BACKGROUND
This Samsung Electronics (hereinafter referred as “Samsung”) case illustrates the history of Samsung’s success in their strategy in getting into the Dynamic Random Access Memory (DRAM), the high growth memory market segment in 1980s when then-key player, Intel had chosen to exit the business. Despite Samsung’s high internal production cost ($1.30 for a single 64K DRAM chip) which exceeded the prevailing market price which is below $1.00, consistent with its strategy, Samsung went ahead to build its large manufacturing fabrication facility amidst Samsung’s unproven technical knowledge in memory manufacturing business, uncertain industry performance then, harsh environment to build the semiconductor facility from ground zero which is highly sensitive to dust and electronic shock. All these coupled with Samsung’s vision, perseverance and determination has seen Samsung grown to a $25.1 billion of semiconductor exports as of 2004 commanding a 10.4% of the country’s export volume.
In this report, we will analyze in depth Samsung’s production cost advantages that brought this chaebol to where it is today, and how Samsung’s competitive advantage has translated to Samsung commanding a price premium in DRAMs in 2003 before providing recommendations to Samsung’s senior management to respond to the threat of large-scale Chinese entry into the industry in order to continue differentiating itself as a market leader over its competitors.
QUESTION 1: WHAT ARE THE SOURCES OF SAMSUNG’S COST ADVANTAGES IN DRAMS IN 2003?
Exhibit 7a shows a comparison of overall DRAM operating profit between Samsung and its main rivals in 2003 where Samsung had gained remarkable advantages over its competitors in almost every cost items, e.g. raw materials, labor costs, depreciation, and selling, general and administration (SG&A) except in R&D expense where Samsung spent at an industry average level.
We extracted the “cost advantages (CA)” by cost item below to facilitate comparisons:

Type Samsung’s
Unit Cost
$ Competitors’ Unit Cost*
$ Samsung's CA ($) Samsung's CA (%)
Raw material 1.18 1.83 -0.65 -35.52%
Labor 0.54 0.74 -0.20 -27.03%
Depreciation 1.35 1.64 -0.29 -17.68%
R&D 0.60 0.62 -0.02 -3.23%
SG&A 0.65 0.87 -0.22 -25.29%
Total 4.31 5.70 -1.38 -24.21%
* based on weighted average
Raw Material
Main raw material costs are generated in the process of chip production. In accordance with the above table, Samsung had the highest advantage in this item, 35.52% lower than the CWA (Competitors’ Weighted Advantages). This could be greatly attributed to the vision of Samsung’s management in early 1990s when they made a decision to place huge investments ($1 billion) into development and building of the next generation wafer production line (8-inch), leading over competitors who had avoided investments then. Although it is a common sense in this industry that bigger size wafer may efficiently cut down the manufacturing costs, this investment was still an adventure since the 8-inch wafer technology was far from being proven reliable at that time. Samsung succeeded and consequently gained and maintained manufacturing costs advantage in the following decade.
Another prominent strategic decision Samsung made was in choosing “stacking” method in 1980s. Some main producers, including IBM, NEC and Toshiba, chose the “trenching” method instead and then they finally had to switch to “stacking” method after “trenching” method was proven ineffective resulting in several years being wasted in their technology development.
The above two strategic decisions had established Samsung’s technical advantages in this industry. From Exhibit 10a to Exhibit 10c, we find that in 2003, Samsung had a Yield Rate much higher than its competitors (80% versus 50% to 67%). For example, although Infineon had launched higher percentage of more advanced 12-inch wafer lines (33% versus Samsung’s 12%), this advantage was traded off by its backward in process technology, where Infineon still adopted the 0.14μm Design Rule and Samsung had mainly adopted the 0.11μm technology. The latter might produce 80% more net dies under the same circumstance (352 dies versus 188 dies on 8-inch wafer, 845 versus 451 on 12-inch, according to Exhibit 10b ).
Labor
Samsung also had big advantages in this perspective against its competitors from U.S. and Europe, i.e. Micron and Infineon. The average salary at Samsung in 2003 was $44,000; while the comparable figures for Micron and Infineon were estimated to be $54,000 and $72,400 respectively. However, Samsung still successfully recruited lots of foreign talents from west countries and it was also very open (maybe the most in main Korean chaebols) to expatriate engineers and managers. One interesting point we noticed is that Samsung stressed much on recruiting the Korean disporas who had education backgrounds or living experiences in western countries (similar to “Haigui” or “Sea Turtle” in China). Although it was not detailed in the article how Samsung attracted these Korean Haigui with a comparatively lower salary package, we infer that it might be, to certain extents, attributed to the nationalism or patriotism, which were the values generally cherished by Eastern Asian nations .
Samsung’s average salary in 2003 was much higher than that of its main Korean competitor Hynix ($44,000 versus $24,600, i.e. around 1.8 times). However, it is amazing that Samsung had almost equal performance with Hynix when looking into the unit labor cost according to Exhibit 7a ($0.54 versus $0.51, around 1.06 times only). This reflected that Samsung had much higher labor productivity and efficiency over Hynix. Samsung’s HR management team contributed positively for the following noteworthy merits:
• Develop and maintain a culture of hardworking, dedication and inter-department/team cooperation;
• Encourage innovation, not punish failure;
• Take care of employee’s concerns on living burdens;
• Invest more in employee’s training and development; and
• Promulgate attractive performance-based incentives, e.g. Project Incentives, Productivity Incentives, and Profit Sharing Program.
Depreciation
Samsung’s unit depreciation expense was 17.68% lower than the CWA. We do not have sufficient details from this article to make a thorough analysis on this item. However, according to the article, Samsung was the only chip manufacturers having ability to produce a full series of products from “frontier products” to “legacy products” in this industry (see Exhibit 4 and Exhibit 5 for Samsung’s product mix versus its competitors). This may partially explain why Samsung had better capital returns. This industry has a very rapid product updating speed. “[P]rices for new-generation products stayed high for only a few quarters before plunging rapidly”. When a generation passed, Samsung may transform the legacy product lines to process high-value niche products, which improved the utilization rate of equipments.
In addition, Samsung’s strong designing capacity made it possible to share a common core design on many applications. This avoided lots of overlapping investments on equipments too.
Reviewing Exhibit 1, we noticed that all the main chip manufacturers including Samsung had jumping increases of their total asset values in the year 1999 to 2000. This should be an industry-wide expansion. However, we found that only Samsung had another total asset value increase in the year 2002 and 2003 while the other manufacturers’ asset value kept decreasing, which means that Samsung might be the only firm who continued to rapidly increase investments and expand its production scale in those two years. These new fixed assets investments would be capitalized in the following years and therefore it was questionable if Samsung could still maintain its advantage on depreciation costs and hence the overall cost.
R&D
Samsung did not invest in R&D much more than average. However, Samsung’s R&D management has proven to be more efficient. According to the article: “Samsung’s main R&D facility and all of its fab lines were located at a single site… In contrast, its competitors’ facilities were scattered across the globe”, and, “With the benefit of collocation and scale of fab investment, Samsung was estimated to have saved an average of 12% on fab construction costs.” As already analyzed in Section “Labor”, Samsung’s advantage in unit labor costs and its strategy of recurring overseas talents should also contribute to its R&D productivity because such labor expenses usually occupy substantial part in this item.
SG&A
We have limited information in SG&A expenses to analyze why Samsung could establish advantages in this area (25.29% lower than CWA). As a common understanding, labor expense is one of the major components of SG&A. Based on Exhibit 7a, Samsung’s SG&A expenses were lower than competitors from Europe and America but much higher than SMIC, the Chinese company. This also showed a positive correlation with the labor costs. In addition, Samsung’s advantages in the item Labor Costs (27.03%) and SG&A (25.29%) were close. Thus, it should be a reasonable inferring that Samsung’s advantages in SG&A mainly sourced from its lower and more efficient unit labor costs.
QUESTION 2: WHAT ARE THE SOURCES OF SAMSUNG’S PRICE PREMIUM IN DRAMS IN 2003?
Exhibit 7a demonstrates that Samsung had a $0.72 price advantage over the CWA in term of average sale price. It also shows that Samsung had $1.39 lower costs per unit than the CWA. Thus the following calculation provides the relative importance of the price premium as part of Samsung’s total profitability:
(∆ price advantage) / (∆ operating profit)= 0.72 / [0.72 - (- 1.39)] = 0.72 / 2.11 = 34.1%
With the contribution of low cost and price premium, Samsung obtained the highest operating margin of 24.1% (in Exhibit7a) comparing with the other competitors.
However, with the average price 14.52% higher the CWA ($5.68 / $4.96 x 100%, according to Exhibit 7a), Samsung gained a production volume of 896.4 millions in 256Mbit equivalent in 2003, which was higher than any of its main competitors in the same period. Surprisingly, customer still chose Samsung’s DRAM products over its competitors despite Samsung’s DRAM product sold at a premium, both in terms of premium over competitors’ pricing and premium over the production costs (e.g. margin).
We found that Samsung’s success in achieving great price premiums in spite its huge production volume could be attributed to a variety of factors mainly including the followings:
Provide products with the highest reliability
During the 1980s and early 1990s, Samsung’s products were criticized by customers as “shoddy products” due to its poor quality. Since 1994, Samsung’s top management endeavored to shift its strategy toward reliability by creating a company culture oriented at quality. They made great efforts to set up the most rigorous quality control system and cast the belief “Quality” into employees’ minds. Samsung even launched a mass burning of its defective products in order to motivate employees and reshape Samsung products’ images in customers’ eyes. Only after several years, by the late 1990’s, the company had already won key industry competition for reliability. It had the most advanced precision technology with lower deficiency among all suppliers. Obviously, consumers were more willing to pay more for a reliable product because it will save the maintenance and replacement costs and mitigate the risks of system breakdown due to hardware defects. This essentially will lower the warranty costs to be incurred by Samsung’s customers. Till 2003, Samsung had been awarded by most major customers for its reliability and performances. Even customers who are rivals of each other, e.g. Sony Ericsson and Nokia which have strict and high quality requirements, both chose Samsung as their suppliers.
Successfully customize products to customer demands
Samsung prided itself on the ability to customize its products according to customer’s required specifications and special demands. Different from its competitors, Samsung always tried to create new usage and functions for DRAMs and had launched new DRAM products with specific applications in laptops and personal game players. In addition, thanks to the company’s design and production capability, these different applications could share a common core design. With this strategy Samsung had developed the widest product range in the DRAM application industry. As of 2003, Samsung offered over 1,200 different variations of DRAM products. Product ranged from “frontier products” to “legacy products” including the “legacy products” and “niche products” that could bring high profits. This was “unprecedented in the memory industry”. Consequently, Samsung’s customers are also in big variety, which make it much easier for Samsung to build brand loyalty. Furthermore, making full use of manufacturing facilities substantially lowers its operation cost.
Collocation of fabrication and R&D facilities
Samsung’s fabrication and R&D facilities were bundled into one location which helped engineers solve process and design problems together. Easier internal conversations among engineers contributed to decrease time to adoption of more advanced technology and processing rules and launching of next generation products into the market. Exhibits 10 (a to c) demonstrates how Samsung maintained its technical advantages to its competitors as of 2003. With wide employment of both 0.11μ.11 strates how Samsung maintai/12-inch wafer, Samsung led the industry with the highest Yield Rate of 80%.
Gordon Moore’s theory, i.e. semiconductor density would double every 18 months, applies to the DRAM industry too. Thus, the early release of new generation products would realize high benefits derived from price premium of the “legacy products”. Samsung gained higher price premiums over its production costs with its technical leading status in this industry.
Talent pool strategy:
In the Section “Labor” of our answer to Question 1, we have analyzed the contribution of Samsung’s human resource strategy and management to its advantage of unit labor costs. We believe that these also contributed to Samsung’s price premium.
Easy access to local talents, sponsoring employees for PhD and MBA education, advanced rewarding systems, and the culture of dedication and teamwork, these had given employees more incentives and/or motivations to improve their productivity and efficiency, which will further facilitate Samsung’s efforts in achieving its goals in product design, production and sales, hence reducing production costs and thereby increasing the price premiums over its production costs.
High global market share and production volume
Exhibits 4 and 5 illustrated that Samsung produced 33.2% more than Micron, 67.5% more than Infineon, 71.9% more than Hynix and more than 13-fold than newly set up SMIC in 2003. Samsung’s production of 896.4 million unit of 256Mbit equivalents indicates that Samsung has achieved better economies of scales over its rivals as early as 2003. This has certainly provided Samsung a head start at an early stage, resulting in price premiums over its production costs.
QUESTION 3: WHAT RECOMMENDATIONS WOULD YOU GIVE TO CHAIRMAN LEE REGARDING THE RESPONSE TO THE THREAT OF LARGE-SCALE CHINESE ENTRY?
Large-scale Chinese entry threat is not a new phenomenon in this global market. In the past, threats to global textile and garment industry has seen China currently controlling more than 45% of the total textile and garment production across the globe, according to www.ehow.com. The saying “if you cannot beat them, join them” clearly indicates that in the wake of such threats, Samsung should properly defined its position, product and path to identify areas where the low-end products are expected to continue flood the market causing price and profit margin erosion but shielded by Samsung’s cost advantages, hence the principle remains to command market share for low-end product.
The Chinese players are determined to penetrate the market just like Samsung in 1980s. Similar with Samsung, Chinese players currently faced higher cost due to diseconomies of scales (and hence incurring gross loss) that they are willing to endure in exchange for market share. Although the Chinese players lack critical infrastructure to support a cutting-edge semiconductor industry, they are backed by the Chinese government’s offering in the forms of cheap credit, abundant land, cheap facilities, engineering talent, tax incentives, and other essential resources to any foreign companies who can team up with a local partner to form such cutting-edge semiconductor facility. This appears, on one hand, to escalate the threats of potential large-scale Chinese entry into the market, but on the other hand, represents a “first move advantage” which we recommend Samsung to tap on selectively.
It is based on the 2 principles and strategies “if you cannot beat them, join them” and “first move advantage” that we build the following specific recommendations to Samsung’s senior management.
RECOMMENDATION 1: Samsung is recommended to reduce its production of low-end DRAM memory chips and instead license out low-end DRAM memory chips production to local Chinese players in Beijing and Shanghai as propagated by the Chinese government. According to Robert M. Grant, a company can gain competitive advantage from responsiveness to change. We foresee the continued mass production of low-end DRAM memory chips which yields low profits but is important in order to maintain market share which will form the core strategy and objective for this recommendation.
 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 offered by the Chinese government. Nonetheless, there are still many other semiconductor competitors in the market that focused solely on production of low end DRAMs primarily to supply for mass production for electronic appliances and technology gadgets. The primary recommendation that resulted from this observation is that the low-end DRAM market has become overcrowded and competitive but remains necessary for the mass market and important to reap market share in the global market which is second after US consumption where Chinese semiconductor market boasts an enormous domestic electronics market.

 Samsung is recommended to engage collaborative partnership with Chinese players in setting up its fabrication plants in China. There are many benefits that the partnership may capitalize on its Chinese partners such as the access to the government resources and tax incentives, and also abundant engineering talents with relatively lower wages, etc. Such collaborations will establish fabrication lines in China putting Samsung a better position to capture more market shares with improving cost advantages.

 These collaborative partnerships can take in the form of equity joint venture with Samsung taking 50% of equity stake or less. The main purpose for this collaboration is to capture the most market share in the mass electronics consumption market with reasonable (or marginal) returns of investments. Alternatively, licensing model option is another form of collaborations where Samsung will license the low-end product technology and where applicable, production know how to a local Chinese player for a license fee (minimum guarantee and revenue share). The scope of product should only include low-end DRAMs that are currently in the market for mass electrical and electronic appliances and gadgets.
RECOMMENDATION 2: Samsung should invest an extensive strategic movement towards capturing the higher-end of the DRAM market, as well as new niche markets, such as Flash memory.
 “Memory makes the world go round” – www.samsung.com. We expect the memory components that process and store consumer data to require significant power moving into the future as more electrical and electronic gadgets are getting more complex and are embedded with more functionality and higher powered operating systems. Furthermore, we also foresee the following flash memory and high-end DRAM to take off in the global industry in light of the tablet personal computer market. This may potentially include above 20nm 3 bit NAND flash memory, high speed DDR NAND memory card, above 40nm DRAM, above 40nm DDR3 DRAM, etc. Our recommendation is based upon the positive outlook of potential and continued upsurge of brisk sales of Apple iOS and Android-powered tablet personal computers and smart phones.

 Samsung’s management philosophy embraces co-prosperity. Extracted from www.samsung.com, Samsung believes that a business cannot be successful unless it creates prosperity and opportunity for others. Samsung is dedicated to being a socially and environmentally responsible corporate citizen in every community where we operate around the globe. The ever growing global data traffic will escalate demand even further. Such explosion of demand for memory in the current high technology art of work will also see a potential outcry to protect global environment from global manufacturing pollution. Hence we recommend that Samsung proactively emphasize on the performance and efficiency of memory products with emerging “Green Memory” solutions and solid state drives (SSDs) to help reduce energy consumption across multiple computing applications. Such initiatives although would result in a higher than average production cost but will build an excellent corporate social responsibility profile for Samsung which is consistent with its management philosophy.

 Consequent to the above, Samsung is recommended to immediately invest in next generation manufacturing facility to support the fabrication of flash memory technology as well as new breakthrough DRAM technology while incorporating “Green Memory” solutions and SSDs. This will bring Samsung’s strategy to a level of high value of niche products and cede the lower end of market to local Chinese players.

 Invest extensively in the protection of intellectual property rights on its products and technology. This should be in the form of legal rights protection on a worldwide basis as well as embedding high technology protection on its solutions and physical products against threats from local players to replicate its product blueprints for mass production which is prevalent in the industry especially in China.

 In order to be in China business and at the same time enjoying Chinese government local incentives, we propose to build 100 years (from today) blueprint and master plan that Samsung envisions into the future. This could be in the form of how lifestyle living evolves over the next century and how Samsung could build memory technology to make this future lifestyle living possible. Samsung may form R&D alliance with Chinese producer to co-develop new product and technology consistent with this blueprint and master plan that may take a significant risks and resources to develop. This is going to reduce the company’s investment cost and shorten the new product’s time-to-market cycle in order to better compete with other major industry players for more market shares moving forward.

 Following the preceding recommendation, Samsung could work on creating a new working culture – a blended one between Chinese and Korean cultures – in the R&D production facilities based in China, resulting in two different competitive working systems. This would create excellent platform of competition and if a new working culture is successfully formularized, the company would eventually take pride for its innovative attempts and further strengthen the company’s position in the semiconductor industry with the winning and successful team taking the ultimate lead in this joint venture guiding the new Sino-Korean entity into the future.