Vectorial shift of bubble firms into sustainable companies

There are many Asian bubble companies. Prior to the crisis, these companies generally lacked focus as they expanded their businesses blindly, often into sectors where they did not have expertise or strong competitive assets. Their competitiveness is low since their resources and focus are spread thin across many businesses. These companies are also typically highly reliant on massive debt-financing to fuel their expansion. When Asian currencies sharply devaluated, many of these companies fell into financial crisis as their debt burdens soared.

The Korean chaebols, and many other Asian conglomerates, are classic examples of bubble companies. The chaebols, which dominate South Korea's economy, have been so obsessed with growth that they built enormous overcapacity in major industries and piled up huge debts. Aggressive diversification into various businesses also corroded the chaebols' competitiveness (i). They did not have the capacity to manage all of their business well, nor was the domestic market large enough to support them. Their business units are also too small to compete globally, since only a few of them can reap the economies of scale that global competitors enjoy, or achieve the huge sales volumes necessary to maintain world-class research and development.

Companies falling within this category face the biggest challenge to emerge from the crisis as winners, or even merely to survive, since they must do a "vertical shift" to become a sustainable company. The vertical shift comprises two elements: improving the company's market competitiveness (the vertical shift) and improving the financial condition and management (the "horizontal shift"), (see Figure 7-1). As with any vectorial movement, there are two ways to achieve a destination. The company can first do the horizontal shift (improving its financial condition by restructuring its debt and improving its risk management), before it does the vertical shift (improving its competitiveness by refocusing its business and reassessing its business strategy).

Alternatively, the company can focus on improving its competitiveness first before fixing its financial problems. As the Andersen Consulting's study shows, most Asian companies are focusing on improving their financial condition first. The best and fastest way is to adopt a comprehensive turnaround program that encompasses both competitiveness and financial improvements. However, only companies with strong management and financial resources can consider doing this. Most importantly, bubble companies need to start making some kind of shift, since failure to make any shift will drive the company into unprofitability or bankruptcy.

Korea's Samsung Electronics is an example of a bubble company that is focusing on improving its financial condition first. As an initial step to restructure its business, it has cut 27 percent of its workforce (16,000 people), discontinued 52 product lines, sold non-core assets, like an office complex in New Jersey, and repaid US$4.7 billion in debt (ii). Also, the company cut many expense items, such as golf-club memberships, executive meals and chauffeured company cars. The cost-cutting efforts are expected to save the company $1.3 billion a year.

CEO Yun Jong Yong, acknowledges that "restructuring is only the first step since cost reductions will no longer produce big profits." He adds that earnings will now come from intangible assets like marketing abilities, brand image and new product lines. Thus, while its cost-cutting efforts continue, Samsung Electronics is constructing a strategy to strengthen the company's competitiveness. A key plank of the new strategy is to focus on innovation and improve its research and development.

As another example, Daewoo, Korea's second chaebol after Hyundai, intended to undergo both "shifts" at once. After growing into a sprawling global conglomerate in 32 years, Daewoo was forced to embark on a massive downsizing effort to shed its debt burdens and get the group into a lean fighting shape (iii). The group's precrisis aggressive expansion left Daewoo, after the crisis, with $50 billion in debts, nearly five times the group's assets. Under pressure from creditors and the Korean government, founder and CEO Kim Woo-Choong decided to sell all or part of Daewoo's most profitable businesses, from shipbuilding to luxury hotels, to halve the corporate debt by year-end. After the restructuring, Daewoo will concentrate on carmaking, plus trading and finance.

Consequently, Daewoo has about 30 divestment deals in progress that could bring in over $6 billion. It has, for example landed a preliminary agreement to sell its auto-suspension manufacturing to Delphi Automotive Systems for $113 million. Japan's Mitsui Engineering and Shipbuilding is eying Daewoo's shipyard business. European firms are looking into buying Daewoo's truck and bus operations.

From these examples, it can be inferred that survival is the top priority for companies that expanded too fast. They must solve their financial problems by managing their short-term cash flow and containing risks that might jeopardize survival. They must also refocus on core businesses that have a chance of becoming globally competitive, while selling, spinning off or shutting down other businesses where they cannot achieve a competitive advantage. No matter which they do first, these companies cannot maintain the status-quo, since doing so might bring them to the brink of bankruptcy.

Asian conglomerates' commitments to restructure, however, have been proven "easier said than done". The Korean chaebols, for example, have been reluctant to merge operations of similar businesses among each other (iv). They do not seem ready, despite the Korean government's strong urging for them to do so. While some have announced merging their operations (for example, Hyundai and LG will merge their memory chip operations), many have not taken the necessary steps to cut excess capacity such as plant closures.

(i) Yuji Akaba, Florian Budde and Jungkiu Choi, A Cure for Sick Chaebol, The Asian Wall Street Journal, Nov. 19, 1998.

(ii) See Reinventing an Asian Brand, Asiaweek May 14, 1999.

(iii) See Daewoo's Incredible Shrinking Act, Fortune, May 24, 1999.

(iv) Yuji Akaba, Florian Budde and Jungkiu Choi, A Cure for Sick Chaebol, The Asian Wall Street Journal, Nov. 19, 1999.