WATCH OUT, SONY
How Samsung's finance chief is taking the Korean electronics giant to the world.
By Abe De Ramos

Like the constant drizzle that has cast a dour mood all over Seoul, the daily slide in the share price of Samsung Electronics has dampened the spirits of its employees, who see the movement on TV screens in every corner of the headquarters. This chilly March morning is a repeat of yesterday with a loss of 2 percent, and analysts blame Intel. The Goliath of semiconductors warned of poor sales this quarter, and it follows that Samsung, which is in the same business, must suffer the same fate. But tell that to Doh-Seok Choi and the mild-mannered CFO of the Korean chaebol can only shake his head. "I've been trying hard to eliminate that misconception in the market," he says. "We're being labeled as a semiconductor company, which is untrue."

It's a fair comment. In 2002, Samsung made a record profit of 7.25 trillion won (US$5.7 billion), nearly double Intel's US$3.1 billion, on sales of 40 trillion won. Sales were evenly split among three divisions - semiconductors, telecommunications, and consumer electronics - all of which were profitable.

Handsets alone made up 40 percent of earnings. This is a significant achievement given that Samsung only started making them in the late 1990s, and it is now the most credible threat to industry pioneers Nokia and Motorola. "Our business portfolio substantiates the fact that we are a diversified company," says Choi, "and we're trying to communicate the changes that have taken place in the company to the outside world." In short, Samsung is seeking recognition. But as what, is not exactly clear.

The company is unique in being the only one in the world that manufactures the whole gamut of modern technology - from semiconductors to video cameras to smart phones to microwave ovens. Unlike Sony where the focus is consumer electronics, Nokia where it is handsets, Intel with its chipsets and Electrolux which concentrates on home appliances, Samsung's product range is so wide that analysts describe it as being a category on its own. And yet, investors continue to pigeonhole Samsung for the business it has had since the 1970s.

To shake off the chip label, CEO Jong-Yong Yun has vowed to make Samsung a market leader in all its product segments by 2005. Ambitious? Very, but that's just half the story. Samsung also wants to be the most profitable of all its peers. Sure, it has overtaken the venerable Sony in terms of market capitalization, but Yun and Choi dismiss its importance. "What does it mean to overtake Sony?" Yun told the Financial Times. "The only measure that counts is long-term profit growth." Less dramatically, Choi says carefully: "Shareholder value would be adequately served if we pursue the course of long-term profit maximization. That's my personal philosophy.""

Margin Call

Let's leave the market leadership to Yun, the visionary, or as Choi would call him, the "rooster" of the house. Yun began his global push long ago, spending US$400 million a year on marketing, and is now reaping the fruits of this expensive labor. Last year, Interbrand ranked Samsung as the 34th biggest global brand, gaining 30 percent of its value over a year. In the profit leadership sphere, the game is all about margins. Increasing profit margins is both a financial and operational task, which usually falls on the housekeeper, the "hen" of the house. And that is how Choi likes to think of his role as CFO and president of Samsung Electronics.

To understand what Choi is up against, take a look at Samsung's operating margins, or the ratio of operating income to sales revenues, against those of its peers in the most competitive sectors. In the memory-chip business, Samsung is the industry winner as rivals continue to lag in technology. In handsets, it is just ahead of market leader Nokia. In TFT-LCD screens, it has an advantage over LG. Philips (10 percent versus 7 percent), and in consumer electronics, it is neck-and-neck with Sony.

Samsung's leadership in memory chips isn't likely to change soon. "We're looking at growth in the wireless communications segment," says Chuan-Yang Lim, an equity analyst at Standard & Poor's in Singapore. "Within the memory-chip sector, Samsung has the largest exposure in wireless, so it will outperform the rest." This stability - cast against its short track record and the predatory nature of the other sectors - is perhaps what makes investors feel more comfortable associating the company with semiconductors than the other businesses.

In other industries, Samsung is stirring the status quo. "If you ask Nokia who they're most worried about, they will tell you it's Samsung," says Richard Windsor, an analyst at Nomura International in London. But Samsung still lags in market share (9.8 percent versus 35.8 percent), and analysts say the difference in scale will make it difficult for the Korean company to sustain its slight profit margin edge over Nokia. "The thing to remember in the mobile phone market is the more you produce, the more plausible you become, so those who don't control 10 percent aren't going to make it," says Ari Bensinger, telecommunications analyst at S&P in New York.

The competitors are not about to let Samsung steal their thunder. In a staff meeting at Sony, reports Nikkei Weekly, chairman Nobuyuki Idei yelled at his employees: "Whoever designs a product beaten by Samsung is a failure!" Sony is also aiming to double its operating margin.

Choi is undaunted. Samsung has embraced leading-edge technology, and there is no turning back. Now, all Choi has to do is keep his costs down to forge ahead profitably. A planner and number cruncher, he has memorized his formula like a mantra. "The way I plan to maintain our overall position is through leading-edge technology, so we can command higher prices and lower our production cost," he says. "This would ensure that we get decent profit margins, thereby enabling further capital investment."

It's a call few analysts doubt. Asked what could derail Samsung's long-term profitability, they cite external factors such as a worse-than-expected deterioration of market conditions, or an unexpected SK Group-like blowout owing to its chaebol-like structure. A look at Samsung's consolidated income and balance sheet statements, which include the performance of overseas subsidiaries, also reveal figures less rosy than the headquarters'. Internally, analysts believe that Samsung has put in place the right infrastructure. "Operationally, they're one of the best managed companies in the region," says Kishore Suratkal, head of Asian technology research at Deutsche Bank, "and that's what made them a profit leader."

A possible drag on Samsung would be its market strategy in handsets. CEO Yun chose to focus on the high-end in part to kill the notion that Samsung is a second-rate mass producer of Sony clones. But this could prove its undoing as analysts say that signals clearly point to the low-end market. "A mistake in their handset strategy could impact the overall business," says Suratkal. "At this point, they're doing fine, but the market is far more competitive than they imagine."

Phoenix from the Flame

If the last five years is any indication, Choi has the credentials to make Yun's vision of market and profit leadership work. Choi became CFO in 1997, the onset of the Asian crisis that crippled South Korea. Back then, Samsung was in a state of virtual bankruptcy. Its global debt amounted to 21 trillion won, equivalent to a debt-to-equity ratio of 465 percent, and almost as much as the headquarters' assets of 23 trillion won. That year, it incurred a paltry net profit of 124 billion won on sales of 18 trillion won, barely generating a return on equity of 2 percent. Operating margin was just 11.3 percent. "Our asset turnover was very minimal, only 0.8 percent, meaning the assets weren't working hard enough to generate business," says Choi.

A career man at Samsung Electronics, Choi was placed at the helm of the restructuring program. While the then newly-appointed CEO, Yun, had a vision of what he wanted the company to be, what he needed to do to move forward was to fix its ailing finances. No one knew exactly how ill those finances were better than Choi.

Now 54, Choi joined Cheil Industries, a textile subsidiary of the Samsung Group, as an accountant fresh out of college in 1975. His career at Samsung Electronics started as an accounting manager in 1981, and over two decades he crept up every rung of its corporate ladder, leading him to positions such as general manager for accounting, GM for financial management, corporate controller, and finally CFO. As such, Choi, who also became a director in 1999 and president last year, knows Samsung's numbers by heart, throwing out five-year-old figures with the assurance of a gray-haired librarian.

Of course, the financial crisis was a whole new ballgame for Choi. For Samsung to survive, the company had to take then inconceivable measures such as letting go of financial investments in non-core businesses and cutting down its workforce by a third. It was all part of Yun's global vision, and Choi knew he had to change his own way of thinking. "I was personally in charge of all the planning and execution of the whole restructuring process," he says. "Never did I realize I would have such a responsibility. When I was young, what I wanted to be was a doctor."

Choi educated himself, literally, about global best practices, supplementing the MBA degree he earned in 1996 with constant reading. "The crisis made me aware of the need to shift the paradigm toward international standards," he reflects, "and to do that, to make the whole company's operation more transparent, I had to change myself pretty quickly." That entailed reading many a weighty tome and regular sit-down sessions with experts and advisors from the Samsung Economic Research Institute. "My involvement with investor-relations activities also helped - going abroad twice a year to see our major investors, hearing their recommendations and comments on what Samsung had to do to be a global company."

The Samsung Symphony

What followed was a massive restructuring that Choi carried out through unprecedented cost-cutting, inventory reduction, asset disposals and unwinding of cross investments in unrelated ventures. "In other words, anything that did not bring about value added had to be eliminated, and we even sold off our golf memberships," says Choi. "It was a make or break situation."

As a result, Samsung saw its earnings soar from 313 billion won in 1998 to 3.2 trillion in 1999. By the end of last year, it had assets worth 34 trillion won, a debt-to-equity ratio of 6.7 percent, an asset turnover of 1.8 percent, and a return on equity of 25 percent. Overall operating margin was 17.9 percent. While the company predicts that net profit this year will remain flat at best due to the probable economic devastation caused by the war with Iraq, Morgan Stanley, an American investment bank, thinks Samsung should be able to increase it by 19 percent.

If all this doesn't make Choi an astute money maker, then perhaps his cash balance does. At 7.42 trillion won (five times the figure in 1997), Samsung has, depending on the exchange rate, about as much cash as Sony (US$6.5 billion) and IBM (US$5.9 billion) - a dizzying amount, enough to tempt any CFO to spend with abandon.

But Choi, with the Asian crisis not far behind him, swears by his financial discipline, and benchmarks Samsung only with other global blue chips. Every investment, he says, has to be measured against its ability to create economic value added (EVA). Investments in existing businesses have to be limited to their retained earnings and generate returns in two years. New investments have to show returns in four years. By yearend, Samsung should be debt free, funding its 6 trillion won capex and 3 trillion won R&D spend with internal cash flow.

"The highest priority that I have is capital expenditures, and we will invest only within the earnings of the respective divisions," Choi says. "Through research of our peers, we found that for a top global company, a cash balance equivalent to roughly 20 percent of sales is quite ample, and we're aiming for that."

But even with liquidity concerns out of the way, Choi believes that his strategy in keeping Samsung afloat during the crisis will also take the company forward to its interlocked ambition of global market leadership and high profitability. He likens his strategy to an orchestral performance - specifically, Beethoven's Fifth Symphony conducted by Herbert von Karajan, which he enjoys listening to in his wood-paneled office. "I like to view the company as an orchestra," he says. "Every piece has to work together to create a global, profit-optimizing company."

That musical metaphor is hardly likely to sound intimidating to competitors, but it captures what Choi has done to enable Samsung to be a credible threat to anyone it plays against: making its divisions work together to cut costs and develop superior technology. The industry has two unique traits: it requires constant innovation - in the case of cell phones, current models become obsolete in months, while in semiconductors, Moore's Law still rules - and it is often capital intensive. As such, any savings on cost have to be pumped into product innovation.

In the end, the ultimate goal is fat profit margins. Sun Chung, an analyst at Merrill Lynch in Seoul, sums up what Samsung has accomplished in the memory-chip business, and what Choi is trying to apply throughout the company. "Compared to its peer group, Samsung is better on the cost side, given that they have the most advanced technology which enables them to command a higher selling price," says Chung. "They also have a diversified product portfolio, so if you put them all together, that pretty much enables them to have a high profit margin."

Standard Deviation

Choi's first step in bringing down Samsung's production cost is a process he calls standardization of components. This is when different products with similar parts inside begin to use the same model of each component, bringing economies of scale and thus reducing the material cost. "By standardizing components, we were able to enhance the quality of our products, thereby reducing servicing cost and R&D lead time," says Choi. "We were able to make purchases from our suppliers on a larger scale, so we were able to get discounts from them."

If standardization sounds like a no-brainer to you, then you're not working for a company of this size. "In the past, people who were in charge of development within a certain business unit didn't even know their counterparts in the other divisions," says Choi. Take its white goods business for example. Before standardization, Samsung used 300 different kinds of rubber hoses for its washing machines. Now, it's down to 20. By standardizing components, what Samsung also did was to unite its design groups.

"What I've done is to bring all the people in charge of development together in meetings to talk about what they're doing, so they can learn from each other. In effect, we're trying to spur internal benchmarking among different divisions," says Choi. "If a certain division adopted a model process from outside, in the past, the benefit would only be confined to that division. Now this knowledge spreads across the company."

This design unison benefits Samsung beyond cost. Working together enabled one division to take advantage of the strength of the other. "One of the strategies is to deploy the development of chips into the consumer electronics products to make it different from the competitors," says Lim of S&P. In short, Samsung uses its knowledge of chips to design more competitive electronics products which use these chips. Similarly, its R&D in TFT-LCD computer screens also benefits handsets, which are coming up with larger, more advanced screens.

It's an ongoing process for Samsung, whose product models number easily in the hundreds. In 2000, Choi found that his material ratio - the portion that material cost takes up in the total value of a certain item - had risen to 65 percent from 57 percent in 1997. "The proportion of material cost within the total product value added was actually rising since the crisis years, [undermining] the 20 percent overhead savings that I've made since the restructuring," says Choi. Last year, through standardization, Choi reduced his material cost by 7.4 percentage points from the year before, resulting in savings that exceed the labor expense of the 50,000-strong company.

With such big savings, it's no wonder Samsung can afford to invest heavily in a downturn. This year, its capital expenditure is 6 trillion won, or US$4.7 billion - greater than Intel's US$3.9 billion. Much of this would go to the highly cyclical semiconductor business, which includes memory chips and, oddly, TFT-LCD monitors. "It's quite important to invest in bad times to adequately prepare for good times," says Choi.

Pricing Power

This kind of financial prowess sends shivers down its competitors' spines. The business is capital-intensive, yet the demand for technological upgrades is constant. As such, no sooner had semiconductor companies recovered their investment in one level of technology, than new investments in a higher level were required.

To avoid this trap, Choi invested in 12-inch wafers - which lowers the cost of production - when others weren't. The result: Samsung now makes the most technologically advanced chips at cost that is slowly killing smaller competitors. Investors could only approve of this approach. "Samsung tends to take an individualistic stance when it comes to investment strategy," says Keon Han, a Morgan Stanley analyst, in a report. "A counter-cyclical strategy has proven effective during the past DRAM downturns, resulting in both market share gains and profitability."

This year, Choi's focus is to add new types of chips in its semiconductor product line, which currently includes DRAM, flash memory, and SRAM chips. "Since the business requires an enormous amount of investment, we need to hedge it and we do so by diversifying the portfolio," says Choi. "If one segment of the market crashes, hopefully, the other segment will more than make up for the losses, and make earnings and sales more stable."

In a similar move, Samsung's huge capex last year for the production of fifth-generation TFT-LCD monitors - expected to see shipments early this spring - has raised the entry barrier for competitors. As a low-cost producer, Samsung can aggressively cut prices this year as a pre-emptive strike against Taiwanese competitors who have yet to invest in 5G, say analysts. By stifling the growth of competitors and setting the standard in technology, Samsung will consequently be able to command higher prices, and in effect, margins, in TFT-LCDs.

Samsung applies a different profit strategy for its mobile phone business, where the product is less commoditized and competitors are more mature. The company has targeted the high-end segment of the market, meaning it doesn't sell units cheaper than US$150 on average. Among other features, Samsung is a pioneer in color screens and built-in cameras across CDMA and GSM platforms. Soon, it will be supplying handsets to NTT DoCoMo in Japan, for the latter's hugely popular i-Mode service. Windsor of Nomura estimates that of the 420 million handsets sold globally last year, only 20 percent were high-end, of which 50 percent came from Samsung.

Choi says Samsung will stick to this approach even in China, the current mobile phone hotspot where Nokia and Motorola are market leaders. "We're targeting the premium, high-income bracket in China, which number as much as 70 million," says Choi. "We used to transfer to China our manufacturing facilities for products that were being phased out, and now it's no longer true. We'll be sending high-tech, leading edge products to China, which we feel is cost competitive."

For now, this strategy has enabled Samsung to grow its market share by 47 percent last year - the most robust growth compared to Nokia's 8.4 percent and Motorola's 9.4 percent. Operating profits from telecommunications amounted to 2.98 trillion won, resulting in a 24 percent margin.

In the near term, analysts wonder how long this will last. "Low-end is where the market is, so they need to produce more of these," says Windsor. "It's surprising," Bensinger of S&P agrees. "People thought high-end was going to be the trend, but investors are beginning to understand that it's a long-haul transition. So the new markets these players are penetrating are emerging markets, which have a lower per capita income." But over the long term, Bensinger concedes, the replacement rate for mobile phones will increase - about 50 percent of mobile phone sales last year was already driven by replacements - and the trend is to upgrade to higher-end phones. While Samsung is already in position for this growth - it has a new model almost every month to stimulate replacement appetite - so is Nokia. "Nokia has got good vision, fantastic margins, and is vertically integrated," says Windsor.

Where Samsung needs the most improvement is in consumer electronics, which lumps home appliances such as refrigerators with electronics such as DVD and MP3 players, laptops and digital cameras. This division, although profitable, pales in comparison to the semiconductor and telecommunication divisions. In 2002, it made 520 billion won in operating profits, or just 7 percent of total. Yet, it made up 43 percent of total cost, according to estimates from BNP Paribas (official figures are unavailable).

Margins are inherently low in this industry. Sony, the market leader, has an operating margin of just 3.5 percent. The Asian industry average is all of 1 percent (the other major players are Japanese, including Matsushita and Sharp). Samsung is not doing badly at 3.9 percent but, by Yun and Choi's standard, it is underperforming. While Choi glows when he discusses handsets and chips, he gives a blunt comment on this division. "It's good for brand equity," he says.

That's not to say that there is no clear plan to improve it. In fact, Samsung's vision is long-term - that arcane dream of network convergence, when refrigerators will be able to hook up to the internet to order milk from the grocery store, all without human intervention. Samsung calls it "digital solutions". Choi calls it a challenge. "I find digital solutions, which seeks to prepare the company for future businesses, the most difficult to tackle of all my businesses," he admits. "As long as you know the nature and concept of a business, it's not difficult to make decisions, but this is an entirely new concept to me, and in order to understand it, I sometimes sweat a lot."

But guess what - Sony claims to have already grasped the whole concept of network convergence, declaring that its new thrust is no longer churning out Walkman after Walkman, but integrating its hardware, software, and media content with high-speed wireless connections.

In the end, Samsung is just about running at the same pace as its competitors. The question is whether this maverick will be able to achieve its goal of market and profit leadership. Choi, whose youthful, chin-up face reveals a man pleased with his accomplishments, happily accepts the challenge. "Once you are able to overcome the initial hurdles and build a momentum," he says, "then you keep on going, and it's quite difficult to drop out."

Abe De Ramos is executive editor, Hong Kong, for CFO Asia