‘Focus on core business and compete globally’

2013-10-27 14:10

‘Focus on core business and compete globally’

IE Business School professor warns chaebol of risks in diversification
By Choo Sung-ho

The country’s three recently-failed conglomerates — Woongjin, STX and Tongyang — appear to have collapsed under mainly snowballing debt. But at the root of their demise are a series of bad managerial decisions by group chairmen. Rather than focus on core businesses, they expanded into other areas, largely construction, shipbuilding and other old industries. To finance their “reckless” expansion, they borrowed the excessive amounts of money from financial institutions and issued corporate bonds. But their businesses suffered greatly amid the prolonged global economic downturn and became unable to service debts.Several more business groups, which heavily depend on the domestic market and are involved in too many categories of business, may face a similar fate in the coming months, according to a European scholar familiar with corporate management and strategies.
In an interview with The Korea Times’ Business Focus, Carl Kock, a strategic management professor at IE Business School in Spain, said Korea’s family-run business groups, or chaebol, should focus on their core businesses and compete in the global market, rather than indiscriminately expand into other businesses domestically.
In the early stage of industrialization in Korea, chaebol like Samsung and Hyundai became very powerful through diversification. But as Korea economy matured, business groups need to change their strategies in order to compete with other global firms, the professor said.
Kock shared his thoughts on chaebol and other business issues affecting Korea Inc. with Business Focus. The following conversation with Kock is edited.
Q. What is diversification and what is its purpose?
A. There are two main logics for diversification. One is “balancing risk” and the other one is “exploit synergy.” Apple is the best example of the synergies in a diversified firm. When Apple first introduced the iPod, the music player, it built a very strong consumer franchise. The consumers were extremely loyal to Apple and became Apple’s good assets. When Apple introduced the iPhone, it had a huge synergy because all the consumers, who listened to the music with the iPod, bought the phone. That’s what the synergy is. Firms don’t need to build a new brand. They can use the existing one and apply it to more output. The important thing is that what are the links between these different areas and do they actually help each other or not.
Q. Does diversification always create the synergies in business?
A. Sony is a good example of failed diversification. Back then, Sony was a pioneer in electronic devices and ruled the walkman era. And then they decided to expand their business into content by buying a movie studio called Columbia Pictures. By being in different areas, Sony expected that it would have synergy from this business diversification. But it didn’t work because there is absolutely no point of doing that really. Look at Apple, they don’t own any content but all content is available on their platform because they own the consumers. Sony didn’t play very well because the diversified area really could not do much better. Because they went to the different areas where, whatever they knew in one area — their ability to create competitive advantages — didn’t have anything to do with the other area but they pay a lot of money to buy these assets. That is the problem with diversification. From a value generating perspective, unrelated diversification is at least questionable.
Q. You are saying that diversification is questionable. But chaebol were able to grow through diversification in the past. Under what circumstances does diversification work?
A. In emerging countries, many institutions such as stock exchange and the labor market are under developed. For companies, it is difficult to find high quality workers on the open market or raise money in the market. It is difficult for a shareholder to buy shares of other firms to diversify. If the economy has lower institutions or missing institutions, unrelated diversification by one firm makes more sense than if the firm has perfect market conditions. Diversification urge was very strong in the beginning of development in Korea because it could help to diversify the risks and also could help the company to build an internal market for labor and other things.
I would say that diversification is good when the economy is under-developed. But once the economy develops to the stage like you have in Korea now, the rational of the chaebol goes down. And they are required to be changed.
Q. Then what effort do you think the Korean companies should make for a sustainable growth?
A. Chaebol are now undergoing transitions. As I mentioned earlier, in the past, chaebol become very powerful, following the logic of unrelated diversification, because they internalize markets for labor and the stock market so they have to become very big. My prediction is that now in global competition, Korean companies have to focus on the area where they are the best, like Apple. Apple only invests in one device and makes sure that it is the best in the world, which is comparatively easier than trying to be the best in every different area. It is like the life cycle of a product. When companies approach the maturity stage in the market, firms do not diversify but they concentrate. Today, being the best means that you have to spend a significant amount money on research and development (R&D), to focus on the core area.
Q. What do you think about chaebol’s corporate governance?
A. Having a strong family is positive on the one hand, because they are very interested shareholders, who have a strong intention to monitor what managers do, and make sure there is no cheating. Sometimes the manager is even from the family and feels a strong bond to the family and that creates a governance instrument — trust. However, minority shareholders, who have different desires from the owner, might create problems.
Q. How was Korea’s corporate governance different from European or U.S. companies?
A. Corporate governance has two meanings. One is the district governance in terms of overcoming the principal-agent conflict between shareholders and owners. And the other is a question about how you run the firm, which is the broader sense of strategy. There is no fundamental structural difference between those. What you have is different stage of development and of some contingency that create differences in details but not the underlying logic. You always have to analyze what is the best in order to manage the conflicts of interests between the owners and managers or between firms and society.

About bambooinnovator
Kee Koon Boon (“KB”) is the co-founder and director of HERO Investment Management which provides specialized fund management and investment advisory services to the ARCHEA Asia HERO Innovators Fund (www.heroinnovator.com), the only Asian SMID-cap tech-focused fund in the industry. KB is an internationally featured investor rooted in the principles of value investing for over a decade as a fund manager and analyst in the Asian capital markets who started his career at a boutique hedge fund in Singapore where he was with the firm since 2002 and was also part of the core investment committee in significantly outperforming the index in the 10-year-plus-old flagship Asian fund. He was also the portfolio manager for Asia-Pacific equities at Korea’s largest mutual fund company. Prior to setting up the H.E.R.O. Innovators Fund, KB was the Chief Investment Officer & CEO of a Singapore Registered Fund Management Company (RFMC) where he is responsible for listed Asian equity investments. KB had taught accounting at the Singapore Management University (SMU) as a faculty member and also pioneered the 15-week course on Accounting Fraud in Asia as an official module at SMU. KB remains grateful and honored to be invited by Singapore’s financial regulator Monetary Authority of Singapore (MAS) to present to their top management team about implementing a world’s first fact-based forward-looking fraud detection framework to bring about benefits for the capital markets in Singapore and for the public and investment community. KB also served the community in sharing his insights in writing articles about value investing and corporate governance in the media that include Business Times, Straits Times, Jakarta Post, Manual of Ideas, Investopedia, TedXWallStreet. He had also presented in top investment, banking and finance conferences in America, Italy, Sydney, Cape Town, HK, China. He has trained CEOs, entrepreneurs, CFOs, management executives in business strategy & business model innovation in Singapore, HK and China.

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