Transformation, not restructuring
In fast-changing business environment, Korean conglomerates begin to embrace culture of relentless restructuring
By Cho Jin-seo
When SK Telecom made a bid for Hynix Semiconductor in early July, responses from stock market analysts were skeptical. Does a telecom company with a stable profit model really need to take the risk of doing business in the highly volatile, low-margin semiconductor industry? Many said the acquisition would be too risky. SK Telecom’s stock price dipped, and even the firm’s employees were not very enthusiastic.
“Most people want to stay in the telecom division and only a few want to work in the new businesses,” said a mid-level manager who didn’t want to be named. Most employees are afraid of being dispatched to the new business unit even if that’s where the future growth is, he said. “People came to a telecom company because they wanted a stable job. So why would they want to take the risk of doing something new?”
This reluctance of the firm’s employees is a typical problem firms face in M&As and restructuring. It is in human nature that when things look good people resist rapid change and prefer the status quo. But Kim Jong-nyun, a senior researcher of Samsung Economic Research Institute, says that the fast-changing global business environment has made big firms embrace the relentless transformation of their business models and switch industries when necessary. SK Telecom’s bid for Hynix may feel uncomfortable for its employees and look unnecessary for stock analysts with short-term outlooks. But from management’s perspective, it was a very reasonable decision, he said.
“Internal transformation has become a global trend, because technology and industrial landscapes have made them change rapidly,” he noted, after publishing the Transformers of Business report last week, which was named after the popular Hollywood movie series.
Kim prefers the term transformation to corporate restructuring, because the latter is commonly used when referring to downsizing. Especially in Korea, the word restructuring has become synonymous with layoffs, salary cuts or early retirement programs.
“Since the Asian financial crisis of the late 1990s, people began to think of downsizing or bankruptcy when they hear the word restructuring. But what happens these days at big firms is not restructuring through downsizing. Big companies are trying to grow faster by selling old units and using the money to invest in new businesses. That is what the term restructuring should really stand for.”
Like SK Group’s bid for Hynix, a number of Korean conglomerates have turned to business transformation in the past few years. Samsung Group is expanding into the biotech and healthcare sectors, and LG Group is active in the new energy industry.
The solar power industry is especially popular as a destination for fresh investment as smaller business groups such as STX, Woongjin Group and Dongbu Group have all set up subsidiaries for making solar panels and parts.
But the lure of renewable energy seems dangerous, Kim said. There may not be enough reasoning behind those moves into the new energy sector as STX is a shipbuilder, Woongjin best known for its water purifiers and Dongbu, inter-city express bus services.
Effective transformation does not necessarily mean investing in new and fashionable business items. “You shouldn’t just follow what others do. You need to do what you can do best,” Kim said. One example of a good transformer is Cheil Industries, the clothing and textile subsidiary of Samsung Group.
Though the firm is better known for fashion brands, a large chunk of its profit nowadays is in the electronic parts and chemicals business. Cheil knew that its knowhow in handling synthetic textiles could be used in manufacturing chemicals and electronic components, Kim said.
Role models
On the global stage, Kim suggests four role models in terms of business transformation — GE, Dupont, Hitachi and Philips. GE has shifted its focus from power generation and industrial materials to healthcare (“Healthymagination”) and energy (“Ecomagination”), while Dupont is reorganizing its resources from chemicals to biotech and new energy sectors. Philips, too, is now investing heavily in healthcare after withdrawing from the semiconductor and electronics parts sectors. Hitachi has reduced the portion of household electronics from its business portfolio and has instead been focusing on infrastructure businesses such as power generation, construction equipment and transportation management systems.
Not all global firms have succeeded in managing change, though. And even after a firm manages to succeed once, it can flop at the next attempt. Many business school classes studied Nokia, the once dominant force in the global mobile phone market, as the prime example of business transformation as it used to produce paper in the 19th century. But these days Nokia has lost most of its glamour as it failed to adapt quickly to the rise of smartphones such as Apple’s iPhone. In the most recent quarter, the firm posted a loss of $523 million.
Nowadays, Nokia is only rated Baa2 by credit ratings agency Moody’s. “The challenges we are facing during our strategic transformation manifested in a greater-than-expected form in Q2 2011,” its CEO Stephen Elop said in an announcement last month.
Another firm that needs a radical reform is Research in Motion (RIM), the maker of BlackBerry phones. Once revered as the epitome of innovation, the Canadian firm just announced 2,000 job cuts and is facing a “painful transition,” according to investment bank UBS.
Desperate telcos
The decline of Nokia and RIM has been sending a warning signal to the entire mobile phone and telecom sector. In Korea, LG Electronics too has struggled by not adapting to the market shift to smartphones. And telecom firms have sensed that their margins are squeezed as revenue from text messaging services, once their cash cow, has been falling due to the rise of Internet-based messaging services.
But changes are not easy to execute. The telecommunications market is strictly protected from competition by the government’s licensing system so telecom firms often lack the DNA for transformation.
In case of SK Telecom, the firm has tried many ventures in and outside of Korea with the ample cash they took in every year from mobile phone users but all of them, an investment in China Unicom, a U.S. venture called Helio, and S-Fone project in Vietnam, failed.
One reason for these dismal results is that telecom markets are heavily regulated and protected in most countries so it is difficult for foreign firms to win in the local market. Another reason is that SK Telecom itself does not possess the right capability for overseas expansion, analysts say. “You need to understand the country and its culture, but SK Telecom is not very good at it,” says Park Jong-soo of Hanwha Securities.
The bid for Hynix is different from previous failures in that it is a Korean firm in a different industry. But still, many think the prospects for the deal are not rosy. Most brokerage houses have released negative outlooks and SK Telecom’s stock price fell by over 10 percent between June and July.
Knowing when to sell
Kim at SERI says that it is time for Korea’s big firms to change, because the traditional growth model of conglomerates has reached its limit. He collected data from 114 big manufacturing companies listed on the KOSPI bourse between 2000 and 2010. These companies represent Korea Inc.
On average, their operating profit rate fell to 7.2 percent from 8.4 percent during the 10-year period. The operating profit rate measures how much profit a firm makes from its everyday business, so a falling rate means their profit margin is being squeezed from competition, probably those from China.
What’s important for firms is that they have to let go of unprofitable businesses and use their resources for indentifying new and more profitable opportunities, Kim says. “Profitable and sustainable growth is possible only when investments in new businesses go together with the restructuring of old ones,” he said. “It would be too late if you try to sell a business after it becomes a sunset industry. You must sell at its peak.”
In Korea, selling a firm is usually the last resort of conglomerates in financial trouble. Most large business groups do not sell subsidiaries or other assets such as real estate as long as they remain profitable, even if there are potential buyers who offer attractive prices. This means that they sell assets only when they have no other means to make cash, and this puts them in an inferior position in price negotiations with buyers.
To illustrate this problem, Kim compared growth and the operating profit of the top 20-percent of firms in Korea and in the rest of the world in terms of asset sales. In Korea, those firms that sold the largest amount of assets saw their average operating profit rate fall by 1.5 percentage points between 2000 and 2010.
On the other hand, global firms with the highest asset sales ratio saw a 0.8 percentage points increase in their operating profit rate during the same period.
Korean firms sold assets when they needed cash to stay afloat, while many global giants sold assets when they needed the money to invest in better opportunities. “But I see positive signs that Korean firms’ mindset is changing,” Kim said.