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Case Study of Samsung Electronics (Samsung) 1. What are the sources of Samsung's cost advantages in DRAMs in 2003?

You need to run the numbers to get the answer. Samsung Electronics (Samsung) started DRAMs business in the early 1980s and rise up to the top of the industry since 1992. The company was claimed as the most profitable semiconductor producer across the DRAMs industry. In order to find out how Samsung could develop its cost competitiveness in DRAMs business, let us dig into the cost structures of Samsungs DRAM compared with its competitors for 2003 based on the chart below.
Exhibit 7a comparison of operating profit of DRAM in 2003(256Mbit equivalent)
Samsung Micron Infineon Hynix SMIC competitors' weighted average $4.96 $5.70 $1.83 $0.74 $1.64 $0.62 $0.87 -$0.74 -15.00% Samsungcompetitor s' weighted average $0.72 -$1.39 -$0.65 -$0.19 -$0.29 -$0.02 -$0.22 competitor s'weighted average/Sa msung(%) 87.3 132.2 155.1 137.0 121.5 103.3 133.8

average selling price fully loaded costs raw materials labor depreciation R&D SG&A operating profit(a) operating margin production volume in 256Mbit equiv. (millions)(b) operating profit in $million(aXb)

$5.68 $4.31 $1.18 $0.54 $1.35 $0.60 $0.65 $1.37 24.10% 896.4 $1,224.30

$4.93 $6.61 $1.93 $0.94 $1.88 $0.57 $1.28 -$1.68 -34.10% 672.8 -$1,129.50

$5.05 $5.02 $1.58 $0.76 $1.50 $0.71 $0.46 $0.02 0.50% 535.3 $12.90

$4.97 $5.33 $1.93 $0.51 $1.48 $0.58 $0.83 -$0.36 -7.30% 521.3 -$188.10

$4.43 $4.84 $1.84 $0.23 $1.63 $0.80 $0.34 -$0.41 -9.30% 68.2 -$28.10

Samsung incurred 55.1% lower in costs of raw materials than its competitors in average. (Exhibit 7a) This was mainly because the company possessed the technology capacity to produce more chips from each designated size of wafer. Thanks to the decisive plan by the companys senior manager, back to the early 1990s, who was able to convince the company to invest US$ 1 billion into developing the technology that can produce 8-inch wafers and successfully pushing this technology into the mass production. Larger wafer means more chips could be cut at one time. As a result, Samsung was able to achieve better economic of scales by pushing down per unit cost of raw materials incurred much lower than its competitors. This also means that the precision technology Samsung developed to produce 8inch or 12-inch wafer is the most proven and reliable one across the industry, as evidenced that Samsung who produced 12 % and 88% of its total unit chips using 12-inch and 8-inch

wafer respectively achieved 80% in production yield as of 2003 compared to Infineon - the worlds second largest memory chips maker who produced 33% and 67% of its total unit chips using 12-inch and 8-inch wafer respectively achieved only 60% in yield rate. (Exhibit 10c) Exhibit 10c comparison of production by wafer size, design rule, and yield rate
Samsung Micron Infineon Hynix production volume by wafer size 8 inchi 12 inch wafer wafer total 88% 12% 100% 97% 3% 100% 67% 33% 100% 100% 0% 100% process technology main design % of rule (um) usage 0.11 67% 0.13 80% 0.14 80% 0.13 72% yield rate 80% 60% 67% 50%

Notes: yield rate is based on 0.11um process technology for 256Mbit

It was amazing to find out that Samsung was able to maintain its labor cost at competitive level 37% lower than its competitors in average while still generating the most desirable annual sales figures across the industry. (Exhibit 7a) The company claimed neither the highest nor the lowest average salary among its major competitors - at US$ 44,000 in 2003. However, the company provided to its employees with one of the most attractive compensation packages across the industry or notably recognized as performance-based incentive programs which consist of project incentives, productivity incentives and the profit sharing program. Furthermore, the company had endeavored to break its traditional seniority-based promotion, implement meritocratic evaluation system and promote those talented and capable young managers up to the top position of the organization. Besides, the company invested aggressively in employees education and training program such as Regional Specialist Program and sponsored hundreds of employees to study MBA and PhD overseas. The extra costs incurred to reward its employees were partly traded-off with better operational efficiency within the organization and lower staffs turnover rate. Samsung incurred the lowest depreciation cost among major memory chips makers reflecting its lower capital expenditures. (Exhibit 7a) However, the company was able to churn out 1,200 different variations of DRAM products as of 2003 - the most varied product mix in the industry. Thanks to the companys design and production team, where its R&D engineers worked on developing new products using a common core design while its production engineers focused on continuously improving and modifying its existing production equipment so that multiple product architectures could be produced on each production line. As a result, the company managed to produce many new products without investing new production equipments but still could achieve lower defect rate and higher productivity due to increased production efficiency. This evidence can be seen from its 2003s

financial results (Exhibit 1) when Samsung recorded 15.1% in return on assets (ROA) whereas its other competitors Infineon, Hynix and Micron was having negative ROA. Moreover, the company generated US$ 1.11 in revenue for every US$ 1 in assets, the highest among its other competitors Infineon, Hynix and Micron who respectively generated US$ 0.61, US$ 0.56 and US$ 0.44 for every US$ 1 in revenue. An excerpt from Exhibit 1 Financial Results (USD, million), 2003 2003 net revenues net income total assets ROA asset turnover Samsung 36385 100.0% 4975 13.7% 32892 15.1% 1.11 Micron 3091 -1280 7075 -18.1% 0.44 Infineon 100.0% 4884 100.0% -41.4% -345 -7.1% 8018 -4.3% 0.61 Hynix 4030 -1770 7218 -24.5% 0.56 100.0% -43.9%

Notes: ROA = net income/total assets asset turnover = revenue/total assets

Samsung incurred lower R&D cost, partly thanks to the companys collocation strategy of putting its main R&D facility and manufacturing plants at a single site, so that the R&D engineers and production engineers could quickly solve the problems pertaining to product design and process engineering. This has reduced the communication cost between R&D engineers and production engineers, shorten the time needed to rollout new products and improve production efficiency. Another reason is that the company is pushing for an R&D alliance with design firms such as Rambus, together with the companys engineers, responsible for creating many new products with shared common core design. This has helped the company to create many innovative products and rollout new products into the market faster save time and money. SG&A (unable to describe on this point)

2.

What are the sources of Samsung's price premium in DRAMs in 2003?

Exhibit 3 DRAM average selling price(ASP),operating cost, and operating margin (256Mbit equivalent) 1Q'00-1Q'04

Average average selling price operating cost operating margin price premiun of Samsung ASP over competitors' ASP operating margin of (Samsungcompetitors'average)

Samsung $15.25 $8.50 44% 34% 53%

Micron $11.09 $12.51 -13%

Infineon $10.58 $9.90 6%

Hynix $11.42 $10.68 6%

Worldwide $12.63

As being shown in the chart above, one could find that Samsung customers were paying 34% premium over the price offered by other major DRAMs suppliers. This had made Samsung the most profitable DRAMs maker with 44% in average operating margin - far higher than its other major competitors for the period 1Q 2000 1Q 2004. Why Samsung customers were willing to pay that price premium? There are two possible reasons that could simply explain this - the reliability of Samsung products and the companys ability to customize products to customer demands. From the customer perspectives, they are willing to pay more for a reliable product with less deficiency which help solving their problems and provides convenience and creates added values to them. Besides, they prefer dealing with those suppliers who are able to customize products according to their specification and required features, and committed to their satisfaction. How Samsung achieved those two objectives? Thanks to the companys years of conforming to strict quality control practices and its strong obsession towards reliability and performance. Samsung took pride for having developed one of the most advanced precision technologies which produced more chips with lower deficiencies. This can be evidenced by its ability in 2003 to achieve 80% in production yield performance the highest among other DRAMs suppliers. (Exhibit 10c) The company ensures that only the most viable and proven technologies not necessary the complicated one, were employed to produce its products. This may assure reliability and consistent performance of products. Moreover, the engineers may promptly solve the product problems and retain customers confidence. This fact was further supported by a true event happening back in early 1980s when Samsung made a critical decision to use stacking

method to produce its 4Mbit DRAM instead of following its other major competitors footstep that had chosen to use the trenching technology. The process of stacking was simple and modular, thus making it far easier to see and fix mistakes. Those who had used the trenching technology were eventually losing their competency ground in DRAM industry after discovering the complex problems associated with the trenching system. 3. What recommendations would you give to Chairman Lee regarding the response to the threat of large-scale Chinese entry? In reacting to the threat of Chinese competition, Chairman Lee may consider some of the suggestions as follows: a. Samsung may engage collaborative partnership with Chinese producer in setting up its manufacturing plants in China. There are some advantages that the company may capitalize on its Chinese counterpart such as the access to the government essential resources and incentives, and also abundant engineering talents with relatively lower wages and so on. Apart from the reduction in investment cost, there is another compelling reason the company could not resist to consider partnering with Chinese counterpart is that China is going to consume more semiconductors second only after the US in years to come due to its enormous domestic market for consumer electronics products. That means establishing production lines in China is the only option to put the company into a better position to capture more market shares with better cost competitive products. b. Samsung may form R&D alliance with Chinese producer to co-develop new product and technology. This is going to reduce the companys investment cost and shorten the new products time-to-market cycle in order to better compete with other major industry players for more market shares. c. 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 be a bold move and if a new working culture is successfully molded, and is moved ahead into favoring both parties in positive outcome, the company would eventually take pride for its innovative attempts and further strengthen the companys position in the semiconductors industry.