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1. Sources of Samsung’s cost advantage in DRAMs
Samsung’s cost advantage is clearly visible from the comparison of costs (and their elements) that were borne by the company and its competitors in 2003 (Tab. 3): Samsung’s overall cost was 24 per cent lower than the weighted average cost of the other four producers; two most significant elements of the cost structure, i.e. raw materials and labour, were 36 and 27 per cent lower respectively. When expressed by means of a relation of average selling price to costs (“productivity” of cost elements), the differences are even more visible (comp. Tab. 4 ): overall superiority of Samsung over its competitors exceeded 51 per cent!
The cost advantages related to raw materials may be explained by better negotiated agreements with suppliers (perhaps due to the larger volumes of purchases – comp. Fig. 5) and possibly less shipping and distribution costs that stem from the fact that Samsung’s fab facilities are geographically collocated (while competitors’ facilities are spread world-wide). In terms of labour productivity only Chinese SMIC outperformed Samsung, but that came hardly unexpectedly: low labour costs in China had been and were to remain unbeatable for some time yet.
Other possibly meaningful factors that cannot be forgotten include: higher yields (due to process quality and use of more efficient, larger silicon wafers), use of common core design for different products supported by the flexibility of production lines (which enabled cost-efficient production of a wide variety of different semiconductors), and – reportedly – 12 per cent lower investment in capital assets related to the aforementioned strategic decision on fab collocation.
The last but not least element of the Samsung’s “cost puzzle” (which, unfortunately cannot be supported by concrete numbers from the case study, and is rather based on intuition) was the way the firm built and maintained intellectual capital and stimulated innovativeness and creativity among employees. It had established an incentive-based remuneration system, it sponsored employees for PhDs and MBA education, it created a family-friendly working environment in which more of employees’ energy could be devoted to solving problems at work instead of troubles in private lives. In most modern industries, such a long-term approach and investing in human capital eventually pays off resulting in higher productivity and better and cheaper products.
2. Sources of Samsung’s price premium in DRAMs
Samsung achieved an almost 15 per cent price premium over (the weighted average price of) its competitors (comp. Tab. 3). How was that possible?
There were, apparently, two main reasons for that: quality and product mix.
The former was definitely a unique advantage in the semiconductor industry which was, generally, characterised by little product differentiation (in terms of physical and functional properties), and where demand was highly price-driven. Even though, due to the outstanding quality and reliability of its products, Samsung had managed to achieve a position which justified paying premium for its products. Between 1995 and 2005 the company won awards for performance from most of its major customers, and many of them (even rivals of one another) named Samsung their supplier of choice. Of course, the highly-recognisable brand (the value of which was estimated at almost USD 11 billion in 2003 !) helped to maintain the price premium as well.
The Samsung’s successful product mix strategy, on the other hand, was realised through extremely wide differentiation of products that the company manufactured: in DRAM memory segment it was over 1,200 different types! The large product portfolio allowed Samsung to address a very broad market and to avoid fierce price fighting in the most competitive sector of so called commodity DRAMs (where many producers had to sell below production costs). Apart from the ‘mainstream’ mass products (in general: low-cost commodity DRAMs), Samsung offered:
• “legacy products”, i.e. older types of chips, production of which was continued after the industry had moved to newer generations and which – due to limited supply – could be sold at price premium;
• “specialty products” – chips designed for niche uses where the price wass usually agreed on bilaterally between Samsung and a given buyer (at the same time, the company was able to optimise costs by building the customised architectures using a common core design).
3. How Samsung should react to threat of large-scale Chinese entry?
In my opinion, none of the two options of reacting to the Chinese “menace” that were presented in the case study, should have be chosen by Samsung as the only one. Rather, a mix of the two seemed to be an optimal approach.
Samsung’s unique ability to maintain the low-cost and, at the same time, differentiated production should have been maintained, but – simultaneously – certain aspects of the changing industry environment might have been taken advantage of as well. It was not necessary for Samsung to desperately look for ways to decrease its labour costs (which is usually a reason for established companies to move their production to China): its cost advantage over competitors was supposed to remain for some time. On the other hand, in line with an old Chinese saying: “keep your friends close, but the enemies even closer”, it was not advisable to ignore the rising competitors (as the industry had done years earlier with regards to Samsung itself). Earlier of later, China itself was posed to become a significant (if not the most significant) market for semiconductors, thus all actions aiming at better positioning itself to sell in the market seemed to be highly desirable.
Therefore, Samsung should have decided to partner with a Chinese firm for production of its low-end, legacy products. At the same time, its state-of-the-art technologies had to be kept in-house. Such a strategy would let Samsung preserve its valuable intellectual property; manufacturing of the mass market products together with Chinese did not pose a threat to the IP, since technologies necessary for that usually were no longer proprietary information. On the other hand, the partnership might result in a possibility to further decrease the costs due to availability of attractive subsidising from the Chinese government and lower labour costs, and – of course – prepare grounds for enlarging sales to customers in the opening and growing market.
There was, however, a number of important aspects that had to be remembered while implementing the strategy:
• Samsung’s competitive advantage related to the unique breeding environment for innovation and efficacy of the centralised R&D and production should have been preserved, thus all new product development had to be kept in the Korean headquarters;
• another competitive advantage of the company, the quality, should have been definitely maintained, too; it might have become a challenge if part of the production was to be moved to China, therefore Samsung had to ensure it could properly influence its Chinese partner (e.g. by remaining a majority stakeholder in the joint undertaking);
• while overall reduction of costs was not of key importance for Samsung, the partnership with a Chinese firm could have been, nonetheless, used for reduction of labour costs related to production of legacy products (in case of which the associated gain was to be most significant) with no risk of compromising valuable intellectual property; that way, another competitive advantage of Samsung, the industry’s best ASP to cost ratio, would be further strengthened.
However, in parallel to building the partnership, Samsung couldn’t have forgotten about other Chinese would-be competitors which would supposedly flourish around. Therefore, the company should have kept strong focus on maintaining its technological leadership through cutting-edge R&D (still unavailable at the time, despite having relatively easy access to capital, for Chinese start-ups), especially towards future substitutes for DRAMS: flash memory chips.
Another way of impeding development of the competition, although more risky and thus to be applied with care, was to suppress Chinese entrants by decreasing margins on low-end DRAMs. A price on the edge of profitability, connected with Samsung’s well-known quality, was likely to push competitors towards more or less significant operational losses; at the same time, Samsung would be still able to earn on the other products from its wide portfolio. A price war never is, however, sustainable in the long run, so a question remained: for how long were the Chinese challengers able to operate in red? Some experts suggested that they might be even better prepared for the years of initial losses than Samsung had been back in the 1980s…
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"Samsung Competitive Analysis." 123HelpMe.com. 11 Mar 2014