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Korea's Unstoppable Conglomerates

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Korea's Unstoppable Conglomerates

Source:Ming-Tang Huang

The global market share of South Korea's biggest companies is on the rise. How have these chaebols managed to stay both big and flexible, and why are they so competitive?

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Korea's Unstoppable Conglomerates

By Hsiao-Wen Wang
From CommonWealth Magazine (vol. 448 )

South Korea attained a major milestone recently when it finished ahead of archrival Japan for the first time ever in the annual competitiveness rankings of the Lausanne-based International Institute for Management Development (IMD).

Though the result may have come as a surprise to some, the Japanese had already noticed the ascendance of its East Asian neighbor. The weekly magazine Nikkei Business ran a cover story early this year called, "Secrets behind the Rise of Korea's Big Four," revealing how Japanese companies are stooping to learn from South Korea's Samsung Electronics, LG Electronics, Hyundai Motor Company and steel giant Posco (Pohang Iron & Steel Co.).

Engulfing the Globe

At a time when mobile phone giants Nokia, Motorola, and Sony-Ericsson were seeing their market share slide, Samsung and LG bucked the trend. Over the past three years, the global market share of Korean handsets has jumped to 30 percent from 25 percent.

In the global LCD TV market of nearly 150 million sets, Samsung and LG have assumed dominance over perennial leaders Sony, Panasonic and Sharp. Last summer, Sony's average LCD TV price fell below Samsung's for the first time ever. Soon after, LG's market share surpassed venerable Sony's, giving it the second highest global share in the industry. In merely three years, the global market share of Korean LCD TVs has risen from 27 percent to 37 percent.

Korean companies, which had already swept through the global TFT-LCD and DRAM sectors, took advantage of the economic meltdown to widen their lead. Samsung's capital expenditure is an unprecedented US$16 billion this year, more than Intel, IBM, and Sony combined. Of that, Samsung's investment in memory chips is more than four times the combined investment of Taiwanese DRAM makers Inotera Memories, Nanya Technology Corp., Powerchip Semiconductor Corp., and ProMOS Technologies.

These outstanding results beg a few simple questions: When American and European firms were wallowing in losses, how were Korean companies able to remain both big and flexible? And what special skills do Korean CEOs possess that have enabled them to steadily steer their giant battleships?

The answer can be found in the huge conglomerates that Koreans cannot figure out whether to love or hate – the chaebols.

Chaebols as Instruments of Government Policy?

The revenues of Korea's 30 biggest conglomerates account for 70 percent of the country's GDP. Kim Sang-Jo, an economics professor at Hansung University, says that based on public information filed with South Korea's stock exchange, the assets of the top four conglomerates (Samsung, Hyundai, LG and SK Telecom) amount to 50 percent of the country's GDP, and their capital expenditure represents 35 percent of the country's total investment.

"Chaebols are the Janus face of the Korean economy," says Kim, who as executive director of nonprofit group Solidarity for Economic Reform has sued Samsung and Hyundai on behalf of small shareholders. Seated in his simply appointed office, pensively lighting a cigarette, Kim muses on South Koreans' conflicted feelings toward their country's corporate giants – they are proud that the chaebols have become global leaders, but also disgusted at their corrupt practices, tax evasion, breach of faith, and illegal transfer of company assets.

To this day, these tenacious, stubborn giants remain the key levers used by South Korea's government to prop up the economy, as has been evident in its exchange rate policy. In just six months in 2009, the Korean won depreciated by 60 percent against the U.S. dollar, and the central bank's benchmark interest rate fell to 2 percent from 5.25 percent. The big Korean conglomerates saw their exports surge, and their cost of capital was cut in half.

"If the won had not depreciated, it would have taken longer for the Korean economy to recover," says Goohoon Kwon, the executive director of Asia Investment Research at the Seoul branch of Goldman Sachs (Asia), who previously worked at the IMF for 10 years. "If the won didn't depreciate, the only chance for Korean enterprises to increase profits would have been cutting down staff, which would have only deteriorated domestic demand," Kwon says, exposing the close relationship between the government and the chaebols.

Secret 1: Managing the Balance Sheets

Though the chaebols have been buttressed by government policies, they have also greatly improved their own capabilities. Compared to the last Asian Financial Crisis, when the credit crunch hit in 2008, they were much more adept at managing their balance sheets to improve their staying power and flexibility.

In the 1990s, the Daewoo Group relied on raising debt overseas to expand into foreign markets and counted on a "hostage" strategy and fears that it was "too big to fail" to threaten the government to rescue it. But the strategy failed, and Daewoo declared bankruptcy in 1999 before being restructured. There was also the case of heavily indebted Hyundai, which was forced to split up in exchange for a government bailout 13 years ago.

But traces of these unscrupulous corporate practices rarely appear today.

"We are in an era with the best management since the Korean War," Sim Shang-Bok, president and publisher of Forbes Korea, observed. The debt-to-equity ratio of Korean companies has fallen from 425 percent at the height of the financial crisis in 1997 to 112.8 percent.

Five huge LCD screens loom large in the office of Lee Ju Hyuk, CFO of Hyundai Card Co. Accompanied by a fine view of the country's National Assembly building, these screens surround Lee and constitute the war room of Hyundai Card, which last year had revenues of 1.8 trillion won (NT$52.1 billion) and income growth of 11 percent.

Every morning at 7:30 when Lee arrives at his office, he first looks at three numbers: cash flow, transaction volume and return on assets. Under the glass cover of his desk are lists of investors from the most recent two weeks and sources of capital. The five big screens show that debt portfolio volume is US$19 billion.

"CFOs are easily trapped into borrowing a lot of short-term loans and issuing a lot of asset-backed securities," Lee says sternly, as though advising a client.

But Hyundai Card's exposure to relatively cheaper short-term debt is not allowed to exceed 40 percent of the company's total debt, and the maturities of loans must be 10 percent longer than those of assets to ensure that loans can be repaid without trepidation. Lee has also established a rule that less than 20 percent of total assets can be devoted to asset-backed securities (such as car loan, mortgage, or credit card loan securitizations), which are popular in his industry for their ability to raise asset liquidity, but also carry high risk. Most noticeably, Hyundai Card and sister company, Hyundai Capital, had a credit line of US$1.4 billion in 2009 and did not touch a dime of it.

These risk management guidelines were installed by Hyundai Card deputy CEO Bernard van Bunnik after the company was formed as a joint venture between Hyundai Motor Group and GE Capital, which invested US$3 billion in HyundaiCard and Hyundai Capital. Every month, Bunnik, Lee and the company's CEO hold a risk management meeting.

This comprehensive risk management has enabled Hyundai Card to grow eight-fold in nine years in the South Korean market, where the average person owns 4.2 credit cards, and along with its sister company, Hyundai Capital to generate a higher margin in 2009 than the country's biggest bank, Kookmin Bank, despite being one-tenth its size.

Secret 2: Staying in Markets through Thick and Thin

The staying power of Korean conglomerates, the second key to their success, can be attributed to not giving up easily after getting involved in an industry or business, and taking advantage of crises to expand.

Kang Hong Sik, the head of the Korea Electronics Association's Marketing & Exhibition Team and a 30-year veteran of the information industry, has witnessed first-hand the country's steep and rugged climb from seller of cheap goods to maker of global brands.

"In industries where it's winner-takes-all, where there is competition over capital, size and costs, South Korea will be resolute to the end," says Kang.  

The DRAM sector is another long-time field of battle. In the first quarter of 2009, at the peak of the financial crisis, Samsung Electronics' semiconductor business lost 670 billion Korean won (NT$18.5 billion), but though it was losing money, it continued to invest. In the first quarter of 2010, however, when DRAM prices began to rebound, Samsung's semiconductor business earned 1.9 trillion won (NT$54 billion).

"In such a volatile business cycle, Philips would have pulled out of semiconductors, but Samsung stuck it out," Kang says admiringly of Samsung's perseverance.

Hyundai Kia Automotive Group also expanded while the global economy was weak and others were retrenching. In the third quarter of 2009, before the U.S. economy began to regain momentum, Hyundai Kia chairman Chung Mong Koo announced the company would invest US$1 billion to build a Kia plant in the U.S. state of Georgia with an annual production capacity of 300,000 cars a year. The first vehicle to be produced on the line, the US$19,999 (NT$640,000) Kia Sorento, was custom-designed for the U.S. market, and it has since carved into the market share of Toyota's RAV4 SUV.

So how are Korean conglomerates able to withstand losses and persevere to the end, even to the point of expanding in a down market? Ultimately, the main reason – the concentrated shareholder structure – is not very inspiring.

When Kim Sang-Jo, of Hansung University, turns on his computer to access public information on the Korea exchange, a dense array of tiny numbers pops out on the screen – the shares of affiliates of the big four. The family of Samsung chairman and CEO Lee Kun-hee directly owns only 3 percent of the company's shares, but through circular ownership, Lee and his family control 17 percent of the voting shares.

The family of Hyundai Kia chairman Chung directly controls only 5 percent of the company, but again through circular ownership, his family holds 26 percent of the voting shares. The family of the founder of South Korea's third biggest conglomerate, LG Electronics, controls 48.6 percent of the voting shares, and the family of the founder of the fourth biggest company, SK Telecom, controls 32 percent.

"When chaebols make important decisions, the chairman himself has the final say. The decisions rarely go under the review of a board meeting or a shareholder meeting. Shareholders' opinions are far less crucial than the chairman's," Kim says. He calls this form of corporate governance "chairman dictatorship," and cites another case involving Hyundai chairman Chung Mong Koo, who removed five deputy board chairmen in less than two years.

"The advantage of ‘chairman dictatorship' is fast and good execution. The disadvantage is that once the chairman makes a wrong decision, then every shareholder bears the consequences," Kim says, citing the case of Samsung, which once got into the car business to fulfill the dreams of Samsung chairman Lee Kun-hee. But Samsung Motors became insolvent during the Asian Financial Crisis and was later taken over by Renault.

Secret 3: Rapid Expansion into Emerging Markets

The third key to the dramatic rise of Korean conglomerates on the global stage is their rapid expansion into emerging markets in recent years.

"Ten years ago, Samsung and Hyundai rarely had significant investment overseas, but now Samsung, Hyundai, and LG have all quickly gone global," says Goldman Sachs' Goohoon Kwon.

In 2009, a record 70 percent of Korea's exports went to emerging markets. A Goldman Sachs report noted that more high-tech products were sold to BRIC countries (Brazil, Russia, India and China) last year than to the United States, Japan and Europe for the first time ever. Just five years ago, the picture was reversed, with Korea shipping five-times more high-tech goods to the three advanced economies than to emerging markets. 

Korean companies have also proven to be adept at quickly identifying "local" needs in new markets. LG long had a reputation for selling cheap home appliances, but it has recently relied more on innovation. Last summer, it teamed up with universities and health authorities in India to develop an ultrasonic air conditioner that can get rid of the mosquito that carries dengue fever, and the appliance has become a big hit.

Two years ago, it released a plasma TV in the Middle East with embedded software containing all 114 chapters of the Koran. The 42" plasma TV, which comes with a hard disk and can even recite the Koran out loud, sold for only slightly more than other flat-screen TVs and gradually became a hot item. The innovation helped LG capture a 40 percent share of the plasma TV market in the Middle East in 2009.

The only problem for the chaebols is that their growth model has limitations, as Kung Ming-hsin, the vice president of the Taiwan Institute of Economic Research, contends.

"Korean companies can become the world No. 1 in mass-produced standardized commodities. But they are not capable of using innovation to dominate the globe. That's why South Korea cannot produce companies like Intel," Kung says. 

In the field of smartphones, for example, the technology of Taiwan-based HTC remains superior to that of Samsung and LG. In the North American battleground for LCD TVs, U.S.-based Vizio, an affiliate of Taiwanese TV maker Amtran Technology, has held its own against Samsung. Learning from the example set by Acer Inc., Vizio has farmed out its manufacturing to concentrate on brand marketing and actually outsold Samsung, which does everything itself, in the U.S. market in 2009.

"Taiwan is one big Samsung. But the whole of Taiwan does not use the power of one conglomerate to maintain control. Instead, it must rely on industry consensus where divisions of labor naturally emerge in every area and become the source of Taiwan's overall strength," says Acer founder Stan Shih, who has always opposed Taiwan's following the Korean model.

"Taiwanese people can still sleep at night, but Koreans can't," Shih says, "because South Korea only has Samsung and LG. The moment something goes wrong at Samsung or LG, South Korea is finished. Taiwan has a lot of Samsungs, so I don't care if one of them has a problem. That's the Taiwan model. The reason it's the more correct model is because it captures the spirit of democratic politics and diversity."

Translated from the Chinese by Luke Sabatier

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