SEOUL Jeong Yun-seop is happy with his new smartphone, despite its lack of brand image. The second-year student at Hankuk University of Foreign Studies had bought the Redmi 2 for 230,000 won ($198), including tax, on a foreign website in October. The handset, made by Chinese manufacturer Xiaomi, costs as little as one-fourth the price of the Samsung Electronics model he had used until then. "I found no problems using it," he said. "The new handset is surprisingly cheap, though its brand image is not so attractive."
Samsung's smartphone business has been mired in a slump. The growing presence of Chinese handset vendors, such as Huawei Technologies, Lenovo Group and Xiaomi, has intensified competition in the low- and mid-range segment since 2014. Samsung's share in the global smartphone market dived to 20-25% from more than 30%.
Chinese rivals are gradually luring customers away from Samsung even in the South Korean market, where the South Korean company once enjoyed its overwhelming dominance. Huawei has sold a total of 70,000 handsets since entering the market in September 2014. The Chinese company said its performance was better than expected.
Now that tough competition has been forcing Samsung to offer deeper discounts and increase promotional costs, even a slight fall in its market share could have a serious impact on its bottom line. The company's group operating profit in the July-September period surpassed the year-earlier level for the first time in two years, but operating profit shrank approximately 30% from 2013, when its smartphone business was in its heyday.
Even so, Samsung remains a highly profitable business, with an operating profit margin of 14%, fairly high for a manufacturer. This is because earnings at the company's semiconductor division more than offset a fall in profit from smartphones. However, the semiconductor business is volatile and unpredictable.
In a November editorial, Chosun Ilbo, South Korea's influential daily newspaper, called for vigilance against Chinese semiconductors. The piece highlights widespread concern among South Koreans that Chinese companies' aggressive advance into the memory chip sector, taking advantage of their abundance of cash, could threaten the monopolistic market position held so far by Samsung and SK Hynix.
Western Digital, the U.S. hard-disk drive manufacturer, announced in October that it would acquire SanDisk, the world's third-largest NAND flash memory chipmaker. Tsinghua Unigroup, a Beijing-based chipmaker under the direct control of the Chinese Ministry of Education, recently bought a 15% stake in Western Digital. The Chinese government also has an ambitious plan to build an enormous chip factory in Wuhan, Hubei Province, at a total cost of $24 billion.
China is one of the most important trading partners for South Korea, whose exports to the country make up roughly one-fourth of its total shipments. Semiconductors account for the largest portion of South Korea's exports to China, followed by display panels. These two items constitute more than 30% of total shipments. If South Korea loses its competitive advantage in the semiconductor and display panel sectors, it would seriously undermine the country's export performance.
AUTO DROP The business results of Hyundai Motor, another representative South Korean company, also remain weak. In the July-September quarter, the automaker suffered a 25% drop in net profit from a year previously. Hyundai Motor Chief Financial Officer Lee Won-hee said, "In China, local brands focusing on low-priced vehicles have outperformed our models." In China, the South Korean automaker faces two big challenges -- an economic slowdown and fast growth of local rivals. The rapid rise of Chinese manufacturers is supported by the nation's huge domestic demand. Unit labor cost in China has exceeded Japan's, according to a recent Nikkei report. South Korea's strength lies in its technological capability, like Japanese companies that eventually succumbed to the competitive pressure of South Korean rivals. The problem is that Chinese manufacturers' technical skills are catching up with those of South Korean companies.
South Korean industry was stunned by a report prepared in June by the Ministry of Science, ICT and Future Planning that said the technology gap between South Korean manufacturers and Chinese ones has narrowed to 1.4 years. South Korea has observed its technology gap with key countries in such major areas as information and communications, machinery, and medical care. While South Korea's gap with the U.S. or Japan has shrunk, its difference with China has nearly halved in the past seven years. In contrast, China is more than four years ahead of South Korea in the field of aerospace engineering, in which South Korea lags behind other major countries.
In South Korea, there are persistent concerns about the future of Samsung and Hyundai Motor, which still boast high profitability despite their relatively slow performance, because the country has yet to find a way to fend off strong pressure from Chinese companies.
Stagnant business results have shed light on corporate governance issues looming large at conglomerates known as chaebol.
At the Seoul Central District Court in June, a representative from Elliott Management, a U.S. hedge fund, claimed that the planned merger only benefits Samsung's founding family and offers no benefits to rank-and-file shareholders. Samsung is planning the merger of two Samsung group units -- Cheil Industries, Samsung's de facto holding company, with trading house and construction company Samsung C&T. Opposing the internal merger plan, Elliott filed an injunction seeking to block an extraordinary shareholders meeting, but its request was denied by the court. The hedge fund also lost a proxy fight for the extraordinary meeting. But because many shareholders supported the fund's argument, Samsung managers must have found themselves in a cold sweat while fighting for the plan.
CHAEBOL WOES The majority of South Korea's leading companies belong to chaebol conglomerates that are still largely controlled by their founding families. But it is often pointed out that the chaebol system lacks transparency regarding capital ties and decision-making. During the time of phenomenal economic growth, no one complained about transparency issues as employees, business partners and other stakeholders enjoyed sufficient merits including job security, rising wages and rising stock prices. Now that the economic outlook has become gloomier, the negative side of the chaebol system has become apparent.
In April, Hyundai Motor announced that it set up an independent organization tasked with protecting the interest of minority shareholders within the board of directors. Establishment of the transparency management committee consisting of four outside directors is aimed at enhancing dialogue and communication with shareholders.
When Hyundai spent more than 10 trillion won to buy land for a new office building in the heart of Seoul in 2014, the company came under fire from shareholders, who argued that the money should be used for more meaningful purposes such as investment in next-generation car development. After it was reported that Hyundai Chairman Chung Mong-koo, from the second generation of the founding family, made a discretionary decision on the land deal, some raised questions about the company's decision-making process.
A family feud surrounding the Lotte group also shows the negative side of family-owned conglomerates. The group, which straddles South Korea and Japan was established by Shin Kyuk-ho in Japan when the South Korean was still young. In the past, the founder's two sons shared the group's management with the eldest son, Dong-joo, in charge of Japanese operations and the younger, Dong-bin, responsible for the South Korean side.
The family conflict was triggered when the founder removed the eldest son from several key posts in late 2014 and early 2015. Dong-joo filed a series of lawsuits in Japan and South Korea, claiming the dismissals were unjust and unacceptable. Complicating the matter, the founder changed his stance quickly and brought an action against the second son, saying he had dismissed the eldest son because of a falsified document. The founder, who is siding with the elder son, is locked in a long-running battle with the younger one. As nearly one year has passed since the outbreak of the family feud, consumers and investors has begun to feel disgusted by the lingering conflict, sending the stock price of Lotte Shopping, the group's core unit, drifting at low levels.
The impact of subdued performances at South Korean conglomerates, which have long been the driving forces behind the country's economic growth has begun to be felt in the macro economy.
"Our country's potential growth rate, that was around 3.5% shortly after the 2008 financial crisis, is likely to have declined as a result of slow investment and a decrease in labor force," Lee Ju-yeol, governor of the Bank of Korea, the country's central bank, told a news conference after the bank's monetary policy committee on Nov. 12.
South Korea now expects its gross domestic product in 2015 to rise 2.7% from the previous year. The growth rate will be considerably lower than its initial projection of 3.4%, dipping below 3% for the first time in two years. The weaker forecast is mainly attributable to sluggish exports resulting from economic slowdown in China and Europe and oil price falls, along with weak capital spending.
"I don't think our country's potential growth rate has fallen below 3%," Lee, the central bank chief, said, retaining his bullish view on the economic outlook. Meanwhile, the state-run Korea Development Institute and other think tanks largely agree that the potential growth rate has already slipped to the 2% mark. Their bearish view stems primarily from projections of the country's working-age population (aged 15-64). The population is expected to shrink after reaching its peak in 2016, which will inevitably lead to persistently stagnant domestic demand.
South Korea has embarked on aggressive stimulus measures to spur economic growth, learning a lesson from Japan that suffered a long-term economic slump since the 1990s and faced a decrease in its working-age population, starting in 1996. "Our country should not mimic Japan's lost two decades of growth," said Choi Kyong-hwan, deputy prime minister for economy and minister of strategy and finance.
One of the highlights of the stimulus package is easing of mortgage rules. After taking office as deputy prime minister for economy last summer, Choi loosened the regulations on loan-to-value and debt-to-income ratios to make it easier for potential home buyers to have access to bank borrowing. The policy helped reinvigorate the dormant housing market. The central bank also underpinned the government's efforts by cutting the key interest rate. As a result, the ratio of unsold homes as of March -- an indicator of unsold housing inventory -- declined to about 20% of the December 2009 level. The trend has contributed to spurring construction investment, becoming one of the factors driving the country's economic growth.
Under the auspice of the South Korean government, the country's first-ever full-scale joint retail event was held in early October, participated by major local retailers, such as E-mart and Lotte Shopping. About 26,000 outlets across the country including department stores, large supermarkets and convenience stores took part in the event, dubbed the local version of Black Friday, a post-Thanksgiving shopping spree that originated in the U.S. Combined sales at 22 major retailers on Oct. 1-14 jumped 21% from a year earlier, according to the Ministry of Strategy and Finance.
Encouraged by the successful Black Friday event, the government aims to hold similar events regularly starting next year. However, brisk sales results emerged as a reaction to a sharp fall in consumer spending caused by the spread of Middle East respiratory syndrome. The results were also buoyed by a rush in demand fueled by the festive mood to shop for the special occasion. It is widely considered that the South Korean economy lacks positive incentives, except for active housing transactions promoted by easing of mortgage rules.
However, the deregulation also has put a heavy burden on households, causing rapid growth in household debt. Statistics from the central bank showed that outstanding household debt stood at 1.166 quadrillion won at the end of September 2015, up more than 60% from 2008. Some economists point out that lower-income class earning 30 million won or less a year are borrowing more from banks. The worsening household finances would likely lead to mounting bad loans.
The Bank of Korea lowered its policy interest rate to a record low of 1.5% in June, when the spread of MERS posed an imminent threat to consumption. However, taking the key rate lower could fuel a buildup of housing debt. "Although a rate cut can be an effective tool to improve consumer sentiment, it has only a limited spillover effect on the real economy," said Yoon Yeo-sam, a fixed-income analyst at KDB Daewoo Securities. Accordingly, relying solely on monetary policy won't work for long. In late January, the National Assembly was rocked by a shocking report on the nation's long-term fiscal outlook. Compiled by the National Assembly Budget Office, the report forecasts that total spending could surpass total revenue in 2021 due to expanding medical and welfare costs amid the rapidly aging society, sending the country into a budget deficit and increasing the issuance of government bonds. The report said the country could go bankrupt in 2033.
The total fertility rate in South Korea fell to 1.21 in 2014, even lower than in Japan, where the population is declining and its society is aging at the fastest pace in the world. In 2060, South Koreans aged 65 or older will make up 40.1% of the population. The country is predicted to become a "super-aged" society, as is the case for Japan. With South Korea's household finances remaining fragile, is it possible for the country to handle its aging society while avoiding financial collapse? There are growing concerns over the future course of the economy.
Nikkei staff writer Koichi Kato contributed to this report.