Price Advanced Topics in Operations Management 502 Case Study

Price
Advanced Topics in Operations Management 502
Case Study: Samsung Electronics
Samsung Electronics—Case Study
A. Executive Summary
From its humble beginnings as a manufacturer of black and white televisions in 1968, the
Samsung Electronics company rose up to become the global market leader in the semiconductor
industry. In fact, it is so dominant, that it is in fact responsible for 22% of all Korean exports
(2004) and “represented 23% of total market value of the Korea Stock Exchange”. By 2004, the
Samsung Group’s (parent company) 212,000 worldwide employees worked together to deliver
net sales totaling $134 billion across its three business units (electronics, finance and track &
services). In short—they were doing something right.
(Please note that this case will only be exploring business issues within its electronics
units.)
Perhaps surprisingly (to those workers not in the electronics sector), Samsung Electronics
exhibited an extraordinarily high brand value ($12.6 billion), which placed it just behind Sony
in 21st place globally. These numbers would normally please any chairman, but not Chairman
Kun Hee Lee, who recognized the threats and opportunities that the emerging Chinese market
offered. He was mindful of the history of Samsung who had overtaken Japan in the market
space twenty years earlier by employing tactics eerily similar to those that the Chinese were
now employing. In fact, his decision was needed quickly. That is the focus on this case.
Over the course of this case study write-up, I will accomplish the following:
1. Present a summary of the competitive landscape & industry that Samsung Electronics
finds itself within,
2. Provide a brief overview of Samsung Electronics, in order to gain an richer appreciation
of its business challenges and issues,
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Advanced Topics in Operations Management 502
Case Study: Samsung Electronics
3. Identify the issues that Samsung Electronics faces and
4. Offer my recommendations as to the course of action that it should take.
We turn now to the first item on the agenda—an overview of the competitive landscape.
B. Competitive Landscape
The semiconductor industry essentially creates three types of memory chips—DRAM
(Dynamic Random Access Memory), SRAM (Static Random Access Memory) and Flash
memory. In 2000, the industry delivered $200 billion in sales with an annual growth rate of
16%. The sub-sector—memory chips—accounted for $33.7 billion of the aggregate total. It is
important to note that the memory industry is cyclical in nature (which affects both price and
revenue streams).
Over half of the total market for memory chips in 2003 could be attributed to the sale of
DRAM memory. However, the DRAM portion of the business was in the mature—if not
declining part of the product life cycle. From 1990-2003, the portion of DRAM utilized in PCS
dropped from 80% to 67%--approximately 1% per year.
SRAM (temporary storage memory) accounted for 10% of sales, whereas Flash brought
in 32% of the total (2003) and was predicted to grow significantly due to the rise in its use in
iPods, phones, cameras, etc. In contrast to SRAM memory, Flash memory maintained its stored
data when removed from a power source.
As is typical of nearly all electronics, prices tend to drop rapidly after product
introduction. Why? Because consumers know that manufacturers will introduce the next “best”
product, if only they wait a little bit longer. At that point they can either purchase the “next
generation” product at the higher price point or the previous generation product at a lower price.
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Advanced Topics in Operations Management 502
Case Study: Samsung Electronics
Generally, the memory industry is filled with price-conscious consumers. Remember this
point—it will come into play later.
Owing to the fact that each generation of memory chip/Flash built upon the previous
generation’s intellectual architecture, the number of firms with both the financial and working
knowledge the number of major competitors was declining.
OEMs (PC computer
manufacturers) customer base is extremely fragmented—none control more than 20% of the
market. Logically, this has led to certain marketing activities that will draw consumers to their
respective brands. In one such move, OEMs “pay upwards of a 1% average price premium for
a reliable supplier” of memory, as a defect in the memory would make the computer nonfunctioning—and destroy brand equity.
Chinese manufacturers began to enter the memory business in large numbers beginning
in 2005. These firms primarily competed at the low price point and with older generation
products, as to repeat an earlier point, they did not have a knowledge bank to compete within
the latest generations. This will become important in the Identification of the Issues section.
On the following page is a chart, which compares the highlights of the major competitors
in the industry sector.
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Advanced Topics in Operations Management 502
Case Study: Samsung Electronics
Major Competitors
Elpida Memory, Inc.
Hynix Semiconductor, Inc.
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Infineon Technologies AG
Micron Technology
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Nanya Technology
Corporation
Semiconductor
Manufacturing
International Corp. (SMIC)
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Highlights:
Japan’s only DRAM producer
Focused on memory products for mobile devices
Construction of $4.5 billion (second) wafer fab begun in
2004
South Korean company
Unlike Samsung, had difficult timing go-to-market
strategies with market realities—led to financial & market
share losses
Recent Chinese joint venture with ST Microelectronics for
memory production
Germany based
Historically, formed partnerships to reduce financial risk &
shorten time-to-market. Found success doing so.
Planning on investing $1.5 billion in the Asian market
Only US-based producer of memory
Acquired Texas Instruments’ memory division in 1998
Experienced many periods of “severe financial distress” in
26 years of business
96% of sales came from DRAM
$500 million investment from Intel for next-gen DRAM
development and research
Taiwan based
5th largest DRAM manufacturer
Partnered with IBM in 1998 to develop technology
Invested $2.2 billion for production facility near Taipei
Founded in 2000
Chinese company; headquarters in Shanghai (Only Chinese
firm in section at present time)
“…did not design chips…but rather, took designs from
other firms and produced chips based on blueprints.”
Partnered with Infineon to license its technology
Y02 to Y03 revenue increased from $50.3 to $365.8 million
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Advanced Topics in Operations Management 502
Case Study: Samsung Electronics
C. Samsung Electronics: Overview
The culture, as we will discover shortly is to be credited with much of Samsung
Electronics success thus far. One such culture trait is that of thoughtful risk—or taking into
account market and industry conditions, which may lead to a business decision that may appear
at first glance to buck conventional wisdom. This business philosophy has allowed Samsung to
go to market strategically, and armed with cutting edge products, a library of “legacy” products
and $66 billion in assets to “back up” its ambitious plans to remain number one in the industry.
Specifically the case study mentions five arenas—development of the memory business,
technology development, product mix, design and production, and human resource policies) that
I will now discuss.
1. Development of the Memory Business—Korea’s semiconductor industry was
founded in 1974 by Korea Semiconductor Company, which was later acquired by the Samsung
Group on the recommendation of Chairman Lee to his father (the chairman at the time of
acquisition).
The 1980s saw the Samsung Group bucking semiconductor industry trends during a
down market cycle. Instead from 1983-1985, Samsung funneled $100 million into DRAM
development, while the rest of the industry was significantly reducing its R & D spend. It is
important to note that at that time, “it cost $1.30 to produce a single 64K DRAM chip, whereas
market prices were at that time below $1.00.” In effect, a company needed to lose money to
gain market share.
With an eye towards anticipated significant DRAM market growth,
Samsung gambled and as a result, began to overtake the Japanese in the market.
Another portion of their success came from tight project & operations management. For
instance, most new fabs took upwards of 18 months to build—Samsung built one in six,
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Advanced Topics in Operations Management 502
Case Study: Samsung Electronics
spreading out its workforce over each hour in the week so that time was not wasted. This was
even more impressive when one considered the difficulty of such an undertaking. In fact, the
ever-increasing cost of creating a chip manufacturing plant from scratch was increasing at such
a level that it was difficult for new market entrants to emerge without financial backing (as the
Chinese were beginning to do).
2. Technology Development—To repeat a recurring theme in this write-up, Samsung
needed a partner to get its chip memory business off the ground in the early 1980s. It paid
Micron to license its DRAM technology and teaching it “how to produce 64K DRAM”. After
initial success, it formed two competing (but cooperative) development teams to create the next
generation. In essence, they were quickly building their knowledge bank.
When development of 4Mbit DRAM memory emerged manufacturers needed to decide
whether to utilize stacking (building up the chip) or trenching (building below the chip) in order
to fit all of the necessary cells on the chip. While most of the industry went with trenching,
Samsung once again bucked the trend and decided to focus its efforts on stacking. Chairman
Lee assumed (correctly) that it would be easier to spot problems than with trenching, as
everything that needed to be seen was in plain sight. After committing billions of development
dollars into trenching, IBM, Toshiba and NEC lost both market share and development time as
it tried (in vain) to catch up to Samsung (and Hitachi) who by the early 1990s were the market
space leaders.
Further, Samsung took a significant additional risk in its development cycle by being first
to market with 8-inch (chip wafer) boards, which allowed more chips to be cut at time, thus
saving time and money. As a result of its thought leadership, Samsung finally gained its much
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Advanced Topics in Operations Management 502
Case Study: Samsung Electronics
sought after number one position in the industry—which at the time of this case study, it had
held for 13 years straight.
3. Product Mix—Samsung once again defied industry convention (DRAM is viewed as
a commodity) by bringing over 1,200 variations of DRAM to the market at any given time.
Much of time, of course, resulted from customization of existing (and new) offerings for
specific companies. However, what is interesting is that Samsung continued to offer past
generations as “legacy products”—and charged much more for them.
Logically, the
supply/demand economics imply that less demand for these products would allow a higher price
point, although I suspect that it’s a bit more than that. I suspect that by offering such products,
Samsung took the view that customers would pay a premium for hard to find “space parts” that
were no longer mass-produced.
Owing to the fact that the growth rate of DRAM is closely associated with PC sales,
which had become “a mature, single-digit growth market” Samsung sought to increase its
commitment to (and sales of) Flash memory, which was seen as a product with both anticipated
double digit growth and relatively high market prices for the foreseeable future. Additionally, it
sought to reduce R & D time from 18 months to 12 months for Flash memory under the new
Hwang’s Law that its president had originated.
4. Design and Production —A significant factor behind Samsung’s success was a
commitment to sustainability and repeatability, although not specifically mentioned in the case.
In much the same manner where car manufacturers utilize one “platform” for various cars, in
order to get to the most bang for their buck, so to speak, so too did Samsung do this with their
DRAM which often shared a “common core design”.
Samsung could then leverage this
common core to further differentiate itself from competitors by allowing for customizations.
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Advanced Topics in Operations Management 502
Case Study: Samsung Electronics
Another point for differentiation for Samsung was that all of its manufacturing was
completed in a single facility near Seoul, South Korea. Its competitors lost the advantage of
economies of scale and shared (local) knowledge by having sites all around the world.
Additionally, “Samsung was estimated to have save an average of 12% on fab construction
costs” by utilizing the single location strategy for its manufacturing.
Somewhat strangely (at least from an American perspective), all of Samsung’s R & D
and production engineers lived in the same company-provided housing. Think about that for a
moment—these workers literally lived and worked with their colleagues 24 hours a day. A
pessimist might assume that would translate into burnout, but it is important to note that Asians
cultures often have a different opinion on personal space preferences & loyalty to one’s
company. In contrast, this could lead to stronger trust and collaboration between colleagues—
and result in better products, production cost savings and increased commitment to the company
mission.
5. Human Resource Policies—Again bucking tradition (this time Korean traditions),
Samsung hired staff based on aptitude tests, rather than whether an applicant went to a
prestigious school or grew up in the “right region”. In effect, Samsung wanted to hire the
brightest minds regardless of where and how they grew up. Recruitment also went beyond the
South Korean borders.
Samsung actively recruited top talent from around the world—
especially within the executive ranks.
Additionally, promotions were given to those who placed in the top tier of a yearly
evaluation twice in three years—not seniority. Again, this was against Korean traditions.
Its culture is one in which it rewards success, yet does not get rid of employees who fail.
In essence, it’s a learning, supportive culture.
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Advanced Topics in Operations Management 502
Case Study: Samsung Electronics
Samsung covered 90% of the cost of expenses for employees and their families for such
items as healthcare, education and retirement, however salaries at the firm hovered around the
50th percentile ($44,000) in the industry, with SMIC (China) at the low-end ($10,800) and
Infineon ($72,400) at the high-end.
Wages at Samsung were supplemented with three types of incentives:
(1) Project
Incentives: Cash (a few thousand to $1 million) for successful launches spread out amongst the
project team; (2) Productivity Incentives of up to 300% of base salary; and (3) a Profit Sharing
Program, up to 50% of base salary.
Next, we turn to the identification of the issues suggested in the case.
D. Identification of Issues
Samsung Electronics’ management team essentially faces two central decisions
according to the case, as it begins to take steps to control the Chinese market space and limit the
influence of emerging Chinese manufacturers: (1) Actively collaborate with a Chinese partner
or (2) Increase its R & D spend “in cutting-edge memory products, particularly for new niche
markets”.
It is extremely important to note that China is in effect, in a very similar situation as
South Korea found itself in twenty years prior—essentially, that it would do just about anything
to ensure a piece of the growing semiconductor industry. As the Koreans did before them, the
Chinese are more than willing to commit to years of business losses, if that translates into
significant market share in the top echelon.
China is attracting billions of dollars in seed money to begin semiconductor companies
owing to the fact that it is estimated that by 2010, it will be the second largest consumer of such
products. In short, it is a monster market just waiting to be tapped.
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Advanced Topics in Operations Management 502
Case Study: Samsung Electronics
Actively Collaborate with a Chinese Partner—Samsung has thus far resisted investing
in China, despite the opportunities for growth.
majority of its competitors.
This, surprisingly, is in line with the
And not without good reason—China does not fully protect
intellectual property rights. In effect, Samsung runs the risk of a Chinese partner stealing its
collected knowledge once it feels that it has learned enough and then turn around and
become a major competitor. This doesn’t strike me as a bargain for Samsung.
On the flipside, the Chinese government will “provide cheap credit, abundant land, cheap
utilities, engineering talent, tax incentives and other essential resources to anyone who
wanted to build a cutting-edge semiconductor facility with a Chinese partner.” Admittedly
tempting, but incredibly shortsighted. A partnership is not an acquisition. The Chinese
firm would remain a separate entity, and most assuredly at some point will decide to break
ties with Samsung to embark on their own business journey—and the knowledge that
Samsung taught it.
Additionally, China is a communist country. Everything is state owned. If Beijing
decides that Samsung is no longer welcome, then with a wave of its hand, Samsung would
need to leave the country, leaving the spoils to the Chinese. It is a bit too uncertain for my
tastes.
However, I do not buy the argument that shifting Samsung’s culture over to China (even
in partnership) would translate into a failed business, stemming from Samsung’s unique
business culture centered in Korea. In fact, it may be more successful in doing so. I am
swayed into believing this when I consider Samsung’s R & D teams that were made up of
Americans and Koreans (in the United States and South Korea). They were successful and a
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Advanced Topics in Operations Management 502
Case Study: Samsung Electronics
Chinese/Korean pairing (in a similar capacity) would likely also be successful. In fact, the
Chinese may be able to offer a unique perspective on design challenges or similar capacity.
Increase R & D Spend to Grow Niche Markets—At the present time, with many of its
products Samsung is the low-cost and productivity leader. By selecting the previous option,
Samsung would essentially be teaching the Chinese how to accomplish this as well—thus
setting up the potential for a future competitor. Not a scenario that would be welcomed by
Samsung.
There is also the option to abandon the low-end market and invest more into the high-end
niche market. Let that settle in for a moment. What this option is essentially advocating is
that Samsung abandon the highly effective go-to-market strategy that vaulted it into the
global market leader position to focus on niche-markets (in China) that would entail
spending significantly more R & D dollars in order to make it workable. In short—stop
doing what it does best. Huh?
I categorically do not accept this as a valid option. (1) Why does going after a high-end
niche market necessarily translate into the need to cede the low-cost market? Samsung has
successfully catered to both markets across the globe. (2) Samsung produces memory.
Memory must be put into an end product for it to be a functional entity. With no end
product, the memory chip just sits there and does nothing. Since China is not a large
producer of (Chinese manufacturer) PCs, cameras, etc., who will be buying the memory
chips that are to be produced there in either event? Most end products of this nature tend to
originate in either Japan or the United States.
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Advanced Topics in Operations Management 502
Case Study: Samsung Electronics
E. Summary Recommendations
Typically, in this section, I will choose the best alternative solution amongst several. In
truth, however, I do not find either option very appealing. On one hand Samsung could partner
with a Chinese firm and have absolutely zero insurance that its intellectual property rights
would not be stolen and a competing Chinese firm rising out the “partnership ashes” as a result.
On the other hand, it would just be lunacy to cede a market segment to the Chinese that
Samsung has been the market leader within for over 13 years. That doesn’t make any sense to
me either.
So what should Samsung do?
1. They should continue to maintain a wide product line in order to serve each segment of
its consumer base that it is currently serving. It has been highly successful for them.
Why should they stop now? They shouldn’t.
2. As the Chinese are able to get their hands on product whether or not you directly sell it
to them, it doesn’t make any sense (financially) to not sell to them. However, they
should not manufacture the product in China. Chips are lightweight and thus relatively
inexpensive to ship. South Korea isn’t a significant distance from China. If China is
indeed expected to become the global #2 with respect to purchasing semiconductors in
2010, they’ll buy them whether or not they are produced in China.
With this
recommendation—while they would access to the chips, they would not acquire the
knowledge in how to manufacturer them. The counterclaim will consider that the chips
could be reverse engineered. True. But that would take time—time for which a 12-18
months product life cycle does not allow. In effect, they would consistently be behind in
the development cycle.
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Advanced Topics in Operations Management 502
Case Study: Samsung Electronics
3. It would be advantageous for Samsung to begin R & D in the next “big thing” in
memory. DRAM and SRAM are in declining market cycles and Flash will not be in
double-digit growth forever. From its electronics B2B customers, it should seek out
primary data as to what their business requirements are and develop a new industry
“standard” that would meet those needs. First to market, could mean significant profits
down the road.
4. Keep a close eye on China. The reality is that eventually one of Samsung’s current
competitors is going to partner with a Chinese firm—and when that happens, all bets are
off. China will become a serious market competitor. Samsung would be served well to
have planned for this contingency both in marketing messaging and go-to-market
strategies. However, it should not deviate from its current way of doing business at this
time.