From Hardware Manufacturing to Value Creation — Smart Phones, Taiwan and Korea

1. From Hardware Manufacturing to Value Creation — Smart Phones, Taiwan and Korea Peter T. L. Shih Director, Commercial Division Taipei Economic and Cultural Office in Boston February 28, 2012 INNOVATION, GLOBAL COMPETITIVENESS, AND NATIONAL ECONOMIC DEVELOPMENT ADMINISTRATIVE SCIENCES DEPARTMENT METROPOLITAN COLLEGE BOSTON UNIVERSITY

2. Outlines • Revisit the Value Chain and Smile Curve • Path of Taiwan’s economic development • A story of the smart phones • Analysis — Taiwan’s ICT industries and value added • Innovation paradigm change and the way forward

3. Value Chain - concept from business management first described by Michael Porter in 1985 (Competitive Advantage: Creating and Sustaining Superior Performance)

4. Smiling Curve – A supply chain value analysis concept proposed by Stan Shih, founder of Acer, Inc.

5. Path of Taiwan’s Economic Development Manufacture oriented Investment oriented Innovation Oriented Labor intensive Capital Intensive TechnologyIntensive Knowledge Intensive • Large-scale infrastructure projects • Labor-intensive to capital-intensive • Lay foundation for high-tech industries • The burgeoning of FTAs • Regional competition become fierce • R&D and high value added are focus • Promote high-tech industries development • ICT industries gradually became the mainstream • Agriculture • Labor-intensive light industries aimed at livelihood need and import substitution • Improve agricultural technology • Labor-intensive industries aimed at export • Internationalization and technology upgrade • ICT and other electronic industries well mature 1952 1960 1970 1980 1990 2000 2010

6. The Story of The Smart Phones Missed the smartphone market Lost the smartphone market Losing the business smartphone market Changed the smartphone market Changing the smartphone market(?) What made their success? • Game changing capabilities or design innovations - differentiated their products • Products that matched customer needs The lessons learned? Why did they fail? • Lost touch with customers - Failed to adapt to the changing world and hold onto their market leading business for too long! • stalled innovation – the original differentiators no longer matters in the new environment

7. Dominance by Apple In terms of profits and added value !

8. Dominance by Apple In terms of profits and added value !

9. Design (R&D), Brand & Marketing: $228 (45.7%) Apple (U.S.A), AT&T, Verizon… • Component & Parts : $260 (52.1%) Microprocessors, LCD, etc: $114 (22.9%) Korea Bluetooth, audio chips, etc: $15 (3.0%) U.S.A Driver, IC, connectors, etc: $130 (26.1%) Taiwan • Assembly & Labor cost: $11 (2.2%) China Retail Price: $499 for 16GB model

10. Implications for Taiwan’s ICT Industries: Are OEMODM model sustainable? iPhone Profit Breakdown iPad Profit Breakdown • The success of Apple casts doubts on Taiwan ICT’s business models and strategies • Apple keeps the high value-added activities (design, software, brand management & marketing) to itself while outsourcing manufacturing to others • Apple’s strategy of ‘Brand + Manufacturing Outsourcing’ creates huge volumes of revenue and high profit margin for its value chain. However, the place that Taiwan ‘s ICT industries occupy in the chain may not be ideal • The profit margin or share from OEM/ODM for Apples are not necessarily higher than OEM/ODM for HP or DELL

11. Where should Taiwan’s ICT industries go?OEMODMOBMBranding  High Value Services？ Source: Gartner, compiled by III, Taiwan Unit: US$ 100 Million • Small growth for PCs，Almost no growth for Servers, Continue rapid expansion for Smart phones • IHS Screen Digest: 2010 Apple Apps revenue (~$1.8B) is less than 3% of Apple’s revenue of $65B, and less than 1% of its profit • Gartner: 2010 worldwide IT Service revenue is about $800B, it will be $961B by 2014

12. Analysis of Taiwan’s ICT Industries Source: Chung Hua Institute of Economic Research, Ministry of Economic Affairs, Taiwan

13. Percentage of Value Added by Taiwan’s Manufacturing Sectors Base Year: 2001 Source: Directorate-General of Budget, Accounting and Statistics, and Council for Economic Planning and Development, Taiwan

14. Percentage of Value Added by Manufacturing Sectors —Taiwan vs Korea Base Year: 2001 Source: Directorate-General of Budget, Accounting and Statistics, Taiwan; OECD

15. Percentage of Value Added by Electronic and Optical Goods and Equipment —Taiwan vs Korea Base Year: 2001 Source: Directorate-General of Budget, Accounting and Statistics, Taiwan; OECD

16. Percentage of Intermediate Goods of Taiwan’s Total Export Category A: intermediate goods need to be further processed for consumption or used as inputs in the production of final goods Category B: intermediate goods need not to be further processed for consumption or used as inputs in the production of final goods Source: Taiwan’s export and import statistics, compiled by CEPD’s study

17. Disadvantages (?) of Over-rely on Intermediate Goods • Lack of the ability/technology for system integration and development of software/services • Lack of control/understanding of the markets, trends and consumers’ preference • Without own brand, difficult to diversify/expand markets • Intend to be capital-intensive, and high in energy/resources consumption Source: Chung Hua Institute of Economic Research, Ministry of Economic Affairs, Taiwan

18. Go to market • E.g. Xerox vs Microsoft • # of patents vs # of products • Marketing leadership • Price + Features • Product niches • Choices + Product Paradigm • Technology • Productivity = • Solutions + Services, Business Innovation & Globally Integrated • Flexibility and Values • Value net ecosystem • Transform innovations into delivered values • Value net leadership + = Innovation Paradigm Change Focuses Differentiators Through • Knowledge / Intellectual Property (operational models, insights, assets, etc.) • Value capture & delivery Business Value Paradigm

19. SWOT Analysis of Taiwan’s Industries • Division of labor (upstream/downstream) and supply chain are quite complete • Good technique/management/int’l marketing • Good legal infrastructure and labor force • Export concentrations high on ‘China’ and ‘electronics’ • Value added are not high • Efficiency of use of energy/resources need to be improved • Lack of cross-sectors/industries human resources S W O T

20. SWOT Analysis of Taiwan’s Industries • The signing of ECFA helps attract FDI to Taiwan • Asian emerging markets provide Taiwan excellent opportunity • Demographic trend and living environment are conducive to new product development S W O T • Burgeoning FTAs/RTAs may marginalize Taiwan • Increasing competition from ‘Korea’ — technology, brand and market penetration • Some traditional industries need to be upgraded ASAP

21. The Way Forward — A strategic thinking • The overall strategy — ‘Technology Pull’ and ‘Market Pull’ • Transfer of new technology • co-operation in R&D, brand/marketing management • Efficiency/capability in: • OEM/ODM • Quality mass production in short time • Tailor-made production as well • Supply chain/global logistics management Technology Pull ∥ Building Strength on Your Own Strength!

22. Market Pull= Building Strength on Others’ Strength! (e. g. China) • Economic Cooperation Framework • Agreement (ECFA): • Commodity and Service Trade Liberalization • Investment Facilitation and Protection • Industrial Co-operation (standards, R&D) Population: 1.3 Billion ! • A market of huge potential/source of revenue/profits • A ground to test/fine-tune your technology/products/services • A platform to build your own brand • Provide you economy of scale! (lower costs) • Geographic vicinity and cultural connection

23. Government’s Role In Fulfilling This Strategy • To lead and support large-scale, high-risk and innovative R&D • Applied research in multiple • Industrial technology fields • Technology transfer and IP • Business • Open lab and incubator • Industrial consultancy services Industrial Technology Research Institute (ITRI) Founded in 1973 Flexible Display Technology by ITRI • R&D in network, multimedia, • Green ICT, ICT security, etc. • Industry think tank • Science and technology law • Incubation • Technology transfer and Patents • Research in marketing, consumer behavior and lifestyle • Promoting innovative business models • Business policy recommendations Commerce Development Research Institute (CDRI) Founded in 2007 Institute for Information Industry (III) Founded in 1979

24. Government’s Role … • To help and facilitate, if it is necessary, the collaboration (M&A) among businesses (DRAM, LCD panel) • To create an environment conducive to the introduction of high quality human resources (in particular R&D and global management talents and skills, for example: http://hirecruit.nat.gov.tw/english/index.asp )

25. Government’s Role … • Help diversify the markets by introducing the right products Unit: million BRICs (Brazil, Russia, India, China, S. Africa, Indonesia, Middle East, etc.) TOP US$20,000 Markets Taiwan currently focuses on US$5,000 New potential markets: quality yet inexpensive products US$1,500 Poor and least-developed markets Source: ITRI(IEK) and III(MIC)

26. Government’s Role … • Level the playing fields for Taiwan’s businesses by concluding FTAs with key trading partners (US, EU, Japan, ASEAN, etc.) • Promote and encourage the development of new industries (to diversify in order not to over-rely on ICT): medical care, biotech, green energy (solar, wind power, electrical car, LED), tourism (incorporating medical care), cloud computing, etc.

27. Thank you! Comments, Q&A

28. Aide-memoire to P. 5: Path of Taiwan’s Economic Development • 1949 - 1960 • Policy goals: stabilize the agricultural sector, increase agricultural outputs and ‘import substitution’ • Agriculture: land reform — rent reduction to 37.5% (1949), sale of public land (1951) and land to the tillers (1953) • Import substitution: 1. Encourage labor-intensive industries, textiles, food processing, cement, glass, etc., to satisfy domestic demand 2. Impose import restriction measures to discourage import 3. Two-tiered exchange rate system disadvantaged to import 4. Preferential loans to targeted industries, e. g. textiles • US official aide (1950-1965): staple foods and raw materials

29. 1960 – 1970 • Policy goals: ‘export-oriented expansion’ to accumulate capital and technique for the next stage development • Act of Encouragement of Investment (1960 – 1990 with various amendments at different stages): tax and duties deduction, tax deductibles for investment, accelerated depreciation of equipment, government fund support or investment in targeted industries, preferential loans, development of industrial parks, etc., with emphases on local contents of manufactured products and export. • Exchange rate reform: uniform pegged exchange rate and depreciation of NT dollars to encourage export. • Establishment of Export Processing Zones (EPZs, first of which established in 1966) — preferential treatments and incentives for investors inside the zones to export

30. 1970 – 1980 • Policy goals: government investment and expenditure to counter economic impact by the 1970s oil crisis and ‘2nd Import Substitution’ • 10 Major Construction Projects: 6 of transportation, 3 of heavy and petrochemical industries, and 1 of energy supply (nuclear power plant). The results of these investment-led Projects are immediate improvement of Taiwan’s infrastructure and transformation to capital- or technology-intensive industries • 2nd Import Substitution: encouraging petrochemical and steel mill industries to meet domestic demand of raw materials

31. 1980 – 1990 Policy goals: industrial upgrade and economic transformation by promoting development of targeted ‘strategic industries’ Strategic industries: high value-added, high technology-intensive, low in pollution level, low energy-intensive R&D support by ITRI, III, etc. : 25% of non-military governmental R&D expenditures were by ITRI between 1983 to 1994, and more than 165 spin-off start-ups Semiconductor industry development: 1. Initiated by MOEA in 1974 with initial funding of US$ 12 millions, in cooperation with RCA 2. 1980: establishment of Taiwan’s 1st semiconductor manufacturer, UMC 3. 1987: world’s 1st dedicated semiconductor foundry manufacturer, TSMC Science Parks: 1st of which established in Hsinchu in 1980, with support from the government development fund, state-run banks and venture capitals for investors inside (the 2010 total revenue of Hsinchu Science Park accounted for 10% of that of Taiwan’s manufacturing sectors) Statute for Upgrading Industries enacted in 1989

32. 1990 – 2000 Policy goals: deregulation and liberalization to prepare Taiwan’s businesses for internalization and foreign competition 1987: deregulate foreign exchange market 1989: amend the Banking Law to release control of interest rates and approve establishment of 15 new banks in 1991 1989: allow indirect import from China 1990: allow indirect Taiwanese investment in China 1990-2002: GATT/WTO accession to align Taiwan’s trade and investment regimes with international norms and get equal treatment in other WTO members’ markets Privatization of state-owned enterprises: still mill, shipyard, petrochemicals, fertilizer, civil construction, etc.

33. 2000 — present May 2010: Act of Industrial Innovation — retain tax incentives for R&D, human resource development, regional operation centre and int’l logistic centre in Taiwan (For the rest, please refer to P. 21 to P. 26)