Beyond The Global Factory' Model: Innovative Capabilities For Upgrading China's IT Industry
Beyond The Global Factory' Model: Innovative Capabilities For Upgrading China's IT Industry
Beyond The Global Factory' Model: Innovative Capabilities For Upgrading China's IT Industry
x, xxxx 1
Dieter Ernst
East-West Center,
1601 East-West Road, Honolulu, HI 96848
Fax: 808-944-7399 E-mail: [email protected]
Abstract: China is now the largest exporter of IT goods, surpassing the USA,
up from a world ranking of tenth in the year 2000. But this ‘global factory’
model now faces new competitive challenges as globalisation transforms
markets for technology and knowledge workers. This has forced China’s policy
makers and corporate strategists to seek ways to move beyond the ‘global Author: Please
factory’ model. A brief review of China’s ‘global factory’ model highlights its reduce abstract
integration into diverse global network arrangements. This paper introduces the of no more than
concept of ‘Industrial Upgrading’ (IU) that links specialisation with firm-level 100 words.
and industry-level upgrading. This concept is used to discuss what specific
innovative capabilities are required to upgrade China’s IT industry. This paper
also emphasises that ‘soft’ entrepreneurial, management and system integration
capabilities need to complement ‘hard’ R&D. The argument is that ‘technology
leadership strategies’ that focus on ‘radical’ innovations are not the only option.
‘Technology diversification’ can serve as a complementary and arguably less
costly option.
1 Introduction
China’s Information Technology (IT) industry may be a relative newcomer on the world
scene but it is doing something right, and in a big way. China is now the largest exporter Author: Please
check if the
of IT goods, surpassing the USA, up from a world ranking of tenth in the year 2000.
highlighted
And China’s booming market for electronics products and services reshapes the global reference
IT market and defines innovation roadmaps (von Hippel, 1988, 2005).1 As the second citation is ok.
largest IT importer (up from the seventh place in 2000), China has accumulated
bargaining power, especially for telecommunications equipment (both fixed-line and
wireless), computers, software and semiconductors (Hopfner, 2007).2
China’s success is due to a unique combination of competitive advantages (Ernst,
2006b; Ernst and Naughton, 2007). The rapid growth of the Chinese market encompasses
both high-end ‘lead customers’ (Beise, 2004) in Shanghai, Beijing and Shenzhen, as well
as ‘bottom-of the pyramid’ customers in lower-tier cities and rural areas (Prahalad and
Lieberthal, 1998) that require ultra-low-cost products and services. China also has the
world’s largest pool of low-cost and easily re-trainable knowledge workers.3 This has
attracted Foreign Direct Investment (FDI) on an unprecedented scale. For China, inward
FDI is more than ten times as important as during Japan’s and Korea’s high growth
periods – and nowhere more so than in high technology exporting. This has given rise to
a deep integration into Global Production Networks (GPNs), exposing Chinese firms to
leading-edge technology and best-practice management approaches (Ernst, 1997, 2002a;
Ernst and Kim, 2002; Borrus et al., 2000; Ernst, 2003, 2004, 2006f).4 This, in turn, has
created new opportunities, pressures, and incentives for Chinese firms to upgrade their
technological and management capabilities and the skill levels of workers.
Equally important for China’s success are aggressive, yet selective and continuously
adjusted support policies that have enabled domestic firms to exploit those opportunities
and to improve their positions in these networks. Of particular importance are concerted
policy efforts (both at the national and regional level) to strengthen China’s innovation
system and foster the emergence of sophisticated lead users and test-bed markets
(especially in wireless telecommunications).
But this ‘global high tech factory’ model is now confronted with new competitive
challenges, both from below and from above. From below, the rise of lower-cost
manufacturing sites in Vietnam, India, Bangladesh, Pakistan or Sri Lanka implies that
simply creating cheap-labour manufacturing jobs is not a viable development strategy.
And from above, China is now confronted with a more hostile international environment,
where established industrialised economies in the USA, the EU and Japan are seeking
new ways to protect their industries, and to recreate their competitive edge through R&D.
In addition, the ‘global factory’ model is also facing new challenges that arise from
shifts in the global innovation system, as globalisation transforms markets for technology
and knowledge workers. These challenges include the intensifying competition for a
limited global talent pool and profound changes in the innovation management of global
corporations that give rise to the geographic dispersion of research, development
and engineering jobs through global innovation networks (‘innovation offshoring’)
(Ernst, 2006a).
This has forced China’s policy makers and corporate strategists to seek new ways
to move beyond the ‘global factory’ model. Much of the debate has focused on a strategy
of IU through innovation. But most firms and policy-makers are still groping in the dark
Beyond the ‘Global Factory’ model: innovative capabilities 3
to understand what precisely that strategy requires; for the time being they are content to
adopt a pragmatic trial-and-error approach until they find something that works.
This paper seeks to establish what is necessary and feasible, using illustrative
examples from China’s IT industry. It starts out with a brief review of China’s ‘global
high tech factory’ model, highlighting its integration into diverse global network
arrangements, as well as achievements and weaknesses of the model. In part two, the
concept of ‘IU’, that links specialisation with firm-level and industry-level upgrading,
is introduced.
Finally, in part three of the paper the specific innovative capabilities which are
required to upgrade China’s IT industry are explored. It is emphasised that ‘soft’
entrepreneurial, management and system integration capabilities need to complement
‘hard’ R&D in order to create products and services that customers are willing to pay for.
It is argued that ‘technology leadership strategies’ that focus on ‘radical’ innovations are
not the only option. ‘Technology diversification’ can serve as a complementary, and
arguably less costly, option.
A defining characteristic of China’s ‘global factory’ model is its integration into multiple
corporate and informal global networks of production and innovation. China is far
more integrated into global knowledge networks than were Japan and Korea at a similar
stage of their development.
Formal corporate networks link Chinese firms to global customers, investors,
technology suppliers and strategic partners through FDI as well as through venture
capital, private equity investment and contract-based alliances.5 And informal global
social networks link China to more developed overseas innovation systems, primarily
in the USA, through the international circulation of students and knowledge workers.
Asia is concentrated in the electronics industry, with China dominating hardware R&D
for hardware.
As for non-equity forms of R&D internationalisation (‘offshore outsourcing’), China
is now the third most important location behind the USA and the UK, but ahead of
Germany and France. The same survey projects that China will be a more attractive
location for future foreign R&D than even the USA.
The concept of IU can serve as a focusing device for China’s attempts to move beyond
the ‘global factory’ model and to unlock new sources of economic growth. The main
objective is to exploit the productivity-enhancing potential of innovation, in order to
avoid a race to the bottom that is driven solely by cost competition.
Hence, in general terms, IU must focus on improvements in specialisation, local
value-added, productivity, and forward and backward linkages, all of which necessitate
a broad base of knowledge and innovation (Ernst and Lundvall, 2004).
Two aspects of IU are of greatest policy relevance: ‘firm-level upgrading’ from
low-end to higher-end products and value chain stages, and ‘industry-level linkages’ with
support industries, universities and research institutes (Ozawa, 2000; Ernst, 2001).14
‘Firm-level upgrading’ is the key dimension – without it, there is little hope that
China can sustain and reinvent the success of its IT industry. In other words, Chinese
firms must develop the capabilities, tools and business models that will allow them to
address the weaknesses of the ‘global factory’ model. And it is the strength of such
firm-level upgrading that will decide whether Taiwan can cope with the new challenges
from shifts in the global innovation system.
But for firm-level upgrading to succeed, upgrading must take place simultaneously at
the level of ‘industry linkages’. To broaden the pool of firms that are fit for sustained
firm-level upgrading, strong support industries are required, so are dense linkages
with universities and research institutes. The challenge is to enable firm-level and
industry-level upgrading to interact in a mutually reinforcing way, so that both types of
upgrading will give rise to a ‘virtuous circle’.
IU in China also faces a second challenge. As its companies are integrated into
multiple global networks of corporate production and innovation and informal knowledge
communities, it is obvious that international linkages are critical for IU. Hence, we need
to distinguish domestic (‘local’) and international (‘global’) elements.
Finding the right balance between firm-level and industry-level upgrading, and
between domestic and international elements poses a continuous challenge for
policy makers and corporate planners – the ‘right balance’ is a moving target, it is
context-specific and requires permanent adjustments to changes in markets and
technology. All four elements hang together – a strategy that neglects one element to the
detriment of the others is unlikely to create sustainable gains. The stronger the links
between those four elements, and the better they interact, the greater are the chances that
Chinese firms can shape markets, prices and technology road maps.
The international dimension of IU will be addressed in a separate paper. Our focus
here is on the domestic elements. We know from the study of ‘national innovation
systems’ (e.g., Freeman, 1987; Nelson, 1993; Lundvall, 1992) that peculiar features of
Beyond the ‘Global Factory’ model: innovative capabilities 7
economic structures and institutions offer quite distinct possibilities for learning
and innovation, and, hence, shape the technological (or economic) performance of
a country/region. The economic structure determines specialisation (i.e., the product mix
and the production process) and learning requirements (the breadth and depth of the
knowledge base, tools and capabilities). Institutions, on the other hand, shape learning
efficiency; they define how things are done and how learning takes place. An important
concern is the ‘congruence’ (Freeman, 1997, p.13) of different subsystems, which is
necessary to create a virtuous rather than a vicious circle.
This indicates that, on the domestic front, an essential prerequisite for IU are
institutions and incentives that facilitate innovation and the development of support
industries, and that provide a sufficiently large pool of experienced and re-trainable
knowledge workers with specialised skills. The role of institutions and incentives is well
covered in the literature (e.g., Naughton and Segal, 2001). But we know less about the
second, equally important, domestic element – how specialisation in products and types
of production may enhance the potential for IU.
By contrast, the scope for differentiation is broader for high-end handsets (especially
smart phones) and for the mobile network industry. Both are examples of ‘early PLC
stage’ industries. While entry barriers are high in both industries, in terms of investment
and technology, there are ample opportunities for new entrants to upgrade through
innovation.
High entry barriers are accompanied by qualitative competition. This requires
complex capabilities to understand customer needs and to provide integrated
solutions. Without policy support in ‘industry-level’ upgrading, Chinese firms would be
hard-pressed to cope with these demanding requirements.
At the same time, this is an industry where premium pricing is possible, at least in
some market segments. To the degree that this translates into high profit margins, this
facilitates investment in R&D. As system architectures and interface standards remain
fluid and are evolving rapidly, there are many learning opportunities and Chinese
firms are under considerable pressure to develop their capabilities. Furthermore, the
mobile network industry provides ample opportunities for creating value-added and for
developing linkages (both domestic and international) with customers, suppliers of core
components and technology, and private and public R&D partners.
Beyond the ‘Global Factory’ model: innovative capabilities 9
activities (by measuring ‘hot spots’); and the knowledge exchange between inventors at
different locations.
Especially useful for our purposes is research that, based on questionnaire surveys
and structured firm interviews, has developed operational data sets for measuring
firm-level innovative and R&D capabilities (Lall, 1992; Ernst and O’Connor, 1992;
Hobday, 1995; Ernst et al., 1998; Amsden and Tschang, 2003; Jefferson and Kaifeng,
2004)17. For instance, a comprehensive taxonomy of firm-level capabilities was
developed in a study, prepared for the United Nations Conference on Trade and
Development (UNCTAD), that distinguishes capabilities required for production,
investment, minor change, strategic marketing, establishing inter-firm linkages, and
major change (Ernst et al., 1998). This taxonomy, which suggested a sequential ordering
of priorities for capability formation, was largely confirmed in that study’s comparative
analysis of how electronics and textile firms have developed their capabilities in Taiwan,
Korea, Thailand, Indonesia and Vietnam.
• raise money required to bring an idea quickly to the market (the litmus test
of innovation)
• deliver unique and user-friendly industrial designs (which is of critical importance
especially for fashion-intensive consumer devices, like mobile handsets)
• develop and adjust innovation process management (methodologies, organisation
and routines) in order to improve efficiency and time-to-market
• manage knowledge exchange within multi-disciplinary and cross-cultural innovation
projects
• participate in and shape global standard-setting
• combine protection and development of IPR
• develop credible and sustainable branding strategies.
Each and every of these ‘soft’ capabilities is important in its own right. But they are also
inseparable. For instance, a narrow focus on brand marketing is insufficient. Branding
efforts need to be supported by a broad mix of ‘soft’ and ‘hard’ innovative capabilities.
This implies that a capacity to provide ‘integrated solutions’ is arguably one of the most
important prerequisites for IU based on innovation.
According to Davies et al. (2001, p.5), ‘integrated solutions’ encompass four sets of
capabilities:
• system integration: to design and integrate components and subsystems into a system
• operational services: to maintain, finance, renovate and operate systems through the
life cycle
• business consulting: to understand a customer’s business and to offer advice and
solutions that address a customer’s specific needs
• finance: to provide a customer with help in purchasing new capital-intensive systems
and in managing a customer’s installed base of capital assets.
By and large, US, Japanese and European electronics firms have sophisticated and
proven strategies in place that can provide simultaneously these four complex ‘integrated
solutions’ services.
A few large Chinese IT firms (like Lenovo, Huawei, ZTE and Haier) are now making
serious efforts to catch up in the mastery of these most critical innovative capabilities.
They are seeking to develop less over-engineered and expensive products that address
effective customer needs that market leaders have neglected. Two examples are Huawei’s
integrated IP phone services platform ME60 (discussed below) and Lenovo’s Tianxi
laptop, a decisively low-tech model introduced in the mid-1990s that single-handedly
created the Chinese PC market for private consumers and small businesses (Ernst, 2006b,
2006d; Ernst and Naughton, 2007).19
In addition, a few Chinese chip design start-up companies (such as Verisilicon,
Chipnuts, Vimicro, RDA, Jade) have made efforts to build a broad portfolio of ‘soft’
innovative capabilities and to provide unique and lower-cost integrated solutions
(Ernst, 2006e). But these efforts still have a long way to go. This requires conscious
efforts of industry-level upgrading. The challenge for policy-making is to foster
Beyond the ‘Global Factory’ model: innovative capabilities 13
resultant products, and the more they are prone to breakdowns due to unproved
technology. The IT industry is full of examples that show that only very large, cash-rich
firms can cope with such high risks21.
In China’s IT industry, only very few companies can master this game. But even they
are sometimes forced to stretch their resources to the limits. An example is the super
computers. China’s decision to develop, by herself, high performance computing
technology, as well as some other key technologies such as those in telecom equipment,
was largely due to the technology export control imposed by organisations of the most
developed countries, such as the Coordinating Committee for Multilateral Export Control
(COCOM). In a way, China was forced to choose the ‘technology leadership’ option.
That strategy did produce some tangible results. China’s most powerful
supercomputer, Dawning’s 4000A, was ranked as 10th in the world as early as in 2004.
Its grid-oriented AMD 64 PC-Cluster design uses some unique features, which allows for
a theoretical peak performance of 22 T Flops. This is quite an achievement for a company
that pales in size relative to global industry leaders and that has only limited financial and
human resources. Of critical importance were close links with the Institute of Computing
Technology of the Chinese Academy of Sciences (CAS), whose president chairs the
board of Dawning. But to keep up with the accelerating pace of high-end computing
technology will require increasingly large resources.
A similar story of impressive, yet costly achievements emerges from Lenovo’s
super computer projects (Ernst, 2006b). The first project was the DeepComp 1800
supercomputer, introduced in 2001, which, based on 526 Intel Xeon processors, was
ranked 51st by 2002. This was followed, in November 2003, by the DeepComp 6800
model that was ranked 14th worldwide, and was jointly funded by the Ministry of
Science and Technology and the Chinese Academy of Sciences. There were expectations
that a commercialised version of this machine could be used during the 2008 Beijing
Olympic Games for a precise 36 h weather forecast on a specific area within just 30 min
of computing work (which now requires 40 h). Markets were also expected to exist for
computing data from oil fields, in disease control centres and physics labs. It is unclear,
however, to what degree these expectations will materialise.
Finally, the most recent project, the 1000 TFLOPS supercomputer, which was started
in 2005 and scheduled for completion before 2010, is supposed to be nearly ten times
more powerful than the world’s fastest supercomputer. But resource requirements are
also growing. The underlying rationale was clearly more political than commercial,
driven by the perception that China cannot rely on other countries to develop
a supercomputer that meets its needs.
In short, for Chinese IT firms, ‘technology leadership’ based on ‘radical’ innovations
pose a difficult challenge – investment requirements are huge and require substantial
government support, while markets are likely to be limited. There may, however,
be indirect commercial benefits, as successful completion of a radical innovation project
may help to establish a company as a serious player and foster its brand image.
Nevertheless, the future of China’s IT industry critically depends on quick access to
radical innovations, especially in generic technologies. For instance, Chinese firms need
core component technologies and insider information on interface standards, in order to
compete in the mobile network industry. The same is true for in SOC design for wireless
and optoelectronics systems and for embedded processors. And quick application of
nano-technology research is critical for the upgrading of China’s semiconductor and
optoelectronics industries.
Beyond the ‘Global Factory’ model: innovative capabilities 15
Capability requirements are demanding, but they are within reach of Chinese
companies. By definition, late-latecomers like Chinese IT firms continue to lag behind
industry leaders in the breadth and depth of their R&D and innovative capabilities.
Their strength, however, is that they are familiar with peculiar characteristics of China’s
markets and institutions, and that they are exposed to user requirements that global
industry leaders have neglected. Having started as distributors of foreign products and
services, Chinese firms have been exposed to China’s insatiable but largely untouched
demand for products and services that are not over-engineered and hence are less
expensive, but provide essential performance features.
Chinese firms can use this knowledge to penetrate China’s large mass markets, not by
following but by breaking new ground in product development. Of critical importance is
the capacity to develop products and services that are less over-engineered and expensive
than those of global market leaders, and that address ‘effective customer needs’23 that
incumbent global market leaders have neglected. This requires a change in the
architecture of a product or service.
And barriers to implement that new architecture are limited. In fact, Chinese firms
do not need to develop the necessary components, nor do they have to change them.
Integration into multiple global production and innovation networks enables
Chinese firms to buy in the relevant component technology from specialised suppliers.
As demonstrated by Iansiti (1997), global markets for technology imply that a firm’s
competitive success critically depends on its ability to monitor and quickly seize external
sources of knowledge. Hence, Chinese firms can leverage basic or generic technologies
developed elsewhere. Chinese firms might also engage in collaborative development of
some of these components.
An early example is the development of China’s electronic switching system HJD04
– the innovation consists in developing a system architecture that optimises performance
features in line with the specific features of the national telecommunications network
structure and the specific needs of the service providers (Shen, 1999). Other examples
include: the development of Chinese-language electronics publishing systems by the
Founder Group Company, a spin-off from the Institute of Computer Science and
Technology of Beijing University (Lu, 2000, Chapter 4); and the development of the
unique Chinese Video Compact Disk (VCD) technology and the successful transition to
Chinese DVD system technology.
While these architectural innovations use existing component technology, they,
nevertheless, introduce substantially new and distinct features to existing system
architectures. Another more recent example is Huawei’s development of a new integrated
IP service platform ME60. This is the first integrated multi-service platform on the
market that enables telecommunications operators to substantially improve the quality of
service and the security of their IP services at a reduced cost of operation.
Current IP networks do not offer the security and quality of service that operators
request, while traditional networks are incapable of supporting bandwidth-hungry
multimedia services such as IPTV. Operators have a number of consumer and business
products in the market, such as DSL, cellular, Asynchronous Transfer Mode (ATM) IP
VPN24, and central office exchange services. To improve service quality and security,
these products need to be aggregated and run over a common IP core25. The ME60 is the
‘Swiss army knife’ that enables operators to aggregate multiple services from various
networks into one IP core and that improves the operators’ real-time control over these
services.
Beyond the ‘Global Factory’ model: innovative capabilities 17
5 Conclusions
This paper has explored what innovative capabilities are required for upgrading China’s
IT industry. To answer that question, the achievements and weaknesses of China’s ‘high
tech global factory’ model have been highlighted.
In addition, the concept of ‘IU’ that links specialisation with firm-level and
industry-level upgrading has been introduced. At the centre of this concept is the need to
find the right balance between firm-level and industry-level upgrading, and between
domestic and international elements. This poses a continuous challenge for policy makers
and corporate planners – the ‘right balance’ is a moving target, it is context-specific and
requires permanent adjustments to changes in markets and technology.
The paper culminates in a discussion of specific innovative capabilities that are
required to upgrade China’s IT industry. ‘Soft’ entrepreneurial, management and system
integration capabilities need to complement ‘hard’ R&D in order to create products and
services that customers are willing to pay for has been emphasised. It has been argued
that, as ‘technology leadership’ strategies are extremely costly and risky, only few
companies in China’s IT industry can master this game. As the future of that industry
critically depends on quick access to radical innovations, especially in generic
technologies, this requires concerted industry-level upgrading efforts by the government
and industry. Such efforts are needed to reduce the very substantial barriers that
individual firms face when they try to move to technology leadership strategies.
Hence, ‘technology leadership strategies’ that focus on ‘radical’ innovations are
not the only option for China’s ‘upgrading through innovation’ strategy. ‘Technology
diversification’ can serve as a complementary, and arguably less costly, option. It is
18 D. Ernst
emphasised that the most important bottleneck to technology diversification right now are
‘soft’ entrepreneurial, management and system integration capabilities.
This has important implications for the design and implementation of China’s
upgrading strategy. First, as a late-latecomer, China has to develop her own idiosyncratic
approach to policies, support institutions and business strategies. The experiences of
other countries, in Asia, but also in the USA and Europe, can provide important insights.
But, in the end, China has to come up with her own solutions, based on its own peculiar
strengths and weaknesses.
Second, given the rapid pace of change in the global electronics industry structure,
upgrading the country’s electronics industry involves multiple moving targets; hence,
solutions have to be constantly adjusted. Of critical importance is the choice of
appropriate sequencing patterns for developing innovative capabilities. Equally important
is a sufficient degree of flexibility in policies and institutions that allow for quick
response and adjustments to abrupt changes in markets and technology, and to
unexpected outcomes of upgrading policies.
Third, and finally, multiple international linkages are considered to play an important
catalytic role in facilitating and accelerating the upgrading of China’s electronics
industry. The focus, however, has moved away from an earlier heavy reliance on
technological capabilities developed within affiliates of global flagships, and their
eventual spill-overs into local firms. Also, earlier attempts (especially in the car industry)
to trade market access in exchange for access to technology may not be sustainable any
longer.
China needs to expand and deepen international knowledge sourcing through multiple
linkages with foreign universities, research institutes, and consulting firms, and by
tapping into the vast informal global peer group networks of overseas Chinese
researchers, engineers and managers. A progressive integration into these diverse global
innovation networks can help Chinese IT firms to bridge existing gaps in specialised
skills and innovative capabilities. Most importantly, it can catalyse changes in
organisation and procedures that are necessary to develop these capabilities locally.
Acknowledgement
I gratefully acknowledge ideas, comments and suggestions from Calestous Juma, Greg
Shea, Clark Duncan, Richard P. Suttmeier, Barry Naughton, Ron Wilson, Xielin Liu,
Xudong Gao, Chintay Shih, Kane Wang, T.C.Tu, Shin-Horng Chen, Pang Eng Fong,
Wong Poh Kam, Ted F. Tschang, Xiaobai Shen, Boy Luethje and Adam Segal. At the
East-West Center, I am grateful to Charles Morrison and Nancy Lewis for supporting this
research, and for discussions with Ray Burghardt, Carol Fox, Dick Baker and Mark
Borthwick. The Volkswagen Foundation provided generous funding. Kitty Chiu, Peter
Pawlicki and Rena Tomlinson provided excellent research assistance. I am grateful to
Brenda Higashimoto for her constructive suggestions in editing the manuscript.
Beyond the ‘Global Factory’ model: innovative capabilities 19
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22 D. Ernst
Notes
1
The importance of lead users for innovation is demonstrated by von Hippel (1988, 2005).
2
Rapid growth of mobile, internet and broadband subscribers, together with still vibrant PC
sales, drive massive investments in IT infrastructure and generate a voracious demand for
semiconductors. Together with Japan, China now dominates Asia’s semiconductor market, well
ahead of South Korea, Taiwan and Singapore (Hopfner, 2007).
3‘
Knowledge workers’ are defined to include science and engineering personnel, as well as
managers and specialised professionals (in areas like marketing, legal services and industrial
design) that provide essential support services to research, development and engineering.
4
For the concept of global production networks, see Ernst (1997, 2002a) and Ernst and Kim (2002).
For case studies, see Borrus et al. (2000) and Ernst (2003, 2004, 2006f).
5
An additional important development, not addressed in the paper, is the integration of Chinese IT
firms into international standard-setting alliances.
6
The UNCTAD sample consists of the first 300 firms of the R&D scoreboard of the 700 top
worldwide R&D spenders, published by the UK Department of Trade and Industry (DTI).
7
Private equity investment is medium- to long-term finance provided in return for an equity stake in
potentially high-growth companies that are not listed on a major public stock exchange. According
to the British Venture Capital Association, it encompasses both ‘venture capital’ (from the seed to
the expansion stages of investment) and management buy-outs and buy-ins.
8
Sources include the US and the UK National Venture Capital Associations and consulting firms
like Greenwich Associates, Private Equity Intelligence (PEI) and Shanghai-based Zero2IPO for
China.
9
Courtesy of Private Equity Intelligence (PEI), a London-based specialised consulting firm
(July 6, 2006).
10
An example is the recent indictment of Warburg Pincus’s Korean office on charges of insider
trading (‘Warburg Pincus faces Won 26 bn fine’, FT, 19 April 2006, p.16).
11
Data, courtesy of the US Council of Graduate Schools, March 2006.
12
China apparently now also relies on a growing circulation of students and knowledge workers
with other Asian countries (especially Taiwan, Japan and Singapore), as well as with the EU,
Russia and Eastern Europe (Interviews Beijing 05 24 06).
13
In 2000, 85% of global R&D expenditures were concentrated in only seven industrialised
countries. The USA occupied the leading position with 37% (Dahlman and Aubert 2001, p.34).
14
The other three forms of ‘industrial upgrading’ discussed in the literature are:
• inter-industry upgrading proceeding from low value-added industries (e.g., light industries) to
higher value-added industries (e.g., heavy and higher-tech industries)
• inter-factor upgrading proceeding from endowed assets (i.e., natural resources and unskilled
labour) to created assets (physical capital, skilled labour, social capital)
• upgrading of demand within a hierarchy of consumption, proceeding from necessities to
conveniences to luxury goods.
See Ozawa (2000) for discussion of upgrading taxonomies. Most research has focused on a
combination of the first two forms of IU, based on a distinction between low-wage, low-skill
‘sun-set’ industries and high-wage, high-skill ‘sunrise’ industries. Such simple dichotomies
however have failed to produce convincing results, for two reasons (Ernst, 2001): First, there are
low-wage, low-skill value stages in even the most high-tech industry, and high-wage, high-skill
activities exist even in so-called traditional industries like textiles. And second, both the capability
requirements and the boundaries of a particular ‘industry’ keep changing over time. An example
is the transformation of the personal computer industry from an R&D-intensive high tech industry
to a commodity producer that depends on the optimisation of supply chain management.
15
I use these distinctions to move the research agenda beyond the popular, but somewhat
schematic dichotomy of ‘Fordist mass production’ vs. the ‘Post-Fordism Flexible Specialization’.
For a detailed theoretical discussion, based on evidence from chip design, see Ernst (2005b).
Beyond the ‘Global Factory’ model: innovative capabilities 23
16‘
Design methodology’ is the sequence of steps by which a design process will reliably produce
a design ‘as close as possible’ to the design target, while maintaining feasibility with respect to
constraints.
17
Important contributions include Lall (1992), Ernst and O’Connor (1992), Hobday (1995),
Ernst et al. (1998), Amsden and Tschang (2003) and Jefferson and Kaifeng (2004).
18
This broad definition is in line with Peter Drucker’s classic statement: “The test of an innovation,
after all, lies not in its novelty, its scientific content, or its cleverness. It lies in its success in the
marketplace” (Drucker, 1985, p.VIII).
19
For case studies on Lenovo and Huawei, see Ernst (2006b, 2006d) and Ernst and Naughton
(2007).
20
Presentation by Ltd. General Wen Xisen, President of China’s National University of Defense
Technology (NUDT), at the Asia-Pacific Center for Security Studies, Honolulu, 18 June, 2007.
21
A telling example is Sony’s third-generation PlayStation that is based on radical, but still unstable
Bluetooth technology which causes lengthy delays in its market introduction.
22
For IC design, the government has established two national multi-project wafer (MPW) service
centres (one in Beijing, and one in Shanghai) that provide access to foundries and assembly
companies, both from Taiwan (for sophisticated design rules) and from China. And seven
government-supported Research Centers for Integrated Circuit Design (in Shanghai, Beijing,
Suzhou, Wuxi, Hangzhou, Xi’an, and Chendu) provide a variety of knowledge-intensive services,
including subsidised access to leading-edge EDA tools, that help to overcome constraints that
individual Chinese design houses face when trying to transform their designs into silicon. Equally
important are attempts to develop standards that could leverage China’s large market and its
peculiar characteristics, such as TD-SCDMA, a third generation (3G) digital wireless standard.
23
I define ‘effective customer needs’ as those customers are willing to pay for.
24
Virtual Private Network – allows secure remote connection within an organisation’s network over
the internet.
25
The IP core, also sometimes called backbone, is the primary path of an IP network traffic.
It connects smaller segments of a network and has a high concentration of traffic.
26
A gateway is the entrance to another network. The gateway allows equipment with different
protocols to communicate.
27
The main explanation for the incumbents’ focus on standard solutions is their very high
development costs. This reflects the fact that global industry leaders have their major R&D
operations located in high-cost industrialised countries. In addition, many of their products are
over-engineered – they provide leading edge technology that exceeds by far the needs of most
users. These high R&D costs necessitate a business model that seeks to reap economies of scale
through ‘mass-manufacturing’ of standard and fairly inflexible solutions.
28
Huawei unveils god box, Unstrung, 21.06.2005, http://www.lightreading.com/document.asp?
doc_id=76055.
29
According to the same source, Alcatel, another global industry leader, may only be able to build
a similar system if it had the capacity to develop broadband remote access servers.