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2016-10-20 14:22:16
Charred chaebol
Burning batteries are not the only problem facing the world s second-biggest technology firm
Oct 15th 2016 | SEOUL
WHEN Samsung Electronics announced on October 11th that it would discontinue its flagship smartphone, the Galaxy Note 7, one crucial event in the history of the world s second-biggest technology company by revenues (after Apple) sprang to mind. In 1995 Lee Kun-hee, then its boss, ordered 150,000 mobile phones burned and bulldozed in front of 2,000 weeping employees. Business partners who had received the devices as gifts from him had reported back that they did not work properly.
The South Korean auto-da-f is said to have helped create a culture of permanent crisis at the firm, which drives employees to work incredibly hard. Now the question is how the ignominious end of the Galaxy Note 7 handset, which some hardware aficionados had called the best phablet (or large smartphone) ever made, will change Samsung, which is going through a leadership transition. In the midst of the crisis, the firm announced that Lee Jae-yong, the son of Mr Lee, would join the board of Samsung Electronics later this year, taking another step towards succeeding his father, who two years ago suffered a debilitating heart attack.
Samsung had thought that it was over the worst of the Note 7 crisis by early September. It had swiftly recalled 2.5m of the phones after the batteries in some had caught fire (the result of one such conflagration is pictured). But earlier this month it emerged that the replacement units, which came with different batteries, were also prone to combustion. Shortly after two of America s leading mobile operators decided to stop selling the phones, Samsung scrapped the whole lot to avoid further damage to its brand.
It is still not known what exactly made the Note 7s catch fire. Lithium-ion batteries, which power most mobile phones, have caused trouble before. But in its rush to get replacements out, Samsung overlooked the root cause, while appearing to blame suppliers. Experts suspect that the device was too tightly packed, leaving no room for the batteries to expand as they need to when charged quickly or used heavily. The resulting pressure can damage batteries innards, causing them to short-circuit and release densely stored energy in the form of excessive heat.
Commercial forces encourage Samsung to push the envelope. Since the Galaxy phones run on Android, Google s operating system, which is used by most mobile-device makers, the firm needs to differentiate its high-end devices with ever better design and hardware. The Note 7, which sold for more than $800, is replete with all kinds of features, including a super-high-resolution camera, an iris scanner (to unlock the phone) and an especially powerful battery. There is now so much that can go wrong in such devices, says Carolina Milanesi of Creative Strategies, a consultancy.
The financial cost of removing the device from the market will be substantial. On October 12th the company said that profits in the past quarter will be a third lower than expected because of the recall. Many Note 7 owners will now opt to buy Apple s iPhone 7 Plus or a Pixel phone from Google. But Samsung will move on fairly swiftly even if it kills the Note brand altogether, which some analysts are calling for. Within its extensive smartphone and tablet portfolio the Note is a niche product (it would be a different story if its bestselling Galaxy S7 devices were affected). And if the firm s new models, to be unveiled early next year, have no major flaws, it should be able quickly to restore its reputation as a maker of excellent hardware.
But the crisis has posed a number of questions for the company, and underlined longer-term problems. It now needs carefully to consider the increasing complexity of the products and of its supply chain in the light of the Note 7 debacle, argues Chang Sea-jin of the National University of Singapore.
Another contributing factor, albeit an indirect one, is Samsung s convoluted corporate structure, which features cross- and even circular shareholdings. This has allowed the Lee family to exert control over the group with an overall stake of a few percent. But the set-up has serious drawbacks. Corporate governance is below the standard of global firms. Most of the non-executive directors, for example, have limited experience in the technology industry.
The Note 7 crisis should put wind in the sails of Elliott Associates, a hedge fund whose affiliates own 0.62% of Samsung Electronics. On October 5th it sent a letter to the Samsung directors with a detailed proposal for untangling the firm s hairball of shareholdings without the Lee family having to give up control (even at the point when they have to pay inheritance tax after the death of the older Mr Lee, which could amount to $6 billion). The core of the plan is to simplify the structure by splitting Samsung Electronics into an operating and a holding company.
Although the younger Mr Lee is said to favour such a restructuring, he is unlikely to approve of Elliott s plan. It also provides for Samsung to make regular dividend payments, and to pursue a listing in America, obliging it to comply with international standards on corporate governance. But Elliott now stands a better chance of influencing matters than it did last year, when it failed to block the merger of C&T and Cheil, two Samsung firms, which helped consolidate the Lee family s control.
The battery crisis should also make Samsung move more vigorously to address another structural problem. Despite the firm s efforts to keep its devices at the cutting edge, smartphones and other connected devices are becoming ever more of a commodity. How useful and competitive they are will increasingly depend on the software and services they offer. But Samsung s culture is still based around a fast-follower mentality centred on hardware, notes Park Kang-hee of IBK Economic Research Institute, a think-tank in Seoul. Internally, he says, there will now be louder calls to alter that.
Samsung has so far responded mainly by buying startups, such as LoopPay and SmartThings, which have respectively developed a mobile-payment system and a platform for connected devices. But the value in digital technology is shifting from software and services to data and artificial intelligence. One example is the emergence of so-called smart speakers, such as Amazon s Echo and Google Home. These are delivery vessels for the two firms digital assistants, Alexa and Assistant, and allow owners to use voice commands for playing music and ordering goods online.
To catch up, on October 6th Samsung acquired Viv, another digital assistant, created by the same people who had developed Siri, Apple s offering in this category. Although Samsung can build Viv into many of the devices it makes, ranging from smartphones to household appliances, the service may not be able to compete because Samsung lacks the data and skills to make use of them.
This weakness means that Samsung is unlikely to remain as dominant in smartphones as it is today (see chart). That is a far more intractable problem than burning batteries. Still, it would be wrong to predict a decline on the scale of Nokia, which only a decade ago was the world s number one handset maker but has since exited to focus on making gear for networks (another difficult business, as a profit warning on October 12th from Ericsson, a Swedish firm, confirms). Samsung also has several other thriving businesses to rely on, such as semiconductors and electronic displays.
Perhaps one day Samsung will be as well known for its smart drugs as for its smartphones. In November the firm plans to take public its subsidiary BioLogics, a drugmaker, hoping to raise more than $2 billion. Some of the money is earmarked to help it become a big contract manufacturer for biotech drugs. It has worked out that growing proteins in animal cells, at massive scale in ultra-clean factories, is quite similar to growing circuits on silicon wafers. Happily, in that business the risk of spontaneous combustion is very low.