Samsung Electronics Strategic Analysis

Executive Summary Whirlwind Consulting Company has reviewed the current position of Samsung in the semiconductor and memory chip industry, and has completed an extensive internal and external analysis to determine Samsung’s options in response to the threat of significant future expansion within the Chinese semiconductor industry. It is our opinion that Samsung should begin an incremental decline in the production of low-end DRAM memory chips, and initiate an extensive strategic movement towards capturing the higher-end of the DRAM market, as well as new niche markets, such as Flash memory.

The external analyses showed that there are many competitors that have begun to focus solely on production of low end DRAM. The greatest threat observed is the rampant growth of the Chinese company SMIC, which comes as a result of low-cost production and tax-incentives from the Chinese government. The primary recommendation that resulted from this analysis is that the low-end DRAM market has become overcrowded, while the high-end market is currently occupied by only one major competitor, Eplida Memory.

The internal analyses were a clear indication that Samsung’s current organizational structure, policies, and business strategy are all competitive advantages. The conclusions drawn from the SWOT analysis were that Samsung’s strengths carry more weight than your weaknesses, and that the opportunities that exist, if properly exploited, should help Samsung navigate the threats with no significant difficulties.

The financial analysis was also an indication of the exemplary track record of Samsung Electronics, most notably the semiconductor division. Our opinion is that Samsung should have no financial difficulty with shifting your concentration to a new segment of the memory chip market.

It is the recommendation of Whirlwind that the implementation of this strategic shift should occur in two phases. The initial phase will be a concentrated focus on R&D and informing channel partners of the upcoming changes. The second phase will be the restructuring phase. Both production structure and employee structure will need to be shifted to facilitate the manufacture, advertisement, and sale of the new focus for Samsung’s memory chip business. Current Issue

Samsung Electronics has been a model example of success in the constantly shifting technology industry over the last twenty years. Samsung has risen to the top of the semiconductor sector of the market, and has enjoyed the largest market share for over thirteen years. However, as a result of the success of all sectors of the technology industry, it does not usually take long for new competitors to enter any portion of the market.

Similar to the way that Samsung entered the semiconductor industry over 15 years ago, several companies in China have been working diligently to obtain market share at the expense of Samsung. Through mainly low-cost production, these Chinese companies pose a threat to the leading segment of Samsung’s semiconductor business, the 256Mbit DRAM division.

As of 2003, the 256Mbit DRAM production, shown in Table 1, represented 78% of Samsung’s manufacturing process. Some analysts have estimated that by 2010, China will be the world’s second largest producer of semiconductors behind the United States. The issue facing Samsung is how to deal with this newly developed Chinese semiconductor industry. The future of Samsung will depend on how it evolves in response to this imminent change to the structure of the global semiconductor market. Competitor Analysis

Samsung has five major competitors within the memory chip industry. They consist of the following: Elpida Memory, Hynix Semiconductor, Infineon Technology, Micron Technology, and Semiconductor Manufacturing International Corporation (SMIC). All these companies have unique characteristics that are outlined in Table 2, and described below.

Elpida Memory is the only DRAM producer left in Japan. Their strategic focus is on memory chips for smaller devices, such as cell phones, gaming systems, and other consumer electronics. In 2004, they added another production facility in an attempt to increase output, and increase market share. Elpida manufactures advanced memory technologies, like double data rate (DDR) DRAMs and Rambus-based DRAMs, in addition to standard memory modules. They have investment ties to Nintendo, Hitachi, and Intel.

Hynix Semiconductor is the second largest memory chip manufacturer in Korea behind Samsung. Hynix has suffered over the last 6 years as a result of poor economic decisions, and legal troubles in the United States. Hynix still manufactures DRAM and other standard memory chips, but sold most of their other businesses to avoid bankruptcy as a result of their former debt. Despite financial troubles, Hynix has recently decided to collaborate with a Chinese company to build a new production plant in China. Hynix accounts for almost two thirds of the memory chip sales in Asia.

Infineon Technologies is a German-based company, and has manufactured semiconductors since the start of the technological revolution. Infineon has more than 25 locations for research and development spread all over the world. They have significant financial and business development ties to various smaller memory chip companies.

Three quarters of Infineon’s sales are in Asia and North America. Its primary product is DRAM. Infineon’s top customers are Hewlett-Packard and Dell, two of the largest home and office computer suppliers in the world.

Micron Technology is the only remaining US producer of memory chips. They have grown in size mostly through acquisitions and mergers. Micron has also had some financial difficulties and has been forced to sell most of its non-DRAM divisions. Micron sells to companies in telecommunications, but the majority of its sales are in the computer market, mainly Dell and Hewlett-Packard. More than half of Micron’s sales are in Asia, while the United States accounts for 30% of sales. Micron has financial ties to Intel, and is currently researching and developing new-generation DRAM technology.

Semiconductor Manufacturing International Corp (SMIC) is China’s largest producer of logic and memory products. SMIC is a foundry for semiconductor technology. A foundry implies that they do not engineer the technology for the memory chips, rather they use designs from other companies and manufacture duplicates. SMIC has license agreements with Motorola, Infineon, as well as Elpida. SMIC has grown significantly since its inception in 2000.

This growth can be attributed to large contributions from Chinese and foreign investors, as well as considerable tax breaks from the Chinese government. This has given SMIC the opportunity to sell their products at a lower cost in exchange for additional market share. SWOT Analysis

We have analyzed Samsung Electronics, and have determined its strengths, weaknesses, opportunities, and threats. The results are outlined in Table 3, and are described below.

Strengths •Market Share: Samsung currently is the world’s largest producer of DRAM memory chips, and has continued to stay atop the industry for over ten years. •Product Reliability: One of the company’s key competitive advantages is the stress that CEO Lee places on quality. This is evidenced by the large number of awards won for reliability and performance from almost every major customer.

•Manufacturing Process: All of Samsung’s manufacturing is performed in Seoul, South Korea. This has provided cost savings from collocation and scale of investments for the production process. •Human Resource Policy: Samsung covers 90% of the expenses associated with health benefits, retirement, and education. They also have a rewards system based upon achievement, and they promote based upon merit, not achievement. This has created a healthy competition within the corporate culture, and has greatly benefited Samsung.

Weaknesses •Market Volatility: The technology industry is generally susceptible to changes in national and global markets. Samsung has dealt with economic downturns relatively well in the past, but there is no way to determine if current actions will help them in future economic recessions. •Diversification: Despite having the largest selection of DRAM products, Samsung is generally not diversified outside of its industry.

The majorities of products produced are considered commodities, and as described above, can be greatly affected by shifts in the economic environment. •R&D costs: As with the rest of the technology industry, R&D is essential to remaining ahead of the industry. Samsung devotes around 10% of their net revenues to R&D. If these R&D efforts do not pay off, Samsung will have trouble staying on top of the market in the future.

Opportunities •Chinese Market: Samsung has a chance to benefit from the large growth of the technology manufacturing sector in China. The labor costs are less than Korea, and tax incentives are available from the Chinese government. There are some risks, such as copyright infringement, and Samsung will have to weigh these risks against the opportunities available in the future. •Globalization: Worldwide trade has grown astronomically over the last ten years, and should continue to grow as emerging economies enter the market. Trade agreements throughout North America, Europe, and Asia have also facilitated this growth.

Samsung is able to market its products across a much larger base of customers than ever before. The growth of the Internet has also helped to facilitate business transactions, and has made multi-national sales almost effortless. •Flash Drives: The flash drive market is expected to grow at double digits rates for a number of years to come. Whereas the DRAM demand has slowed, the flash drive demand has remained at a high level. With this larger demand, Samsung can continually capitalize on higher prices, if they devote the R&D required to keep up with the flash drive market.

Threats •Chinese Substitutes: As the Chinese market can be an opportunity for Samsung, it can also be considered a potential threat for the same reasons. Low labor costs and tax incentives for the technology industry have attracted investors to China, and could create a lower cost market for DRAM and other memory chip products. Chinese quality is an issue, but as with most markets, low-cost production tends to outweigh quality issues. •Computer Market:

The computer market has reached its maturity stage which indicates that the growth has slowed to a constant, low rate. This could create increased competition as the large consumers in the market try to lower costs to increase profits, in an attempt to offset the slowed growth. •Changing Industry:

As new products emerge on an almost monthly basis, the technology industry is in a constant state of change. Technology companies invest significant portions of their cash flow into R&D in order to create newer, better, and more unique products than their competitors. As semiconductors are a component of finalized goods, Samsung needs to constantly be aware of new products and companies that the market will shift towards. Financial Analysis

Some financial data is available on the semiconductor division of Samsung and is outlined in Table 4. As a division, Samsung semiconductors have been an extremely healthy part of the umbrella Samsung Electronics. From 1999 to 2003, revenues grew 59.6% from $22.8 billion to $36.4 billion. While COGS and R&D have also increased, they have not increased enough to stifle net income, which enjoyed growth of 79.7%.

Net debt has been decreasing over the same time period, from $3.9 billion to -$5.7 billion, or -243%. These are all indicators of strong financial positioning. The revenue growth comes as a result of the successful strategic investment during the rapid growth stage of the DRAM industry. The initial investments made prior to 1999 were all recovered during the next five years, as shown by the negative net debt.

The success of the semiconductors division has helped to keep the entire Samsung Electronics Company a healthy and profitable corporation. The ratios outlined in Table 4 are all based upon the financial statements of Samsung Electronics. Similar to the results of the semiconductor division, Samsung Electronics enjoyed healthy profit margins, an increasing net margin, and decreasing debt ratios.

In 2004, the current ratio dropped below zero, which would normally be an issue for investors. However, the current ratio is 1.23 which indicates that Samsung has a large inventory, and since the inventory turnover ratio of 9.08 is healthy, the fact that the current ratio is slightly below zero is not a problem. Potential Options

Our organization has indentified three options that Samsung Electronics could pursue in response to the threat of Chinese entrants into the DRAM market. The options are as follows:

1)Cooperate with Chinese companies and invest in growing Chinese DRAM market. 2)Decrease production of low-end DRAM and concentrate on specialized high-end portion of memory chip market and new niche products. 3)Ignore growth of Chinese market, and continue to manufacture same type and volume of DRAM products.

The pros and cons of each option are described below.

Option #1 Cooperation with Chinese companies ProsCons •Low Cost production will help abate lower prices •Potential for Continued Growth in Market •Potential to attract investors to Samsung through relationships developed in China•Potential for copyright infringement and loss of technology secrets through corrupt business practices observed in China •Risk of political troubles in China

•Investing in a sector of the industry that is expected to have negative growth in prices over the next 5 years

Option #2 Invest in High-End Memory and Other Niche Markets ProsCons •Ability to capitalize on growth of new sectors of the industry, i.e. Flash memory •Utilization of existing low-cost business practices to continue to attract new customers in new markets •Brand image and awareness will increase with the diversification of Samsung across the industry •Potential with new technologies to tap deeper into the US market beyond the personal computer market, i.e. consumer handheld electronics•Costs associated with shifting production to new products •Extensive investments into R&D

•Increased risk with new technologies and markets •New competitors

Option #3 Ignore Chinese market and continue with current production ProsCons •No changes to cost structure •Comfortability level will remain with existing suppliers and consumers •Samsung can continue to invest in improving its current products and production process•Threat of decreased market share with increase of low-cost Chinese alternative •Risk of market shifting and Samsung will not be able to catch up •Risks associated with staying in a sector of the industry that is forecasted to have negative growth in prices over the next 5 years •Risk of stagnating profits

•Risk of decreased brand image Recommendation

Option 1, stated above, is not a recommended option. The cons far outweigh the pros for this course of action, the most significant of which is the potential loss of proprietary information and technology. This is not an acceptable loss, and completely disqualifies this option.

Option 3 is also not a preferred option. Samsung Electronics has been a market leader for over ten years by successfully executing two essential strategic practices: product reliability, and shaping their business around the changing market. By pursuing Option 3, Samsung would be grossly disregarding the practice of reacting to change within the market. Coupled with the forecast of falling prices for DRAM, this action would certainly decrease Samsung semiconductor division’s overall revenue and profit margins, and most likely set Samsung behind the market.

Option 2 is by far the most highly recommended option for Samsung. The increased competition from Chinese firms and foundries, like SMIC, has begun to shift the low-end DRAM market from a large oligopoly to a more monopolistic competition type of market. As this shift occurs, consumers gain more buying power, and prices drop. As the current market leader, Samsung will still have relatively successful DRAM revenues, but only for a finite period of time.

As each year progresses however, revenues and profit margins will continue to fall, and potentially could decrease as much as 40-50%, based upon the pricing projections in Table 5. In order to avoid this decline, Samsung should begin to concentrate less on the 256M DRAM production, and focus on the higher end of the DRAM market, as well as the new product markets, like Flash memory.

As seen in the competitor analysis, only one of Samsung’s major competitors currently produces high-end memory chips and other similar products, Elpida Memory. This gives Samsung an opportunity since the high-end of the memory chip market is relatively non-crowded. Some of Samsung’s competitors have encountered past financial difficulties in this segment of the market.

However, if Samsung utilizes its competitive advantages of sound business execution, product reliability, well funded R&D, and healthy internal competition, Samsung will succeed where other firms have failed. Increasing the scope of the product line to Flash memory and other new, cutting edge forms of memory chips should also help to increase Samsung’s share in the US market, as a large number of new electronics products are often mass produced for the technology-savvy country.

The opportunities significantly exceed the risks for this option, and based upon Samsungs past success in navigating the continuously shifting memory chip industry, it is our opinion that Samsung will continue to thrive in this course of action. Implementation

The implementation of Option 2 will involve two major shifts within the company. The first shift will involve a large number of resources to be redirected to R&D in order to investigate and design new products and ideas. As indicated by Samsung’s semiconductor division’s financial statements, there have been billions of dollars of positive cash flows and net profits over the last five years.

These cash flows should help to finance the initial shift in funding. Samsung should also seek out new channel partners who are interested in purchasing the higher end DRAM chips, as well as any new products that Samsung will be developing. These companies could include any of the cell phone conglomerates, GPS companies, handheld device companies, and other such high-end electronics manufacturers. This phase should be completed within 12-18 months.

Phase 2 of this shift will involve more of an organizational shift. Once Samsung has developed a product or series of products that it believes will succeed in the market, production of one of its fabs will need to be shifted towards these new products. The second fab that Samsung currently operates will still continue to manufacture low-end DRAM, as you do not want to exit the low-end market completely at this time. At the same time that this shift in production is occurring, there also needs to be a shift in organizational structure.

Employees need to be trained on the new products that Samsung will be entering into the market. Additional labor resources will be needed to develop new customers, and to educate the market on the new product offerings. Labor resources will also be required to develop and strengthen supply chains to support the new products. The management structure and human resource policies will not need to be altered, as the current structure is ideal for this shift. This shift should take no more than 3-6 months, so that Samsung can ensure that their products are market leaders rather than laggards.