees of Samsung's Gami factory. Many employees credit this as the pivotal moment in redefining Samsung Electronics' strategic focus and initiating a successful turnaround. Under Lee Kun-hee's leadership, Samsung Electronics sig- nificantly increased spending on research and devel- opment (R&D) as well as on marketing and design. Once economies of scale due to a larger market share could be reaped, he moved Samsung to the high end of the market, offering premium consumer electronics such as flat-screen TVs, appliances, semiconductors, and mobile devices, including its famous Galaxy line of smartphones.

In 2007, Apple introduced the iPhone, redefining the entire category of mobile phones and setting the standard for the way smartphones looked and felt. Samsung played catch-up again, ratcheting up spend- ing on R&D and marketing. In particular, the company applied its time-tested "follow first, innovate second" rule. As a key component vendor to other leading tech- nology companies including Apple, Samsung Elec- tronics saw early on what directions other companies were taking. Within a short time, it had overtaken Motorola, HTC, BlackBerr], Nokia, and even Apple to become the number-one vendor of smartphones in the world and the largest technology company globally by revenues, and held the largest market share by units (see Exhibit MCI7.l). By 2012, with the release of its Galaxy S III phone, Samsung had successfully imitated the look and feel of the Apple iPhone. Apple and Samsung, however, have been locked in ongoing court battles over infringement among the various smartphone models. Samsung lost a high-profile case against Apple in a California court in 2015, where damages were later reduced to some $500 million.

Despite the temporary competitive advantage Samsung achieved n 2012, within several years it snrm- bled, with revenues and profits down sharply from its peak tn 2013 (see Exhibit MCI7.2). Although it sells fewer phones than Samsung, Apple's profit margin per phone is much higher. With the introduction of the iPhone 6 in 2014, Apple again pulled away from Sam- sung. With the larger screen on the iPhone 6 Plus, Apple

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MINICASE 17 Samsung Electronics: Burned by Success? i 505

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also negated Samsung's lead with its successful Galaxy Note phablets. Apple followed up with the iPhone 7 in 2016 and its 10th anniversary model in 2017. With a string of incremental innovations, Apple has continued to capture a greater share of the high end of the mar- ket. Although Apple's market share in terms of units in the global smartphone industry is less than 20 percent, it captures a whopping 92 percent of all the profits gener- ated in the industry!

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Samsung Electronics not only lost market share on the high end of the mobile phone market, but also on the low end. Chinese technology companies Oppo, Huawei, and Xiaomi are becoming more and more popular. In particular, the Chinese startup Oppo has challenged Samsung and Apple in consumer markets with huge growth potential such as China. By 2017, Oppo, often described as China's Apple, had become the

number-one seller of smartphones in China by units. Similarly, by launching new smartphones quickly, almost like fashion accessories, India's Micromax had become the number-one seller in its home market.

Samsung Electronics is being squeezed in the middle. On the high end, it has fallen behind Apple, which con- tinues to pull away with its innovation and design setting new standards for the most profitable segment of the mar-

ket. On the low end, upstarts from China and India are capturing leading positions in markets with huge growth potential. Within the company, the soul-searching about Samsung's future has begun. In 2010, Lee Kun-hee set the sffategic intent that Samsung should quadruple its rev-

enues from $100 billion to $4O0 billion by 2020 (which would be more than the revenues of Apple, Google, Micro- soft, and Amazon combined).

By 2016, the situation for Samsung Electronics was getting worse. From selling well over 30 percent of all mobile phones globally, its market share had fallen to 18 percent by the end of the year.

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506 i tllNlCASE 17 Samsung Electronics: Burned by Success?

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During the struggles identified above, which may seem part of the rough and tumble of high-stakes com- petition, Samsung had to face three separate crises that rocked the company further: leadership struggles, product recalls, and political scandal.

LEAnfn$HlP $TRUSSLE$. Although the business situation for Samsung Electronics seems to be improv- ing, its downward spiral for the past few years coin- cided with Lee Kun-hee's heafi attack in 2014, which left him incapacitated. The 75-year-old had ruled Samsung with an iron fist: No strategic or personnel decisions were made without his approval. With the leadership vacuum, the turf battle for Samsung's top job began, with many observers convinced that Lee Kun-hee's only son, Lee Jae-yong (who goes by Jay Lee), was the heir apparent. Prior to his arrest and charge in 2017 ,, the younger Lee held the position of vice chairman within the Samsung Group. At the same time, Samsung Electronics currently has an unusual leadership structure, with three co-CEOs each acting as the leader of his respective division (components,

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mobile, and consumer electronics). The involvement of the Lee family in Samsung is persistent through- out the conglomerate, however, with descendants of the company's founder serving in multiple leadership positions.

Lee Jae-yong holds a relative small stake in Sam- sung Electronics, which is key to running the entire conglomerate. At the same time, activist shareholders such as Elliott Management of the United States are pushing to restructure the Samsung conglomerate to provide more transparency in its governance structure, and to break open the tight grip that some Korean families have over the chaebols, despite fairly small share holdings. The younger Lee also faces billions in inheritance taxes when his father dies.

PR00UCT RHCALL. Samsung Electronics was already dealing with shrinking margin share, when it encoun- tered the Galaxy Note 7 debacle. The Note line of mobile devices are Samsung's phones with larger screens, in which the South Korean company had been leading Apple. The new Note 7 was introduced in the summer of 2016 to great fanfare and raving reviews (e.g., o'best phone ever").

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But just a few days after its launch, reports of spon- taneous explosions and fires that the new smartphone was experiencing started to circulate in the media. Rushing to contain the looming problem, Samsung Electronics blamed a faulty battery from a specific supplier. It decided to no longer use this particular supplier and exchange all the phones already sold with new Note 7 phones that contained batteries from a different supplier. Alas, this did not solve the prob- lem. The media storm was gathering strength as more

and more reports of spontaneous phone explosions and resulting fires came in. In the United States, the Federal Aviation Administration acted swiftly by ban- ning all Samsung Galaxy Note 7 phones from flights. Flight crews made announcements before every flight, reminding each traveler of the problems Samsung was

facing with its Note J at about the same time as Apple was introducing the new iPhone 7, which turned out to be a bestseller. After recalling millions of Note 7 phones globally, Samsung announced in October 2016

that it would permanently end production and sale of the tarnished smartphone.

In the spring of 2017, Samsung launched its new Galaxy S8 (a smaller version, not related to its Note line of phone) with considerable success. In the same year, Samsung Electronics also reported record prof-

its as demand for the Galaxy 58 and the company's microchips was strong.

P0LITICAL $CAl'lDAL. The leadership challenges facing Lee Jae-yong may have also led to events that embroiled him in a political scandal. In 2017 , prosecu- tors accused him of bribery, embezzlement, and perjury.

He was subsequently arrested, becoming the first Sam- sung leader to land in jail. (His father, Lee Kun-hee, was convicted in 2008 for emb ezzlement and tax evasion, but later received a presidential pardon.)

In the case of the younger L,ee, prosecutors allege that he sought South Korean President Park Geun-hye's

support and influence in a conffoversial merger of trvo Samsung affiliates. Lee Jae-yong, who holds only a 0.6 percent share in Samsung Electronics, needed the merger to go through to generate much-needed cash, and more importantly to strengthen his hold on Sam- sung Electronics, ensuring a smooth leadership transi- tion along the Lee family lines. And one reason he may

have needed that cash was to deal with the inheritance taxes relative to his share of Samsung Group. To achieve his goal, Lee Jae-yong turned to President Park, pros- ecutors allege, who in turn influenced Korea's National

MINICASE 17 Samsunq Electronics: Burned by Success? i 507

Pension Service to cast the deciding vote in favor of the proposed merger within the Samsung conglomerate. The National Pension Service obliged, even though it was losing money in the transaction.

To ensure continuation of the cozy relationship between politics and business in South Korea, Sam- sung made a $38 million "donation" to foundations held by a close friend of the president, Choi Soon- sil. She is one of the key figures in the scandal rock- ing South Korea because prosecutors allege that Choi Soon-sil had a huge influence on the president's deci-

sions and access to confidential government papers, despite not holding any formal position. Park Geun-hye

is the first Korean president to be impeached. Charges against her include abuse of power, bribery, and leak- ing of government secrets. Caught up in the presiden- tial scandal, Lee Jae-yong, Samsung's de-facto leader and figurehead, was convicted of bribery in the summer

of 20IJ, and sentenced to five years in jail. His attor- neys immediately appealed the ruling. In the meantiffie,

Samsung's leadership vacuum continues.

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Gorporate Strategy and Governance

What makes Samsung a conglomerate? What type

of diversification does Samsung pursue? Identify possible factors such as core competencies, econo-

mies of scale, and economies of scope that were the basis of its past success as a widely diversified conglomerate. Why is Samsung as a conglomerate struggling today?

Despite being a widely diversified conglomer- ate, Samsung prefers vertical integration: in-house

design and development teams, manufacturing in

large company-owned factories, and coordinating a sprawling global supply chain. In contrast, Apple concentrates on the design (and retail sales) of high-

end mobile devices, while it outsources its produc- tion to Foxconn and others. Do you think Samsung's high degree of vertical integration contributed to its

recent problems? Why or why not? Explain.

What is a chaebol? What arc some of the corpo- rate governance challenges that chaebols such as

Samsung face? What arc some of the advantages and disadvantages of chaebols ? What changes to a chaebol's governance structure are Ameri- can activist investors such as Elliott Management pushing for, and why?

L

2.

3.

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508 i ultllcAsE 17 Samsung Electronics Burned by success?

4. With South Korea being rocked by the presi- dential scandal exposing a deep-running and long-standing nexus of bribery and chummy rela- tionships between industry and politicians, and by the call for more transparency and governance changes in the chaebols, do you think reform and changes will happen, or will things return to busi- ness as usual? What is your opinion? Explain.

Business Strategy

5. Lee Jae-yong, the 5O-year-old grandson of the Samsung founder, was educated at Seoul National University, Keio University (in Japan), and Har- vard Business School. He wrote a master's thesis at Keio University on Japan's struggle to retain its world leadership in manufacturing in the mid- 1990s when the country's fast-growing period was ending. He concluded, "Japan's troubles were worsened by its manufacturers' pursuit of scale and market share."l Is Samsung Electronics' pur- suit of scale and market share to blame for its los- ing its competitive advantage?

6. Why is Samsung Electronics encountering prob- lems selling its flagship line of smartphones, the Galaxy? How should it compete against premium phone makers such as Apple and low-cost lead- ers such as Oppo and Micromax? Do you think

Samsung will be making a comeback with its Gal- axy line of phones? Why or why not?

Endnote

1. Cheng, J., and Lee, M. J. (2015,, May ll), 'After Galaxy smartphone debacle, samsung questions game plan," The wall street Journal.

Sources: Jeong, E.-Y. (2017, Aug. 25), "samsung Heir Lee Jae-yong Convicted of Bribery, Gets Five Years in Jail," The Wall Street Journal; Tsang, A. (2017, July 7), "Samsung, seeking to move past scandals, forecasts record profit," The New York Times; Fowler, G. (2017, Apr. l8), "Samsung Galaxy S8 review: Great phone, but that's not all that matters," The Wall Street Journal; Jeong, E-Y., and T. W. Martin (2017, Apr. 7), "Samsung heir takes center stage in South Korea's 'trial of the century,"' The Wall Street Journal; Mozur, P. (2017, Jan.22), "Galaxy Note 7 fires caused by battery and design flaws, Samsung says," The New York Times; Song, J., K. Lee, and T. Khanna (2016), "Dynamic capabilities at Samsung: optimizing internal co-opetition," California Management Review 58 (a): 118-140; "Charred chaebol," The Economist, october 15, 2016; Bellman, E., and R.J. Krishna (2015, June 4), "India's Micromax churns out phones like fast fashion," The Wall Street Journal; "samsung: The soft succession," The Economist, May 23,2015; Cheng, J., and M.-J. Lee (2015, May 11), 'After Galaxy smartphone debacle, Samsung questions game plan," The Wall Street Journal; Cheng, J. (2015, May 11), "What to know about Samsung," The Wall Street Journal; Cheng, I. (2015, Mar. 1), "Samsung unveils Galaxy 56 to answer iPhone 6," The Wall Street Journal: Cheng, L (2014, Oct.27), "Samsung's primacy is tested in China," The WalI Street Journal;Lee, M.-J. (2014, Oct.7), "Samsung girds for cost cuts after downbeat guidance," The wall Street Journah "samsung: waiting in the wings," The Economist, September 27,2014; "How Samsung got big," TechCrunch, June I,20L3; "The rise of Samsung and how it is the mobile reshaping ecosystem," Business Insider, March L4,2013; "Faster, higher, stronger: The rise and rise of Samsung," The Sydney Morning Herald, August 13,2012; "Samsung: the next big bet," The Economist, October 1,2011; "Samsung and its attractions: Asia's new model company," The Economisl, October l,2Ol1; Khanna, T., J.Song, and K. Lee (2011), "The paradox of Samsung's rise," Harvard Business Review, July-August; and various Samsung Annual Reports.

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