Recovering from Success: Innovation and Technology Management in Japan

RECOVERING FROM SUCCESS

This page intentionally left blank

RECOVERING FROM SUCCESS Innovation and Technology Management in Japan Edited by D. HUGH WHITTAKER Doshisha University

ROBERT E. COLE Doshisha University/UC Berkeley

1

3

Great Clarendon Street, Oxford ox2 6dp Oxford University Press is a department of the University of Oxford. It furthers the University’s objective of excellence in research, scholarship, and education by publishing worldwide in Oxford New York Auckland Cape Town Dar es Salaam Hong Kong Karachi Kuala Lumpur Madrid Melbourne Mexico City Nairobi New Delhi Shanghai Taipei Toronto With offices in Argentina Austria Brazil Chile Czech Republic France Greece Guatemala Hungary Italy Japan Poland Portugal Singapore South Korea Switzerland Thailand Turkey Ukraine Vietnam Oxford is a registered trade mark of Oxford University Press in the UK and in certain other countries Published in the United States by Oxford University Press Inc., New York ß Oxford University Press 2006 The moral rights of the authors have been asserted Database right Oxford University Press (maker) First published 2006 All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted, in any form or by any means, without the prior permission in writing of Oxford University Press, or as expressly permitted by law, or under terms agreed with the appropriate reprographics rights organization. Enquiries concerning reproduction outside the scope of the above should be sent to the Rights Department, Oxford University Press, at the address above You must not circulate this book in any other binding or cover and you must impose the same condition on any acquirer British Library Cataloguing in Publication Data Data available Library of Congress Cataloging in Publication Data Recovering form success: innovation and technology management in Japan/edited by D. Hugh Whittaker, Robert E. Cole. p. cm. Includes bibliographical references and index. 1. Technological innovations–Japan–Management. 2. Industrial management–Japan. I. Whittaker, D. H. (D. Hugh) II. Cole, Robert E. HD70. J3R435 2006 338. 0640952–dc22 2006007846 Typeset by SPI Publisher Services, Pondicherry, India Printed in Great Britain on acid-free paper by Biddles Ltd., King’s Lynn, Norfolk ISBN 0–19–929731–2 978–0–19–929731–3 ISBN 0–19–929732–0 (Pbk.) 978–0–19–929732–0 (Pbk.) 1 3 5 7 9 10 8 6 4 2

Contents

List of figures and tables List of contributors Acknowledgements 1

Introduction Robert E. Cole and D. Hugh Whittaker

Part 1: 2

Industries, technologies, and value chains

The telecommunication industry: A turnaround in Japan’s global presence Robert E. Cole

3

Modular production’s impact on Japan’s electronics industry Timothy J. Sturgeon

4

Technology management and competitiveness in the Japanese semiconductor industry Takashi Yunogami

5

Global value chains in the pharmaceutical industry Jocelyn Probert

6

Software’s hidden challenges Robert E. Cole

Part 2: 7

MOT in and between enterprises

The open innovation model: Implications for innovation in Japan Henry W. Chesbrough

vii ix xi 1

29

31 47

70 87 105

127

129

8

Managing creativity and control of knowledge workers Clair Brown

145

9

Rethinking innovation Eiichi Yamaguchi

166

v

Contents 10

‘Microbursts’ of knowledge and creative work in Japan Philippe Byosiere

184

11

Hitachi’s nascent ‘new production(ist)’ system D. H. Whittaker

199

12

Interfirm networks and the management of technology and innovation in Japan James R. Lincoln

Part 3:

Transforming Japan’s innovation system

215

235

13

Innovation policy for Japan in a new era Tateo Arimoto

237

14

Security and techno-systems: A comparative analysis Yuzo Murayama

255

15

Technology management training in Japan: Government initiatives and their effects Atsushi Kaneko, Yoshi-fumi Nakata and Muneaki Yokoyama

271

Electronic government in Japan: Towards harmony between technology solutions and administrative systems Toshiro Kita

286

16

17

Conclusions and reflections: Emergent models D. Hugh Whittaker and Robert E. Cole

Index

vi

298 321

List of figures and tables

Figures 1.1 2.1 4.1 4.2 4.3 4.4 4.5 4.6 4.7 5.1 6.1 6.2 6.3 9.1 9.2 9.3 9.4 9.5 10.1 10.2 11.1 11.2 13.1 13.2 13.3 13.4 13.5

Evolution of the semiconductor industry Japan’s trade balance in telecommunications equipment Changing DRAM share by country Japanese computer shipments Three phases of wafer process technology Superior etching technology Technology and quality Quality and yield Two evaluation axes of technology Value chain fragmentation options International comparison of rate of introduction of IT-related applications Proportion of Japanese and US companies that found their IT investment effective Measures by Japanese and US companies to optimize effectiveness of IT investment Paradigm disruptive innovation and performance disruptive innovation Innovation process for the blue light emitting diode The number of published papers vs. the number of researchers with PhDs in 1999 Trends in academic papers by year Academic papers and company value Decline in R&D efficiency in manufacturing industry Degree of satisfaction with treatment by researchers ‘Inspire A’ businesses (Stage 2) Monozukuri, MOT, and corporate management (Stage 3) Projected population decrease in Japan Projected decrease of researchers Convergence of disciplines The pipeline and the tree: a new framework for training and career development in the natural sciences Universities, society, and S&T in the 21st century

12 32 71 73 75 75 77 79 81 88 113 115 121 169 173 177 178 179 190 192 207 210 240 241 242 244 246

vii

List of figures and tables 13.6 16.1 16.2 16.3 17.1

Innovation system for Japan after catch-up Configuration of the Juki-net Configuration of the Juki-card ‘C2G2B’ service model Dual innovation system

250 288 289 294 304

Tables 1.1 ICT equipment exports, 1990–2000 1.2 LCD firm’s average profitability by national site, Q1 2004 3.1 Net income (loss) of the ten largest Japanese electronics firms, 1996–2004 3.2 Examples of recent and planned electronics factory investments in Japan 3.3 Examples of recent restructuring in the Japanese electronics industry 5.1 Changes in the domestic landscape, 1992–2002: An increasing Western presence 5.2 Selected consolidation moves in the Japanese pharmaceutical market 6.1 Ways of building information systems 8.1 Time spent working in a team and independently 8.2 Training by current employer 8.3 Importance of sources of technical information 8.4 Channels of technical information acquisition from other semiconductor companies 8.5 Sources of knowledge to solve a specific technical problem 11.1 Corporate senior staff (2001–03) (Stage1) 12.1 Denso’s share of Toyota’s total inputs of selected electronic parts by year 15.1 Management skills for MOT 15.2 Types and characteristics of MOT programmes in the US and Europe 15.3 Types and characteristics of MOT programmes in Japan 17.1 Open and closed innovation orientations

viii

4 7 54 57 59 96 97 112 151 151 153 155 156 203 226 275 277 283 304

List of contributors

Tateo Arimoto is Executive Research Fellow at the Economic and Social Research Institute, Cabinet Office, Japanese Government, and Visiting Professor at the Tokyo University of Science. Clair Brown is Professor of Economics and the head of the Center for Work, Technology, and Society at the Institute of Industrial Relations, University of California, Berkeley, as well as Omron Fellow and Visiting Professor of Graduate School of Policy and Management at Doshisha University, Kyoto. Philippe Byosiere is Professor at Doshisha Business School and Faculty Research Fellow at the Institute for Technology, Enterprise and Competitiveness (ITEC), Doshisha University, Kyoto. Henry Chesbrough is Lecturer and Executive Director at the Center for Open Innovation, Institute of Management, Innovation & Organization and Management of Technology Program at the University of California, Berkeley. Robert E. Cole is Omron Distinguished Professor, Doshisha Business School, Kyoto, Professor Emeritus, Haas School of Business and Department of Sociology, as well as Co-Director of Management of Technology Program, Haas School of Business and College of Engineering at the University of California, Berkeley. Atsushi Kaneko is Chief Consultant of the MOT Project Office and General Manager of the Learning Innovation Department at Mitsubishi Research Institute, Inc, Tokyo. Toshiro Kita is Professor at Doshisha Business School and Faculty Research Fellow at the Institute for Technology, Enterprise and Competitiveness (ITEC), Doshisha University, Kyoto. James Lincoln is Warren E. and Carol Spieker Professor at the Haas School of Business, University of California, Berkeley, and Omron Fellow and Visiting Professor of the Graduate School of Policy and Management at Doshisha University, Kyoto. Yuzo Murayama is Professor at Doshisha Business School and Faculty Research Fellow at the Institute for Technology, Enterprise and Competitiveness (ITEC), Doshisha University, Kyoto.

ix

List of contributors Yoshi-fumi Nakata is Professor at Doshisha Business School and Graduate School of Policy and Management, and 21st Century Centre of Excellence Programme Leader at the Institute for Technology, Enterprise and Competitiveness (ITEC), Doshisha University, Kyoto. Jocelyn Probert is Lecturer at Birmingham Business School, and Visiting Research Fellow at the Institute for Technology, Enterprise and Competitiveness (ITEC), Doshisha University, Kyoto. Timothy Sturgeon is Senior Research Affiliate at the Industrial Performance Centre, MIT, and Visiting Research Fellow at the Institute for Technology, Enterprise and Competitiveness (ITEC), Doshisha University, Kyoto. D. Hugh Whittaker is Professor at Doshisha Business School and Director of the Institute for Technology, Enterprise and Competitiveness (ITEC), Doshisha University, Kyoto. Eiichi Yamaguchi is Professor at Doshisha Business School, Deputy Director of the Institute for Technology, Enterprise and Competitiveness (ITEC), Doshisha University, Kyoto, and Executive Vice President of Powdec KK. Muneaki Yokoyama is Consultant of the MOT Project Office at the Learning Innovation Department at Mitsubishi Research Institute, Inc., Tokyo. Takashi Yunogami is Research Fellow of the Institute for Technology, Enterprise and Competitiveness (ITEC), Doshisha University, Kyoto, and Visiting Professor at Nagaoka University of Technology, Niigata.

x

Acknowledgements

This book grew out of our experiences in setting up a new business school, a new research institute, and developing executive education programmes in technology management (MOT) at Doshisha University, Kyoto. On the one hand, these experiences gave us insights into the changing institutional framework of innovation in Japan, especially the role of universities, and the challenges currently facing Japanese technology companies. One the other hand, they forced us to question our assumptions about business education, the goals and nature of technology management, and a host of related issues such as labour mobility and the encouragement of spin-offs, which were to some extent influenced by practices and debates in the US and Europe. Consequently we sought contributors who were involved in the emerging MOT and innovation framework and/or who held perspectives which might shed light on it. We are most deeply indebted to the participants of MOT seminars, especially TBI (Technological Business Innovation) at Keihanna, who provided a ‘reality check’ for our ideas and contributed ideas of their own. Ronald Dore did likewise, and we appreciate his support, as well as that of ITEC COE Project Leader Yoshi-fumi Nakata. We are grateful, too, to Miles Dodd, Tom Cole, and the staff of ITEC, especially Makiko Kawasaki, for their help in preparing the manuscript. Ministry of Education, Culture, Sports, Science and Technology (MEXT) financial support through the 21st Century Centre of Excellence Programme is gratefully acknowledged, as is support from the New Energy and Industrial Technology Development Organization (NEDO), and from the Omron Corporation benefaction, which helped to launch many of the initiatives at Doshisha University and funded Robert Cole’s Chair. Finally, we would especially like to thank our colleague, Philippe Byosiere, who came up with the original idea to have Doshisha faculty do a book on management of technology and helped us at various points to accomplish the project.

xi

This page intentionally left blank

1 Introduction Robert E. Cole and D. Hugh Whittaker

Japan is a prolific importer and creator of acronyms. Around 2002 a new acronym spread throughout industry and the business media: MOT–management of technology–was heralded as a cure to Japan’s ‘lost decade’ tribulations and was seen as a means of rehabilitating the Japanese economy to face the 21st century. That the meaning of MOT was vague only served to heighten interest and debate. Some observers reacted with skepticism, dismissing MOT as another here today–gone tomorrow fad, or as a US import which would not work in Japan. Others, however, felt that it gave expression and conceptual coherence to emergent changes which had taken place during the ‘lost decade’, and that its transformative potential should not be under-estimated. We have chosen to edit this book which is broadly about MOT because a) it offers an excellent prism or vantage point to observe challenges to Japan’s previously successful innovation model and how that model is undergoing change; b) even fads can have lasting and unpredicted consequences, as happened in the quality movement in the US in the 1980s and early 1990s; and c) MOT has been used as a lever to try to engineer changes to Japan’s innovation system, and these attempts and the vision behind them are noteworthy. This book is not, however, a systematic exposition of MOT practices in Japan. ‘Innovation’ in the title signals our broader interest in the Japanese macro-level innovation system, as well as corporate level innovation and technology management. We see the hitherto successful Japanese model of innovation facing new challenges from the mid-1990s. The first challenge is that other countries began to emulate aspects of the successful Japanese model and were able to shrink the productivity and quality gap. The second is that new competitive models undermined some of Japan’s advantages in a number of industries, notably information and communication technology (ICT). These two challenges, in turn, exposed previously hidden weaknesses in the Japanese innovation system and corporate level technology management. Thus, there are the two major sets of (external) challenges which we highlight through our MOT prism; emulation and new business models.1 We ask how the

1

Recovering from success challenges were perceived, the responses, and the significance of the responses. Are Japan’s technology champions destined to adopt the US model(s), either partially or substantially, or will they plot a new path, or indeed decline without effectively addressing the challenges? Is the national innovation system being reshaped, with higher education incorporated, for instance, as has been the case in the US? Are the levers of industrial policy changing, and if so, how? In terms of sectoral coverage, we are necessarily selective. We focus on the industries most directly challenged by the resurgent US. We do not cover, on the one hand, the highly successful automobile industry or emerging strengths like functional materials or, on the other hand, industries in the sheltered sector, which do not face open, global competition. Our focus is rather on the ICT sector defined broadly to include electronics as well as pharmaceuticals. This selective approach may annoy some readers, but a systematic exposition of MOT in a broad range of industries would mean a fundamentally different book. Instead, we offer pithy ‘snapshot’ chapters which illuminate aspects of the challenge and response–or would-be response–theme we outlined above. In doing so, we seek to move beyond the ‘lost decade,’ which has been the preoccupation of much writing about Japan in recent years, to consider the potential for corporate and economic renewal in the early 21st century. There are recent signs of renewal, but how far will they take Japan? Can one expect another role reversal with the US, or has the global competitive environment changed too much relative to Japan’s capabilities? By way of clarification, technology management is a comprehensive approach to how firms can capture value from technology, involving not just technological capabilities, but business and organizational factors as well. In the broadest sense of MOT, firms are supported or supplemented in their attempts to capture value by a range of other actors and institutions, including universities, research institutes, government agencies, and venture capital firms. These all fall within the scope of interest of this book. Different combinations of technological capabilities, business models, and organizational architectures and skill sets are required for success in different industries. The remainder of the Introduction examines the emulation and new business model challenges, and the MOT boom, or ‘fad,’ as a response. Having set the scene, we then provide a brief synopsis of the chapters which follow. Our assessment is left to the Conclusions.

The challenges The ‘Japanese model’ which so dazzled the world in the 1980s fell into disrepute in the 1990s. The model was constructed on a succession of manufacturing industries which became fiercely competitive on the world stage and

2

Introduction demonstrated rising levels of technological sophistication as well as innovative practices, which combined efficiency and continuous improvement in cost competitiveness and quality.2 This productionist model was based on intense exchange and circulation of design information throughout the firm along with decentralized decision making at the workshop level (Aoki 1988; Fujimoto 2004). Innovations in human resource management and subcontracting relations, not to mention patient capital, loaned further support to the productionist system. Scholars fiercely debated the significance of government policy, especially industrial policy, but it was generally considered constructive though exaggerated in some quarters. Odagiri and Goto (1993) analysed the key factors of the productionist system that brought great success to the Japanese in the 1980s. They stressed the importance of Japanese managers investing heavily in large R&D efforts, into making products efficiently, and incorporating the results swiftly and smoothly into manufacturing and marketing. They saw four factors as lying at the heart of Japan’s innovation system: 1 2 3 4

Bias to growth maximization (willingness to invest in technology) Familiarity of management with research, production, and marketing Close R&D–production–sales links Smooth transfer of new processes and products into production (Odagiri and Goto 1993: 109).

All four factors are in a narrow sense about the management of technology, though they are supported by a range of other factors, such as those mentioned above. The argument for the importance of Japanese management’s familiarity with research, production, and marketing was based on the fact that the largest proportion of company directors (who were full-time) came from production and technology departments. This was in contrast to the situation in the US and the UK where many directors are part-time outsiders, with a significant proportion of directors having an accounting and finance background. The backgrounds of Japanese managers and company directors were seen as enabling them to be particularly effective in managing technology (including being better able to evaluate outcomes from R&D and to having more favourable views of what R&D can contribute). However, Odagiri and Goto recognized education as a contributor to Japan’s system of innovation, primarily in terms of the education system’s ability to provide firms with well educated individuals who had generalized technical skills rather than in terms of its contribution to research. The university share of national R&D expenditure had declined, from 20 percent in 1978 to just 11.6 percent in 1990, and within this figure the proportion spent on basic R&D declined from 57.3 percent to 52.9 percent (Lee 1997).3 R&D expenditure per researcher at universities was less than half that in companies (Odagiri and

3

Recovering from success Goto 1993: 111). Such under-funding of Japanese educational R&D limited its contribution to economic growth. A depiction of the US innovation system in the same volume provides a stark contrast. Mowery and Rosenberg (1993) characterize core elements of the postwar US system as publicly funded (federal) R&D, representing two-thirds of basic research expenditure; growth of academic research; commercialization of technology through new firms; growing research collaboration between industry and universities; increasing exploitation of external sources of technology; and strengthening of enforcement of intellectual property. We shall explore later the extent to which Japanese leaders are seeking to adopt some elements of this model. Despite–or in some cases because of–its formidable strengths, Japan’s productionist system ran into trouble in the 1990s. The recession of the early 1990s could be ascribed at first to fallout from the bursting of the country’s massive asset bubble in 1990, and subsequently to woes in the financial sector. By the second half of the decade, however, problems were emerging in hitherto competitive manufacturing industries. Most immediately there were falling profits, declining market share, and in some major cases, especially among the large electronic makers, lots of red ink. From top position in 1989–93, Japan began to slide rapidly down IMD’s World Competitiveness Survey rankings. This was not due to a lack of R&D investment. On many key R&D indicators, such as per capita R&D expenditure, industrial R&D costs, and number of R&D personnel and patents issued, Japan was still ranked at or near the top. Yet many companies were having increasing difficulties in capturing the benefits of this investment. Table 1.1, for instance, shows the weak Japanese growth in key ICT sectors in 1995–2000 compared to those of the EU and the US. Reasons behind the difficulties were varied, some of them nation, industry, and firm specific.4 Many of them will be treated in subsequent chapters; here we focus on two of the largest drivers–emulation of Japanese best practices of Table 1.1 ICT equipment exports, 1990–2000 (value in millions of current US dollars and growth in percentages) Exports

1990

1995

2000

Average Annual Growth (2000/95)

Computer equipment

US Japan EU

23,005 18,584 40,119

34,476 29,521 66,460

54,685 27,558 94,131

9.7
1.4 7.2

Communication equipment

US Japan EU

4,063 5,614 9,541

10,933 6,904 26,440

20,680 8,106 69,179

13.6 3.3 21.2

Electronic component

US Japan EU

13,826 14,678 16,330

27,668 43,270 36,393

70,001 50,348 55,972

20.4 3.1 9.0

Source : OECD, ITS database, January 2002 (cited in Nezu 2002: 12)

4

Introduction the 1980s by Japan’s foreign competitors in the 1990s, and the transformation of global competition from being among large vertically integrated firms in many ICT industries to competition among networks of specialist firms. Examination of why the large Japanese producers had so much difficulty responding to these challenges leads to a discussion of adjustment difficulties and ‘large firm malaise’. Failure to respond strongly to these challenges in the context of falling profits, declining market share with still high R&D investment in technology driven industries led to increasing self-doubt among Japanese corporate leaders and provided fertile ground for the emerging interest in MOT.

The emulation challenge Since the mid- to late 1980s, there has been widespread diffusion of critical elements in the Japanese design/manufacturing model sketched above. Some of the key elements that have diffused include practices making for shorter product development cycles; the importance of managing the handoff from design to manufacturing; management of suppliers; standardized work processes; continuous improvement; and an emphasis on quality. Asian tigers, Korea and Taiwan, have largely mastered these approaches in key sectors and, significantly for the future, Chinese firms in the PRC are in the process of mastering them; their progress has been strikingly faster than many Japanese firms anticipated. Not only have many of Japan’s new competitors emulated the Japanese model, but sometimes they have dramatically improved on it in ways that the Japanese have found difficult to follow (e.g., the Taiwanese development of the foundry model in semiconductors coupled with ‘fabless’ semiconductor designers around the world). Japanese capital spending was low for much of the 1990s. Without strong investment in new equipment and factories, many companies didn’t go far beyond their 1980s capabilities. The average age of manufacturing equipment in 2003 stood at 12 years (9.3 in 1991), compared to 7.9 for the United States (Nikkei Weekly, 15 Sept. 2003), and even lower in key growth industries in countries like Korea that have invested heavily in capital equipment. Korean manufacturers like Samsung have been particularly aggressive. It is not only Japan’s new East Asian competitors that have mastered or improved on the Japanese 1980s success formulas, but also its traditional competitors from the US and Europe have made giant strides in improving the quality of their products, optimizing supply chains (not just supplier relationships), reducing time to market, capitalizing on their skill in global standard setting (e.g., telecommunications), and so on. Nowhere is the progress of US firms more evident than in the global market for PCs. Dell, in particular, pioneered the build-to-order model for computers. The top three global market shares for PCs in 2003, totaling 39 percent, were held by the

5

Recovering from success American firms Dell, Hewlett-Packard, and IBM, with NEC standing at 3 percent and Fujitsu-Siemens at 4 percent (Nikkei Weekly, 2 Aug. 2004). Moreover, contract manufacturers (EMS firms) like Flextronics and Solectron have emerged which, by virtue of their specialization in manufacturing, also have been able to master the model. A key sector in which the Japanese lead in quality and R&D cycle times has been eliminated is in semiconductors (Leachman and Hodges 1996; Macher et al. 1998: 113–18; Leachman 2002). Intel’s ‘copy exactly’ strategy has been very effective for a firm with a limited product line focused in shrinking Wintel architecture (Microsoft software coupled with Intel chips) at regular time intervals. In the case of the foundries (contract fabrication plants) with a greater product mix a different solution was required. The Taiwanese creative solution was to integrate R&D into manufacturing. Thus, R&D tends to be done concurrently with manufacturing. To do so, the foundries invested heavily in upgrading their manufacturing engineering human capital. Korea’s Samsung was also effective in reducing R&D cycle times and co-locating design and manufacturing facilities. In both the semiconductor and computer cases, the improvement of the competitive position of Western competitors rested very much on the embrace of modular production enabling Western firms to take advantage of low cost Asian suppliers. One sector where US producers have made only modest incursions on Japanese performance advantages is the automotive sector. US firms reduced the quality differential in the 1980s, and the average performance differences between US and Japanese producers had narrowed on many measures by the mid-1990s. Since the late 1990s however the gap seems to be increasing once again between Toyota’s performance (e.g., product development lead time) and its American competitors (Fujimoto 1999: 220–1).5 As we shall see, however, the automobile industry is characterized by product architectures and organizational practices that distinguish it from many of the ICT sector firms. Moreover, not all Japanese auto manufacturers are doing so well. Japanese ICT firms have found it increasingly difficult to protect their intellectual property from other East Asian competitors. To take advantage of lower costs, they have somewhat reluctantly located many of their plants in China and other Asian locations. That has, however, made it easier for competitors to access the renowned Japanese process technology through hiring away skilled workers from these facilities. In key technologies such as LCD panels, moreover, the Koreans and the Taiwanese have been able to purchase the same advanced production machinery from Japanese and other equipment vendors. While the Japanese long-term employment system still makes it difficult for East Asian competitors to poach key technical personnel, some of those laid off in the late 1990s restructuring and retirees, including key managers, have found new employment with Korean, Taiwanese, and Chinese firms.

6

Introduction In the 2003 Nikkei Survey of global shares of 23 product categories (mostly IT products), Japanese firms maintained top ranking in several categories but continued to lose ground across a broad range of products. The Samsung Electronics Group was placed in the top five in seven of the 23 categories, with its share climbing in six of the seven. It took top rank in DRAMs and the flash memory market, the latter a technology first commercialized by Toshiba. In LCD panels (TFT LCD devices), LG Philips LCD (South Korea) and Samsung solidified their position as first and second ranked, while Sharp continued to loose market share (Nikkei Weekly, 2 Aug. 2004). In 2004, Samsung and LG jumped into first and second place for plasma panels, while Fujitsu-Hitachi Plasma Display plummeted to fourth (Nikkei shinbun, 19 July 2005). The Koreans have established a strong global position in cell phones, whereas the Japanese, despite world class technology, are limited mostly to the domestic market. Strong business models trumped strong technology. Even when the Japanese producers haven’t lost market share, they have often had to cut prices to meet other East Asian competitors’ prices so that profit margins have fallen substantially. In the case of memory chips, PCs, cell phones, digital cameras, and LCD panels, they have suffered losses in market share and have had to cut prices to survive. In these IT markets such reduction in profit margins makes it difficult to raise funds for the next product generation investment cycle. Nor are these short-term fluctuations. Japanese firms led by Sharp created the LCD industry. As late as 1997, there were 11 Japanese firms competing in one or more segments of this industry. Aggressive investment by Taiwanese and Korean manufacturers has forced most of them either to leave the industry or merge with domestic competitors. Japanese market share for the total LCD market fell from 62 percent in 1999 to 24 percent at the end of 2002.6 Table 1.2 shows the kinds of profit pressures being applied by Taiwanese and Koreans in the total LCD market. The great disparity in profitability has made it difficult

Table 1.2 LCD firm’s average profitability by national site, Q1 2004 (in millions of US dollars)

Revenue Profit Profitability

Japan: Sharp, Toshiba, Hitachi

Korea: Samsung, LG-Philips

Taiwan: AUO, CMO, CPT (TFT), GDI, Hannstar

2,668 143 5.4%

3,835 1,311 34.2%

3,261 845 25.9%

Note : Compared with Japan, South Korea is estimated to have 5% less R&D cost, 5% less salary cost, 10% less depreciation cost and the two major producers LG-Philips and Samsung pay respectively 7% and 30% as their effective tax rate compared to roughly 41% for large Japanese companies (Exchange rates calculated at $1¼1165.4 won, $1¼108 yen, $1¼33.965 NT$). Source : This table was prepared by Hirohisa Kawamoto, Nara Institute of Science and Technology based largely on data prepared by Masahiko Ishino, Senior Analyst, Mitsubishi Securities.

7

Recovering from success for Japanese firms to match the capital investment levels of their Asian competitors thereby jeopardizing their future in these technologies.

Rise of the specialist firm and the modularization challenge A second major development in the competitive environment has been the transformation of many ICT/electronics sectors from large vertically integrated firms with broad product lines to a network of specialist firms closely coordinating their value added activities. There are two major drivers for the rise of the specialist firms. One is the shift from integral architecture and closed proprietary standards to modular architectures with often open standards. The second is increasing recognition by managers that they can make breaks in the value added production chain that allow them to outsource parts of production. Most notable is the transformation of the computer and semiconductor industries and major parts of the telecommunication industry. These industries in varying degrees shifted, or are in the process of shifting, from either integral and/or closed technology standards to modular and/or open technology standards. Fujimoto Takahiro argues that Japan’s global competitive strength lies in industries like automotive with integral architecture and closed proprietary systems. Integral architecture requires exceedingly close coordination among product designers and external or internal production units, something at which the Japanese excel. In contrast, US firms tend to be more competitive in industries with modular architecture and open systems (Fujimoto et al. 2001; Fujimoto 2002: 23). The latter more often involve alliance strategies and systems integration at which US firms seem to excel. A brief introduction to integral and modular architectures is in order to grasp its competitive implications. Integral architecture has a set of common requirements that all components must share. Integral architecture allows for optimization, for example, of compactness and functionality in ways that make very attractive, but often expensive, products (such as Japanese mobile phones). Integral architectures can be said to appeal to the engineer’s desire for creativity. Modular architecture is based on separate modules operating as part of a system. Modules are units whose structural elements are powerfully connected among themselves and relatively weakly connected to elements in other units but nevertheless these units work well together in a larger system. Modularity provides flexibility by enabling firms to tailor a variety of products and service variations to better fit consumer needs (enabling mass customization). Modularization provides efficiency and speed. Components are interchangeable, providing plug and play compatibility. This in turn creates ease of use and variety for consumers. The components are also individually upgradeable, and thus innovation is less constrained by other parts of the system. Above all, the

8

Introduction component’s interface with the overall system is standardized; this provides the very premise for modularity (Baldwin and Clark 2000). These are valuable assets from both selected producers’ and consumers’ points of view and, as such, their competitive significance is profound. Japanese manufacturers’ weakness in modularized design (coupled with open systems) and production has put them at increasing competitive disadvantage in a number of key industries. There are some sectors where Japanese producers have embraced modular design and production with closed proprietary systems and thrived, such as selected machine tool manufacturers. However, while individual firms may thrive using this model, it does limit the number of complementary innovations produced by suppliers, since the competitive field is open only to selected suppliers. Modularity and the development of standardized interfaces are often coupled with the development of ‘open standards’ architecture. Open standards enable open systems by ensuring the spread of standardized design specifications to all possible industry participants, thereby lowering barriers to entry and increasing competition. One needs to distinguish between modularization in design, modularization in manufacturing, and modularization in use. Much of the scholarly literature is about modularization in design, and the assumption is that modularization in design precedes modularization in the manufacturing process. This is indeed the way the process evolved in the computer industry. In some industries, however–automotive is one example–there is a great deal of ongoing modularization in manufacturing, especially in Europe, but not as much in design. This means that even with an integral architecture, firms find ways to make a logical cut in the production chain where they can outsource a given system, such as an auto seating system or cockpit design. Typically this occurs in areas where design standards have been formalized.

The computer industry The Japanese high point in computer sales in worldwide markets in the early 1980s was associated with their overtaking of IBM in its mainframe business. Yet at the very moment this was occurring, fundamental changes were occurring in American mainframe architecture. Until the mid-1960s, mainframe computer design was based on an integral/closed computer architecture. Change came with the release of the hugely popular IBM System/360 in 1964. While still based on a closed proprietary design, the IBM/360 was the first truly modular design architecture. New subindustries emerged (e.g., computer storage devices, computer peripheral devices, and computer programming services) which did not make the whole computer system, but rather made parts or provided services–modules–for the larger computer system. In the era of the IBM System/360 series, they were ‘plug compatible’ with IBM

9

Recovering from success equipment. As modular designs spread throughout the industry, first in mainframes and then in portable computers, ‘the industry changed from being a virtual monopoly to a very large modular cluster’ where economic power was a function of control over critical modules (Baldwin and Clark 2000: 6–18). Japanese computer producers failed to embrace the modularization of the industry and for a long time continued on their own path (as did many US firms that are no longer with us, like Burroughs and, later, DEC). This meant a forgoing of the benefits of specialization and the network alliances and geographically distributed production chains that it made possible. Dell Computer exemplified an embrace of modularity. It developed deep logistic capabilities to coordinate its various partners, enabling optimization of its direct sales and build-to-order business model. The efficiency and cost competitiveness of this model, based on modularly designed and manufactured products, has yet to be matched by Japanese firms.

The semiconductor industry The semiconductor industry provides the foundational building blocks for the computer industry as well as other electronics-based industries, not to mention its strong impact on a wide variety of other industries such as automotive, retail, and finance. Japanese manufactuers rose to worldwide prominence in the mid-1980s by capturing larger and larger shares of the memory device market–DRAMs. The very strength of the Japanese in low margin DRAMs pushed many of their US competitors into logic devices, ‘mixed signal’, and other digital signal processes that allowed them to exploit their strengths in product innovation.7 These new emphases, and the aforementioned ability of American firms to emulate the success of their Japanese competitors in quality and process management, provided the basis for the strong American retaking of worldwide semiconductor market sales at the same time that Japanese manufacturers were succumbing to new competition in DRAMs from the Koreans, Taiwanese, and US-based Micron Technology. To understand developments in this industry, one needs to consider broader developments that have shaped the recent evolution of the electronics industry. First, in the US starting in the early 1990s, partly in response to Japanese competitive pressures, American manufacturing firms started to outsource a variety of those functions they decided were not part of their central mission and which could be done more efficiently and to a high quality elsewhere. This movement had its intellectual rationalization in the framework of core competencies developed by Prahalad and Hamel (1990). Firms were encouraged to identify and develop their core competencies and then to consider outsourcing those activities that didn’t fall into the inner core. The movement spread and contributed to the rise of many new specialist firms in a variety of industries.

10

Introduction The seminal development that contributed to the breakup of the organizational structure of the semiconductor industry (the Integrated Device Makers or IDMs), however, was the rise of the foundry model. ‘Fabless’ semiconductor firms, mostly located in the US and specializing in design, linked with Asian foundries (Taiwanese producers dominate this group) specializing in manufacturing. These foundries at the end of 2002 accounted for some 16 percent of all chips produced, and they were the fastest growing segment of the industry. Fabless semiconductor firms are concentrated in computer and telecommunications and are able to offer more innovative designs (as long as they meet the specifications of the Asian foundries) with shorter delivery times than the extant merchant semiconductor firms (Macher et al. 1998: 119–20). This development is linked to the source of much of American innovation being concentrated in start-up companies. Those start-up companies whose expertise was chip design were unable to afford the huge costs associated with building manufacturing capabilities. Thus, the rise of the foundries created the basis for a marriage that led to an alternative organizational architecture for the industry.8 More generally, the 1990s witnessed a growing reliance of firms in the US semiconductor industry on collaborative strategies among networks of specialist firms. These networks are both vertical–linking suppliers and OEMs–and horizontal–linking OEMs with one another–and have stretched across national borders. The spread of creative alliance and partnership models allows specialized firms to compete with integrated producers. They create economic networks that offer customers the virtues of specialization combined with the offerings of variety (Kogut 2000). Figure 1.1 depicts the growing specialization of the worldwide semiconductor industry.9 Up to the mid-1980s, the IDMs were the dominant organizational form for chip makers. The 1990s saw the rise of the fabless/foundry model just discussed. By the late 1990s new firms specializing in contract assembly, packaging, and testing had entered. We are also witnessing further vertical disintegration, with system design separating from chip design (Qualcomm is moving in this direction) and the rise of specialized intellectual property firms (such as Rambus). It has now become more common to license reusable design components (Intellectual Property (IP) blocks); specialized software firms producing automated chip design (Synopsis) have emerged. Corporate leaders in the Japanese semiconductor industry were slow to act upon these developments. The Japanese semiconductor operations were typically divisions or subsidiaries of large diversified electrical equipment firms. Compared with nimble, specialized firms, especially start-ups, they were slower to make decisions. Only with huge mounting losses did they exit DRAMs in the very late 1990s and early 2000s, leaving one fledgling national champion, Elpida, a joint venture between Hitachi and NEC. Until very recently they had very broad product lines, with each producer more or less

11

Recovering from success Specialized chip and process suppliers license and re-use design components (IP blocks)

Integrated chip company Modified chip company

Chip design

Chip design

Chip design

Chip design

System design

Intellectual property

Chip design

System design Chip design

Design services Fabrication

Assembly and testing Before 1986

Fabrication

Fabrication Foundry

Foundry

Assembly Contract and assembly testing and testing

Assembly and testing

1990s

After 2000

Assembly and testing

Figure 1.1 Evolution of the semiconductor industry Source : Shafter 2000: 174, 176

mimicking the product mix of its domestic competitors. Their failure to appreciate the ‘select and concentrate’ approach of their American and European competitors ultimately proved very costly. Prominent in the computer and semiconductor industries, as well as other electronics industries, has been the growing importance of contract manufacturers. These specialist producers have altered the basis of competition by drawing on economies derived from shared production, and by forcing firms to rethink their strategies for differentiation.10 Japanese firms have been only modest users of this model. This is understandable since they saw their core strength as manufacturing. As noted above, Fujimoto Takahiro argues that the long-term competitive strengths of Japanese firms have been in integral architecture and the concomitant dense circulation and communication of design relevant information delivered to the customer in the form of sophisticated products. It is this movement of information that is necessary for the critical coordination between design and other functions. Modular design architecture and manufacturing undercuts and fundamentally devalues this strength. Modular systems increase the ability to innovate while reducing costs of technical (though not necessarily other forms of) coordination and integration. Technical integration is handled by the presence of standardized interfaces. Minimizing the need for coordination and integration also reduces the need for the traditional,

12

Introduction highly personalized ‘relational contracting’ with its heavy emphasis on trust, which has been a forte of Japanese manufacturers (Dore 1987). Japanese productionist firms, in the ICT sector, have been increasingly swimming in a modular ocean. At the same time this is not a unidirectional trend. New generations of technology may create a shift back to integral product architectures, catching nonadapting firms in a ‘modularity trap’ (Chesbrough and Kusunoki 2001), one in which organization architecture designed for modularity becomes a liability. The dynamics of technologies, products, and industries vary greatly so that it can be exceedingly difficult to know if and when the pendulum may be swinging in the opposite direction, and how to calibrate organizational practices to these developments.11

Adjustment difficulties We have documented key challenges posed for Japan by two major changes in the competitive environment: the emulation of Japan’s 1980s success formula by old and new competitors, and the transformation of several key sectors, especially in ICT, into networks of specialist producers facilitated by modular technologies and open standards. While we have treated these two factors for the most part as independent forces, they interact in powerful ways (modularization in design and production led to the very effective network of alliances between Japan’s competitors: the US and Asian upstart producers). We turn now to some of the reasons for the slow response to these forces by Japanese producers. A well established axiom of organizational analysis sees the failure of once successful firms as rooted in their past success. Dosi (1982) argues that through successive organizational and technological choices, a firm’s trajectory leads it to become more accomplished in a given set of capabilities, while at the same time declining in those capabilities that would allow it to pursue different directions. Those persons that led the firm to the top develop over time, with reinforcement, a confidence in the soundness of their success formula and a blind spot for alternative approaches. Their expertise is based on previously successful strategies and work routines and they promote employees and favour strategies that will keep these tasks central. When hit with a competitive threat the magnitude and character of which are not well understood, they initially fall back on familiar solutions (Starbuck and Milliken 1988: 53; Burgelman and Grove 1996; Fligstein 1996: 667). For Japanese leaders, the success formula was low cost high quality precision hardware achieved through continuous process improvement in a framework of dense communication of design information across organizational units. It was a success formula, however, that over time was increasingly characterized by slowed decision making processes, caution, and a reduced tolerance for risk.

13

Recovering from success Inagami and Whittaker (2005: 141–2) call this ‘large firm malaise’ in their detailing of of Hitachi practices in the 1990s. Analyses of ‘large firm malaise’ place emphasis on the decision maker. Japanese firms are well known for their practice of late screening and late promotion. Kato’s study in the early 1990s found that the average age at time of appointment to CEO was 49 for the American and 56 for the Japanese firms. The Nikkei Weekly reported a trend toward selecting younger leaders for Japanese companies for the first half of 2005. Yet the average age for those becoming President (or CEO) in this period was still a high (by American standards) 56.3 years old, about the same as Kato had found some 13 years earlier. Kato also found that the length of service before promotion to chief executive was notably higher in Japanese firms; one in four American top executives had 25 or more years of firm experience before being promoted compared to one out of two in Japan. The larger the firm, moreover, the more firm-specific human capital was required for promotion (Kato 1993: 109–25). Such differences were held up by Kato and others as a reason for Japanese success in the 1980s. When managers finally arrived in positions of leadership, they had a strong stake in the firm, an intimate knowledge of firm culture and practices, and a long-term perspective. When a firm is faced with discontinuous change and new business models, however, organizational memory can become a barrier to innovation rather than an asset. Hitachi’s problems in the rapidly evolving ICT sector in the 1990s, for example, may have been intensified because many top managers were drawn from the heavy electric operations, or within ICT from mainframe operations, that were part of Hitachi’s past success. A strong institutional memory should be seen as a contingent asset. Finally, a rapid adaptation to modularization trends seems to have posed the risk of embracing a new unproven methodology at the expense of the tried and the true. It would have required a more rapid reduction of Japan’s domestic manufacturing labour force, which most large firms believed they could not do, especially in the early and mid-1990s (Inagami and Whittaker 2005: 148–51). In summary, there were ample problems in the late 1990s to which a solution packaged as a better way to manage technology and capture its value would have strong appeal. MOT was just such a solution.

The MOT boom Fads and the birth of MOT Fads are not to be dismissed out of hand. They can have lasting–and sometimes unanticipated–consequences. This is well illustrated by the US response to the Japanese quality challenge in the 1980s. The initial response to the

14

Introduction Japanese quality challenge was, predictably, denial. As Schein (1992: 298–302) argues, ‘unfreezing’ of a system requires not just a mass of disconfirming data, but anxiety or guilt on the one hand, and a belief that the problem can be tackled on the other. Crises typically accelerate the transition from denial through to a new readiness to learn and implement changes. There was a sufficient sense of crisis in the 1980s US to trigger this transition, and ‘In the course of responding to the Japanese quality challenge, a social movement developed, filled with zealots, nonbelievers, inspirational leaders, opportunists, and institution builders’ (Cole 1999: 231). Cole notes: Many scholars treat individual managers as atomistic agents, weighing all the evidence and then making rational decisions on behalf of their firms to improve or not to improve in the context of their specific environment. Yet, with the Japanese cast in the role of challengers in the early 1980s, the American incumbents banded together to mobilize resources and defend their markets. Managers developed networks to reduce knowledge barriers and to further adoption. Organizational action developed in response to a collective challenge, and these collectivities acted with common purpose, solidarity, and continuity to promote change in industry practices, often meeting strong resistance by those with vested interest in existing arrangements. Individual employees often saw quality as a kind of crusade and indeed were called quality zealots by their detractors. Thus, the very vocabulary suggests a social movement. (Cole 1999: 13–14)

Media interest came and went. Many companies abandoned quality circles. As we have seen, however, some of the key lessons were learned, and by the 1990s more effective quality practices became institutionalized and the quality gap across a range of industries had significantly closed. US manufacturers in the 1980s also sought to learn from the Japanese about the benefits of building partnerships with key suppliers. Imitation was imperfect here, too, especially in the automotive industry, but it led to innovation. Supplier management ideas and practices mutated, combined with the new information technologies, and evolved into supply chain management. The focus was now not just on optimizing bilateral ties between Original Equipment Manufacturers (OEMs) and suppliers, but on optimizing the whole supply chain. Supply chain management, in turn, has become an object of study and learning for Japanese manufacturers. By focusing on improving business processes, the Japanese-inspired quality movement in the US also became the basis for other new developments, including new fads like business process re-engineering. Again, aided by information technology and modular product architecture, these developments (albeit with problems in their implementation) boosted the revival of US manufacturing which, along with new challenges from Asian competitors, contributed greatly to the late 1990s crisis in Japan. Ironically, MOT in the US can hardly be called a fad, or movement with a public face. In their distress, US industrialists called on American business

15

Recovering from success schools and engineering colleges to make their training and research more relevant to the needs of business faced with a rapidly changing competitive landscape. Some of this pressure on universities was public, such as the open letter on TQM (total quality management) from the chairmen of American Express, Ford, IBM, Motorola, P&G, and Xerox published in the Nov./Dec. 1991 issue of the Harvard Business Review (Robinson et al. 1991: 94–5). Much of it, however, was privately expressed through industry advisory boards to these professional schools, and through the selection of university programmes that corporations chose to support financially. At the same time, many researchers were trying themselves to come to terms with the changing competitive environment, globalization, and the growing role of technology as a competitive factor (e.g. Teece 1998). A combination of these factors led to the emergence of Management of Technology–MOT–in the late 1980s–early 1990s.12 There was little government leadership and no coherent model of MOT, covering all phases of the production and enterprise life cycle. Instead there were a range of ad hoc innovations in industry and academia spread sometimes, as in the case of quality, through consultancies and industry-based associations, but at other times they came from leading firms such as IBM being imitated by a host of followers. A variety of programmes came into being in academia, sometimes going under the name MOT, but just as often using terms like innovation management, technology management, networking management, and entrepreneurship. These terms are scholarly descriptions of the subject matter rather than being part of the working language of those in the corporate world. The Technology and Innovation Management Division of the Academy of Management was formed in 1987 to bring together scholars interested in innovation, research, and development, and the management of technology-based organizations. The Division had over 1100 members in 2005, making it one of the larger divisions within the Academy of Management. Its research domain encompasses the strategic management of technology and innovation processes.13

MOT hits Japan Fast forward a decade to Japan. In line with the Odagira and Goto analysis, we see that Japanese companies have long practiced the management of technology. Indeed, it has been one of their strengths. It has been buttressed by the training, consultation and promotional activities of numerous industrial organizations. When MOT courses began to emerge in the US, moreover, Japanese engineers and R&D managers attended, and invited leading US MOT academics to Japan to share their knowledge. The immediate impact, however,

16

Introduction was local and limited. Japanese manufacturing companies were recording profits into the 1990s, and were able to attribute difficulties to a host of environmental factors. Except for a minority who sensed a change in the ground rules of competition, faith in their own productionist models was largely intact. The situation changed around 1998 when financial crisis was compounded by mounting losses in manufacturing, which triggered restructuring and even factory closures. This was enough to spark a questioning of previously successful practices, and a more urgent interest in the causes of the US resurgence, not just by individual managers but collectively. The wave of corporate governance reform hit Japan simultaneously, and firms were pressed to manage for profitability, with greater attention to shareholder interests. In 1999 the Japan Productivity Centre for Socio-Economic Development (JPC-SED) began work to establish the Japan Research Centre for Technology and Innovation Management (TIM-Japan). The Centre was launched in 2001, along with an MOT course in JPC-SED’s Management Academy. At the Kansai Science City, too, the Kansai Research Institute launched the Technological Business Innovation (TBI) executive seminar. Such seminars marked the emergence of MOT as a collective management issue in Japan, in 2001. More significantly, it was emerging as a policy issue. MOT was cited in a number of governmental reports in 2002, from the Council on Economic and Fiscal Policy to the Intellectual Property Strategy Council, and even the Central Education Deliberation Council. The Ministry of Economy, Trade and Industry (METI) had been contemplating MOT for some time, in fact. It was moved to action, in part, because of the seeming paralysis of many Japanese industry leaders in the late 1990s. In 1999, it started a feasibility study and then accepted bids, finally choosing Mitsubishi Research Institute (MRI) as its contractor to create an MOT Consortium in 2002. MRI invited bids from universities to develop MOT courses, which would create the basis of an MBA programme in all but name. Thirteen universities were selected to develop 16 courses. MRI and METI hoped–optimistically–that the courses, when placed online for use by other would-be MOT educators, would leverage its seed money into a nationwide campaign to bring management and entrepreneurship to technologists and engineers. It pointed to the large numbers of engineers graduating from MOT courses in the US, and their virtual absence in Japan. Later in the year METI secured a significant increase in funds (roughly ¥3 billion) from the Supplementary Budget, and seed funded 48 MOT education projects in universities, research institutes, and private companies. Companies took note and began to sound out universities to develop MOT courses for their engineers. Universities, in turn, sought to buttress their MOT credentials in order to access such funds and to make closer links with the corporate sector.

17

Recovering from success All this ignited media interest. Articles on technology management (gijutsu keiei) in the Nikkei group newspapers (Nikkei shinbun, in passing, was a vociferous advocate of restructuring for profitability and shareholder interests in the late 1990s) rose from around ten a year prior to 2002 to 34 in the second half of the year. In the first half of 2003, articles topped 100, a rate sustained throughout the following two years. Articles referring to the acronym MOT similarly began to rise sharply in 2002 to around 100 in the first half of 2003, and continued to rise, more modestly, over the next two years.14 Business journals began to run special articles on MOT from 2003 and academic books with MOT in the title began to appear shortly afterwards (some no doubt were hastily re-titled to exploit the upsurge in interest on the subject). New journals on the subject such as Nikkei Biztech (2003) and Technology Management Journal (2004) were also started.

University-industry (U-I) relations Adding to the foment were attempts to strengthen university-industry (U-I) relations, and changes to universities themselves. There is nothing new about the former. As far back as 1977 the Council of Science and Technology called for strengthening of basic research through U-I (and public research lab–P) collaboration, and programmes such as ERATO and U-I were created to do this in the early 1980s.15 It can be argued, moreover, that U-I collaboration did strengthen significantly over the next two decades. Commonly used indicators such as university held patents, licence income and university-based entrepreneurship highlight continued weaknesses, but different indicators such as joint publications suggest a more nuanced picture.16 These relations, however, were often informal, and constrained by legal and bureaucratic obstacles, as well as the under-funding of universities we noted earlier. As Japanese companies sought to leverage basic research in universities, they frequently turned overseas. Research contracts awarded by Japanese companies to domestic and foreign universities were broadly comparable in 1989 (¥38.4 billion and ¥43.0 billion respectively), but by 2000 domestic contracts had grown to ¥67.5 billion, while those for universities abroad had grown to ¥157.0 billion.17 Inspired by the US model (depicted above by Mowery and Rosenberg) and specifically the 1980 Bayh-Dole Act, the Japanese government responded by passing laws almost every year from 1998 to 2002 to encourage technology transfer from universities; to make it easier to trade intellectual property rights derived from publicly funded research; to promote use of university technology licensing offices (TLOs–25 were recognized by late 2001, 32 by 2004); and to encourage collaboration through tax measures. Then in late 2001, key governmental and nongovernmental bodies jointly launched a series of Regional U-I-P Summits, and in 2002 the massive

18

Introduction Conference for the Promotion of U-I-P Collaboration in Kyoto, which attracted over 4000 participants. These events have since been held annually. The launch of the regional summits, moreover, coincided with the first phase (2001–05) of METI’s Industrial Cluster Plan, for which 19 projects were chosen, and MEXT’s Knowledge Clusters scheme (2002), for which 18 projects were chosen. There were compelling reasons on the universities’ side to engage in these activities. In 2001 public sector research institutes and national hospitals became independent administrative institutions, after the UK agency model. This model, with some modifications, was applied to national universities in 2004. One objective was cost cutting. Another was to encourage–force– universities to become more active in new business creation through science and technology resources. Whatever the balance, and irrespective of the controversy about university autonomy (see Tabata 2005), U-I relations were set to assume a growing institutional, strategic importance in 2001–02.

The life cycle and appeal of MOT While neither MOT nor U-I collaboration were new, the specific circumstances of 2001–02, following the upheavals of the late 1990s, gave them a higher profile and potency than might otherwise have been the case. A new ingredient was enthusiastic, institutional participation by universities. The enthusiasm with which the business media took up MOT, with which universities raised the MOT flag to declare their intent to interact with business, and the rebranding of existing seminars, publications, and initiatives with the MOT label evoked criticism and in some cases derision. It was, critics claimed, a) a fad, with a shelf life of a couple of years at most; b) a superficial phenomenon of repackaging; c) a mish-mash of concepts jumbled together; d) another ‘three letter’ (acronym) import, further symbolizing Japan’s loss of confidence; and/ or e) a ‘black ship’ import tempting Japan’s manufacturers to try to emulate foreign practices and forgo their own strengths. Proponents, on the other hand, were attracted to MOT for a variety of reasons: a) it would make top managers situate technology more centrally in corporate strategies; b) it would encourage researchers and engineers to incorporate business model considerations in their technology and product development decisions; c) it would provide insights into the inroads made by US and Asian competitors, and how to counteract them; d) it would free up canalized thinking, allowing for new competitive concepts and approaches to be incorporated; e) it would accelerate participation by, and change in, inertia-bound universities; and/or f) it would encourage coordinated microand macro-level renewal strategies which built on Japanese strengths. In one sense the critics were right. The shelf life of media interest was about two years. As the economy recovered, Nikkei references to gijutsu kanri and

19

Recovering from success MOT halved in the first half of 2005 from the previous half year. That does not mean, however, that the movement has run its course. Non-degree and inhouse MOT programmes run by a variety of organizations continue to experience strong market demand.

The monozukuri boom Finally, in closing this section, we would like to consider another vogue term which is not an imported acronym but claims an indigenous heritage (arguably as an invented tradition). ‘Monozukuri’ means the making of things. We have used the adjective ‘productionist’ to convey its value orientation.18 Monozukuri has few detractors in Japan; it evokes the sense that it is the backbone of the Japanese economy, and should be in the future as well. The concept captured public attention in the depths of Japan’s despair to reaffirm the core strengths of Japanese manufacturing firms.19 In 1999 the Basic Law for the Promotion of Monozukuri Base Technology was enacted to shore up the position of manufacturing in the economy. Notable in this law was the recognition that interministerial action was required to address manufacturing problems; three ministries–METI, MEXT and the Ministry of Health, Labour and Welfare–produce the Monozukuri White Paper, published annually since 2000. Media citations of monozukuri began to rise in the second half of 1998, and have continued to rise ever since.20 While Fujimoto (2004) has presented a sophisticated version of what monozukuri means, subsequent popularizers have been less than careful. The popularized versions may allow monozukuri to be used as a justification of established ways of doing things that include many outmoded management practices. By encouraging firms to focus on their traditional strengths, it may divert them from adjusting to the new competitive environment. It is conceivable, conversely, that MOT concepts can be diffused through monozukuri since it is indeed the case that, for many firms, success will entail building on their traditional strengths. Significantly, references to monozukuri in regional Nikkei shinbun editions are twice as high as in the Nikkei sangyo shinbun (Nikkei Industrial Newspaper), but the ratio is reversed for gijutsu keiei and MOT. Interest in MOT appears to be concentrated in larger industrial firms, whereas monozukuri additionally reaches down into the myriad of smaller local manufacturers as well as reaching a general audience. The MOT boom appears to be accelerating the process of unfreezing, and to be opening up possibilities for new business models and strategies. If past Japanese experience is anything to go by, cognitive restructuring will take on a dialectical quality. In the same way that scientific management was introduced enthusiastically but applied selectively and creatively following friction with Japanese ‘traditions’ (especially in employment relations, see Tsutsui

20

Introduction 1998), MOT may be used to introduce tension and explore new possibilities, even as it is ultimately indigenized.

Synopsis The chapters have been organized into three parts. Those in Part 1–Industries, technologies, and value chains–explore challenges to Japan’s innovation and technology management practices at an industry level. Three of the chapters look at the ICT/electronics sector. First, Cole shows how former strengths became debilitating weaknesses in the telecom industry. NTT was the ‘locomotive’ which powered the industry with its ‘family’ of equipment suppliers in the 1980s. In the 1990s, however, it placed its bets on ‘competency enhancing’ ATM and ISDN, and fell victim to the ‘disruptive’ technology of TCP/IP. Strong relational ties with its suppliers led them as well to be weak competitors in the emergent Internet networking equipment industry, and a lack of new entrants forestalled alternatives from emerging within Japan. Cole also points to Japanese problems in international standard setting, betting on the established committee process and failing to engage in the fluid IETF process. Cole’s analysis finds strong echoes in Yunogami’s treatment of the semiconductor industry in Chapter 4. This is not surprising, perhaps, because many of the protagonists are the same. The quality regime ultimately deriving from NTT (and the Japanese government as customer) was vital in the ascent of DRAMs in the 1980s, as in telecom, but it created a path-dependent approach to innovation which proved disastrous when the main use of DRAMs switched from mainframes to personal computers. As market share plummeted, Japanese semiconductor engineers continued to take solace in the fact that they were ‘not beaten in technology’, an attitude which Yunogami argues further condemned them to failure. Chapter 3 takes up modular production/manufacturing (as well as emulation) which, Sturgeon notes, poses a direct challenge to a host of the most cherished strategies of Japanese electronics firms, including employment protection. Contradictory pressures to respond to the modularization challenge, on the one hand, and maintain cherished strategies on the other, lead to ‘simultaneously shedding and protecting jobs, getting out of old business lines and adding new ones, opening their sourcing networks and investing in new in-house component plants, expanding some facilities and shrinking or closing others’. Overall, Sturgeon finds adoption of aspects of modular production in low-end manufacturing, but much less for advanced products and technologies, creating a ‘mixed model.’ In Chapter 5, Probert looks at value chains in the Japanese pharmaceutical industry, which has until recently been relatively isolated from global consolidation, value chain modularization, and indeed global markets. One reason

21

Recovering from success has been the institutional and regulatory environment–including, again, governmental emphasis on safety over effectiveness–but corporate strategies have also played a part, including (until recently) a strong preference for organic growth and employment security. She also notes the limited contribution from university-based research activity, especially in biotechnology. But this industry is now in the throes of rapid change. Probert offers the prospect that leading pharmaceutical companies may well respond to their challenges while retaining cherished traditions through global niche strategies. In the final chapter in Part 1, Cole looks at another key ICT industry– packaged software–of which Japan is a huge net importer. In what goes to the heart of the modularization issue, Cole notes that the large electronics firms were reluctant to unbundle hardware and software, and insisted on maintaining proprietary systems; indeed, free software was (is) frequently used to boost hardware sales. Spinning out software divisions as group companies led to the maintenance of this orientation, rather than the creation of a thriving set of independent software firms focused on innovation. In what he calls the ‘curse of genba shugi’, Cole argues that the cherished shopfloor focus of Japanese manufacturing firms, despite its many positive contributions to productivity and quality, creates enormous pressures for customization which add heavy costs and foreclose benefits of standardization and corporatewide optimization that would come from the use of packaged software. In Part 2 we move to a micro-level view of innovation and technology management, within firms and between them. Chesbrough explores the implications of the transition from closed to open innovation over the past two decades which as Probert showed in the bio-pharma case, Japanese companies have been relatively late to address. Chesbrough gives examples of the fate of similar US companies. On the one hand the wide dispersion of critical knowledge for innovation is ignored at great risk, on the other alternative paths to market for internal ideas may be ignored at great loss. Chesbrough explores strategies for dealing with ‘false negatives’–which at first look unpromising but later turn out to be valuable–including the time-honoured Japanese practice of spin-offs. Brown looks at the HRM (human resource management) and knowledge system dimensions of open innovation in Chapter 8. In line with Chesbrough, she highlights the rising importance of externally derived knowledge. She establishes a link between the internal–external orientation of HRM systems and the type of external knowledge accessed. Internally/externally oriented HRM systems are associated with public/private external knowledge respectively. The latter tends to be closer to the cutting edge. Once again, this analysis points to difficulties Japanese companies face in participating in global knowledge networks. However, it also points to tradeoffs, between support for individual creativity on the one hand, and team work and control on the other.

22

Introduction Yamaguchi (Chapter 9) amplifies a number of the preceding themes and provides new insights in his case study of the blue LED invention. Distinguishing between ‘paradigm-disruptive’ innovation and ‘performance-disruptive’ innovation, he argues that large firms face difficult problems with both, but especially the former (because of their ‘competency-enhancing’ innovation bias, noted earlier, as well as growing bureaucracy and, more recently, restructuring). Using the blue LED case, he argues that there is a greater chance of top managers following a hunch, or creating a ‘field of resonance’ with their scientists in smaller companies. The implication of Yamaguchi’s paper is a call for hastening the shift to a more open innovation system in Japan, with a greater role for start-ups and networks of innovative small firms. Homing in even further on the individual, Byosiere explores the challenge of unleashing individual creativity in large corporations through examining the environment and incentives of R&D researchers. He finds considerable tension in the relationship between the individual researcher and the firm, especially over special rewards given to successful research results and research expenses available to researchers. Deeper causes, however, flow from the fracturing of the sense of community brought on by corporate restructurings. Finally, Byosiere notes that researchers see risk avoidance by their superiors as the major obstacle to doing creative work, the result of the shift by Japanese firms from being aggressive challengers in the postwar period through the 1980s, to becoming defenders of existing assets. In Chapter 11, Whittaker provides a case study of Hitachi’s response to its first postwar loss in 1998, in the face of growing competitive challenges we have outlined, and ‘large firm malaise’. It began with HRM reforms and an attempt to reshape employment relations, as well as organization and governance reforms. From 2001 MOT concepts were progressively introduced, through what he calls exploratory, strategic and systemic stages. These attempted to combine technologies with new business models, to develop areas of technology focus, and to develop management systems to more effectively mobilize and integrate group and external resources. Whittaker speculates as to whether these constitute a ‘new production(ist) system’. Keiretsu are important for understanding the openness–or otherwise–of Japan’s innovation system and MOT, corporate specialization, and boundary management. In the final chapter of Part 2, Lincoln draws on a series of studies which portray keiretsu ties as both a cause and a consequence of innovation. They foster organizational learning and innovation, and they grow through strategies which allow spin-offs to commercialize core company R&D. Innovation strategies can cause the ties to strengthen (as in the case of Matsushita), or weaken or become strained (Toyota-Denso). A quantitative study finds that keiretsu ties remained influential for non-R&D activities in the 1990s, while R&D relations became more strategic and less influenced by keiretsu, especially ‘legacy relations’ (see also Lincoln and Gerlach 2004).

23

Recovering from success Part 3 moves to the macro level, and policy attempts to reshape Japan’s innovation system. Prominent among these has been moves to create an environment conducive to basic research and breakthrough innovations. Arimoto, a policymaker himself, reminds us that this is not simply a matter of strengthening university research and forging closer links between universities and industry, but requires universities to address a broad range of skill needs, particularly in professional fields like law, management and intellectual property matters, which individual companies can no longer address on their own. He notes that social issues must also be addressed, including greater efforts being made to promote public understanding of and support for science and technology. This requires directing S&T and innovation policies towards the needs of the many rather than the few. Ultimately, Arimoto argues, the necessary values and creativity have to reside in individuals, a point with which Byosiere would surely agree. Murayama (Chapter 14) extends this discussion into the area of security, which has been thrust onto the policy and innovation system debate agenda in the wake of 9/11. He first compares key features of the US and Japanese national innovation systems, and the respective roles of defence. Defence has played a relatively minor role in Japan’s innovation system, but like civilian industry in the 1990s, Japan’s defence industry failed to adapt to a dramatically changed (post Cold War) environment in the 1990s. In the new century, however, anzen-anshin (safety and security/peace of mind) has the potential to influence both. The trajectory of influence is still fluid, but Murayama’s preference is clearly for a civilian-oriented security techno-system. Kaneko, Nakata, and Yokoyama return to skills, focusing specifically on MOT. (The significance of the growing policy emphasis on skills is discussed in the Conclusion.) They outline five problem areas for MOT which must be addressed with new skill sets. Identifying these is one thing; resolving them is another. After reviewing MOT education in the US, Europe, and elsewhere in Asia, the authors discuss its provision in Japan, identifying problems in curriculum design (hastily assembled, objectives unclear), teaching methods (too much one-way transmission), and teaching resources (too few competent teachers). On the corporate side, too, there is much reliance on tacit knowledge. A common challenge is to find ways to make the key precepts for MOT explicit, so that they can be debated, developed, and diffused. The final chapter in Part 3 looks at government and policy from a different perspective: e-Government has been an important if overlooked part of the e-Japan strategy, and central to this is Juki-net. Kita analyses the debacle of its introduction, which was marked by initial confrontation with anti Juki-net campaigners concerned about privacy and information security, and subsequently between administrative agencies and residents, where passive resistance virtually consigned the Juki-card to oblivion. Kita proposes a ‘customer-oriented’ solution to the impasse, which he considers symptomatic of

24

Introduction the whole e-Japan programme. In his analysis, the policymakers are as much in need of MOT education as the engineers and managers who still believe in the linear model of innovation. We end the book with the Conclusion in which we attempt to tease out the implications of the individual chapters for the future of innovation and MOT in Japan.

Notes 1. There are other, related challenges, of course, such as escalating foreign direct investment in the 1980s, which accelerated in the 90s as Japan moved more production to China and raised the spectre of ‘hollowing out’. 2. Not all manufacturing industries were competitive though, and service industries visibly lagged in productivity growth (see Porter et al. 2000). 3. In national research institutes R&D spending also declined relatively, from 27.5 percent in 1978 to 21.7 percent in 1990, and within this, basic research from 18.5 percent to 14.2 percent (Lee 1997). 4. Macro factors include the appreciation of the yen, from ¥258/$1 in the first quarter of 1985 to ¥84/$1 in the second quarter of 1995. 5. We are indebted to Prof. Fujimoto for conversations with regard to more recent developments, 19 July 2004. 6. Asahi shinbun (2002). ‘Japan’s LCD Muscle Shrinks’, http://www.asahi.com/english/ business/K2002122800357.html 7. This subsection draws heavily on Macher et al. 1998: 107–36). 8. Conversations with Robert Leachman, UC Berkeley, College of Engineering, proved especially helpful in this formulation. 9. Notwithstanding, there are still semiconductor areas such as leading edge DRAM design where close coordination with production is critical, and in these cases there are pressures for integration rather than specialization (Macher et al. 2002: 6). 10. See Sturgeon 2002, as well as in this volume for an extended treatment of contract manufacturing. 11. See also Fine 1999; Kusunoki 2004. 12. At UC Berkeley, a committee set up by the Haas School of Business and the College of Engineering in 1988 drafted a Long Range Plan for the Joint Program in the Management of Technology, which was launched in 1989. MIT began MOT education in 1985, and started the Leaders for Industry Program in 1988. 13. In the UK, which also faced the brunt of competition from Japan in the 1980s, there were numerous initiatives encompassing elements of MOT, but they did not coalesce into what we would call MOT until the mid-1990s (see Gregory 1995). 14. In many cases MOT and gijutsu keiei appear in the same article. Figures are from the Nikkei Telecom 21 database, accessed 8 December 2004, and 3 August 2005. A similar if less pronounced trend can be found in references in the Asahi shinbun’s Asahi DNA database. References to an alternative expression for technology management–gijutsu kanri–showed no marked trend over the period. This term is less

25

Recovering from success

15.

16.

17. 18. 19. 20.

associated with the imported concept of MOT, and commonly refers to technology management in a less strategic sense. Lee 1997. ERATO stands for Exploratory Research for Advanced Technology. It was under the Science and Technology Agency, while U-I were under the Education Ministry. In 2001 the STA was merged into the Ministry of Education, now the Ministry of Education, Culture, Sports, Science and Technology (MEXT). Pechter and Kakinuma (1999) compare joint publications in Japan and the US and find as much if not more collaborative activity on this count in Japan. Branscomb, Kodama and Florida (eds.) (1999) provide a good survey on U-I relations in Japan and the US until the late 1990s. In 2003 the figures were ¥83.4 billion and ¥198.5 billion respectively (Somucho 2003). Japan’s capitalism has also been depicted as ‘production-oriented’ capitalism (see Dore 1987: 13). For a critical view of the monozukuri vogue see Tsai 2005. Again, this is according to the Nikkei Telecom 21 data base. Citations until the first half of 1998 were under 50, by the second half of 2004 they exceeded 300, well over twice the figures for gijutsu keiei and MOT.

References Aoki, M. (1988). Information Incentives and Bargaining in the Japanese Economy, Cambridge: Cambridge University Press. Baldwin, C. and K. Clark (2000). Design Rules, Cambridge, MA: MIT Press. Branscomb, L., F. Kodama and R. Florida (1999). Industrializing Knowledge: University– industry linkages in Japan and the United States, Cambridge, MA: MIT Press. Burgelman, R. and A. Grove (1996). ‘Strategic Dissonance’, California Management Review, 38(2): 8–28. Chesbrough, H. and K. Kusunoki (2001). ‘The Modularity Trap: Innovation, technology phase shifts and the resulting limits of virtual organizations’, in I. Nonaka and D. Teece (eds.) Managing Industrial Knowledge: Creation, transfer and utilization, London: Sage. Cole, R. (1999). Managing Quality Fads: How American business learned to play the quality game, New York: Oxford University Press. Dore, R. (1987). Taking Japan Seriously, Stanford: Stanford University Press. Dosi, G. (1982). ‘Technological Paradigms and Technological Trajectories’, Research Policy, 11: 147–62. Fine, C. (1999). Clockspeed: Winning industry control in the age of temporary advantage, New York: Basic Books. Fligstein, N. (1996). ‘A Political–Cultural Approach to Market Institutions’, American Sociological Review, 61 (August): 656–73. Fujimoto, T. (1999). The Evolution of a Manufacturing System at Toyota, New York: Oxford University Press. —— (2002). ‘Architecture, Capability, and Competitiveness of Firms and Industries’, Working Paper, University of Tokyo. —— (2004). Nihon no monozukuri tetsugaku (The Philosophy of Japanese Production), Tokyo: Nihon keizai shinbunsha.

26

Introduction —— , A. Takeishi and Y. Aoshima (2001). Bijinesu akitekuchia, seihin, soshiki, purosesu no senryakuteki sekkei nijumon (A Primer on Business Architecture, Strategic Design of Products, Organizations, and Processes), Tokyo: Nihon keizai shinbunsha. Gregory, M. (1995). ‘Technology Management: A process approach’, Proceedings of the Institute of Mechanical Engineers, 209: 347–56. IMD (2004). The World Competitiveness Yearbook, Lausanne. Inagami, T. and D. H. Whittaker (2005). The New Community Firm: Employment, governance and management reform in Japan, Cambridge: Cambridge University Press. Kato, T. (1993). ‘Internal Labor Markets for Managers and the Speed of Promotion in the U.S. and Japan’, Japan Institute of Labour, An International Comparison of Professionals and Managers, JIL Report Series No.2, Tokyo: 1–245. Kogut, B. (2000). ‘The Network As Knowledge: Generative rules and the emergence of structure’, Strategic Management Journal, 21: 405–25. Kusunoki, K. (2004). Synthesizing Modular and Integral Knowledge, in H. Takeuchi and I. Nonaka (eds.) Hitotsubashi in Knowledge Management, Singapore: Wiley. Leachman, R. (2002). ‘Competitive Semiconductor Manufacturing: Final report on findings from benchmarking eight-inch., sub 350nm wafer fabrication lines’, CSM-52, Engineering Systems Research Center, University of California, Berkeley, CA. —— and D. Hodges (1996). ‘Benchmarking Semiconductor Manufacturing’, IEEE Transactions on Semiconductor Manufacturing, 9(2): 158–69. Lee, K. (1997). ‘Managing Basic Research in Japan: Towards a Japanese system of breakthrough innovation?’ PhD dissertation, Judge Institute of Management Studies, Cambridge University, Cambridge. Lincoln, J. and M. Gerlach (2004). Japan’s Network Economy: Structure, persistence and change, Cambridge: Cambridge University Press. Macher, J., D. Mowery, and D. Hodges (1998). ‘Reversal of Fortune? The recovery of the U.S. industry’, California Management Review, 41(1): 107–36. —— , D. Mowery, and T. Simcoe (2002). ‘eBusiness and the Semiconductor Industry Value Chain: Implications for vertical specialization and integrated semiconductor manufacturers’, Industry & Innovation, forthcoming. Ministry of Economy, Trade and Industry (METI) (2001). Trends in Japan Industrial R&D Activities–Principal Indicators and Survey Data, Tokyo: METI Technology Research and Information Office. —— (2003). Trends in Japan Industrial R&D Activities–Principal Indicators and Survey Data, METI, Technology Research and Information Office. Mowery, D. and N. Rosenberg (1993). ‘The U.S. National Innovation System’, in R. Nelson (ed.) National Innovation Systems, New York: Oxford University Press. Nezu, R. (2002). ‘Perspective and Strategies for Japanese Industry’, presented at the Prospects for Core Industries in Japan and Germany Conference, Japanese-German Center, Berlin, Fujitsu Research Institute and German Institute for Economic Research, Nov. 28–9. Nikkei Weekly (2005). ‘Companies Tap Young Leaders’, Nikkei Weekly, 43(2) (13 June): 1,7. Odagiri, H. and A. Goto (1993). ‘The Japanese System of Innovation: Past, present and future’, in R. Nelson (ed.) National Innovation Systems, New York: Oxford University Press.

27

Recovering from success Pechter, K. and S. Kakinuma (1999). ‘Co-authorship Linkages Between University Research and Japanese Industry’, in L. Branscomb et al. (eds.) Industrializing Knowledge, Cambridge, MA: MIT Press. Porter, M., H. Takeuchi, and M. Sakakibara (2000). Can Japan Compete? Basingstoke: Macmillan. Prahalad, C. K. and G. Hamel (1990). ‘The Core Competence of the Corporation’, Harvard Business Review, 3: 79–91. Robinson, J. et al. (1991). ‘An Open Letter: TQM on the campus’, Harvard Business Review, 69 (Nov./Dec.): 94–5. Schein, E. (1992). Organizational Culture and Leadership, 2nd edn, San Francisco: Jossey Bass. Shafter, S. T. (2000). ‘The Chipping News’, Red Herring, 30 October: 174, 176. Somucho (ed.) (2003). ‘Heisei 15 nendo kagaku gijutsu kenkyu chosa hokoku’ (Research Survey Report on Science and Technology), Tokyo. Starbuck, W. and F. J. Milliken (1988). ‘Executives Perceptual Filers: What they notice and how they make sense’, in D.C. Hambrick (ed.) The Executive Effect: Concepts and Methods for Studying Top Managers, Greenwich, CN: JAI Press. Sturgeon, T. (2002). ‘Modular Production Networks. A new american model of industrial organization’, Industrial and Corporate Change, 11(3): 451–96. Tabata, H. (2005). ‘Reform of Japan’s National Universities’, Social Science Japan Journal, 8(1): 91–102. Teece, D. (1998). ‘Capturing Value from Technology Assets: The new economy, markets for know how, and intangible assets’, in R. Cole (ed.) California Management Review, 40: 55–79. Tsai, M. H. (2005). ‘The Myth of Monozukuri: Manufactured manufacturing ideology’, ITEC Working Papers Series, Doshisha University. Tsutsui, W. (1998). Manufacturing Ideology: Scientific management in twentieth century Japan, Princeton: Princeton University Press.

28

Part I Industries, technologies, and value chains

This page intentionally left blank

2 The telecommunication industry: A turnaround in Japan’s global presence Robert E. Cole

Japanese telecommunication firms entered the 1990s as major players in the global market. Despite the explosion in global demand for telecommunications products, they witnessed a strong decline in global competitiveness over the subsequent decade. We explore the factors accounting for this shift, focusing on a key emergent sector: the Internet network equipment industry. The global explosion of demand for telecom products during the 1990s can be seen in the rise of carrier telecommunication revenues in the OECD from roughly US $400 billion in 1992 to US $800 billion in 2001 (Matsuo 2003: 20). For a closer look, we can examine exports of communications equipment; this is a broader category than just telecommunication equipment (telecommunication equipment accounts for roughly 21 percent of total communication exports). Exports of communication equipment from OECD countries increased from US $49 billion in 1991 to US $165 billion in 2001. Communication equipment export growth was 12 percent per annum in the EU, 11 percent in the United States and zero in Japan. In 1991, Japan accounted for 27 percent of total OECD communication equipment exports. By 2001, Japan’s share had fallen to 8 percent (OECD 2003: 228–30). In short, Japanese firms did not share much in the increased trade in communication equipment. If we focus only on the telecommunication equipment balance of trade for Japan from 1990–2001 as shown in Figure 2.1, we see first that exports rose from roughly US $11.7 billion in 1990 to US $13.2 billion in 2001. Set against this very modest increase (in view of the growth of worldwide demand), we see a dramatic growth of telecommunication equipment imports from roughly US $2 billion in 1990 to almost US $10 billion in 2001. This growth in imports more than cancels out the rise in exports, so that Japan’s overall telecommunication trade balance shows a sharp decline from almost US $10 billion in 1990 to US $4 billion in 2001.

31

Industries, technologies, and value chains 18 16

Billion US$

14 12 10 8

Total exports Total imports Trade balance

6 4

2001

2000

1999

1998

1997

1996

1995

1994

1993

1992

1991

0

1990

2

Figure 2.1 Japan’s trade balance in telecommunications equipment Source: OECD Telecommunications database, created by Kenji Kushida, 2004

A key component of this sector is the Internet network equipment industry, a segment of the industry that did not exist much before 1990. The market for this sector was estimated to be US $39 billion in 2000 (Semilof 2000). American firms, especially Cisco, dominate the global market. Cisco, for example, is estimated in 2002 to have 80 percent of the US $6.6 billion market for routers, 69 percent of the US $10.4 billion market for switches, 48 percent of the US $2.1 billion market for IP telephones, and 30 percent of the market for network security equipment. Moreover, its closest competitors are typically North American firms (Yamazaki 2003: 50). Japanese firms, with some modest exceptions, are notable by their absence. In response to the developments described above, the then Director-General of Commerce and Information Policy Bureau of the Ministry of Economy, Trade, and Industry (METI) met with top officials at NEC, Hitachi, and Fujitsu in December 2002 to urge these companies to integrate their telecommunications equipment businesses. The most promising opportunity was to create a ‘merger among equals’ between NEC and Hitachi but the effort failed. Such government interventions are typically reserved for troubled industries perceived to be in crisis. This action to consolidate the domestic industry into a few strong corporations reflected not simply the troubled state of the worldwide telecommunications industry but was also spurred by ‘a sense of crisis about declining Japanese telecom equipment technology’ (Nihon Keizai Shinbun 2003: 10). The cost of R&D to compete in telecoms has risen so much that Japanese government officials believe that mergers must take place for Japanese firms to be competitive in the future.

32

The telecommunication industry How do we account for these dramatic shifts in fortune? The causal factors are not consistent across industry sectors. The factors which accounted for the dramatic decline in Japan’s global share of second generation handset sales are not the same as the ones that explain Japan’s failure to participate in the explosive growth of the network equipment industry (see Funk 2002 for an exposition of the mobile phone case). There are, however, some overlapping factors such as the strategic failure of Japanese firms to effectively play the global standards game. Keeping these issues in mind, we will focus on the network equipment industry both because of its position as being critical for future IT developments and because there is relatively little literature on this subject.

NTT’s miscalculations and their consequences We begin with a change in the competitive environment that has had profound reverberations for the development of the Information and Communication Technologies (ICT) sector worldwide. This was the worldwide movement toward controlled deregulation of the telecommunications sector. First were the various regulatory reforms around the world that led to continued liberalization of the sector. Second, various technological innovations of the 1990s (including fibre optics, high capacity, and high speed hard disk drives and digital subscriber lines) expanded the volume and capacity of communications. Third, and most importantly, has been the convergence of the telecommunications and information technology sectors, especially in the mid-1990s with the emergence of the World Wide Web and the browser; this ‘linked the existing capital stock of computers and communications systems in an open network that significantly increased their utility’ (OECD 2003: 56–7). The US took the lead in these developments. In the 1970s, the arguments for deregulation of regulated industries gathered strength as the ideology of competition received renewed emphasis (Temin 1987). It was in this environment that the breakup of the Bell System and the creation of the ‘Baby Bells’ as the cornerstone of a 1982 anti-trust settlement took place. Along with AT&T, seven new ‘regional operating companies’ were created. The divestiture ushered in a new era characterized by a more open competitive environment throughout the communications sector. This environment, when combined with the creation of the World Wide Web and wireless radio-based telephony, allowed for the entry of thousands of new competitors in the communications sector. Messerschmitt (2000: 212) estimates that venture capital played more of a role in networked computing than in perhaps any other industry other than bio-tech. Until 2003–04, Japan was a consistent outlier when it came to the costs of accessing the Internet and the pricing of leased lines. Despite early public

33

Industries, technologies, and value chains discussion of the coming importance of the convergence between communications and computers, Japan lagged in adopting and applying these new capabilities. Much of that lag can be traced to the failure to deal creatively with the NTT telephone monopoly in Japan. Powerful institutional forces and vested interests contributed to both slow the process of deregulation and shape it in ways that preserved much of NTT’s structure and pricing power (Vogel 1997; Tilton 2003). It is striking that one of the major groups adamantly opposing the NTT breakup was the traditional ‘family’ of NTT equipment suppliers: NEC, Hitachi, Fujitsu and Oki Electric. Yet, it is these companies that, long-term, would be the most likely major beneficiaries of such a breakup insofar as the changes could be expected to accelerate the creation of an ICT infrastructure and associated products and services. It would appear that the equipment suppliers focused primarily on the disruptions that a breakup might create for their up to then guaranteed NTT markets. This suggests contingency for the view that relationship contracting (networks of preferential stable, obligated trading relationships among upstream and downstream customers and suppliers), so prevalent in Japan, has strong positive benefits (Dore 1987: 173–91). Ronald Dore’s analysis of what he called relational contracting stressed the criticality of long-term trust-based relationships, risk sharing among partners in good times and bad, and the efficiency benefits that flow from such cooperation. When innovation and exploitation of new opportunities, however, are the objective (not ever-improving efficiency), and the environment is characterized by discontinuous change and strong first mover advantages, then seeking out new partners and employees with ready made capabilities may be required to successfully take advantage of new opportunities. The NTT suppliers ignored the long-term benefits they might receive from reorienting product lines to compete in worldwide markets in favour of the short-term benefits associated with continuing to cooperate with NTT. It is instructive to note that a recent analysis of Chinese success in global telecom markets showed that the Chinese have learned from Japanese mistakes, to wit, that Japanese telecom equipment companies tied their fortunes too closely to Japanese carriers, ‘which developed technological standards that they expected the rest of the world to adopt. When that didn’t happen, the Japanese vendors became captives of their home market’ (Rhoads and Hutzler 2004). NTT was Japan’s largest employer throughout the 1980s and into the 1990s (291,000 employees in 1989), the world’s most valuable company until the early 1990s, the centre of Japanese telecom R&D activity, and an engine of national economic growth. Not surprisingly, privatization and breakup had major implications for other institutional actors including the unions, NTT equipment suppliers, the ministries, and politicians. The unions were particularly active and effective in opposing the breakup (Tilton 2003: 3). Finally, as

34

The telecommunication industry NTT was seen as the core of Japan’s R&D capabilities in telecom, a breakup was seen as a threat to these capabilities. The breakup of AT&T and resultant dissipation and splintering of R&D capabilities was held up as an example to be avoided at all costs. Predictably, the combined external forces for inertia were large and strong. There were also powerful internal institutional rigidities that slowed NTT’s support for the emergence of networking technologies in the form of new products and services. NTT researchers didn’t see the potential of TCP (Transmission Control Protocol)/IP (Internet Protocol)–layers four and three of the layered network reference model) and the Ethernet (layers two and below of the layered network), in part because of their ingrained focus on the need for high reliability systems for provision of domestic universal service. This, after all, had been their long-term mandate. We see, however, that under certain conditions the vaunted quality of Japanese firms can be the enemy of innovation. The Internet, based on packet technology, was a ‘best effort’ network that did not initially match the traditional quality benchmarks (in the network area these are known as Quality of Service (QoS) benchmarks) provided in universal voice service. In particular, it was in the beginning quite deficient in minimizing delays and in providing sufficient bandwidth guarantees as well as in insuring reliability (correctness of data transfer). As a best effort network, the Internet does not guarantee delivery of specific messages and involves re-transmission of dropped packets. In the early 2000s some 3 percent of all packets sent daily were dropped.1 Moreover, each packet is delayed by variable and unknown amounts and the bandwidth available to each connection is unpredictable. The traditional ‘five nines’ (99.999 percent) reliability target of telephone companies was simply not a design requirement for the Internet architects. All this was anathema to the QoS culture of NTT. The many low QoS and reliability features exhibited by the early Internet are a common feature of disruptive technologies (Christensen 1997). Engineers, however, are often able to incrementally add new features and improve reliability as one after another of the technical problems of disruptive technologies gets resolved. High reliability organizations, like traditional telephone companies in particular, have a great deal of difficulty in understanding and responding positively to disruptive technologies with these trajectories because they initially challenge existing value propositions. (See Yunogami in this volume for the consequences of strong emphasis on reliability in the semiconductor industry when applications and markets changed.) In the late 1990s there were still senior NTT executives who didn’t understand TCP/IP. Moreover, most NTT researchers, well into the mid-1990s, still by and large preferred Asynchronous Transfer Mode (ATM) technology as their mainstream approach to networking and viewed TCP/IP as an interesting option. Indeed, the IP router was only one of many possible pieces of

35

Industries, technologies, and value chains equipment for building the data network. Many NTT researchers preferred ‘IP over ATM’ as the ideal solution from the point of view of providing high QoS. It was not a matter, however, of choosing between two new promising technologies. NTT began research on ATM switching in the mid-1980s. ATM was a ‘competency-enhancingtechnology’(Anderson andTushman1997: 48–50) in that it was a natural extension of the existing public telephone network relying on circuit switching. In circuit switching, distance and duration of connection determine the cost of communication service (Yamashita 2004: 1). Such competency enhancing technologies are typically easier to incorporate into incumbent organizations and thus they are more attracted to them. NTT predictably wanted to continue to extract high levels of profit from their existing fixed line investments. Moreover, ATM was consistent with the high reliability culture of NTT. ATM is connection oriented, meaning that all host to host communications requests are provided a connection (fixed route) through the network. There are two alternative approaches to transmission. The first is to devise complex mechanisms in the core to reduce error; this is the path followed by ATM in the effort to deliver guaranteed QoS. The second is to have terminals located around the network and to engage in re-transmission when error occurs; this is the path followed by Internet architects. The development of ATM was designed to improve NTT’s existing digital switches. Originally designed for voice, NTT officials were convinced ATM could be made to be multipurpose. They believed in the early 1990s that ATM was the ultimate solution mixing voice and data traffic over fibre. In 1991 Fujitsu became the first company worldwide to offer an ATM switching system that enabled high speed, two way transmission and routing of voice, video, and data simultaneously. In the early 1990s, NTT anticipated replacing the existing current narrow band digital network with the large capacity broadband ATM trunkline network somewhere around the year 2000 (Fransman 1995: 86, 116, 123). NTT officials were confident that they were leaders en route to building the new information highway. They pursued this dead end trajectory with the strong support and urging of the Ministry of Post and Telecommunications, buttressed by tax incentives and public money. Rather than wait and let equipment suppliers take the lead in developing ATM switches, NTT took the initiative and led its suppliers in developing this new technology. This also involved NTT taking the lead in developing the software required for the broadband ISDN services that they expected to be deployed over this network. In this way NTT thought it would insure that it accumulated and controlled the key competencies required for operating, maintaining, and modifying the switch software necessary for providing new services. This was in keeping with its long-standing view that it was their job to take the lead in advance of the equipment vendors in developing complex new technologies (Fransman 1995: 115–16, 119). Correspondingly, this led equipment vendors to

36

The telecommunication industry take a passive view and wait for NTT to take the lead when confronting complex technologies. As we shall see shortly, this passivity had disastrous consequences for Japan’s emergent network infrastructure industry. In 1995 NTT was experimenting with vBNS, a network built on the commercial ATM lines. It was built with a speed of 155 Mb/s and was expanded to 622 Mb/s in two years. Those collaborating with NTT aimed for a speed of 2.4 Gb/s. This group concluded at the end of 1997 that it was not feasible to achieve 2.4 Gb/s and that it would be more effective to exclude ATM from the network and utilize IP directly over SONET [Synchronous Optical Networking]. SONET is a layer two network technology for communication over optical fibre. It is only at this point that NTT executives began to realize that ATM was not the ultimate end to end solution (Oie et al. 2001: 184–5). In 1997–98 they finally realized that everything needed to be changed. This recognition was delayed by the strong internal political commitment to ATM. NTT had incurred a substantial investment in ATM switches and had developed rated products. Its executives didn’t want to admit failure even after key engineers in their Basic Research Lab concluded that ATM could not provide the speed possible with TCP/IP over SONET and the Ethernet. In particular the Network Service Systems group, which made telephone switching systems for ATM, continued to push ATM and lobbied NTT executives to continue supporting it throughout much of the 1990s. It was not until the late 1990s that NTT finally stopped their research on telephone switching units based on ATM. In late 1999 the mobile phone market was growing rapidly and the number of subscribers to DoCoMo’s i-mode was exploding. NEC, accustomed to following NTT’s lead, shifted resources including personnel who had worked on ATM over to second generation phones. They thought it would have potential for export markets to China and Europe, a hope that would prove unfounded. Of course, NTT engineers were not ignorant of the emergent Internet technology. A small informal group promoting Internet concepts emerged in NTT in the early 1980s.2 Dr Shigeki Goto, a research group leader (kacho) at the NTT Research Laboratories, arranged to send a Dr Okuno to Stanford University. With Ken Murakami as the lead person, the Japanese team finally succeeded in 1988 in connecting the NTT Laboratories Computer Network to the CSNet (Computer Science Net) and ARPANET through CSNET in the US. Even this was done informally because at the time NTT was forbidden by the government to engage in overseas activities. The Internet group operated initially as a ‘skunkworks’ (an informal group flying under the radar of the formal organization). A key step in the process of formal recognition of this group came in 1992 when Shigeki Goto became a department head (bucho). This enabled him to start several Internet projects with the official support of the Director of NTT Software laboratories. The initially small pro-Internet group promoted TCP/IP and the Ethernet as desirable solutions and gradually key researchers were won over. The turning

37

Industries, technologies, and value chains point for them to accept TCP/IP was the arrival of Mosaic in the period 1993–95. Nevertheless, as we saw above, top NTT executives continued to resist these networking solutions until the late 1990s.3 With this background in mind it is not surprising that the Japanese electronics industry has lagged in the introduction of cutting edge products and services associated with networking. ISDN requires digital switches, and many of their researchers were kept busy with the very consuming task of developing all sorts of equipment to allow the telephone lines to handle data. By contrast, TCP/IP requires routers, network interface cards, and sophisticated software such as network configuration management software. TCP/IP protocols are mostly implemented in software, running at both the router’s and the user’s computers. When one examines the global market for these products one is struck by the almost complete absence of Japanese vendors (International Data Corporation 2000). Without a strong domestic market in the networking products associated with TCP/IP and the Ethernet Japanese electronic firms were unable to build up scale economies that could serve as a platform for competing in international markets. In a Soumusho-commissioned survey of Japanese and foreign information communications researchers, respondents were surveyed on the superiority of Japan, the US and Europe in specific information and communication technologies. Respondents saw great Japanese strength in intelligent home appliances, mobile terminals, and optical communications. They ranked the Japanese weakest, however, in software, the Internet, content production support, computer systems, and security. In these areas, they acknowledged overwhelming American superiority (Soumusho 2003: 10).

Other (non)players In summary, the major Japanese electronic firms were accustomed to relying on NTT to set future technology directions in the field of communications. With NTT being slow to grasp the significance of TCP/IP and the Ethernet, the major electronic firms lagged in the development of ICT products and services. We can see this being played out in the behaviour of NEC and Fujitsu. In the early 1990s, Masao Hibino, President and CEO of NEC Magnus Communications, was General Manager of Modem Development at NEC and stationed in Silicon Valley. He thought TCP/IP and the Ethernet were important developments and sent information to NEC offices in Tokyo to that effect. They responded, however, that ‘TCP-IP’ wasn’t real communication because it was ‘connection-less’. In short, without a dedicated connection, they believed that there was no real communication. At this time he says, ‘NEC people thought ATM delivering ISDN services was the final solution to broadband. Everyone in Japan thought so and we worked with ITU-T

38

The telecommunication industry (International Telecommunication Union–Telecommunication Standardization Sector) to get each standard approved for ATM’. NEC also had mid-career Industrial Associates at UC Berkeley and these individuals were aware of the evolving Internet technology. Even when these individuals realized the significance of the Internet, however, they were reluctant to take the kind of risks that would be entailed in strongly championing what was seen at their firm as a nonmainstream technology. By the time NTT and the electronic companies began to focus strongly on the Internet, Cisco had already disseminated its products in the market and it was hard for NEC to differentiate its products and find a niche market. At the same time, the hardware and especially the software had become complex. Cisco had proprietary IOS intellectual property based on TCP/IP protocol. To simply copy Cisco products would have led to legal action from Cisco, so in 1997 NEC made the decision to distribute Cisco routers, hubs, and switches. The problem, however, was not simply Cisco’s intellectual property rights per se; Japanese vendors could develop their own router codes to get around that. The challenge was posed by the operator’s (enterprise’s) deployment and familiarity with Cisco’s router command interface (CLI). Customers wanted to insure that any new hardware and software had interoperability and compatibility with Cisco products and operations. Cisco also protects its competitive position from new entries by virtue of the extensive versions of its software that accommodate different legacy systems. No other competitor can match that connectivity.4 Seeking to keep pace with the evolving technology, NEC and Hitachi announced plans in December 2003 to jointly develop next generation routers designed for high speed Internet connections to telecom service providers. The total development costs over a three year period were estimated to be about ¥20 billion (US $180 million dollars) with half the cost to be subsidized by METI (Nihon Keizai Shimbun 2003: 3). It is remarkable (or perhaps unremarkable) that despite strong foreign and domestic criticism of METI’s old style ‘industrial targeting’, it continues to orchestrate and invest in such downstream product development activities. The situation at Fujitsu was somewhat similar to NECs, but with some variance. In the mid- and late 1990s, Fujitsu had two groups that were relevant for adoption of Internet related technologies: the Communications Systems Group that focused on sales to the telecom sector and carriers like NTT, and the Computer and Information Processing Group concentrated on sales to enterprises. The Communications Systems Group, like NEC, was accustomed to following the direction set by its lead customer, NTT, and thus saw the future as one dominated by ATM delivering ISDN services. As a consequence, it was not open to the Internet’s potential. By contrast the Computer and Information Processing Group, focused on sales to enterprises, was more open to Internet technologies. The problem here

39

Industries, technologies, and value chains was that investment decisions were made for them by top leaders higher up in the corporation who, at the time, did not appreciate the Internet’s potential and ignored the needs of emergent Internet businesses. So Fujitsu ended up investing heavily in carrier routers but not enterprise routers. In so doing, they abandoned the enterprise global market to Cisco.5 Fujitsu continued to manufacture a relatively full line of data communication products such as switches and routers and simple equipment such as repeaters and hubs. Most products, however, are designed for the domestic market, though there are some modest sales of routers and switches to SE Asia, and it does have a leading position in the global market for SONET, including an estimated 28 percent of the American market (Takemoto 2004: B3). In early 2004, Fujitsu announced it would stop developing routers by itself and would distribute routers from outside companies. Fujitsu said it would seek to rebuild its telecom business by strengthening the development of lowprice servers with router functions, distributing products of other manufacturers and exploring co-development with other large electronic companies (Nihon Keizai Shimbun 2004: 13). Cisco moved with incredible speed to build market share, using its elevated stock price to acquire start-ups that had the desired sets of skills and product lines. Originally they had made only a small part of the router but with the build up of their capabilities through mergers and acquisitions, they could market the whole router. As a result they secured tremendous first mover advantages as discussed above. None of the large vertically integrated Japanese electronic companies were capable of that kind of speed. The big US players like HP, IBM, and Lucent were somewhat faster to recognize the significance of the Internet than the large Japanese electronic companies, but they too were not fast enough to respond effectively to Cisco. The pace at which NTT came to recognize the significance of TCP/IP undoubtedly would have accelerated if the conditions had been created for the entry of new firms committed to innovation; they would have put pressure on NTT and would have provided the opportunities for acquisition that were available to Cisco. Even if NTT had speeded up its timetable for recognizing the importance of TCP/IP, however, what NTT did or did not do would not have mattered as much if the institutional field for networking had been augmented by new firm entries. Such firms would not have been constrained by the traditional mission of ‘five nines’ reliability, or the commitment to building on existing competencies by using the public telephone network, or by NTT’s past political commitments to ATM. Nationally, the conditions favourable for market entry by new venture start-ups, however, had not been created. To be sure it can be argued that from the time information about the foundations of the Internet first came to the attention of NTT researchers to the point in the late 1990s when TCP/IP and the Ethernet became accepted as the de facto standard for networking, NTT made–from a historical

40

The telecommunication industry perspective–a rather quick adaptation to a discontinuous technology. Shigeki Goto makes this argument and he certainly is correct.6 From the perspective of coping effectively with the rapidly changing competitive environment, however, one can make an equally strong argument that the process of adaptation was painfully slow.

Setting standards Of particular relevance is NTT’s decision to have the entire ATM network go through the ITU (International Telecommunications Union) standardization process prior to implementation; this consumed a great deal of time. ITU is the international organization within the United Nations’ System where governments and private sector companies coordinate global telecom networks and services. The Europeans, who traditionally liked to standardize around one technology, have been particularly active in ITU. The ITU has been known for its very slow standardization process whereby protocol suites are discussed at face to face meetings and then put out to review by mail. Each country’s representatives can propose the ultimate solution that they would like and this leads to a long iterative process of negotiation and further discussion before a common standard is finally selected. Moreover, to satisfy as many of these constituencies as possible, the solutions have tended to involve complex protocol solutions that are difficult to implement. NTT had long been committed to working with ITU and it was only natural that they would continue to do so with ATM. If researchers/engineers working on international standards wanted to be promoted at NTT it was fully expected that they would work with ITU. A quite different approach, however, was taken by the IETF (Internet Engineering Task Force) in which Americans have been the most active members. This organization is made up of volunteers from the international community. The IETF had its beginnings in 1986 at a meeting in San Diego attended by 21 individuals and has evolved into the principal body engaged in the development of new Internet standard specifications. It holds three meetings a year but the primary goal at these meetings is not to set policy or to agree on standards but to reinvigorate the working groups where the vast majority of IETF work is done. Each working group has a charter and a chair whose job it is to keep the discussion on track. Much of the work effort is done between meetings relying heavily on online communication; emergent policies are by rough consensus. Proposed specifications are repeatedly discussed and their merits debated in open meetings and especially in public electronic mailing lists and made available via worldwide online directories. One joins a working group by subscribing to the mailing list for a given group. The face to face working group meetings are much less important than the need to gain consensus on

41

Industries, technologies, and value chains the working group mailing list. Every IETF standard is published as an RFC (Request for Comments) and every RFC starts out as an Internet Draft. Internet Drafts can be submitted by an individual or as a product of a working group. After an Internet draft has been sufficiently discussed, and if there is rough consensus that it would be a useful standard, it is presented to the Internet Engineering Steering Group (IESG) for consideration. The IESG, after soliciting still further comments, has the authority to approve the draft as a Proposed Standard. Before this happens, however, it is ‘highly desirable’ that there be independent interoperable implementations of each part of the standard. The more the number of successful independent interoperable implementations, the more substantial the operational experience, and the more the candidate specification is used in increasingly demanding environments, the more likely the draft will be accepted and eventually become a Draft or Internet Standard. Most of the standards in common use are Proposed or Draft Standards that have never moved forward to the status of ‘full’ Internet Standards. Often this is because people found more important projects to work on or the specification is not considered all that important. This suggests a much less bureaucratic organization than the ITU. Moreover, many of the protocols that are standardized at the IETF have been relatively simple compared to ATM, and required fewer people to work on them. The simplicity of the Internet architecture and the low expectations of performance (relative to ATM) make this possible.7 Moreover, standards were approved even more swiftly in the early days of the IETF when the numbers participating were still smaller. Over time, and with the growing interest of commercial organizations, it inevitably is becoming more structured in its procedures. As a result of these working routines, IETF has been much more responsive to real time market forces in its development of new Internet standard specifications than was ITU in its development of ATM standards. As we have seen, the Internet community’s support for a given standard, ceteris paribus, is stronger for technology solutions that have been successfully deployed. Letting the market place decide the winners, while not without its problems, tends to be a faster process. This case is also instructive for researchers who commonly distinguish between de jure standards created by committees and de facto standards created by markets (Besen and Farrell 1994; Funk 2002: 1). The IETF process shows that a committee-based approach facilitated by online communication can be a powerful force that is quite in line with market forces (see Shapiro and Varian 1999). Finally, Japanese researchers played only a minor role in setting IETF’s Internet standards in the critical early years (1986–96). While the number of Japanese attending IETF meetings has grown in recent years, they participate mostly as observers rather than as active members. That is telling in terms of their continuing status as followers not leaders. Failure to master the standard setting process can leave ICT firms at an acute competitive disadvantage. This is because firms and nations typically seek to use the global standard setting

42

The telecommunication industry process to enhance their own competitive positions by seeking to incorporate into the global standard their solutions or solutions that are compatible with their capabilities.

Conclusion The decades of the 1980s and 1990s saw a huge opportunity missed with Japan’s failure to deregulate telecom and break up NTT’s monopoly power. As a result, NTT was able to keep prices high (therefore limiting the spread of the Internet) and to push its own proprietary technologies. This delay severely retarded the development of ICT infrastructure and that, in turn, led to a retarded development of ICT products and services. Institutional rigidity and ill-conceived decisions regarding standard setting have clearly slowed the growth of Japan’s ICT sector. The absence of a hospitable environment for new ventures and the constraints imposed by relationship contracting on key electronic firms by their ties to an NTT committed to ATM technologies slowed the private sector’s embrace of the Internet and related networking technologies. As a result, US firms reaped huge first mover advantages in the global network equipment industry. With respect to Internet related patents, the US holds a commanding lead over Japan with 4.6 times as many patents (Soumusho 2003: 41). To be sure, the advantages held by Japan’s competitors are by no means unassailable. There is growing deregulation in the Japanese telecom market with real competition being provided by up-starts like Softbank. Japanese firms need to learn to participate more effectively in the international standard setting process, however. The weakness they have demonstrated in the past in setting global standards, whether it be a function of poor English capabilities, or a naive belief that the best technology will always win, or their insularity, or their own engineering arrogance, or a failure to join the shift from a traditional committee-based approach to the more dynamic IETF model, or some combination of all of these factors, has put them in a disadvantaged position. There are larger forces on the horizon that contain the seeds of a Japanese revival. While US firms are superior to Japanese firms in the conventional PC-centred Internet and related technologies of content, production, and security, many experts predict that the future will be one of ubiquitous networks centred on mobile communications technology. It is here that Japanese firms have significant advantages. Their wireless technology is quite sophisticated. Mobile communications technology requires terminal technology for overcoming restrictions of receiving devices and of terminals; it also requires optical technology for overcoming performance problems. These are areas in which the Japanese are quite strong (Soumusho 2004: 10–11). Wireless networks and ubiquitous computing using cell phones provide Japanese firms an opportunity to break Cisco’s near monopoly on the network equipment business.

43

Industries, technologies, and value chains There are many US researchers, however, who believe that the future lies in wireless sensor nets providing the key platform, not the mobile phone. They envision a smorgasbord of seamlessly interfaced wireless technologies such as WiMax (long-range wireless networking), WiFi (short-range networking), and self-configuring self-powered mote networks enabling a range of wireless applications. Should the cell phone be less central to the emergent solutions then Japanese potential advantages will be correspondingly reduced. In the networking area, although their global market share is very low, Japanese producers have maintained a high level of technology through servicing domestic firms so that should an opportunity occur, they are in a position to capitalize on it. Japanese firms and government officials are exploring possible alliances with Chinese and Korean firms to challenge Cisco’s dominant position, and were they to unite on setting technology standards, their international clout would be formidable. We have attributed Japan’s problems to a complex set of factors around the management of technology ranging from NTT management making the wrong technology bets on ATM and ISDN, institutional rigidities within NTT, damaging approaches to standards, to a failure to move more strongly to restructure the slow moving monopolistic NTT. There are those, however, who attribute Japan’s decline in telecommunication global markets to the weakening of NTT. To those proponents we can ask the following question. Would Japanese consumers have experienced the recent rapid spread of DSL and rapidly falling prices if NTT had been stronger? The answer is clearly, no. Indeed, the consequences of an even more rapid restructuring of NTT accompanied by the strong encouragement of new entries and the rapid introduction of new technology might have led to even more positive outcomes for the Japanese telecom sector and consumers. Such initiatives would have produced wide benefits for Japan’s whole economy and society. AT&T’s standing in the US now is but a shell of its former formidable organizational body. Who can deny, however, that the US, despite the excesses of the 1990s and resultant over-capacity in fibre networks, has emerged much stronger in global telecommunications as a result of the AT&T breakup. Such is the power of ‘creative destruction’ as envisioned by Joseph Schumpeter. It is one of the features of industrial evolution that market forces sometimes may lead to better management of technology than governments’ efforts to protect incumbents and micro-manage business decisions.

Notes 1. Lecture by John Chuang, 10 Sept. 2001, UC Berkeley. John Chuang is Professor of Information Management Systems at UC Berkeley.

44

The telecommunication industry 2. I am indebted above all for this account of Internet development at NTT to Dr Shigeki Goto of the School of Science and Engineering, Waseda University and formerly of NTT, and also to Ken Murakami, Senior Research Scientist at NTT laboratories. 3. This section is based on an interview with Prof. Shigeki Goto, Waseda University, Tokyo, on 11 June 2003. 4. This section draws heavily on an interview with Masao Hibino, President and CEO of Magnus Communications Ltd, 23 Oct. 2003. 5. I am indebted to Haruki Koretomo, Chief Scientist, Network Systems Group of Fujitsu for this account, 22 Oct. 2003. 6. Interview with Prof. Shigeki Goto, Waseda University, Tokyo, 11 June 2003. 7. This section relies heavily on two IETF documents: Bradner 1996: 1–31; IETF 2001: 1–27. I also benefited from the observations of Ye Xia of the University of Florida, Gainesville, and Ken Murakami, Senior Research Scientist, NTT Laboratories.

References Anderson, P. and M. Tushman (1997). ‘Managing Through Cycles of Technological Change’, in M. Tushman and P. Anderson (eds.) Managing Strategic Innovation and Change, New York: Oxford University Press. Besen, S. and J. Farrell (1994). ‘Choosing How to Compete: Strategies and tactics in standardization’, Journal of Economic Perspectives, 8: 117–31. Bradner, S. (1996). The Internet Standards Process—Revision 3, Network Working Group, IETF, http://www.ietf.org/rfc/rfc2026.txt Christensen, C. (1997). The Innovator’s Dilemma: When new technology causes great firms to fail, Boston: Harvard Business School Press. Dore, R. (1987). Taking Japan Seriously, Stanford: Stanford University Press. Fransman, M. (1995). Japan’s Computer and Communication Industry, New York: Oxford University Press. Funk, J. (2002). Global Competition Between and Within Standards, Hounsdsmills, Basingstoke, Hampshire, UK: Palgrave. IETF (2001). The Tao of IETF: A novice’s guide to the Internet engineering task force, http://www.ietf.org/tao.html International Data Corporation (2000). Worldwide Computer Networking Equipment Supplier Shipment Share, Framingham: IDC. Matsuo, T. (2003). Policy Strategies for Knowledge-driven Growth—The OECD approach, Washington DC: OECD, 22 January, L: 1–49. Messerschmitt, D. (2000). Understanding Networked Applications, San Francisco: Morgan Kaufmann. Nihon Keizai Shimbun (2003). ‘NEC, Hitachi Kyoudou Kaihatsu’ (NEC and Hitachi in Joint Development), Nikkei Shimbun, 17 Dec.: 3. Nihon Keizai Shimbun (2004). ‘Fujitsu, Routa Gaibu Choutatsu’ (Fujitsu will Procure Routers from Outside) Nikkei Shimbun, 20 Feb.: 13. OECD (2003). OECD Communications Outlook, Paris: Organisation for Economic Co-operation and Development.

45

Industries, technologies, and value chains Oie, Y., S. Goto, K. Konishi, and S. Nishio (2001). ‘Intanettou Dai 1 sho: Intanettou Nyumon’ (The Internet Volume!: An introduction to the Internet), Tokyo: Iwanami Shoten. Rhoads, C. and C. Hutzler (2004). China Telecom Forays Squeeze Struggling Rivals, WJS.com, http://online.wsj.com/artricle/),SB109459495670311660,00.html ** Semilof, M. (2000). Cisco’s Challengers, 16 October, http://www.crn.com. Shapiro, C. and H. Varian (1999). Information Rules, Boston: Harvard Business School Press. Soumusho (2003). Information and Communication in Japan 2002 White Paper, Tokyo: Ministry of Public Management, Home Affairs, Posts and Telecommunications. Soumusho (2004). Reference on Perception of Superior Technologies in J vs U.S., p. 10. Takemoto, Y. (2004). ‘Fujitsu Expects 16% Rise in U.S. Sales’, International Herald Tribune, 13 May: 13. Temin, P. (1987). The Fall of the Bell System, New York: Cambridge University Press. Tilton, M. (2003) ‘Ideas, Institutions, and Interests in the Shaping of Telecommunication Reform: Japan and the USA’, in L. Weiss (ed.) States in the Global Economy, New York: Cambridge University Press. Vogel, S. (1997). ‘Telecommunication Reform in Japan’, in Japan Information Access Project, Japanese Deregulation: What you should know, Proceedings (April): 143–53. Yamashita, M. (2004). ‘Towards the Emerging Ubiquitous Networks Society’, Japan Economic Currents, 43(April): 1–3, 8. Yamazaki, R. (2003). ‘Kesu Sutadei Shisuko Shisutemuzu: Gyakukyo o bane ni kousei’ (Case Study Cisco Systems: Aggressiveness After The Crisis), Nikkei Business, 26 May: 49–50.

46

3 Modular production’s impact on Japan’s electronics industry1 Timothy J. Sturgeon

Global integration has accelerated the worldwide flow of knowledge and information, causing societies to become embedded in one another in complex ways, even as they retain their distinctive characters. This chapter examines the process of global integration through the lens of national industrial models–the collection of routines and strategies generally shared by corporate managers in a particular society. Some might question the notion of national industrial models, rightly pointing to diversity among firms based in a specific society. All Japanese firms, for example, are not the same (Suzuki 2004). I would agree with Berger’s (2005) assertion that managers face ‘open pathways’ and so can and do choose a range of strategies. Nevertheless, societies continue to have distinct cultures, institutions, and histories, and so differences persist in the face of global integration in ways that profoundly shape corporate strategy. In the course of sustained field research on the locational and organization strategies of more than 600 firms in a variety of industries and countries conducted by a team of researchers at the MIT Industrial Performance Center during the period 1999–2005, such national characteristics were evident.2 At the same time, the managers interviewed were clearly making choices based on what they perceived companies in other societies to be doing. It is this process of outside pressure, reflection, and response that is at the heart of this chapter’s analysis. As a window into the process of global integration, the chapter develops a stylized account of Japanese electronics firms’ response to a new organizational model emanating from the United States: the Modular Production System. The account is stylized both because it is intended to tell a general story about the Japanese electronics industry and because we are required to omit firm-specific data collected during our field interviews to protect the personal and corporate confidentiality of our respondents. There were many differences as well as similarities in the strategies chosen and concerns

47

Industries, technologies, and value chains expressed during our interviews, and an analysis of these differences would doubtless be fruitful, but my aim here is to highlight areas of agreement and similarity.

The evolution and circulation of industrial models Industrial models consist of a range of norms, practices, routines, and tendencies. As such, they are always stereotypical, and firms vary widely in how closely they hew to the stereotype. Nevertheless, industrial models have been characterized at a variety of levels. Some have coalesced at specific historical moments across a wide range of countries, such as the post World War II ‘social contract’ between labour and capital that emerged in the United States, Europe, and Japan in the post World War II period, albeit in different forms. Others have been associated with groups of countries; individual countries; industries in specific countries; regions within countries; and even individual large firms. The core idea that has emerged from this work is that alternative viable forms of industry and corporate organization can co-exist within capitalism (Berger and Dore 1996). But what of the notion that global competition and integration accelerate the degree to which industrial models influence one another? There is a rich body of literature in this area as well, from work that documents the rise and uneven geographic spread of ‘financialization’, the increased responsiveness of publicly traded firms to pressure from financial analysts and large institutional investors (Lazonick and O’Sullivan 2000; Williams 2000) to research on how the collection of ‘best’ industrial practices known as Lean Production (Womack et al. 1990) have been differentially adopted and adapted by managers from different societal home bases and in different industrial sectors (e.g., Abo 1994; Liker et al. 1999). The central message here is that industrial models are not static but evolve with time, and that the pace of transformation tends to accelerate when practices are transferred from one society to another. The Japanese Production System, for example, emerged in the 1950s and 1960s as Japanese firms adapted the principles of ‘Fordist’ mass production to the constraints of the post World War II Japanese economy, namely small markets, scarce capital, and limited consumer spending power (Sayer 1986). Because of the success of Japanese firms in the 1980s, some of the key principals of the Japanese Production System in turn had a profound impact on the organization of industrial production in the United States and Europe in the 1990s. But the elements of Lean Production were introduced into societies with very different institutional structures and industrial histories, and so the process has been one of adaptation and transformation rather than of simple imitation and adoption.

48

Modular production’s impact There is now a rich literature on how the Japanese Production System has been adopted and adapted differentially in various industries, companies, workplaces, and stages of the value chain (e.g., Kenney and Florida 1993; Abo 1994; Liker et al. 1999; Holweg and Pil 2004). American firms did respond to the Japanese Production System, and the MIT book that codified its elements as ‘Lean Production’ (The Machine That Changed the World), was extremely influential among managers in the automotive industry and beyond. North American investments by Japanese firms in the 1980s and 1990s also did much to expose managers and workers at American suppliers to key elements of the Japanese Production System. These lessons resulted in an increased focus on quality at American firms, achieved through systematic and continuous defect reduction programmes and reduced in-process inventories (Cole 1999). In the realm of industry organization, however, the value chain elements of Lean Production that admonished lead firms to ask more from their suppliers dovetailed with other forces in the United States that were both driving and enabling increased outsourcing. I will refer to the industrial model that emerged from this process as the Modular Production System.

Value chain modularity as a response to the Japanese production system Outsourcing became extremely popular in the United States in the1990s, and it was driven by some of the same motivations that exist in Japan: the search for greater flexibility in the face of increased international competition and market volatility through the transfer of fixed assets and inventory to suppliers. A close lead firm–supplier relationship was a key aspect of the Japanese Production System. Japanese lead firms tend to be relatively vertically integrated, and when suppliers are heavily used, they are more likely to be highly dependent on one or a small number of key customer firms. Buyer–supplier relationships have traditionally been canted towards affiliates of the same industrial group, or keiretsu. The qualification process for new suppliers (Japanese and non-Japanese) can be extremely lengthy. Lead firms may make equity investments in their suppliers and can in some cases come to dominate them financially.3 Lead firms often provide the required technical assistance and financial support to help affiliated suppliers adopt asset-specific production technologies, inventory management, capacity planning, and quality control systems. These tight linkages between lead and suppliers have been identified as a source of competitive advantage for Japanese firms (Dyer 1996). While in the United States outsourcing grew beyond anything that had been imagined in Japan, one striking difference was that relationships with

49

Industries, technologies, and value chains suppliers did not change their adversarial tone, but retained much of their arms-length, short-term, and contractual character (Helper 1991). Nevertheless, the challenges of transferring and coordinating complex and sensitive information along the supply chain, reducing in-process inventories, and ensuring quality remained. Here American industry drew on its long history of systems integration, ‘the art of conceiving, designing, and managing the development of large systems involving multiple disciplines and many participating organizations’ (Sapolsky 2003: 31).4 Elsewhere I and others have characterized the new model that emerged in the United States during the 1990s, in part as a response to Lean Production and in part as a response to home grown pressures to ‘re-engineer’ the corporate landscape, as the ‘Modular Production System’. It is based on value chain specialization, formalization of value chain linkages, and an increase in the scale and global reach of each horizontal segment–or ‘module’–of the value chain.5 In modular value chains distinct breaks in the chain of activities tend to form at points where information regarding product and process specifications can be highly formalized. As in modular product design, activities tend to remain tightly integrated and based on tacit linkages within functionally specialized value chain nodes. Between these nodes, however, linkages are eased by the application of widely agreed upon protocols and standards. Discrete nodes of tacit activity can reside within divisions of the same firm, but only when activities are outsourced can scale economies build up beyond the level of the firm (Langlois and Robertson 1995). According to Pavitt (2003), the robustness of systems integration in the face of growing complexity in the realm of commercial products has been enabled by advances in information technology, especially computer simulation technologies that reduce the cost of experimentation and technological search. This has enabled the development of simplified and codified methods for transmitting detailed product and production information along the value chain. Specifically, the key business processes that have been computerized are product design (e.g., computer aided design), production planning, and inventory and logistic control (e.g., enterprise resource planning), as well as various aspects of the production process itself (e.g., assembly, test and inspection, material handling). Furthermore, the Internet has provided an ideal vehicle for sharing the data generated and used by these systems. Such technologies and practices are at the core of the Modular Production System. It is the formalization of information and knowledge at the inter-firm link, and the relative independence of the participating firms that gives value chain modularity its essential character: flexibility, resiliency, speed, and economies of scale that accrue at the level of the industry rather than the firm (Sturgeon and Lee 2005).6 Value chain modularity introduces risks as well as benefits for participating firms. Responsiveness may suffer as contracts are hammered out. There is

50

Modular production’s impact potential for intellectual property and other sensitive information about product features, pricing, production forecasts, and customers to leak to competitors through shared suppliers. The ability of lead firms to innovate and design successive product generations may suffer from the atrophying of manufacturing and component knowledge, a problem that has been referred to by Chesbrough and Kusunoki (2001) as the ‘modularity trap’. Reliance on standard interfaces may lead to the use of standard components, leading in turn to a loss of product distinctiveness. Shared and overlapping inventory resident in supplier organizations can lead to distortions and tracking problems that introduce waste. How the risks and benefits of the Modular Production System balance out depends, like all things in business, on execution. Both lead firms and suppliers must perform their respective tasks well, anticipate problems before they occur, and deal with them effectively when they inevitably do. One unavoidable issue is that independent firms in buyer–supplier relationships often have competing interests. In sum, there appears to be no single best way to organize production. Takeishi and Fujimoto (2003) argue that firms and industries that make products with integral product architectures7 tend to have integral value chains, while firms and industries that make products with modular product architectures tend to have modular value chains. But value chain architecture is not always a function of design architecture. As Baldwin and Clark (2000) have shown, there are many cases in which break points in modular value chains have been willfully engineered. While products with highly modular design architectures such as the personal computer certainly make value chain modularity more likely, even a single modular link in the flow of activities, such as the link between an integral design and manufacturing, can unleash the dynamics of value chain modularity. In addition, firms such as Autodesk, Cadence, and Mentor Graphics have aggressively created new opportunities for value chain modularity by developing and marketing design automation tools that produce files in standard format. The degree of modularity in a given chain of activities thus involves a large measure of strategic choice, and is not a simple function of design architecture. The question, then, is how well a given industrial model fits with the product, industry, and larger institutional and competitive factors that influence firm strategy. What is clear is that national scale institutions heavily influence managerial choices related to industry organization. For example, corporate responses to intensified competition and market volatility depend on the strength of worker protection and how well the institutions of new firm formation function at the level of the nation-state. In the United States, volatility is high, not only because globalization and technological change displace workers in vulnerable industries, but also because worker protection is relatively weak

51

Industries, technologies, and value chains and labour unions have been in serious decline for decades (only 8.5 percent of the United States private sector workforce is unionized). On the other hand, the financial and regulatory mechanisms that enable rapid entrepreneurship and corporate restructuring are very strong, and so volatility has spurred the formation of new kinds of businesses that focus on the pooling and rapid redeployment of workers and machines. Today, lead firms in the United States can lease almost anything, from workers to trucks to entire factories by making a phone call to Adecco, Ryder, or Solectron. These large, specialized suppliers have arisen in direct response to increased volatility. In countries where worker mobility is lower, such as in Japan (Brown et al. 1997), the infrastructure and motivation for new firm formation tends to remain underdeveloped, and so volatility is weakly translated into industry re-organization and modular suppliers of pooled resources have not emerged. In the American electronics industry, value chain modularity took shape during the late 1980s and early 1990s. Because many established firms had in-house manufacturing and components divisions, this change required the breakup of vertically integrated corporate structures and the aggregation of cast-off activities in suppliers. Hewlett Packard and IBM led the way, selling most of their worldwide manufacturing infrastructure to contract manufacturers such as Solectron and Flextronics, or spinning off internal divisions as merchant contract manufacturers, as IBM did with its Toronto manufacturing complex in 1997, creating the contract manufacturer Celestica. Another source of growth in contract manufacturing was increased business from newer firms that never built up internal manufacturing divisions, such as the Internet switch company Cisco and the computer workstation and server firms Sun Microsystems and Silicon Graphics. Circuit board and final product assembly work was mostly transferred to contract manufacturers based in North America, specifically the big five ‘electronics manufacturing services’ (EMS) firms Flextronics, Solectron, Sanmina-SCI, Jabil, and Celestica, while the assembly and even some of the design of notebook computers went to ‘original equipment’ and ‘original design’ (OEM and ODM) contract manufacturers based in Taiwan, such as Quanta, Compal, Inventec, Hon Hai (Foxconn), and the various contract manufacturing arms of Acer. By the end of the 1990s, much of the manufacturing capacity of the Taiwan-based contract manufacturers had shifted to mainland China, and the big five US-based contract manufacturers had established a global-scale network of factories (Sturgeon and Lester 2004). At the level of components, the 1990s was a time of rapid growth among ‘fabless’ semiconductor design firms as well as the semiconductor foundries that serve them, such as the Taiwan-based TSMC and UMC, as well as IBM (Linden and Somaya 2003). Thus, by the end of the 1990s, the Modular Production System in the United States’ electronics industry had become fully developed and global in scope.

52

Modular production’s impact

Competitive challenges to Japan’s electronics industry at the end of the 1990s Value chain modularity came to the attention of Japanese electronics firms in the late 1990s, triggered by the fantastic growth of the Internet and the huge demand for data communications and Internet enabled enterprise computing equipment that came with it. American firms are leaders in nearly all Internetrelated electronics hardware and software product categories; Cisco Systems and Juniper Networks in Internet routers and switches; IBM and Sun Microsystems in powerful computer servers; Dell in personal computers; EMC in storage arrays; Microsoft and Netscape in Internet browsers; Yahoo! and Google in Internet portals and search engines; Amazon and E-Bay in Internet retailing and auctions; and Accenture, Price Waterhouse, McKinsey, and IBM in Internet enabled corporate computing networks. Japanese electronics firms are focused on components, stand alone consumer electronics devices, and proprietary enterprise computing systems that connect client sites through private leased data lines.8 The sudden rise of the Internet, and almost complete lack of any driving role for Japanese electronics firms in this rise, combined with severe financial losses, initiated a period of questioning in the Japanese electronics industry. Cisco Systems, based in California, jumped to an early lead in the market for Internet (TCP/IP) protocol switching equipment. Through a combination of technological excellence and a shrewd and efficient acquisition strategy, Cisco managed to accrue and maintain an 80 percent market share in Internet routers while continuing to drive innovation in the field (Mayer and Kenney 2004). As they rushed to learn about the Internet, Japanese firms looked to Cisco and saw some very striking features. First, Cisco relied almost entirely on third-party systems integrators such as Accenture and McKinsey for the creation of fully functional Internet enabled data networks and enterprise computing systems. Even more striking from the Japanese point of view was that Cisco did not directly produce its own equipment, but relied on contract manufacturers such as Solectron and Flextronics. Cisco’s success was based on its ‘platform leadership’ (Gawer and Cusumano 2002), that is, its ability to drive the standard setting process through technological and market leadership while leveraging the capabilities of its suppliers and customers. The major Japanese electronics firms, on the whole, are much more vertically integrated, with in-house design and manufacturing of many subsystems and components. In 2001 competition from American firms in modular production networks formed only part of the challenge facing Japanese electronics firms. Korean firms such as Samsung, LG Electronics, and Hyundai are highly vertically integrated. Similar to Japanese firms, large Korean electronics firms tend to follow the ‘components plus products’ strategy; they manufacture and sell

53

Industries, technologies, and value chains components on world markets, and use their most advanced components first in their own branded products to the highest degree possible. Until the late 1990s, Japanese companies followed the ‘flying geese’ strategy of licensing older component technologies to less capable firms in Korea and Taiwan and moving to newer technologies without much worry, but by 1999 Korean firms, especially Samsung and LG, began to close the gap in specific consumer electronic and component markets, such as mobile phones, digital cameras, digital televisions, computer monitors, high capacity memory chips, and flat panel displays. In Japan, intensified competitive pressure from both the United States and Korea fostered the widespread impression that Japanese electronics firms were losing pace. This, along with losses at several firms in 1998, focused managerial attention on the practices of rival firms and fostered the consideration of radical shifts in strategy. The build-up of the Internet bubble, and its bursting in 2001, whipsawed Japanese electronics firms along with the global industry, not because Japanese firms were driving innovation in the field, but because they were significant suppliers of components, personal computers, and computer peripheral equipment, the sales of which were being driven by the expanding Internet. As a result, the near moratorium on IT spending that followed the excesses of the Internet bubble deeply affected Japanese firms along with the rest of the industry. But the losses posted in 2001 and 2002, while very large, were this time accompanied by even greater losses at the North American firms that had been most caught up in the mania of the Internet boom, such as Lucent, Nortel, JDS Uniphase, and Solectron. Table 3.1 summarizes the financial performance of the ten largest Japanese electronics firms during the period 1997–2004.

Table 3.1 Net income (loss) of the ten largest Japanese electronics firms, 1996–2004, US$million Firm name

1996

1997

1998

1999

2000

2001

2002

2003

2004

Matsushita Sony Fujitsu NEC Toshiba Hitachi Canon Mitsubishi Sharp Sanyo Top 10

1,228 1,243 411 827 598 800 839 76 433 157 6,612

764 1,812 46 387 60 41 970 (864) 202 101 3,517

107 1,409 (107) (1,190) (109) (2,652) 862 (351) 36 (204) (2,199)

898 1,098 385 94 (252) 152 633 224 253 195 3,681

376 152 77 513 871 946 1,215 1,131 349 366 5,995

(3,427) 123 (3,064) (2,499) (2,035) (3,876) 1,342 (625) 91 11 (13,959)

(160) 948 (1,002) (202) 152 229 1,566 (97) 268 (506) 1,196

374 785 441 364 256 141 2,446 398 539 119 5,862

545 1,527 297 632 429 480 3,200 663 716 (1,599) 6,892

Source : Company reports Notes : Except of Cannon, dates are approximate calendar years ending on 31 March of the year following the year listed. US$ figures were derived from average currency ‘ask’ prices for the period 1 April of the year listed through 31 March of the following year. Currency pricing was obtained from http://www.oanda.com

54

Modular production’s impact

The response to modular production: A new Japanese model?9 This section examines the strategic responses of Japanese electronics firms to Modular Production in the period 2000–04, responses made in the context of the competitive and financial challenges discussed in the previous section. Our interviews (as part of the IPC Globalization Study) reveal that Japanese electronics firms have been strongly influenced by Modular Production but that they have, unsurprisingly, resisted certain aspects of the model while adopting and adapting others. What emerged most powerfully in our interviews was the depth and scope of the questioning taking place within the highest levels of Japanese electronics firms. One respondent summed up the situation in the late spring of 2001 in this way: Mega-competition means we are facing strong companies with narrow core competence, such as Micron and Dell. Such single-function players are very strong. We are an all around diversified player so we cannot fight such players with agility. We have convened a series of one-day meetings to determine how to survive. (Japanese electronics executive, June 2001)

The dilemmas and contradictions facing the largest Japanese electronics companies were great during the interview period, as they continue to be today. Japanese electronics firms are highly diversified and have large numbers of employees both in Japan and abroad. For firms selling enterprise computing systems, key customers in Japan, which prominently include national and local governments, are demanding IT systems comprised of the best hardware and software in the world, and since such systems now must be Internet compatible or even Internet-based, this often means using elements created by non-Japanese companies. For firms selling consumer electronics products and electronic components, competition is intense from low cost producers with modular value chains, such as Dell in personal computers, and with high levels of vertical integration, such as Samsung in mobile phones and flash memory chips. These pressures prompted decision makers at Japanese electronics firms to consider new strategies to rapidly acquire or develop new competencies, increase specialization, and relocate in-house operations to low cost locations such as China. At the same time, the managers we spoke to agreed that it would be politically and strategically impossible to enact the layoffs that would be required if radical restructuring was taken too far. The bursting of the Internet bubble in early 2001 led Japanese managers to step back from the brink of radical transformation. The ‘dot.com’ crash dramatically exposed some apparent weaknesses of the Modular Production System. As a result of over-anticipating demand, Cisco was forced to liquidate US$2.2 billion of finished and in-process inventory, largely held by its contract manufacturers. The company cut 8500 jobs and posted its first loss in its 11 years as a public company (US$2.69 billion) in the third quarter of 2001

55

Industries, technologies, and value chains (Niece 2005). Over the next few years Solectron, Cisco’s most important contract manufacturer, suffered a total of US$6.5 billion in losses and laid off nearly a third of its global workforce of 60,000. However effective these developments were in driving Japanese firms back to their traditional industrial model, managers at Japanese electronics firms have nevertheless made significant breaks with past practices. Only key components, such as system-on-a-chip (SoC)–known in Japan as LSI–semiconductors, leading edge flat panel displays, high capacity batteries, and advanced memory chips are to be produced in Japan, either in-house or in joint ventures with other Japanese firms. In-house final assembly in Japan is largely being limited to high-cost models with advanced features. Low end products are to be produced offshore, especially in China, either by affiliates or by Taiwanese contractors. Divestiture of old, unprofitable, and unrelated businesses and products lines has accelerated, though these moves comprise only an incremental step toward downsizing and specialization. Increased specialization, increased complexity, and the continued importance of foreign component sales has led to increased outside purchasing and heightened dependence on global markets for a wider variety of inputs, including technology inputs.10 The remainder of this section presents evidence of these changes, and their limits, in three areas: alliances, outsourcing, and information technology and communications services.

Alliances The renewal of traditional strategies at Japanese electronics firms has a high price. The fast pace of technological change in the technologies that underlie key components has required a spate of new investments in leading-edge factory production in Japan (see Table 3.2 for some examples). The high cost of many of these new investments has convinced managers to forge an unprecedented set of production sharing alliances. Seven of the 25 factory investments listed in Table 3.2 involve more than one firm. The shift in thinking about alliances is captured by the following statements made by the same top manager in 2001 and 2002: We have a terrace-house style management where we exchange ideas with people in the same house, so we don’t want to sell our factories to other people. (Japanese electronics executive, June 2001) We’re thinking of a smaller terrace house now. And we’re also thinking about having good neighbours. (Same Japanese electronics executive, July 2002)

In contrast to the technology and standards development deals forged with American and European firms in the 1980s, most of these recent agreements have been between Japanese firms. In some cases the deals are simple technology

56

Modular production’s impact Table 3.2 Examples of recent and planned electronics factory investments in Japan Investment ¥B

Planned opening

Firm name

Kind of factory

Location

Renesas Technology (Hitachi-Mitsubishi joint venture spin-off)

Semiconductors (system LSI)

Hitachinaka, Ibaraki

200

Latter half of 2005

Elpida Memory (Hitachi-NEC joint venture spin-off)

Semiconductors (DRAM)

Higashihiroshima, Hiroshima

500

Latter half of 2005

NEC Electronics

Semiconductors (system LSI)

Tsuruoka, Yamagata

100

Latter half of 2005

Toshiba

Semiconductors (flash memory)

Yokaichi, Mie

270

Latter half of 2005

Fujitsu

Semiconductors (system LSI, ASIC)

Kuwana, Mie

160

First half of 2005

Renesas Technology (Hitachi-Mitsubishi-NEC joint venture spin-off)

Semiconductors (system LSI, flash memory)

Kagami, Kochi

200

Undecided

Matsushita

Semiconductors (system LSI)

Uozu, Toyama

130

Latter half of 2005

Sony

Semiconductors (microprocessor)

Isahaya, Nagasaki

200

First half of 2005

Sony

Semiconductors (CCD)

Kyushu (undecided)

100

Undecided

Sharp

Semiconductors (flash memory)

Fukuyama, Hiroshima

50

First half of 2006

Oki

Semiconductors (undecided)

Kiyotake, Miyazaki

100

Undecided

Toshiba Matsushita Display Technology

Liquid crystals for cellular phones

Kawakita, Ishikawa

50

April 2006

Sharp

Liquid crystal displays for TVs

Kameyama, Mie

150

June 2006

IPS

Liquid crystal displays for TVs

Mobara, Chiba

110

2nd Q, 2006

Toshiba-Canon

SED displays

Taiji, Hyogo

180

January 2007

Matsushita (Panasonic)

Plasma displays

Ibaragi, Osaka

60

April 2004

Matsushita (Panasonic)-Toray

Plasma displays

95

Fujitsu Hitachi plasma display

Plasma displays

Pioneer

Plasma displays

Amagasaki, Hyogo Kunitomi, Miyazaki Tatomi, Yamanashi

September 2005 Latter half of 2006 September 2004

Konica Minolta

Polarizing film for Kobe, Hyogo liquid crystal displays

Fuji film

Film for flat panel displays

Kikuyo, Kumamoto

100

Dainihon insatsu

Film for liquid crystal panels

Kitakyushu, Fukuoka

30

End of 2006

Toppan insatsu

Film for liquid crystal panels

Hisai, Mie

50

October 2006

85 26–7 30

Autumn 2006 December 2006

Sumitomo Chemical

Polarized plates

Niihama, Ehime

10

Autumn 2006

Asahi glass

Glass plates for liquid crystal panels

Takasago, Hyogo

25

Autumn 2006

Source : Nikkei Shinbun, various dates: 2004–06

57

Industries, technologies, and value chains development and patent sharing deals between firms with complementary assets and capabilities. In other cases firms have combined component divisions and spun them off as separate companies. In still other cases firms have purchased the divisions of other firms to gain control over needed components or to build larger, more viable divisions, especially in the face of volatile global markets and fierce competition (e.g., DRAMs). Of the greatest interest and significance are eight deals listed in Table 3.3 that involve joint factory investments, where partner firms share output. Such deals require significant investment that heighten risk and make withdrawal difficult. Alliances of this kind create shared factory space, and shared risk. They move the Japanese electronics industry in the direction of Modular Production in that large fixed investments are pooled and shared by a number of industry players. But in this case the number of firms sharing capacity is limited to the members of the alliance, which is typically two and in a few cases three firms. Overall, this restructuring activity is leading the Japanese electronics industry on a path toward greater specialization, concentration, and fixed capital sharing. These are the same goals that American firms have sought as they have moved toward the Modular Production System, albeit pursued in a somewhat different and more partial way. Table 3.3 provides some examples of recent restructuring in the Japanese electronics industry, including mergers, spin-offs, acquisitions, and alliances.

Outsourcing In the realm of outsourcing as well, Japanese electronics firms have taken a partial step in the direction of Modular Production. Dense interactions between design and manufacturing is one of the hallmarks of the Japanese Production System, and much criticism was leveled at the tendency at American firms to ‘throw designs over the wall’ to manufacturing (Kenney and Florida 1993). But this was one lesson of Lean Production that went largely unheeded in the United States. On the contrary, one of the most significant challenges to the traditional Japanese system posed by Modular Production is the notion that manufacturing can be entirely separated from product development. Were American firms simply misguided or had technology enabled new ways of organizing the value chain? One respondent put the question this way: Traditionally we thought that if we don’t keep manufacturing, we can’t keep our core technological competence. US firms threw that out. This is the central question. For ‘analog’ manufacturing, where you have the in-house accumulation of technology, [outsourcing] is dangerous. For ‘digital’ manufacturing, [outsourcing] is OK. But does digital equipment eliminate the accumulation of manufacturing expertise? This is one of my questions. We need at least to keep experimental pilot plants in Japan. For manufacturing technologies, like miniaturization, there is real Japanese strength. What will

58

Modular production’s impact Table 3.3 Examples of recent restructuring in the Japanese electronics industry Partners (% share)

Year announced

Sony-Konica-Minolta

2005

Matsushita-Olympus

2005

Hitachi-Matsushita

2005

Hitachi (50%)-Matsushita (23.4%)-Toshiba (23.4%) NEC-Pioneer

2004 2004

Seiko Epson (55%)-Sanyo (45%) Toshiba-Mitsubishi Sharp-Sony Ericsson

2004 2004 2004

Casio (51%)-Hitachi (49%)

2003

Konica-Minolta

2003

Fujitsu

2002

Hitachi (55%)-Mitsubishi (45%) (Renesas Techology)

2002

Mitsubishi-NEC-Hitachi (Elpida Memory)

2002

Toshiba (60%)-Matsushita (40%) NEC

2001 2001

Sony-Toshiba-IBM

2001

Matsushita-NEC

2001

Matsushita-Toray

2000

Fujitsu-Hitachi

1999

Toshiba (50%)-Canon (50%)

1999

NEC (50%)-Hitachi (50%)

1999

Mitsubishi-Matsushita Electronic Toyota Jido Shokki (50%)Sony (50%)

1998 1997

Products

Type of deal

Digital still cameras (SLR) Digital still cameras (SLR) Flat panel displays (plasma)

Joint product development

Flat panel displays (liquid crystal) Flat panel displays (plasma) Flat panel displays (liquid crystal) Semiconductors Software for cellular phones Cellular phones

Joint product development Joint R&D, production, marketing, and intellectual property sharing Joint production Sale to Pioneer Merger and spin off Sale to Mitsubishi Joint development

Joint product development, design, and purchasing Cameras, printers, and Merger copiers, etc. Flat panel displays Spin off of division (liquid crystal) Semiconductors Merger and spin off of (system LSI) R&D, product development, production, and marketing Semiconductors Merger and spin off of (DRAM) R&D, product development, production, and marketing Flat panel displays Joint production (liquid crystal) Semiconductors (net- Spin off work applications) Semiconductors Joint product development (system LSI) Software for cellular Joint product development phones Flat panel displays Joint venture (plasma) Flat panel displays Joint production (plasma) Flat panel displays Joint R&D and production (SED) Semiconductors Merger and spin off of (DRAM) R&D, product development, production, and marketing Semiconductors Joint product development (system LSI) Flat panel displays Joint venture (liquid crystal)

Source : Trade press publications and Nikkei Shinbun

59

Industries, technologies, and value chains US core competence be if all their manufacturing goes? New technology must combine various technologies and expertise within the company. The question is: can we throw manufacturing out of this mix totally? (Japanese electronics executive, July 2001)

The general strategy in Japan has been to keep the production of leading edge products in-house but embrace outsourcing for high volume, price sensitive products such as low end personal computers, mobile phones, and previous generation video game consoles. But instead of American contract manufacturers, Taiwan-based contract manufacturers have received the lion’s share of these new orders. Taiwanese contract manufacturers were thought to have access to lower cost capital and be willing to tolerate lower returns on investment than American firms. Taiwanese manufacturers of commodity flat panel displays, personal computers, and mobile phones are especially popular. Some use of Taiwan’s semiconductor foundries (TSMC and UMC) was reported as well. Japanese managers have confined the use of contract manufacturers to older and simpler products and components because of the engineering time required to transfer specifications and because they fear the leakage of intellectual property. One respondent put it as follows: Some of our products require special components and finishes. If we used a Taiwanese [contractor], we would also use them as parts vendors, and we’d have to teach them about this [advanced process], and we don’t want to – it would take too much of our engineering time. Eventually they will be able to do everything, but we don’t want to teach them so quickly. It’s a constant decision to figure out how much of our resources to invest in teaching them as opposed to the cost of doing it ourselves. Moreover it leads to the leakage of our intellectual property. Eventually they catch up – but maybe we can delay that (Japanese electronics executive, October 2004)

This statement reveals a deep ambivalence about outsourcing that has not been as evident in American electronics firms, which tend to deal with such problems by codifying complex product specifications and punishing suppliers that try to compete with them by withdrawing business. While not unheard of, American companies have had no appreciable problems with IP leakage to rivals via shared suppliers. Managers of Japanese electronics firms, in contrast, have largely opted to continue traditional strategies that seek to develop and leverage synergies within their organizations. As one respondent put it: In can be an advantage to have both components and [final products] in-house; we can use advanced components in our own products first and introduce new features faster. If manufacturing is outsourced, 100% of the strength of Japanese companies will die. Launching new models quickly is the key. If we don’t have a manufacturing function, we will not be able to launch new products based on new [in-house] technologies, such as batteries, LCDs, and semiconductors, nor could we make modifications to existing products. The ability to make incremental modifications on the factory floor

60

Modular production’s impact is important. Dell doesn’t create. They will have a hard time creating new products because they depend on outside [contract manufacturers] that have no unique technology. Making parts and products is important. When products are commodities, then using [contract manufacturers] is OK, but advanced products are better made in-house. (Japanese electronics executive, June 2001)

Still, it was recognized that the benefits of this strategy were declining with the increased ability to codify product and process information that has come with digitization. One respondent put the problem this way: With digital technology it becomes easier to gain the capability to manufacture. It’s easier to make personal computers than televisions. Everyone can buy the technology. The machines embody the instructions. It’s no longer a ‘black box’; the Japanese advantage when it used to be that way is eroding. For example, the Koreans can simply buy the machines and have the technology. (Japanese electronics executive, July 2001)

On the other hand, in some areas the increasing consolidation of functionality enabled by digitization has created new technical challenges and a greater need to integrate product and component design efforts. The Japanese managers we spoke with believed this to be especially true in the case of system-ona-chip semiconductors.11 As one respondent put it: United States companies specialize in a core competence, a piece of the value chain. We do it all: system LSI, [product] design, manufacturing, production equipment, and marketing. The main business [of our division] is to manufacture digital audio-visual products. To do this we must co-develop with our semiconductor group. We can put all of our knowledge about system design into the LSI design. The system LSI made by a specialist may not work as well or fit as well within the final product. In the past we could buy key components from the outside, but now system LSI determines everything so we buy these from inside. But this is the exception. Other components can be bought from the outside. (Japanese electronics executive, October 2004)

Another respondent listed the benefits of in-house system-on-a-chip semiconductor production as: Speed, cost, and intellectual property protection . . . When outside vendors are used, roadmaps are leaked to competitors. Inside we don’t have that problem. (Japanese electronics executive, October 2004)

Our interviews suggest that by 2003 the questioning on the topic of outsourcing had led only to modest changes. One of the main difficulties was the work-force reductions that would be required for more radical restructuring. If we got rid of manufacturing, we’d have to get rid of 50% of our workforce. We couldn’t survive if we did that because other stakeholders, like the governments who procure our services, couldn’t accept our doing such a thing. (Japanese electronics executive, July 2002)

61

Industries, technologies, and value chains Severe workforce reductions were also seen as problematic because of their effect on morale. As one respondent put it: We can’t just fire people, because if we did, we couldn’t keep the others. This is the Japanese way of business; we can’t just adopt the American way. We have to make full use of Japanese people. If we fire the laggards, the talented promising people will think about their own future and also leave. They would think that [our company] is not a good place to work. We are building up some outside companies like real estate and maintenance to absorb excess people, but all this has to happen slowly. We are thinking of cutting some businesses, but this must be done gradually, according to the Japanese way. (Japanese electronics executive, June 2001)

To sum up, Japanese firms appear to have settled on a mixed model in the realm of outsourcing. Advanced components and products are to be produced in-house or in joint ventures, and older, simpler, and non-strategic components and products lines are to be outsourced. While this strategy might seem clear and decisive on its face, it provides no real guidance on how far to take outsourcing. What comprises a core technology, a key component, or advanced product? How soon should advanced process technologies be transferred to outside suppliers? It was recognized that the definition of core competencies and key components would shift over time. One respondent summarized this point as follows: In regard to outsourcing, we have a mixed model. We make key components in-house. We must choose these key components carefully and engage in constant search and revision. What is considered key will change over time. Then, we must choose our real high tech collaborators; firms that can provide specialties and have special R&D capabilities. (Japanese electronics executive, October 2004)

What this suggests is that Japanese electronics firms face the same strategic challenges that their foreign competitors do and have similarly moved in the direction of Modular Production, in most cases for older product lines but in other cases with the aim of developing high level technological collaborations. But even in the case of older, nonstrategic products, the migration of in-house production to low cost locations, especially China, was mentioned at least as often as outsourcing. What is clear is that the degree and speed of these changes are limited in the Japanese institutional context. The following statement sums up this point well: Suppose we do away with all of our plants and fire all of our workers? If we were driven to this we might do it, but in Japan you can’t do this. It is our policy to protect [manufacturing workers’] jobs. It is part of our mission as a company. So we must continue to develop products that cannot easily be outsourced. Putting parts together is the job of a trading company. We are not a trading company. This is why we cannot do what Apple computer has done [externally sourcing the components and assembly of its iPod digital music player]. (Japanese electronics executive, March 2004)

62

Modular production’s impact

Information technology and communications services As they lost money in the late 1990s, Japanese electronics firms with the breadth to supply large scale corporate computing systems saw a solution to their financial woes through growth in the service side of their business, following IBM’s long success in this area. An expanding information technology and communications (ITC) services business is attractive in many ways, not least in its potential to absorb a large number of employees in high valueadded, knowledge intensive work. But customized ITC systems and IT-enabled business services tend to require a deep and thorough understanding of the end user’s line of business and close collaboration to identify and fulfill the buyer’s needs. Such ‘domain knowledge’ is typically industry-specific, requiring knowledge that is applicable only to relatively narrow ‘vertical’ markets, so there is an obvious knowledge gap.12 Japanese electronics firms have very little experience providing ITC services outside of Japan. There is, moreover, a great deal of competition in the realm of ITC services, both from other integrated electronics hardware and software firms such as IBM and from services-only consulting firms, such as Accenture, Price Waterhouse, and McKinsey. Competing with foreign ITC service firms even in Japan has proved difficult, and Japanese electronics firms have found that their product lines and service offerings are not considered serious contenders. One reason for this is Japanese electronics firms’ continued bias toward using their own products for the ITC systems they sell. The provision of advanced ITC services to Japanese customers, but especially to global clients, introduces a contradiction with the traditional Japanese way of doing business. Japanese electronics firms, when providing complete ITC systems to clients, produce and thus have an incentive to supply a full range of their own hardware products, from components to PCs to servers to large computers to networking equipment, as well as software. With the deployment of global scale data communications systems, and especially since the rise of interoperability based on Internet, or TCP/IP, protocols, it has become much easier and in some cases necessary to integrate hardware and software from a variety of vendors. In fact, many customers, even in Japan, believe that their systems should be built from best products available. It has been very difficult for Japanese electronics firms to adopt this model, not least because of strongly held notions about the learning synergies between various components of large complex systems. In addition, sales forces have little or no experience selling products from outside vendors, and may well have incentive structures that discourage this practice. One executive explained this dilemma as follows: Five to seven years ago, there were no cases of United Sates [firms’] success in selling [IT systems] in Japan, but today, even local governments are choosing whoever has the best integration package. If we try to sell only our own products we’ll lose business. We do have one case where we sold a big system integration solution with no in-house

63

Industries, technologies, and value chains products. It included only American-made hardware and software. Our engineers on that project asked, ‘What company am I working for?’ But pure systems integration like this is profitable. (Japanese electronics executive, July 2001)

Debates about shifting from manufacturing to services at Japanese electronics firms have apparently been quite intense. For now, it seems as if the integrated approach has won the day. This is captured well by the following three statements made by the same high level Japanese electronics executive: Now we want to change from a hardware to a software and services solutions business, so we need more differentiation to fit customers in every country. Will turning away from manufacturing create weakness? We are struggling to find an answer. Even on government programmes, we can’t do it ourselves and so we are using some American firms as sub-contractors. Accenture, Mckinsey, and Price Waterhouse and others have a very good business in Japan and can win bids over us. Our engineers make full use of our products first. So customers prefer to go with American companies because they’ll provide integrated packages using the best components from a variety of vendors. Our engineers are trying to integrate products from Cisco and others but sales and engineering issues force them to use our own products, so we lose some bids. (July 2001) There are two different views at our company. Some say we should simply be good at choosing the best components, but others say anyone could package them in the same way. They would be standardized parts, so anyone could do the same thing. Where’s the competitive advantage for us then? With no differentiating hardware, there is no way of succeeding in a pure software/services business. How would we make profits in such a business? In this view, we need to maintain advanced hardware capabilities. (July 2002) Service companies cannot expect to make profits. We found we cannot make money from just software services. Even IBM is facing losses from its system integration business. Competition is too tough in being a pure provider of services. Therefore my opinion now is that we need to keep making all the necessary hardware in our company. Some people in our company said we should lead in services and software and use the best hardware we can find whether it’s ours or another company’s. Gradually we realized that the company that produces the key hardware in-house can provide customers with the confidence and security they need. (October 2004)

Conclusions The failure of Japanese electronics firms to participate fully in the Internet fueled growth in the global electronics industry during the late 1990s triggered a period of questioning among the top executives in Japan’s leading electronics firms. At the time, the Modular Production System emanating from the

64

Modular production’s impact United States seemed to be providing American firms with significant competitive advantages. Moreover, the key features of the Modular Production System provided a direct challenge to a host of the most cherished strategies of Japanese electronics firms. In Modular Production, manufacturing capacity is pooled in specialized contract manufacturers, freeing lead firms to engage in ‘open innovation’ (Chesbrough 2003) by specializing in specific aspects of technology development and system architecture while depending on outside firms for complementary system elements. The goal of ‘platform leaders’ (Gawer and Cusumano 2002) in the Modular Production System is to attain early market dominance to set standards in emerging technologies, thereby forcing ‘partner’ firms to create products, subsystems, and components that comply with the standards they set. These strategies clash with the strongly held belief among Japanese managers that competitive advantage comes from design collaboration within a diversified organization, tight feedback between internal design and manufacturing, and the first use of internally developed components. The bursting of the Internet bubble in 2001, and the ensuing inventory and financial problems at firms closely associated with Modular Production such as Cisco and Solectron, affirmed the skepticism of Japanese managers regarding the model. Our interviews after 2003 suggested that the pressure for radical moves away from manufacturing had lost momentum and that traditional strategies of vertical integration were being reasserted, especially for advanced products and technologies. In addition, financial performance at many large Japanese electronics companies improved in 2004, driven in significant degree by rising demand from Japanese customers with booming sales to China for products such as steel, ships, and heavy machinery. Only the threat from Korea failed to diminish. So the period of intense questioning came to an end, at least temporarily, as decisions were taken to deepen traditional strategies, especially for advanced products and technologies. Japanese electronics firms continue to have shallow, tactical alliances with foreign firms, and have reasserted their vertically integrated approach by investing in a new round of factory construction–in Japan–for key components such as system-on-chip semiconductors, advanced flat panel displays, high capacity batteries, and high-performance memory chips. There have been partial but significant steps taken in the direction of Modular Production in the form of increased specialization, outsourcing of low end products, and shared factory investments in Japan, but wholesale restructuring has been resisted, at least for now. However slowly it may be moving, restructuring at Japanese electronics firms is indeed underway, and most large firms reported reductions in their global workforces by 10–15 percent since the late 1990s, mostly through attrition. Still, this restructuring is proceeding under the substantial weight of existing organizational routines, investments, and workforces, and is being

65

Industries, technologies, and value chains driven by contradictory pressures. As a result, Japanese electronics firms are simultaneously shedding and protecting jobs, getting out of old business lines and adding new ones, opening their sourcing networks and investing in new in-house component plants, and expanding some facilities and shrinking or closing others, both off- and on-shore, in an effort to rebalance their organizations. While it is too early to determine how successful these changes will be, or if they will add up to a new and distinct industrial model in the end, there are a host of new challenges and opportunities that now face Japanese electronics firms given their recent experiments with joint technology development, production alliances, relocation, and global outsourcing. Whether Japanese electronics firms can simultaneously and quickly shed noncore business, develop new software and service competencies, and carry the weight of the substantial new component manufacturing investments, many of which are being made in the context of new and completely untested alliances, is unknown. Finally, what do recent trends in the Japanese electronics industry tell us about the global circulation of industrial models? First, firms can and do react to external pressures for change, but in a complex and increasingly integrated world, there are multiple models that are viable at any given moment, and even if a particular model is quite popular, firms receive mixed signals from the outside. For Japanese electronics firms, challenges have come not only from the Modular Production System, but also from Korean firms such as Samsung and LG Electronics, which remain highly vertically integrated. Second, the resistance to radical change is typically quite high, so changes tend to be introduced in piecemeal fashion. It is this process of partial application, experimentation, and reversal, however, that could work to create a new model, one well adapted to the industrial history and institutions of Japan as well as to the exigencies of global markets.

Notes 1. This chapter is based on research funded by ITEC (COE) at Doshisha University, Kyoto, and the Alfred P. Sloan Foundation. The field research was conducted by the author, other members of MIT’s Globalization Study Team (see http://ipc-lis.mit.edu/ globalization/main.html) and Yoshiji Suzuki of Doshisha University. Clair Brown and Gregory Linden at UC Berkeley, Martin Kenney at UC Davis, and Mon-Han Tsai and Kazushi Nakamichi at ITEC, provided important insights and valuable support, as did Jun Kurihara of the John F. Kennedy School of government at Harvard University. Hugh Whittaker and Robert Cole provided helpful suggestions for improving the text. All responsibility for the final text, of course, resides with the author. 2. At the time of this writing MIT’s Globalization Study Team had conducted 622 field interviews in 19 countries, including 42 interviews with managers of electronics companies in Japan.

66

Modular production’s impact 3. Although this pattern of cross-holding has been quite strong historically, the keiretsu structure has loosened considerably in the past decade or so, in part driven by the efforts of foreign investors, such as Renault, to drive down the cost of components. See Lincoln, Chapter 12, in this volume. 4. Systems integration developed as a formal practice in the United States during the Cold War in response to a need to coordinate the invention, development, production, deployment, and maintenance of increasingly complex and exotic weapons and aerospace systems. Projects to create complex weapons systems such as ballistic missiles, early warning radar systems, and nuclear submarines were so large and interdisciplinary that detailed knowledge required to design and produce all of the subsystems were far beyond the scope of knowledge and expertise contained within any single military branch, firm, university laboratory, or other single organization. Someone had to make sure the systems worked as intended. At first, the task of systems integration fell to a few aerospace contractors, government agencies, and specially created nonprofit agencies, but over time the approach and methods of systems integration migrated to the private sector as private military contractors gained experience with the approach and systems engineering and management became established, if much maligned, academic disciplines by the 1970s (Johnson 2003). 5. Baldwin and Clark 2000; Sturgeon 2000, 2002; Takeishi and Fujimoto 2001; Langlois 2003; Principe et al. 2003; Gereffi et al. 2005; Sturgeon and Lee 2005. 6. The high volume of nonprice data flowing across the inter-firm link differentiates modular value chains from simple markets. Because of this complexity it is not unusual that additional engineering and coordination be required. The hand off of product and process specifications between firms need not be perfectly clean, but only relatively so for modular value chains to function. 7. Products with integral architectures have tight design interdependencies with components and subsystems of which they are comprised. 8. See Cole, Chapter 2, for a detailed account of the Japanese response to the Internet and the weakness of Japanese firms in the network equipment sector. 9. This section is based on several rounds of interviews with top managers at Japan’s largest electronics firms. The interviews were semi-structured in that the same themes were covered. They were conducted at the respondent’s office, and typically lasted 1–2 hours. The names of the firms and managers are withheld for reasons of confidentiality. The respondents typically, but not always, occupied high level decision making positions at their firm. 10. For example, most large Japanese electronics firms have licensed processor cores, a modular block of design code (or ‘IP block’) for inclusion in SoC semiconductors, from the British firm Advanced RISC Machines (ARM) as a way to stimulate business in Europe, where ARM technology amounts to a de facto standard for embedded communications equipment. 11. This is in contrast to American lead firms, which commonly source their SoC semiconductors externally or do the logic design in-house and outsource the remaining design and fabrication tasks (Greg Linden, personal communication, September 2005). 12. See Rtischev and Cole (2003) for an analysis of the not always wise penchant of large Japanese firms to try to use expanding businesses to absorb redundant labour.

67

Industries, technologies, and value chains

References Abo, T. (ed.) (1994). Hybrid Factory: The Japanese production system in the United States, Oxford: Oxford University Press. Albert, M. (1991). Capitalism vs. Capitalism, New York: Four Wall Eight Windows. Baldwin, C. and K. Clark (2000). Design Rules, Cambridge, MA: MIT Press. Berger, S. and R. Dore (eds.) (1996). National Diversity and Global Capitalism, Ithaca, NY: Cornell University Press. —— (2005). How We Compete; What companies around the world are doing to make it in the global economy, New York: Doubleday. Brown, C., M. Reich, L. Ulman, and Y. Nakata (1997). Work and Pay in the United States and Japan, New York, NY: Oxford University Press. Chesborough, H. (2003). Open Innovation: The new imperative for creating and profiting from technology, Boston, MA: Harvard Business School Press. —— and K. Kusunoki (2001). ‘The Modularity Trap: Innovation, technology phase shifts, and the resulting limits of virtual organizations’, in L. Nonaka and D. Teece (eds.) Managing Industrial Knowledge, London: Sage. Cole, R. (1999). Managing Quality Fads: How American business learned to play the quality game, New York: Oxford University Press. Dore, R. (1986). Flexible Rigidities: Industrial policy and structural adjustment in the Japanese economy 1970–1980, Stanford University Press: Palo Alto. Dyer, J. (1996). ‘Does Governance Matter? Keiretsu Alliances and Asset Specificity as Sources of Competitive Advantage’, Organization Science, 7(6): 649–66. Gawer, A. and M. Cusumano (2002). Platform Leadership; How Intel, Microsoft, and Cisco Drive Innovation, Boston, MA: Harvard Business School Press. Gereffi, G., J. Humphrey, and T. Sturgeon (2005). ‘The Governance of Global Value Chains’, Review of International Political Economy, 12(1): 78–104. Hall, P. and D. Soskice (eds.) (2001). Varieties of Capitalism, Oxford: Oxford University Press. Helper, S. (1991). ‘How Much has Changed between U.S. Automakers and their Suppliers?’ Sloan Management Review, 32 (Summer): 15–28. Holweg, M. and F. Pil (2004). The Second Century: Reconnecting Customer and Value Chain through Build-to-Order. Cambridge, MA: MIT Press. Johnson, S. (2003). ‘Systems Integration and the Social Solution of technical Problems in Complex Systems’, in A. Prencipe, A. Davies, and M. Hobday (eds.) The Business of Systems Integration, Oxford: Oxford University Press. Kenney, M. and R. Florida (1993). Beyond Mass Production: The Japanese system and Its transfer to the United States, Oxford and New York: Oxford University Press. Langlois, R. (2003). ‘The Vanishing Hand: The changing dynamics of industrial capitalism’, Industrial and Corporate Change, (April) 12(2): 351–85. —— and P. Robertson (1995). Firms, Markets, and Economic Change, London: Routledge. Lazonick, W. and M. O’Sullivan (2000). ‘Maximising Shareholder Value: A new ideology for corporate governance’, Economy and Society, 1 February, 29: 13–23. Liker, J., W. M. Fruin, and P. Adler (eds.) (1999). Remade in America: Transplanting and transforming Japanese Management Systems, Oxford: Oxford University Press.

68

Modular production’s impact Linden, G. and D. Somaya (2003). ‘System-on-a-Chip Integration in the Semiconductor Industry: Industry structure and firm strategies’, Industrial and Corporate Change, 12 (3): 545–57. Mayer, D. and M. Kenney (2004). ‘Economic Action Does Not Take Place in a Vacuum: Understanding Cisco’s acquisition and development strategy’, Industry and Innovation, December 11, (4): 299–325. Niece, J. (2005). ‘Cisco’s first glitch’, Journal of Business Research, 58: 1003–5. Pavitt, K. (2003). ‘Specialization and Systems Integration: Where manufacturing and services still meet’, in A. Prencipe, A. Davies, and M. Hobday (eds.) The Business of Systems Integration, Oxford: Oxford: University Press. Principe, A., A. Davies, and M. Hobday (eds.) (2003). The Business of Systems Integration, Oxford: Oxford University Press. Rtischev, D. and R. E. Cole (2003). ‘Social and Structural Barriers to the IT revolution in High-Tech Industries’, in J. Bachnik (ed.) Roadblocks on the Information Highway, Landham, MD: Lexington Books. Saplosky, H. (2003). ‘Inventing Systems Integration’, in A. Prencipe, A. Davies, and M. Hobday (eds.) The Business of Systems Integration, Oxford: Oxford University Press. Sayer, A. (1986). ‘New Developments in Manufacturing: The just-in-time system’, Capital and Class, 30: 43–72. Sturgeon, T. (2000). ‘Turn-key Production Networks: The Organizational Delinking of ¨ ergens (ed.) New Product Development and ProProduction from Innovation’, in U. Ju duction Networks: Global industrial experience, Berlin: Springer Verlag. —— (2002). ‘Modular Production Networks: A new American model of industrial organization’, Industrial and Corporate Change, 11(3): 451–96. —— and J.-R. Lee (2005). ‘Industry Co-Evolution: Electronics contract manufacturing in North American and Taiwan’, in S. Berger and R. Lester (eds.) Global Taiwan: Building competitive strengths in a new international economy, New York: M.E. Sharpe. —— and R. Lester (2004). ‘The New Global Supply-base: New challenges for local suppliers in East Asia’, in S. Yusuf, A. Altaf, and K. Nabeshima (eds.) Global Production Networking and Technological Change in East Asia, Oxford: Oxford University Press. Suzuki, Y. (2004). ‘Structure of the Japanese Production System: Elusiveness and reality’, Asian Business & Management, 3(2): 201–19. Takeishi, A. and T. Fujimoto (2001). ‘Modularization in the Auto Industry: Interlinked multiple hierarchies of product, product, and supplier systems’, International Journal of Automotive Technology and Management, 1(4): 379–96. —— and—— (2003). ‘Modularization in the Car Industry’, in A. Prencipe, A. Davies and M. Hobday (eds.) The Business of Systems Integration. Oxford: Oxford University Press. Williams, K. (2000). ‘From Shareholder Value to Present-day Capitalism’, Economy and Society, February, 29(1): 1–12. Womack, J., D. Jones, and D. Roos (1990). The Machine that Changed the World, New York: Rawson Associates.

69

4 Technology management and competitiveness in the Japanese semiconductor industry1 Takashi Yunogami

After experiencing a dizzying rise in the 1970s and early 1980s, the Japanese semiconductor industry went into a precipitous decline in the 1990s. Various reasons have been advanced for this decline, predominantly related to management failures. Technology, by contrast, is widely considered to have remained competitive. This chapter argues that such a dichotomous characterization, while comforting for engineers and researchers, is misleading, and may be part of the problem itself. It explores the declining competitiveness of the semiconductor industry in Japan as a failure to link technology to changing market conditions, and hence as a failure in technology management, and ultimately in technology itself. It explores the reasons for the failure, and links it to the very factors which propelled the industry to prominence in the first place. It raises the possibility, furthermore, that excessive emphasis on quality, or reliability, which is at the crux of the failure, is not limited to semiconductors, but can be found in other industries as well. (See Robert Cole’s Chapter 2 in this volume for another example.) The chapter first explores reasons given for the decline in the international competitiveness of the Japanese semiconductor industry during the 1990s, including politics, management failure and the excessive quality thesis advanced here. These are not mutually exclusive, of course. There are many contributing factors to the decline, but excessive quality has been overlooked in the past because of the analysts’ use of a dichotomous management vs. technology distinction. This is followed by a brief examination of the main wafer process technologies required for producing semiconductors. I then show that in all three technology phases–elementary process technology, integration process technology, and mass-production technology–the problem was not a lack of technological sophistication, but an excess of it (at least

70

The Japanese semiconductor industry until recently). Japanese manufacturers remained locked into the quality paradigm set by NTT for mainframe semiconductors, even when they were producing for PCs. This substantially increased their costs, both in monetary terms as well as in time. Comparative evidence suggests that the competitors who stole market share from Japanese semiconductor manufacturers pursued technologies which were appropriate for PCs, allowing them to save on development time, to save on costs, and to raise yields rapidly, eventually undermining the Japanese manufacturers with their ‘superior’ technology. This chapter concludes by exploring why this happened and possible implications for other industries. The research which this chapter is based on is ongoing, and the thesis advanced is therefore subject to refinement.

The ‘lost market decade’ The 1990s have been disparagingly called by some, Japan’s ‘lost decade’. For the semiconductor industry, it might be called the ‘lost market decade’. As Figure 4.1 shows, a dramatic rise in Japan’s DRAM share from the mid-1970s to the mid-1980s was followed by an equally precipitous decline, with very little market share remaining by the early 21st century. Needless to say, various reasons have been advanced to explain this decline. In this section I will explore the main explanations. The first type seeks to place the blame on external factors, beyond both corporate-level management and technology. Oyane (2002) attributes the seeds of decline to politics. The very success of the industry, and the decline

100 Japan

Share (%)

80

US

60

Korea

40 20 Europe 0 1975

1980

Taiwan 1985

1990 Year

1995

2000

Figure 4.1 Changing DRAM share by country

71

Industries, technologies, and value chains of the industry in the US, provoked a sharp reaction from the US who tried to impose various constraints on Japanese semiconductor makers under the guise of leveling the playing field (see Murayama in this volume). These constraints were so successful that they eventually took the wind out of the Japanese sails and left it vulnerable to attack from both a resurgent US and emerging Asian competitors. Most analysts, however, place the blame closer to home, even if they have some sympathy for the political constraints view. Most focus on management failures. Itami (1995), for instance, notes that US semiconductor manufacturers such as Intel focused on micro-processing units (MPU) in response to the Japanese onslaught and survived. Korean semiconductor manufacturers focused on DRAMs and made huge and timely investments necessary to become and remain competitive in the industry. Japanese semiconductor manufacturers, by contrast, failed to focus, they spread their investments too thinly and competed without a clear strategy. Kawanishi (1997), a former top semiconductor manager, concurs. These authors note that semiconductor manufacturers were part of large, sprawling business concerns with high overheads and which, in the case of companies like Hitachi, were steeped in heavy electric cultures averse to risk and slow in decision making. Semiconductor businesses require heavy investments in the trough of the silicon cycle; by the time Japanese semiconductor businesses got around to making their investments, they were too late to capture the bulk of profits on the upswing. Indeed, blame is placed with management failure by most industry insiders. In an interview survey by Yunogami and Arikado of 21 engineers from the semiconductor consortium SELETE,2 14 cited a loss of cost competitiveness as the key reason for Japan’s decline and, relatedly, poor management strategies or the absence of strategy (see Appendix, A1). Only two thought that technology was an issue. Indeed, when asked about Japan’s technological strengths compared with competitors in other countries, 20 out of the 21 rated them as equal or superior. Interviews with engineers from the Japan Semiconductor Consortium (A2) carried out in September 2004 elicited similar views. A report by the Semiconductor Industry Research Institute Japan (SIRIJ) in 2003, based on a wide-ranging survey of Japan’s ten leading semiconductor manufacturers, is one of the most authoritative analyses.3 It cites problems with cost competitiveness and lack of focus (semiconductors being part of much broader electric and electronics businesses). With regards technology it noted that Japan’s design technology was superior to that of Korea and Taiwan, but was losing ground to the US. With regards wafer process technology, Japan was at the forefront, along with the US, but Korea was catching up in front-end processes. The report argued that Japanese companies should restructure their businesses, cut costs, strengthen design and systems

72

The Japanese semiconductor industry integration, and so on, but it made no recommendations with regards wafer process technology, again suggesting that this was not an area of concern. In brief, dominant views place the blame at the feet of management and not engineers (in other words, the ‘strong factory–weak headquarters’ syndrome: (Fujimoto 2004). If there are any problems for the latter to address, it is in design. A dissenting view to this orthodoxy is Fujimura (2000), who warned against technology complacency by arguing that a) Japanese semiconductor makers had fallen behind because of inadequate development capabilities in element process technology as well as inadequacies in integration process technology, and b) semiconductor makers of Korea, Taiwan, and the US increased their share by producing low cost DRAMs. Even for Fujimura, however, technological capabilities and cost competitiveness were different issues. A fourth view–that presented here–is that not only is technology a problem, but it is intimately linked with the cost competitiveness problem. This view is implicit in the work of Yoshioka (2004), who stresses the impact on DRAM makers of the shift from mainframes to PCs in the late 1980s (see Figure 4.2). Japanese semiconductor makers, she suggests, made a poor transition because of organizational rigidities. Korean semiconductor makers–particularly Samsung–on the other hand, did not have these legacy problems (leading to rigidity) because they were in an early phase of growth as the PC market developed. They were helped by being able to purchase the newest manufacturing equipment, much of it produced in Japan, in which key elementary process technology was embedded. They developed a production system for 25000

20000 PCs

Mainframes ¥ Bill.

15000

10000

5000

0 1983

1985

1987

1989

1991

1993

1995

1997

Year Figure 4.2 Japanese computer shipments

73

Industries, technologies, and value chains DRAMs made for the PC market, rather than one adapted from DRAMs made for mainframes. As we shall see, this explains another finding of her study, namely that Samsung became able to develop DRAMS more quickly and so was able to surpass its Japanese competitors.4 In sum, various reasons have been advanced for the decline of the Japanese semiconductor industry, ranging from political factors to management failures, technology, and organization. Most accounts, especially by insiders, focus on management failures and argue either explicitly or implicitly that technology was not a significant problem. This distinction is problematic, however. In fact, making this distinction may itself have contributed to the decline. According to this distinction, technology is evaluated according to a relative measure of ‘higher’ (or more advanced, superior) vs. ‘lower’ (inferior). Higher is better. Full stop. But higher is not better if it results in a high cost structure which undermines cost competitiveness where cost is critical, as in DRAMs for PCs. The lack of cost competitiveness of Japanese DRAMs, I contend, did not simply result from excessive overheads in diversified companies–which also existed during the heyday of Japanese DRAMs in the early–mid-1980s–but from the technology deployed to make them. It is dangerous to sever technology from market requirements, and even more dangerous to then take comfort from the fact that one’s technology is ‘superior’ to that of competitors who are gaining market share. In this view, a precondition for restoring competitiveness in the industry is to reconnect technology with market needs.

Wafer process technology for semiconductor production Before trying to show that declining competitiveness was linked to technology and technology management problems, we need to know something about the wafer process technology used in semiconductor production. There are three phases of wafer process technology involved: elementary process technology, integration process technology, and mass production technology in the factory (see Figure 4.3). Let us look at each of these in turn.

Elementary process technologies Semiconductor devices are produced in a number of steps. The basic unit technologies for these steps are called elementary process technologies which include thin film deposition on the silicon wafer by chemical vapor deposition (CVD) or sputtering; lithography by which a resist mask is made on the film; etching which removes nonmasked film using plasma chemical reaction; cleaning technology by which the resist mask and other residue is cleaned off; and inspection technology. Fine processing technology is a combination of lithography and etching.

74

The Japanese semiconductor industry

Mass production technology (yield and quality are important)

Elementary process technology Film depo.

Lithography

Etching

Cleaning

Inspection

Si

Si

Si

Si

Si

Flow 1. 2. 3.

Flow 100. 101. 102.

DRAM DRAM

Yield

Integration process technology (construction of device flow) Flow

Test

Time

498. 499. 500.

Technology transfer Development center

Flow 1. 2. 3.

Flow 100. 101. 102.

Flow

Factory

498 499 500

Figure 4.3 Three phases of wafer process technology

Gate electrode etching, in which the finest processing is demanded, demonstrates the difference between ‘superior’ and ‘inferior’ elementary process technology. Superior etching produces a perpendicular sidewall (B in Figure 4.4a), rather than a tapered or overhanging sidewall (A, C). Precision here has a major impact on transistor performance. And in micro-processing, minimum future size as well as the aspect ratio are critical (see 4.4b: B is superior to A, C is superior to B), as is uniformity (A is technologically superior to B in 4.4c). There is little doubt that Japanese semiconductor manufacturers achieved highly advanced levels in elementary process technologies, which

Figure 4.4 Superior etching technology

75

Industries, technologies, and value chains increased their competitiveness, but this came at a cost, a result of the Japanese companies’ decision to press for frequent customization of equipment.

Integration process technology Integration process technology combines the elementary process technologies to create semiconductor devices on silicon wafers. In the case of the DRAM, over 500 steps are involved. ‘Superior’ integration technology is the ability to integrate the elementary process technologies in such a way as to produce high performance semiconductor devices. Few would doubt that Japanese semiconductor manufacturers succeeded here as well. Quality or performance alone, however, is not sufficient to ensure competitiveness. Time is critical, as well as cost. Indeed, being able to create a given level of performance with the minimum of steps–keeping mask layers to a minimum, for instance–may be considered the ultimate test for superiority of integration process technology. I shall return to this point later.

Mass production technology Mass production technology creates semiconductor devices on silicon wafers according to the process flow built with the integration process technology. Quality and yield are crucial. The three main elements of quality are performance, reliability, and uniformity. The yield indicates the percentage of satisfactory–defect-free–semiconductor devices built on the silicon wafers. Several hundred circular semiconductor devices are created on each silicon wafer, but during the several hundred steps particles from equipment and so on can lead to defects. (It is important to note that if the specifications are increased, the yield will decline, even if the quality distribution remains unaltered. Therefore, a high yield rate per se does not equate with high quality.) ‘Superior’ mass production technology is the ability to mass produce high performance, reliable semiconductor devices uniformly; in Figure 4.5 B is superior to A and C. During the first stages of mass production the yield is normally low. It is crucial to identify problems in the production process and to correct them promptly to raise the yield. The ability to do this reduces the cost and enhances opportunities for profits. Here there is a direct link between cost competitiveness and technology which, as we shall see shortly, has been problematic for Japanese semiconductor manufacturers.

Competitive and excessive technology How competitive is Japanese technology? The question is more easily posed than answered. The simplest way to answer it would be to compare the three phase technologies above across a range of Japanese and non-Japanese

76

The Japanese semiconductor industry

Number of devices

A

B

C

Low

High Quality

Figure 4.5 Technology and quality

semiconductor manufacturers, relative either to each other or to benchmarks. Semiconductor firms, however, are extremely reluctant to allow outsiders in to observe their operations–for obvious reasons–which makes this method impossible. Instead, the following methods have been used in this study, based on interviews with three groups of engineers.5 1 Interviews with equipment manufacturers: Equipment manufacturers deliver equipment to semiconductor manufacturers throughout the world. Their engineers install the equipment, and during the start-up process they have a chance to speak with the engineers at the semiconductor manufacturers. By doing so, they have the opportunity to compare the levels of elementary process technologies at Japanese and non-Japanese semiconductor companies. Three engineers were interviewed, taking care not to compromise their nondisclosure requirements (A3). 2 Interviews with Japanese engineers assigned to foundries abroad: Foundries are businesses which manufacture semiconductors on contract but do not design them. They are frequently located in Taiwan or China. Their customers include Japanese semiconductor manufacturers whose engineers are able to compare wafer process technology between their home base and the foundry during technology transfer of the process flow. Three engineers were interviewed (A4) (A5). 3 Interviews with engineers who have moved from Japanese to non-Japanese semiconductor manufacturers: In spite of ‘lifetime employment’, some engineers– sometimes key engineers–have left Japanese semiconductor manufacturers to join semiconductor firms abroad. Such engineers are also able to compare the element, integration, and production technologies of their current with those of their former employers. One engineer was interviewed (A6).

77

Industries, technologies, and value chains The comparisons of these three groups of engineers provide revealing insights into the three types of technology discussed above.

Elementary process technology The consensus of the engineers from the three groups above was that Japanese elementary process technology was very advanced. Three engineers assigned to an overseas foundry commented: ‘Japanese semiconductor makers’ fine processing technology is far superior’ (A4) (A5). Not only was the fine processing technology held to be superior, but the consensus was that the development strengths were also superior. In the words of an engineer from a dry etching equipment maker, also echoed by engineers of the other groups: ‘The Japanese fine processing technology and development strengths are higher than those found overseas’ (A3). Indeed, one engineer argued that semiconductor manufacturers elsewhere in Asia were ‘incapable of creating new elementary process technology’(A6). The Taiwanese foundries, at least, ‘are dependent on the equipment makers for the elementary process technology’ (A4). By contrast, Japanese semiconductor manufacturers were not content with the performance of standard equipment and placed orders for customized equipment providing higher levels of performance (A3). This is telling. It indicates the existence of high technology and technology development levels for elementary process technology in Japan, but at a cost–at the very least, the cost of customization, which is far from negligible when it comes to semiconductor equipment. A dry etching engineer commented: ‘The elementary process technology and developmental strength in Japan is a bit excessive’. Semiconductor makers elsewhere in Asia, he suggested, were capable of producing their devices on standard equipment. Without superior fine processing technology, they were nonetheless achieving the same level of integration process technology and minimum pattern size as their Japanese counterparts who were using more expensive equipment, which took extra time to produce.

Integration process technology The view on integration process technology was similar: ‘Integration process technology to produce high-performance semiconductor devices in Japan is high’ (A5). Here too, however, it was felt that there was a tendency to create products that go beyond necessary specifications (A5). It is very likely, then, that along with excessive elementary process technology, excessively high performance is set as a goal. Equating the highest specifications with the highest level of technology, and lower specifications with lower level technology is a kind of technological snobbery that ignores market requirements. Producing cost competitive

78

The Japanese semiconductor industry devices requires a sophisticated deployment of technology resources, particularly in the phase of integration process technology. Two engineers were told by engineers at a Taiwanese foundry that the process flow brought over from Japan was too long (A4). It was cut by one-third, prompting the Japanese engineers to question whether the devices produced would perform reliably. In fact, not only did they perform reliably, but the yield went up and profitability improved (A4). Japanese semiconductor manufacturers are said to use more mask layers than elsewhere in Asia (A4) and this has a direct impact on cost competitiveness. Micron Technology of the US allegedly uses only twothirds of the number of masks used by Japanese semiconductor manufacturers, achieving a large reduction in costs (Kanazawa 2000).

Mass production technology High performance and durable semiconductor devices are often equated with superior mass production technology. A Japanese engineer proudly commented on his company’s DRAM mass production facility overseas: ‘This is the only factory producing DRAMs which can be guaranteed for over ten years’ (A7). As the main use for the DRAMs nowadays is in personal computers with a short product life, however, this pride was almost certainly misdirected. Consider Figure 4.6; an impulse to pursue high quality will push the target specification line to the right, reducing the number of devices passed (thus lowering the yield rate). With an emphasis on adequate rather than excessive quality, the target specification line lies further to the left which, all things being equal, increases the yield rate and hence significantly lowers costs. This

Number of devices

Target specification

Pass products

a Low

High Quality

Figure 4.6 Quality and yield

79

Industries, technologies, and value chains is compounded by the fact that less time needs to be spent in reaching the target specification during ramp up. The much vaunted mass production technology of Japan is weak in the area of cost competitiveness. It creates time lags. One engineer noted ‘the slow pace of start up for the yield’ of Japan compared to Taiwan (A5). He also noted that Japanese semiconductor firms need more equipment. Another noted that Japanese semiconductor firms feel a need to increase not only the yield but also the quality level of the devices, while Asian competitors are mainly concerned with just raising the yield. During development, the former want to incorporate new technology, while the latter will not add new technology unless it leads to a rise in the yield. Equipment, processes, or process flows are not changed unless absolutely necessary (A6). Indeed, non-Japanese manufacturers sometimes extend the life of mass production technology deliberately, for example in maintaining KrF lithography for semiconductor devices under 90 nm when competitors had switched to more advanced ArF lithography from the 130 nm generation of semiconductor devices (A6). Even if this is making a virtue out of necessity, if the result of extending the life of equipment is improved cost competitiveness while achieving the required performance and reliability, it can be considered astute technology management. In conclusion, there is little doubt that the elementary process technologies of Japanese semiconductor manufacturers are ‘high’. Their development abilities in this phase also appear to be high. Moreover, the integration process and mass production technologies necessary to produce high quality semiconductor devices are high. However, it is very likely that the elementary process technologies are in fact excessive, and the high levels of integration process and mass production technology lead to the manufacture of DRAMs of excessively high quality for the purposes for which they are required. Imposing special requirements, in turn, results in the need for more equipment. There are more masks and a greater number of steps in the process flow. Costs are raised as a direct consequence, and also as a result of the concomitant difficulties in improving yield and lengthening lead times. The latter are critical when it comes to cost competitiveness and profitability in the DRAM business. Thus, those who argue that the declining world share taken by Japan’s DRAM industry results from management problems but not technology or management of technology are mistaken. Fujimura (2000) correctly argues that technological development is also a problem, but the evidence here suggests that it is not so much one of a decline in the levels of elementary process technology development or integration process technologies, but rather one of excessive technology deployment. To put it bluntly, Japanese semiconductor makers either lacked or did not deploy the technology necessary to be cost competitive. Compared to the

80

rea Ko wan i Ta

Ideal

Japan

Low

Technology for low cost High

The Japanese semiconductor industry

Low High Technology for high quality Figure 4.7 Two evaluation axes of technology

quest for ever greater quality and performance, the pursuit of low cost and mass volume is not glamorous. But it is not easy either. Japanese semiconductor firms which tried to imitate Micron Technology in mask reduction were unsuccessful (A8). Micron Technology had developed a technological competence which was difficult to imitate. Thus the Japanese failure is a failure of technology itself, as well as a failure of technology management.

Why? Why did this happen? It was hardly a matter of technological backwardness. What other plausible reasons are there? The reasons, I suggest, are embedded in the history of the industry, its technology, and its very success.6 The history of the DRAM starts with the invention of the 1K bit DRAM by Intel in 1971. As shown in Figure 4.1, the US held the top share in the DRAM market in the 1970s and the DRAM was developed in this environment. The major Japanese electronics companies invested huge amounts of energy and resources into DRAMs (see Okimoto et al. 1984) and, by the early 1980s, had overtaken the US to claim a dominant share of the global market. The main use for Japanese DRAMs during this period was for large, mainframe computers (see Figure 4.2), and dominance was achieved on the basis of quality (see Nonaka and Nagata 1995). Reliability requirements were especially stringent, with 25 year guarantees sought (A8)! It is said that the reliability demands made were influenced by NTT because of their need for a long-term guarantee for phone systems. This is important because it arguably created a mindset equating rising competitiveness with improved quality, to which all technological efforts were focused. Cost competitiveness was not so

81

Industries, technologies, and value chains much designed into the production system as ensured by relative wage levels and the exchange rate. Let us look briefly at the technology required for a 25 year guarantee. Known as Moore’s law, the degree of integration level of semiconductors has increased by a factor of four every three years. Along with increasing degree of integration, minimum pattern sizes have decreased by a factor of 0.7 every three years. Pattern size reduction not only increases complexity, but increases speed and reduces the minimum necessary power by the scaling rule. In other words, size reduction results in higher performance, and as such, it has continuously been a target for development engineers of DRAMs and other semiconductor devices. Size reduction presents developers with two problems: fine processing and maintaining uniformity. Lithography and etching technology used in the early 1970s were not conducive to miniaturization and uniformity. At the end of the 1970s, however, a new type of stepper was developed by Nikon and Canon which made it possible to create an extremely small resist mask reliably and with uniformity. New dry etching technology known as reactive ion etching (RIE) was also developed at the end of the 1970s and early 1980s by a number of companies, including Nichiden-Anelva, Toshiba, Tokuda Seisakusho, and Hitachi, which made anisotropic fine processing (referred to in Figure 4.2) possible in wet etching (Tarui 1991). With these innovations, Japanese semiconductor manufacturers simultaneously attained fine processing and uniformity. Their engineers continued to push the envelope with respect to the performance of equipment. When they were no longer satisfied with the performance, they would develop new equipment. It was not unusual for semiconductor companies to work hand in hand with the equipment makers to do this. To increase performance and reliability, new processes–in annealing, for instance–were needed. The number of mask layers increased. Inspection was detailed and rigorous. These were all needed to mass produce high quality DRAMs with a 25 year guarantee. These efforts, in turn, set the standards for succeeding generations. Production of high quality DRAMs became the norm for which engineers continued to strive, with strong support and guidance from the quality assurance department, which had a key function. The idea of producing a DRAM inferior in quality to the preceding generation was inconceivable and would have required significant changes to the way semiconductors were designed and produced. By default then, it seems that Japanese semiconductor manufacturers ended up with significantly more inspection steps, transistor forming steps, and heat treatment steps to eliminate damage or defects–perhaps 10 percent more for each of these–than was appropriate for mainframe quality DRAMs. Korean semiconductor manufacturers, by contrast, had not established themselves in the age of the mainframe and they grew with the PC market. They designed sufficient but not excessively high quality into their semiconductor

82

The Japanese semiconductor industry technology. Micron Technology of the US, too, dumbfounded Japanese semiconductor manufacturers with its lower costs: the so-called ‘Micron shock’. The technology requirements in the new era were, simply put, deploying the most cost effective technology in the respective phases. With elementary process technology, this could be done with standard equipment purchased from equipment makers, thereby reducing development costs, the number of processes or steps, and time. Prolonging the useful life of technology where possible is a virtue, not a vice. With integration process technology, it involves designing of a process flow that would produce semiconductors of appropriate quality quickly, reducing where possible the number of masks and steps, aiming for simplicity, and limiting inspection to what is absolutely necessary. Mass production technology involves raising yields at adequate quality as quickly and efficiently as possible. Failure to meet these requirements reduces cost competitiveness, squeezing profits and hence funds for reinvestment. This ultimately undermines competitiveness, even in areas of strength. The reasons for these failures have been suggested, but need amplification. First, whatever their intentions might have been, the Japanese manufacturers continued to make DRAMs largely in the ways they had established in the 1970s and 1980s. They created a technology culture that was resistant to change and, as a result, created path dependence, even as the changing environment made this response inappropriate. They allowed the technology development process to become separated from market requirements. Second, the very fact that they had been so successful no doubt made it harder to change. Success creates big organizations, which in themselves become hard to change, being more introverted and less sensitive to changing market conditions. Success validates certain ways of doing things and norms which then become resistant to change. Top managers have usually had a direct stake in creating the conditions for past success, and so they often are the last to recognize the need for change. The ‘poison of success’ phenomenon is well recognized and shows little regard to nationality.7 Cole and Whittaker treat this same phenomenon in the Introduction to this volume. Third, and somewhat speculatively, there is probably a link with the Japanese productionist culture which, despite its many strengths, also has some blind spots. This productionist culture stresses quality improvement and performance improvement as a way of engaging and motivating engineers. Moreover, it may encourage a view of technology as ‘high’ (good) or ‘low’ (bad), rather than focusing on what customers want. If this is so, the same problems may be present in other industries which have experienced a decline in competitiveness in recent years. Cole’s chapter on telecoms in this volume, for instance, suggests that NTT’s same high quality requirements set standards for its suppliers (major electronic companies) that led to an unwillingness to take TCP/IP protocols seriously, and this proved disastrous for Japan’s competitive position in the emergent networking equipment industry. Further

83

Industries, technologies, and value chains research is needed, both in the semiconductor industry and other industries, before the findings can be generalized, but there is growing evidence that DRAMs are not an isolated case.8

Concluding comments Most analyses of the decline of Japan’s semiconductor competitiveness have stressed general management failures. Technology and technology management have largely been exonerated. The common industry view is that Japan ‘lost in management, strategy and cost competitiveness’ but ‘did not lose in technology’. To some extent this view is correct. But it is also one of the reasons the Japanese semiconductor industry finds itself in such a pinch. The failure to recognize that costs are crucially linked with technology development meant that manufacturers continued to produce semiconductor of excessively high quality when they should have been focusing on developing and deploying technology to achieve cost competitiveness. It also meant, conversely, that efforts to reduce costs through heavy restructuring were only partially effective. In fact, they may have hurt the companies as much as they helped them because many key engineers were lost as a result. (To compound the loss, some were recruited by expanding Asian competitors.) If Japan’s once proud semiconductor industry is to survive at all, it will need to migrate, as suggested by Figure 4.7, by linking technology and technology management more effectively to market requirements.

Appendix: Interview and survey list A1 Results of survey conducted with 21 engineers by the author and Dr T. Arikado, former CEO and first Research Department Head of Semiconductor Leading Edge Technologies, in September 2004. A2 Interviews conducted with five engineers from the Japan Semiconductor Consortium in September 2004. A3 Interview conducted with three engineers at a dry etching equipment manufacturer, 4 May 2004. A4 Interview conducted with two engineers from a Japanese semiconductor manufacturer which consigned work to a foundry, 27 April 2004. A5 Interview conducted with an engineer from a different Japanese semiconductor manufacturer which consigned work to a different foundry, 19 April 2004. A6 Interview conducted by the author and Dr H. Yoshioka with an engineer who had left a Japanese semiconductor manufacturer to work for a semiconductor manufacturer in Asia, 10 July 2004.

84

The Japanese semiconductor industry A7 Interview conducted with an engineer at a Japanese semiconductor manufacturer’s DRAM factory in Southeast Asia, 28 January 2004. A8 Interviews by the author and Dr H. Yoshioka with a former department head of the semiconductor department at Hitachi, 19 August 2004.

Notes 1. Several people have contributed greatly to the research and arguments of this chapter. I am very grateful to Dr T. Arikado, former CEO of Semiconductor Leading Edge Technologies (SELETE) for sharing his valuable insights, as well as to the cooperation of SELETE researchers. Also to Mr H. Mizokami, former head of the Oki Electric DRAM Production Division and former CEO of KLA-Tencor. As will become evident, Dr Hidemi Yoshioka of Kyushu University provided a number of important insights which stimulated the research, and also participated in some of the research itself. I would like to express my deep appreciation to her for her help. Any factual and interpretive errors are the responsibility of the author. Funding and support from the following are also gratefully acknowledged: 1) Ministry of Education, Culture, Sports, Science and Technology (MEXT) 21st Century Centre Of Excellence Program at Doshisha University (ITEC); 2) New Energy and Industrial Policy Development Organization (NEDO) grant ‘Scientific View and Product Development Capabilities in the Semiconductor Industry’; 3) the Murata Science Foundation ‘Comparison of the Technology of Semiconductor Industry in Japan, the US, Korea, and Taiwan: Increasing the International Competitiveness of the Japanese Semiconductor Industry’. 2. SELETE (Semiconductor Leading Edge Technologies) is a consortium of more than 10 of Japan’s semiconductor manufacturers, formed to develop element and module technology for micro-fabrication of next generation transistors, wiring and lithography. SELETE engineers are seconded or transferred from the R&D labs and production facilities of member companies. 3. SIRIJ was established in 1995 to plan and implement programmes to ‘revitalize the Japanese semiconductor industry, increase its international competitiveness and explore the many possibilities of the semiconductor devices’. It is comprised of researchers sent from the member companies, and when necessary research groups are formed with those from the semiconductor and related industries to collect and analyse information. Member companies are Fujitsu, Matsushita, NEC, Oki, Renesas, Rohm, Sanyo, Sharp, Sony, and Toshiba. The Semiconductor Industry Strategy Promotion Committee, established within SIRIJ, was responsible for the report and its recommendations. 4. There are other reasons behind Samsung’s competitiveness vis-a`-vis Japanese semiconductor manufacturers, including organizational factors. Exploration of these are beyond the scope of this chapter. 5. Although the number of interviews introduced here is limited, the interviews are corroborated by the author’s experiences in DRAM research and development (retrospectively) and other informal discussions. 6. I am grateful to Hugh Whittaker for helping me with this section.

85

Industries, technologies, and value chains 7. See for example, Schein 1992; Gerstner 2002; Inagami and Whittaker 2005 (and Whittaker in this volume). 8. Before the arrival of Carlos Ghosn, for instance, Nissan is said to have suffered from similar problems (See Ghosn et al. 2003).

References Fujimoto, T. (2004). Nihon no monozukuri tetsugaku (The Philosophy of Japanese Production), Tokyo: Nihon Keizai Shimbunsha. Fujimura, S. (2000). Handotai rikkoku futatabi (Resurrecting semiconductors), Tokyo: Nikkan Kogyo Shimbunsha. Gerstner, L. (2002). Who Says Elephants Can’t Dance? Inside IBM’s historic turnaround, New York: Harper Business. Ghosn, C, P. Rise, and Y. Takano (2003). Carlos Ghosen keiei o kataru (The management of Carlos Ghosn), Tokyo: Nihon Keizai Shimbunsha. Inagami, T. and D. H. Whittaker (2005). The New Community Firm: Employment, governance and management reform in Japan, Cambridge: Cambridge University Press. Itami, H. (1995). Nihon no handotai sangyo: Naze mitsu no gyakuten wa okottaka? (The Japanese semiconductor industry: Why did three reversals happen?), Tokyo: NTT Shuppan. Kanazawa, T. (2000). Wagakuni handotai sangyo no mezasubeki tokoro (What the Japanese semiconductor industry should be aiming for), Tokyo: Kikaishinko-kyokai. Kawanishi, T. (1997). Waga handotai keiei tetsugaku (Management philosophy of Japanese semiconductors), Tokyo: Kogyo Chosakai. Nonaka, I. and K. Nagata (1995). Nihongata inobeshon shisutemu: Seicho no kiseki to henkaku e no chosen (The Japanese innovation system: Growth miracle and the challenges of change), Tokyo: Hakuto Shobo. Okazaki, S, A. Suzuki, and T. Ueno (2003). Hajimete no handotai risogurafi gijutsu (Introductory semiconductor lithography technology), Tokyo: Kogyo Chosakai. Okimoto, D., T. Sugano, and F. Weinstein (1984). Competitive Edge: The semiconductor industry in the US and Japan, Stanford: Stanford University Press. Oyane, S. (2002). Nichibeikan handotai masatsu (US–Japan semiconductor trade friction), Tokyo: Yushindo. Schein, E. (1992), Organizational Culture and Leadership, 2nd edn., San Fransisco: JosseyBass. Semiconductor Research Institute Japan (2003). Waga kuni handotai sangyo no genjo to kadai (Current situation and issues for the Japanese semiconductor industry), Tokyo: SIRIJ. Tarui, Y. (1991). Handotai rikkoku Nippon: Dokusoteki na sochi ga kizukiageta kiroku (Japanese semiconductors: The record of unique devices), Tokyo: Nikkan Kogyo Shimbunsha. Tokuyama, T. (1992). Handotai durai echingu gijutsu (Semiconductor dry etching technology), Tokyo: Sangyo Tosho. Yoshioka, H. (2004). ‘Consideration of Catching-up of Samsung Electronics in the DRAM Market: From the aspect of change in the demand for DRAM’, Journal of Korean Economics Studies, 4, August: 21–44.

86

5 Global value chains in the pharmaceutical industry Jocelyn Probert

Introduction The configuration of the global pharmaceutical industry’s value chain has undergone substantial change since the molecular biology ‘revolution’ of the 1970s. This has allowed many new specialist firms to emerge as suppliers of technologies or drug candidates to established pharmaceutical companies.1 These new firms have created a market for know-how in various aspects of the discovery research function. The emergence of contract service providers has also encouraged fragmentation of the industry’s value chain in the development, manufacturing, and marketing functions (see Figure 5.1). In contrast to the vertically integrated pharmaceutical companies of the pre-biotechnology age, modern pharmaceutical firms are able to build and draw on dispersed networks of collaborators and alliance partners who share both the costs and the risks of their joint endeavour–a logic that Chesbrough (Chapter 7) describes as the Open Innovation model. This approach, of using externally derived knowledge and technology to complement in-house research and development activities, is common to several of the high tech industries discussed in this volume. But to what extent have Japanese pharmaceutical companies participated in this strategy of fragmentation and reconfiguration? If the short answer to this question is ‘not much until now’, we could well ask why should this be, does it matter, and is their position changing? In this chapter, I compare the strategies of large Japanese pharmaceutical companies with those of their US and European counterparts, looking particularly at interactions with external R&D parties, attitudes towards industry consolidation, and the implications for future growth and performance. The chapter starts with a brief outline of developments in the global industry, then looks at the institutional features

87

Industries, technologies, and value chains Typical alliances/partnerships From biotechs/universities Technology Target identification Lead optimization

From biotechs/other pharma Compounds (all stages): -global rights -territorial rights -co-development

Discovery Research Large pharma company

Target identification Target validation Screening Lead substance -identification -optimization

Development

From biotechs/other pharma Co-promotion Co-marketing

Manufacturing

Marketing

Pre-clinical Phase I Phase II Phase III

To CROs Patient recruitment Phase II trials Phase III trials Data management

To CMOs Biologics mfg Formulation Packaging

To contract marketing organizations Territorial marketing rights

Typical outsourcing/supply contracts

Figure 5.1 Value chain fragmentation options

of the Japanese industry that have been important in shaping firms’ attitudes to the transformation of the R&D process. The third section looks at the activities of individual firms, drawing on interview data from an on-going cross-national research project2 as well as secondary sources, including industry analysis and corporate websites. In conclusion, I discuss the implications of recent strategies for the future competitiveness of the Japanese pharmaceutical industry.

Change in the global pharmaceutical industry and the management of technology The pace of change in biological and chemistry-based sciences presents a challenge to the fully vertically integrated model of pharmaceutical firms. Advances in genetic engineering, cell biology, protein chemistry, and other scientific disciplines as well as the emergence and refinement of technological tools are so diverse that not even Pfizer, the world’s largest pharmaceutical

88

Global value chains in the pharmaceuticals company, aims to possess leading-edge capabilities in all scientific areas. Research and technology collaborations with external parties allow a firm to sample new approaches without immediately having to establish its own research programme. But a firm cannot simply buy in discovery research from outside: it needs internal capabilities to select between competing technologies, and the absorptive capacity to exploit the imported resources effectively (Odagiri 2003). Research partners may be geographically dispersed too, and this adds monitoring and communication skills to the set of capability requirements a firm must possess. In recent decades firms have become more aware of technology not only located outside their own organizational boundaries, but also across national borders. The quest for global reach has encouraged the internationalization of R&D activity, with some pharmaceutical firms operating research sites, sometimes organized as a network of Centres of Excellence (CoEs), outside the home country. More and more, the purpose of such facilities is to tap into the scientific/technological knowledge resources of the host country, rather than to follow the older practice of adapting home country innovations to local market requirements. Roche’s acquisition of a majority stake in the Japanese pharmaceutical firm, Chugai, is an example of the new strategy. Scientific/technology- or market-related factors drive choices around the location and type of site. When firms invest internationally to take advantage of host country skills and knowledge, they are no longer tied exclusively to their native innovation system. But the ease with which they can exploit the advantages of proximity to external resources depends partly on how closely they are tied to their home environment. The national system of innovation in which research-intensive organizations operate influences the type and intensity of research conducted. It reflects past patterns of technological strength and shapes the development of further technological competences (Nelson 1993; Cantwell and Molero 2003). Attitudes to the acquisition of technology affect the sort of linkages made between public and private sector organizations. If there is cutting-edge technological know-how in academic research institutions, firms are more likely to increase the amount of collaborative work they conduct (Hemmert 2004). Corporate strategy and the availability and quality of internal human and capital resources also shape innovation capabilities (Hemmert 2004), as does the organization of knowledge management and internal knowledge transfer (Nonaka and Takeuchi 1995). How successful individual firms are at accumulating scientific and technological competences ultimately determines the competitiveness of an industry at the national level. The cost of accessing and managing the complexities of the wide range of scientific and technological competences necessary for pharmaceutical R&D today partly explains the escalating price tag of bringing a new drug to market– US$800 million in 2000 is a commonly cited figure (DiMasi et al. 2003).

89

Industries, technologies, and value chains A second factor is the heavy regulatory burden imposed by the US Food and Drugs Agency (FDA) and other national or regional authorities, in the form of increasingly complex and extensive clinical trials. The need to recoup R&D expenditure and to maximize returns during the patented life of the product has intensified pressures on firms to globalize their sales and marketing operations. Yet research productivity has not matched the rise in research costs: only 26 new molecular entities (NMEs) reached the market in 2003, compared with 40 NMEs in 1993. The Bain Drug Economics Model 2003, cited by Mertens (2004), shows that the cumulative success rates of drugs moving from the pre-clinical stage through the three phases of clinical trials and onto the market have declined from 14 percent in 1995–2000 to only 8 percent in 2000–02, a record that exposes the increased vulnerability of firms to research failure. Among American and European pharmaceutical firms, strategies to overcome rising costs and pipeline gaps have included mergers and acquisitions to achieve economies of scale, as well as alliance formation and in-licensing. Although M&A activity has apparently not solved their research productivity issues, it has created a set of companies that dwarf the Japanese pharmaceutical industry’s biggest players, both in terms of research budget and marketing muscle. Only three Japanese firms–Takeda, Sankyo and Yamanouchi–appeared in the ranking of the world’s top 20 pharmaceutical companies in 2000. Consolidation increased the world market share of the top 20 firms from 36 percent in 1990 to 69 percent in 2000, yet the three Japanese firms increased their world market share only from 3 percent to 4 percent, while European companies grew their share from 19 percent to 30 percent and US companies from 14 percent to 35 percent (Schofield 2001). In 2003 Pfizer recorded pharmaceutical revenues of US$43 billion, nearly five times greater than Takeda’s US$9 billion, and its research budget of over US$7 billion similarly dwarfed Takeda’s US$1.2 billion. Japanese pharmaceutical industry R&D expenditure as a whole grew much more slowly during the 1990s than in earlier years, reflecting a stagnant domestic market, while R&D expenditures accelerated in the US and Europe.

The institutional background Historically, Japanese firms have been relatively isolated from the rest of the world pharmaceutical industry in terms of their presence in global markets and their access to or usage of external knowledge networks. In market terms, less than 15 percent of Japanese discoveries achieved global status3 in the period 1985–1994, compared with 40–60 percent of products from Swiss, German, British, and US firms (Thomas 2001). More recent data from CMR International (2000) indicate that during the 1990s only one in eight NMEs

90

Global value chains in the pharmaceuticals launched by Japanese companies was sold internationally, compared with one in three European and US drugs. Few Japanese firms have the organizational infrastructure to market their innovative drugs in all major markets. The domestic biotechnology sector is also very immature compared with the sector in the US, the UK and even Germany–the Japan Bioindustry Association (2003) identified 334 firms in 2003, of which only four had gone public. This reduces the possibilities for pharmaceutical firms to access domestic innovations in biotechnology. On the other hand, firms in other industries (such as foods and textiles) are suppliers of know-how and technological competence to an extent not found in other leading pharmaceutical nations. This suggests a rather different pattern of development for the Japanese pharmaceutical industry. Firms have felt rather little pressure to consolidate because of the lack of foreign competition in their home market (Thomas 2001), but also because, as in Germany, shareholder pressure has been limited. As a result, firms have stayed small relative to their American, British, and Swiss peers. Reasons for the relative isolation of the Japanese industry can be traced to Japanese drug pricing policies in the 1980s and 1990s, which helped to keep out foreign firms while also reducing domestic firms’ financial resources, the regulatory approval framework, and the under-developed nature of industry–academic relations. In the following sections, the consequences of each of these factors will be explored in turn.

Pricing policies Drug pricing policies are widely regarded as disadvantaging Japanese pharmaceutical company competitiveness in world markets (Howells and Neary 1995; Thomas 2001). From 1981 onwards near annual reimbursement price cuts penalized firms with older product portfolios; combined with perverse incentives that encouraged doctors to prescribe multiple drugs at each patient consultation (particularly the newer drugs on which the doctors earned high margins), this pricing policy prompted drug companies to launch waves of minor, imitative drugs suited only to the domestic market. Clinically more valuable older drugs disappeared from the market as their prices fell while newly marketed products, irrespective of their innovative value, at least initially earned prices that were high relative to drug prices in the US or Europe (Thomas 2001: 114–15). Only in the 1990s did the health care ministry, under pressure from the finance ministry to rein in overall health care costs, begin to set initial launch prices in the Japanese market closer to global norms, while adding a supplement of 10 percent–increased to 40 percent in 2000 and 100 percent in 2002– for newly listed ‘innovative’ drugs (Motohashi 2004). But because annual or bi-annual reimbursement list price cuts continued, the Japanese market

91

Industries, technologies, and value chains registered virtually no growth between 1990 and 2000 (JPMA 2002), in sharp contrast to the 10 percent annual growth seen in the United States, and 5–6 percent growth in some European markets (Interview Notes 2004). Pricing policies have strongly influenced the ways that firms operated. While the domestic market was rich and growing rapidly, as it did until the early 1990s, they had little incentive to look for new opportunities in foreign markets–particularly the US and Europe, whose more demanding regulatory authorities (see below) were unlikely to approve the sort of drugs that the Japanese pricing system encouraged firms to produce. Although firms began establishing overseas operations in the late 1980s, they paid much more attention to honing their domestic sales activities. After the new ‘innovation’ price supplements were introduced in the 1990s, foreign firms began to compete more aggressively and to take a greater share of the zero growth domestic market. That pushed the more innovative Japanese pharmaceutical companies to start more actively operating in important Western markets.

Regulatory framework The domestic market also stayed relatively isolated because of a prohibition until the mid-1980s on nonJapanese firms applying by themselves for drug approval in Japan (Reich 1990). This encouraged Japanese pharmaceutical companies to seek opportunities to in-license drugs already marketed in the US or Europe, making the identification of such drugs their primary technology strategy (Cockburn et al. 1999). At the same time it protected them from foreign competition. Throughout the 1980s and early 1990s clinical testing standards in Japan emphasized safety over effectiveness, reinforcing the incentives for firms to proliferate and imitate drugs already available (Thomas 2004). And yet full clinical trials on foreign drugs had to be repeated in Japan despite the more rigorous pre-approval testing they had already undergone elsewhere. The high costs of re-testing continued to protect the domestic industry, even after foreign firms were finally allowed to lodge their own applications for marketing approval, since not all firms were prepared to bear the cost of repeating the trials. A consequence of the authorities’ concentration on safety above efficacy was the relatively low percentage, noted above, of Japanese drugs that found global markets. In this protective regulatory environment the Japanese pharmaceutical industry remained highly fragmented compared, for example, with the UK. British firms had faced a challenging competitive environment since the 1950s because the government set high efficacy standards and gave incentives to all firms, foreign and domestic, investing in pharmaceutical research–a policy that meant only firms able to compete at the international level could survive (Thomas 1994; Gambardella et al. 2000). But the international

92

Global value chains in the pharmaceuticals harmonization of standards on good clinical practice gradually eroded Japan’s market isolation. The revisions implemented in 1997 introduced in Japan the principle of informed consent for clinical trials and also established objective standards for drug approval for the first time (Motohashi 2004). Firms could also now conduct small ‘bridging’ studies to complement clinical trial data collected abroad. Since domestic clinical trial costs are high and large scale trials are difficult to organize because the hospital system is so fragmented (Howells and Neary 1995), Japanese firms able to conduct trials overseas were in a better position than those with purely domestic operations. Another regulation also made Japanese firms behave differently than their foreign competitors. Until the Pharmaceutical Affairs Law was amended in 2002, drugs were approved on the basis of applications to manufacture, rather than on marketing applications, as is the case in the US and Europe. This meant that firms had to retain control over their entire value chain, keeping all manufacturing in-house. Since the amendments, several firms have announced the spin-off of their production sites into separate subsidiaries, which will also offer contract manufacturing services to other firms. Contract research organizations (CROs) were also slow to develop in Japan compared with the US and Europe, because they found it hard to break into the tight relationships between pharmaceutical companies and doctors. The strengthening of clinical trial guidelines began to change attitudes–although CROs struggled until recently to recruit good staff (Interview Notes 2004). Also, some of the leading domestic pharmaceutical firms began to gain experience of CROs in foreign markets. These changes in the regulatory environment have gradually supported the emergence of a variety of external service providers to the domestic pharmaceutical industry.

Industry–university linkages The rise of the US biotechnology industry on the basis of start-up firms created by entrepreneurial academics (often with the support of venture capitalists) is a well documented story, repeated on a lesser scale in parts of Europe. Scientists displaced from large firms through mergers are another source of venture creation in Western countries. But in Japan neither of these trends was evident until recently. Instead, pharmaceutical firms and established firms in other sectors have been the prime movers in bio-pharmaceutical activity, and they have dominated the biotech patenting process (Thomas 2001; Kneller 2003). There are no start-up Japanese genome database firms like Celera or Incyte in the US; neither have any important new firms with bioinformatics expertise come out of the universities. Why has Japan’s biotechnology capability not emerged from universitybased research activity? It has been said that suitable conditions to foster standalone biotechnology firms and academic spin-outs did not emerge

93

Industries, technologies, and value chains because the government did not recognize the potential value of biotechnology (Mahadeva 2004). But the slowness of Japanese academic researchers to move into areas such as genomics can also be traced to the poverty of universities,4 compared with the substantial resources available to US life sciences academics (primarily through the NIH’s competitive grant awards). From the 1960s, funding for universities failed to keep up with student growth, putting a squeeze on resources available for research in science and engineering (Whittaker 2003). And although master’s programmes–whose graduates entered corporate R&D laboratories–boomed, there was no equivalent flow of students into PhD programmes (Kobayashi 1997). The tiny number of PhDs given in biology–only 200 each year compared with 6000 in the US, according to Lehrer and Asakawa (2004)–provides a stark contrast. As the academic qualifications of corporate scientists are comparatively low, moreover, it is hard for them to grasp easily the significance of academic advances in biology. Part of the problem lies with Japanese public sector governance mechanisms. Unlike the liberal university–industry institutional environment in the US, in Japan there has traditionally been a clear boundary between academic (non-profit) activity and (profit-seeking) commercial activity. Academic researchers were not allowed to patent discoveries from externally funded research projects, and the commercial use of intellectual property arising from government sponsored research was also difficult (Lehrer and Asakawa 2004). Not surprisingly, the flow of cutting-edge academic knowledge into the commercial sphere was very poor, particularly because public university professors were barred from playing a direct role in private companies. The rules even on collaborative work with companies were so restrictive that researchers sometimes gave their findings to companies in exchange for donations to their laboratories (Whittaker 2003). Instead, relations between industry and university have typically been based around semi-formal and informal research networks and government sponsored research consortia like those around the genome and SNPs in the 1990s and proteomics in 2000. Another problem has been that various government bodies wanted to take the lead in biotechnology throughout the 1980s and 1990s. This picture finally changed in the late 1990s. Several new laws were passed in 1998–2000, including the equivalent of the US’s 1980 Bayh-Dole Act, to stimulate Japan’s participation in global biotechnology research. National science policy reforms focused on producing what Lehrer and Asakawa (2004: 929) call ‘networked scientist-entrepreneurs’, and in 1998 the first university technology licensing office (TLO) to assist in the commercialization of research was established. By January 2002 there were 26 TLOs in operation (Motohashi 2004). The first example of an IPO by a university biotechnology spin-out was AnGes MG, founded by an Osaka University professor and listed on the Mothers section of the Tokyo Stock Exchange in September 2002. Significantly, the performance of national universities and research institutes

94

Global value chains in the pharmaceuticals is now becoming based on quantitative indicators, such as patent filings, publications, and the winning of external grants and research contracts (Motohashi 2004). Although these measures have improved conditions for industry–university linkages, they cannot guarantee either the same mobility of researchers between universities and firms or between firms that has been so important to the US bio-pharmaceutical industry or the availability of venture capital for start-ups. In a society where the social stigma attached to bankruptcy and to frequent job hopping is high, scientists are not prepared to take the risk of joining a start-up firm when the chances of the main project failing are high (as they are in biotechnology). Similar problems hampered the development of the biotech industry in Germany. As for pharmaceutical firms, they apparently appreciate the involvement of companies from other industries (such as Hitachi) in government sponsored research consortia but are concerned about the possible leakage of their own technologies to rivals. Even so, they often feel government pressure to participate. Finally, it is possible that linkages between universities and companies do not work because companies themselves have internal procedures and processes that deter cooperative activity, such as a value system that favours in-house product development and disregards the potential benefits of research alliances. Against this background, we next explore the strategies Japanese firms use to capture knowledge and technology resources.

Firm-level strategies Although the size and wealth of the domestic market provided little incentive for firms to establish overseas activities, larger players including Takeda, Eisai, Yamanouchi, and Fujisawa began in the 1980s to develop international operations. In the 1990s other companies attempted to offset difficult domestic market conditions by tapping into overseas markets. The number of companies with operations (including pharmaceutical bulk materials, medical devices and nutrition tonics, as well as pharmaceutical R&D activities) in the US rose from 22 in 1990 to 34 in 1995 and to 51 in 2000, while in the major European markets (France, Germany, and the UK) they increased from 18 to 36 and then to 46.5 By the end of the 1990s some leading firms were deriving 35– 45 percent of sales from foreign markets and, in some cases, a considerably higher percentage of profits, based on innovative compounds to treat ulcers (Takeda, Yamanouchi), prostate cancer (Takeda), Alzheimer’s (Eisai), and organ transplant patients (Fujisawa). This allowed them to increase their R&D expenditure even though total Japanese pharmaceutical R&D expenditure slowed. Firms with small or no overseas sales struggled to grow. At the same time, foreign competition in the domestic market intensified. Table 5.1 shows the rising importance of foreign companies.

95

Industries, technologies, and value chains Table 5.1 Changes in the domestic landscape, 1992–2002: An increasing Western presence 1992 Overall 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25

Company Takeda Sankyo Sumitomo Yamanouchi Shionogi Fujisawa Daiichi Eisai Tanabe Otsuka Chugai Banyu Kyowa Hakko Dainippon Tsumura Bayer Ono Green Cross Hoechst Taiho Pfizer Schering Sandoz Kaken Yoshitomi

2002 Rx sales

Overall

2608 2450 1950 1825 1617 1500 1383 1367 1158 1017 908 858 808 800 767 755 717 650 633 592 524 519 508 500 483

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25

Company Takeda Sankyo Pfizer/Pharmacia Yamanouchi Daiichi Eisai (New) Mitsubishi Fujisawa Novartis Shionogi Banyu/Merck Chugai/Roche Otsuka Tanabe GSK Sumitomo Ono Kyowa Hakko Aventis Dainippon AstraZeneca Bayer Taiho Meiji Seika Boehringer

Rx sales 5208 2925 2783 2100 2083 1942 1775 1717 1525 1508 1500 1383 1325 1183 1117 1075 1067 1067 1050 958 917 708 683 650 622

Source : Japan PharmaCyclopedic, cited in a presentation by Bill Mattson, The Mattson Jack Group at BioNetwork 2003, Newport Beach, CA, 28 October 2003 Note : The merger between Yamanouchi and Fujisawa placed Astellas second, behind Takeda, in 2005.

The common factors among firms with fast growing overseas businesses were a) innovative drugs that met global standards, and b) their own clinical development facilities in the US and Europe. Having one without the other did not work. Overseas clinical development capabilities allowed firms to capture more of the value of their compounds before (perhaps) assigning marketing licences at a later stage–Sankyo could earn only royalties on US sales of its blockbuster anti-cholesterol drug, because it could not do any overseas development work. These facilities also give firms the option of conducting clinical trials overseas first, and later doing only bridging studies in Japan. More importantly, launching a drug first in the US, where pricing is market-based, allows firms to establish a level from which to negotiate launch prices in controlled markets like Japan (Interview Notes 2004). The competence to manage clinical development in Western markets has become an important dividing line between Japanese pharmaceutical companies. Some firms also began to disperse their discovery research facilities, opening sites in the US and Europe to complement domestic research laboratories, and

96

Global value chains in the pharmaceuticals to tap into local technologies and human capital resources. Eisai opened a facility in Boston in 1989 and one in London in 1990; Yamanouchi ran a basic research institute in Oxford from 1990 until its work was reintegrated into the Tsukuba lab in 2002; and Fujisawa opened a small neuroscience research facility in Edinburgh in 1990 and later a small pharmaco-dynamics unit near Chicago. Eisai’s US research site was responsible for discovering one drug (for sepsis) that by 2004 was in Phase 2 clinical trials. Takeda, on the other hand, chose to establish clinical development and marketing joint ventures with local partners in the US and Europe (which it usually later bought out), while retaining all its basic research in Japan. Sankyo, similarly, has always kept all its discovery research in Japan. Industry consolidation has been slower in Japan than elsewhere. As noted earlier, Japanese companies have not participated in any of the big international mergers, preferring their independence to economies of scale. But since the late 1990s several mergers have taken place, both between domestic companies and between a Japanese company and a foreign partner (Table 5.2). The first merger between leading companies occurred only in 2005 with the creation of Astellas from the former Yamanouchi and Fujisawa. Since then, Sankyo and Daiichi Pharmaceutical have also merged, but both Eisai and Takeda have firmly stated their intention to go it alone. The experience of Mitsubishi Pharma, formed from mergers between four drugs companies, shows that size by itself is no help without competitive new drugs in the pipeline. Internal corporate restructuring measures–led by Takeda–have also focused firms more closely on high margin pharmaceutical business. Nonpharmaceutical activities such as chemicals and animal health have been sold, and noncore functions such as manufacturing transferred to

Table 5.2 Selected consolidation moves in the Japanese pharmaceutical market 1998 1999 2000 2000 2001 2002 2002 2002 2003 2003 2005 2005

Yoshitomi and Green Cross merged to create Yoshitomi (renamed Welfide in 2000) Tokyo Tanabe and Mitsubishi Chemical merged to create Mitsubishi-Tokyo Pharmaceuticals Boehringer Ingelheim (Germany) OTC acquired 51.4% of SS Pharmaceutical (OTC activity) Schering (Germany) acquired Mitsui Pharmaceutical Welfide and Mitsubishi-Tokyo Pharmaceuticals merged to create Mitsubishi Pharma Roche (Switzerland) acquired a 50.1% stake in Chugai Pharmaceutical Abbott bought outstanding 33.3% of Hokuriku Seiyaku Taisho bought 20% of Toyama Chemical, formed R&D alliance, and established joint sales force Suntory merged pharma activities into Daiichi Suntory, a new subsidiary 66% owned by Daiichi Pharma Merck (US) increased its stake in Banyu Pharmaceutical from 51% (in 1984) to 99.4% Yamanouchi and Fujisawa merged to create Astellas Dainippon Pharmaceutical and Sumitomo Pharmaceuticals merged to create Dainippon Pharmaceutical

Source : Company materials and news databases

97

Industries, technologies, and value chains subsidiaries. Some nonpharmaceutical companies have completely withdrawn from drug-related activities. As a result, the landscape of the domestic pharmaceutical industry has changed significantly since the late 1990s. Turning to research strategies, a survey of 16 leading Japanese companies in 1999 found that they were active in as many therapeutic areas (on average, six) as Western counterparts, despite their much smaller R&D budgets (CMR International 2000). An examination of corporate websites and drug development pipelines in 2005 indicates that–in parallel with organizational restructuring– many companies are focusing their research efforts more narrowly on their ‘franchise’ therapeutic areas,6 plus a limited number of additional key areas. The newly formed Astellas, for example, claims a global franchise in urology (from the Yamanouchi side) and the transplant segment of immune disorders (from Fujisawa), while Sankyo declares a franchise in cardiovascular diseases, is prioritizing metabolic, bone and joint, and immunological diseases, and regards oncology and infectious diseases as ‘challenge’ areas. Eisai mentions three areas (neurology, gastrointestinal diseases, and oncology) and Takeda, four (oncology, urology, central nervous system diseases, and ‘lifestyle-related’ complaints–diabetes, obesity and hypertension). All the same, and despite R&D/sales ratios matching those of Western pharmaceutical companies, research budgets remain relatively thinly stretched. Japan’s biggest companies, Takeda and Astellas, spent ¥130 billion (US$1.2 billion) and ¥140.5 billion (US$1.3 billion) respectively on research in 2004, but this is just a fraction of what leading firms in the US each spend.7 Many Western pharmaceutical firms have turned recently to in-licensing compounds at various stages of development, to replenish depleted drug pipelines. Yet in-licensing is not a core strategy for Japanese companies, large or small. They had earned low margins on products in-licensed in the 1980s from foreign firms for marketing in Japan, and this type of arrangement fell out of favour in the early 1990s for two reasons: their desire to reduce dependence on foreign innovations and foreign firms’ lack of interest in marketing their products in Japan because of unfavourable government pricing policies. It has also been suggested (by Kneller 2003) that Japanese companies see partnering and licensing agreements as a way of dividing up geographic markets and dealing with regulatory and marketing challenges, rather than of integrating themselves into a global network, for example by participating in the early stages of drug development. Some research (Takayama et al. 2002) even claims that drug in-licensing is a stop-gap strategy for Japanese firms entering a new therapeutic area, until in-house drug candidates in the same therapeutic area reach the market, at which point the in-licensed products are de-emphasized in the firm’s portfolio. But these comments apply to foreign drugs in Japan. Most Japanese companies would find it hard to compete for a licence to develop and market a foreign drug worldwide, because of the costs involved and the infrastructure they would need. On the other hand, in the domestic

98

Global value chains in the pharmaceuticals market food and chemical firms have for many years been important sources of early stage compounds for Japanese pharmaceutical companies, in effect fulfilling a role similar to the role Western biotechnology firms play vis-a`-vis Western pharmaceutical firms.8 One way for Japanese companies to leverage their relatively small research budgets is to form research alliances and partnerships, allowing them to share both the costs and the risks of research. The proportion of R&D budgets spent outside the firm has been increasing steadily over the last 25 years, although again, not as much as at Western firms. A survey by the Ministry of Public Management, Home Affairs, Posts and Telecommunications showed above average outsourcing expenditure by the pharmaceutical industry in 2001 (some 15.9 percent of R&D spending, compared with 11.1 percent for Japanese industry as a whole). The proportion of outsourced pharmaceutical R&D accelerated since the early 1990s, even though pharmaceutical industry R&D spending in Japan flattened, and foreign companies were the major beneficiaries of this trend. An analysis of inter-corporate alliances by Hirai (2002), which Motohashi (2004) cites, shows that US biotechnology firms are the fastest growing group of collaborators for Japanese pharmaceutical companies, and that target identification alliances account for one-third of all alliances. Research has shown that although the leading firms certainly form more alliances around drug discovery technologies or target identification than for drug candidates in pre-clinical or clinical development, they are much less active in forming alliances than Western firms (Kneller 2003). Another survey, by CMR International (2000), points out that Japanese firms are much less active in making alliances and technology acquisitions than US firms, but not so different from European firms when firm size is taken into account. Odagiri (2003) also finds that 60 percent of the alliances he identified are research partnerships, and the rest are development/marketing agreements. One example of recent in-licensing activity is Takeda’s acquisition of the development and marketing rights in Japan for an obesity drug still in phase two clinical trials at the UK biotech company, Alizyme. Some firms reported to us that forming alliances with European biotechs is easier than with US biotechs, because competition is less intense (Interview Notes 2003). Since the US biotech industry is the most dynamic source of key discovery technologies, firms that do not have a physical presence in California or Boston may find it difficult to identify and build important research networks there. Generally speaking, our own interviews indicate that the number of technology or product partnerships signed by Japanese firms with foreign biotechs is very small compared with the wealth of alliances made by American and British pharmaceutical companies. Japanese pharmaceutical companies were a welcome source of financing for new biotechnology firms in the 1980s, when venture capital markets were tight–Chugai’s full acquisition of Gen-Probe in 1989 is one example.9

99

Industries, technologies, and value chains But senior management at Japanese firms have usually preferred minority stakes in biotech firms rather than outright acquisitions, over-riding the strong recommendations of their scientists (Interview Notes 2003).10 Some companies, including Takeda (and both Yamanouchi and Fujisawa, the precursors of Astellas), have established small VC funds in the US to identify early stage research opportunities among the many biotech firms there. But in Japan, a vibrant biotechnology industry has been slow to develop, partly because there are no substantial domestic VC funds.11 In any case, Japanese pharmaceutical companies seem sceptical that domestic biotechs can play a role in providing important technologies (Kneller 2003). But there are bright areas in the Japanese industry, and the trend among Western firms towards research alliances means that even firms confined until now to the domestic market have some opportunities to develop overseas business if they have promising compounds in development. Western firms recognize the excellent science being conducted in some companies and are forming strategic pharma-pharma research relationships that resemble the more familiar pharma-biotech alliances.12 GlaxoSmithKline established early stage research alliances with both Shionogi and Tanabe in 2001 that it describes as ‘virtual CEDDs’ (Centres of Excellence in Drug Discovery), which it uses to complement its in-house CEDDs (Interview Notes 2004). Tanabe is supplying GSK with potential compounds in several therapeutic areas, while the Shionogi alliance revolves around specific compounds in two disease areas plus exclusive rights over future compounds in the same areas. A joint venture will develop and commercialize the products globally, helping Shionogi to expand its international presence. Tanabe has been almost entirely domestically focused, but is using R&D alliances with GSK, Novartis, and Menarini to expand its overseas operations. Finally, Japanese firms have developed more formal research partnerships with foreign universities than with domestic public research laboratories. Several firms list collaborations formed with US universities in recent years. Eisai’s London research facilities–like Fujisawa’s Edinburgh centre–are embedded in a university department. Collaborative relationships with foreign universities are important vehicles for recruiting scientists, as well as achieving specific research goals. Over time, they may help to overcome the cultural and linguistic mismatches that seem to plague some research relationships. In Japan, secondments of bench-level scientists from companies to universities are not uncommon (Hicks 1993) and could bridge the gaps in understanding between industry scientists and university researchers that Kneller (2003) highlights. In summary, Japanese firms are becoming more integrated into the research networks that global pharmaceutical firms typically build, but they are more cautious than Western firms in forming alliances and partnerships. There has been a general preference for organic growth, but that picture is changing as

100

Global value chains in the pharmaceuticals the domestic industry restructures. Japanese firms now not only seek external partners to plug competence gaps (e.g., in gene expression) but are sought themselves by Western firms as sources of early stage compounds, in recognition of their innovative capabilities.

Conclusions The strategic intent of individual firms is beginning to show through more clearly in response to the many changes in the institutional landscape since the mid-1990s–including growing foreign competition in a previously rather isolated domestic marketplace. Various reconfigurations are taking place, not least the creation of Astellas and the Daiichi/Sankyo merger, yet in global industry terms the leading firms remain medium sized at best. Mega-mergers among US and European firms have not proved that size guarantees R&D success, but they have created giant marketing machines capable of distributing blockbuster drugs worldwide. Japanese drugs have only reached blockbuster status through the marketing muscle of their global licensors. With research costs and complexities rising rapidly, Western (especially US and UK) firms have placed options on various compounds and technologies by forming alliances with a range of external partners. These collaborations are important risk-sharing mechanisms that allow firms to evaluate the potential of a particular technology or research area before spending too much, and to withdraw easily if the arrangement is unfruitful. Japanese firms have been more wedded to organic growth and have been slower to externalize functions such as clinical trials, or to withdraw from unpromising areas of research, probably partly because in-house scientists on ‘lifetime’ contracts need to be kept occupied. The lack of employee mobility between university and firm, and from firm to firm, hindered the creation of the specialized research or platform technology spin-offs that underpin the world’s biotechnology sector and contribute to the rapid commercialization of new scientific ideas. But with corporate restructuring, the development of a small domestic VC industry, and the strong desire of government agencies to put biotechnology at the centre of science and technology policy, a biotechnology sector is beginning to emerge. Yet, as the case of Germany shows, a negative institutional environment takes many years to overcome, and missed opportunities in the past damage current corporate scientific capabilities. An optimistic view of Japan’s pharmaceutical companies is that their cautious attitude to new biotech research tools means they have not wasted large sums of money on approaches that have yet to prove fruitful (as some would say Western firms have); a more negative perspective is that they have lost years of experience working with such tools and integrating them into their research laboratory methodologies. It could take another decade to reveal which is the case.

101

Industries, technologies, and value chains The largest Japanese companies do have innovations in their drug pipelines, like their much larger European and American competitors. But it is unlikely that any Japanese firm will join the group of global mega-companies (unless as part of an international merger, in which case it may lose its identity). Even if it discovers a potential blockbuster drug, it lacks the necessary global marketing strength to create the blockbuster status. But in any case the blockbuster model is under some threat from patent expiries, a lack of suitable candidates, and increasing resistance by health care insurers (in the US) to the high price of these drugs. This suggests that a strategy that continues to devote R&D resources to compounds for low severity diseases where several acceptable treatments already exist (e.g., hypertension, hyperlipidemia or arthritis) is relatively risky. When a blockbuster drug comes off patent, corporate sales will fall sharply unless there are other big drugs following on behind. But a plausible alternative strategy is to focus on high severity conditions with significant unmet needs (e.g., HIV, thrombosis, transplant) and/or smaller disease areas that are unattractive to the mega-players. Because these drugs require smaller clinical trials, the cost of development is lower–regulatory authorities or insurers regard them in better light than another treatment for a ‘lifestyle’ disease. Medium sized European companies seem to pursue niche market strategies with success, and even large US firms such as BMS and Johnson & Johnson are moving towards finding treatments for unmet needs. In Japan, the strategies of Astellas (urology and transplants) and Shionogi (HIV) point to similar thinking. The advantage of such specialist care products is that only small sales forces are needed to achieve complete coverage of important overseas markets. But the key challenge for Japanese companies as well as for American and European firms is to generate important drug candidates. And that means leveraging research resources around the world to their full extent, both by giving suitable autonomy to overseas research laboratories and by being open to potential opportunities for collaboration with other firms.

Notes 1. The focus in this chapter is on producers of ethical pharmaceuticals, i.e. prescription drugs, that are under patent protection. 2. I am indebted to ITEC at Doshisha University and the Cambridge-MIT Institute for financial support for this research, and to Christel Lane (University of Cambridge) for our many discussions of external knowledge sourcing practices. 3. Defined as a product approved in at least two out of the three Triad markets. 4. The education ministry has extensive regulatory and funding powers to control both public and private universities. 5. Asian countries also became important locations.

102

Global value chains in the pharmaceuticals 6. Where they already have significant market presence and more compounds in research. 7. Members of PhRMA, the American industry association, collectively spent US$33.2 billion on research in 2003. 8. In an interesting new development, some smaller Japanese firms are choosing to out-license products to their larger peers for the North American market, rather than to US or European firms. Examples include Mitsubishi Pharma’s diabetic neuropathy drug and Dainippon Pharmaceutical’s gastro-intestinal drug, both of which have been out-licensed to Takeda for the US and Europe; and an acute heart failure treatment licensed by Daiichi Suntory to Fujisawa (now Astellas). 9. When Roche acquired a majority stake in Chugai, US anti-trust laws required the divestment of Gen-Probe in light of Roche’s pre-existing ownership of Genentech. 10. Western pharmaceutical companies have indicated to us that they will acquire product-based biotech firms, but prefer licensing or collaborative arrangements with technology-based firms, in case the technologies are superseded later. 11. German biotech industry growth was also hampered by a lack of VC funding. 12. The comparison is facilitated by the disparity in size between the organizations, although the Japanese firms have greater downstream experience than many biotechs.

References Cantwell, J. and J. Molero (eds.) (2003). Multinational Enterprises, Innovative Strategies and Systems of Innovation, Cheltenham: Edward Elgar. CMR International (2000). Japan in Focus: Strategies for innovation and global drug development–What differentiates Japanese pharma companies from their Western counterparts? CMR International, R&D Briefing No.28, Epsom. Cockburn, I., R. Henderson, L. Orsenigo, and G. Pisano (1999). Pharmaceuticals and Biotechnology, U.S. Industry in 2000: Studies in Competitive Performance, The National Academy Press, www.nap.edu/openbook/0309061792/html/363.html DiMasi, J. A., R. W. Hansen, and H.G. Grabowski (2003). ‘The Price of Innovation: New estimates of drug development costs’, Journal of Health Economics, 22: 151–85. Gambardella, A., L. Orsenigo, and F. Pammolli (2000). Global Competitiveness in Pharmaceuticals: A European perspective, Brussels: European Commission DG Enterprise. Hemmert, M. (2004). ‘The Influence of Institutional Factors on the Technology Acquisition Performance of High-tech Firms: Survey results from Germany and Japan’, Research Policy, 33: 1019–39. Hicks, D. (1993). ‘University–Industry Research Links in Japan’, Policy Sciences, 26: 361–95. Hirai, H. (2002). ‘Alliance of Pharmaceutical Firms in Europe, Japan and United States’ (in Japanese), OPER Report No.4, September. Howells, J. and I. Neary (1995). Intervention and Technological Intervention: Government and the pharmaceutical industry in the UK and Japan, Basingstoke: Macmillan Press. JBA (2003). Statistical Analysis of Japanese ‘Bio-ventures’, Tokyo: Japan Bioindustry Association 20 (1–3).

103

Industries, technologies, and value chains JPMA (2002). The Japanese Pharmaceutical Industry, Tokyo: Japan Pharmaceutical Manufacturers Association. Kneller, R. (2003). ‘Autarkic Drug Discovery in Japanese Pharmaceutical Companies: Insights into national differences in industrial innovation’, Research Policy, 32: 1805–27. Kobayashi, S. (1997). ‘Educational System in Raising Human Capital’, in Japan Commission on Industrial Performance (ed.) Made in Japan: Revitalizing Japanese manufacturing for industry growth, Cambridge MA: MIT Press. Lehrer, M. and K. Asakawa (2004). ‘Rethinking the Public Sector: Idiosyncracies of biotechnology commercialization as motors of national R&D reform in Germany and Japan’, Research Policy, 33: 921–38. Mahadeva, H. (2004). ‘BioJapan 2004 – Promising biotech growth in Japan’, 29 Nov., IMS Health Online Store. Mertens, G. (2004). Targeted Cancer Therapies: Innovative drugs and their impact on the future of oncology, London: Reuters Business Insights. Motohashi, K. (2004). OECD/TIP Project on Biopharmaceutical National Innovation Systems. National Report: Japan, March, OECD/TIP. Nelson, R. (ed.) (1993). National Innovation Systems: A comparative analysis, New York: Oxford University Press. Nonaka, I. and H. Takeuchi (1995). The Knowledge-Creating Company, New York: Oxford University Press. Odagiri, H. (2003). Transaction Costs and Capabilities as Determinants of the R&D Boundaries of the Firm: A case study of the ten largest pharmaceutical firms in Japan, Managerial and Decision Economics, 24: 187–211. Reich, M. (1990). ‘Why the Japanese Don’t Export More Pharmaceuticals: Health policy as industrial policy’, California Management Review (Winter): 124–50. Schofield, M. (2001). ‘The Global Pharmaceutical Industry’, in P. Nightingale (ed.) Globalization: The external pressures, Chichester: John Wiley & Sons. Takayama, M., C. Watanabe, and C. Griffy-Brown (2002). ‘Alliance Strategy as a Competitive Strategy for Successively Creative New Product Development: The proof of the co-evolution of creativity and efficiency in the Japanese pharmaceutical industry’, Technovation, 22: 607–14. Thomas, L. (1994). ‘Implicit Industrial Policy: The triumph of Britain and the failure of France in global pharmaceuticals’, Industrial and Corporate Change, 3/2: 451–89. —— (2001). The Japanese Pharmaceutical Industry: The new drug lag and the failure of industrial policy, Cheltenham: Edward Elgar. —— (2004). ‘Are We all Global Now? Local vs. Foreign Sources of Corporate Competence: The case of the Japanese pharmaceutical industry’, Strategic Management Journal, 25: 865–86. Whittaker, D. H. (2003). ‘Crisis and Innovation in Japan: A new future through technoentrepreneurship?’ in W. Keller and R. Samuels (eds.) Crisis and Innovation in Asian Technology, Cambridge: Cambridge University Press.

104

6 Software’s hidden challenges1 Robert E. Cole

Software is the fastest growing sector of the Information and Communications Technologies (ICT) sectors, and is at the heart of the revolution in information technologies through its increasing criticality in providing functionalities for hardware (OECD 2001: 105). Software-related sales in OECD countries grew at a rate of 16 percent a year from 1992 to 2001 (OECD 2002: 58). Given the growing scale of these activities, and the high probability that firms, industries and even nations approach these activities differently, it would be surprising if such differences didn’t have some strategic consequences. Indeed, research suggests that how firms apply software increasingly serves as a critical element determining competitive success (Rapp 2002). In the past, data seemed to show that Japanese industry invested far less in software than American firms. According to OECD data, for example, Japan was only spending 25 percent of its ICT investment on software versus 46 percent for the US (OECD 2001: 65). As Jorgenson and Motohashi (2003) have recently shown, however, a large part of these differences derive from how software investment was measured. US data include the three basic types of software for investment: prepackaged, custom made, and firms creating software on their own account. However, Japanese software investment is measured only using custom made software. When adjustments are made for the absence of the large number of firms developing their own software (own account) and for the smaller number of purchasers of prepackaged software, the software/ICT ratio is almost comparable for the two countries. To be sure the sectoral location of software investment is an issue. The productivity spurt experienced by the American economy in the last half of the 1990s was stimulated not only by innovation in the ICT sector but also by the widespread adoption of ICT outside the high tech sector (Oliner and Sichel 2002), especially in services. It is in such sectors as financial services and retail that the Japanese have lagged behind the Europeans and the Americans.2 The discussion to follow is based not on the failure of Japanese firms to invest in software or the sectoral

105

Industries, technologies, and value chains location of investment but rather on their mode of investment and the types of organizational change made to support IT investment. If one asks Japanese managers in the ICT sector what are their major competitive problems today few, if any, will mention software as an issue. A variety of Japanese government surveys routinely ask experts in given fields if they are leading or lagging in key technologies. These experts consistently report that Japan is lagging in software and software tools (METI 2003: 162–3). We see then a large gap between managerial perceptions and expert judgments. What accounts for this gap? In part it is because the experts focus on innovation in a broad range of areas, including the ongoing worldwide development of packaged solutions based on standardizing best practices; Japan has not contributed much to these global developments either as developer or user. Managers, however, focus on software usability and in this regard, Japanese managers have been largely content to rely on customized software developed in-house or with the help of outside system integrators. Japanese high tech firms have been slow to act on the potential of the software revolution and its profound implications for future competition. I focus on three dimensions of this transformation with the twin objectives of understanding the reason for the large role of customized software solutions used by Japanese ICT firms and the competitive consequences of these decisions. The first dimension is the emphasis on proprietary systems that grew out of the different trajectories of the U.S and Japanese software industries over the last 30 odd years. The second is the metamorphosis of hardware firms into software firms. The third is what I call the ‘curse of genba shugi,’ which leads managers to insist on customized software that enshrines existing organizational practices, whether or not they confer competitive advantage. In the final section, I discuss the future trajectories of customization and packaged software.

Evolution of the software industry in Japan and the US With regard to the first dimension, the Japanese computer manufacturers of today rose out of the large integrated multi-product firms that originally supplied NTT. These large integrated electronic firms had few incentives to cooperate and competed fiercely with one another as they sought to differentiate product and services and lock customers into their own proprietary standards. The result was fragmented national standards (Cottrell 1996). Originally, this competition got played out in mainframes but the fragmented structure was carried over to PCs (Fransman 1995: 175). The trajectory can be seen most clearly in the experiences of NEC, which once dominated the domestic computer market but saw its shares plummet in the 90s. NEC was most effective, relative to its domestic competitors, in using

106

Software’s hidden challenges its proprietary operating systems to protect its market share, but in doing so isolated itself and the software needed to run its products from world markets. In 1982 it introduced its PC9801 using its proprietary operating system N88 Basic. It slowly migrated its support to MS-DOS, but with a proprietary graphic controller and expansion throttle that was incompatible with the IBM PC. Other leading mainframe producers followed suit. Because the dominant Japanese computer makers saw the PC as a front end to the mainframe, or as an entry level computer, they each developed incompatible standards to lock in their existing mainframe customers (Dedrick and Kraemer 1998: 80–1). Moreover, as Fransman (1995: 175) notes, apart from applications software, NEC retained all the design, manufacturing, and services required for its emergent PC business. Its subsidiaries provided a variety of services including a great deal of software and a variety of system integration services. NEC’s situation as a full service manufacturer and service provider, mimicked by other major Japanese competitors, meant that it was slow to see software as a product distinct from hardware. Software was provided for free as a way of boosting the sales of proprietary hardware systems (see Anchordoguy 2000: 395). Even today, customer firms are reported to be reluctant to pay extra for software. A key development took place in the early 1990s with IBM’s introduction of DOS/V for IBM PC/AT, a bilingual operating system for IBM and its compatibles, and the subsequent rise of application software for the new operating system. A second major development was Microsoft’s introduction in 1993 of a Japanese version of Windows 3.1 that could run both NEC and DOS/V hardware. This further broke down the wall separating the Japanese consumer market and component sourcing from the rest of the world. NEC’s dominant share of the market began to erode. The architecture of the IBM PC/AT was open and, as it evolved, it produced a variety of de facto standards. By the mid-1990s, NEC partially conceded by offering a customized version of Microsoft’s DOS/Windows for its 9800 series PCs. It capitulated in 1997 when it introduced fully compatible Windows machines, but by then its market share had fallen from above 50 percent in 1994 to 27 percent in 1998.3

Unbundling The example of IBM’s unbundling of hardware and software spread in the late 1970s, but Japanese computer manufacturers were slow to follow suit. When they did, they adopted halfway measures that involved assigning software development to their keiretsu contractors. There also arose user software spinoffs, many from financial sector firms. This structure for providing software services tended to stunt the development of independent software houses. The computer maker spinoffs and user spinoffs as keiretsu firms grew expert and quite comfortable at churning out code to strict contractor specifications,

107

Industries, technologies, and value chains instead of learning how to develop products for mass market individual and corporate customers (Hamilton 1993: B4). Corporate spinoffs seldom challenged incumbents with innovative software applications. Their focus was on achieving current usability for an individual firm and not innovation or standardization (except for pursuing standardization within a firm or among a group of cooperating companies). In 1990, independent software houses accounted for only an estimated 28 percent of all software sales, with user spinoff software houses accounting for 26 percent, computer vendor’s software sales accounted for 31 percent, and computer maker spinoffs for 15 percent (Baba et al. 1996: 108). Independent software houses throughout the 1980s found it particularly difficult to compete because the hardware makers were not required to publicize information about their hardware (Anchordoguy 2000: 396). By contrast, the US developed a thriving and diverse set of independent software firms focused on innovation. These firms began to develop in the 1960s with the period between 1965–70 marking the beginning of the independent software industry. It was spurred by the introduction of the IBM 360 with its standard operating system which increased the size of the installed base of mainframe computers that could use packaged software designed to operate specific applications (Mowery 1996: 24–5). Development further accelerated with IBM’s decision to unbundle the pricing and supply of its software and services from its hardware in 1969. Still further impetus for new entries resulted from the development of the microprocessor, IBM’s decision to outsource its components, and the rapid emergence of ‘dominant designs’. In particular, IBM’s effort to encourage a large number of applications and other programs for its PC encouraged new entries. Under increasingly open environments, software solutions were increasingly modularized; this acted as a catalyst for further product development, industry standardization, and encouraged new entries with no ties to hardware manufacturers (Ministry of Internal Affairs and Communications 2002: 4, 12). The result has been a vibrant industry filled with a continuous stream of newcomers. Consider only that between 1996–2001, software venture capital investments totalled 18.2 percent of all US technology venture capital investments (OECD 2002: 123).

The transformation of hardware into software firms With regard to the second dimension of the software revolution, most large US electronic and telecommunication companies started off as hardware companies but are increasingly becoming software companies. They initially treated software as a cost centre, but are increasingly coming to realize software is providing the most value added.4 As hardware commodification proceeds,

108

Software’s hidden challenges many firms seek refuge in software as a source of differentiation and higher margins. EMC, for example, a leader in selling data storage equipment, has been rapidly assembling an array of software capabilities (through acquisitions) for handling data and other tasks. This is, in large part, a response to the drift toward commodification of its hardware products (Forelle 2004: B3). Large telecommunication firms have gone perhaps the furthest in shifting their strategic focus to software. Firms like Alcatel, Nortel Networks, Lucent, and Ericsson, once known as equipment makers, now talk about themselves as software firms. Nortel Networks, the North American telecom equipment supplier, outsources most of the gear it builds and focuses internally on developing the software programs to run that gear. Software now drives most networking functions and allows new features to be added in the field (Delaney 1999: B8). Japanese telecom firms have lagged in these developments. Japanese firms still tend to assign most of their efforts for finding solutions for IT integration problems to hardware rather than software vendors.5 The net result is that software application vendors can expect a very small share of the solution revenue. This stunts the development of an independent software sector and leaves many large Japanese manufacturing companies with hardware-oriented solutions. Not unrelatedly, the fundamental premise at MITI in the 1980s and through the early 1990s was that hardware production was more important than software production and thus government policies to promote industry favoured expansion of hardware production and sales over software (Baba et al. 1996: 122; Anchordoguy 2000: 402). It is not surprising, too, since hardware (and the monozukuri culture that underlies it) provides the basis of current managerial capabilities and skill sets. Of course, many Japanese manufacturing managers are aware of the significance of the software revolution. Yet they find it hard to imagine a successful strategy of differentiation in the marketplace using software that would be competitive with Western hegemony in this area. This being the case, they fall back on their past ability to differentiate based on their hardware capabilities. The relative merits of hardware and software have changed along with the development of innovative new applications, however. Software solutions are often superior in term of cost, time to market, and design and field flexibility; firms can reprogram new features while the product is in the field rather than investing in new hardware (Delaney 1999: B8).6 Better software can often reduce the need for costlier hardware (Bulkeley 2003: A1, A6). Those that recognize these developments early are in a position to accelerate the process and gain competitive advantage from it. To be sure, the shift to software solutions has often been made uncritically, and there are cases where hardware solutions are better (such as when very high reliability is a high priority for users and when speed is critical. Software doesn’t always deliver on shorter time to market. Nevertheless, it is clearly the

109

Industries, technologies, and value chains case that software is increasingly being used to determine hardware functionality. The promise of what is known as adaptive or reconfigurable computing is one in which software is able to effectively redraw a chip’s physical circuitry (Markoff 2003: C1, C4). We can only expect software’s role to grow. An observation by Isao Okawa, the founder of CSK, one of Japan’s few successful software start-ups, summarizes the matter as follows: ‘It is the caliber of software that increasingly determines the preference for hardware’. While a number of perceptive Japanese managers may share his evaluation, few seem to have acted on his vision. One area where huge investment in software has taken place is ‘embedded software’. This technology has become vastly more important for Japanese manufacturers, with annual sales of embedded software products estimated to total US$500 billion a year in Japan (Yarime and Baba 2004: 8). Embedded software is incorporated into products such as computer printers, DVDs, cameras, scanners, and scientific instruments. The huge sales of such goods testifies to the capabilities of Japanese software engineers. Nevertheless, even with embedded software, one sees problems. Second generation phones are a major example where preference for hardware over software solutions, in the context of the specific business models being used, has limited the Japanese presence on global markets. European, American, and Korean handset makers rely on programmable processors using software for expressing features and other modes of differentiation. Their phones are more modular than Japanese handsets, with companies like Nokia developing platform modules (called engines) which can then be used for different models, thereby reaping huge cost savings as basic costs are spread out over many models. Nokia was initially forced into the platform model by its need to serve multiple carriers across the European market. In a similar fashion, Samsung, constrained by a small domestic market, aimed at the global market and thus had strong incentives to develop platforms for various models that would appeal to diverse global customers. By contrast, the Japanese handset manufacturers build their models ‘from the ground up’, both in terms of hardware and software. Carriers such as DoCoMo and Au (the KDDI brand) contract with their vendors to develop distinct phones from the basic hardware and compensate them by guaranteeing high volume sales or in some cases commit to paying a portion of the vendor’s R&D costs. This model reflects the continuing power of NTT vis-a`-vis the handset makers. It is also a rational response to market conditions. The Japanese handset makers, in contrast to the Koreans, are subject to the seduction of the large domestic market. The business model adopted by the carriers and the handset makers, based on custom built handsets, works admirably for the large Japanese domestic market, yielding strong profits to major industry players. In other industries, the Japanese have been able to build on the economies of scale

110

Software’s hidden challenges achieved in domestic markets to launch successful attacks on global markets. But this success assumes that key users in the domestic market are sufficiently in tune with global user needs and that the domestic business models can be applied to global markets. In the case of mobile phones, this has not been the case. Japanese handsets are more fine tuned, usually more compact, and with superior optimization for performance than those of Korean or European handset makers. The use of more expensive hardware than software solutions is a major factor in their ability to optimize designs. That said, the phones are very expensive since costs can not be spread out over many models; the heavier use of hardware further raises costs. Their failure to use more modular designs based on a more software oriented platform makes it difficult for them to spin out a large number of variations from a single model, which would reduce costs.7

Customization and the ‘curse of genba shugi’ We now turn to the third dimension, what I called the curse of genba shugi, which leads managers to insist on customized software that enshrines existing organizational practices, whether or not they confer competitive advantage. As discussed earlier, there are historical factors and subsequent path dependent trajectories that led Japanese firms to emphasize customization. These flowed from the proprietary technologies adopted by each of the hardware makers. Historical practices, however, need to be reinforced by current constraints if they are to continue to survive. The focus on ‘genba’ in Japanese firms–a source of great competitive advantage–has played this role. By genba, I mean a focus on the workplace where the actual work gets done and in particular to the workplace as the focus of production. Genba shugi is said to have its historical antecedents in the early Meiji period, when managers focused on the production shop floor as they tried to bridge the gap between traditional artisanal skill sets and the skill sets required by imported Western technology (Nakagawa 1990: 17–19). I elaborate this argument by first showing the relative weakness of the Japanese packaged software industry and then proceed to illustrate the problem with an analysis of Enterprise Resource Planning (ERP) packaged software.

Packaged software We can document the heavy reliance of Japanese firms on customized development and the limited use of packaged software. In Table 6.1, we see the results of a NTT Data survey commissioned by the Ministry of International Affairs and Communications. Seventeen percent of Japanese firms reported using packaged software with little customization compared to 29 percent of US firms; 26 percent of Japanese firms reported customizing their package

111

Industries, technologies, and value chains Table 6.1 Ways of building information systems

Japan United States

Packaged software with little customization (%)

Customized packaged software (%)

Developed or ordered custom software (%)

17 29

26 49

54 16

Source : Ministry of Internal Affairs and Communications (2004): Appendix, p. 340.

software vs. 49 percent of US firms while 54 percent of Japanese firms reporting developing their own or ordering custom software versus only 16 percent of US firms (Ministry of Internal Affairs and Communications 2004: Appendix, p. 340). The differences are quite striking. Are they significant? Fransman (1995: 188) noted similar differences, but concluded that they don’t reflect any technical competencies but rather the lucrative opportunities offered by the Japanese customized software market. Certainly he is correct as far as he goes, but by emphasizing the development of customized software for their Japanese customers, Japanese software firms have excluded themselves from participating in the global competitive market for packaged software. As such, they have foregone not only the chance to earn profits in this rapidly growing industry but, even more importantly, the opportunity to participate in the standardization of the software in ways that are particularly suited to Japanese practices and customer needs.8 Japan is a huge net importer of software. Its expenditures for software imports are 15 times higher than its receipts for software exports (METI 2003: 224). It is estimated that some 90 percent of packaged software sales in Japan are accounted for by foreign firms, and not just American; 20 of the top 100 software firms in Japan are European (Nezu 2002: 138). In the past, internationally competitive Japanese manufacturing firms had advantages in rapid product development and supply chain management, but a number of these advantages have been eroded in some key sectors in the last decade, in part because Western firms have been quicker at incorporating software applications to improve these processes taking a total systemwide perspective. Japan’s overall slowness in adopting packaged software applications has been documented in a METI survey. As can be seen in Figure 6.1, with the exception of CAD and EDI, Japan shows lower rates of adoption of various application software than competitor nations; these are applications for running the business. Japanese firms meet or exceed foreign competitors in only two of the listed applications: EDI and CAD. With the advent of the Internetbased applications and the development of XML, EDI is rapidly diminishing in importance. In the case of CAD, moreover, Japanese companies are said to have lagged behind US companies more recently in adopting 3d-CAD.

112

Software’s hidden challenges (%) 100

Japan USA Europe Asia (NIEs)

80

60

40

20

0 CAD

ERP

SCM

CRM

KM

EDI

Figure 6.1 International comparison of rate of introduction of IT-related applications Notes : CAD figures are for the manufacturing industry, SCM figures are for the manufacturing, wholesale and retail industries, and the others are for all industries. Source : International Survey of Corporate Management Strategies (METI)

Japanese managers will often claim that their failure to adopt a broad range of packaged applications reflects the uniqueness of their organizational requirements vis-a`-vis Western competitors. It is interesting to observe from Figure 6.1, however, that the rate of adoption of these applications by their direct and highly successful Asian competitors from Korea and Taiwan is significantly higher than for Japan. Do they not also have unique organizational requirements?

Enterprise resource planning (ERP) We turn our attention now to one of the key IT applications of the 1990s– Enterprise Resource Planning (ERP) software. ERP application software originated as a solution to automating information entry and processing across the major functions of a company, integrating this information in a predetermined way, and allowing all of these business functions to access this information in a real-time environment. The software subsequently evolved to include information from supply chain partners and end customers. These kinds of applications are based on modelling the respective business processes and then creating a standardized best practice model.

113

Industries, technologies, and value chains Before going further, we should note an interesting contradiction among US firms. Although adoption of ERP is widespread among US firms, few users say they received the full benefits they expected and there is a widespread view that ERP software projects have a negative return on investment (ROI) (Braue 2003; McKinsey and Company 2003). The potential direct measurable benefits from ERP, as reflected in reduced headcount, and improved performance metrics resulting in greater revenue and/or lower costs, typically do not compensate for the high total cost of ERP acquisition, implementation and maintenance (Davenport et al. 2003).9 Although proponents of ERP argue that its benefits only grow over time, from the perspective of failed expectations, its adoption by large numbers of US firms appears irrational. Assuming reasonably efficient information flows across firms, one would expect that a bad perceived experience by one firm would be quickly communicated to other potential adopters and they would be reluctant to adopt ERP. Why didn’t this occur? Further analysis documents that there are a variety of indirect and more difficult to measure benefits that flow from ERP software projects that are not included in typical ROI calculations. First, there are cumulative enhancement benefits (improvement in existing software functionalities and more functionality), delivered in upgrades, that are not typically experienced in the first year or so after adoption. For example, the standardized ERP package has become more and more configurable (without requiring programming skills) and thus easier to personalize to fit specific corporate needs. Second, the provision of more accurate, more timely, and more accessible business data is a commonly recognized ERP benefit and has a number of potential strategic outcomes. These include, for example, improving customer relationships by allowing better customer management (Davenport et al. 2003), which should translate into increased revenue via higher repeat sales. Improved employee productivity is another, but it is so intertwined with other factors that it is hard to separate out its effects. The largest indirect benefit, however, is probably the facilitation of better corporate strategic decision making, resulting from access to higher quality and more timely data. This allows better and speedier identification and targeting of new strategic objectives and activities. Like any capability (resource) with extremely broad possible applications, some firms will move faster and more effectively than others to extract value from it. Some firms have a higher ‘IT IQ’. This view runs counter to that espoused by Rapp (2004), who argues that capabilities enabled by standardized software confer no competitive advantages because they are available to all,10 but is consistent with Jim Collins (2001: 79) who found that there is no evidence that good to great companies had more or better information than the comparison companies; what set them apart rather was their ability to use information strategically. In summary, despite the absence of strong direct

114

Software’s hidden challenges benefits in terms of reduced costs, we can make a prima facie case that American firms have been more willing to invest in ERP because of the indirect strategic benefits that may ensue. We don’t have comparable data for Japanese ERP adopters, but there is reason to believe that many of the early adopters in Japan also had bad experiences with ERP, that these were also widely publicized, but that in Japan these reports did lead to a reluctance among potential followers to adopt. What might account for the different responses of Japanese managers to the same data as their American counterparts, and ultimately the difference in adoption rates suggested by Figure 6.1 (which probably also applies to the number of ERP modules used in addition to overall adoption)? Adding to our understanding of this matter is data from a Japanese government survey of US and Japanese firms on their perceptions of the effectiveness of their IT investments (a category broader than just ERP, but revealing nevertheless). According to Figure 6.2 the perceived effectiveness of IT investments was much greater for US than for Japanese firms in the following areas: increasing sales, winning new customers, development of higher value added products/ services, increases in customer satisfaction, and in improvement in product and service quality (Ministry of Internal Affairs and Communication 2003: 15). By contrast, when it came to reducing costs and increasing operational efficiency, US and Japanese managers had relative similar perceptions of the

Increase in sales 80

48.3 60

Improvement in the quality of products/services

35.1 70.5 48.5 20

Winning new customers

36.3 24.5

26.5 42.2 53.7 73.4

Increase in customer satisfaction

Development of high added value of products/services Japan

US

Figure 6.2 Proportion of Japanese and US companies that found their IT investment effective

115

Industries, technologies, and value chains effectiveness of IT investments. We can infer from these findings that US firms seem to value and believe in the indirect, hard to measure strategic benefits of IT investment far more than the Japanese firms, which concentrate on direct operational benefits. In short, it makes sense that the Americans would be more willing to invest in ERP software since they seem more focused on and confident that they will be able to extract indirect strategic benefits. The Japanese by contrast are interested primarily in the hard direct benefits relating to operational efficiencies, and when these do not seem to exceed investment costs, they are less willing to invest in ERP. This is consistent with long-term findings that Japanese manufacturing firms orientate themselves more to process than product innovation (Mansfield 1988: 225–6). It is also the case, as we shall see, that Japanese executives had more confidence in customized solutions. One measure of the degree to which IT investment is viewed as strategic is the proportion of firms with a Chief Information Officer (CIO) post. The percentage of firms in all industries in the US with a full-time CIO (56 percent) is reported to be nearly five times higher than in Japan (Yokota 2001: 29). It is also reported that while 51 percent of American CIOs state that they participate in designing corporate strategy, only 13 percent of Japanese CIOs make a similar claim (Ministry of International Affairs and Communication 2003: Appendix, p. 340). Parenthetically, it is plausible that competitive pressures among CIOs in large US corporations, fuelled by success stories in IT and CIO journals and subsequent attempts by individual CIOs to emulate their peers, played a major role in the frenzied adoption of IT in the late 1990s.

Customization We turn now to the flip side of adopting application software–customization. Customized software is far more expensive (according to one estimate, Japanese companies are paying upwards of eight times more for customization and services of ERP-like applications than for a licence for ERP packaged software).11 Of course, there are implementation costs for packaged software, so the gap is not this large (though, as discussed below, long-term maintenance and upgrade costs are much higher for customized software). By customizing so heavily, Japanese firms are getting applications that are finely tuned to their current practices. They are getting these functionalities, however, at a tremendously high cost relative to packaged software, costs which escalate with upgrading and efforts to network with other companies to maintain the customized software’s utility in face of changing circumstances. In the fierce global competitive environment faced by many ICT firms, the additional costs imposed by the use of customized software can be a heavy burden. (See Yunogami, this volume, for a comparable example of the costs imposed by excessive customization of hardware for DRAM production.)

116

Software’s hidden challenges For firms that are industry leaders with finely honed business processes that confer strong competitive advantage, it makes perfect sense to develop customized software internally to reflect and build on these practices. Such is the path taken by many industry leaders like Toyota, Nippon Steel, and Ito-Yokado as well as Western companies like Dell and Nokia (see Rapp 2002. We note, though, that even some of these companies will use packaged software for noncore business processes and even core business processes such as product design.) To emulate these companies, as so many seek to do, firms need to develop superior proprietary business processes; only then typically does it make sense to build your own customized software for those business processes that confer competitive advantage. To jump immediately to customized IT solutions for most business processes may only lock a firm into inferior and expensive solutions. Where the technology and the know-how are widely available, one can make a strong argument that the right approach to closing performance gaps with market leaders is by using reliable low cost off the shelf applications (see Farrell et al. 2003: 4). Regardless of geographical location, the best companies use standard applications packages for routine and certain specialized (e.g., chip design) business tasks and aim to minimize customization. By doing so they put themselves in the position to do inexpensive and rapid upgrades. Infrastructure is kept as uniform as possible to ease integration among departments and geographically diverse sites. In this way, IT spending shifts from maintenance and system integration toward developing new applications–the ultimate driver in the creation of business value (Lohmeyer et al. 2002: 8). While pressures for customization are prevalent among US and European firms, Japanese manufacturing firms, as we have seen, are especially prone to engaging in extensive customization.12 This is typically explained by the desire of firms to differentiate their business from competitors: ‘Because even Japanese organizations that belong to the same industrial sector usually have different management policies and organization, it makes sense for the processes to be customized than to be purchased as prepackaged programs’ (Baba et al. 1996: 124). This reasoning applies just as well to US, European, and Korean firms, however, which are nonetheless much more receptive to using packaged software. If the point of customization is to differentiate, moreover, it is hard to understand the oft-noted observation that Japanese competitors in the same industry seem to excessively mimic each other’s strategies and practices. A more substantive argument for customization is that Western software, with a presumed top–down decision making model, and presuming a different division of labour in work organization, doesn’t fit Japanese decision making practices (Fujimoto 2004: 318–21). Insofar as software firms use leading Western firms (lead users) to model best business processes in designing their software products, there is some truth to this argument.

117

Industries, technologies, and value chains This explanation, we note, is intertwined and reinforced with the ‘curse of genba shugi’. Masahiko Aoki (1988) provides an analytical perspective on these characteristics. He describes the internal information structure of the Japanese firm (the J-firm) as relatively more decentralized and with relatively more autonomous problem solving at individual work units than those of Western firms, while at the same time the J-firm relies more on horizontal communication among functional units rather than hierarchy. These decentralized practices, in turn, are based on worker integrative skills as opposed to the development of highly specialized jobs as more likely occurs in Western firms. So tasks such as responsibility for quality, which evolved in the West as specialized staff jobs devolved in Japanese firms into the workplace as production unit and production worker responsibilities (see also Udagawa et al. 1995; Tsutsui 1998: 190–235). This has indeed been a major strength of Japanese manufacturing, especially in industries where different operational divisions are highly complementary and information is effectively and efficiently shared across these units. The emphasis on delegating operational problem solving tasks to those who have the relevant on-site knowledge makes this decentralized decision making a quite effective approach, as has been stressed in some breathless accounts of Japanese focal factories (see Fruin 1997: 30–1). As the ancient Greeks (e.g., Pythagoras) remind us, however, even beneficial concepts and practices, when taken to the extreme, begin to suffer negative effects. To put it more generally, ‘excess turns virtues into vices’. In this case, it can lead to an emphasis on local optimization at the expense of company-wide optimization, and to turf protecting behaviour. Applied to IT, Japanese manufacturing firms have tended to stress optimizing IT at the plant level (see Shimizu 2001: 136–7) while forgoing many of the benefits that would derive from firm-wide data consolidation. The focus has been on maintaining shop floor usability (Baba et al. 1996: 124), rather than on organization-wide optimization. This is seen most clearly in the slow uptake of applications that aim at supply chain optimization. In the US, improving overall supply chain efficiency is a major driver of ERP and SCM sales. In all firms, regardless of nationality, small business units exhibit a strong tendency to want to use IT to optimize their processes; they tend to resist IT when it doesn’t promise that outcome–even if told that their acceptance will help the whole organization. This resistance is especially fierce in Japan because production units tend to have a good deal more autonomy and power–genba shugi is strong–thereby often sabotaging systemwide optimization objectives. Many firms allocate IT budgets to each division separately and there is usually complete freedom in how they use that budget. Managers of these divisions stress the efficiency of the day to day activity at their genba rather than optimizing at a broader system level or trying to achieve a long-term reduction of overall IT spending. This tends to result in heavy customization.13 It also makes

118

Software’s hidden challenges it difficult to achieve synergies across divisions in this era of system solutions and technology fusion. In one large Japanese electronics manufacturer which I studied there was fierce opposition to the proposed implementation of a packaged ERP system from the shop floor because the proposal was seen to detract from plant level efficiency. The corporate managers driving the implementation process aimed to use ERP to move from monthly production planning to weekly production planning. The plant managers, however, liked the old system of monthly production planning. From their point of view, moving to weekly production planning was not optimal because it detracted from efficiency of their operation. They would have to purchase raw materials and parts in smaller quantities, raising their costs. Moreover, with weekly production, they would have to change schedule frequently, thereby raising changeover costs and increasing probability of defects. Weekly-based production was much more challenging. The plant personnel failed to consider, however, that under the current system, the company had to maintain large amounts of expensive inventory, largely because the products being produced were not closely tuned to actual customer demand as would likely be more the case with weekly production schedules. The plant personnel focused only on optimizing their own unit (genba) and not on systemwide benefits that would result from adjusting their behaviour.14 The core of the problem lies in the assumption that all current practices are the best possible. This is the true curse of genba shugi. When the practices required by new application packages don’t match up, managers manifest an instinctive tendency to customize the application to fit current practices. This also naturally leads to maintaining legacy IT systems. Yet there are huge costs associated with customizing for system integration, and especially for long-term maintenance and future upgrades. And as time goes on, these standardized software packages get better and better at modelling real business processes and are, as noted earlier, becoming more and more flexible in allowing greater configurability to account for specific business needs. To ensure that current practices are assessed for their ability to confer competitive advantage and to use packaged software like ERP to achieve strategic objectives takes strong management leadership. In a large number of Japanese ICT firms, however, ERP implementation is given over to either internal IT department personnel or outside system integrators. The former typically do not have strong clout or understanding to assess the value of existing practices; they lack deep knowledge of functional processes. The external system integrators, on the other hand, typically do not have the incentive or the knowledge to engage in such systematic analysis. Under these constraints, IT managers and outside system integrators are little match for strong functional managers who seek to preserve existing practices. Even when outside system integrators want to do the right thing, they

119

Industries, technologies, and value chains complain that it is very hard to identify suitably strong management leaders who will take the initiative in implementation. Both of these problems, in turn, reflect the lack of pursuit of strategic objectives in adopting IT in many–though certainly not all–Japanese manufacturing firms. In this environment, Japanese firms are probably better off not even attempting ERP implementation. For those exceptional Japanese firms noted for their strategic use of customized software to enhance their competitive status, IT managers are said to have deep functional knowledge (Rapp 2004). Manifestation of resistance to change can be found in the findings of the aforementioned NTT Data survey, which examined the measures taken by Japanese and US companies toward optimizing IT investment effectiveness. As shown in Figure 6.3, only 42 percent of Japanese respondents reported reform of organizational practices to comply with IT system operations, vs. 65 percent of US respondents. Similarly, while almost 83 percent of US respondent firms reported conducting operational process reviews (e.g., establishing workflows) to comply with IT systems, only 69 percent of Japanese respondent firms reported doing so (Ministry of Internal Affairs and Communications 2004: 17). We might further hypothesize that when these changes are undertaken, they are likely to be more far reaching in American firms. What are the costs of using IT to preserve and enshrine current practices? Bruce Harreld, chief strategist at IBM, notes: ‘Just spending money on IT never creates any value. It’s what you do differently in terms of business processes that matter’ (Schlender 2003: 82). If IT installations are followed by heavy customization that preserves existing business processes, not all that much has been accomplished from a competitive point of view. The evidence suggests that for all the success the Japanese have had in using IT to rationalize the shop floor, they are, as noted earlier, more reluctant than their American counterparts to use IT for strategic purposes such as business expansion (see Motohashi 2004). The relative reluctance of Japanese firms to adopt standardized software applications for the many existing business practices that do not confer competitive advantage does not bode well for Japan’s competitive strength in the future. Viewed over the last 30 years, Japanese manufacturing firms are slowly migrating away from closed customized software solutions to open packaged systems. Because of the ‘path dependent’ nature of knowledge and practices, this has been a slow evolutionary process (see Baba et al. 1996: 117). The adoption of the MS–Windows platform was a major step forward toward eliminating fragmented standards in operating systems. Japanese firms will have to move much further and faster, however, if they are going to be able to effectively draw the full benefits of combining standardized solutions, semicustomized and customized ones as strategic tools for running the firm.

120

Re-utilization of generated effects (e.g., reduced cost) in business management (investment in new fields, etc.) Thorough communication of the background of introduction and the post-introduction vision of the IT systems to employees

Verification of cost effectiveness before introduction 73.2 80 73.2

Review of operational processes 82.7 (e.g., establishing workflow) to comply with IT system

82.9

60 57.8 48.4

66.2

40

53.1 33.5

20

68.8

13.5 Reform of organization and systems to comply with IT system operations

Establishment of a quantitative effectiveness index for verification of cost effectiveness

62.4

41.8 Regular quantitative verification of effect after introduction

64.9 64.1

50.5

Selection and concentration of operations (clarification of core competence/labour saving rationalizing and outsourcing measures for noncore operations)

73.3 Top management makes decisions on IT-related investment based on the company’s circumstance

74.4 79.6

Formulation of IT strategy based on business strategy This figure shows the percentages of companies that answered either ‘fully implemented’ or ‘somewhat implemented’ for the respective measures

Japan

121

Figure 6.3 Measures by Japanese and US companies to optimize effectiveness of IT investment

US

Software’s hidden challenges

58.0

Industries, technologies, and value chains

The future Arguments that customized and semi-customized applications win the day (e.g., Rapp 2002) are betting against the history of industrialization. Standardization has been at the heart of productivity improvement since the days of Henry Ford and the development of standardized interchangeable parts. Under most circumstances, standardized components are less expensive than a component designed and produced for one time use. The lower cost is obtained largely through producing in larger volume, and achieving greater learning effects and economies of scale. Standardized components also produce higher performance (for a given cost) than one of a kind designed components (Ulrich 2003: 132–3). These are powerful principles that have demonstrated their power again and again in the course of industrialization. There are no convincing reasons to think that, over time, the software industry will be exempt from these principles. The software application industry is still in its infancy and many of the standardized solutions have initially ill-fit the needs of industry. Five years ago, the IT firms were saying to their customers the equivalents of Henry Ford’s, ‘You can have the Model T in any colour, so long as it’s black’. Now personalization is increasingly the objective of IT firms’ efforts, with the customers more in the driving seat. Japanese firms are only marginal participants in these developments, to their disadvantage. At the same time, developing innovative products and services often does require customized solutions both to create and protect competitive advantage. The future, enabled by web services, may be one in which firms eschew the purchase of large monolithic ERP packages from one vendor. Instead they may subscribe to web services that will give them the specific pieces of needed functionality in modular form. They will choose from multiple vendors competing to show they have the most suitable products. In this fashion, they will build up many capabilities from numerous vendors to create seamless experiences for users. Alternatively, they also have the option of buying prepackaged composites from software vendors. In either case, firms will access these services over the web using http with published Application Programmer Interfaces (APIs). These APIs will enable a smooth integration of the different modules into a larger system and enable firms to cost effectively access these services. Should this vision come to pass, we will witness a process in which the modularization of the PC, and all its attendant consequences for vendor competition described earlier in the chapter, comes to be paralleled by how software is developed, sold, and used. Japanese firms continue to lag in their participation in these evolutionary developments.

122

Software’s hidden challenges

Notes 1. The author is indebted to the Doshisha Business School and Doshisha University’s Center of Excellence (COE) Program for financial support for this research as well as Ford Motor Co. IT Research Grant to the Management of Technology Program, Haas School of Business, UC Berkeley. Funds were also contributed by the Center for Japanese Studies at UC Berkeley. The author benefited from the research assistance of Yasuyuki Motoyama and Toru Ebata. Finally, I would like to especially thank Michael Ger of Oracle USA, Hideyuki Yamagishi of Oracle Japan, and Josh Greenbaum, Principal, Enterprise Applications Consulting (specializing in SAP applications) for explaining the many fine points of Enterprise Resource Planning software. Comments from Dimitry Rtischev, Hitotsubashi Business School (ICS) were also helpful. My colleague at Doshisha University, Toshiro Kita, played a special role in challenging my interpretations. None of these individuals are responsible for the use I have made of their comments. 2. I am indebted to communications with and research documents from Kazuyuki Motohashi of the Research Center for Advanced Science and Technology, University of Tokyo. 3. This section draws heavily from Fransman (1995: 174–5). 4. I am indebted to my colleague David Messerschmitt of the Electrical Engineering and Computer Science Department of UC Berkeley for this formulation. 5. Interviews with selected Oracle managers, Nov. 2002. 6. Conversations with colleagues at Berkeley Wireless Research Center, UC Berkeley, 17 Feb. 2000. 7. Individual Japanese handset makers cannot easily shift to a modular strategy, on the other hand, without sacrificing their profitable domestic market share to existing competitors. This section drew heavily from the observations of Kimio Inagaki, President Jabil Circuit, Japan. I also benefited from conversations with Prof. Jan Rabaey, Scientific Co-Director of the Berkeley Wireless Research Center. Neither of these individuals are responsible for my interpretations. 8. Despite Japan being the second largest economy in the world, only NTT Data (ranked 7th in sales) makes the list from Japan of the 20 largest software firms in the world (defined as having 90 or more percent of sales derived from software and services). Moreover, like many Japanese software firms, and unlike many of the other entries on this list, NTT Data derives much of its sales from customized software (Yamaguchi 2004: 72). 9. We should keep in mind that the studies of ERP’s ROI vary widely in methodologies and what and how they count lending a strong subjective element to these findings (Alter 2003: 20). They also measure ROI at different time periods since implementation. 10. This discussion draws from research on the secondary literature by Ian Larkin, Ph.D. student, Haas School of Business, UC Berkeley. 11. Conversations with selected Oracle managers Nov. 2002. Anchordoguy (2000: 397) also mentions in passing the heavy costs imposed by the Japanese preference for customized software based on closed standards.

123

Industries, technologies, and value chains 12. Interview with Risaburo Nezu, Fujitsu Research Institute, Dec. 2002. When packaged solutions are clearly superior, however, such as for chip design, Japanese firms like NEC eventually use a great deal of packaged software (Rapp 2002: 35). 13. I am grateful to Eugene Y. Kawamoto, IBM Japan, for these observations. 14. See the ‘Naniwa Tech’ case by Cole 2004.

References Alter, A. (2003). ‘ROI Roundtable’, CIO Insight, Oct. 15 (1): 1–20. Anchordoguy, M. (2000). ‘Japan’s Software Industry: A failure of institutions?’ Research Policy, 29: 391–408. Aoki, M. (1988). Information, Incentives, and Bargaining in the Japanese Economy, Cambridge: Cambridge University Press. Baba, Y., S. Takai, and Y. Mizuta (1996). ‘The User-Driven Evolution of the Japanese Software Industry: The case for customized software for mainframes’, in D. Mowery (ed.) The International Computer Software Industry, New York: Oxford University Press. Braue, D. (2003). ‘ERP: Carving a new niche’, ZDNET, http://www.zdnet.com.au/news/ business/0,39023166,202724921,00.htm Bulkeley, W. (2002). ‘IBM to Spend More on Services’, Wall St. Journal, 20 Nov.: B5. —— (2003). ‘For Clues to Why Tech is Still Down, See Mr. Kheradpir’, Wall St. Journal, 3 Mar.: A1, A6. Cole, R. (2004). ‘Naniwa Hi Tech: Implementing ERP’, Business case, Doshisha Business School, Kyoto, Japan. Collins, J. (2001). Good to Great, New York: HarperCollins. Cottrell, T. (1996). ‘Standards and the Arrested Development of Japan’s Microcomputer Software Industry’, in D. Mowery (ed.) The International Computer Software Industry, New York: Oxford University Press. Davenport, T., J. Harris, and S. Cantrell (2003). Better Things Come to Those Who Wait: Enterprise system benefits, Accenture Institute for Strategic Change. Dedrick, J. and K. Kraemer (1998). Asia’s Computer Challenge, New York: Oxford University Press. Delaney, K. (1999). ‘Telecom-Equipment Concerns Focus on Software’, Wall St. Journal, Oct. 18: B8. Farrell, D., T. Terwilliger, and A. Webb (2003). ‘Getting IT Spending Right this Time’, McKinsey Quarterly, http://www.mckinseyquarterly.com/article_print.aspx?L2¼13& L3¼13&ar¼1285 Forelle, C. (2004). ‘EMC to Buy Software Firm Smarts’, New York Times, 21 Dec.: B3. Fransman, M. (1995). Japan’s Computer and Communications Industry. Oxford: Oxford University Press. Fruin, M. (1997). Knowledge Works. New York: Oxford University Press. Fujimoto, T. (2004). Nihon no monozukuri tetsugaku (The Philosophy of Japanese Monozukuri), Tokyo: Nihon keizai shinbunsha. Hamilton, D. (1993). ‘U.S. Companies Rush in to Fill Japanese Software Void’, Wall St. Journal, 7 May: B4. Jorgenson, D. and K. Motohashi (2003). Economic Growth of Japan and the United States in the Information Age, Tokyo: METI, RIETI Discussion Paper Series 03-E-015.

124

Software’s hidden challenges Lee, G. and R. E. Cole (2003). ‘From a Firm-Based to a Community-Based Model of Knowledge Creation: The case of the Linux Kernel development’, Organization Science, Nov.–Dec., 14(6): 633–49. Lohmeyer, D., S. Pogreb, and S. Robinson (2002). ‘Who’s Accountable for IT?’, The McKinsey Quarterly, 4: 1–9. Mansfield, E. (1988). ‘Industrial R&D in Japan and the United States: A comparative study’, American Economic Review Papers and Proceedings, May, 78(2): 223–8. Markoff, J. (2003). ‘Computing’s Big Shift: Flexibility in the chips’, New York Times, 16 June: C1, C4. McKinsey and Company (2003). ‘Enterprise software: Where now’, McKinsey Quarterly, (Summer): 45. METI (2003). Trends in Japan Industrial R&D Activities: Principal Indicators and Survey Data, Tokyo: Ministry of Economy, Trade and Industry; Industrial Science Technology policy and Environment Bureau, Technology Research and Information Office. Ministry of Internal Affairs and Communications (2002). ‘Kokusai kyoso ryoku no tame no kigyo no IT ka senrakyu kenkyukai’ (Research group for promoting IT within firms for the purpose of increasing global competitive power), http://www.soumu. go.jp/s-news/2002/pdf/021220_3_02.pdf —— (2003). Kigyo keiei ni okeru IT katsuyo chosa (IT Practical Survey of Company Management), Tokyo: Ministry of Internal Affairs and Communications. —— (2004). 2003 White Paper on Information and Communication in Japan, http://www. johotsusintokei.soumu.go.jp/whitepaper/eng/WP2003/2003-index.html. Motohashi, K. (2004). Building an Information Infrastructure for Knowledge Based Economy, Part B: ICTusers in Japan, Paper presented to K4D Hitotsubashi Seminar, Tokyo, 13–14 Nov. Mowery, D. (ed.) (1996). The International Computer Software Industry, New York: Oxford University Press. Nakagawa, K. (1990). Nihon kigyo no keiei kozo no hikaku shiteki kosatsu (Reflections on Comparative History in Management Organization of Japanese Firms), in K. Nakagawa (ed.) Kigyo keiei no rekishiteki kenkyu (Historical Study of Firm Management), Tokyo: Iwanami. Nezu, R. (2002). ‘IT sengoku jidai’ (IT’s Warring Period), Tokyo: Chuo koron shinsha. OECD (2001). OECD Science, Technology and Industry Scoreboard, Paris: Organisation for Economic Co-Operation and Development. —— (2002), OECD Information Technology Outlook, Paris: Organisation for Economic CoOperation and Development. Oliner, S. and D. Sichel (2002). ‘Information Technology and Productivity: Where are we now and where are we going?’ Federal Reserve Bank of Atlanta Economic Review, Third Quarter: 15–44. Rapp, W. (2002). Information Technology Strategies: How leading firms use IT to gain advantage, New York: Oxford University Press. —— (2004). ‘Information Technology Strategies: How leading firms use IT to gain an advantage’, Presentation given at the Doshisha Business School, 22 Oct. Schlender, B. (2003). ‘The Next Battles in Tech’, Fortune, 12 May: 80–2. Shimizu, K. (2001). ‘Kodo johoka no jidosha kumitate Shokuba’ (Moving Toward Information-based Activity in an Automotive Assembly Workshop), in K. Odaka and T. Tsuru (eds.) Dejitaru-ka jidai no sosiki kakushin (The Organizational Revolution in the Digital Age), Tokyo: Yuhikaku.

125

Industries, technologies, and value chains Stein, T. (2004). ’Big Strides for ERP’, Information Week, 715: 67. Tsutsui, W. (1998). Manufacturing Ideology: Scientific management in twentieth century Japan, Princeton: Princeton University Press. Udagawa, S. H., K. Nakamura, and I. Nonaka (1995). Nihon kigo no hinshitsu kanri (The Quality Management of Japanese Companies), Tokyo: Yuhikaku. Ulrich, K. (2003). ‘The role of Product Architecture in the Manufacturing Firm’, in R. Garud, A. Kumaraswamy and R. Langlois (eds.) Managing in the Modular Age, Oxford: Blackwell. Yamaguchi, E. (2004). ‘Sofuto sangyo no bokko wo hagukumu Nihonteki jijyo’, (Japanese style circumstances which give rise to barriers for growth of the software industry), Nikkei Biz Tech, 004: 68–74. Yarime, M. and Y. Baba (2004) ‘Dynamics of Embedded Software Development: Coevolution of OS standards and community networks in Japan’, Working Paper, Research Center for Advanced Science and Technology, University of Tokyo. Yokota, T. (2001). ‘Abstract of the White Paper on International Trade 2001’, Journal of Japanese Trade and Industry, July/ August: 25–9.

126

Part 2 MOT in and between enterprises

This page intentionally left blank

7 The open innovation model: Implications for innovation in Japan Henry W. Chesbrough

Introduction Industrial innovation is becoming more open, requiring changes in how firms manage innovation. External sources of knowledge become more prominent, while external channels to market also offer greater promise for utilizing internal knowledge. This elevates the importance of the evaluation of early stage technology projects, which often involve significant technical uncertainty and significant market uncertainty. Companies need to ‘play poker’ as well as chess, in such circumstances. Measurement errors (false positives, false negatives) are likely to arise from judgements about the commercial potential of early stage projects. Most companies’ policies consciously limit ‘false positives’ in assessing a project’s commercial potential, but few companies take steps to manage the risk of ‘false negatives’. New metrics may help a firm focus more upon external sources of innovation to enhance its business model, and enable the firm to salvage value from false negatives that otherwise would be lost. Open innovation should not be understood to mean the lack of any internal mechanism to capture value from innovation. It may be better viewed as an open–closed process, where the openness helps to create value throughout the value chain of the company, its suppliers, its customers, and the ultimate end users. Once value is created, which means that the technology has been embraced by the players in the value chain, the closed-ness helps to claim a portion of that value. Openness also has important implications for the boundary of the firm, particularly in Japan. Technologies should move more fluidly between organizations and, at times, new organizations may be the most effective means of pursuing a new technology opportunity. Spin-offs stand as a mechanism to

129

MOT in and between enterprises manage the risk of false negatives and explore new business models to create and capture value in the Japanese context, though much remains unknown about their effectiveness in practice in doing so.

The shifting process of industrial innovation Not long ago, internal research and development was viewed as a strategic asset, and even a barrier to competitive entry in many industries. Only large companies with significant resources and long-term research programmes could compete. Research-based companies like DuPont, Merck, IBM, GE, and AT&T did the most research in their respective industries. And they earned most of the profits as well. Rivals who sought to unseat these firms had to ante up their own resources, and create their own labs, if they were to have any chance against these leaders. There were significant economies of scale in R&D, and the biggest companies generally developed the best technologies. Vertical integration was the dominant business logic of the last century. Underlying the logic was the belief that valuable knowledge was fundamentally scarce. As a result, companies sought to develop a knowledge advantage that others could not match. This corporate world view brought with it a number of working assumptions: . The company which gets an innovation to market first, will win. . If you create the most, and the best, ideas in the industry, you will win. . The smart people in our field work for us: Companies competed for the best and the brightest graduates and offered these recruits the best salaries and equipment. . If we discover it ourselves, we will get it to market first: Internal R&D was seen as a barrier against smaller competitors. . To profit from R&D, we must discover it, develop it, and ship it ourselves: The rise of companies like DuPont, General Electric, General Motors, IBM, Xerox, Merck, and Procter & Gamble were all fuelled by sustained investment in internal R&D. A by-product of this emphasis was the ‘not invented here’ syndrome, where companies rejected any technology that had come from outside. . We should control our intellectual property so that our competitors don’t profit from our ideas. For most of the twentieth century, this closed innovation model worked, and worked well. We can thank it for a whole range of inventions and developments. It enabled Thomas Edison to invent the phonograph and the electric light bulb among other things. In the chemicals industry, companies like DuPont established central research labs to identify and commercialize an amazing variety of new products such as the synthetic fibres nylon, Kevlar,

130

The open innovation model and Lycra. And Bell Labs researchers discovered groundbreaking physical phenomena and harnessed those discoveries to create a host of revolutionary products, including transistors and lasers, winning a number of Nobel prizes for their research along the way. However, this model of closed innovation ran into severe problems towards the end of the century. By way of illustration, compare Lucent, which inherited the lion’s share of Bell Laboratories after the breakup of AT&T, with Cisco. Bell Labs was perhaps the premier industrial research organization of the last century. Within the old model of innovation, this heritage should have been a decisive strategic weapon for Lucent in the telecommunications equipment market. Yet, Cisco, without the deep internal R&D capabilities of Bell Labs, has consistently managed to stay abreast of Lucent, occasionally beating it to market. Today, Cisco dominates the telecommunications equipment market, while Lucent (which nearly went bankrupt at one point) is a distant follower. How can Cisco’s relative success vs. Lucent be explained? The two organizations were simply not innovating in the same manner. Lucent was a classic example of a closed innovator, devoting enormous resources to exploring the world of new materials and state of the art components and systems, seeking fundamental discoveries that could fuel future generations of products and services. In contrast, Cisco deployed a very different, and far more open, strategy. Whatever technology the company needed, it acquired from the outside, usually by partnering or investing in promising start-ups (some, ironically, founded by ex-Lucent veterans). In this way, Cisco was able to keep up with the R&D output of perhaps the finest industrial R&D organization in the world, and without doing much internal research of its own. The story of Lucent and Cisco is hardly an isolated instance. IBM’s research prowess in computing provided little protection against Intel and Microsoft in the personal computer business. Similarly, Motorola, Siemens, and other industrial titans watched helplessly as Nokia catapulted itself to the forefront of wireless telephony in just 20 years, building on its industrial experience from earlier decades in the low-tech industries of wood pulp and rubber boots. And pharmaceutical giants like Merck and Pfizer have watched as a number of upstarts, including Genentech, Amgen, and Genzyme, have parlayed the research discoveries of others to become major players in the biotechnology industry. These days, the former leading industrial enterprises are finding remarkably strong competition from many newer companies. These newcomers conducted little or no basic research on their own. They have been very innovative, but they have innovated with the research discoveries of others. And there is a legion of other, even newer, companies waiting to supplant these firms, if an opportunity should arise. To make matters worse, some companies that made significant long-term investments in research found that some of the resulting output, however

131

MOT in and between enterprises brilliant, wasn’t useful for them. They found ways to gracefully exit from further funding of these projects, and moved on to more promising work. Then, to their amazement, some of those abandoned projects later turned into very valuable companies. This was the experience of the Xerox Corporation, for example, with its Palo Alto Research Center. Numerous valuable computer hardware and software innovations were developed at PARC, but few of them made any money for Xerox and its shareholders.

The shift to open innovation Over the past two decades, the management of innovation has fundamentally changed. It is still true that no company can grow and prosper without new ideas. It is also clear that the changing needs of customers, increasing competitive pressure, and the evolving abilities of suppliers necessitate continual creative thinking for a company to stay ahead of the pack. The challenge is that the distribution of this critical knowledge has shifted from being locked up in the corporate laboratories of the biggest firms in the industry, to being dispersed among for-profit firms of all sizes, and non-profit organizations like universities and research institutes. This has important implications for how every company thinks about growth and innovation. There are many fewer economies of scale in R&D today. The reasons behind this basic change are many and varied. In the United States one factor was the success of the GI Bill which increased college numbers in the postwar years. Other factors include the rise in the amount and quality of university research, the increased mobility of skilled personnel between companies, and the growth in venture capital and private equity that created a pool of risk capital to fund the development of new ventures. In Japan, the accession to the World Trade Organization, the liberalization of import markets, the recent acceleration in the development of legal systems to promote cooperation among academia, industry (including the conversion of national universities and research institutes into Independent Administrative Institutions), and the government personnel and institutions, the movement toward modularized product architecture and production, and the rise of the Chinese economy have all changed the innovation landscape for Japanese firms. See Probert in this volume for a description of how the landscape has changed for the Japanese pharmaceutical industry. The result in both countries has been an erosion of the carefully created and nurtured knowledge monopolies inside leading industrial corporations. Instead of being retained within corporate walls, knowledge streamed out of centralized R&D to suppliers, customers, start-ups, and spin-offs. A new generation of companies arose, which innovated with ideas brought in from outside. Of course, they added to this knowledge base, and crafted innovative

132

The open innovation model business models around that knowledge. But they did little internal R&D on their own, relying instead on licensing, acquiring, and copying external technology. While many large companies in Japan remain successful within their industries, few have escaped the pressures of stronger foreign competition within Japan, combined with tremendous competition to establish market leadership in emerging economies like China and India. We have moved from closed innovation to a new logic of innovation: open innovation. This new logic builds upon the recognition that useful knowledge is widely distributed across society, in organizations of all sizes and purposes, including nonprofits, universities, and government entities. Rather than reinvent the wheel, the new logic employs the wheel to move forward faster. What accounts for the apparent decline in the innovation capabilities of so many leading companies? We are witnessing a ‘paradigm shift’ in how companies commercialize knowledge from ‘closed innovation’ to ‘open innovation’. Closed innovation is a view that says successful innovation requires control. Companies must generate their own ideas, and then develop them, build them, market them, distribute them, service them, finance them, and support them on their own. This paradigm counsels firms to be strongly self-reliant, because one cannot be sure of the quality, availability, and capability of others’ ideas. Increasingly, however, the closed innovation approach to innovation is no longer sustainable. A paradigm of open innovation is emerging in its place (Chesbrough 2003). The open innovation paradigm assumes that firms can and should use external ideas as well as internal ideas, and internal and external paths to market, as they look to advance their technology. Open innovation assumes that internal ideas can also be taken to market through external channels, outside the current businesses of the firm, to generate additional value. This transition to open innovation will not be easy or painless. Clair Brown’s chapter in this volume explores the human resource challenges involved in implementing a more open innovation approach. People must be recruited from new places, given different assignments, provided different reward systems and new job definitions and roles. There are technical issues as well. Admitting external sources of technology into a company’s innovation process increases the number of possible sources of innovation. This greater complexity places even greater burdens upon the ability to evaluate early stage technologies. It suggests that innovators must address a key concern: measurement error.

The problem of technical and market uncertainty: Measurement error Successful commercialization of a new technology involves managing both technical and market uncertainty. The capability and performance of a fledgling technology often are poorly understood. This technical uncertainty is

133

MOT in and between enterprises compounded by market uncertainty, when early stage technology projects also address an uncertain market. How a technology might be used by customers, and what benefits it might provide to them, are far from clear. Measurement errors (both false positives and false negatives) are inevitable. Yet companies evaluate early stage R&D projects with processes that implicitly assume that the Type II (false negative) error rate is nearly zero. This is because they employ no processes to re-examine earlier negative decisions to discontinue the technology. Evaluating the commercial potential of a new technology is less subject to measurement error when it addresses a current market with a known set of customers. Xerox had little apparent difficulty dealing with even high degrees of technical uncertainty, for example, when those projects directly addressed its copier and printer markets. The company managed to convert its entire technology base from a mechanical base in its early years, to an electromechanical base in its high growth years, to a fully electronic and digital platform in the 1990s (Chesbrough 2003: Ch. 1). Where the innovation challenge frustrated Xerox was where the company had to apply its promising technologies outside of its current markets and customers. Here, the technical uncertainty that they had to contend with was joined to a new market uncertainty: which customers and which uses of its technology would be most valuable. The personal computer industry had to be invented, in order for these PARC technologies to become valuable. Coping with market uncertainty greatly complicates the already difficult challenge of managing technical uncertainty, because resolving the technical uncertainty depends on which market the technology is intended to serve, and vice versa. One cannot anticipate the best path forward from the very beginning. Not only is this path unknown, it is unknowable. No amount of planning and research can reveal the facts, because they simply don’t exist yet. Instead, a firm must experiment, adapt, and adjust, in response to early feedback. This is a fundamentally different process from the usual process of advancing the current business, more akin to a game of poker than to a game of chess.

Playing poker: The management of false negatives A large number of false negatives have emerged over the years, where projects that looked initially very unpromising turned out later to be commercially quite valuable. When Intel first obtained its design win for the 8088 microprocessor for the IBM PC, it did not regard this as even ranking among the top 50 prospects for the chip (Moore 1996). IBM almost abandoned a software project (the XML parser) that today forms the centrepiece of its WebSphere Internet services strategy (Chesbrough 2000a). The compound UK-92480 that was under development as a treatment for hypertension within Pfizer did not

134

The open innovation model achieve sufficiently positive clinical results to warrant further development. Due to a rather unusual side effect, however, UK-92480 gave rise to one of Pfizer’s most profitable compounds today, Viagra. Similarly, Thalidomide, which was driven from the market in the 1960s due to the large number of birth defects encountered by pregnant women taking the drug, has re-entered the market successfully in the late 1990s as the preferred treatment for myeloma, a fatal form of cancer in bone marrow. In this volume, Yamaguchi shows how, one after another of the large Japanese electronic firms and NTT gave up on gallium nitride crystals as the path to creating a blue LED only to find out later that researchers at a small firm outside the mainstream had successfully commercialized the blue LED based on the gallium nitride solution. How can firms manage these false negatives? By their very nature, false negatives are projects that seem unpromising inside a company due to the lack of fit with the business model of that company. As a result, these projects receive no further support. This is as it should be. One cannot continue to support unpromising initiatives or else nothing would get out into the market. How then can one determine whether or not an unpromising project truly lacks value? In these situations, a company must develop a second process for managing innovation, a process for playing poker. The analogy comes from Jim McGroddy, the former head of IBM’s TJ Watson Research Center: When you’re targeting your technology to your current business, it’s like a chess game. You know the pieces, you know what they can and cannot do. You know what your competition is going to do, and you know what your customer needs from you in order to win the game. You can think out many moves in advance, and in fact you have to, if you’re going to win. In a new market, you have to plan your technology entirely differently. You’re not playing chess any more, now you’re playing poker. You don’t know all the information in advance. Instead, you have to decide whether to spend additional money to stay in the game to see the next card.

The metaphor of poker is well suited to situations of high technical and market uncertainty. Not all the information is yet known in these situations, yet companies often manage these situations as though they were just like situations in the main business, where they are playing chess. Xerox was actually very good at chess, at finding technologies to advance its copier and printer business. However, it was a poor poker player, unable to explore the potential options of computing technologies in new markets (Chesbrough 2002, 2003). To play poker, companies need to meter their capital carefully, and to stage their investments in projects upon the receipt of new information. Projects still have to have funding terminated. But now the company

135

MOT in and between enterprises must observe what happens after that decision. How are the researchers responding to the decision to terminate further support? Have they moved onto the next project or are they still committing time to the terminated one? If the latter is the case, have they found any external customers for the project? A second process to play poker is to expose the ‘failures’ to outsiders, to gain their perspective on the potential of these projects. (After all, once you have decided to discontinue their funding there is little at risk for you.) When IBM placed its XML Parser software on its external AlphaWorks website back in 1998, it had discontinued internal funding for the project. However, the number of people who downloaded this particular code from the website was ten times the usual number. To IBM’s credit, they took note of this high interest level and began to probe the technology more closely. They reconsidered their earlier decision, and today the XML Parser is a core element of IBM’s WebSphere Internet services initiative (Chesbrough 2000a). A third approach is to out-license the rejected project, which allows another firm to utilize the ideas and see if they are valuable. This not only provides additional funds to the licensing firm, it can allow that licensor to watch and learn from the experience of the licensee. When Intel originally invented the microprocessor, it did so under a contract from Busicom in Japan. As Intel saw what Busicom was doing, it realized that the microprocessor had great potential, and bought back the licence (Moore 1996).

Spin-offs: A Japanese mechanism to manage false negatives? Organizations can also respond to a potential false negative by creating a new venture to pursue the technology, without being constrained by the current business model. Forming an external spin-off venture allows the technology to develop further outside the originating firm than it would if kept bottled up within. Having an external venture spin-off enables new learning to occur. Moreover, if the venture becomes profitable, the equity owned by the originating firm may become valuable. This organizational strategy attempts to achieve greater decentralization, higher incentives, and greater focus while preserving coordination with the parent firm. Such endeavours have had a checkered past in the US (Burgelman and Sayles 1986; Block and MacMillan 1993; Chesbrough 2000b, 2003), but are commonly done in Japan (Odagiri 1992; Odagiri and Goto 1993). There are indications that forming new subsidiaries is becoming even more prevalent in Japan (Sako 1997). Companies like Fujitsu are themselves the end product of a series of ‘hivings off’, with the Furukawa group partnering with Siemens to form Fuji Electric, and then Fujitsu spinning off from Fuji Electric in the 1930s. (Fanuc would later spin off from Fujitsu in the 1960s).

136

The open innovation model Spin-off formation may be particularly helpful in the Japanese institutional environment, where labour markets are relatively rigid and start-up venture capital is relatively scarce. These conditions make the creation of de novo start-up firms problematic, and comparatively advantage spin-off companies that are ‘endowed’ by the parent firm with human capital and financial resources. These subsidiary firms are managed differently from the parent firm in terms of labour policies, pay packages, and sometimes even the union relationship (Sako 1997). Generally, these subsidiaries do not enjoy the status of the parent firm, and must recruit from second- and third-tier universities for their personnel. As such, observers believe that such firms provide technology that is ancillary to the core technology of the parent firm (Odagiri 1992; Okimoto and Nishi 1994). Because of the pressures on lifetime employment in Japan, observers also feel that these subsidiaries are increasingly important to the Japanese employment system, and that ‘lifetime employment’ is now promised within the enterprise group, rather than within the parent firm (Sako 1997; Kusunoki and Numagami 1998). The work of James Lincoln and his colleagues reported in this volume shows that Japanese firms often utilize an organizational process that will incubate a new technology inside the parent corporation, and then spin it off as a separate entity to commercialize the technology. There are risks to consider with this approach, however. As Ritschev and Cole (2003) report in their research on ‘internal venture capitalism’ at companies like Sony, large companies may constrain the operations of new spinoffs in ways that reduce their chances for success. One type of constraint is to limit the markets for the venture to those deemed ‘strategic’ by the corporate parent. Another different constraint is, as Ritschev and Cole (2003: 145) put it, ‘Many large Japanese manufacturing firms cannot resist the temptation of solving their problem of redundant fifty-year old engineers through new spin-offs’. These transferred personnel may lack the skills needed for success in the new venture, while the young company lacks the time required to retrain them for the new skill requirements. Spin-off formation has important benefits for innovation. The new venture’s activities reveals new information about the potential for a technology that might otherwise remain latent. When Lucent’s New Ventures Group formed Lucent Digital Video as a separate company, it judged that digital video was far from being ready for the market. Once LDV got going, though, it became clear that the market was closer–and bigger–than Lucent originally judged. Lucent found that it was selling hundreds of millions of dollars of telecommunications equipment to the Chinese market, bundled with the digital video encoders from this tiny start-up company. Lucent ended up reacquiring the rest of the venture and hastened its own entry into digital video (Chesbrough and Socolof 2000). Had Lucent not formed the spin-off, it may never have realized the market potential of this technology.

137

MOT in and between enterprises

Metrics for managing open innovation IBM also has embraced the idea of enabling others to utilize their own technology. The company reported royalties of US$1.7 billion in 2001, about 15 percent of its operating income that year. It received these royalties in payment for licensing its technology for other companies to use in their businesses. Procter & Gamble (P&G) similarly has set a policy in place that, if a patented technology had not been picked up by at least one P&G business within three years, that technology would be made available to outsiders–even competitors. P&G rightly assumes that its technology is perishable, and that keeping it on the shelf only dissipates any potential value from the technology. If P&G is not going to use it, it is better to let others do so and profit thereby. P&G is also an active participant in the marketplace for externally generated ideas. It determined that, in 2001, about 10 percent of its pipeline of new products came from external sources. It decided that in order to meet its growth objectives, the percentage of external ideas should rise to 50 percent over the next five years. If the context of industrial innovation is shifting from closed to open, and if there is latent value in managing false negatives, companies will need to alter their usual metrics for managing innovation. These metrics will help companies play poker as well as chess. This was the subject of a workshop held at the Industrial Research Institute’s Spring Meeting in May 2003. Many large Japanese firms were among the attendees, including representatives from Fujitsu, Hitachi, NEC, and Toshiba. In response to the challenges of managing innovation within an open system, and to monitor the opportunities offered by that system, a number of metrics were identified across multiple small groups within the workshop (reported in Chesbrough 2004). These metrics included: 1 What % of your sales of products and services last year came from externally licensed technologies? Is this % increasing or decreasing from 2–3 years ago? 2 What % of your net income last year came from technology licensed out to other companies? Is this % increasing or decreasing from 2–3 years ago? 3 How long does it take for patented ideas inside the company to be put into use via a company’s own products or services (i.e., taken to market via a new product or service)? Has this time interval changed in the past five years? In what direction? 4 What % of your internal ideas are offered for external licence? How much time elapsed between the patenting of ideas and their external licensing? 5 How many projects were terminated in the past year? How many were reviewed at a later date? How many subsequently were offered to external parties for further development?

138

The open innovation model 6 Of the projects tracked in #5, are any of them developing faster technically, and/or growing faster in the market than expected? Are any projects able to raise external capital for further development? Have they signed any major customers? Metrics 1 and 2 focus management attention on the outputs of the open innovation process, whether that be growth in product sales or growth in licensing activity. Participants in the workshop felt that the senior leadership within their own companies needed their R&D organization’s metrics to connect directly to corporate sales and profit measures. Metrics 3 and 4 focused on a second ‘currency’ for R&D, namely time to market for new products and services, either internally as in metric 3 or externally as is metric 4. Shortening the time required for products and services to get to market was viewed as important, as this increased the rate of learning from R&D for the company, and increased the productivity and effectiveness of R&D as well. A more subtle benefit is that the prediction horizon of the marketing organizations in these organizations was shorter than the usual time it took for the R&D cycle to run its course. Reducing the time to market for new technologies increased the chances that the innovation output was still desired by the market (and that the market hadn’t shifted in the meantime). Participants felt that metrics for managing ‘false negatives’ were at an early stage of understanding. No participants reported any internal tracking system that actively monitored the occurrences of false negatives. The typical pattern was that, once a decision was taken to terminate funding support for a given project, no further tracking of that project was done. Initial metrics to manage false negative projects in metric 5, therefore, should focus on recording their incidence and build a tracking system to follow them after the initial decision to terminate further support. Metrics like those in metric 6 should evaluate any further progress of potentially false negative projects against the expectations of the company that terminated further funding support. Most projects will likely cease at this point. When a project continues and makes further progress that significantly exceeds expectations, a re-assessment of the project’s technical and/or market potential is warranted. The ability of a project to raise external capital or to sign a major customer, should act as a strong signal that a false negative may exist. A poker playing company may reverse itself at this stage and find a way to get back into the game. For Japanese companies that are endowed with strong R&D portfolios, it is important that new ways be found to unlock the potential value in these portfolios. Spin-offs are not the only means to do this, but they may be an effective means to explore situations where new business models are needed to commercialize the technologies in new markets. If an established business

139

MOT in and between enterprises model already exists, then the company would do well to license the technology. But many new R&D programmes lack a clear path to market. These situations are where spin-offs can be most useful. At the moment, venture capital markets and entrepreneurship remain under-developed in Japan. Spinoffs may provide the most effective near-term mechanism to rejuvenate the Japanese innovation system, even as longer term initiatives in higher education and the financial and labour markets begin to bear fruit. It should be noted in passing that implementing these concepts of open innovation in Japan will also require more proactive management of intellectual property (IP). Japan is actively exploring how to become a leader in IP management, and many of its largest companies have rich portfolios of patents that may enable more open, proactive utilization of Japanese technologies in a wide variety of industrial contexts.

Open up to a point: Open–closed innovation Mr Hajime Sasaki, chairman of the NEC Corporation, had an interesting and important analysis of open innovation. He argued in an address1 to the Japanese International Intellectual Property Society in Tokyo that the term ‘open innovation’ was a little misleading. He stated that, understood properly, it should be viewed as open–closed innovation. In a forward that he has graciously contributed to the Japanese language version of Open Innovation (Sanno Daigaku Publishers, 2004), Mr Sasaki reminds us that openness is necessary to create value for customers in the innovation process, and to enable a value chain to deliver that value profitably. A certain amount of closed-ness is needed, however, to make a profit from innovation and to be able to continue to innovate in the future. According to Mr Sasaki, at NEC they regard open innovation as an ‘open–closed’ process. Intel also exemplifies the open–closed approach. Much of the internal R&D it undertakes is done to connect the company to external research in its supply chain (through its Components Research Lab) or to its customers and developers (through its Intel Architecture Labs). Intel also spends more than US$100 million annually in funding university research, seeking new ideas that it can bring into its business. Intel does not own these ideas; it does, however, gain early access to them. So Intel is open in these regards. To capture value from these ideas, however, Intel uses its internal labs. Most of Intel’s internal research is concentrated in its Microprocessor Research Lab, which focuses on new generation Pentium technologies and architectures. It is very closed about the activities in this part of its business and it seldom outlicenses any of its work in this lab to other companies. So Mr Sasaki’s point is well taken. To go further, open innovation concepts are not equally applicable to all industries. For example, the nuclear reactor

140

The open innovation model industry depends mainly on internal ideas and has low labour mobility, little venture capital, few (and weak) start-ups, and relatively little research being conducted at universities. Whether this industry will ever migrate towards open innovation is questionable. At the other extreme, some industries have been open innovators for some time. Consider Hollywood, which replaced the studio system (which in its heyday was highly vertically integrated, and rather closed) with a far more open model. Since at least the 1960s the industry has innovated through a network of partnerships and alliances between production studios, directors, talent agencies, actors, scriptwriters, independent producers, and specialized subcontractors such as the suppliers of special effects. And the mobility of this workforce is legendary: every waitress is a budding actress, every parking attendant has a screenplay he is working on. And everyone has an agent. Many industries–including those of copiers, computers, disk drives, semiconductors, telecommunications equipment, pharmaceuticals, biotechnology, and even military weapons and communications systems2–are currently undergoing a transition from closed to open. For such businesses, a number of critically important innovations have emerged from seemingly unlikely sources. Indeed, the locus of innovation in these industries has migrated past the confines of the central R&D laboratories of the largest companies and is now situated among various start-ups, universities, research consortia, and other outsiders. And the trend goes well beyond high technology. Other industries such as automotive, health care, banking, insurance, and consumer package goods have also been moving toward open innovation.

Issues for further research While open innovation suggests a greater external focus to industrial R&D, there may be many paths by which to get there. In the area of spin-offs, for example, it is important to contrast the use of voluntary spin-offs in Japan with the US pattern of spin-offs, most of which are involuntary (from the perspective of the originating firm). Involuntary spin-offs result from engineers and managers moving from one company to a competing company without the permission of the first company. This occurs frequently in the US and is almost legendary in places such as Silicon Valley. For the originating company, this flow can be quite disruptive to the continuity of internal research and development activities (Okimoto and Nishi 1994). While these involuntary spin-offs may be disruptive, they have been quite prolific in many key high tech industries in the US. One can construct a genealogy of disk drive firms from the diaspora of engineers emanating from IBM, Memorex, Control Data, and a few other early entrants into the drive

141

MOT in and between enterprises industry. A similar genealogy of semiconductor firms also could be developed from firms that emerged out of AT&T, Fairchild, and Texas Instruments.3 Involuntary spin-offs face an exciting, but Darwinian, world of high risk and high reward. When individual engineers and managers perceive new opportunities arising from innovation, they can opt to form an involuntary spin-off. If things go well, the new firm will raise capital, begin product shipments, and perhaps achieve an initial public offering (IPO) or be acquired at an attractive profit. If, however, subsequent events prove unfavourable for the venture, its financial backers will shut it down. Voluntary spin-offs, which are much more common in Japan, face different prospects. They can help a large firm focus upon a new market opportunity without creating the disruption that might ensue if that opportunity were pursued inside the firm. If the spin-off fails, there may be some possibility for employees to return to the original company. Initial capital provided by the firm reduces the financial difficulty of raising initial start-up capital. And the spin-off generates new knowledge about the market and the technology. This reduces the risks to established firms. As a result they may enter later, but they can enter with greater confidence that they will be able to protect their investments upon entry. However, creating new spin-off organizations may introduce tensions between the new entity and the parent organization. How these tensions can be managed is an important research question that remains to be answered. While Lincoln’s work is encouraging (Chapter 12, this volume), Ritschev and Cole (2003) offer a more mixed assessment. The effectiveness of voluntary spin-offs is not yet well established, and the impact of forming such spin-offs upon the performance of the parent organization after the spin-off has occurred is similarly unexplored. Clair Brown’s research in Chapter 8 of this volume also examines the costs and benefits of incorporating more open approaches within the company’s core human resource practices. With these different pathways to open innovation, there may also be different metrics required to track the progress of innovation systems. The processes for managing false positives and false negatives are poorly understood at this point. There may be an analogy to the early days of the quality movement, when Juran and Deming advanced their concepts of management responsibility for quality and statistical process control respectively to a recalcitrant US audience, only to find their ideas enthusiastically embraced in Japan. Quality used to be inspected at the very end of the process, until Juran and Deming’s concepts entered into Japanese manufacturing practice. False positives and false negatives also may be identified and managed throughout the innovation process in the future, rather than being identified at the end of the process. In sum, there are clear changes underway in the industrial innovation system, in the US, in Japan, and throughout the leading industrial economies.

142

The open innovation model There is an increasing appreciation that early stage technologies intended for nascent markets suffer from high degrees of measurement error. Both Type I errors (false positives) and Type II errors (false negatives) can arise in the evaluation of these technologies. Companies have designed their R&D evaluation systems to manage the Type I errors, but typically lack any system to manage the risk of Type II errors. Spin-offs stand as one mechanism that offers a means to manage these latter measurement errors, though we have much to learn about their performance in practice.

Notes 1. Keynote Address at the Japan International Patent Licensing Seminar, meeting of the Japan International Intellectual Property Society, Royal Park Hotel, Tokyo, 27 January 2004. 2. In 2000, the Central Intelligence Agency financed a venture capital firm, In-Q-Tel, intended to assist the intelligence agency in identifying promising technologies from start-up companies. The reason for forming this unusual organization was that the defence procurement process is so onerous that most start-up companies avoid selling to the government. Because important new technologies are emerging from start-ups in areas such as software and cryptography, to take two, the CIA decided it needed a new process to access this technology. 3. An important, but seldom recognized, dependency emerges here. Start-up firms that raid the talent of established firms are highly dependent upon the presence of successful, established firms to supply the management and technical talent they require. Start-up firms, and the venture capital that funds these firms, have no interest in paying for training for their people. Without an ample supply of qualified people to hire from these start-ups would be greatly impaired in their ability to grow.

References Block, Z. and I. Macmillan (1993). Corporate Venturing: Creating new businesses within the firm, Boston, MA: Harvard Business School Press. Burgelman, R. and L. Sayles (1986). Inside Corporate Innovation, New York: Free Press. Chesbrough, H. (2000a). alphaWorks: IBM’s technology talent agents, Harvard Business School case #9–601–001. —— (2000b). ‘Designing Corporate Ventures in the Shadow of Private Venture Capital’, California Management Review, Spring, 42 (3): 31–49. —— (2002). ‘Graceful Exits and Foregone Opportunities: Xerox’s management of its technology spinoff organizations’, Business History Review, winter, 76(4): 803–38. —— (2003). Open Innovation: The new imperative for creating and profiting from technology, Boston, MA: Harvard Business School Press. —— (2004). ‘Managing Open Innovation: Chess vs. poker’, Research–Technology Management, Jan.–Feb. 47: 13–16.

143

MOT in and between enterprises Chesbrough, H. with S. Socolof (2000). ‘Commercializing New Ventures from Bell Labs Technology: The design and experience of Lucent’s new ventures group’, Research– Technology Management, March, 43: 1–11. Kusunoki, K. and T. Numagami (1998). ‘Interfunctional Transfers of Engineers in Japan: Empirical findings and implications for cross-functional integration’, IEEE Transactions. Moore, G. (1996). ‘Some Personal Perspectives on Research in the Semiconductor Industry’, in R. Rosenbloom and S. William (eds.) Engines of Innovation: Industrial research at the end of an era, Boston, MA: Harvard Business School Press. Odagiri, H. (1992). Growth Through Competition, Competition Through Growth, Oxford: Clarendon Press. —— and A. Goto (1993). ‘The Japanese System of Innovation: Past, present and future’, in R. Nelson (ed.) National Innovation Systems: A comparative analysis, Oxford: Oxford University Press. Okimoto, D. and Y. Nishi (1994). ‘R&D Organization in Japanese and American Semiconductor Firms’, in M. Aoki and R. Dore (eds.) The Japanese Firm: Sources of Competitive Strength, Oxford: Oxford University Press. Ritschev, D. and R. Cole (2003). ‘Social and Structural Barriers to the IT Revolution in High-Tech Industries’, in J. Bachnik (ed.) Roadblocks on the Information Highway: The IT revolution in Japanese education, New York: Lexington Books. Sako, M. (1997). ‘Forces for Homogeneity and Diversity in the Japanese Industrial Relations Systems’, in M. Sako and H. Sato (eds.) Japanese Labour and Management in Transition, London: Routledge.

144

8 Managing creativity and control of knowledge workers1 Clair Brown

This chapter focuses on how high tech firms structure their human resource and knowledge systems to support and control the creative activities of their knowledge workers. The results are based on a unique survey of R&D engineers in three Japanese and two US semiconductor companies and an intensive study of product development at two leading semiconductor companies, one in the US and one in Japan. The survey of engineers explores how companies vary in the ‘external’ as opposed to ‘internal’ orientation of their HRM and knowledge systems by examining how work organization, incentive systems, and communication systems affect the creation, sharing, and control of knowledge. Following the arguments of Iansiti (1998) and Chesbrough (2003), this study explores whether HRM and knowledge systems with an external orientation facilitate R&D engineers’ access to leading-edge technology compared to systems with an internal orientation. The survey results show that overall the two US companies have a more external orientation of the HRM and knowledge systems than the three Japanese companies, yet their HRM and knowledge systems share many similarities. The product development study shows how two companies successfully manage tension between control and creativity, which are inherent in innovation activities. The management of creativity and control operates differently in Japan compared to the US, and a trade-off appears to exist between supporting team members working together and supporting individual creativity within the team in developing knowledge. Overall these results indicate that Japanese teamwork provides control and may constrain individual creativity, and that Japanese management practices for knowledge workers can benefit from supporting more individual innovation within the team setting.

145

MOT in and between enterprises

Introduction Managing knowledge workers plays an important role in creating competitive advantage in high tech companies, where innovation is critical to long run competitiveness. This chapter explores how human resource management (HRM) and knowledge systems in select semiconductor companies in Japan and the United States affect the creation, sharing, and control of knowledge. The Japanese HRM system has highly developed systems to support specific interfirm knowledge creation and sharing (i.e., the joint development of ideas or the acquisition of knowledge from other firms) and intrafirm knowledge creation and sharing programs (i.e., the joint sharing of knowledge and skills among employees within a team and across groups) (Nonaka and Takeuchi 1995). The US human resource system is better at structuring and rewarding individual as opposed to group initiative and endeavours (Sutton 2001; Malone 2004). Although US companies do not have a long history of interfirm knowledge sharing, US semiconductor companies have been undertaking joint ventures with other companies, including participation in the consortium SEMATECH, largely in response to extremely high capital and research and development costs. In addition, US semiconductor companies have increasingly turned to start-ups or emerging companies as an important source of innovation, and often acquire the company or license the technology instead of developing the technology internally (Rtischev and Cole 2003). HRM and knowledge systems that organize development activities reflect these differences in the US and Japan, and a trade-off appears to exist between supporting information sharing and supporting individual creativity in knowledge development. Precisely those HRM and knowledge systems of the Japanese firm that support team-based learning and problem solving impose constraints on individual initiative and autonomy. Precisely those structures of the US firm that support individual creativity and breakthroughs impose problems of control over the process.

HRM and knowledge systems The HRM system has three major components: 1) work organization; 2) training and skill development; and 3) pay and promotion (MacDuffie 1995; Youndt et al. 1996; Huselid et al. 1997). The knowledge system also has three major components: 1) sources of technical information; 2) communication networks; and 3) intellectual property (IP) controls (Tyre and von Hippel 1997; Teece 2000). The knowledge and HRM systems together produce the organizational structure in which engineers solve problems and create new technology. An engineer’s activities are situated within the project team, and the individual engineer’s work tasks may be undertaken independently and/or

146

Managing knowledge workers with other team members. They may draw from a variety of knowledge sources, including firm-based, publicly available, and private networks. The HRM and knowledge systems structure their employees’ problem solving activities, which are facilitated by their ability to locate and integrate knowledge. Here HRM and knowledge systems are characterized as having an external (outside the firm) or internal (within the firm) orientation. The components of the HRM system can be described as internal or external according to their orientation to firm-based rules or external markets, respectively, in determining how work is organized, skills are learned, and pay and promotions are determined. At one extreme an internal HRM system relies upon bureaucratic rules to organize work in teams, to train, and to structure compensation by seniority and performance. At the other extreme an external HRM system relies upon the external labour market to set pay for individual workers, who are in charge of their own careers, maintain a network of other professionals working in similar areas, and often work independently even within project teams. The components of the knowledge system also can be described as internal or external, and external can be divided into public and private sources. Internally oriented knowledge systems rely primarily on knowledge sources (both personal contacts and documents) inside the firm. When engineers in internal knowledge systems access external knowledge and information, their sources are public in nature (patents, journal articles, reverse engineering, conferences, tradeshows, popular press, and newsletters). In contrast, an externally oriented knowledge system relies on engineers supplementing their firm-based knowledge sources through external private networks with professionals at other companies and through the company’s private collaborative agreements (alliances). A worker’s external knowledge is also expanded through changing jobs as often as every three years, which reflects the semiconductor life cycle. The public–private division of external knowledge is more a function of the age of the knowledge rather than its characterization as tacit or explicit (Nonaka and Takeuchi 1995). Although knowledge may be codified, or embedded in tools, the most up to date and nuanced knowledge is likely to be tacit, such as knowledge that comes with experience or learning by doing. The speed associated with word of mouth interactions versus the time it takes to codify and then disseminate new technical knowledge favours external systems for technology development and problem solving in rapidly evolving industries. Even when knowledge can be codified, however, often it is not documented because it is not expected to be used by people outside the group, or because the knowledge depreciates rapidly, or because engineers do not like to document and would rather explain it to other engineers. Use of documented technology by new users often requires that they already know the previous generation, since complete codification would be cumbersome and often not

147

MOT in and between enterprises worth the time. Although private external knowledge includes both tacit and explicit knowledge, this is less important than the fact that it is state of art knowledge and is transferred among people who specialize in a technology and already have a repertoire of both tacit and explicit knowledge upon which to build. Public external knowledge would be mostly explicit in that it has already been (mostly) codified. For these reasons, private external sources contain state of the art knowledge, while public sources contain more dated material. The importance placed on internal knowledge sources vs. external knowledge sources has changed over time and across countries. In the past, engineers were often reliant on colleagues, or gate-keepers, within their own organizations (Allen 1977), and companies were likely to use a ‘local language’ that impeded the ability of their engineers to communicate effectively with outsiders (Katz and Tushman 1997). Earlier studies (Dore 1973; Whittaker 1990) focused on ‘market orientation’ vs. ‘organization orientation’ as critical features of HRM systems that shaped the organization of work incorporating technology in Britain and Japan, respectively. Today problems and solutions are not likely to be local in nature as common technology is used across products. Also the complexity of technology across the value chain has resulted in specialization at each activity, from design (e.g., QualComm) to manufacturing (e.g., TSMC) to packaging (e.g., Amkor) to assembly (e.g., Flextronics, Dell), which makes it very difficult for an integrated company relying only upon its internal knowledge base to stay competitive (Gereffi et al. 2005). Companies creating new products in an industry characterized by proliferating products with short product generations find themselves relentlessly combining new internal knowledge with external knowledge to keep pace with the industry (Iansiti 1998; Iansiti and West 1999; Eisenhardt and Galunic 2000; Chesbrough 2003). In the semiconductor industry, knowledge specific to a product generation depreciates rapidly, and the need to create the next generation requires access to the latest research and education and is supported by individual creative activities. Although a team is still needed to coordinate and integrate activities, the team is a less useful structure for on the job training and accessing private external knowledge. The individual team members must pursue learning and ideas as he/she creates new knowledge that incorporates external and internal knowledge into the innovation process. Based upon our fieldwork and past literature, we think that engineers who regularly tap into expertise both inside and outside their firms and who are supported by an HRM system that encourages external ties and rewards individual creative performance can be more creative in their innovation activities compared to engineers who work mostly in a team setting and rely upon firmbased expertise and knowledge.

148

Managing knowledge workers

Comparing HRM and knowledge systems in Japan and the United States The two countries under study are known for having different national labour market institutions (Brown et al. 1997; Sattler and Sohoni 1999; Appleyard and Brown 2001) and for occupying different market positions in the semiconductor industry (Macher et al. 1998). Japanese employees are characterized as performing the majority of their work in teams where the building of consensus is important. Japanese firms have mostly struggled to break into highmargin semiconductor markets, which require the continual development of new products, after their dominance was eroded in the low-margin DRAM market, which relied on relentless cost cutting as well as continual innovation. US engineers are characterized as more likely to work independently and to seek career advancement and technical information from their personal contacts outside their firms, which are leaders in the industry, particularly in logic devices and signal processors. To some degree, national institutions constrain the firm’s ability to cultivate external or internal knowledge and HRM systems. For example, company control over intellectual property is influenced by national labour market institutions. In Japan, where professional careers are primarily advanced within a company, and opportunities for advancement outside the company are limited, engineers and their company share the same goal of expanding and protecting knowledge within the company. Japanese companies, which focus on team performance, are concerned with the long-term development of their engineers and with long-term relationships within the company. With low turnover, they are less concerned about internalizing their engineers’ knowledge and protecting knowledge. With increasing job mobility among engineers, especially to other Asian countries, we are seeing an increase in company concerns about losing control over intellectual property. In the United States, where professional careers are often advanced through a succession of jobs at different companies, engineers rely on expanding their own knowledge for advancing their careers. In contrast with the situation in Japan, individual engineers have less incentive to expand and protect knowledge within the company. US engineers often pick jobs on the basis of the technology they will have access to as well as pay, since learning new technologies will advance their careers and affect their attractiveness to future employers. US companies that focus on individual performance are concerned with labour mobility and competing for talented engineers with their competitors. Their focus is on retaining their best workers, protecting their IP, and internalizing their engineers’ knowledge. With short product life cycles, however, the protection of knowledge often is secondary to getting leading-edge products to market. Here we use the results of a unique survey of engineers in three Japanese and two US leading semiconductor companies to describe the basic

149

MOT in and between enterprises characteristics of the HRM and knowledge systems for engineers in major semiconductor companies in the two countries.2 Although our limited sample is not representative, it provides profiles of the systems that are consistent with our extensive fieldwork at semiconductor companies in Japan and the United States. Here the respondents, who are engineers in R&D and fabrication facilities (fabs), include 35 engineers from three leading Japanese semiconductor companies and 27 engineers from two leading US semiconductor companies. All five companies are integrated semiconductor companies. The surveys were collected during the mid-1990s. They represent what might be considered best practices from the industry in the two countries. In the tables presented below, significant differences in the sample distributions between the two countries are reported using Analysis of Variance (Prob>F gives the level of significance). Differences in the sample distributions that are statistically significant will be denoted as ** for p