Samsung mystique at risk after death of Galaxy Note 7

Samsung Electronics Co. is corporate royalty in South Korea. It's also a company recognized for its marketing smarts and engineering savvy worldwide, so much so that consulting firm Interbrand ranked it as the world's seventh most valuable in its 2016 survey, ahead of Amazon and Mercedes-Benz.

So how is it that the pride of South Korea has so botched the recall of 2.5 million Galaxy Note 7 smartphones after complaints of exploding batteries - and a ton of negative publicity by the media in the U.S., Europe and China, not to mention the vast echo chamber of social media?

When it recalled its phones last month, it assured consumers it had diagnosed the problem and that its replacements were safe. Not so it turns out: Customers reported the lithium batteries in new phones went up in flames too, in some instances. On Tuesday, Samsung took the dramatic step of killing off the Note 7 for good.

"This is a calamity," said Srinivas Reddy, director at the Center for Marketing Excellence at Singapore Management University. "The threat for Samsung is how soon they can get back. If they don't get back soon, it provides a vacuum for others to creep in."

The company has not said how many new or replacement phones will be affected. Analysts estimated that the original recall would cost between $1 billion and $2 billion, but that figure will now certainly rise.

The move sent Samsung shares down 8 percent on Tuesday, vaporizing $17 billion in market value. Samsung's sterling brand image built up over decades is at risk unless the management team led by Vice Chairman Jay Y. Lee, 48, doesn't get out in front of the crisis soon.

"It's a very critical moment for Samsung," said Martin Roll, a brand strategist and author of Asian Brand Strategy. "How Samsung is handling this crisis is kind of a way for Samsung to step into the modern era because Asian firms have only started to emerge as very iconic, contemporary consumer brands like Apple. The history of Samsung as a brand is still being written."

Some six weeks after the first reports of exploding phones surfaced, Samsung engineers, as well as U.S. and South Korean government investigators, have yet to discover why lithium batteries in the company's new smartphone product overheat and in some cases explode.

The Korean Agency for Technology and Standards (KATS) said in an emailed statement Tuesday it is investigating the possibility the Note 7 smartphones may have a new defect. An official at the Ministry of Trade, Industry and Energy didn't rule out the possibility that the problem may be tied to the overall product design or production. Samsung has said it's working with investigators and still trying to identify the source of the battery problem.

Whether the Samsung brand takes a lasting hit will depend, in part, on how long the mystery of the Note 7 batteries continues and whether the company is perceived by consumers as stonewalling.

"Samsung must come clean with a thorough explanation as the previous explanations don't completely add up now," said Mark Newman, an analyst with Sanford C. Bernstein in Hong Kong.

The company needs to find out the exact cause and communicate it clearly to consumers, according to Yoo Jong-woo, an analyst at Korean Investment & Securities Co. "I think the company will be able to recover from the blow to its image over time, if the problem does not spread to other phones," he said.

Brand strategist Roll agreed that consumers will be forgiving if this is viewed as an aberration at an otherwise reliable company. "Consumers need to be kept in the loop here because they've put trust in Samsung's brand," Roll said. "It's a partnership."

Until Samsung can come up with some answers, it faces thorny challenges. Six analysts surveyed by Bloomberg had originally estimates that Samsung would ship 13 million Note 7s this year. Now it has a hole in its product lineup, just as Apple begins selling its iPhone 7 and high-end devices from Google hit the market.

There's also the risk that the Note 7 troubles spill over to other smartphones in the Galaxy lineup, dampening overall sales momentum against key rivals such as Apple and Huawei Technologies Co. Samsung faces a serious image problem in China, where customers and government-owned media have railed about Samsung's handling of its recall.

"They're done in China," said Shaun Rein, managing director of Shanghai-based China Market Research Group. "For the Chinese, they don't differentiate between the Note 7 and all Samsung phones. So they're not willing to buy any Samsung phones right now."

Back in South Korea, some consumers are more forgiving. Several customers shopping at a smartphone retail store in Seoul's Jonggak neighborhood shrugged off suggestions the latest crisis could hurt Samsung's image. They said they would still consider Samsung phone as an option despite reports of Note 7 catching on fire.

One customer said it was a matter of national pride. "As a South Korean we should purchase Samsung phones because we should think about the country," said Shin Young-Su, 50, who is self-employed. He said he was encouraging more young Koreans to buy Samsung phones to help the company.

Another customer who prefers Apple's iPhone because of functionality with his other Apple devices said he didn't think the latest crisis would hurt the Samsung brand. "The igniting issue is a problem for only few phones," Kim Sung-Min, 38, who would only say he works in the service industry. "Even if a phone ignites in my hands, I believe Samsung will take care of everything for me. I believe in the brand."

Samsung will almost certainly take a meaningful financial hit in the fourth quarter from the Note 7, according to Bernstein's Newman. That said, he estimates the entire Note line only accounts for 8.5 percent of his 2017 net profit forecast and thinks Tuesday's market reaction was overdone.

Dan Baker, an analyst at Morningstar Inc. in Hong Kong, pegs the direct cost from the initial Note 7 recall at as much as 1 trillion won ($892 million). "But the damage to reputation and future sales is probably going to be bigger," he said. "It's not just the phone: their whole ecosystem is behind this - displays, memory chips. If their phone sales drop, then their sales of other parts of the business will be impacted. It's a spiral."

Baker expects Samsung to try to shift the focus to the next version of the smartphone. "They're probably going to double the testing on it," he said. "They don't want this to happen again. There will be people's jobs on the line."

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Bloomberg contributors: Min Jeong Lee and Peter Pae.