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Samsung attempts to reinvent itself through disruption — again

Geoffrey Cain
Sunday, 28 Jul 2013 | 8:42 PM ET
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Samsung chairman Lee Kun-hee insists on creating a crisis mentality at the world's largest electronics company.

That might seem odd, given that Samsung has emerged as the decade's cutting-edge gadget maker.

Once ridiculed for its cheap knock-off phones and TVs, this week it surpassed Apple as the world's most profitable smartphone maker, with $8.5 billion in quarterly profits. It sold an estimated 71 million units, more than doubling iPhone sales.

Despite its success, Samsung chairman Lee insists that his company remain in a state of perpetual shake-up. In classic Samsung style, he's attempting to ward off the burnout that afflicts so many consumer electronics companies. It's a common story in the tech world, where executives who've hit it big become complacent, unwilling to risk their salaries on bold new ideas.

(Read more: Samsung trumps Apple sparking calls for low-cost iPhone)

Examples abound. Corporate arrogance and sluggishness deadened Sony's once-iconic Walkman product line; from 2010 to 2012 the formerly dominant rival was in the red. For Apple, which in April posted its first quarterly profit decline in 10 years, the affliction appears to be a dearth of new ideas.

"An empire built on silicon can fall quickly," as one commentator put it.

The company is moving quickly to avoid the trap of hubris.

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At the moment, the anxiety at Samsung is justified. Despite the Galaxy's wild success, when the company reported earnings yesterday smartphone sales were weaker than expected, and the company cautioned that phone sale growth will slow in the next few months. A serious threat looms on the horizon, if rumors prove true and Apple begins marketing cheaper iPhones.

Either way, many analysts fear smartphones are becoming commoditized, and will suffer from lower margins and stiffer competition. Record profits aside, Samsung shares plummeted in June after J.P. Morgan forecast that the smart phone market will peak this year.

Here at its campus in Suwon, an hour's drive south of Seoul, the company recently marked the twentieth anniversary of Lee's transformation of Samsung into an international brand. It's the stuff of company legend, known as the "New Management Initiative."

(Read more: An 'emerging' threat to Samsung, and it's not Apple)

Lee used the occasion to send a rare email to his 357,000 global employees. "This is the new beginning for Samsung's New Management," he wrote. "As we move forward, we must resist complacency and thoughts of being good enough, as these will prevent us from becoming better."

"New management" may sound wonkish, but it actually says a lot about the top-down, Spartan ethic that differentiates Samsung from its more informal Silicon Valley competitors, and explains its crisis mode.

Lee is a celebrity of Steve Jobs' stature here in Korea, and many big endeavors come straight from his office. Authors continuously debate how he's kept Samsung on top in an industry known for rapid fluctuations, while critics accuse the nation's richest man of wielding unhealthy power over the economy.

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"Lee Kun Hee definitely has achieved cult-like worship at Samsung," said Michael Kim, a former senior manager in the semiconductor business from 2008 to 2010. "For new employees, there is an orientation which is practically a boot camp about all things Lee Kun Hee."

To grab an early lead in a world where the current smartphones are losing their luster, the company is pouring resources into new, expensive display technologies. As early as August 1, Samsung will begin selling a first-generation product, a $13,000 curved, super-thin OLED television.

It's a risky proposition with limited appeal to consumers. But the company is acting on a lesson from 10 years ago, when it invested heavily in LCD display technology, crushing Sony in the process.

(Read more: Samsung's profit jumps 50%, but mobile business shrinks)

Samsung then became a major LCD supplier for Apple, despite the fact that the two competitors were later locked in about 50 patent infringement lawsuits on four continents.

This time, "Samsung is anticipating Apple's move in TVs," explains Tim Bajarin, the president of Creative Strategies, a market intelligence firm in San Jose, California. It "wants to either leap frog them or be ready to respond when Apple does announce its TV offering."

As part of its drive to succeed, the Korean company is also trying to imbue a hip Silicon Valley flair to its formal and deferential ranks. It recently set up an institute called Creative Labs, where junior employees can work on projects without adhering to the rigid respect for seniority common in Asian mega-corporations. It's building a $300 million campus in Silicon Valley, in hopes of boosting its software prowess.

In the past, such moves would have seemed ludicrous.

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In the 1970s and 1980s, the company had a reputation for churning out cheap, blockish televisions and dishwashers. It got by because South Korean dictators handed out tariffs and easy loans, insulating the group from competition.

But the Korean conglomerates, known as chaebol, developed one key strength that persists today: quickly reworking existing technologies, and selling them at lower prices than their American and Japanese counterparts.

Because of its rapid expansion, Samsung built another unusual advantage. In a break from industry tradition, it made phones and televisions, along with the semiconductors and parts used by competitors. That gave Samsung one fallback if any single market slumped. Today, it has a legal way of knowing what competitors are ordering and thus an industry roadmap — should it tap into the information.

But its focus changed in 1987, when Lee's father, the founding industrialist, died of lung cancer.

(Read more: Samsung close to mobile-device deal with FBI - sources)

Upon taking over, Lee Kun-hee learned that Samsung's televisions and washing machines were the laughing stock of the industry.

In 1993, the flamboyant sportsman summoned his executives to a three-day series of speeches at a hotel in Frankfurt, Germany, in which he laid his New Management Initiative, emphasizing high-end products. The city was a symbolic pick for its reconstruction after World War II.

"Change everything except your wife and kids," Lee famously proclaimed.

In a ritual purification, he later ordered factory workers to throw more than $50 million worth of low-quality cell phones and fax machines into a bonfire.

It worked, despite early blunders in car and Internet ventures. By the early 2000s, Samsung had transformed its disparate collection of clunky products into a sleek, uniform lineup of televisions and mobile phones.

  • Matt Hunter is the senior technology editor at CNBC.com.

  • Cadie Thompson is a tech reporter for the Enterprise Team for CNBC.com.

  • Working from Los Angeles, Boorstin is CNBC's media and entertainment reporter and editor of CNBC.com's Media Money section.

  • Jon Fortt is an on-air editor. He covers the companies, start-ups, and trends that are driving innovation in the industry.

  • Lipton is CNBC's technology correspondent, working from CNBC's Silicon Valley bureau.

  • Mark is CNBC's Silicon Valley/San Francisco Bureau Chief covering technology and digital media.

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