KOREA'S AUTOMAKERS TAKE ON THE WORLD (AGAIN) THE WEST ONCE SCOFFED AT JAPAN'S PLANS TO EXPORT ITS CARS. NOW DETROIT AND OTHER AUTOMAKERS MAY BE UNDERESTIMATING THIS NEW GLOBAL CHALLENGE TOO. HAVE THE KOREANS REALLY WHIPPED THE QUALITY PROBLEM, AS THEY CLAIM?
By LOUIS KRAAR REPORTER ASSOCIATE RONALD B. LIEBER GUSTAVO GILABERT-JB PICTURES

(FORTUNE Magazine) – You might think the world has all the cars and trucks it needs. But don't say that to South Korea's automakers. To bulldoze their way onto this seemingly overcrowded international stage, they plan to invest $35 billion to build new factories at home and abroad, enough to quadruple their current exports.

To succeed, the Koreans will have to leap over some mighty high hurdles. Chief among them is a well- deserved reputation for making low-quality cars. Meanwhile, Korea's one competitive edge --low prices--grows blunter. Also at risk: a hot domestic market where Korean automakers have long been coddled by extreme protectionism and which they are using to finance their global move. If the Koreans are able to increase their current market share in automaking countries like the U.S., Germany, and France, those nations are sure to demand increased access to Korea. Further complicating the picture, emerging markets in the Third World will want joint-venture stakes in assembly plants in their countries, and many of the jobs such factories will create.

Much of this scenario, of course, evokes the birthing pains of Japan's early export push of some 25 years ago--and it could produce offspring of equally startling proportions. Once again Detroit and other overseas competitors may be underestimating this new challenge from the Land of the Morning Calm. They tend to dismiss the Koreans because their role on the world stage is so minor, forgetting that their cars now rank among the leading imports in several growing markets, such as Chile.

Many industry watchers believe that the Koreans will be able to improve quality while maintaining their cost advantages. Consider the Koreans' proven success in other supposedly saturated markets like steel, shipbuilding, consumer electronics, and semiconductors. Warns Maryann Keller, the influential auto analyst at Furman Selz: "If the Koreans played by the rules of the Harvard business school, they'd still be rice farmers. They are going to build an auto industry, and they are going to find markets."

The Korean automakers have clearly learned from past mistakes, Japan's as well as their own. They hope to increase sales in the U.S. and Europe, but executives at the Big Three--Hyundai, Kia, and Daewoo--vow to avoid flooding those markets and provoking trade restrictions. Instead, the Koreans aim to use the West as a show window for their biggest target: new emerging markets. Says Kim Woo-Choong, chairman of Daewoo: "Mainly we'll be selling our cars in places with growing demand like India, China, and Russia." Along with Latin America, Africa, and the Middle East, such regions accounted for about half of Korea's exports last year, or some 740,000 vehicles. By the turn of the century, the automakers hope to be turning out six million cars a year, half of them for export. To ease their way into the Third World, they are busily setting up assembly operations in such places as Egypt, Botswana, Vietnam, and Uzbekistan.

Strategically, the Koreans see themselves as simply filling a vacuum in the small-car market. Japanese manufacturers, faced with a strong yen and a sluggish home market, can no longer make much on such cars-the best-sellers in the Third World, where price is a top priority. One Korean auto executive explains the attraction of this low end of the market very simply: "The Japanese need somebody to take that business off their hands, and that's where we come in."

It would be a mistake to dismiss such talk. This fiercely independent country has already managed to build a huge auto industry by using other people's money and expertise but without yielding management control. Japan's Mitsubishi Group, for instance, owns around 10% of Hyundai Motor. Ford Motor has a 10% stake in Kia, and Mazda, 8%. With the exception of Kia, which makes only cars, trucks, and their components, the other Korean automakers have the additional edge of being parts of huge conglomerates, or chaebol. Steady earnings from Hyundai's shipbuilding business, for example, or Daewoo's trading company enable their automaking siblings to plan and invest long term, just as Japanese automakers were able to do when they eyed the rest of the world. Two other Korean conglomerates, in fact, find automaking so rosy that they have decided to join the ride. SsangYong, known for its cement and construction activities and already a maker of sport utility vehicles, has formed an alliance with Germany's Daimler-Benz to make Mercedes cars in Korea by 1997. Samsung, one of the country's largest diversified business groups and a company known worldwide for its consumer electronics products, will gate-crash the business with Nissan know-how. Samsung plans to invest some $5.3 billion and expects to turn out 500,000 cars annually in five years.

Even some Koreans are alarmed that the field is getting overcrowded. Among them: Kim Sun Hong, 62, chairman of Kia. Perhaps because he does not have the strength provided by conglomerate backing, he predicts, "There will be high chaos in our auto industry, and it will be hard for Korean manufacturers to get competitive power." Hyundai's Baik Hyo-Whi, who oversees exports, frets, "My big worry is that the quality of the cars Daewoo and Kia send overseas will hamper Hyundai's image."

Baik's comment typifies the potshots that Korea's auto execs consistently take at one another. But it also signals the long way that Hyundai thinks it has come in the drive to improve quality. It was Hyundai, after all, that spearheaded the export charge into the U.S. in the late 1980s and took the eggs in the face as a maker of lemons.

As always, the last word belongs to the consumer. Hyundai's new lineup includes the Accent, a subcompact now available in the U.S. and Canada. With a base sticker price of about $8,000, the car is some $2,000 less than the competing Toyota Tercel. Kia's contender in this class is the Sephia (with a base price of $8,495), on the market since last year.

The pricing edge won't be enough to carry Korea very far into the future, however. For one thing, it is not as sharp as it used to be. Although labor costs emerged from a spate of recent strikes way under Japan's--about $7 an hour vs. $24--offshore assembly is likely to offset Korea's cost advantage. Some of the new models already have sticker prices about equal to their foreign competitors'. For example, at $14,500, Kia's Sportage, a sport utility vehicle, is about the same as Suzuki's Sidekick, a rival.

Potential customers in price-sensitive emerging markets, meanwhile, are far from shoo-ins. Just last year Kia's export plans got crimped by a series of setbacks: a sluggish economy in Turkey, a shortage of foreign exchange in Iran, and negotiations in Indonesia that, as they always do there, took longer than expected. In short, it's difficult to count on stable demand in such places.

The enormous potential of emerging markets will obviously draw many competitors. Consider Thailand, which is shaping up as a prime battlefield for the world's automakers. Annual vehicle sales should reach over 750,000 by the end of the decade. Both Toyota and Honda are already expanding existing factories, while Ford is considering a plan to produce pickup trucks in league with Mazda. Korea's Big Three are all after this same market, setting up dealer networks, assembly plants, and the like. Similar international scraps seem sure in such big markets as India and Indonesia.

In contrast, Korea is meeting less challenge in such vest-pocket markets as Barbados and other countries in the Caribbean. Says analyst Keller: "It appears that they are going after every small country on earth to sell cars. They've found anyplace where they can sell a couple of hundred cars, and are still largely ignored by Western and even Japanese manufacturers."

Potentially, China offers the biggest prize, of course (see box). But forget about anything happening soon in North Korea. As a Kia executive points out, "North Korean highways are almost empty," but so are the population's pockets.

The extent to which Koreans can become major car exporters depends in large part on how well they have learned from Japan. No automaker can expect to boost exports and at the same time indefinitely preserve a privileged sanctuary at home. Korea retains a 99% share of a domestic market that has grown an average of more than 12% annually, to 1.55 million cars in 1994. To do so, Korea has banned Japanese imports absolutely and slaps all kinds of taxes on U.S. and European imports that can double the price of a car. Of course, Japan has demonstrated how foot-dragging can add years to the life of an exclusionary market.

What follows is a quick tour of these rugged, determined corporations, reviewing their strategies and the new models that will confront American, Japanese, and European automakers. HYUNDAI GETS THE QUALITY MESSAGE. "We didn't know the export market before, but now our eyes have opened," says president Chon Sung Won, 62. "We're still behind the high-class Japanese and U.S. manufacturers, but the quality gap has narrowed." Chon allows, "Our image got stuck on the cheap, low-level car, and it's very difficult to change." He's right about that, of course, but Chon has more than a mere image problem. In a survey of new-car owners, J.D. Power & Associates found that all four 1994 Hyundai models ranked almost at the bottom of the heap, with an average 193 problems per 100 cars, vs. the industry's 110. The only car with worse marks was Alfa Romeo. The National Highway Traffic Safety Administration gave the Elantra its lowest grade (one star out of a potential five) in crash tests designed to measure passenger safety. The automaker fared no better last year with Consumer Reports: "Hyundai models have competed well in price, but not much else."

Hyundai hopes to find redemption with the Accent subcompact, which is benchmarked on the Toyota Tercel for performance and the Chrysler Neon for cost. To bolster the quality of its cars, Hyundai sent the leaders of its once militant labor unions to the U.S. to witness firsthand the intense competition and hear dealers' complaints. Says Baik, the executive VP who oversees exports: "Our aim is to meet Japanese quality but at a more competitive price."

The Accent is the first export that the company has designed on its own--its predecessors were based on Mitsubishi designs. The effort cost $437.5 million, 57% of it for production equipment, and took 52 months. Chai Won Kim, head of Hyundai's passenger-car engineering center, believes, "We have created an eye-catching design that will appeal to the young." To do so, the company freed teams of young engineers to come up with the car they'd buy and gave them a Cray supercomputer to help incorporate such safety features as optional antilock brakes and dual airbags into the snazzy design.

Equally important, the company claims to have learned the hard way about how to sell cars in the U.S. In 1988, Hyundai sold some 264,000 Excel compacts, a warmed-over version of the late Mitsubishi Colt. But then demand for the car collapsed, largely because of well-publicized quality problems. Last year Hyundai's U.S. sales reached about 126,000 cars, in four models, giving it a 1.4% market share of passenger vehicles. That still reflects a drop from 1988's market share, indicating that the company has yet to recover fully from its reputation for shoddy quality. Although the fast-growing domestic market eats up more of the cars Hyundai produces in Korea, a plant built in Bromont, Canada, to make Sonata compacts for North America sits idle. Hyundai has postponed writing off that $300 million investment, which exceeds the subsidiary's entire profits for the past few years. Hyundai Motors earned some $72 million in 1993 and an estimated $125 million in 1994 on sales of $8.9 billion and $11.9 billion, respectively.

The big challenge ahead for Hyundai, which still sends more than half its exports to America and Europe, is to expand its international markets. The company has a strong financial incentive: Hyundai can get 15% profit margins on exporting knocked-down compact cars for local assembly in such countries as Thailand and Botswana, vs. only marginal profits from selling a complete car in the U.S. KIA COUNTS ON ENGINEERS AND ALLIES. Executives of Kia, the second-largest Korean automaker, often describe themselves as "country bumpkins"-but don't be misled. They simply mean that the Kia Group (with $10 billion sales last year) focuses entirely on building cars, trucks, and their components. Kia's able engineers have absorbed much know-how from Ford Motor Co. and Mazda, with whom it has manufacturing alliances. The Kia brand is familiar to Europeans but new to Americans. Even so, the company's small cars, all of them made in Korea, have been in the U.S. market since the 1987 model year as Fords, first as the Festiva and now the new Aspire. Kia's strategy depends on such partnerships. Says company chairman Kim: "Our competitors are huge conglomerates that compete in terms of market share, but we cannot afford to forget financial reality."

Kia's global ambitions are evident at a new integrated plant, soon to be complete with its own port, in Asan Bay, about 55 miles southwest of Seoul. Sprawled over 421 acres, with nearby housing for workers, is an entire Korean motor town, with highly automated production lines and a four-lane, high-speed oval track with 40-degree banked turns. The site is the centerpiece of a $7.75 billion commitment that will double annual capacity to 1.5 million vehicles, 40% of them for export. Turning out new models designed especially for the U.S. and Europe, Kia's factories run two shifts six days a week. For the first time, Kia is exporting cars of its own design. Ford dropped out of the project to make the perky-looking Sportage sport utility vehicle because the model didn't suit its global plans, and Kia went ahead on its own, investing some $600 million over seven years to complete the vehicle. And although the new Sephia compact is powered by a fuel-injected Mazda engine, Kia plans to replace this soon with an engine of its own.

As Cho Sung Hwan, executive director of the research and development center, makes clear, Kia has learned from Hyundai's past experiences. "Price alone will not sell products," says Cho. "Competitive power comes from technology. We have talented engineers who work longer hours than you'd ever find at GM. Otherwise we couldn't survive."

Kia has taken innovative steps to make a good first impression on Americans. In 1993, a year before introducing the Sephia in the U.S., the company supplied 2,000 of them to Budget Rent-A-Car, which used them for 12 months for an average 20,000 miles. Feedback from rental customers prompted small improvements before mass production of the Sephia. A noisy speedometer, for instance, was replaced with a silent electronic one. Says Greg Warner, 51, executive vice president of Kia Motors America and a veteran of Ford, Toyota, and Hyundai: "The most consistent question people ask about our car is whether it's like a Hyundai or a Honda." What they mean, of course: Are Kias reliable? Part of Warner's answer is its free three-year or 36,000-mile service warranty. In 1994, its first year in the American market, Kia sold 12,000 cars through a network of new dealers.

To sell more cars, Warner, who is also the only American director of any Korean automaker, is now expanding his dealer network, spreading out from the western U.S. To grab more of Europe, meanwhile, Kia has made an alliance with Karmann, a company that assembles cars in Germany, to build Sportages. And with help from Ford's overseas plants, Kia cars are already being assembled in such places as Taiwan and Venezuela.

DAEWOO FINDS NEW FRONTIERS. Daewoo Motor Co. has the most daring strategy. It is setting up 11 offshore factories in areas with few competitors, including Romania, Iran, and Uzbekistan, formerly part of the Soviet Union. With local partners it plans to produce a total of one million vehicles a year in such places. Says Kim Woo-Choong, chairman of the parent company: "Those are huge potential markets, and not enough companies want to take the risks of going there. We're willing to go because we are latecomers. We have no choice." Kim has taken big gambles before, building Daewoo into a flourishing conglomerate by acting on his belief that risky markets deliver the largest returns. He is investing $5 billion to expand Daewoo's annual capacity from 465,000 vehicles to two million, including those made offshore, by the end of the decade. Kim is given to making midnight visits to his auto assembly lines, just to let everybody know he has his eye on quality.

Daewoo's export sales should benefit from being inside emerging markets. Example: From resource-rich Uzbekistan, Daewoo's cars should have easy access to neighboring republics. Besides, Daewoo can do barter deals that would stymie most automakers. The Uzbekistan joint-venture operation, for instance, will pay for some imported components with cotton and fertilizer, welcome goods for a conglomerate with an international trading arm. Nor will there be a problem with the awful lot of inconvertible lei Daewoo will be collecting this year in Romania, where it plans to sell 20,000 cars. Says Kim: "We can use that money to buy Romanian steel and other commodities."

The only Korean automaker to gain a foothold in China, Daewoo has agreed to build plants for making engines, transmissions, and other components in a joint venture with a state enterprise. This ambitious effort, which may require an investment of $2 billion, is Daewoo's best crack at winning approval to build complete cars in China. Beijing welcomes component makers but has imposed a moratorium on new joint-venture assembly plants for at least two years. Until that happens, Daewoo plans to export Chinese-made components across the Yellow Sea to its own factories in South Korea. Says Wang Young-Nam, executive vice president for overseas operations at Daewoo Motor: "China is just like Korea in the 1970s. We've got to be there."

Since dissolving a joint venture with GM in late 1992, the Korean automaker has more than doubled its exports, to over 110,000 vehicles last year. Daewoo cars have become leading imports in such countries as Chile and Peru. This year, Daewoo plans to invade Britain. To do so, it is bypassing dealers and opening about 30 Vision 2000 Car Stores, suburban showrooms with service shops, play areas for children, and snack bars.

Daewoo's marketing is more innovative than its cars, however. The current Cielo, introduced in Britain and Germany, is a restyled offspring of GM's Pontiac LeMans. Daewoo's first completely new export model, a sporty-looking car being developed with help from an Italian designer and an engineering team in England, won't be ready until late 1996. Code-named the T car, the car will hit North America in 1997.

The most searing criticism of Korean autos comes not from other countries but from Samsung. The company already makes trucks and will add cars in 1997. "The biggest problem is that there is no basic trust in Korean cars," says Jeong Ju Wha, executive vice president of Samsung Heavy Industries and a 20-year veteran of Hyundai. "Our manufacturers have made a very rapid ascent focused on quantity rather than quality. Everyone has been in too much of a hurry. We think it's time to build a quality car here." Equipped with deep pockets and the latest technology, Samsung is bound to give the Korean Big Three what Victor Sun, auto analyst for Hong Kong's Peregrine investment bank, describes as "a much-needed jolt."

Or shove any one of them out of the business. The big export push is clearly an enormous gamble for all the players. Another stumble would leave them forever on the fringes of their industry.