New Product Development in a Global Knowledge Network: The Notebook PC Industry Kenneth L. Kraemer Personal Computing Industry Center The Paul Merage School of Business University of California, Irvine Seminario Globalizacion March 15-17, 2006 Mexico City This talk is based on research conducted by Jason Dedrick and Kenneth Kraemer, sponsored by the Sloan Foundation.

Globalization: from manufacturing to knowledge work Computer industry originally concentrated in the U.S. and Japan Manufacturing shifted from U.S. to Taiwan and SE Asia in 1990s, then to China since 2000 Will knowledge work follow? Case study of new product development in notebook PCs illustrates factors and trends in knowledge-intensive part of the PC industry The process of globalization in the computer industry and other high-tech sectors has been most visible in the shift of manufacturing from the U.S. to East Asia, and most recently to China. We have argued that while this process has led to a significant loss of manufacturing jobs in the U.S., it also was a key to the sustained competitiveness of U.S. computer industry (Borrus and Zysman) . In addition, we have argued that the loss of hardware manufacturing jobs to Asia was more than offset by job creation in the U.S. in software and IT services. This shift from blue collar production jobs to knowledge-based jobs may be seen as a natural progression in an advanced economy in the information age. Today, however, globalization is rapidly expanding into knowledge activities, as knowledge work such as R&D, product design and software development is outsourced to places such as China, the Philippines, Ireland, Israel, and India. This raises questions about the future role of U.S. companies and workers in computers and other high-tech industries.

Leading computer producing countries Hardware production in US$ millions and share of total global production World region 1995 2000 2005 Value Share Global Rank Mexico US 3,110 76,284 1.1% 26.5% 11,900 90,430 3.1% 24.0% 10,156 61,069 2.9% 17.3% 10 2 Japan 72,678 25.2% 65,130 33,618 9.5% 3 Singapore 21,127 7.3% 22,209 5.9% 18,233 5.2% 5 Taiwan 16,007 5.6% 27,212 7.2% 5,022 1.4% 7 China 5,600 1.9% 27,500 97,500 27.6% 1 Malaysia 5,280 1.8% 17,368 4.6% 13,161 3.7% 6 S. Korea 6,795 2.4% 15,241 4.0% 20,244 5.7% 4 Source: Reed Electronics Research, Yearbook of World Electronics Data

Taiwanese companies: key link in PC industry globalization Manufacturing #1 makers of notebook PCs, motherboards, scanners, keyboards, add-on cards, optical drives, monitors, some network equipment. Driving shift of production to China. New product development Original design manufacturers (ODMs) develop over half the world’s notebook PCs. Customers include all major PC vendors. Taiwan’s manufacturers have led the world in many categories of hardware production since the 1990s. In recent years they have shifted most of their production to China to cut costs under pressure from their brand name customers (Dell, HP, Apple, Sony et al). They also have moved upstream and downstream in the value chain, taking over component production, new product development, manufacturing and even warranty support. In the notebook PC industry, Taiwanese ODMs are responsible for the majority of new product development, capturing knowledge work that used to be done by U.S. companies in the U.S. To understand the division of labor between US firms and their Taiwanese suppliers, and across geographies, we look at the following overview of the new product development process for notebook PCs.

Taiwan’s top notebook ODMs Name 2003 volume (thousands) Major OEM partners 1. Quanta 8,500 Gateway, Dell, HP, IBM, Apple, Sharp, Sony, Fujitsu-Siemens (F/S) 2. Compal 6,000 Dell, HP, F/S Toshiba, Acer 3. Wistron 2,500 IBM, Dell, Acer, Hitachi, F/S 4. Inventa 1,800 HP, Toshiba 5. Arima 1,500 NEC, Gateway 6. FIC NEC, Legend 7. Asus Epson, Canon, Sony, Apple, Trigem 8. Mitac 1,100 Sharp, F/S, NEC, JVC 9. Uniwill 1,000 Clone, F/S, Actebis, Samsung 10. ECS Apple Total 23,900 Source: Taiwan Ministry of Economic Affairs, 2003 (table provided to authors)

Notebook NPD process New product development is highly modular Three major stages: design, development, production. Each requires different skills, favoring firms and locations with those skills. There are linkages or interdependencies among those stages that influence where the process can be handed off between firms or locations. New product development is highly modular

Interdependencies Concept design and product planning are linked by need to translate technology and market trends into specific product designs. Design and development can be separated organizationally and geographically. Product plans are codified and can be handed off. Development and manufacturing are closely linked by need for manufacturability. There is a strong link between the two design phases (concept and product planning), which require tacit knowledge and iterative processes to go from general market and technology goals to specific product designs. Between the design stage and physical development (next three phases), there is a natural hand-off point (to use Tim Sturgeon’s terminology), as the product plan is codified into design language and specifications. Then, there is a strong link between development and production, as manufacturability is critical to a viable notebook PC design. In fact, products are often developed with a specific assembly plant, with specific processes, in mind.

Organizational forms Notebook NPD follows three patterns Inhouse design/development by PC company (Lenovo, Toshiba). Joint design/development – (Dell, HP) : PC maker does design, ODM does development and mfg. Pure ODM design – PC makers choose ODM designs off-the-shelf to sell. Share of global market: 20% in-house; 60% joint vendor/ODM; 20% pure ODM The result is that there are three organizational models for notebook design/development and manufacturing. One is vertically integrated, with design, development and manufacturing all done by the PC maker. Still the model for Lenovo (former IBM) Thinkpads, and Toshiba, although they use ODMs for low-end models. Second is joint development, which is the dominant model for branded PC vendors. Close collaboration with PC maker designing product and overseeing development. Third is pure ODM, used mostly by small PC makers who don’t have in-house capabilities, or by larger vendors to fill out product line when they don’t have time or resources for a new design.

Joint development model PC makers retain control of key decisions. Product management, marketing, brand image Architecture, standards, key components. Interact with Intel, MS, key component makers. Decide on specific product features ODMs Develop products to match their mfg. processes. Choose suppliers of many parts, components Responsible for quality, support

Location factors: skill and proximity Concept design and product planning. Skill in translating market and technology trends into product concepts. Analytical/managerial skills. Proximity to lead markets. Access to supplier innovation. Development Specialized engineering skills, e.g. board design, thermal, EMI, power management, materials, software. Hands-on skills. Production engineering and sustaining support Process engineering skills and proximity to production processes. Hands-on skills. The previous discussion explains the interfirm division of labor. Next we look at the geographic division of labor, starting with a discussion of the requirements of each major stage in the process, then looking at the capabilities of the U.S., Japan, Taiwan and China in those terms. Each stage requires specific skills (shown in slide). Design benefits from proximity to the sources of new technologies (e.g., semiconductors, displays, software) and the leading markets where those technologies are first adopted. Production engineering benefits from proximity to the assembly plant to work out production problems on-site.

Skills and costs by location Characteristics U.S./Japan: strong analytical and management skills, creative problem solving; leading markets Taiwan: specialized notebook competencies, strong hands-on but weaker analytical and management skills China: mixed engineering skills, gaining hands-on experience. Weak analytical, managerial and independent problem solving skills. Average base salary for electronic engineers U.S.: $82K Japan: $63K Taiwan: $20K China: $10K Focusing on those requirements, we can identify the strengths and weaknesses of the major centers of the notebook industry. Based on skills and proximity to technologies and markets, the US and Japan have dominated design, while most development is located in Taiwan. Production engineering is moving largely to China, as is sustaining engineering (supporting and upgrading products throughout their lifecycle). However, economic forces in the form of salary differentials create pressure to shift knowledge work to lower cost locations.

Production “pull” of NPD activities Testing equipment can be moved to production site for faster prototype testing. Pilot production at manufacturing site eliminates need for dual assembly lines. In addition, the benefits of proximity to production create a pull on upstream development processes. For instance, moving pilot production to the final assembly plant means there is no need to run a pilot assembly line. Then, if expensive testing equipment is moved to the production site, it is possible to speed up the iterative process of producing and testing prototypes. The overall need to achieve manufacturability of designs means it is beneficial to locate development and testing close to manufacturing. Need for manufacturability links development & production.

Shifting location of NPD activities Design Development Mfg. Concept Product planning Design review Proto- type Pilot Prod. Mass Sust. support 2003 United States Japan Taiwan China Concept Product planning Design review Proto- type Pilot Prod. Mass Sust. support The impact of economic forces and production pull are leading to a geographical realignment of the new product development process. Based on interviews with ODMs, PC makers and industry analysts in Taiwan and China, we see a significant shift of knowledge work just from 2003 to 2006. China is moving upstream to the development stage. Taiwan retains development for more valuable products and the latest technologies. Development shifts out of Japan as Toshiba and IBM/Lenovo use more ODMs and develop internal capabilities in China. Interestingly, the U.S. is less affected as it retains its role in defining product architectures, product management, marketing and branding. However, firms such as Dell and HP have set up design centers in Taiwan to take over coordination of ODMs. 2006 United States Japan Taiwan China

China’s role in NPD Solve problems related to production process. Sustaining support for existing products while new product teams move on. Taking over pilot production and testing, likely to move to prototype and design review in some cases. Made by Taiwan in China.

Implications for developing countries Production = game over? Landed cost more important than labor cost. Assembly close to major markets – Mexico, E. Euro Production close to use = new game. Operations – localization, IT, BPO, call centers Requires low cost, skilled labor and project managers Innovation – NPD in software, hardware, content Requires high skilled professionals, entrepreneurs, patient capital Multiplier effect for support jobs Investment for upgrading Education, R&D, technology alliances, market data

Impacts of China Availability and cost of engineering talent can’t be ignored. Experience will provide hands-on skills and work out cross-cultural management issues. Biggest impact on Taiwan and Japan as development moves. U.S. has lost this already. China will only take over concept design stages if it becomes a leading market and source of innovation.

Global knowledge networks Global production networks are well known and studied. Global knowledge networks overlay these production networks for coordination, but they also extend beyond for innovation. Innovation occurs at the edges of value networks: R&D labs, universities, upstream suppliers, customers in vertical markets. Knowledge and innovation no longer concentrated in a few countries, but widely distributed. Firms create competitive advantage through organization of knowledge networks as well as production networks.