Preface

This report investigates how Samsung was able to build a competitive advantage in the global memory chip industry and what steps it should take to sustain its advantage in the face of the imminent threat of Chinese competition.

Analysis of Samsung’s business strategy and competitive advantage

Porter’s 5 forces model in Exhibit 1 is used to analyze the global memory chip industry and Samsung’s strategy to date. Samsung had become the dominant player in the global memory chip industry and was able to increase the gap from other competitors in terms of technology and market share by following the below strategy.

1. Aggressive investments in R&D

The memory chip industry is technology driven. A significant investment is required in R&D at the product design stage. As illustrated in exhibit 1 Samsung Electronics had maintained its technology leadership by outspending its rivals in R&D by over 1.5 to 20 times from 1998 to 2003 (Exhibit 3), which was possible thanks to the Samsung group’s diversified portfolio that allowed it the take calculated financial risks.

Since Samsung was able to create and maintain technology leadership it was able to earn a very high premium at the initial stages of a new product to recover its initial investment and if competitors began producing the same product it could aggressively lower prices to make it difficult for followers to stay in the competition.

2. Differentiation

Faced with the challenge that the DRAM industry might fall into a commodity trap and therefore be subject to cutthroat price competition and price fluctuations, Samsung developed the below classification of broad product differentiation.
• Frontier: Cutting edge products with the highest margins
• Legacy: Current products, potentially manufactured using technology used to develop the frontier products resulting in cost savings
• Specialty: Products to target niche markets

3. Cost advantage

Samsung was able to command better operating margins as compared to its competitors because of
• Cheap labor: 35% cheaper as compared to non-Chinese manufacturers
• Use of new design rules: This allowed Samsung to produce more chips per wafer (the key raw material in chip manufacturing).
• Better sourcing: Raw materials cost 37% less than its competitors probably due to volume discounts and better bargaining power
• Better manufacturing processes o Yield rates were are at 80%, as compared to 50-67% for the competitors o Samsung was able to get 2.4 times the amount of die’s by using 12-inch wafers as compared to 8-inch wafers, at 90% of the costs per chip leading to better gross margins
• Lower depreciation costs: By collocating and scaling its fab investments, Samsung saved an average of 12% of the fab construction costs
4. Price advantage

Samsung was able to command a higher average selling price as compared to its competitors because of its

• Ability to offer customized memory chips that no other manufacturer could offer allowed them to command premium pricing on these products
• Better quality control that lead to reliability enabled Samsung to obtain an average price premium of 1% average price

5. Human resource policies

Samsung was able to maximize its advantages in technology by creating a company culture that was unique to Samsung in the following ways:

• Talent hiring: Samsung actively recruited the best global people
• Talent development o Sponsored employees to gain further knowledge by sponsoring their MBA/PhD studies o Merit based promotions to motivate new hires o Foreign assignments to develop global skills
• Talent retention o Very generous benefits package allowed the employees to focus on work o Performance and productivity based profit-sharing incentives o Tolerance for mistakes

Exhibit 2 illustrates how Samsung is able to use its capabilities relating to manufacturing, R&D and quality control to create value.
Analysis of options to react to the threat of Chinese competition

Options Advantages Risks
Setup a fab facility in China in a JV with a Chinese partner • Higher operating margins due to o Access to cheap labor o Access to cheap credit and tax incentives
• Strategic location for penetrating the Chinese market • Possibility that intellectual property rights might be violated
• Samsung might lose some of the competitive advantage that it had by having the R&D and manufacturing teams work together
License manufacturing technology to a Chinese company • Lower manufacturing costs • Akin to handing over blueprints and expertise to the Chinese competitors on a platter
• Loss of product differentiation
Ignore the Chinese competition • Forces Samsung to innovate at a faster pace to maintain technological edge • Potential to lose market share to Chinese competitors on lower end products
Reduce prices on lower end products and compete on price • Might potentially force the Chinese competitors out of business • Lower profits, since the Chinese manufacturers are prepared to lose money to gain market share

Recommendations
• Setup a fab facility in China in a JV with a Chinese partner because o It allows Samsung to further lower its manufacturing costs, allowing Samsung to compete on a level playing field with the Chinese manufacturers o Provides Samsung access to the Chinese market o Better control over intellectual property as compared to licensing o If intellectual property is copied by a Chinese competitor, the Chinese fab unit would take 2 years to set up and by that time Samsung would have already moved on to the next technology and the Chinese memory chips would be obsolete
• Invest in knowledge sharing system within Samsung so that some of the advantage lost by separating the R&D in South Korea and the manufacturing facility in China is regained
• Continue investing heavily in R&D o The competition in this industry is based on increasing complexity and decreasing the size of chips, as manifested in Moore’s law. Therefore it is imperative that Samsung continues to invest heavily in R&D facilities to maintain its edge.
• Invest heavily in flash memory because o Double-digit growth expected for next 5 years o Better margins since flash memory prices were quite high relative to DRAM

Exhibit 1
Analysis of the global memory industry using Porter’s five forces to determine the competitive intensity and the various forces at play in the industry

Exhibit 2
Value chain analysis of Samsung electronics classifying the various activities of Samsung electronics used to create and deliver Samsung’s competitive advantage in the memory industry

Exhibit 3
R&D spend by the various competitors in the global semiconductor industry in USD (millions)

1998 1999 2000 2001 2002 2003
Samsung 1378 1390 1603 1824 2451 2947
Micron 272 322 428 490 561 656
Infineon 637 733 1092 1336 1011 864
Hynix 29 68 254 264 338 296