How Samsung Became the World's No. 1 Smartphone Maker

I’m in a black Mercedes-Benz (DAI) van with three Samsung Electronics PR people heading toward Yongin, a city about 45 minutes south of Seoul. Yongin is South Korea’s Orlando: a nondescript, fast-growing city known for its tourist attractions, especially Everland Resort, the country’s largest theme park. But the van isn’t going to Everland. We’re headed to a far more profitable theme park: the Samsung Human Resources Development Center, where the theme just happens to be Samsung.

The complex’s formal name is Changjo Kwan, which translates as Creativity Institute. It’s a massive structure with a traditional Korean roof, set in parklike surroundings. In a breezeway, a map carved in stone tiles divides the earth into two categories: countries where Samsung conducts business, indicated by blue lights; and countries where Samsung will conduct business, indicated by red. The map is mostly blue. In the lobby, an engraving in Korean and English proclaims: “We will devote our human resources and technology to create superior products and services, thereby contributing to a better global society.” Another sign says in English: “Go! Go! Go!”

More than 50,000 employees pass through Changjo Kwan and its sister facilities in a given year. In sessions that last anywhere from a few days to several months, they are inculcated in all things Samsung: They learn about the three P’s (products, process, and people); they learn about “global management” so that Samsung can expand into new markets; some employees go through the exercise of making kimchi together, to learn about teamwork and Korean culture.

They will stay in single or shared rooms, depending on seniority, on floors named and themed after artists. The Magritte floor has clouds on the carpet and upside-down table lamps on the ceiling. In a hallway, the recorded voice of a man speaking Korean comes over the loudspeakers. “Those are some remarks the chairman made some years ago,” a Samsung employee explains.

She’s referring to Lee Kun Hee, the 71-year-old chairman of Samsung Electronics, who declined to be interviewed for this article. Despite making headlines in 2008, when he was convicted of tax evasion, and 2009, when he was pardoned by South Korea’s president, he maintains a low profile. Except within Samsung, that is, where he’s omnipresent. It’s not just the slogans over the sound system; Samsung’s internal practices and external strategies—from how TVs are designed to the company’s philosophy of “perpetual crisis”—all spring from the codified teachings of the chairman.

Since Lee took control of Samsung in 1987, sales have surged to $179 billion last year, making it the world’s largest electronics company by revenue. That makes Samsung Electronics the world’s largest electronics company by revenue. For all its global reach, though, the company remains opaque. We all know the story of Steve Jobs and Apple (AAPL), Akio Morita and Sony (SNE). But Samsung and Lee Kun Hee? People may bring up the South Korean government’s support of local champions and access to easy capital, but within the company it all goes back to Chairman Lee and the Frankfurt Room.

It doesn’t look like much: early 1990s vintage décor and a large table with a fake flower centerpiece. But the Frankfurt Room is to Changjo Kwan as the Clementine Chapel is to St. Peter’s Basilica: an extra-special place inside an already special place. Photography is forbidden; people whisper when inside. It’s a meticulous recreation of the drab conference room in the German hotel where, in 1993, Chairman Lee gathered his lieutenants and laid out a plan to transform Samsung, then a second-tier TV manufacturer, into the biggest, most powerful electronics manufacturer on earth. It would require going from a high-volume, low-quality manufacturer to a high-quality one, even if that meant sacrificing sales. It would mean looking past the borders of South Korea and taking on the world.

  

Samsung is having a moment. It’s dominant in TVs and sells a lot of washing machines, but it’s smartphones that made Samsung as recognizable a presence around the world as Walt Disney (DIS) and Toyota Motor (TM). If Samsung isn’t yet as lustrous a brand as Apple, it’s finding success as the anti-Apple—Galaxy smartphones outsell iPhones. And Samsung is probably the only other company that can throw a product introduction and have people line up around a city block, as they did in New York City on March 14 for the launch of the Galaxy S 4. That never used to happen when Samsung unveiled a refrigerator—although the kimchi-specific models made for the Korean market are really quite impressive.

Samsung Electronics is the largest part of Samsung, a conglomerate that accounts for 17 percent of South Korea’s gross domestic product. It employs 370,000 people in more than 80 countries, but nowhere can its presence be felt more acutely than in its native country, where it’s so dominant it may as well be a second government.

A Seoul resident may have been born at the Samsung Medical Center and brought home to an apartment complex built by Samsung’s construction division (which also built the Petronas Twin Towers and the Burj Khalifa). Her crib may have come from overseas, which means it could have been aboard a cargo ship built by Samsung Heavy Industries. When she gets older, she’ll probably see an ad for Samsung Life Insurance that was created by Cheil Worldwide, a Samsung-owned ad agency, while wearing clothes made by Bean Pole, a brand of Samsung’s textile division. When relatives come to visit, they can stay at The Shilla hotel or shop at The Shilla Duty Free, which are also owned by Samsung.

Conglomerates have been out of favor in most of the industrialized world for decades. What separates Samsung from Gulf + Western, Sunbeam, and other extinct examples is focus and opportunism taken to the extreme. “Samsung is like a militaristic organization,” says Chang Sea Jin, a professor at the National University of Singapore and the author of Sony vs. Samsung. “The CEO decides which direction to move in, and there’s no discussion—they carry out the order.”

“Samsung’s like clockwork,” says Mark Newman, an analyst at Sanford C. Bernstein (AB) who worked at Samsung from 2004 to 2010, for a time in its business strategy department. “You have to fall in line. If you don’t, the peer pressure’s unbearable. If you can’t follow a specific directive, you can’t stay at the firm.”

Consider the disciplined way Samsung Electronics moves into new product categories. Like other Korean conglomerates—LG and Hyundai come to mind—the first step is to start small: make a key component for that industry. Ideally the component will be something that costs a lot of money to manufacture, since costly barriers to entry help limit competition. Microprocessors and memory chips are perfect. “A semiconductor fab costs $2 billion to $3 billion a pop, and you can’t build half a fab,” says Lee Keon Hyok, Samsung’s global head of communications (and no relation to Chairman Lee). “You either have one or you don’t.”

Once the infrastructure is in place, Samsung begins selling its components to other companies. This gives the company insight into how the industry works. When Samsung decides to expand operations and start competing with the companies it has been supplying, it makes massive investments in plants and technologies, leveraging its foothold into a position that other companies have little chance of matching. Last year, Samsung Electronics devoted $21.5 billion to capital expenditures, more than twice what Apple spent in the same period. “Samsung makes big bets on technologies,” says Newman. “They study the hell out of the problem, and then they bet the farm on it.”

In 1991, Samsung started making LCD panels it sold to other television brands. In 1994 it started making flash memory for devices such as the iPod and smartphones. Samsung is now the No. 1 maker of LCD televisions and sells more flash memory and RAM chips than any other company in the world. And in 2012 it passed Nokia (NOK)to become the world’s largest mobile-phone manufacturer.

As Samsung has risen, others have failed, often in spectacular fashion: Motorola was split up and its handset business sold to Google (GOOG). Nokia watched its long-standing No. 1 position erode when it got blindsided by smartphones. The Sony-Ericsson (ERIC) partnership dissolved. Palm disappeared into Hewlett-Packard (HPQ). BlackBerry (BBRY) continues to be on a 24-hour watch and has had its belt and shoelaces confiscated. When it comes to mobile hardware, today there’s only Apple, Samsung, and a desperate crowd of brands that can’t seem to rise above being called “the rest.” 

 

Lee’s father, Lee Byung Chull, founded Samsung in 1938. The name means “three stars,” which was the company’s logo for decades. Lee took over as chairman following his father’s death in 1987. (Lee Kun Hee’s son, Lee Jae Yong, is vice chairman and heir apparent.) The company immediately prospered under Lee Kun Hee’s leadership. “Between 1988 and 1993, the company had grown two and a half times,” says Shin Tae Gyun, Samsung’s president of the Human Resources Development Center, “so executives thought things were working.” Lee, however, didn’t just want Samsung to be a successful Korean company. He wanted it to be a world player, something on the level of General Electric (GE), Procter & Gamble (PG), and IBM (IBM). He even set a deadline: the year 2000. “2000 was not that far away,” says Shin. “At that growth rate, could we become a world-class company in time? The answer was no.”

To see how his company was faring internationally, Lee embarked on a world tour in 1993. His findings were not encouraging: A visit in February to a Southern California electronics store revealed Sony and Panasonic (PC) TVs in the front window and Samsung TVs gathering dust on a low shelf in the back. Lee was not happy.

By June, he’d made it to Germany and was staying at the Falkenstein Grand Kempinski Hotel in Frankfurt. He summoned all of Samsung’s executives—who numbered in the hundreds—to meet him there. “He did this at the drop of a hat, and they all gathered,” says communications chief Lee. On June 7 the chairman delivered a speech that lasted three days (they adjourned in the evenings). The most famous quote to emerge from the address was, “Change everything but your wife and children,” which has “Ask not what your country can do for you” levels of recognition at Samsung.

Chairman Lee’s relentless ­dissatisfaction and discipline are Samsung’s driving forces

The event became known, formally, as the Frankfurt Declaration of 1993, with all the United Nations import the name suggests. The content of the Frankfurt Declaration is called New Management, its principles distilled into a 200-page book that’s distributed to all Samsung employees. A stand-alone glossary was later published to define the terms laid out in the first book. Workers who weren’t fully literate were given a cartoon version. Lee went around the globe, evangelizing his gospel to all corners of the Samsung empire. “He conducted a lot of lectures,” recalls Shin. “It comes to 350 hours. We transcribed those events; it took 8,500 pages.”

And so, just across from New Management Hall at the HRDC in Yongin, is the hallowed Frankfurt Room. A tour guide proudly notes that everything in the room—including the chairs, drab pink tablecloth, and a painting of Venice—are the originals from the room in the Kempinski when Lee delivered his declaration. Samsung had all the furnishings shipped back to Korea and recreated the room precisely.

New Management is centered around a number of central slogans: “Fostering the individual” and “change begins with me” are commonly heard phrases. Perhaps most important, it deals in quality control, or “quality management,” as it’s called within the company. All of that is vividly on display at another Samsung holy site, the Gumi complex, located about 150 miles south of Seoul. Gumi, Samsung’s flagship smartphone manufacturing facility, is where Samsung built its first mobile phone: the SH-100, a Brobdingnagian handset that rivaled Gordon Gekko’s Motorola DynaTac 8000 in tonnage. 

 

The first thing you notice about Gumi is the K-pop. Korean pop music seems to be everywhere outside, usually coming from outdoor speakers disguised as rocks. The music has an easy, mid-tempo style, as if you were listening to a mellow Swing Out Sister track in 1988. The music, a Samsung spokeswoman explains, is selected by a team of psychologists to help reduce stress among employees.

There are more than 10,000 workers at Gumi. The vast majority are women in their early 20s. Like most twentysomethings, they move in groups, often with their heads down as they look at their phones. Workers wear pink jackets, some wear blue—which color is a matter of personal preference. Many of the unmarried employees also live at Gumi in dorms that have dining rooms, fitness centers, libraries, and coffee bars. Coffee’s big in Korea; the coffee shop on the Gumi campus has its own roaster.

Inside, Gumi is surprisingly warm and humid. The factory is part of a global network of Samsung facilities that, in 2012, produced a total of 400 million phones, or 12 phones every second. Workers at Gumi are not on an assembly line; production is done on a cellular basis, with each employee standing within a three-sided workbench that has all the necessary tools and supplies an arm’s reach away. The employee is then responsible for the overall assembly of the phone. Computer stations located throughout the assembly facility can call up real-time manufacturing data from any Samsung facility in the world.

Banks of quality-testing equipment fill one room. Small plastic propellers spin above the air vents of many of the machines. “It was an employee’s idea,” a tour guide explains. “It was difficult to determine if a machine was functioning from far away. The employee suggested that propellers would be a good indication if the machine was on.” Samsung employees are given incentives to come up with ideas like these. A cost savings is calculated, and a portion of that is returned to the employee as a bonus.

Such striving for efficiency and excellence wasn’t always a priority. In 1995, Chairman Lee was dismayed to learn that cell phones he gave as New Year’s gifts were found to be inoperable. He directed underlings to assemble a pile of 150,000 devices in a field outside the Gumi factory. More than 2,000 staff members gathered around the pile. Then it was set on fire. When the flames died down, bulldozers razed whatever was remaining. “If you continue to make poor-quality products like these,” Lee Keon Hyok recalls the chairman saying, “I’ll come back and do the same thing.”

The lesson stuck. In May 2012, three weeks before the new Galaxy S III was to be shipped, a Samsung customer told the company that the back covers for the smartphone looked cheaper than the demo models shown to clients earlier. “He was right,” says DJ Lee, the marketing chief of Samsung Mobile. “The grain wasn’t as fine on the later models.” There were 100,000 covers in the warehouse with the inferior design, as well as shipments of the assembled devices waiting at airports. This time, there would be no bonfire—all 100,000 covers, as well as those on the units at the airports, were scrapped and replaced.

 

 

Besides the Great Phone Incineration of 1995, two other signal acts helped propel Samsung’s rise in smartphones. The first was in 2009, when it bet big on Android, Google’s operating system for mobile. Samsung’s first Android device was called the Galaxy. “We were not successful with our first Android phone,” says DJ Lee. “The app store was limited.” Android was still in its infancy, greatly outclassed by the iPhone’s operating system, iOS. But Android was open-source, which meant that it was available free of charge to any manufacturer that wanted it.

In 2010, Samsung introduced the Galaxy S line, exemplifying its second momentous decision: using bigger screens. The Galaxy S’s screen was significantly larger than the original Galaxy and other Android models. “We settled on a 4-inch screen, which people thought was too big,” says DJ Lee. “There was a lot of argument about that.” But the bigger screens proved to be a major selling point; they grew larger still on the Galaxy S II and S III. Now, Samsung smartphones come in sizes ranging from 2.8 inches to 5 inches (to say nothing of the company’s “phablets,” which go up to 5.5). “Nobody had any idea what the right screen size was, so Samsung made all of them and saw which one worked,” says Benedict Evans, a researcher at Enders Analysis.

Producing a range of similar devices in various sizes to see which sells best is one of those high-cost undertakings most companies shy away from. But Samsung’s ability to produce display, memory, processors, and other high-tech parts gives it a flexibility competitors can’t touch. “There was this orthodoxy 10 years ago that vertical integration was passé,” says Tero Kuittinen, an analyst at Alekstra, a mobile-phone consultancy. “Then it turned out that the only two companies that took it seriously [Samsung and Apple] took over the whole handset industry.”

Apple’s approach is fewer models, each of them exquisitely designed. Samsung’s is try everything, and fast. “When we released the Galaxy S III, our research showed that, for some people in some markets, the handset was too big,” says DJ Lee. “So we were able to create the same phone with a 4-inch screen, and we called it the Galaxy S III mini.” Getting the smaller device into production took about four to six months, says DJ Lee. “We watch the market, and we immediately respond,” he says. The new Galaxy S 4 is coming out only nine months after the GS3. “Samsung has taken differentiation to a new art,” says Michael Gartenberg, an analyst at Gartner (IT). “If I want something in between an iPad and an iPad mini, I can’t get that from Apple.”

Apple’s vertical integration has one thing Samsung’s doesn’t, though: control over the software. Only Apple smartphones and tablets run iOS, and one of the hallmarks of the iPhone and iPad is how smoothly the software and hardware work together. That’s fostered an industry of app makers, and the company gets a cut of every app sold.

Samsung is making efforts to strengthen its position by opening a software development center in Silicon Valley. It may never have the kind of operating system control that Apple has. Samsung does, however, use its production depth and flexibility in ways that are arguably as powerful. It makes the processors, memory chips, and cameras that are in not only their own smartphones but also in many others—including the microprocessor in the iPhone 5. The express policy of the company is that the components business is walled off from the “set” business (its own finished products, like the Galaxy S 4), and that the one side doesn’t know what the other is doing. But few people who watch the company think Samsung keeps itself in the dark. New technologies take time to develop, particularly if that technology is needed in large quantities. “Having that early-stage insight into the supply chain has been one of the key factors to give them an edge,” says Neil Mawston of Strategy Analytics. “They can see three years ahead.”

This is an extremely sore subject with some of Samsung’s customers. Apple sued Samsung in the U.S. and elsewhere for patent infringement, from the basic shape of the phone to how a screen bounces back when users scroll to the bottom; Samsung denies the accusations, and has countersued. The legal war shows no sign of ending. Apple won a round in August, when a federal jury awarded Apple $1 billion in damages. That case is now on appeal, and the judge recently reduced the award by about half.

However the many court cases play out, Samsung wouldn’t have to break the law to use its position as a supplier to its advantage. If a manufacturing customer merely approaches Samsung with a request for a new kind of processor, that information is valuable. “Having a road map of, say, Apple and knowing what competitors are doing is pretty useful,” says Bernstein’s Newman. “It’s not copying, and it’s not illegal. You just know that in 2013, Apple’s going to need a quad-core processor.” 

 

For the Galaxy S 4 unveiling in mid-March, Samsung rented Radio City Music Hall on a Thursday night. TV trucks were parked outside, and lines of people snaked around the block. The lobby was packed. As a point of comparison, a Motorola event in New York six months earlier was held in a party space that had sold its naming rights to Haier, the Chinese appliance company. Nokia’s event the same day was nearby at a low-profile, generic event facility.

At Radio City, Broadway actor Will Chase mastered the ceremonies in between surreal sketches of actors portraying average consumers using the Galaxy S 4’s features in various situations. Elaborate sets evoking a school, Paris, and Brazil emerged from the stage floor. An orchestra rose up on hydraulic lifts. A little boy tap-danced. The whole show seemed inexplicable—save as a metaphor for Samsung’s try-everything mobile business. “Samsung makes every kind of handset in every market in every size at every price,” says Evans. “They’re not stopping to think. They’re just making more phones.”

The Galaxy S 4 doesn’t come out until late April. It’s fast, has a big, bright screen, and will probably be another huge hit for Samsung, as will the S 4 mini that will go on sale soon after. Yet when discussing Samsung’s immediate future, Lee Keon Hyok betrays zero triumphalism. He’s seen this before and knows that it’s counter to the principles of New Management to derive pleasure from the success of today. “In 2010 it was a banner year for the whole group,” he says, sitting in his 35th-floor office in Seoul. “The chairman’s response? ‘Our major businesses can disappear in 10 years.’ ”

Perhaps Samsung will grow so huge it invites new government scrutiny in Korea. Maybe iPhones 6, 7, and 8 will prove so beautiful and compelling, not even the chairman will have an answer. A likelier scenario is that another company, probably from China, will do to Samsung what it has done to its competitors. “The Chinese look like Samsung did five years ago,” says Horace Dediu, an independent mobile analyst. He identifies Huawei and ZTE as particular threats; other analysts bring up Lenovo (LNVGY). “Samsung makes less profit per smartphone than Apple,” Dediu continues. “The Chinese make even less. If the smartphone is going to become a commodity, how does Samsung play in that game?”

Lee Keon Hyok predicts that smartphones will indeed become commoditized, just as PCs did in the 1990s. “But you have to remember, we make a lot of parts,” he says. “The shape may change, but phones are still going to require AMOLED displays, memory, and processors. We are well prepared to meet those changes.” AMOLED refers to active-matrix organic light-emitting diodes. It’s the state of the art and possibly the only display technology that has its own K-pop song: Amoled, a catchy 2009 number by Son Dam-bi and After School.

When the mobile business ceases to be profitable, Samsung will have to force its way into some other industry that requires a lot of upfront capital and expertise in mass-manufacturing. The company announced in late 2011 that it would spend $20 billion by 2020 to develop proficiencies in medical devices, solar panels, LED lighting, biotech, and batteries for electric cars. And if Samsung batteries or MRI machines don’t take over the market, maybe the chairman will set a huge pile of them on fire. “The chairman is saying all the time, ‘This is perpetual crisis,’ ” says mobile marketing chief DJ Lee. “We are in danger. We are in jeopardy.”

BusinessWeek