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By Gwak Jeong-soo

“Hyundai Motor is racing ahead at full speed with no brakes.”

“Samsung Electronics has had its greatest renewal in history.”

Not long ago, the press showered praise upon Samsung Electronics and Hyundai Motor as they announced their 1Q10 results. Since the second half of 2009, the two companies have been setting and breaking quarterly records. Perhaps thanks to their efforts, South Korea’s economic results have been enough to make the nation the honor student even among the members of the Organisation for Economic Co-operation and Development (OECD), the organization for advanced nations.
At the same time, however, some concerned observers have begun to ask whether this praise is truly warranted. According to these observers, we should not let ourselves be dazzled by the outwardly impressive numbers, but instead turn our attention to the suffering of the many small and mid-sized companies hidden in the shade of these major corporations.

“Major corporations have been producing their greatest results ever, registering double-digit profit margins since the second half of 2009, but the small and mid-sized subcontractors doing business with them are unable to achieve profit margins of even 1 to 2 percent,” said a Mr. Lee, the president of an electronics and automobile parts producer in Incheon.

In order to uncover the real face of the polarization between large and small companies, the Hankyoreh 21 placed under the microscope South Korea’s leading companies, Samsung Electronics and Hyundai Motor, and the subcontractors that are doing business with them. The weekly magazine compared first quarter results for 2007, just before the global economic crisis struck, 2009, when the recovery began and 2010, when the growth trend continued to accelerate.

The subcontractors examined were the 755 of the roughly 1,000 small and medium-sized enterprises (SMEs) doing business with Samsung Electronics and Hyundai Motor for which objective financial information could be verified. Of these 755, a total of 498 were doing business with Samsung Electronics and 257 with Hyundai Motor. The magazine’s efforts to confirm company financial information were assisted by the Korea Information Service, a corporate information database.

The analysis showed that polarization between the large companies and the subcontractors was far greater than expected. While the contracting companies were boasting of double-digit profit margins in 2010, many parts companies were languishing at one-quarter the returns of the major company on average and had yet to return to pre-crisis levels. Naturally, the gap between the contracting and subcontracting company had grown wider than its status before the crisis struck.

In the case of the operating profit margin, a company profitability indicator calculated by dividing operating profits by sales, Samsung Electronics and Hyundai Motor respectively recorded profit margins of 8.23 percent and 7.01 percent for 2009. For Samsung Electronics subcontractors, however, the profit margin was 5.66 percent on average, and for Hyundai Motor subcontractors it was just 2.48 percent. The gap widened further in the first quarter of 2010. Samsung Electronics and Hyundai Motor leapt up to 14.56 percent and 8.35 percent, respectively, but Samsung Electronics subcontractors actually dropped from 2009 to 4.87 percent. Meanwhile, Hyundai Motor subcontractors recorded 4.62 percent, a higher value than in 2009 but still half that of the contracting company. The differential between contracting company and parts company for 1Q10 was 9.79 percentage points for Samsung Electronics and 3.73 percentage points for Hyundai Motor, far greater than the respective tallies of 2.9 percentage points and 3.01 percentage points in 2007.

The situation is the same with the net profit margin, another profitability indicator calculated by dividing net profits by revenue. Samsung Electronics and Hyundai Motor recorded net profit margins of 6.92 percent and 9.3 percent, respectively, for 2009. In contrast, Samsung Electronics subcontractors recorded 3.12 percent, and Hyundai Motor subcontractors just 2.73 percent. For 1Q10, both Samsung Electronics and Hyundai Motor rose into the double-digit range, with net profit margins of 12.78 percent and 11.39 percent respectively. Their subcontractors, however, actually dropped in net profit margin, as Hyundai subcontractors came in at 0.16 percent and Samsung subcontractors at 3 percent.

In 2007, the gap between contracting and subcontracting companies was 6.82 percentage points for Samsung Electronics and 2.49 percentage points for Hyundai Motor, but in January of 2010 it had risen to 9.78 percentage points and 11.23 percentage points, respectively. The profit margin and net profit levels for subcontractors at the time totaled just 3 to 6.5 percent of their pre-crisis totals.

Also demonstrating the severity of the polarization is the revenue growth rate, an indicator of company growth that represents the ratio of current year revenue growth to revenue for the previous year. For Samsung Electronics and Hyundai Motor, those values were 23.06 percent and -1.03 percent for 2009, but their rise in 1Q10 was explosive, with Samsung Electronics registering 33.45 percent and Hyundai Motor 39.56 percent. Meanwhile, parts companies fell far short of their contracting company, with Samsung’s recording revenue growth of 5.24 percent, and Hyundai’s down to -4.58 percent.

The polarization between larger and smaller companies evident in sales and profit statistics. Hyundai Motor sales rose by 1.57 trillion Won ($1.3 billion) in 2008, but sales by subcontractors rose just 44.6 billion Won. In 2009, Hyundai Motor sales dropped by 330 billion Won, but its parts suppliers’ sales plummeted by 936.4 billion Won. When subcontractors enjoyed increases, it was a fraction of those seen by the contracting company, and when their profits dropped, the fall was several times that of the contracting company.

A comparison between the operating profits of Samsung Electronics and its subcontractors also reveals noteworthy results. Samsung Electronics operating profits underwent a rapid drop in 2008, the year the crisis struck, falling by 1.8 trillion Won. In contrast, its subcontractors enjoyed an increase of 203.8 billion Won. In 2009, when the recovery began, the situation made a 180-degree turn, with Samsung Electronics’ operating profits leaping up by 3.25 trillion Won and subcontractor profits falling by 154.1 billion Won. The situation has been a feast for the large company and a funeral for the subcontractors.

Please direct questions or comments to [englishhani@hani.co.kr]

(This is one of two articles in a series.)

See original article at: http://english.hani.co.kr/arti/english_edition/e_business/429935.html

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By Gwak Jeong-soo

South Korea’s favorable economic ratings despite the difficulties experienced by small and medium-sized companies are due to the relative importance of major corporations like Samsung Electronics and Hyundai Motor. The two companies posted exports last year totaling 74.8 trillion Won ($62.5 billion) and 15.8 trillion Won, respectively. Together, they accounted for 19.2 percent of South Korea’s total exports of 460.9 trillion Won. The two companies’ sales of 121.7 trillion Won also accounted for 11.45 of South Korea’s GDP. The optical illusion caused by the deepening of the economic concentration of large corporations is hiding the seriousness of the polarization between large and small and medium-sized businesses.

There are conflicting answers from large and small to medium-sized businesses as to the reason behind the polarization. Subcontractors claim that the main reason is that major companies do not guarantee optimum returns to them.

“Major factors for subpar returns include not only unreasonably lower delivery unit costs, but also the serious issue that the prices do not properly reflect factors such as the rise in the international prices of raw materials,” said a Mr. Lee, the president of a car parts manufacturer in Incheon.
Others say major corporations do not keep pledges made with the government.

“When we meet with the president at Cheong Wa Dae, the chairmen of major corporations promise to show consideration for small and medium-sized businesses, but the reality is completely different,” said the president of another industrial company. “Primary subcontractors directly dealing with major corporations make about 1 to 2 percent profit, but secondary and tertiary suppliers are running virtually in the red.”

Samsung, however, has a contrasting view of the situation.

“Since the global market price of each part is transparent and open, the reality is that we cannot show preferential treatment to domestic parts producers,” said Ha Joo-ho, a member of Samsung Electronics’ public relations team. “If we buy domestic parts at a higher cost, it will cause arguments over fairness. Samsung, as a global leader, offers its products at prices higher than competing firms, so it has the wherewithal to be a bit more generous with its unit prices for delivered parts.”

Yeon Tae-gyeong of Hyundai Motor’s public relations team found the cause in the business environment, noting that carmakers did so well last year because of good exports and internal demand due to rise in the exchange rate and tax support.

“Out of consideration of the environment, Hyundai recently decided as a group to sign production and fair trade agreements with about 2,700 small and medium-sized businesses, including primary, secondary and tertiary subcontractors and boosted plans to support them,” said Yeon.

The trend in the unit price of delivered goods since the economic crisis lends strength to the claims of small and medium-sized businesses. Since the first half of 2008, the international price of raw materials has skyrocketed, but firms producing finished goods have ignored demands by subcontractors to raise unit prices. When parts producers have strongly protested, threatening to suspend production, the major firms accept only half of the demanded price hike.

As the economic crisis took full root in the second half of the year, however, measures were taken to lower the unit price of parts, canceling out most of the rise of the first half of the year. They have had to bite the bullet at the coercive attitude of auto corporations, who tell subcontractors to quit delivering goods if they do not like the price offered.

“In 2009, carmakers did not lower their parts prices, at least nominally, and the rise in personnel and electricity costs were also not reflected in parts prices,” said Heo Man-yeong of the Korea Foundry Cooperative Association. “Carmakers have said that they will reflect the rising international price of raw materials in their parts quotes, but they calculate the unit price based on major parts producers who procure their goods at relatively low prices, so small to medium-sized businesses have no choice but to incur losses.”

The government has announced a plan to cultivate some 300 rising small and medium-sized companies as “hidden champions” by 2020 to boost employment, but there has been criticism that in the current reality, this is like seeking a fish from a tree.

Yunhan University President Kim Young-ho said small and medium-sized businesses account for 99 percent of all companies and 88 percent of total employment, but make just 2 percent of profits in subcontractor deals with major companies. If this continues, most will die within in three to four years.

Small and medium-sized businesses agree that the rise in raw material prices must be properly reflected in the delivery costs per unit. They also say it is urgent to change the system in which major companies monopolize profits.

Kim Seong-su, president of electronics partsmaker Seoo Telecom, said “Side-by-side development of major and small to medium-sized businesses is urgent for national development, but the current structure is one in which major corporations are monopolizing returns and small to medium-sized companies are virtually working as farmhands.”

Please direct questions or comments to [englishhani@hani.co.kr]

(This is the second of two articles.)

See original link at: http://english.hani.co.kr/arti/english_edition/e_business/429936.html

Read Full Post »