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Samsung's Capital Structure

Having described the Revenue, Operating Margin and cost structure for Samsung Electronics it’s time to review their investment strategy.

The Economist summarized it well:

[Samsung's] businesses look remarkably disparate, but they share a need for big capital investments and the capacity to scale manufacture up very quickly, talents the company has exploited methodically in the past.

Samsung’s successes come from spotting areas that are small but growing fast. Ideally the area should also be capital-intensive, making it harder for rivals to keep up. Samsung tiptoes into the technology to get familiar with it, then waits for its moment. It was when liquid-crystal displays grew to 40 inches in 2001 that Samsung took the dive and turned them into televisions. In flash memory, Samsung piled in when new technology made it possible to put a whole gigabyte on a chip.

When it pounces, the company floods the sector with cash. Moving into very high volume production as fast as possible not only gives it a price advantage over established firms, but also makes it a key customer for equipment makers. Those relationships help it stay on the leading edge from then on.

The strategy is shrewd. By buying technology rather than building it, Samsung assumes execution risk not innovation risk. It wins as a “fast follower”, slipstreaming in the wake of pioneers at a much larger scale of production. The heavy investment has in the past played to its ability to tap cheap financing from a banking sector that is friendly to big companies, thanks to implicit government guarantees much complained about by rivals elsewhere.

Can we find evidence of this capital intensity?

To answer, I reviewed Samsung Electronics CapEx as reported in their quarterly cash flow statements. The following graph illustrates the data:

Note that during 2006 and 2007 the company specified expenditures on an operating divisional level. Since 2008 it has reported only a total. For the years where divisional detail is available, the percent split looks as follows.

If we combine the Semiconductor division (Memory and System LSI) with the LCD group and classify this as “components” the split looks as follows:

Therefore, for the two years when information was available, the component divisions consumed 91% of expenditures and Consumer Electronics (Digital Media) together with the Telecom (mobile phones, mainly) were a combined 9%. The least capital intensive division was Telecom, the mobile phone group, with only a 2% allocation of capital.

The other observation is that, after a contraction in the recession years of 2008 and 2009, CapEx expanded greatly in 2010 and 2011. [1]

Coincident with the growth in CapEx, the company’s revenues grew dramatically as well. However, as the graphs below show, the growth has come predominantly from the Telecom division.[2]

I calculated the correlations between each division’s revenues and the growth in CapEx (total) for the time periods 2006 to present and 2008 to present and obtained the same results: The division with closest correlation to CapEx remains the Semiconductor group.

This stands to reason. Capital expenditures are mainly in the service of semiconductor manufacturing. Semiconductors, or components in general, require more capital than assembly of devices or consumer electronics.

However, the revenues and operating income for devices have grown far faster. Samsung’s investment in capacity would have been largely profit-free had they not also been assembling the devices which capture the margins.

One might conclude that Samsung would be better off abandoning its capital-intensive components business and focusing on the devices. However, as James Allworth points out if you only do the devices, you may find yourself vulnerable to value chain disruption. Whoever is involved “upstream” in the value chain will inevitably learn the device business from a base of “commodity” manufacturing and pose a threat.

Now the question poses itself: Which of the usual suspects understands this?

Stay tuned for evidence of an incumbent response.

 

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Notes:

  1. Some of this growth is due to a new (K-IFRS) accounting standard in use after 2010, but the expansion was significant regardless.
  2. The revenues data is was reported using three different accounting methods and each is shown with a different line color: Blue is “Parent basis”, Green is “Consolidated basis” and Yellow is “K-IFRS”.
  • http://twitter.com/JohnRMoran John R. Moran

    “Whomever is involved “downstream” in the value chain will inevitably learn the device business from a base of “commodity” manufacturing and pose a threat.”

    Horace, do you mean upstream (i.e. “earlier” in the value chain)?

    Great post. I wrote a reaction to Jame’s aforementioned piece here, pointing out that Samsung also forward-integrated into TVs from its previous position as an LCD supplier to Sony and disrupted them in the process – they seem to have a history of this strategy: http://rampantinnovation.com/

  • http://twitter.com/hecadon Min-Soo Park

    Samsung’s CapEx mainly centers around semicon lines … 4~5 B $ per line for new processes… I hear they are also building lines in China … Also they are building new R&D center in Seoul which cost about 1 B $… The mobile phones are using up existing capacity pretty fast … (BTW, the revenue graph seems odd … I think it should be in trillion KRW [Korean Won]. 1080 won = $1 )

  • Ittiam

    Horace,

    This article is in complete contradiction to the previous article ‘The real threat…”

    If you are saying Samsung is master of ‘production ramp up’, then Apple learned the tricks from Samsung (since they have been their largest suppliers), and is now trying to emulate the same (which you are hinting as topic of next article)

    • http://twitter.com/juancho Juan

      Scientific method, they are exploring theories not stating dogma

    • http://www.asymco.com Horace Dediu

      I’m not saying Samsung is the master of ‘production ramp up’. How did you come to that conclusion?

      • Ittiam

        Horace,

        From the article “Samsung’s successes come from spotting areas that are small but growing fast.Ideally the area should also be capital-intensive, making it harder for rivals to keep up.”

      • http://www.asymco.com Horace Dediu

        That is a quote from an Economist article. The post is an examination of the assumptions underlying some of the conclusions of the article, and not necessarily that one. My analysis centers on Samsung’s Capital Structure and the relationship of the capital structure and its revenue and operating income.

    • http://www.isophist.com/ Emilio Orione

      It is not. First upstream means that if samsung concentrate only on devices, giving production to someone else, samsung could be disrupted by its supplier, same as Apple which created Samsung as a competitor giving them production.

      Given that apple has understood the threat, the next move will be…

  • deemery
  • http://www.isophist.com/ Emilio Orione

    Should apple invest in manufacturing?
    As an assurance to further disruption from the supply chain?

    Not with small numbers, but with great ones?
    Isn’t it better to augment the number of suppliers and make them strictly dependent on you?
    Can it be done for everything or is better only for key parts?

    If you create big numbers for the supplier of LTE chips could him disrupt you?
    I don’t think so.
    Processor, display, ram, motherboard all from the same supplier could make it happen.

    Is it enough to diversify suppliers? Better integrate processors and display the higher value components and diversify for everything else.

    Why samsung does not do that? That would mine its following time, they have to integrate all to follow faster that anyone else. It looses money because of the heavy investment involved but keeps going.

    Apple on the contrary must try new things and big numbers on a new things are not sure, better be flexible and integrate only the minimum to not be disrupted from upstream. They risk something but earn the maximum.
    Only in the current situation with big numbers in the years to come integration of processor and perhaps display make sense.

  • http://twitter.com/vervaak Sijung

    Since the single most expensive component of a smart phone is the screen, it might be interesting to check out Samsung Mobile Display, the subsidiary that produces the AMOLED screens and the iPad Retina screens:

    2011:
    ₩ 9,590,909 (A) ₩ 4,898,011(L) ₩ 6,586,460 (S) ₩ 874,368 (NI)
    2010 :
    ₩ 4,337,385 ₩ 2,511,217 ₩ 4,470,006 ₩ 295,996
    (In millions of Korean won)

    Assets increased by almost 5 billion USD in just one years. Too bad we can only guess at what the reason is for such an increase.

  • Tatil_S

    If the breakdown is not available since 2008, how do you know most of CapEx is used in semiconductors division instead of telecom during the years the expenditures shot up dramatically and telecom revenue grew very fast?

    • http://www.asymco.com Horace Dediu

      Quoting from the post: “I calculated the correlations between each division’s revenues and the growth in CapEx (total) for the time periods 2006 to present and 2008 to present and obtained the same results: The division with closest correlation to CapEx remains the Semiconductor group.” There is also anecdotal evidence of plants being opened to produce semiconductors and the costs involved. It is possible that devices suddenly began to be capital intensive but it’s important to note that Samsung was a large scale producer of devices in 2007(second in the world) and at the time spent 2% of its capital on that division (which also produces telecommunications equipment.)

      • Tatil_S

        I understand what you mean, but Apple has started investing in its own device manufacturing lines quite a bit after 2008. With a CapEx jump so large, Samsung could have easily fit a billion dollars a quarter for device manufacturing, even if it was spending most of its CapEx into components before then. That would represent a big jump for devices (2% to 15% for example), even though your main point about revenue per CapEx being low for components would still stand I guess.

  • Tatil_S

    Doesn’t Samsun Electronics cover appliances? Doesn’t it spend any CapEx for that division?

    • http://www.asymco.com Horace Dediu

      Yes it does.

      • Tatil_S

        Yes, to appliances I suppose, but how about no CapEx on appliances? Is the manufacturing of appliances all outsourced?

      • http://www.asymco.com Horace Dediu

        Appliances are reported as part of Digital Media.

      • Tatil_S

        Thanks

  • http://twitter.com/M_Gauche James King

    This is an aside but what impresses me about Samsung is how effectively it uses its scale. This is not a company putting out crap products for the most part. At least in CE, it’s quality is generally at the higher end and I myself have not had major issues with any Samsung products, including the PC with which I am typing this.

    Could Foxconn or the other major assemblers produce products of a like quality if they were to compete? Foxconn also makes HP PCs which are notoriously unreliable. Acer has the same quality issues and I think ASUS also has had persistent quality issues. At least in the PC space, only Lenovo seems to have a reputation for quality of the major OEMs. Sony could probably still compete effectively but must deal with far greater labor costs than Samsung.

    It’s one thing to pump out a ton of stuff, it’s another to pump out a ton of GOOD stuff. Samsung doesn’t just imitate its competitors, it ASSIMILATES their best qualities and then uses its scale to hammer them.

    • Tatil_S

      I am fairly certain Foxconn can assemble to the exact quality you specify and pay for. I don’t think quality problems you are alluding to is due to assembly. They usually come down to selection of parts and diligence in integrating all those pieces of hardware together and fine tuning the software.

      • http://twitter.com/M_Gauche James King

        I didn’t think that I had made a correlation re: assembly and quality. I was actually trying to state that Samsung didn’t just build a bunch of factories to churn out more cheap stuff than everyone else, it took the time to focus on the areas of the businesses in which it entered that would give it the strongest chance of success.

        Analyses of the numbers give an idea of how and where Samsung invests but, IMO, they only give half of the picture. Samsung seems to devote an exceptional amount of mind capital in understanding WHY its competitors are successful and then ingraining those qualities into its businesses. Sony had developed a very high degree of customer loyalty and at one time was far and away the number one CE company in the world. Samsung supplanted Sony by selling CE at comparable quality at better prices. But even then you couldn’t say that Samsung was a very popular BRAND because much of Sony’s brand strength came from its focus on high quality. Samsung took over Sony’s business but could not supplant Sony’s brand. Sony still enjoys far more mindshare as a brand than Samsung.

        However that is now changing as a result of Samsung’s efforts in the smartphone arena. Samsung is now becoming a powerful BRAND in its own right. And I think the reason for this is because it has been meticulously studying and imitating the premier technology brand in the world, Apple. Samsung has learned that building great products is only part of the formula, you have to get people to associate those products to your NAME. For years, I had no idea that Blackberry was actually a brand of a company called Research In Motion, even when the devices were at the height of their popularity. Not only has Samsung created a very powerful brand in Galaxy but it has done a phenomenal job in getting people to draw that association directly back to Samsung.

        I’m using this as an example of how Samsung assimilates the best qualities of its competition. It’s focus on building high-quality CE was a direct result of its association with Sony. So far, I have not seen any other company with the capacity to do what Samsung has done to invest the type of effort in understanding the PSYCHOLOGY of businesses the way it does. Samsung builds quality devices because it UNDERSTANDS that is a cornerstone for success and that it can’t just flood the market with a ton of cheap unreliable goods if it going to be successful.

        So I guess I was trying to make a correlation between the quality of Samsung’s goods with the mindstate that it takes to recognize the NEED to produce quality goods to ensure success. There are plenty of companies out there that choose to devote their resources to better marketing at the expense of quality. The reason why we are discussing Samsung is because, despite its scale, it is not one of them. Samsung markets hard but it also does not seem to skimp on making a great product.

    • LeePenick

      I have a Samsung fridge and microwave. The quality would not induce me to buy again from them.

  • uniphore mobility

    Samsung products are better as compare to others and the cost is also cheap then others.

    • Michael Li

      The One X is better than the Samsung SIII (just look at any tech blog including Engadget and The Verge). Samsung just has much better marketing than HTC.

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  • sahana

    I wanted some graphs about microwaves(sold and produced)