Early Indications - August 2007
China's Changing Role in the Tech Sector
At base, technological change and globalization cannot be cleanly distinguished, and thus will be interlinked for the foreseeable future. The shipping container is arguably one of the five great breakthroughs of the twentieth century. Cellular telephony's evolution of participation, the impact of voice over IP on international calling, offshore call centers and code factories, price transparency, and many more facts of global life originated in a lab or startup.
Given that China's rapid growth and wide impact have become essentially synonymous with globalization, it makes sense to examine the current state of the tech industry relative to this awakening giant. Worldwide interest in the question has been on the upswing, prompted by two developments: the acquisition by Lenovo of IBM's PC operation, and Apple's reasonably prominent branding of the iPod's Chinese manufacturing. More recently, the UK's Mail on Sunday newspaper ran a critical story in June 2006 on the Chinese factories from where the devices originate. Since then, attention has been focused on wages, working conditions, and the business models behind the influx of Chinese-made devices and components. (A bibliography appears at the end.)
James Fallows, who writes for The Atlantic Monthly, recently reported from Shenzhen, the port city home to the contract manufacturing factory linked to Apple. One theme that reappears throughout the article is Fallows' amazement at the scale of Chinese activity:
-The port of Shenzhen and Hong Kong (only about thirty miles away) dispatched 40 million cargo containers, or the equivalent of one per second, in a calendar year. (The U.S. exports that return to China in those containers consist primarily of scrap paper and scrap metal, along with empty containers.)
-Shenzhen is a planned city that twenty-five years ago was a fishing town of maybe 75,000 citizens. It is now bigger than New York, having grown 100-fold, or more, in twenty-five years.
-At the Foxconn manufacturing plant, a vast number of employees work twelve hour shifts turning out all manner of electronic goods: the precise number is not made public or perhaps known, but estimates range between 200,000 and 300,000 people, many of them young women from the countryside who have migrated to the factory. The facility serves 150,000 lunches per day.
At the macro level, the impact of Chinese exports on the global economy appear to be mostly anecdotal and probably overstated. In selected markets, however, China's combination of low wages and manufacturing scale has driven prices lower in much of the rest of the world. A famous example is bicycles, but for our purpose, the low prices of many advanced items -- including cell phones, laptop computers, cameras, some medical devices, and electronics equipment in general -- derive in part from China's impact on the industry. That is, the availability of such items as Motorola Razrs for (apparently) free and laptop computers for $500 and potentially $100 owes as much to China's economics as it does to Dell's direct business model or Moore's law.
The companies driving this transition are, for the most part, not household names. The electronics manufacturing services (EMS) industry, formerly known as contract manufacturing, is itself only about ten to fifteen years old, but growing about twenty percent per year. In the mid-1990s, Nokia, Cisco, Sony, and other major brands began exiting the manufacturing business, leaving it in the hands of such companies as Solectron, Flextronics, and Jabil.
The largest current EMS, Hon Hai Precision, is the parent of Foxconn. It is expected to grow from $40 billion to $54 billion in revenues this year after having grown forty-four percent in 2006. The founder, Terry Gou, is a native of Taiwan worth $10 billion, according to the Wall Street Journal; he does not appear on Forbes Magazine's list of the world's richest people, where he would rank in the top sixty-five on the list. Hon Hai, a publicly traded company, is China's largest exporter.
As EMS companies seek to increase margins and avoid commoditization, they take on more upfront work, moving toward becoming so-called Original Design Manufacturers (ODM). A quick quiz: what do Quanta, Compal, Inventec, Wistron, and Asustek do? According to Fallows, they collectively account for ninety percent of global production of laptop computers; at one factory, he saw machines from three different major brands coming off the same assembly line. As a quick check of these companies' Web sites illustrates, many laptops we might associate with HP, Dell, or other major brands began life in one of these Asian firms, which broadly speaking are higher in the food chain than EMS companies.
The final step up the margin ladder is for a manufacturer to design, make, and label its own offerings for market, as an Original Brand Manufacturer (OBM). Brand is in fact a major story at Lenovo, formerly the Chinese Legend PC firm, which bought the IBM business in 2005. The company's marketing is focusing heavily on sporting events, with Olympic sponsorship at both the Turin and Beijing games. Lenovo's story is fascinating: the CEO, Bill Amelio, is an American with a Karate black belt hired away from Dell, while the chairman, Yang Yuanqing, is Chinese. The company's ownership is split among public shareholders (thirty-five percent), the state-run Chinese Academy of Sciences (the original investor in Legend at twenty-seven percent), employees, IBM, and private equity firms. Lenovo sells in sixty-six countries and recently announced plans to open factories in India and Mexico, the better to shorten supply chains and thus accelerate inventory flow.
Lenovo's headquarters moved from Beijing to Raleigh, North Carolina shortly after the IBM transaction, but Amelio lives in Singapore. The culture of the company is in flux as Chinese managers take courses in directness and accountability and IBM, Legend, and Dell habits are sorted out. The legacy IBM business, meanwhile, is being upgraded with investments in IT, R&D (moved increasingly to China from the U.S.), and supply chain. With 8.3 percent global market share, the company ranks third worldwide in PC shipments, barely ahead of Acer and lagging HP (19.3) and Dell (16.1). Competition is intense: Dell recently invested $16 billion in one year in Chinese capacity, more than Lenovo's entire revenues. Lenovo has responded by cutting costs, including laying off 1,400 employees announced earlier this year, and by reinventing its channel model outside China.
While the whole world is watching to see how Lenovo fares as China's first global brand, another company from the other side of the ocean is trying to create a hybrid Chinese-American firm. 3Com has had a wild ride in its nearly thirty years of existence. After being co-founded by Ethernet inventor Bob Metcalfe in 1979, the company sold a variety of networking equipment including interface cards, and attempted several consumer plays including USRobotics (modems) and its subsidiary Palm Computing that were later spun out, as well as the Kerbango Internet radio that never came to market and the Audrey Internet appliance, which lasted less than a year.
In 2003 3Com formed a joint venture with Huawei, now an $8 billion company of 62,000 employees that sells networking gear primarily to telecom operators. Earlier this year, 3Com bought back Huawei's stake for $882 million in the JV, now known as H3C. Total headcount in the company is now heavily weighted toward Asia (5,000, mostly in China) with about 1,200 employees still in the U.S. The company now enjoys a similar R&D situation to Lenovo, in that engineers are about one-fifth as expensive in China as in the U.S., so investment can go a lot farther. 3Com also will encounter some of the cultural issues that slowed Lenovo after the IBM acquisition, but like Lenovo gained global scale via a trans-Pacific deal.
So what's the overall picture? Software creation is generally a non-issue, except domestically, where the Baidu search engine has had some success and Lenovo has introduced some functionality specific to the home market. Chinese firms have proven they can build electronics to order, and build from original designs in certain segments. Quality control and material provenance remain problematic. Lenovo has proven it can sell lots of PCs in its home market and that spending lots of money can build a brand. Unlike India, China has not produced a generation of globally prominent managers and executives, with the exception of Lenovo's Yanqing.
The dominant business model of China's role in the global technology industry, however, is probably still represented by a man James Fallows calls "Mr. China," an Irishman named Liam Casey. Casey runs PCH China Solutions, a firm built up from Casey's personally-acquired Rolodex of factory locations, contract outcomes, manufacturing capabilities, roads, and many other factors. If someone needs a widget built, Casey is likely to know who can build it, who has capacity, who can supply appropriate materials, and how much it should cost. For outsiders entering the country, as they are in droves, such knowledge can be found only with informed intermediaries like Casey; as Fallows notes, "foreigners don't know where to start or whom to deal with in the chaos of small, indistinguishable firms."
The rapid growth, corruption, and lack of supply chain transparency have led to predictable consequences, as when Mattel could not name its suppliers of tainted toys until long after lead was discovered. Pollution, the classic externality, is fast becoming a front-burner issue, and could play a dramatic role in the Beijing Olympics. Working conditions don't measure up to western standards, but at the same time, China's industrialization has alleviated severe issues of rural poverty. Furthermore, the process is probably safer and more humane than what weavers experienced in Manchester, spinners encountered in the Carolinas, or early auto workers persevered through in Flint. To some extent, comparing historical examples of industrial misery is an apples-and-oranges exercise, but it serves to remind us that any judgment of these conditions is relative, and for better and worse, Chinese factory workers are generally better off than they were on a farm. The various winners and losers remain to be fully sorted
out, but China's emergence will continue to reshape many aspects of the global order.
"Bold fusion; Face value," The Economist, Feb. 17, 2007, p. 74.
Steve Hamm and Dexter Roberts, "China's First Global Capitalist,"
Business Week, Dec. 11, 2006.
James Fallows, "China makes, the world takes," Atlantic Monthly,
July-August 2007, p. 48.
Jane Spencer, "Lenovo Looks to Expand Global Reach," Wall Street
Journal, July 27, 2007, p. B4.
Jason Dean, "The Forbidden City of Terry Gou," Wall Street Journal,
August 11, 2007, p. A1.
"The stark reality of iPod's Chinese factories," The Mail on Sunday,
August 18, 2006.