Chaebol fend off extended profit sharing
Smaller companies cry foul over large businesses' unfair practices
By Jung Sung-ki
In the face of growing concerns about socio-economic polarization, the country’s top conglomerates have come up with plans to increase shared growth with small- and medium enterprises (SMEs) in recent years.
The move comes as the Lee Myung-bak administration put top priority on easing the gap between the haves and the have-nots, as it believes polarization between big conglomerates SMEs is the “epicenter” of worsening social polarization.
Larger businesses, for their part, understand boosting mutual benefits with smaller companies based on the performance of SME clusters is one of the key factors in improving their global competitiveness in light of global business trends.
But their effort took a twisted turn when former Prime Minister Chung Un-chan suggested in February that larger corporations share part of their profits with their subcontractors under an “extended profit sharing system.”
Chung’s remarks raised eyebrows in business and political circles, and have been denounced by conglomerates and conservative economists as “radical” or “leftish” in violation of market economy principles.
A former economics professor at Seoul National University, Chung, chairman of the Commission for the Shared Growth for Large and Small Companies, proposed that when a large corporation exceeds its profit target set at the beginning of the year, a certain portion should be returned to relevant subcontractors through a “shared growth fund” mechanism.
The funds would be used in helping related SMEs develop technology, raise productivity or stabilize employment.
The commission also proposed a “win-win index” be developed to measure how far large corporations go in supporting the growth of their suppliers. Initially, the commission plans to assess the performances of 56 corporations in six sectors.
Under the system, the government will provide various incentives, including tax benefits, to companies sharing their profits voluntarily with subcontractors, according to the commission.
Chung reiterated the system is neither an anti-market nor socialist redistribution policy, arguing it is a broadened concept of the existing profit-sharing system in conglomerates. For example, Samsung Group provides 20 percent of its year-end profits to employees as incentives and shareholders as dividends.
In a press conference on March 3, Chung cited Apple and Delphi of the United States and Toyota of Japan as exemplary companies conducting good shared growth programs.
“Apple shares 70 percent of its profits with application developers,” said Chung. “Toyota also cooperates with its subcontractors, and so does Delphi with Korean suppliers. All of these programs are part of benefit sharing, similar to (extended) profit-sharing.”
Backlash
Chung’s argument, however, has drawn sharp criticism from industry officials and economists, as well as big business lobby groups.
“As a matter of fact, there are few systems similar to the so-called [extended] profit sharing system in the world,” Yoon Seong-hyeok, head of the shared growth policy team at the Ministry of Knowledge Economy, told The Korea Times. “The concepts of benefit sharing and profit sharing are just too different.”
Under the benefit, or performance, sharing scheme, for instance, large and small companies agree in advance on certain cost-reduction plans or programs on the joint development of technology or spare parts. If they succeed in meeting these goals, both sides then share the profits from the projects concerned in various forms.
There are about 84 businesses engaged in such benefit sharing programs, according to the Federation of Korean Industries, a lobbying body for the nation’s largest conglomerates.
Extended profit sharing, on the other hand, sets a target goal of year-end profits beforehand and shares the excess with subcontractors, as well as employees and shareholders.
Economics professor Cho Dong-geun of Myongji University in Seoul call Chung’s proposal an “anachronism.”
Cho said it’s difficult to establish guidelines for the degree of contribution from contracting businesses or how much “excess” profit should be calculated and shared with them.
“Under the sharing system, most large companies can’t help exaggerating their profit goals to prevent earned profits from exceeding the former. Or they won’t try to earn more than their target profits,” the professor said. “So the actual profits to be shared with SMEs could be zero.”
The economist also rebutted Chung’s citation of Apple’s benefit sharing effort.
“That’s a clear misunderstanding,” he said. “To be precise, Apple doesn’t share its profits with iPhone app developers. That is, Apple just opened online market places, dubbed app stores, and receives a 30 percent standard cut.”
He continued, “But the market doesn’t blame Apple because sharing profits in half is not necessarily a way of shared growth. When parties concerned agreed on a certain profit sharing formula and signed a relevant contract to improve each other’s profits, that’s a shared growth effort.”
According to a recent survey in the United States, the majority of application developers believe they should receive more than the 70 percent share, complaining about Apple’s current take.
Nearly 50 percent of the 400 developers thought app stores should only get a 10 percent cut, with 90 percent going to those who made the application.
Monopolistic structure
Still, SMEs and liberal economists support the expansion of extended profit sharing, citing the deep-rooted practices of unfair transactions between large corporations and their subcontractors.
“The concept of extended profit sharing is bit different from that of benefit sharing, but the system is similar to benefit sharing in a broader sense,” Professor Kim Sang-jo of Hansung University in Seoul.
“Given that there are still rampant unfair transactions and distrust between large firms and SMEs, such an extended profit sharing measure through a fund could be a better way of enhancing mutual benefits rather than supply cost adjustments,” he said.
Park Hyung-joon, a researcher at the Progressive Financial Network, said large firms’ monopoly on profits largely contributes to low pay, unstable employment and social polarization.
“In many cases, subcontractors assume much of the production cost, while large conglomerates with several suppliers earn bigger profits,” said Park. “Big construction firms dominate almost all contracts, as you know, but actual constructors are their second or third subcontractors.”
According to the think tank, as of 2007 the profit by the nation’s top 30 corporations accounted for about 63 percent of total profit.
The profit of the four largest conglomerates, led by Samsung, represented 27 percent, followed by 23 percent of the other 16 firms. The profit by the top eight banks accounted for 13 percent.
The data was compiled from a total of 372,141 firms, including about 820 large firms and their affiliates. It shows that only 0.2 percent of all the firms in Korea earned nearly two thirds of total profits.
The researcher also claimed low corporate taxes have only benefited large firms. Korea has one of the lowest corporate income tax rates in the world at 20 percent.
The Lee administration lowered the corporate tax rate from 25 percent to the current level after its inauguration in 2008, but most of the benefits go to the top 10 businesses, he added.
In 2009, large businesses with profits of 500 billion won or more had tax benefits of some 2.6 trillion won, but SMEs with profits of 500 million won or less had only 48 billion won in tax reductions, Park said.