3 Jan. 2009

Competition is tightening, but Taiwan's CT sector has managed to continue doing well so far by bringing out a constant stream of new products.

BY JANE RICKARDS , staff writer AmCham Taipei Taiwan's Information Communications Technology sector continues to dazzle on a global level, but as always there are worries about foreign competition snapping at its heels. "It's pretty much the only sector we can be optimistic about," observes Tristan Liu, an economist with the Taiwan Institute of Economic Research.

Although the ICT sector performs brilliantly, fears remain that China and other developing countries may one day be able to duplicate Taiwan's low-cost but high-quality manufacturing and production. Taiwan has upgraded its innovation and research to respond to the challenge, only to find itself engaged in head-to-head competition with both the United States and Japan. At the same time, the aftermath of the current global financial crisis is likely to lessen world demand for consumer electronics while making corporate borrowing more difficult.

In 2007, according to the Institute for Information Industry's Market Intelligence Center, Taiwanese companies collectively made a whopping 97.2% of the world's motherboards, 93.2% of all cable Customer Parameter Equipment (a kind of terminal), 92.8% of the world's notebook computers, 84.7% of digital subscriber line Customer Parameter Equipment, 86.9% of servers, and 88.4% of wireless local area network interface cards. They also hold the world's largest market share in LCD monitors, VoIP routers, digital still cameras, CDT Monitors, IP phones, and IP Set-top Boxes. Manufacturing and assembly of these items is increasingly taking place offshore. According to Ministry of Economic Affairs statistics, the proportion of ICT production occurring overseas has been steadily increasing: from 34.53% in 2002 to 76.48% in 2006 and 84.29% in 2007. This proportion is much higher than for Taiwan's overall manufacturing, which in 2007 stood at 46.13% being performed offshore. But the reliance on overseas production is not viewed as a problem. "Even though manufacturing or assembly takes place in mainland China, more and more core competencies are controlled by Taiwanese companies," notes Sam Shen, the MIC deputy director.

Despite the large amount of offshore output, the sector undoubtedly makes an enormous contribution to the local economy. TIER's Liu says that last year the ICT sector accounted for 14.86% of Taiwan's real GDP growth, up from 6.98% the year before. Technology products in general make up around 40% of all exports. "For the last five years, the ICT sector has been the top industry in terms of R&D and job creation," Liu says. "If you don't count the service sector, it is still the fastest-growing sector in Taiwan." The results can be seen in employment: currently the sector provides jobs for some 715,430 people or around 12.72% of the workforce, while at 4.63% last year the employment growth has been robust, Liu says. Not everyone views this situation as a healthy one. Cheng Ming-kai, head of technology research at CLSA, considers that the Taiwan economy has become too dependent on the technology sector. "That's one of the weaknesses of the Taiwan economy in general," he says. "It's like managing a portfolio. You need to be diversified."

While he regards it as still too early to assess the impact that the current financial crisis may have on ICT spending, MIC's Shen says that the year-on-year growth of Taiwanese ICT hardware shipments (valued last year at around US$105 billion) is likely to drop from 17.6% last year to around 10% to 12% this year. Even without the impact of global financial turmoil, Shen adds, five years from now the annual growth may drop further to 6% or 7% as other countries learn to duplicate Taiwan's experience. For example, Shen notes, last year Taiwan's world market share for motherboards was 97.2%, but this is likely to drop to 93% this year and 92% next year as some mainland Chinese vendors learn to produce very low-priced motherboards for specific markets.

R&D is the key

One of the major factors contributing to the excellent performance of the ICT sector is research and development capability. Liu points to a September 2008 report from the Economist Intelligence Unit (EIU), which ranked the island's ICT competitiveness second in the world (behind the United States), a significant improvement from its sixth place for 2007. "The main reason for Taiwan's improved score was its performance in R&D," Liu says.

The EIU report, which compared ICT industries in 66 countries, gave each nation a weighted scoring, with indicators grouped in six categories - overall business environment, ICT infrastructure, human capital, legal environment, R&D environment, and support for IT industry development. While Taiwan's overall business ranking actually declined from the previous year (sinking from 11th place in 2007 to 19th in 2008), its ranking in R&D shot up to be the world's number one, up from number three in 2007. The island generated more patents over the past year than any other country in the world - averaging one patent for every 2,000 people, the study found.

In addition, Taiwanese companies have developed unique abilities in controlling ICT manufacturing and global logistics so that high quality is not sacrificed as costs are held down. "This gives Taiwanese companies an advantage," says MIC's Shen. "But it won't last for very long, maybe for the next five years."

Peter Kurz, head of Taiwan Country Research for Citi Investment Research, agrees. "No one can touch Taiwan in the downstream in terms of PC and smart phone manufacturing, and that scale and sensitivity to market trends and demands keeps the upstream competitive."

Furthermore, MIC's Shen points out, because of Taiwan's relatively small geographical area and the presence of specialists excelling in many segments of ICT, companies can respond quickly to meet customers' requests or fix any problems that buyers may encounter. Although other Asian nations may be able to produce products more cheaply, he says, they often know only how to make the one product and find it hard to satisfy any new requirements.

Western buyers, for instance, may request that new products be integrated with various kinds of ICT applications, such as a wireless function enabling digital still photos to be automatically transferred back to an office computer or the insertion of a global positioning system module in the camera so that the location of a photo can later be found on an electronic map. "You have to know how to integrate," Shen says. "Different worlds speak different languages and wireless people may not understand the optical mechanism. Only Taiwan can make that kind of integration effective, low-cost, cheap, and fast. That is one of our major strengths." The leading Taiwanese ICT products have changed over time, but currently the main drivers of growth are portable PCs and handsets, says Kurz. He says that while PC trends are moving towards cheaper models with stripped-down functionality, "handsets are ironically going in the other direction: from simple, dumb handsets to almost miniature computers." Desktop PC growth is slowing dramatically, but a new product called the netbook - a budget version of the notebook PC - is thriving, with output growing at a rate of around 40% a year, estimates Kurz. Several analysts lauded Asustek's tiny no-frills laptop, the Asus Eee PC. This netbook, introduced in late 2007 and selling for only around US$400 to US$500, retains about 80% of normal PC functions, including access to WiFi and WiMAX (although it may lack a bit in memory). After Asustek launched this product, Shen says, many major PC vendors followed suit, creating a new market segment.

Asustek in early June forecast that sales of the Eee PC would double next year to 10 million models, media reports said. That would be good news for Taiwan's economy as these netbooks are usually manufactured exclusively in Taiwan, not offshore. "It is actually hard to cost-down to that level and it needs a high degree of technology," says Liu.

Kurz notes that sales of smart phones are also growing very rapidly. A key characteristic of a smart phone is that it can interact with a computer, Kurz says. "But beyond that, particularly with the advent of the i-phone, it can include an MP3 player, cameras and photo display, and finally - in a future driver - internet access as well."

Analysts point to HTC Corp. as another standout Taiwanese success. While Apple's i-phone is popular and setting industry standards, HTC is one of the few companies in the world able to come out with a competing product, says Kurz. Most recently, it has been making such handsets for customers using a smart phone operating system developed by Google. The model, launched in late September, runs on Google's Android software and is cheaper than the i-phone.

Other noteworthy current trends include an increasing demand for high-end handheld GPS systems, produced by companies such as Taiwan's MIO Technology. This demand has been driven by the worldwide craze for bicycling, which has in turn been driven by high oil prices. Another potential area where Taiwan's ICT companies can excel, says MIC's Shen, is in applying technology to improve manufacturing or logistics processes. A downturn in the world economy could even cause demand for these ICT services to mount, as they can reduce costs while enhancing quality. For example, Taiwanese companies with factories in China and Vietnam could control production quality inexpensively by remote-control monitoring of the process from Taiwan. ICT products couldalso be used to monitor the shipping process to significantly reduce customer complaints about delivery, he says.

Facing the competition

Despite their success, Taiwan's ICT companies are under enormous pressure to differentiate themselves from their competitors. Because simply replicating Western ICT manufacturing and production processes is no longer enough, companies must innovate - but they are also still under constraint to operate more economically than their rivals. When companies invest in R&D, Kurz says, it is easy for them to overspend or to "lose sight of the fact that you are trying to make money."

Another challenge for ICT companies has been in trying to move from Original Design Manufacturing (ODM) to branding. While a few companies such as Acer and Asus have triumphed in Europe, and more lately in Korea and Japan, there have also been many failures, industry analysts say. The current global financial crisis will undoubtedly mean consumers will have less money to buy electronics. It is also likely to means that the cost of borrowing will go up and that it will be harder to raise funds through the debt and equities markets. "The war between high-tech companies is no longer just about products and technologies," says Shen. "Some of it is about how you leverage your financial tools, especially as it is hard to borrow money from the banks at this time." It is often the companies with "cash-in-hand" that win out, even if they lack major sales growth, as they have money to invest and buy out underperforming rivals, he notes.

TIER's Liu is slightly more optimistic about consumer demand than most analysts, saying that even though demand is slowing in the West, it is still growing in Asia, particularly Southeast Asia, which will buffer Taiwan from the economic headwinds. The netbooks produced by Taiwanese firms are unique and their low price makes them well suited to emerging markets. "This kind of model performs uniquely well in downturns in the business cycle," says Liu. "It's a market that other Asian countries didn't pay attention to. When the product caught their attention, it was too late to catch up."

The government in the third quarter of this year has also begun implementing policies to encourage ICT companies to switch their attention to emerging markets. The program includes an NT$150 million (US$4.7 million) budget to help companies with such preparatory activities as expanding their logistics networks and dispatching representatives to attend relevant international conferences.

But CLSA's Cheng is less upbeat than Liu about the potential of emerging markets. "The U.S. accounts for 30% of all demand," he notes. "How do you move away from that 30%? It is quite difficult."

Another industry concern is finding and retaining top-level employees. In that respect, the EIU report said that the number of science graduates in Taiwan's - 122,069 last year - was relatively small, ranking 11th in Asia. And yet another worry stems from the more stringent labor laws and less generous tax incentives that Beijing has put in place, raising the cost of doing business for Taiwan-invested manufacturing operations in China. Most of all, the competition is continuously intensifying. "Taiwan is probably the most efficient producer globally, but obviously that gap has narrowed substantially," Cheng concludes.