Samsung survives exploding phones and allegations of bribery to start 2017 strongly

Truly, 2016 was a year to forget for Samsung, as the Note 7 debacle was followed by serious corruption allegations. But, far from being down and out, the company may now be heading towards recovery

Samsung Electronics Chairman Lee Jae-yong is arrested on bribery charges. He denies the allegations

It has been a tempestuous 12 months for the world’s biggest smartphone manufacturer. In September 2016, over $14bn was wiped from Samsung’s market value following a botched global recall of its erratically explosive Galaxy Note 7 handset. With shares tumbling, Samsung scrambled to recover its brand image, discontinuing the malfunctioning device and accepting the ensuing heavy losses. Despite the company’s best intentions, however, these damage limitation efforts proved futile.

By December, the conglomerate had become embroiled in the sensational political corruption scandal gripping South Korea. As special prosecutors alleged collusion between Samsung and the highest levels of the Korean Government, the company’s heir apparent, Lee Jae-yong, was formally indicted on charges of perjury, embezzlement and bribery. With the de facto leader now awaiting trial behind bars, 2017 is shaping up to be an equally testing year for the electronics behemoth.

With its ever-expanding network of subsidiary and affiliate companies, Samsung has established itself as a leading global brand

The scope of the scandal may well be unmatched in Korean political history, but the country is not unfamiliar with such extensive business-government collaboration. Close relationships between conglomerates and the state have been an enduring feature of the South Korean economy since the 60s, when a revisionist government embraced big business as a vehicle for industrialisation. While government connections have allowed Samsung to thrive over the past half-century, they may also prove to be the company’s undoing.

Republic of Samsung
Today, South Korea is one of the most developed, high-income countries in the world. Thanks to its booming hi-tech and heavy industries, the country stands as the world’s 11th largest economy, boasting a well-educated and skilled workforce. However, South Korea hasn’t always enjoyed such prosperity.

“In the post-Korean War period, South Korea was desperately poor”, said Mark Clifford, Executive Director of the Asian Business Council and author of the book Troubled Tiger, which chronicles the modern history of the Korean economy. “It was even poorer than many counterpart African countries at the time. Indeed, it was so poor that people generally thought the Philippines and Burma (as it was then known) would have far better economic prospects than South Korea.”

These dire economic straits began to change in 1961, when Park Chung-hee – the father of recently impeached President Park Geun-hye – seized power in a military coup. The new authoritarian leader had a clear vision for Korea, aiming to modernise the country and turn it from an essentially agrarian economy to an industrial, export-led state. In order to realise this vision, the Park Sr regime started funnelling money into the businesses it trusted to carry out its plan, forging close personal relationships with the families running the companies. After years of receiving state-sponsored credit and assistance, these burgeoning family businesses began to expand into sprawling conglomerates known as ‘chaebol’ in Korean.

Close relationships between conglomerates and the state have been an enduring feature of the South Korean economy since the 60s

Fortunately for founder Lee Byung-chul, Samsung was one of the companies chosen to carry out Park Sr’s development strategy. Starting life as a modest trading company in Daegu, an injection of government capital saw Samsung emerge as a budding economic power in the 60s. By the end of the decade, Lee had launched Samsung Electronics, which would later grow to be the crown jewel of his vast business empire. The next few decades were characterised by intense diversification, with the company entering new markets such as retail, insurance and heavy industries. By the time the Asian financial crisis hit Korea in 1997, Samsung had secured its position as an economic heavyweight. As its weaker rivals crumbled under the pressure of the crash, Samsung emerged not » only unharmed, but with its market dominance strengthened and consolidated.

In the post-crash years, Samsung has gone from strength to strength. With its ever-expanding network of subsidiary and affiliate companies, the chaebol has established itself as a leading global brand, even knocking Apple off the top spot as the world’s largest smartphone maker in 2011. In its domestic market, Samsung’s ubiquity simply cannot be overstated. In Seoul, babies can be born in a Samsung medical centre, grow up to attend a Samsung-owned university, and even live in a Samsung housing complex. Just one in 10 Korean smartphone users has an iPhone, with the vast majority opting for the national brand.

“In Korea, people often talk about the Republic of Samsung”, said Owen Miller, Professor of Korean History at the University of London’s School of Oriental and African Studies. “South Korea’s economic success is ultimately very closely tied to a few specific chaebol, with Samsung and Hyundai the most vital.”

Incredibly, Samsung’s revenue alone represents 20 percent of the nation’s entire GDP, and the company’s products account for 20 percent of South Korean exports. And yet, while the sprawling conglomerate may be the nation’s greatest economic success story, it is also no stranger to controversy.

Crony capitalism
By now, long-standing ties between corporations and the Korean political elite are no secret. Government support may have enabled the nation’s chaebol to thrive in the post-Korean War period, but it has also raised suspicions as to the form of those relationships. As such, a cloud of corruption has lingered over Seoul politics for the past half-century.

By the time the Asian financial crisis hit Korea in 1997, Samsung had secured its position as an economic heavyweight.

“Unfortunately, corruption scandals have been a feature of Korean politics since its democratisation”, said Miller. “Every elected president has had some kind of corruption scandal, usually involving influence peddling and slush funds.”

The scandal currently enveloping impeached President Park Geun-hee is thus the latest in a long list of political wrongdoings. While Park’s impeachment makes her the first democratically elected Korean leader to be forced from office, her predecessors have all faced similar accusations of corruption and cronyism. Before leaving office in 2013, Park’s predecessor Lee Myung-bak was forced to publically apologise over a bribery scandal involving his brother, who was ultimately jailed for two years.

“I can barely hold my head up for embarrassment and sorrow”, Lee Myung-bak lamented, after his brother was found guilty of accepting $500,000 from two businessmen seeking political influence. Lee’s predecessor, Roh Moo-hyun, also found himself embroiled in a multimillion-dollar corruption scandal, ultimately taking his own life in May 2009 as prosecutors progressed with their investigation. Roh allegedly received over $6m in bribes over the course of his presidency, but the corruption case against him was formally closed after his death. In the wake of such high-profile scandals, a 2015 OECD report showed a staggering 70 percent of South Koreans distrusted their government, while less than 30 percent had faith in the nation’s judicial system.

Now, Park stands accused of allowing a friend and aide, Choi Soon-sil, to extort tens of millions of dollars from the nation’s top chaebol. Over 19 conglomerates have been investigated in relation to the scheme, with Samsung emerging as the largest donor to two foundations linked to Choi. Samsung Electronics Vice Chairman Lee Jae-yong is accused of providing up to KRW 43bn ($36m) to Choi in exchange for political support for his succession plans – an allegation he denies.

Lee has been looking to consolidate his control over the sprawling conglomerate since his father – Samsung Group Chairman Lee Kun-hee – was hospitalised with a heart attack in 2014, acting as the de facto head of the company in place of the ailing Lee Sr. In order to ensure a smooth leadership transition, Lee is said to have required state approval for a controversial 2015 merger of two major Samsung units, which Choi allegedly helped to facilitate in return for substantial donations to her numerous overseas foundations.

Corruption cycle
With Lee’s formal indictment, the Samsung heir is following in his father’s footsteps in more ways than one. In 2008, Korean police raided Lee Sr’s home and office, following a tip he was using slush fund reserves to bribe politicians. Despite Lee Sr denying any wrongdoing, he was forced to stand down from Samsung, and was indicted and found guilty of tax evasion and embezzlement. Prosecutors sought a seven-year prison sentence, but the courts sentenced the Samsung patriarch to just three years of suspended jail time and imposed a meagre KRW 110bn ($98m) fine.

With Lee’s formal indictment, the Samsung heir is following in his father’s footsteps in more ways than one

A few months later, Lee Sr was formally pardoned by President Lee Myung-bak, who wanted the Samsung leader to remain on the nation’s International Olympic Committee. According to a government spokesman, Lee Sr’s pardon was simply “in the national interest”. Amid public outcry, the ousted leader returned to Samsung in 2010. Shortly before this return, a 474-page exposé hit shelves in Korea, alleging Lee Sr had stolen up to KRW 10trn ($10bn) from Samsung subsidiaries since moving into the top job.

Penned by the company’s former chief legal counsel, the controversial book divided opinion in Korea. While the author’s earlier allegations had prompted the 2008 investigation, his most serious claims were rejected by prosecutors, who described him as ‘unreliable’, according to the Financial Times. The book was a bestseller in South Korea, though Samsung strongly denied the allegations it contained.

“We’ve had a number of cases like this in the past”, said Clifford. “These cases seem very dramatic at the time, and there are often high-profile trials and even convictions. Every once in a while someone goes to jail, but, more often than not, the sentences are suspended.”

It is too soon to speculate what verdict will be delivered in the case of Lee Jae-yong. As it stands, the Samsung heir faces up to 20 years in prison, potentially scuppering succession plans at the conglomerate. For his part, Lee has denied the donations were made in exchange for political favours. Samsung said it would “do [its] best to ensure that the truth is revealed in future court proceedings”.

Prior to the election in South Korea, anti-chaebol protests were rife

Explosion zone
Samsung is now entering one of the most critical periods in its 79-year history. In August, the smartphone giant unveiled the Galaxy Note 7, a state-of-the-art phablet tipped to rival Apple’s iPhone 7 Plus. With positive reviews pouring in from tech critics, demand for the device was high, breaking pre-order records in South Korea.

Upon its launch, however, reports quickly began to circulate about devices catching fire. Videos began to flood the internet, showing brand new Galaxy Note 7 phones exploding and melting in users’ hands. In the US alone, Samsung received over 90 reports of batteries overheating, resulting in 26 cases of burns. As panic over the explosive smartphone escalated, the US Federal Aviation Administration banned the Note 7 from being taken aboard any flight, even when switched off.

In an effort to contain the escalating fallout, Samsung announced a global recall of the device in early September, and permanently ceased production on October 11. As the company rushed to limit the damage to its multibillion-dollar brand, the costly recall began to burn a large hole in the company’s profits. Samsung had expected to sell some 19 million phones during the Note 7’s product cycle, but the model’s sudden discontinuation put this ambitious target immediately out of reach. According to Credit Suisse analysts, the subsequent loss of revenue and ensuing recall could cost Samsung at least $17bn.

Still grappling with this blow to its balance sheet, the firm’s spate of misfortune continued in November, when it was forced to recall over 2.8 million washing machines over further reports of explosions. The malfunctioning machines saw users suffer various injuries, including a broken jaw, a damaged shoulder, and other blunt-force injuries, with Samsung ultimately receiving over 730 reports of exploding models.

Shaken by these costly recalls, Samsung’s latest launch became something of a make-or-break moment for the conglomerate. In April this year, Samsung released its new flagship handset – the Galaxy S8 – to both high expectations and tough scrutiny. While the device will undoubtedly be placed under the microscope over the coming months, its release has reinforced Samsung’s control over the Android market, ushering in a new era for the company following the Note 7 fiasco.

With the Galaxy S8 launch, however, Samsung is looking to repair the damage to its reputation more than to its finances. Remarkably, the company has emerged relatively unscathed financially from its various product failures, with share prices rising steadily over the past 12 months. Despite the Note 7 debacle, Samsung Electronics profits actually rose by 50 percent in the last three months of 2016. In January, the firm recorded its largest leap in profits in three years.

“From a business perspective, it’s clear that Samsung is in no way, shape or form at risk of going under”, said Kyle Ferrier, Director of Academic Affairs and Research at the Korea Economic Institute. “It has diverse holdings across Korea, with hundreds of affiliate companies spread across the nation. It also has outsized cash reserve holdings, which can always tide the company over.”

Indeed, with over $69bn in cash reserves, Samsung boasts a vast financial safety net. But, if the company seems set to survive the scandal, the same cannot be said for its government ties.

Rising dawn
On December 3, 1.9 million Koreans took to Seoul’s streets in a demonstration against the presidency. For these impassioned protestors, Park’s alleged corruption represented a failure of democracy, reigniting the contentious debate over government-business collaboration.

Remarkably, Samsung has emerged relatively unscathed financially from its various product failures in 2016

“There has been a constant back and forth between the state and the chaebol since at least the 90s”, said Miller. “There have been repeated, popular trends towards trying to control the chaebol, such as trying to break them up or reduce their power. However, these attempts have not been successful, and the chaebol seem to have consistently come back stronger than ever.”

What’s more, during her presidential campaign, Park positioned herself as something of a chaebol sceptic, promising to push ahead with economic democratisation and pledging support for SMEs. In the wake of Park’s stunning fall from grace, chaebol reform has once more entered the national conversation. With many chaebol moving operations overseas, public distrust of the nation’s conglomerates has reached what is perhaps an all-time high.

Now, with a new reformist leader in place, chaebol reform sits at the top of the political agenda. Throughout the short electoral campaign, presidential candidates from across the board pledged to overhaul South Korea’s corporate culture as a matter of priority – but only time will tell if this goal can be realised.

In addition to promising conglomerate reform, newly-elected President Moon Jae-in has honed in on Samsung, delivering a blistering attack on the group. “Samsung must undergo soul-searching on its anti-market practices and the illicit favour it has gained through its close ties with politicians”, Moon told reporters on his campaign trail. “This illicit practice should be put to an end.”

For its part, according to the Financial Times: “Samsung has promised to review measures to simplify its corporate structure, and outlined plans to hire a new independent board member and form a new governance committee.”

Chaebol reform has long been promised, yet remains elusive. With Park’s unprecedented impeachment, however, the tectonic plates of South Korean politics might just be beginning to shift. Calls for chaebol reform are reaching fever pitch but, for most Koreans, actions will speak louder than words.