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SAMSUNG'S Next Act

on Jul 16, 2004

Steeled by crisis and fearful of complacency, a Korean titan searches for an encore. Won-Min Choi, a painstakingly hip designer in the allout assault that Samsung Electronics is waging on the cell phone market, holds up a handset with teensy twin speakers and Surround Sound. At the press of a button the wail of an oncoming train whistles out of the right speaker, passes over to the left and disappears down the tracks. He grins: 'Cool.' Choi, 30, who wears Doc Martens and jams in a garage band after work, is a sound designer in a design lab in Seoul, one of six that Samsung funds in its relentless quest to overtake Nokia.
Ten years ago Samsung was barely a presence in cell phones; it sold only in Korea, and even there it ran a distant second to U.S. invader Motorola. Today the cell phone is to Samsung what the was to Sony--a slick growth engine, an icon of innovation and a brand with a shot at becoming the coolest in the world. Suddenly Samsung is number two worldwide, and it aims to supplant Nokia by 2010. It's a brash boast:Nokia holds a 36% dollar-share of the global $85 billion market, more than twice Samsung's share (13%). But Samsung soars by shunning commodity gadgets and gossamer margins in favor of pricey cell phones with fancy features and fatter profits. Samsung releases a new phone in the U.S. every two weeks, tailored for such features as Sprint's new video mail service. It popularized the PDA phone and was first to equip a cell with an MP3 player. A TV phone will be out this year, as will talking phones that can read mail messages to the listener. Coming soon: Samsung chips that let cell phones handle 20 hours of talk time on a single charge, hold 2,000 songs and 8 hours of video, and play 3-D videogames.

A decade ago Samsung was an overstuffed, lethargic and uninspired maker of me-too memory chips. Now it's a leader in electronic gadgets, one whose $2.7 billion net income in the first quarter, on revenue of $12 billion, made it the most profitable tech company, ahead of Microsoft, IBM and Intel. Samsung's sales could reach $80 billion in 2009, says Jong-Yong Yun, 60, chief executive. ""We're like a snowball that rolled down a big hill,"" says Kitae Lee, chief of Samsung's cell business, which provides a third of Samsung's sales.

The big numbers owe to Samsung's strength in two of the three pieces that anchor most digital devices: memory chips and screens (Intel controls the third,microprocessors). It arms the world's biggest tech names with these parts--yet it also embeds them in Samsung's own phones, screens and Internet-ready refrigerators (see chart) . Samsung is the world leader in memory, making one-third of the world's DRAM and SRAM chips and a fifth of the flash memory. In that last segment, vital in wireless devices because flash holds data after the power is switched off, Samsung has even surpassed Intel. It also is the largest producer of thin-film LCD screens and flat-panel computer screens.

How long can Samsung keep this up? This giant has an image problem. It still lacks the sheen that consumers see on Sony or Dell or Nokia, especially in the U.S. market. Samsung's own research shows that Americans think the brand seems 'more foreign"" than Sony and view it as more rigid and less creative--a copycat rather than an innovator. In spending $800 million a year on ads, promotions and marketing (up fourfold in five years), and presenting its moniker to online users a billion times a month, Samsung has risen from obscurity to claim the 25th spot in Interbrand's best-brand rankings. But it still lags behind Nokia (6th), Hewlett-Packard (12th) and Sony (20th).

""Our brand doesn't provoke an emotional response,"" says Dong Jin Oh, head of Samsung North America. ""We still have a long way to go to be a tier-one company in the U.S.""

And while the brass talks of listing Samsung public on the New York Stock Exchange in a couple of years, the stock continues to suffer from a Korea discount. It has risen 16-fold in six years on the Korean stock exchange, and among emerging-market stocks it is the most widely held by Western investors. But today it trades at just 13 times last year's earnings compared with a lofty 42 times earnings for Sony, whose ADRs trade on the NYSE. For all the stunning numbers Samsung puts up, it doesn't yet adhere to standard U.S. accounting rules, adding to investor wariness. Clearly, Samsung wants--and needs--more respect.

""To be number one, we have to be right about everything,"" says Chief ExecutiveYun. ""To upgrade the brand, we have to come up with great products--high-quality, early-adopter or market-leading products."" His Samsung was steeled by crisis, responding to the Asian financial collapse in 1997 by chopping payroll, wiping out a honeycomb of management layers and speeding up everything it does. That makeover served Samsung well when the next crisis hit--the burst of the Internet bubble. As the rest of tech reeled, profit at Samsung grew 5% from 2000 to 2003.

To keep growing, Samsung is pushing to revamp advertising, fund new research and intensify the focus on snazzy design. The Seoul-based marketing chief, Eric Kim, has put Samsung's $500 million annual ad account up for review, threatening incumbent ad shop Foote Cone &Belding (owned by Interpublic). ""Samsung isn't satisfied with where it is in the U.S.,"" says FCB Chief Brendan Ryan. ""No one there rests."" Samsung built name recognition for five years, Kim says, and now it must lift brand loyalty. ""We want people to say, 'I want a Samsung.'""

The grand plan is to double the research budget from the current $3 billion in the next few years. Samsung employs 20,000 researchers at 15 labs (including sites in China, Japan, Russia and Israel) and hopes to add a few thousand more in the next few years. ""We are too focused on next year's product,"" saysHyung Kyu Lim, who recently was named worldwide research chief. ""We need to be thinking about what's coming in three to ten years."" He is reining in rival efforts at five divisions, focusing everyone on ""the three screens of life""--mobile, home and office. ""As the products converge, you need better coordination,"" he says.

Samsung Electronics was formed in 1969 as a joint venture with Sanyo of Japan, but its roots stretch back six decades. In 1938, when Korea was still a poor colony of Japan, Byung-Chull Lee opened a small dried-fish and fruit export company. His trading outfit developed into what is today Samsung Group, Korea's largest chaebol, or loose conglomerate. It is controlled by Korea's richest family, headed by billionaire Kun-Hee Lee, son of the founder. He owns 3.3% of Samsung Electronics (but has been reported to own as much as 15%) and is its chairman; Samsung Electronics owns stakes in ten other group companies.

The group encompasses an eclectic range of 63 businesses, some of them utterly unrelated--Samsung Fire & Marine (insurance), Samsung Electro-Mechanics (electrical components), Samsung Corning (glass for TV picture tubes and monitors), even Samsung Everland (an amusement park that owns 19% of Samsung Life, which in turn owns 7% of Samsung Electronics).

The first big win for Samsung Electronics came in 1983 in memory chips or DRAM (dynamic random access memory). The chip market already was glutted and seemed destined to be forever dominated by the Japanese, and U.S. regulators had imposed tariffs on Japanese chipmakers. Samsung rushed in, doggedly if belatedly, producing its first chip ever sold in the U.S.:a 64-kilobit chip (able to hold 64,000 bits of data). It debuted three years after everyone else's. But just three years later Samsung had created the world's first one-megabit chip, a jump that should have taken six years, given the industry's usual pace.

Samsung did it by pitting two teams of engineers--one in Silicon Valley and one in Seoul--in a race to be first to hit the megabit mark; Korea won. By 1994 Samsung was making the first chip that held 256 megabits and was now the world's largest producer of DRAM (thanks in part to Korean government subsidies).

Memory chips, however, were an isolated success. Samsung at the time was faring so poorly in the U.S. market in most businesses that it was considering pulling out entirely. It was mired in low-margin items like microwave ovens and cheap TVs, and confined to discount outlets like Kmart. Then came the Asian financial crisis and plunging chip prices in 1997, and suddenly Samsung needed the U.S. more than ever before. U.S. sales would generate hard currency that Samsung could use to whack at its yawning debt as it set about reshaping the company.

But ""we didn't have many products we could use to build our brand""--except, maybe, cell phones, says Kitae Lee, the global cell phone chief. ""The crisis put major pressure on us to succeed,"" adds

Peter Skarzynski, head of the U.S. handset business. To thrive in cell phones, Samsung would have to remake itself to be quicker, flashier, slimmer. And to command higher prices and bring in more hard dollars, it would have to jump far ahead of current technology, pouring profits from the memory and LCD businesses into more innovation and bigger marketing.

Much of that couldn't happen, however, without dramatically altering operations back in Seoul. Yun, who had taken over in 1996 only to face the devastating Asian financial crisis a year later, realized Samsung had to alter itself--or drown. ""The crisis gave us the freedom to restructure,"" he says. With the government's blessing, Yun cut 30% of his 84,000-strong work force, a radical move in a place with militant unions. He worked on whittling Samsung's $12 billion of debt (now down to $8 billion), and debt-to-equity dropped 300% to 30%; he closed 52 product lines. The company idled plans for new factories and outsourced nonessential jobs such as maintenance for company cars. Golf memberships and other perks got axed. Non-Koreans joined the board of directors. This was a new company, and Yun began doing things in new ways.

In hierarchical Korea he is a maverick who fancies efficiency and speed. He studied electrical engineering at Korea's best university, Seoul National University, graduated in 1966 and immediately joined Samsung Group. By the late 1970s he ran Samsung Electronics' Tokyo office (he speaks Japanese and understands English) and from the 1980s onward ran eight different businesses. Yun impressed Chairman Lee with an ability to get things done. One success: creating the first VCR for Samsung after Japanese makers wouldn't share their technology. Later he sped up VCR output by shortening the assembly line--a change his engineers said would take three months to do. Yun got it done in five days.

As boss, Yun gave more latitude to his managers and threw out the seniority-based pay and promotion system. Instead, employees won bonuses tied to the profits of each division, including a stock-option plan that has distributed 4% of the company's shares to 900 executives. Yun's options are worth $40 million.

He also made each business its own profit center: The semiconductor and LCD divisions sell to other Samsung businesses and outsiders for the same price, with no favoritism. ""This is very different from other chaebol, even Japanese and U.S. companies, who favor internal vendors,"" says Woosik Chu, head of investor relations. This assures Apple, HP and other clients that they are getting a fair deal--and knowledge of their buying patterns offers valuable intelligence to Samsung.

""We saw the cell phone was changing from a utility item to a fashion statement,"" says Kim, the marketing czar. ""People used to say, 'Why would anyone want to take a photo with a phone?'"" Now Samsung has a 12% share of the camera-phone market--just one point behind Nokia (but well behind NEC). Samsung's coolness factor got a big boost when one of its futuristic cells was featured in the second and third installments of the sci-fi series The Matrix. It also benefited in the U.S. from an early deal with Sprint, whose wireless network uses the CDMA standard that Samsung follows. Overall, Samsung's cell phone revenue rose more than fourfold in five years, to $18 billion; its handsets are priced 44% higher than rivals'.

Better design plays a role. Samsung has six design labs, five outside Korea. Five years ago engineers told designers what the products would look like. No more. ""Now the designers tell the engineers what features they want,"" says Kook Hyun Chung, who runs the Samsung design center in Seoul and has expanded his staff 50% in two years to 450 people.

At the design lab in London Clive Goodwin and his staff of 18 create whimsical designs for the European market--a plasma TV with clear plastic speakers; a phone with a keypad that slides downward. ""The way a product interfaces with the user is very important. It's like theater,"" Goodwin says.

The obsession with looks pays off in myriad ways. Samsung this year won five design awards at the IDEA competition, more than any other company. A recent survey shows U.S. customers, asked to compare a Samsung cell to a car brand, most often cite Lexus. Typical of Samsung's new design push is the sleek SGH-E700, a clamshell with two LCD panels and a camera with a digital zoom. Designers told the engineers to eliminate the usual bulky antenna in favor of an internal one, and in less than a year the E700 has become one of the world's bestselling phones, at 10 million units.

Samsung releases these beauties at a breathless pace. It used to take 14 months to roll out a product; now it needs only 5. Product cycles have shortened, prices have dropped and employees feel motivated to keep up. ""Consensus is important here, but the speed of implementation and empowerment of employees is equally important,"" says Thomas Quinn, an 11-year veteran who heads Samsung's North American memory sales and marketing division.

Cool. Samsung hopes the cell phone gleam can spill over to its consumer electronics line, the one laggard in the Samsung stable. It provides only 5% of profit, down from 10% five years ago. Yun, who spent a good part of his early career on gadgets and televisions, is making some headway: Samsung's consumer electronics sales in the first quarter were up a modest 16% to $2 billion. Samsung ranks fourth in the world in MP3 players, trailing Apple, iRiver and RCA; its DVD players are number three, trailing Sony and Toshiba.

But Samsung doesn't sell stereos or laptop computers in the U.S., putting it at a disadvantage to Sony in placing its brand in front of consumers. So Samsung's U.S. marketing chief, a frenetic 6-foot-3 American named Peter Weedfald, is resorting to inventive measures, partnering with Hollywood and the music business.'We want brand infatuation,' he says. 'I think of Starbucks. Also Nike.' In June he signed up New Line Cinema to use Samsung gadgets in its films. A Samsung ad online promotes NewLine's new release, The Notebook: Download the trailer and enter to win a Samsung camcorder and a trip to the Hollywood premiere.

Samsung, known now by the cold tagline ""Digitall: Everyone's Invited,"" could switch to a more Intel-style one-liner in its new campaign. ""The Power Within"" could become Samsung's slogan, Weedfald says, though he admits it is risky. ""Will consumers care that our own components are inside our products? Plus, our competitors are our customers,"" he says.

Samsung says its control over manufacturing of tiny screens and potent flash memory is a key element of its rise in the faddish cell phone market; it could help it in consumer electronics, too. ""PCs used to drive the semiconductor business; now wireless products [do],"" says Skarzynski, the U.S. cell phone chief. ""Flash memory, screen technology--Samsung is a leader.""

In flash, a $2.2 billion-a-year business that grew out of DRAM production, Samsung has surpassed Intel. Samsung's 20% market share is number one overall, but flash comes in two forms, identified by allusions to on-off logic: Nor (the older entry, dominated by Intel) and Nand (the newer, used in memory sticks). Samsung has established supremacy in Nand, where it controls 65% of the world market. Both approaches are popular in wireless devices, but many analysts believe Nand will win. ""Nor is faster now, but Nand has more storage space. Give it five years,"" says Peter Nori, who covers global hardware for Franklin Templeton Investments, which owns $1 billion in Samsung shares. ""We plan to accelerate our innovation in Nand,"" says Samsung's Chang-Gyu Hwang, chief of the memory division.

Samsung alleviates market swings in chip prices through customization--its chips already get 17% higher prices than the market average, thanks to special orders from the likes of Nokia, Dell and Microsoft. Intel and Samsung are battling for supremacy in multichip packages, bundled memory and processors that increasingly run cell phones. Hwang thinks Samsung, now second, can take the lead this year.

While Samsung obsesses over speed, rival Sony looks vulnerable. It is in the middle of a huge restructuring. In the fiscal year ended Mar. 31, Sony's earnings declined 23% to $850 million, one-sixth the Samsung number. But Jong-Yong Yun says he worries not about Sony but about Samsung itself. He wants to ensure the company stays focused on the strategy that pulled the company out of the depths of the 1997 debacle. ""The best time is also the most dangerous time,"" he warns. ""We all need to think that we're in crisis and could go bankrupt tomorrow.""


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