(Free Press Release)
Publication: SERI Quarterly
Author: Jong-Nyun, Kim
Date published: July 1, 2010
GLOBAL FINANCIAL CRISIS AND CORPORATE EARNINGS
Korean Firmsâ€˜ 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, Koreaâ€˜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 Ã¢â‚¬Å“Big FiveÃ¢â‚¬ 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 wonâ€˜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 countryâ€˜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 Koreaâ€˜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 Koreaâ€˜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 Koreaâ€˜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 Treacyâ€˜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 Koreaâ€˜s Top 100
By using the SERI CI, the competitiveness level of Koreaâ€˜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 Koreaâ€˜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 Koreaâ€˜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 Koreaâ€˜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 Koreaâ€˜s flagship companies may be seen as the result of large improvements in their competitiveness during themid-2000s.
Koreaâ€˜s Flagship Companies Leading Way
Koreaâ€˜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 Ã¢â‚¬¦ 370,000 in 2000. The figure jumped to Ã¢â‚¬¦ 30.62 million in 2009. For the average value of EVA per capita, the difference was more pronounced: from minus Ã¢â‚¬¦ 14.26 million in 2000 to Ã¢â‚¬¦ 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. Koreaâ€˜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 Koreaâ€˜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., Koreaâ€˜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 companiesâ€˜ level of competitiveness was greatly damaged from 2008 to 2009, the relative competitiveness of Korean companies was estimated to have improved.
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: [email protected]