Samsung's Galaxy empire in crisis

PYEONGTAEK, South Korea/NEW YORK -- Samsung Electronics CEO Koh Dong-jin looked pale when he accompanied his boss, Vice Chairman Lee Jae-yong, to a meeting with South Korea's finance minister earlier this month.

Koh, in charge of the company's IT and mobile communications sector, had a concerned look on his face and did not smile during the group photo session at the company's new semiconductor production base in Pyeongtaek, 65 km south of Seoul. The 57-year-old engineer, who has spent most of his three-decade career in developing mobile phones, is now under enormous pressure to turn around the company's smartphone business that has been struggling with challenges from Chinese competitors.

Shenzhen-based Huawei Technologies became the world's second-largest smartphone brand in the second quarter of this year, as measured by global shipments, pushing Apple to third place, according to Counterpoint Technology Market Research, a Hong Kong-based analysis firm.

Samsung still led the global smartphone market with a 20% share of shipments in the quarter, but its market share has been evaporating in China, garnering only 1% in the second quarter. Four Chinese brands -- Huawei, Oppo, Vivo and Xiaomi -- had a combined 76% market share in their home turf for the three months through June, while Apple had 9%. That was more painful because Samsung once enjoyed a two-digit share in the world's largest smartphone market.

Both Galaxy, Samsung's smartphone brand, and Koh are facing a crisis, and he has been given the mission to wow the market with something new. On Aug. 9, three days after the meeting in Pyeongtaek, Koh appeared at the Barclays Center arena in Brooklyn, New York, to introduce the Galaxy Note 9, Samsung's newest large-screen smartphone model.

The event, called Galaxy Unpacked, at the home of the Brooklyn Nets basketball team was packed with 4,000 customers, journalists and representatives of partnership companies, offering Koh a chance to appeal to consumers in the U.S., the most crucial and lucrative market for the Galaxy line. The U.S. market's contribution to the company's entire smartphone business reached 10.9% in the first quarter, according to data from Counterpoint and Statista.

Koh Dong-jin, Samsung Electronics CEO, with the Galaxy Note 9 at the launch event in New York.   © Reuters

The annual event held in New York is extremely important for Samsung, as Note has been one of two main cash cows for Samsung's entire phone business, along with its S series. "Note is our very important premium product which has drawn many loyal customers," a Samsung spokesperson said.

Koh, in a yellow shirt -- the color of the Note 9's stylus pen, a key feature -- emphasized the 6.4-inch device's all-day battery and up to 1 terabyte storage with a remote control S Pen. The audience did not show much reaction to his 10-minute speech, but they erupted in shouts and applause when the new phone was unveiled. (Lee was not present.)

Galaxy and the smartphone business is a key source of Samsung's brand power. Samsung was ranked sixth with $56.2 billion in brand value in Interbrand's Best Global Brands survey for 2017, largely thanks to the Galaxy name, which appeals to consumers directly.

Apple was the top brand with $184.2 billion in brand value, followed by Google with $141.7 billion.

Analysts say that the new stylus pen and the phone's better appearance than previous Galaxy devices will help Samsung grow its consumer bases.

"More people will look at S Pen and they may try it. The base of users can grow," said Carolina Milanesi, an analyst at Creative Strategies, a U.S.-based research firm. "I like the new colors. If you are changing a phone every year, you want something different. You don't want it to look like your old phone."

Milanesi said that the design of the Note line has improved greatly since its launch in 2011. She said that while in the past consumers had embraced its technology but not its appearance, an appealing design was now becoming part of the series' DNA.

A 44-year-old tourist from France said she was happy with the new Note 9's wide range of functions -- from the enhanced stylus pen to the longer battery life and larger storage. "It's like a computer," said the visitor, who gave her name as Paola. She was with her daughter and husband, both of whom use Apple's iPhone. "I can do everything with this one."

Attendees at the Galaxy Note 9 launch event in New York on Aug. 9. (Photo by Emily Hey)

But some attendees and news reports were more tempered. A headline in The Wall Street Journal described the Note 9 as "strikingly like its predecessor," and the accompanying story pointed to Samsung's "slowing innovation."

The audience had been anticipating an update on Samsung's "game changer" foldable device at the event, but the company gave scant details about it. Koh discussed Samsung's plan for the foldable phone a day after the event during a news conference with South Korean journalists who had traveled to New York for the Unpacked show.

"When we release a foldable phone in the market, I want people to say that Samsung Electronics made it really great," Koh said. "We are almost getting there. It won't take that long."

Analysts expect that the tech giant plans to launch a foldable phone early next year, celebrating the 10th model in the Galaxy S series, which first hit the market in June 2010. The company is in the final stages of completing the foldable phone project: developing optimized software and services for the device.

Koh said that he will not let the opportunity to become the world's No. 1 foldable phone developer slip by, suggesting the release of the new phone could come even earlier than planned. Samsung is feeling the pressure from Huawei, which is planning to roll out the first foldable handset with a flexible screen ahead of its South Korean rival, according to analysts and industry sources familiar with the matter.

Koh has dreamed of making foldable phones for the last few years. "We may have not even started to develop the foldable phone, if we just wanted to try it," he said at the news conference, indicating that Samsung plans to make it a key smartphone line in the future.

The 10th device in the Galaxy S series comes at a time when the largest conglomerate in South Korea faces a turning point. Samsung is cutting its smartphone production in China to cope with falling sales in the country, showing how the company is struggling in the world's largest smartphone market.

Samsung said in a statement on Aug. 13 that it plans to improve "competitiveness and management efficiency activities" at its mobile affiliate in Tianjin, in northeast China, indicating that it will lower production at the factory there. The company added that nothing had yet been decided over whether it would shut down the production line at the affiliate, Tianjin Samsung Telecommunication Co.

Samsung now faces challenges from Chinese smartphone makers, such as Huawei and Xiaomi, as well as declining global consumer demand. Samsung once chased Apple and eventually surpassed it, but it now hears the footsteps from an aggressive player in Huawei, which has vowed to topple Samsung by the end of next year.

In India, another important market, Samsung was surpassed by Xiaomi in the fourth quarter of 2017, though it regained its top spot six months later. Samsung's smartphone market share by shipments reached 29% in India in the April-June period, slightly ahead of Xiaomi, which garnered 28%, Counterpoint said.

An executive with Samsung said the company feels the heat from Chinese rivals. "There are many Chinese brands, so the company needs to set up a specific strategy for each company. It is tough and hard," said the executive. "It is a real threat. The company feels it very seriously."

Now, Samsung is struggling to keep its status as the world's No. 1 smartphone maker, a position it did not always have. Samsung has shaped the smartphone landscape, along with Apple, over the past decade. In 2011, Steve Jobs accused Samsung of being a "copycat" and Apple filed a patent lawsuit against its South Korean rival, but Samsung successfully developed its own designs and functions, sometimes surpassing those of Apple. In June, both sides reached an agreement to end their years-long legal dispute.

The Samsung executive contributes the company's accomplishments in the smartphone business to its "sprit of manufacturer," designing and producing its own devices, unlike Apple, which only designs its iPhones and lets assemblers, led by Taiwan-based Foxconn Technology Group, formally known as Hon Hai Precision Industry, make them.

"We are very proud of being a manufacturer that makes our own products," the executive said. "It is in our DNA, we have no plans to change this."

Samsung's business covers a wide variety of sectors -- from premium to mid- and low-tier products -- leveraging in-house semiconductor and display technology. Thanks to its strong manufacturing base and marketing capability to understand consumers' needs, the company offers even more advanced handsets than Apple.

Samsung opened the door for large-screen smartphones in 2011 by launching its 5.29-inch Galaxy Note. That was three years ahead of Apple's release of its 5.5-inch iPhone 6 Plus in 2014.

Samsung's innovations also led the market in the display segment. The company launched Galaxy S5, the world's first smartphone with an organic light-emitting diode, or OLED, display in 2014. Apple applied the screen last year for the first time in its iPhone X, and is expected to continue adopting the display this year.

Samsung's smartphone production lines in India recently drew South Korean President Moon Jae-in and Indian Prime Minister Narendra Modi. Lee, the company's vice chairman, showed the two leaders its factory in Noida, in the northern state of Uttar Pradesh, last month, when Samsung completed installing its new production lines in the region, doubling its yearly capacity to 120 million units.

But Lee is not satisfied with the company being known primarily as a major manufacturer. The 50-year-old executive, heir to South Korea's largest conglomerate, does not hide his appetite for artificial intelligence, automotive electronics and biopharmaceuticals, and he is seeking to transform the company into a more advanced technology company.

Moreover, he needs tangible innovation to show his leadership after he was released from prison earlier this year. Lee was convicted of corruption charges in August 2017 and given a suspended sentence in February.

South Korean Finance Minister Kim Dong-yeon, left, with Lee Jae-yong, Samsung's vice chairman, at the company's plant in Pyeongtaek, South Korea, on Aug. 6.   © EPA

The company represents the embodiment of South Korea's economic success, which means if Samsung trips, the country could also stumble. Samsung paid 14 trillion won ($12.4 billion) in corporate taxes in 2017, contributing 23.6% of South Korea's total corporate tax revenue, according to data from the tax agency.

Samsung announced earlier this month that it would invest 180 trillion won, mainly for developing its semiconductor and display sectors over the next three years, including 25 trillion won in artificial intelligence, 5G and biopharmaceuticals.

Samsung still remains among the top global tech companies, with a market capitalization of 284.1 trillion won as of Aug. 16. It is equipped with abundant cash and cashable assets worth 31.4 trillion won. Despite a tough environment for its smartphone business, Samsung is able to buy time in order to nurture a new leg of the group on the back of its dominant semiconductor business. Samsung is the world's largest maker both in DRAM and NAND memory chips, enjoying enormous profits thanks to a "super-cycle" in the industry.

The company's semiconductor business is the largest contributor to its earnings, posting 35.2 trillion won in operating profit, or 65.6% of Samsung's total operating profit, last year. That was nearly three times its information technology and mobile communications division, which had 11.83 trillion won in operating profit for the same period.

Analysts forecast that Samsung will post record-high earnings in the current third quarter on the back of the booming chipmaking market and the weak South Korean won.

"Samsung's earnings will improve again in the third quarter of 2018 with the semiconductor industry entering its peak season, as well as the local currency becoming weaker," said William Park, an analyst at Mirae Asset Daewoo. "We expect its operating profit to jump 21% to 17.58 trillion won in the third quarter year-on-year, marking record-high quarterly earnings," he said.

Still, Samsung faces tough challenges in the smartphone business: from both within the company -- by having to present new and innovative products to the market -- and from competitors.

Koh acknowledged that himself at the Galaxy Unpacked event in New York. "You inspired us to push through barriers and make the Note better every year," Koh, with his shirt sleeves rolled up and his arms outstretched, confessed to the audience. "It's not easy every year, frankly speaking."

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