Chaebol: the culture of Samsung and the Note 7's double recall (timeline)


Recently, activist hedge fund Elliott Management, which owns a small stake in Samsung, asked that the crown jewel electronics division of the company be spun off and listed on the NASDAQ, joining the pantheon of tech giants there like Apple, Microsoft, or Google's parent company, Alphabet. This would make Samsung Electronics more transparent and easier to control for shareholders, and would ensure management changes of the type that might have avoided the double Note 7 recall. It also has no chance of happening.

Samsung is run like a typical "chaebol" structure out of South Korea. "Chae" means wealth, and "bol" is a clan, and that's all you need to know about how companies like Samsung, LG, Hyundai and others are often run - as loosely knit family business conglomerates. The family owns stakes in each of the tens of holding companies, which in turn have ownership in the other firms in the network. This prevents outside investors breaking up the conglomerate, but also enshrines performance opacity, as well as rigid "no questions asked" top-down management policy.

Samsung  reported about $7 billion profit in Q2 2016, just a billion less than Apple, and was expected to report a similar amount for this one. The profit will now have to be slashed with up to $5 billion going forward to Q1 2017, and that's not even counting the intangible costs such as the brand damage. For us to understand how Samsung got here, and how this aggressive pursuit of market share, overly rapid innovation adoption, and vertical integration that culminated in the Note 7 fiasco, things need to be laid out in historical perspective.

Samsung origins

As we mentioned, Samsung is still pretty much a "chaebol" - a family-run conglomerate, notorious for its privacy and all-encompassing societal reach. Chaebols like Samsung, LG or Hyundai permeate South Korea, its business culture, and its everyday life with so much influence, that they have become a hot potato issue in many local elections.  

So how do you evolve from selling noodles and dried seafood in 1938, when Lee Byung-hul started Samsung, into a company battling a Silicon Valley juggernaut like Apple for world dominance in the most coveted subset of the consumer electronics market? 

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The answer is again "chaebol" - Lee the founder branched out into many areas such as insurance, construction, shipbuilding and yes, electronics, whereas Lee the son, who was pinpointed as the business heir in 1987, built on the founder's success by nurturing and encouraging innovation and independent thinking. He was mentoring his kids to take over before he was hospitalized in 2014, leaving the company adrift, as nobody from the family could have taken the initiative until he was recovering. Again, family things. 

Amidst the Note 7 recall drama, however, the circumstances forced the board to install his son, Jay Y. Lee, who has been groomed as the heir apparent, as a member that will grant him influence over much more strategic decisions that his vice chairman position before.

Lee Kun-hee

Lee Kun-hee carried his father's push that Samsung must be the leader, or one of the best in every new field it enters, and this particularly paid off in the smartphone business, which has contributed significantly to Lee Kun-hee's $9 billion, or his son's $6 billion personal wealth in the last few years. It's not all puppies and flowers in the family, of course - Lee Kun-hee's older brother and sister sued him for shares in Samsung valued at a combined $850 million. His lawyers, on the other hand, say the father was clear who had to run the business, and the issue should have been raised 25 years ago when he took the helm, not now when Samsung is raking in record profits. 

The share transfers could have weakened the chaebol system, or the network of connected holdings that Lee Kun-hee used to maintain outsized control of Samsung Electronics and about 60 other companies in the group, even though he owns only a small amount in each of the various companies in the conglomerate. The court sided with Lee Kun-hee. 

In the early 90s, the current Chairman Lee Kun-hee realized that the company, as huge as it was, risked becoming a low-cost volume peddler, and said the famous quote: "Change everything but your wife and kids!" The slideshow below that has a timeline of Samsung's milestones, illustrates well the culture of innovation that was happening even before that battle cry.

Lee Kun-hee has a few other quotes, which establish him as a visionary leader, who is not overly concerned with the quarterly profits, but rather with building the right culture to secure strategic advantages for Samsung going forward:

  • "One genius can feed millions of others. For the upcoming era where creativity will be the most important driver of business success, we need to hire the best. The economic value of one genius is more than $1 billion."

  • "The business world has changed significantly. It is becoming increasingly difficult to foresee what sectors will prosper or opportunities will arise in the future. But if you hire the best and brightest, you will solve whatever issues arise in the future.

  • "It is difficult to understand the true dimensions of a problem or a situation when so many things seem to be happening on the surface. This is why I urge my employees to analyze a given situation from various perspectives. This way of thinking allows one to see the true aspects of a situation, which, in turn, allows one to respond wisely.

  • "Firing a CEO because his financial performance was poor is simply a bad decision. I've encountered several situations where a CEO once performed poorly in one sector then went on to perform much better elsewhere. This is one of the reasons Japanese corporations were able to compete successfully against US corporations."

Company culture controversies

Do those remind you of a certain company that says money doesn't matter, but rather the right products? In any case, as with every powerful figure, the Lee Kun-hee's reign is not without controversies, and we don't mean just the family feud for inheritance. In 2008 his house and offices were raided by the police, starting an investigation whether Samsung is maintaining a slush fund that compensates court officials and politicians for favors. 

Moreover, Samsung was using every trick in the book to resist unionization of its workers, and there were even suicide cases among them, allegedly due to overwork and tight deadlines. A leaked power point presentation made to Samsung executives back in 2012, presented different ways that the company could prevent labor unions from representing employees at Samsung. The slides were discovered by the International Trade Union Confederation, and the ITUC says that there is a direct relationship between the "inhumane" treatment of employees by Samsung and the explosions that forced two recalls of the Samsung Galaxy Note 7. Chaebols are often depicted in the media and movies in Korea as almost mafia-type organizations, and such allegations don't help to dissuade the notion.

After being found guilty in things like financial wrongdoing and tax evasion, Samsung's boss was fined $109 million, and issued a three-year suspended jail sentence. "We, including myself, have caused troubles to the nation with the special probe; I deeply apologize for that, and I'll take full responsibility for everything, both legally and morally", Lee Kun-hee commented after the verdict. Pardoned by the government in 2009 in order to help Korea's bid for the Winter Olympics, he returned as Samsung's Chairman in March 2010, then the first Galaxy S was outed in June, and we all know what happened up to the Galaxy Note 7 recall point. Here is a brief primer on that saga in the form of a handy timeline infographic:

It's Samsung's relentless push for vertical integration and strict deadlines to save on costs, the top-down management policies, as well as insistence on tight family control that are behind a lot of the reasons for the Note 7 drama. Jay Y. Lee, the son, is on his last steps before being nominated as a CEO, so we aren't holding our breath for the chaebol management structure to change significantly in the near future, yet we can't wait for Samsung to clarify how it intends to move forward, and not only with the Note line. 

Back in the 90s, annoyed that Samsung phones he gave as New Year's gifts were failing, Chairman Lee collected thousands of them in a field near the Gumi factory, then lit them up, bulldozed the remains, and told everyone to start over. Will Lee the son have the wherewithal to do something similar now that Samsung is a global household brand? He just might have to.

source: Samsung, (infographic) & FT

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