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(originally published by Booz & Company)


What’s a Chaebol to Do?

The family-owned conglomerates made South Korea an industrial powerhouse, but can they transform themselves and their nation’s economy again now that the rules have changed?

The recent news that Samsung Group’s heir apparent, Jay Y. Lee, was named chief customer officer of Samsung Electronics has led some observers to suggest that the younger generation of Koreans is, as Newsweek put it, “abandoning their fathers’ practices for contemporary Western management styles.”

Lee’s appointment to this new post was viewed as an indication that the huge, family-controlled, traditionally secretive Korean conglomerates known as chaebol were becoming more open and transparent. Not so fast. A closer look reveals that these international megaliths, including Samsung, Hyundai Motor, and SK  — to name a few of the corporations that drove the rise of Korea Inc. — have not kept pace with the global competitive environment and are not much different than they were a decade ago, when overleveraged banks and companies collapsed in the wake of the East Asian financial crisis.

In fact, far from spearheading a new approach to business that might give the economy of the Republic of Korea (hereafter Korea) much needed buoyancy, the chaebol continue to resist modern corporate thinking, which is only perpetuating Korea’s leaden economic performance. According to the World Economic Forum’s Global Competitiveness Report, which assesses a country’s business sector, policies, and institutions to measure productivity, Korea fell to 24th place in 2006, five slots lower than the year before.

The chaebol came into being in the early 1960s, when President Park Chung-hee catapulted Korea into the community of industrial nations by giving a number of business tycoons free rein to set up organizations designed to kick-start the economy. By the 1990s, the chaebol had become corporate juggernauts, too big to fail and too big for the government to control. The 1997 financial crisis exposed how debt-ridden these favored corporate behemoths had become: One-quarter of the manufacturers in Korea did not earn enough to meet the interest payments on their loans.

At first, it appeared that the chaebol would be chastened by the state of affairs, especially when they were forced, for example, to take on outsider directors to discipline and control the family owners. But any hope that the chaebol would lead the much-needed transformation of Korea’s economy into an open, globally integrated, knowledge-based system was soon dashed. Consider corporate governance. The reforms of the late 1990s were mostly cosmetic, and chaebol continue to be run by proprietor families through a complex network of cross-shareholdings that give the owners inflated amounts of stock in all the subsidiaries and undue influence over the professionals and the board of directors.

And although the chaebol have led Korea’s rise as a manufacturing powerhouse, they have not been able to build successful service businesses, a distinct disadvantage for Korea because it will not be able to survive on its manufacturing alone — especially with hundreds of thousands of its best factory jobs moving to China. Yet even with the disappearance of factories, Korean companies continue to try to squeeze incremental improvements out of their manufacturing systems, rather than shift their focus to developing service operations. Indeed, labor productivity in Korean service companies is only 56 percent of that in manufacturing, the largest gap among members of the Organization for Economic Development and Cooperation (OECD).

Similarly, the share of foreign direct investment as a percentage of GDP is the lowest of any OECD country except Japan. Following the financial crisis, a number of chaebol subsidiaries were taken over by non-Korean companies. Noteworthy were Renault’s acquisition of Samsung Motors and Otis’s purchase of LG’s elevator business. Yet these sales were driven more by chaebol cash-flow needs than by a fundamental conviction that teaming up with a foreign company could reveal the company’s full potential, even if it meant losing control. And today, most chaebol owners are reluctant to part with their assets. In one recent case, a global leader in the industrial equipment sector was eager to acquire a chaebol subsidiary, a leader in the local market but a small player by international standards. After being courted with one highly attractive offer after another, the Korean owner declined, saying that he would build his business by himself. The response of the foreign company’s chief negotiator was predictably terse: “We remain interested in a partnership, but, with China emerging fast as a global manufacturing and R&D center, the value and importance of this company to us is unlikely to increase going forward.”

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  1. Bernard Black, Hasung Jang, and Woochan Kim, “Does Corporate Governance Predict Firms’ Market Value? Evidence from Korea.” Korea Development Institute School of Public Policy and Management Working Paper Series, Working Paper No. 02-04: Based on a large sample of listed Korean companies, the authors quantify the link between corporate governance and share price. Click here.
  2. Arie De Geus, The Living Company: Habits for Survival in a Turbulent Business Environment (Harvard Business School Press, 1997): Investigates the reason some companies have survived and thrived much longer than others. Click here.
  3. Tariq Hussain, Diamond Dilemma: Shaping Korea for the 21st Century (Random House JoongAng [Korean] and [English], 2006): Facing key educational, commercial, and corporate governance challenges, Korea must open up to the world and embrace global practices. Click here.
  4. Kim Wan-soon, “Foreign Direct Investment in Korea: The Role of the Ombudsman,” in Sustainable Recovery in Asia: Mobilizing Resources for Development (OECD and Asian Development Bank, July 2000): Summary of the tremendous impact of foreign direct investment on Korea’s economy, both quantifiable (e.g., new jobs) and less tangible (e.g., new skills). PDF Download.
  5. World Economic Forum, The Global Competitiveness Report, 2006–2007: An annual guide to the most productive countries with the best commercial sectors, and a companion report on how they achieved this. Click here.
  6. Diamond Dilemma Web site: The author’s blog, addressing Korean competitiveness issues. Click here.
  7. East Asia Institute Web site: Research by JoongAng Ilbo and the East Asia Institute on Korea’s “power organizations” ranks Korea’s companies by perceived influence and level of trust. (In Korean.) Click here.
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