Teaching Note For

TEACHING NOTE: SM-129TN DATE: 06/07/04 TEACHING NOTE FOR SAMSUNG ELECTRONICS: CONQUERING THE WIRELESS DIGITAL WORLD

SUMMARY The digital world is a mixture of universal wireless and universal computer power. Connectivity is everywhere: in local networks (the digital home) and in long distance networks. All devices have connectivity features and computer power.

In 2004, this vision was a dream. The only practical application was the Smartphone market, that was slow to take off. Another application, still in its infancy, was in the CE market, where early adopters were creating the beginning of a digital home. The rest was still speculation.

Yet, giants in telecommunications, CE and information technologies were trying to position themselves according to their interest to capture this potential market.

THEMES 1. Digital convergence 2. Horizontal versus vertical architecture 3. Industry standards 4. Inflection point 5. Industry collision 6. Strategic dissonance 7. Hardware versus software

ASSIGNMENT QUESTIONS 1. How does the convergence affect a company such as Nokia? A company such as Sony? A company such as Microsoft? 2. Who has a digital home in 2004? 3. What is Samsung trying to do? What are the key factors underlying Samsung’s competitive advantage? How have these factors reinforced each other? 4. Does Samsung have what it takes?

This note was prepared by Jean-Bernard Rolland under the supervision of Professor Robert A. Burgelman for the sole purpose of aiding classroom instructors in the use of “Samsung Electronics: Conquering the Wireless Digital World,” GSB No. SM-129. It provides analysis and questions that are intended to present alternative approaches to deepening students’ comprehension of the business issues presented in the case and to energize classroom discussion. Teaching Note for Samsung Electronics: Conquering the Wireless Digital World: SM-129TN p. 2

Assignment Question 1: How does the convergence affect a company such as Nokia? A company such as Sony? A company such as Microsoft or Intel?

Nokia. There were three major risks for Nokia:  Cell phones could become commodities like computers, affecting market shares.  Other manufacturers could overtake them in brand name, affecting market shares.  They would lose control of some layers of the stack, affecting margins.

There was a major opportunity for Nokia and its likes: revitalize their market by providing new needs based on services. Students must come with the two following conclusions:  For voice only, 2G cell phones are sufficient.  3G cell phones have a value only by the IT services that will be provided in addition to voice. In other words, 3G cell phones do not make any sense if they are not Smartphones.

Headquartered in Finland, Nokia manufactured mobile phones. It also provided TV set-top boxes and Internet software and services. Furthermore, it engaged in home networking and cell phone displays for the global market. For fiscal 2003 Nokia generated revenues of $37 billion, a 17.5 percent increase on the previous year's figure of $31.5 billion. Net income for 2003 increased by 27.2 percent from $3.5 billion in 2002 to $4.5 billion in 2003. Nokia Market share of the global mobile phones was 32 percent in 2003—but experts anticipated a decline to 28 percent by 2008.

By early 2004, however, Nokia had been relatively protected from competition by the integrated model of 2G cell phones. A manufacturer wanting to develop handsets had to have:  Significant integration capabilities  Control of critical elements of the stack.  The financial resources to spend a significant amount of money in Research and Development.

In case software standards and component modularity were to become as important as they were in the IT industry, low cost manufacturers would be able to start flooding the markets with cheap products. This threat was particularly worrisome in developing countries such as China or India because:  Those countries had manufacturing capabilities.  They enjoyed the fastest growing demand in the world (Exhibit 5 in the case).  Nokia was traditionally stronger in Europe and the United States (Exhibit 5 in the case).  W-CDMA and CDMA2000, the dominant protocols in Japan, Korea and China, were not Nokia’s best area of expertise of, or even that of Motorola and Ericsson.

Samsung’s efforts to create the strongest brand value in the industry were a second threat to Nokia’s market share. Convergence was a threat to Nokia because:  All other manufacturers’ brand appeals were waning in favor of Samsung’s. Samsung had clearly made marketing a priority. Nokia shares went down and Samsung shares go up. See “Samsung’s rivals” and Exhibit 11. Teaching Note for Samsung Electronics: Conquering the Wireless Digital World: SM-129TN p. 3

 Samsung could leverage their large portfolio to cross-sell products. See the quote in the case: “Phones opened a lot of doors for Samsung. It is almost the only phone company that makes consumer products as well. People who have a Samsung phone and are happy with it become better-disposed to buying its DVD players.” And vice versa.

The fear of Microsoft or Intel controlling the most profitable layers of the stack was the most worrying for Nokia:  This was demonstrated by Nokia’s hesitation, underlined by the case, and to a lesser extent, the hesitation of other manufacturers.  If Intel and Microsoft could force manufacturers to use their products, the other manufacturers would have had to pay a monopoly price on each operating system or each chip—putting serious pressure on margins.  Students could argue that Nokia suffered from scale disadvantages due to its position as incumbent market leader in much of the world. It was compelled to invest heavily in creating the software platforms necessary to take mobile markets beyond voice. (See the controversy about Symbian, and Exhibit 8 in the case.) If Nokia did not move, they could be left behind. If they moved, the industry would suspect they try to control the operating system layer.  In order to ensure interoperability (and preempt incursions by Microsoft) Nokia was obliged to license this core technology to other vendors at low cost. If Microsoft, Linux and Symbian standards coexisted, Nokia would have to make Symbian available at a low price.  Samsung could use Symbian as well as other technologies, as it wished, and focus its development efforts on hardware innovation and a ferocious rate of new product development. (Not mentioned in the case, but Samsung was scheduled to launch as many new models for the Korean market alone in 2004 as Nokia was expected to introduce worldwide).  If Microsoft or Linux were the only winning standard, Nokia would be heavily punished by having tried to play alone.

Handset companies saw convergence as making data available in the entire world. The emphasis was on the digital world rather than on the digital home. However, students should realize that it was unclear whether there was a need for continuous access to data via a mobile terminal—if users had enough broadband stations where they could stop and download their data. The future could be one where mobile computers were standalones, and where broadband access was available everywhere for people to synchronize their information (a “Download and Run” model).

Sony. There was two major risks for Sony:  Other manufacturers could overtake them in brand name.  They will lose control of some layers of the stack.

As in the case of mobile handsets manufacturers, there is a risk that the convergence will create room for new manufacturers to shake the established brand name. Students should use Samsung’s rapidly increasing brand name as an example of what an aggressive marketing can do to a changing industry. (See Samsung in 2004 in the case.) Teaching Note for Samsung Electronics: Conquering the Wireless Digital World: SM-129TN p. 4

However, the key point was that Sony and other CE giants believed the quality of entertainment would be more important than the need for software (See David Levin’s quote in the case “In consumer electronics, ease of use makes the utility. There is no need for complexity”). The digital home was more about communication between features, and less about processing power. They did not believe that PC will be able to threaten home theaters any time soon.

Students should conclude that to Sony and other manufacturers, the priority was to release good products that appealed to customers, while staying competitive on prices. This goes through:  Building brand name though outstanding marketing and aggressive product releases.  Controlling the key components of the 5-layer stack. The example of Intel, losing market share by a pricing mistake in 2003, shows how sensitive the market is to the price of components. CE companies saw convergence as enabling communication among devices within the home. There was no center in their vision.

Microsoft and Intel. There were two major opportunities for Microsoft and Intel:  On the short-term, create a new market for their products while their traditional market was slowing down.  On the long-term, create momentum for new software that would increase the demand for their products.

Intel, Microsoft and other IT companies had been investing heavily. However, mobile devices still represented only a tiny amount of their revenues (0.65 percent of total revenues in the case of Microsoft).

IT companies were trying to create a duplicate of the PC world:  low margins in assembling  de facto standards for software and critical components.

Students should conclude that the added value in Smart devices was the application layer that enabled services. This required sophisticated software and powerful chips. Microsoft also hoped that the interoperability between devices would help to make its products a de facto standard of mobility.

IT companies saw convergence as enabling data processing among devices within the home. In their vision, the PC became a center.

What was a digital home in 2004? A digital home was primarily a combination of software and hardware that allowed users to enjoy multimedia contents (pictures and music, and to a lesser extend video). No other application was mature. No standard yet existed. No firm was either in the position to offer a comprehensive solution, or to lead the future of the digital home by imposing concepts. Students should conclude that to design a functional home, customers needed to be very creative themselves. Early adopters had to be not only be wealthy (around $10,000 to setup a decent multimedia end-to-end solution with a plasma TV, wireless cards, a multimedia computers, a stereo and adequate software), but also technology savvy. It should Teaching Note for Samsung Electronics: Conquering the Wireless Digital World: SM-129TN p. 5 also be noted that there was no average user. Every user had a particular utility of the nascent market of digital appliances. In this sense, it was difficult for companies to identify a market and serve it.

How did the digital home fit in the digital world? The digital world was a world where connectivity would be everywhere at any time. Wireless products would allow us to share data in a car, in the streets via Smartphones, at home on a PC, a television or a stereo. Communications would be one side of the digital world. In addition to communication, specific pieces of software would allow processing diverse services, yet to be invented. There were two early applications of the digital world: on-line consumer electronics and Smartphones. The first were an entire part of the digital home. The second could be the central device of the digital home. However, there is no certainty about this

Was there a market? Was there a need? As pointed at by industry experts in the case, there was currently no demand and no service on a large scale. Was there a need for connectivity everywhere? What was the point of having wireless connectivity everywhere? Were there enough broadband accesses at end points? Customers might have been better off to regularly synchronize their portable devices (laptop or phones) from a broadband landline than paying services to have a permanent access they would only use once in a while.

There were three major components missing in 2004:  A “killer application”. No company had been able to create a hit in the digital home, let alone other wireless markets. Even in Smartphones, the demand proved elusive, with the exception of some specific markets in Japan and Korea. Nobody knew where the value to customer was.  Standards were elusive. Protocols did not always allow satisfying communication between devices. Formats were incompatible. Wireless was often choppy.  Prices were too high, making customers scarce and investments prohibitive.

Assignment Question 3: What is Samsung trying to do? What are the key factors underlying Samsung’s competitive advantage?

What is Samsung trying to do?  Up until the mid-1990’s, Samsung positioned itself as a low cost manufacturer.  At that point Samsung was trying to gain market share and to develop an expertise in high technology.  Students can note that Samsung’s strategy was clearly long-term oriented.  The concept of a strategic inflection point can be introduced. Marketing and great products became a priority in the verge of the financial crisis. This was a very risky strategy. Samsung succeeded through the combination of: o A robust manufacturing capability o The dedication of its workforce, “let’s make things possible as soon as they have been decided by the top management” o The financial support of other companies within the Chaebol. Teaching Note for Samsung Electronics: Conquering the Wireless Digital World: SM-129TN p. 6

 Samsung was now trying to become a reference for consumers. The value discipline was product differentiation. Some students might make a comparison to companies like Nike or Coke. They wanted the “wow” factor. They wanted customers to refer to their products as “cool’ products.  Students should conclude that Samsung’s strategy was not limited to handsets or consumer electronics. It was not to independently gain market shares in a specific industry. Samsung wanted to “Lead the Digital Convergence Revolution”. That statement reflected the fighting spirit that drove the corporation and underscored its vision of leadership as a broad rather than narrow one (i.e. handsets). Samsung want to be a one-stop shop.  Samsung was also playing on the cross selling of its products. Brand awareness earned in the CE market would play in the cell phone market and vice versa.  Students should recognize that Samsung positioned itself as being software agnostic. They were the only company to support Symbian, Palm OS, Microsoft and Linux.

What were the key factors underlying Samsung’s competitive advantage? Samsung’s competitive advantage was a mixture of old capabilities and new capabilities:  Samsung’s manufacturing had a tradition of excellence. Samsung’s engineers were considered some of the best in the world. Students should note the pervasiveness of the engineering culture in the case discussions of Samsung’s history and manufacturing.  Samsung was an integrated manufacturer, which historically allowed better control over critical components (flash memory for example), a shorter time to market and the capacity to more efficiently monitor its margins.  The new marketing effort. Led by Eric Kim at Samsung Electronics, and built over an integrated approach to creating brand awareness, it culminated with the sponsoring of the movie ‘Matrix Reloaded”.

Assignment Question 4: Does Samsung has what it takes?

How did Samsung make money? Samsung Electronics enjoyed comfortable margins (around 32 percent gross margin and 17 percent operating margins in 2003). Yet from 2000 to 2002, margins went down from 20 percent to 6 percent. Students might observe that hardware was a very cyclical business in which margins can dip abruptly.

Who could be unhappy at Samsung? Two populations can be unhappy at Samsung in 2004:  Within Samsung group, the priority was put on the Samsung group. What is the reaction of employees and managers at Samsung Corporation ($ 37 billion in sales), Samsung industries (around $12 billion cumulated) or Samsung Life Insurance (around $17 billion)? The group subsidized Samsung Electronics during its growth phase. Students should ask the question “what is their perception of focus on Samsung Electronics: pride or bitterness?”.  Traditional engineers at Samsung saw marketing specialists, sometimes much younger, hired and promoted to management positions. According to BusinessWeek,1 when Eric

1 Cliff Edwards, Moon Ihlwan, Pete Engardio, “The Samsung Way”, BusinessWeek, June 16, 2003, p. 56. Teaching Note for Samsung Electronics: Conquering the Wireless Digital World: SM-129TN p. 7

Kim was named executive vice-president of global marketing in 1999 he made his first major presentation to 400 managers in English. Sensing Kim would be resented, Samsung Electronics’ CEO warned: ”Some of you may want to put Mr. Kim on top of a tree and then shake him down. If anybody tries that, I will kill you!”.

What were the risks of Samsung’s strategy? Samsung based its strategy on the premium market and on building brand equity. The risks of this strategy were:  Demand for high-end Smartphone market. Research found that the market for Smartphones would be $321 billion in 2010, but the figures were only $1 billion in 2004. In consumer electronics, market predictions were also generous. At the same time, Samsung was heavily investing both in plants and in marketing. In 2001, net margin went down to 7 percent, down from 22 percent in 2000. Samsung was vulnerable to a change in conditions.  Competition among Smartphone manufacturers. In 2004 almost all mobile handset manufacturers were going after Smartphone, and new manufacturers quickly developed in India and China.  Existence of an operating system standard. Although the industry was likely to embrace one form of standard, it was not clear whether one standard would be dominant (one big winner: Microsoft, Symbian or Linux) or whether interoperability and APIs will allow more than one operating systems to coexist and interface.  Application software availability. Students may note that there was no clear need from customer, neither in consumer electronics nor in Smartphones.  Would the macroeconomic fundamentals in Asia, in particular in China, remain as sound as they were in 2004? As proven by its history, Samsung was particularly vulnerable to a financial crisis in Asia. Its stake in the Chinese market, in particular, was high.  The concept of strategic dissonance could be introduced to illustrate the tension between Samsung Electronics’ semiconductors arm as a provider of components both for Samsung Eletronics’ mobile division arm and for other manufacturers. Are the interests of the semiconductors arm and the mobile division arm always aligned?  High margins in the high tech industry were traditionally created in software. Because of their characteristics, “information technology goods” were more profitable than hardware. Yet Samsung made the decision to “ignore” software and to focus on hardware.

Who was Samsung’s most dangerous adversary?  Nokia. Samsung was conquering market share over Nokia. Students can speculate on Nokia’s competitive reaction. Good: lower prices, innovate and increase the number of products,  Sony. Sony and Samsung were now both competitors and partners, in the joint venture set to produce LSD. Sony was struggling with its divisions other than videogames. Students should conclude that Sony was considered more like a model than like an enemy. Sony was monitoring Samsung’s progresses very closely, in particular in consumer electronics. Teaching Note for Samsung Electronics: Conquering the Wireless Digital World: SM-129TN p. 8

 Microsoft and Intel. Students should conclude that the competitive reactions from Intel and Microsoft were the most dangerous for Samsung. Intel was overtaken in flash memories because of a pricing mistake in 2003 and would try to come back. Intel was investing heavily to produce chips and memories for CE goods and handsets. Microsoft was trying to make Windows the standard in the wireless operating systems. Samsung was hedged against Microsoft because it supports all operating systems. It was still vulnerable to the outcome of the competition between Microsoft and Symbian. It was also vulnerable to Intel pressure on components for CE goods and handsets.

Too many battles to fight? As mentioned in the case and teaching note, Samsung was not fighting individual battles in handsets or CE. They were fighting an overall war to become a reference in the digital world. That raised an issue: would they be able to fight efficiently on so many fronts?  They had been successful in two of three main product lines: CE, handsets and semiconductors.  What could compromise their success? Students can come with the following points and discuss related risks: o Competitive reaction of companies in any of the markets where Samsung is fighting (Intel, Nokia, Sony). o Elusive demand. o Strategic dissonance. The semiconductors division might be better off to sell its components to external manufacturers with higher margins. An overall strategy might slow down efforts to capture specific markets. Teaching Note for Samsung Electronics: Conquering the Wireless Digital World: SM-129TN p. 9

SAMSUNG ELECTRONICS IN 2004 SUMMARY by Robert A. Burgelman

1. Samsung Electronics shows that a company can extend itself into high-technology industries that are new to it through a process involving entering through partnering or acquisition, fast following through copying and learning, and mastering the business through developing manufacturing competencies and operational excellence to become cost leader

2. Such strategic transformations are driven by top management and require resource commitments governed by taking the very long-term view on return to investment. This may be more difficult in economies governed by short-term capital market expectations

3. Samsung Electronics also shows that a company can move from a generic strategy based on cost leadership (operational excellence) to one of product leadership (differentiation). But this requires getting the organization to develop new, fundamentally different core competencies (e.g., marketing), which will only happen if strongly driven and monitored by top management

4. Samsung’s corporate culture supports the corporate strategy: “fighting spirit” (don’t give up), emphasis on frontline (“field”) experience, extremely strong work ethic, willingness to finance strategic activities for the very long term

5. Samsung’s corporate strategic scope is very wide, both horizontally and vertically. Horizontally, the strategy covers multiple digital consumer electronics products and their interconnectivity (broader than just the “digital home,” and much broader than “handsets”). Vertically, the strategy covers components, platforms, and end-products (but deliberately no software)

6. Samsung’s organizational capabilities support the broad-scope corporate strategy. In particular, its capability for extremely rapid product development allows the company to manage technological and, in particular, market uncertainties associated with its product leadership ambitions in the new (converged) consumer electronics (CE) industry through an “engage, then see” approach

7. The competitive dynamics of the new (horizontalized) consumer electronics industry, together with Samsung’s broad corporate strategy, require careful consideration of how to both compete and collaborate with different types of companies: Sony and Philips (old CE industry), Intel (components, platforms), Nokia (Symbian as a check on Microsoft)

8. Key strategic challenges facing Samsung Electronics are potential over-extension (how many major battles can they reasonably hope to win) and internally-induced strategic dissonance because the strategies of the different business groups within Samsung Electronics (e.g., semiconductors versus CE products) are not necessarily fully aligned

9. Others?