Samsung Electronics Examination and Evaluation of Business

Samsung Electronics

Examination and Evaluation of Business Strategies and Frontier Markets: Brazil

The South Korean company Samsung began operations in Brazil in December 1986 when it opened a representation office. Since them Samsung has invested a total of U.S.$300 million, employs almost 1,000 staff members and has a revenue of above U.S.$500 million. Since May 1994, Samsung has started offering services to Brazilian consumers, and from November 1995 it has produced TV sets and VCRs locally with an initial capital investment of U.S.$18 million.

Starting from July 1997, Samsung has sold its SyncMaster monitors in Brazil had a little later in June 1998; it started to manufacture them in its Manaus factory in Amazon. In 3 years, Samsung measured its control in this segment in Brazil with 40% of the sales (according to IDC Brazil), conquering over companies that were present in Brazil a good deal before Samsung (Sonis, et al., 2007).

The Samsung factory in Manaus is extremely automated. It has been manufacturing the Samsung Voicer cellular devices since March 1999. Following the path of high technology and advanced design, Samsung Slim, Samsung Colors etc. The company produces 1.5 million cellular devices and 1.3 million monitors per year in Brazil (SEC Family News, 2009). Twenty percent of these products are exported to other countries in Latin America. In 2002 Samsung began the production of disk drives in Brazil with total investments of U.S.$35 million and is starting to export them to neighboring Latin American countries (Baer, et al., 1998).

1. Government stability and openness to foreign investment

Foreign direct investment (FDI) began to change considerably in the 1990s, as Brazil adopted neoliberal policies. The latter consisted of market-oriented policies, privatization of state firms in heavy industries and public utilities, and a drastic decline of protection. In addition, Brazil became actively involved in the Mercosul, the common market of Argentina, Brazil, Paraguay, and Uruguay, which implied a gradual disappearance of regional barriers to trade and investment flows. In this more open economy, especially after the Real stabilization program, which was introduced in 1994, there was a dramatic rise in the inflow of FDI. While in the early 1980s the yearly inflow of FDI amounted to about U.S.$2.6 billion, this declined to about U.S.$1.7 billion in the period 1983 -- 90. FDI stagnated in the early 1990s, averaging U.S.$1.3 billion a year, only gaining momentum after 1994, reaching U.S.$5.5 billion in 2005, U.S.$10.5 billion in 2006, U.S.$18.7 billion in 2007, and U.S.$28.7 billion in 2008 (Martins, 2006).

The privatization process accounted for about one-quarter of the inflow of FDI in the period 1996 -- 98. This represented a dramatic increase of foreign participation in the privatization process. In the first half of the 1990s, when the privatization got started, foreign investments only accounted for about 5% of total privatization. This participation rose to about 35% in 1997 (Balassa 2004). Two factors contributed to this trend. First, the initial lower participation can be explained by the fact that privatization was initially limited to traditional industrial sectors such as steel and petrochemicals. These were not sectors that were inherently attractive to foreign investors. Second, changes in the country's legislation concerning foreign investments made Brazil more attractive to multinational corporations (Geddes, 2003).

The rapid implementation of Mercosul increased the attractiveness of the region to multinationals as it amplified the effective market which they would be serving. The general world flow of capital to emerging markets -- for instance, foreign direct investment in low- and middle-income countries rose from U.S.$23.7 billion in 1980 to U.S.$118.8 billion in 1996 (Savasini, 1978).

Changes in Brazil's legislation concerning foreign capital seemed to have contributed to attracting an increasing amount of FDI. There was an important modification in the Constitution to eliminate the differentiation between Brazilian companies on the basis of resident and nonresident ownership. This allowed foreign firms to invest in a number of sectors that were previously reserved for domestic state or private firms. These sectors include mining, petroleum, electricity, transportation, and telecommunications. The passage of a concessions law for private investors (domestic and foreign) also helped set a framework for the privatization of public utilities, in which foreign groups would be allowed to participate (Arnold, 1999). Nondiscrimination in tax treatment was introduced, as the previously higher taxes on profit distribution to nonresidents discouraged foreign investments.

The role of foreign investment has undergone considerable changes over the past century. Prior to World War II, foreign firms concentrated on public utilities and export-related sectors. During the ISI period, most public utilities were nationalized, and foreign firms were encouraged to establish manufacturing facilities for the protected domestic sector. This resulted in a diversified industrial structure that was relatively inefficient and characterized by secondhand technologies. With the opening of the economy and the privatization process, one finds once again a substantial amount of foreign investments in public utilities. At the same time, one finds that the behavior of multinationals has changed as a result of lower protection from imports, which, together with an overvalued exchange rate in 1994 -- 98, exposed the economy to global competition (Fujita et al., 1999). The multinationals reacted to this by emphasizing investments in advanced technologies, which also led their subsidiaries to attend not only the domestic market, but also to compete internationally, especially within the Mercosul area. In fact, it seems that in the 1990s the existence of the latter and its possibility of expanding became a primary motivating factor for a substantial number of multinationals that established themselves in Brazil for the first time (Sonis, et al., 2007).

Ironically the large inflow of foreign capital in the 1990s also had a problematic aspect in that it enabled the government to postpone a much-needed fiscal adjustment. Since the Real Plan's introduction in mid-1994, which brought down inflation, the government has financed its deficits in a noninflationary way by issuing short-term debt, which was bought by financial institutions and the public at large (Magalhaes, et al. 2001). As long as foreign capital was flowing into the country at a rate which was greater than the sum of the trade deficit, the yearly debt servicing obligations and profit remittances, it was possible to maintain a stable and gradually overvalued exchange rate. This stability reassured the public about the credibility of the government's financial obligations. Unfortunately this stability became increasingly fragile. The government had to resort to excessively high interest rates in order to maintain foreign portfolio investors and prevent Brazilians from sending their money abroad. But gradually, the credibility of the government was undercut by the fast rising domestic debt and the Asian and Russian financial crises of 1998 and 1997, forcing devaluation in February 1999 (Martins, 2006).

2. Strength and stability of local Currency

The various governments of the 1980s and 1990s were either not willing or capable of devising noninflationary ways to deal with the distributive conflict. That is, not being able to maintain a budgetary equilibrium and thus stability of the money supply, the government undermined credibility in the domestic currency, thus setting the stage for the distributive pressures to manifest themselves through price increases (Baer, et al., 1998).

The Constant Absence of a Fiscal Adjustment

In the period analyzed, Brazil suffered from both inflation and stagnation. This contrasts with most advanced industrial economies, where long periods of stagnations have usually been accompanied by either no price increases or very small rates of inflation. (Note that stagflation was talked about in the United States, but for shorter time periods.) Brazil's stagflation comes as no surprise to the observer, since both inflation and stagnation can be interpreted as being different manifestations of the same disequilibrium (Reis, 1999).

Over the years, Brazil's public sector experienced chronic budget deficits, which were financed by increases in the indexed domestic debt. The problem in the 1980s was the gradual decline of the government's credibility with the public, that is, there was increasing doubt about the government's capacity to service the debt and eventually to repay the principal (Baer et al. 1998). This gradual loss of credibility required the shortening of the terms of financing, reaching a point at which most of the debt was being financed through the overnight market and at increasingly higher real rates of interest. The high interest rates, combined with the large stock of the debt, substantially increased the financial expenditures of the government, whose share in total government expenditures grew rapidly. This created a vicious cycle of rising debt -- leading to rising deficit -- leading to further increases in debt (Fujita et al., 1999).

Brazil found itself in a situation in which an enormous amount of financial resources were invested in the overnight market, which was extremely liquid so that investments could at any time be turned into money, with the possibility of a capital flight into real assets. In 1989, for instance, while the stock of M1 was 1.7% of GDP, M2 was equal to 12% of GDP (Cantwell, 1999). Thus there existed the real threat of a loss of control over the money supply due to the possibility of a rapid withdrawal from the overnight market and/or the exhaustion of financing government deficits through the issue of new debt instruments. The consequence was a growing loss of confidence and the rejection of the national currency, making it easier for the distributive conflict to result in price increases.

Within this context, one finds an explanation to such questions as Why did Brazilian firms grant nominal wage increases with little impact on employment levels? Why did Brazilian consumers accept price increases without significantly diminishing their purchases? In other words, why did the market sanction these price increases, allowing the distributive pressures to manifest themselves through inflation? The answer is that all firms know that they can pass on increases in the prices they pay for inputs to their customers, since the latter prefer to keep buying more expensive products than to hold on to currency, whose value, they believe, will continue to decrease at an accelerating rate (Magalhaes, et al. 2001). Of course, the inflationary process does not resolve the distributive conflict and the generalized indexation scheme "institutionalizes" and worsens the phenomenon.

Within this diagnosis, the inconsistency of the various stabilization strategies attempted during the period under analysis may be worth noting (Miyazawa, 1966). On the one hand, the successive shocks and price/wage freezes were not accompanied by a necessary structural fiscal adjustment. Thus they progressively lost their credibility, and each successive shock had a lesser impact on inflation. On the other hand, the policies aimed at fiscal and monetary austerity were insufficient to attain a reversal of expectations, which was crucial for an effective stabilization program. According to our interpretation of the inflation crisis, confidence in the domestic currency depends on a permanent structural adjustment of public finances (Geddes, 2003). Therefore, simply controlling cash flows, postponing certain expenditures, and devising temporary measures to increase receipts will not achieve the desired confidence as they do not guarantee a future effective control of the money supply. Even more serious, however, is the attempt to control M1 in the short run without a fiscal equilibrium, since this will require very high real interest rates. This situation worsens future problems and will cause growing doubts among the general public about the government's financial stability, as it increases the debt and the cost of its servicing (SEC Family News, 2009).

3. Availability of Raw Materials and Suppliers

Samsung currently being the Number One producer and highest in terms of sales for cell phones, requires cheap and high quality raw materials to compete with the likes of Apple (Number Two) and HTC. The effects of the petroleum crisis forced Brazil to redouble its efforts at export promotion and to change its import strategy. A key to the former was the continuation of Brazil's export incentive program, which, on occasion, came under severe criticism in both the United States and Europe. Another important factor in determining the growth of exports was and still is the rate of growth of the industrial economies that are the importers of Brazil's manufactured goods and industrial raw materials (Miyazawa, 1966).

As a reaction to the world petroleum crisis that drastically worsened its balance of payments, Brazil made various attempts to control its imports and to turn once again toward an intensive import-substitution strategy. Massive investment programs in steel, metal products, capital goods, and petrochemicals and derivatives substantially increased the country's dependence on imports for its industrial growth (Balassa 2004).

Brazil's policymakers were not able to use their crawling-peg scheme with as much liberty as expected. On the one hand, there were pressures to devalue the cruzeiro at a more rapid rate than in the past. The rate of devaluation in the 1970s, especially after 1973, consistently lagged behind the domestic inflation rate (even subtracting the inflation rate of its main trading partners), which was growing again after the steady decline of annual price increases in the period 1967 -- 73. In the 1970s, the export incentive program more than compensated the negative effects of an overvalued cruzeiro. The reluctance to devalue was due to the fear that this measure might add substantial fuel to the resurgence of inflation since the oil crisis. Also, since there was a substantial dependency of Brazilian business on foreign loans, every devaluation substantially increased the cruzeiro cost of the debt (Arnold, 1999). This pushed up internal interest rates and thus discouraged new investments and, hence, the rate of growth of the economy. However, the debt crisis of the 1980s and the pressures by the governments of advanced industrial countries to eliminate or moderate various export incentive programs led the government to decree a number of maxi-devaluations and to adopt a crawling-peg exchange rate that did not lag behind the inflation rate.

The combination the massive inflow of capital after the adoption of the Real in mid-1994 caused a significant appreciation of the new currency. The exchange rate was also used as one of the instruments to stabilize the economy. The net result was a substantial rise of imports and a much smaller growth of exports, causing occasional spurts of protective retrogression. The impact of the Asian/Russian crises, however, led Brazil to abandon its high exchange rate policies and drastically devalue the Real in January 1999.

The Search for Sources of Energy and Raw Materials

Until the late 1970s Brazil was able to provide only 20% of its petroleum needs. (Discoveries of new sources in the early 1980s indicate a decline in this dependency by the mid-1980s to about 50%.) It depended on imported coal for its steel industry, and it had to import such raw materials as copper, tin, zinc, and chemicals. Thus many of its foreign economic policy moves were motivated by a desire either for self-sufficiency in these raw materials or for ensuring secure supplies of these vital inputs. In October 1975, the country made an unprecedented move away from the exclusive reserve of petroleum exploration for the state company Petrobras by allowing "risk contracts," (Baer, et al., 1998) that is, foreign companies were allowed to prospect for petroleum in designated areas of the country, and if the prospecting should bring results, the findings would be split between the foreign company and Petrobras. It was hoped in this way to bring in foreign capital for costly exploration activities and to develop Brazil's capacity to extract petroleum more rapidly.

The drive to increase economic ties with Paraguay and with Bolivia was also motivated by energy considerations (SEC Family News, 2009). The building of the world's largest hydroelectric dam at Itaipu as a joint venture between Paraguay and Brazil has made Paraguay the world's largest exporter of electric energy and contributes substantially to the energy needs of Brazil's center-south. No doubt this will make Paraguay's economy very dependent on Brazil (Cantwell, 1999). Similarly, Brazil's large-scale investments in Bolivia are designed to bring that country's abundant natural gas and other raw materials to the industrial center of Brazil. To assure itself of petroleum supplies, a subsidiary of Petrobras, Braspetro, has made technical assistance and prospecting contracts with Middle Eastern, African, and South American countries. There was also an increase in bilateral trade with former socialist countries for the same reason (Reis, 1999).

4. Geographic Location (e.g for exporting)

Keeping Samsungs R&D and manufacturing plants in mind, as long as Brazil's economy was primarily export oriented, the regional distribution of income was determined by the type of primary exports that were dominant. When the principal source of growth became internalized, however, unequal regional growth and development rates tended to perpetuate themselves or even increase at times (Savasini, 1978).

Hicks, among others, have observed that once unequal rates of growth develop, they tend to perpetuate themselves. The disparity in growth rates may even increase because "as industry and trade become concentrated in a particular center, they themselves give to that center an advantage for further development"(Korzeniewicz, 2010). New firms will tend to settle in the already growing regions, unless there are some special reasons to go to another region, since external economies will make investment in those areas more remunerative. Such external economies consist of more readily available skilled labor and a wide variety of auxiliary goods and services that do not have to be imported. Although the initial reason for the faster growth of such a region might have been some geographic advantage, "it is perfectly possible that they may lose their geographical advantage, and yet they continue to grow, through this advantage of concentration. They grow, that is, by an internal economic momentum"(Miyazawa, 1966).

Although the growth momentum is usually cumulative in the dynamic area, it could, under certain conditions, spread some of its dynamism to other areas. In other words, the growth of the dynamic area can act as a centrifugal force in certain circumstances, but it could also act as a centripetal force and drain the marginal areas of any growth potential they might have had.

Growth can be transmitted from the dynamic to the static region through three basic channels: the movement of goods, of capital, and of labor. Growth transmissions through trade take place when the dynamic region is not self-sufficient, leading to part of the incremental wealth being spent in another, complementary region (O'Grady, 1998). Capital will have incentive to move from the dynamic to the stagnant area only if the vital source of supply to the former needs development. Such movement might create new centers of self-sustaining growth, although it might also simply create an enclave economy in a distant region with little local linkage. With the exception of such an incentive, it is probable that the dynamic center will act centripetally as far as capital is concerned, for with all the available externalities, rates of return on investment will probably be much higher in the growing than in the stagnant region (Cason, 2010).

One would also expect labor mobility to be in the direction of the growing region, for the sake of Samsung Electronics. It is most likely that productivity and earnings of labor are higher in the latter than in the stagnant area. The margin of difference in labor remuneration, or the expectation thereof, will have to be enough to overcome the inertia due to change of patterns of living involved in the movement. On the positive side, labor movement might ease the pressure in the stagnant area and even raise per capita income, especially if there existed a considerable amount of disguised unemployment in the area. Such a movement might also benefit the dynamic center by keeping a steady labor supply on hand, thus preventing labor costs from rising too fast. Labor movement can also be a considerable drain on the stagnant region, since there is usually a greater tendency for younger, more vigorous, and better-trained or trainable individuals to move (Cantwell, 1999).

It can also be argued that if the growing area does not attract labor fast enough from other regions, this might ultimately make the latter seem more attractive to capital than previously. It is more likely, however, that relatively lower wages in the stagnant regions will be offset by lower labor productivity and higher costs in other fields, such as transportation or power (Cason, 2010).

If the dynamics of the situation are such as to result in centripetal forces being dominant, equity considerations might force the government to undertake actions to redress regional inequalities. To what extent can this be done without impairing the growth of the dynamic region? Public policy measures of geographical redistribution can be achieved through fiscal policy and/or direct official measures to encourage firms to settle in the more backward regions (Savasini, 1978).

5. Human Resource issues (e.g. attitudes of the people, wage costs, flexibility of workers)

It should be remembered that one of the aims of the Geisel administration was the improvement of the country's income distribution and the rise in the well-being of the masses, which had not participated in the rapid growth of the "miracle years." It is noteworthy that some of the data available show a rise in real wages (Korzeniewicz, 2010). For example, it is noted that real minimum wages rose almost continuously from 1992 to 2002, although in Rio de Janeiro their growth was neither as steady nor as strong. Average real wages of blue-collar and office workers rose steadily until 1979. Table 1, which shows the proportion of the labor force earning different salary levels, reveals that a large proportion of the labor force earns less than one minimum wage per month. There was a slight decline between 1977 and 1981, but thereafter this proportion rose again (SEC Family News, 2009).

Table 1. Selected Wage and Salary Statistics

Labor Force by Brackets of Monthly Earnings, Selected Years (percent of labor force)

1977

1979

1981

1983

Up to 1/2 MW

13.4

10.9

12.1

12.7

More than 1/2 to 1 MW

20.9

18.5

15.8

18.3

More than 1 to 2 MW

24.7

25.2

24.7

22.8

More than 2 to 3 MW

10.2

10.7

12.6

11.8

More than 3 to 5 MW

8.6

9.8

10.2

8.9

More than 5 to 10 MW

5.8

7.0

7.0

7.5

More than 10 to 20 MW

2.6

3.0

2.9

3.3

More than 20 MW

1.3

1.3

1.3

1.3

With no earnings*

12.5

13.6

13.4

13.4

Total

Notes: For 1977 and 1979 the rural population of the Northern Region and the states of Mato Grosso do Sul, Mato Grosso, Goias are not included.

For 1981 and 1982 the rural population of the Northern Region is not included.

*Includes those who received only social security benefits. People with no earnings are not included.

MW = minimum wage.

It should be stressed that the wage policies designed to obtain greater equity in the distribution of income were introduced at the end of the 1970s, when Brazil's inflation/balance-of-payments crisis worsened. This has led to a considerable debate over the impact of the wage policy: whether it was effectively redistributing income and whether it was one of the main causes of the acceleration of inflation (O'Grady, 1998).

The best analysis of the impact of Brazil's wage policy was made by Roberto Macedo. He pointed out that pressures for new wage policies originated in 1974, when the annual inflation rate doubled from about 20% to about 40% (a plateau on which inflation remained until 1979). Thus the pressure for semiannual wage readjustments was based on the consideration that if "nominal wages are readjusted on an annual basis, when the rate of inflation doubles, the fall in real wages between readjustments will lead, within this period of time, to a lower yearly average real wage. Simple intuition suggests that…this larger decline in real wages were reduced in the same proportion by which the rate of inflation was increased" (Arnold, 1999).