Samsung, uneasy in the lead

By Eric Pfanner and Brian X. Chen, The New York Times | Updated: 16 December 2013 10:03 IST

Lee Kun-hee, the man who built the most successful, most admired and most feared business in Asia - a $288 billion behemoth that is among the most profitable in the world - had a message for his employees this year: You must do better.

At other companies, congratulations might have been in order. His companies were headed to another extraordinary year. But this was Samsung, the South Korean industrial group that Lee, an elfin man with a stubborn will, transformed from a second-rate maker of household appliances into a conglomerate with a flagship electronics business that has left most rivals eating its silicon dust. There would be no pat on the back for Samsung's 470,000 employees. Instead, in June, he sent a companywide email sternly urging them to raise their game.

"As we move forward, we must resist complacency and thoughts of being good enough, as these will prevent us from becoming better," Lee, who is 71, wrote. Samsung's management, he said, "must start anew to reach loftier goals and ideals."

Two decades earlier, having taken over the company from his father, Lee met with dozens of his executives and gave them a similar order, one that remains embedded in company lore: "Change everything but your wife and children."

That message was effective. Samsung's sales are equal to about one-quarter of South Korea's economic output. Samsung Electronics, the flagship, posted $190 billion in sales last year - about the same sales as Microsoft, Google, Amazon and Facebook combined.

Last year, Samsung shipped 215 million smartphones, about 40 percent of the worldwide total, analysts estimate; this year, it is expected to ship more than 350 million. Interbrand, a marketing consulting firm, ranked Samsung as the eighth-most-valuable brand in the world. Lee is one of the world's richest men.

(Also see: Quarterly smartphone shipments top 250 million for the first time)

The company's sweet spot has become electronics: It makes chips, display panels and many other electronic parts, and then assembles its own smartphones and other devices.

This kind of vertical integration has fallen out of fashion in the West, where it is considered unwieldy. While Apple designs its hardware and software, for example, the company buys chips from other companies, including Samsung, and outsources the assembly of iPhones, iPods and iPads.

But many years ago, Lee prodded his lieutenants to see the company's deep reach into the supply chain as a competitive advantage, not a burden. So far, it has worked for Samsung.

"I don't think people realize how effective a machine Samsung is in terms of how quickly they can turn around products in response to market change," said Chetan Sharma, an independent analyst who advises mobile carriers.

So why the crabby email? What on earth is Lee Kun-hee so worried about?

The ultimate follower
Lee is worried about what might be called the fast-follower problem. Samsung is a well-oiled machine: If it spots a trend and decides to compete, it can outspend and outpace practically anyone. Its everything-included, research-to-manufacturing-to-marketing model allows it to obliterate the competition.

But Samsung has become so good at executing that few moneymaking areas exist where it doesn't already dominate, particularly in electronics.

Suddenly, the company is the leader, with the onus of creating the next trend.

"If you are on the peak and looking where to go next - this is something new for them," said Chang Sea-jin, author of "Sony vs. Samsung: The Inside Story of the Electronics Giants' Battle for Global Supremacy."

"In the past, they didn't need a strategy because they always had somebody to look up to," he said.

Smartphones have been the major driver of Samsung's growth in recent years, and it doesn't take the instincts of Lee to grasp the fleeting nature of mobile phone leaders. The brands that plunged after reaching the summit are etched in the minds of everyone at the company: Motorola, Ericsson, HTC, Nokia, BlackBerry.

Moreover, upstarts from China are gaining ground with smartphones that cost hundreds of dollars less than Samsung's popular Galaxy S4 or an iPhone. Some of those Chinese brands have growing export ambitions; one, Xiaomi, recently hired a top Google executive, Hugo Barra, to lead its international expansion.

(Also see: Android VP Hugo Barra quits Google for China's Apple)

"There's a feeling of elation and paranoia at Samsung - 'Look at how well we are doing, and look at what might happen,'" said Benedict Evans, an analyst at Enders Analysis in London.

So Lee is pushing the company to think more boldly. Developing new products is no longer enough; Samsung wants to create devices that define whole new categories. And it wants to develop the software that makes them work, something it has mostly left to others.

Much of that work is happening in Digital City, the Samsung Electronics headquarters campus at Suwon, about 25 miles south of Seoul. Like all things Samsung, Digital City is massive: the size of 320 football fields, with room for 40,000 workers, not to mention the biggest parking lot in Asia. Inside its walls are many of Samsung's most tightly guarded secrets. The inner sanctum is R5, a pair of new 27-story, glass-sheathed office towers, where the company's mobile research and development program resides.

The R5 workers who pile into the building favor colorful polo shirts and dresses over the traditional Korean business uniform of black suit and white dress shirt, but R5 is all business. Samsung Electronics is expected to spend nearly $11 billion on research and development this year. This is where Samsung is plotting how to stay at the top of the lucrative electronics market.

A few months ago in an R5 conference room, Lee Young-hee, head of marketing for the mobile division, showed off some new products, including a new version of Samsung's Galaxy Note smartphone and a new smartwatch, the Galaxy Gear. This was before the devices were introduced to the public, but the real revelation was the talk about Samsung's overarching strategy.

"We would like to create a new trend," she said. "If you wear Galaxy Gear, it's a cool thing for young people."

Lee Young-hee is one of the important actors in the plot to change Samsung's reputation. A stylish former executive at the cosmetics company L'Oréal, she wears colorful eyeglasses and a bobbed haircut. Her English is sharp. She speaks in animated fashion about the future of mobile technology and Samsung's role in that future - sometimes to the point that her public relations aides remind her to be more discreet.

"We will make all the celebrities and important people wear it," she added, tongue slightly in cheek. "If you don't wear it, you will be obsolete."

Before Samsung assumes that role, though, the company must shake its lingering reputation as a fast follower.

Samsung executives bristle at the notion that its products are imitations. Yet many of them acknowledge that their company followed Apple into smartphones.

Legal decisions have underscored that reputation. Apple has successfully argued in one major case in California that Samsung infringed on a series of its patents, and now Samsung must pay Apple $930 million in damages. Both companies are set to go to trial in California again in March, for a case in which Apple accuses Samsung of infringing on a separate set of patents on newer Samsung devices.

Devices like the Galaxy Gear smartwatch are meant to position Samsung as a trendsetter, not a follower. Apple has been working on such a device, according to people briefed on the project, and it has registered "iWatch" as a trademark. But it has yet to show off a device bearing that name. With Galaxy Gear, Samsung beat Apple to the market.

Galaxy Gear "bridges the gap between the mobile device and fashion worlds to create truly wearable technology," J.K. Shin, who heads the Samsung mobile division, said before the device was released.

But Samsung is finding that setting trends is not so easy. The company put its full resources behind the watch, making a major marketing push with slick TV ads showing smartwatch-like devices used in movies and television shows by characters like James Bond. But the ads received a far better reception than the device itself. Technology reviewers largely panned it, criticizing its design and software features, and questioned why it existed at all.

Sales have been a bit better. Samsung said it shipped 800,000 of the watches in their first two months in stores, more than it expected. But how many of the shipped devices were sold to consumers remains unclear, and although analysts say Galaxy Gear has been the best-selling smartwatch on the market, no other smartwatch has sold well.

The company has struggled with other flashy new products, too, like televisions with curved screens that use organic light emitting diode, or OLED, technology.

Samsung is "certainly impressive from a technology perspective, and they may even be leading edge," said Ross Rubin, a consumer technology analyst for Reticle Research, "but very often they just seem to be flashy-gimmicky, or technology for technology's sake."

Those struggles - along with the intensifying smartphone competition - have disappointed investors. Shares of Samsung Electronics fell this summer before ticking back up. In a move to appease shareholders, last month the company told investors at a special meeting in Seoul that it would raise its dividend. Shares actually slipped on the news - investors had hoped for more - and they have barely budged since then.

A dependence on Android
Technology analysts and consumers often compare Samsung to Apple. But the elephant in the room in any discussion of the Korean giant is another American technology company: Google.

The vast majority of Samsung's phones run on Android, Google's operating system. Together, Samsung and Google have quickly taken over the global smartphone market. In the third quarter of the year, Android was installed on 81 percent of the mobile phones shipped worldwide, according to IDC, a research firm. That compared with 12.9 percent for Apple's iOS and 3.6 percent for Windows, the nearest rivals.

"Google created a product that helped Samsung make more money than all of Google," said Horace Dediu, an independent analyst in Helsinki, Finland.

That has been great for Samsung so far, but the downside is that the company has become more and more reliant on Google's software. As Samsung rode to the top of the mobile phone industry strapped to Android, the company sacrificed a degree of control over its mobile destiny.

More and more, smartphone hardware looks similar - glass touch screen, nice camera, a few buttons. That has often made the mobile operating system, apps and services - along with "soft" elements of the hardware, like the design and the user experience - the more important distinguishing factors.

"When someone buys our handset, we want them to be interested in the whole experience," said Hong Won-pyo, president of the Media Solution Center, the content and services arm of Samsung Electronics. "Combining excellent hardware innovation and software innovation - when you combine them neatly, the value will be maximized and the consumer will appreciate our products because we integrated them."

The combination of seamless hardware and software has been a crucial part of Apple's success. Once a user is dialed into Apple's system, it is hard to leave it for something else. Switching to an Android phone from an iPhone results in losing access to Apple's exclusive software, like its free text-messaging service, iMessage, or the plethora of third-party apps made only for iPhones.

This gives Apple the advantage of what some analysts call "lock-in" - an advantage that Samsung doesn't enjoy with Android, because Samsung users can always switch to another Android phone, like one made by Motorola, and get many of the same features.

For several years, Samsung has been conducting research on mobile operating systems. Last year, Samsung merged that work with an industry project called Tizen, whose partners include Intel and other technology and telecommunications companies. Samsung is expected to introduce phones running the Tizen operating system soon, in partnership with mobile operators like NTT Docomo of Japan.

While there has been speculation that Samsung's alliance with Tizen is a move to distance itself from Google, the company says it is merely trying to provide consumers with a range of alternatives.

"I don't think they can be a dominant smartphone operating system in the near term," said a former Samsung executive who insisted on anonymity to protect business relationships. "But it's an important step for Samsung to take at the moment. If they want a new success story, they will have to focus on the software side of things."

Tapping into Silicon Valley
One of the people behind Samsung's new software focus is David Eun, an outspoken Korean-American executive who has worked at AOL and Google. About a year after he joined Samsung Electronics in 2011, Eun suggested that some top Samsung executives fly over from South Korea for a road trip in Silicon Valley to visit companies in the world's software mecca.

"This was about trying to understand what makes these people tick in Silicon Valley," said Eun, 46, an executive vice president.

The road trip proved illuminating. Samsung decided it needed a stronger presence in Silicon Valley if it truly wanted to compete in software and Internet services.

That is why Lee Kun-hee, in perhaps his most ambitious undertaking yet, is trying to bring a bit of the culture of Silicon Valley to Samsung. In February, several months after the road trip, Samsung announced its Open Innovation Center, with offices in South Korea, California and New York. In the office in Mountain View, Calif., which is set up in a small two-story office building next to the Caltrain commuter rail station, Samsung employees search for startups to invest in, team with or acquire.

In July, the company bought Boxee, a startup that made an entertainment box with smarter television software. A partnership with Flipboard, the popular news-reading app, came through the Open Innovation Center. Now Flipboard comes installed on Samsung's flagship smartphones in the United States.

Eun also runs something called the Samsung Accelerator program, which opened in July in Palo Alto, Calif., and in September in Chelsea, the Manhattan neighborhood where many tech startups have sprouted. Samsung acts as the lone investor for startups in the program, treating their workers as its own employees, with full benefits, legal resources and insight into Samsung's product road maps. In exchange, the startups make their products exclusively for Samsung.

The Silicon Valley and accelerator programs suggest that Samsung is serious about embracing the creativity and collaborative spirit necessary for software development, and going wherever those creative minds live. But the big decisions will still be made in Suwon or Seoul, where a number of companies in the Samsung group have their headquarters.

"It's still very much a Korean company, with a very Korean mindset," said Chang, the author of "Sony vs. Samsung." "It's all about speed, efficiency and cutting the cost of production, none of which have anything to do with creativity."

Samsung's innovation drive coincides with a push by President Park Geun-hye to promote entrepreneurship and creativity. In her election campaign last year, she promised to bring "economic democratization" to South Korea.

That could be a tall order. The 30 biggest chaebol, or Korean conglomerates, accounted for more than 80 percent of South Korea's exports in 2010, according to the Federation of Korean Industries. All of them - like Hyundai and LG - have built up their production muscles over time, and Samsung is the biggest of the bunch.

Chaebol like Samsung were encouraged to grow in the 1960s and 1970s, under Park's father, the authoritarian ruler Park Chung-hee. In an effort to industrialize the economy after the devastation of the Korean War, the government provided cheap loans and favorable regulations. And until the financial crisis of 1997, South Korea was the leading example of Asia's so-called tiger economies.

Loosening the grip of the chaebol and the powerful families behind them, however, will not be easy. Since 1987, when Lee Kun-hee succeeded his father as chairman, he has led Samsung for all but two years. And Lee is expected to give control eventually to his son, Lee Jae-yong, who is a vice chairman of Samsung Electronics.

So far, deeply embedded Confucian values like a respect for family, tradition and hierarchy have helped Samsung play catch-up by instilling discipline and dedication in its workers. What remains to be seen is whether those same values will prevent the company from stepping outside the pack. Lee acknowledged as much in his June email exhortation: "We must create an environment of ingenuity, where autonomy and creativity abound."

Of course, no one blames the rigidity of Finnish or Canadian values for the downfall of Nokia or BlackBerry. Those companies were simply blindsided by Apple. Samsung was, too, but it managed to accomplish something they did not - it bounced back, stronger than ever.

And one thing is certain: No matter what, Lee will find reasons to worry - and his employees will hear about it.

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