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Shaw Capital Management Headlines : Korean Firms Come Out Winners from Global Crisis

http://www.faqs.org/periodicals/201007/2089147411.html

Publication: SERI Quarterly

Author: Jong-Nyun, Kim

Date published: July 1, 2010

GLOBAL FINANCIAL CRISIS AND CORPORATE EARNINGS

Korean Firms’ Strong Performance

The global financial crisis that began in September 2008 rocked the global corporate landscape and
sorted out those that performed strongly and those that did not. While corporations in the United
States and other advanced economies struggled during the recession, Korean companies managed
surprisingly strong performances. For example, Korea’s listed companies posted record sales in the first
quarter of 2010, with Samsung Electronics, LG Electronics, Hyundai Motor, POSCO, and Hyundai Heavy
Industries – often referred to as the “Big Five” in Korea – establishing their positions as global leaders. It
is claimed that the strong performance Korean companies racked up in 2009 was largely due to weak
won (KRW) and only partially due to their inherent competiveness. Indeed, the won’s value depreciated
by more than 30 percent against the dollar in early 2009. However, the won had returned to pre-crisis
levels by early 2010 and the continued strong performance despite this currency recovery indicates that
Korean companies have become much more competitive and that this is a major reason for their strong
performance in spite of the global crisis.

Korean and Japanese Companies in Opposite Directions

The performance of Japanese companies following the financial crisis starkly contrasted with that of
their Korean counterparts. Korean companies experienced growth in business and profits in 2009 while
Japanese companies suffered sales declines and deteriorating profits. Japanese companies in the past
served as benchmarks for Korean rivals but in 2009 the situations have reversed.

From Local to Global after One Decade

The recent successes of Korean companies can be partially attributed to the painful lessons learned
during the 1997 Asian currency crisis. Having witnessed nearly half of the country’s top fifty companies
collapse, the remaining companies have since developed a keen sense of how to handle crises.

That said, it is remarkable that many of the surviving companies have come to perform so well after only
a decade. Ten years ago, not even Korea’s flagship companies were comparable to their global rivals.
Their sales revenues lagged far behind. In fact, so much so that a comparison chart between Korean
companies and their global counterparts would contain an expethent such as the log scale. Now, these
Korean firms are leading other global leaders in terms of size and profits.

Searching for Second Renaissance

How did Korean companies achieve such astounding growth within a short period of time? To answer
this question, we need to look at the growth of Korean companies during the past twenty years. Korean
manufacturers maintained rapid growth averaging 15 percent in the ten years leading up to the 1997
crisis. This rapid growth was possible due to large investments in Korea’s major industries of steel,
automobiles, and electronics. However, the rapid growth was accompanied by the deteriorating
financial health of Korean companies.

The Asian currency crisis fundamentally changed the management paradigm in Korea’s corporate
community. Companies shifted focus to profitable growth and management efficiency and adopted a
management mode that enabled continuous corporate restructuring. As a result, the restructuring led to
a marked improvement of internal core competencies, while at the same time the rate of company
growth slowed significantly.

Figure 3 clearly shows that growth in both investment – particularly in tangible assets – and sales rose
sharply in 2008, when the global financial crisis hit. This may be an important clue to explaining how the
global corporate landscape has changed during the recent crisis. For example, it can be assumed that
Korean companies have entered a second growth phase on the back of their improved competitiveness.
If so, an examination of what lies behind this strength is necessary.

COMPETITIVENESS OF KOREAN COMPANIES

There is a long-standing debate over the factors that determine corporate performance, and the two
camps are the industry effect and the Resource-Based View (RBV). Those of the former argue that the
industry in which a company belongs is the critical factor behind company performance. Those of the
latter state that core competency (i.e., competitiveness) is the determining factor. The fundamental
difference lies in whether corporate performance is dependent on the external or internal environment.

Since the 1990s, however, companies within the same industry have sometimes shown relatively large
deviations in corporate earnings compared to some other industries. Thus, these widening gaps in
company earnings within the same industry provide more ammunition for the RBV explanation of
corporate performance. Subsequently, studies on corporate competitiveness were actively conducted.
Competitiveness factors have since changed from being tangible to intangible in nature, while
assessments of competitiveness have moved from being individualbased to comprehensive-based.

SERI Corporate Competitiveness Model

The limitations of current corporate competitiveness models are that they are skewed toward making ex
post facto and partial assessments, and they are geared toward evaluating levels of competitiveness
specifically for European and US companies. Thus, the models are not suitable for companies in
emerging countries. To address these problems, Samsung Economic Research Institute developed an ex
ante and comprehensive competitiveness index in 2009.

The SERI Competitiveness Index (SERI CI) shown in Figure 4 consists of two axes: internal resources
(physical structure) and differentiation (strengths). Derived from the three factors of traditional
corporate management (human resources, materials, and financial capital), internal resources are
defined as human capital, investment capabilities, and soundness of capital structure. Based on Michael
Treacy’s competitiveness theory,2 differentiation consists of operational excellence, product leadership,
and customer intimacy. To measure the Key Success Factor (KSF), SERI selected corporate earnings,
universality of data, and measurability as components of the Key Performance Indicator (KPI).

Competitiveness of Korea’s Top 100

By using the SERI CI, the competitiveness level of Korea’s top 100 companies was measured for the
2000-2009 period. The index used 81 companies listed in the KRX 100 (excluding financial companies) as
a sample, and the median value of S&P 100 companies (excluding financial companies) in 2007 as the
index benchmark of 100. The results indicated a large improvement in the competitiveness of Korean
companies. The SERI CI of Korea’s top 100 companies stood at 46 in 2000, then soared to 83 in 2007 and
declined slightly to 78 in 2009.4

Competitiveness of Internal Resources

The internal resources of Korean companies have improved significantly thanks to efforts in achieving
profitable growth. In particular, an enhancement in the competitiveness of Korean workers is clearly
seen in the ratio of Economic Value-Added (EVA) per person employed, which stood at 0 in 2000 and
then jumped above the global level to 111 in 2004 and continued upward thereafter. Also, investment
capabilities and capital structure have been strengthened. Even if considered on the basis of internal
resources alone, Korean companies seemed well positioned to take on almost any task.

Narrowing the scope to the big three, Samsung Electronics, Hyundai Motor, and POSCO averaged 86 in
the internal resource index for 2000. The three reached 73 in 2001 and then rose sharply to 255 in 2004
when the companies began to stand out on the global stage. This development can be interpreted as an
indication that restructuring and innovation at major companies ended up paying off.

Looking at the sub-indices, the human capital index, measured in terms of EVA per capita, soared to 436
in 2004 from 47 in 2001. The investment capability index continued to rise from 76 in 2000 to 144 in
2004 and 210 in 2009. A substantial increase in investment capability may have been the result of efforts
made by large companies to improve their capital structure rather than pursue quantitative growth as
had been done in the past.

Rapid Rise in Differentiation Index

In 2000, the differentiation index for Korea’s top 100 companies stood at just half that of the top 100
global companies. From the mid2000s, however, it rose sharply, approaching two thirds of the global
index in 2007. This implies that Korean companies entered a virtuous cycle wherein greater
competitiveness in internal resources led to more investment in strengthening differentiation power,
which in turn boosted sales revenues and further reinforced internal resources. For example, the
differentiation index of Korea’s big three – Samsung Electronics, Hyundai Motor, and POSCO- averaged
100 in 2008 from around 80 in 2000. The rise was mainly due to the massive efforts companies made in
enhancing their differentiation capabilities. For this very purpose, Korean companies invested their
internal resources to levels twice the average of the top 100 global companies, In particular, the product
differentiation index for Korean companies, measured by the R&D-to-sales ratio, stood high at 178 in
2008. This indicated that Korean companies tried to reach global markets via their advanced
technological capabilities.

However, brand power for the big three turned out to be weaker. Their levels of customer intimacy
(proxied by advertising spending/sales revenue) were just a third of the global level. Generally, a
company with weak brand power finds it difficult to raise prices, and this is why Korean companies
remain behind foreign competitors (as measured by the gross profit ratio, Korean companies have
reached only about two-thirds of the level of global leaders in terms of cost competitiveness). With a
synergy effect created by improvements in both the internal resource index and differentiation index,
the composite competitiveness index of the big three rose to 1 10 in 2002, exceeding the global level. In
2004, they posted a record high of 1 58. Considering that corporate competitiveness rises ahead of
earnings improvements, the recent remarkable performance of Korea’s flagship companies may be seen
as the result of large improvements in their competitiveness during themid-2000s.

Korea’s Flagship Companies Leading Way

Korea’s corporate ecosystem is led by a handful of globalized companies that have improved their
competitiveness significantly over the years. This can be easily ascertained by taking a look at the wide
difference between the median and average values of their competitiveness factors. First, the median
value of EVA per capita for the top 100 Korean companies was minus … 370,000 in 2000. The figure
jumped to … 30.62 million in 2009. For the average value of EVA per capita, the difference was more
pronounced: from minus … 14.26 million in 2000 to … 380 million in 2009. As for the R&D-to-sales ratio,
the median values in 2000 and 2009 were virtually unchanged (1.5 percent in 2000 and 1 .6 percent in
2009). In terms of the average ratio, however, there was a significant increase: from 2.4 percent in 2000
to 3.1 percent in 2009. This implies that, while the improvement in competitiveness was experienced by
the largest 100 companies as a group, the larger leading companies improved much more significantly.

KOREAN COMPANIES READY FOR GLOBAL STAGE

Korean companies strived to shift their focus to profitable growth and pursue restructuring and
innovation. As a result, their competitiveness improved rapidly by the mid-2000s, reaching levels
comparable to global leaders. Thus, the global financial crisis served as a prime opportunity for Korean
companies to push forward. Korea’s flagship companies are leading the charge in changing the global
corporate landscape with their increased competitiveness, and they will likely continue in this fashion
for some time.
On top of competitiveness, two additional factors will play a positive role in the advancement of Korea’s
global companies. The first factor is that the center of economic activity is shifting from the advanced
economies to China and other emerging economies, where Korean companies are performing well.
Second, Korean companies have traditionally been active in responding to change, via innovative
investment and speedy action, meaning that they have plenty dynamic capabilities which is closely
related to corporate growth during transition phases. If Korean companies could strengthen their
networking capabilities and brand power, they could emerge in an even more dominant position on the
global stage.

Translation: LEE Hae-Won

1 Jung Ku-Hyun, et al., Korea’s Corporate Management: 1987 to 2007 [in Korean] (Seoul: Samsung
Economic Research Institute, 2008).

2 Michael Treacy and Fred Wiersema, The Discipline of Market Leaders: Choose Your Customers, Narrow
Your Focus, Dominate Your Market (Cambridge: Perseus Books, 1995).

3 The KRX 100 index includes 100 blue chip companies listed in the Korea Exchange.

4 SERI CI is based on the global level of competitiveness in 2007. Considering that global companies’
level of competitiveness was greatly damaged from 2008 to 2009, the relative competitiveness of
Korean companies was estimated to have improved.

Author affiliation:

KIM Jong-Nyun is research fellow at SERI. His research interests include corporate finance, corporate
competitiveness and risk management. He holds a PhD in International Economics from Sung Kyun Kwan
University. Contact: kjn@seri.org.

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