February 13, 2014 12:00 am JST

Samsung's future on the line

KENTARO OGURA, Nikkei staff writer

SEOUL -- Samsung Electronics is not accustomed to losing and does not enjoy it. Having racked up record profits for several quarters, the South Korean juggernaut suffered its first profit decline in nearly two years in the quarter ended Dec. 31.

     It blamed the setback on a slowdown in its key smartphone business. Although the outlook is not too gloomy, the era of explosive growth appears to have ended. Samsung needs to find a new cash cow if it is to maintain the profitability it has come to expect.

     "Smartphones aren't selling much, so we need you to lower your prices for parts," an official in charge of procurement told employees at subsidiary Samsung Display late last year. Internal discounts do not affect consolidated results, but the squeeze is on because the company's recent performance in the segment has been off.

     At first glance, Samsung is the picture of health. Its operating profit jumped 27% on the year in 2013 to a record 36.78 trillion won ($34.2 billion). But in recent months, sales of high-end smartphones are topping out as markets mature and U.S. rival Apple bounces back from a slump. The South Korean gadget maker can no longer count on a virtuous circle of strong demand for handsets driving sales of its components.

Changing channels

Over the past decades, Samsung rode a global wave of demand for digital consumer electronics. Its low-cost, high-quality products helped the company displace Japanese manufacturers to become the global leader. But despite having the largest market share in flat-panel TVs, for example, profits are slim: At the top end of the market, Samsung battles with rivals from other industrialized countries for a slice of a fairly small pie. The market for cheaper sets is much bigger, but Samsung has hungry Chinese and other manufacturers snapping at its heels in that segment.

     Industry insiders say Samsung remains heavily dependent on smartphones. Handsets and other information technology devices, like tablets and smart cameras, account for 68% of the company's consolidated operating income, up a whopping 43 percentage points in three years. If displays and chips that are made in-house are included, the figure comes to 81%, according to one estimate.

     It is unlikely Samsung's earnings will deteriorate suddenly; its chip business, which generates 19% of the company's total profit, gives it a cushion. But heavy reliance on a few products is worrisome, and concern that the situation for smartphones is starting to resemble the market for flat-panel TVs runs through the company.

Lonely hearts club

One solution is to marry up with competitors, but so far Samsung has not had much luck. It tried to purchase the copier business of Japanese electronics maker Sharp because unlike volatile consumer electronics, copiers bring in steady revenues from corporate customers for supplies and maintenance. Samsung had high hopes for the deal, but it fell through. "We even proposed selling products under the Sharp brand," said a Samsung official who is still upset over how things turned out.

     Samsung is looking for greener pastures outside the electronics business. "We will expand our operations into health care, the environment and other businesses that help improve the quality of life," said Vice Chairman and CEO Kwon Oh-hyun at a business plan briefing in November. In 2010, Samsung named medical equipment and four other key areas for investment and it has made small acquisitions to move in that direction.

     But none have shown signs of becoming a major profit driver that can reduce Samsung's dependence on smartphones. "So long as the company strictly demands that employees show results every year, we cannot take big risks," said an employee involved in development in an existing business field.

     Catching up to and even overtaking rivals in established markets is relatively straightforward, at least as a goal. Targets can be set and means devised for achieving them. The rewards for Samsung have been rich. But developing new products and markets requires a different set of skills -- flexibility and a willingness to embrace trial and error. "I encourage you to think freely and challenge anything," Chairman Lee Kun-hee said in his New Year's message. Whether his subordinates believe Samsung is truly creating a corporate culture that encourages risk-taking is less clear. 

Rich company, poor shareholders

Samsung's skyrocketing earnings have transformed it into a top global company. Its sales soared 90% over the five years through 2013, reaching 230 trillion won that year, equal to about one-fifth of South Korea's gross domestic product. The scale of its operations surpasses even U.S. giant Apple.

     Being at the top of South Korea's largest company has its perks. Full-time directors received an average compensation of around 5.2 billion won in 2012. Chairman Lee is not a director, but his dividend income has been estimated at around 200 billion won.

     Ordinary stockholders get more modest returns. The dividend yield on Samsung stock came to a scant 1.1% for 2013, compared to the 1.5% average for companies listed on the first section of the Tokyo Stock Exchange and nearly 2% for the S&P 500.  Samsung announced a sharp increase in its dividend on Jan. 24. Facing a slowdown in growth, the company is apparently trying to show shareholders it cares about them.