Nice article in this week’s Economist about the downside of outsourcing (see Trouble with Outsourcing). This is a topic I’ve recently discussed in this blog (see Reevaluating Outsourcing).

According to the Economist:

Outsourcing has transformed global business. Over the past few decades companies have contracted out everything from mopping the floors to spotting the flaws in their internet security. TPI, a company that specialises in the sector, estimates that $100 billion-worth of new contracts are signed every year. Oxford Economics reckons that in Britain, one of the world’s most mature economies, 10% of workers toil away in “outsourced” jobs and companies spend $200 billion a year on outsourcing. Even war is being outsourced: America employs more contract workers in Afghanistan than regular troops.

Can the outsourcing boom go on indefinitely? And is the practice as useful as its advocates claim, or is the popular suspicion that it leads to cut corners and dismal service correct? There are signs that outsourcing often goes wrong, and that companies are rethinking their approach to it.

These are not new questions. These issues are central to the fields of international business and strategy (see also Williamson and Transaction Cost Economics). In fact, outsourcing has been one of the hottest topics in both literatures for at least the last 25 years.

But the topic is certainly worth revisiting every once in awhile. And although the economics of outsourcing can be compelling, it is also important for managers to keep in mind that outsourcing is not without strategic consequences.

As the Economist recognizes:

Outsourcing can go wrong in a colourful variety of ways. Sometimes companies squeeze their contractors so hard that they are forced to cut corners…Sometimes vendors overpromise in order to win a contract and then fail to deliver. Sometimes both parties write sloppy contracts. And some companies undermine their overall strategies with injudicious outsourcing.

It is this last outcome that poses the greatest strategic threat. When firms outsource important value-creating activities, it often portends a phased exit from a part of the business that later precludes them from reentering that business.

Think Apple.

For a long time, Apple refused to follow the industry trend to outsource elements of the value chain – operating system, hardware, peripherals. Instead, they remained staunchly closed and proprietary. Apple was roundly criticized for doing so. Most industry analysts had written them off, and Apple was, at one point, on the verge of extinction.

However, it is Apple that got the last laugh.

Apple was ultimately able to benefit from their decision to keep much of their value chain in-house. Indeed, they experienced a miraculous recovery sparked by the innovation that their integrated approach allowed. Their competitors, by contrast, had jettisoned many of the complementary value-chain activities that, in the long run, helped differentiate Apple. As a result, many are now struggling.

One extreme example: IBM. The mighty IBM, king of the PC, fell prey to the very industry outsourcing trend that they helped create, …and they are now completely out of the PC business.

The moral of the story: Beware the long-term consequences of outsourcing.

Japan’s Panasonic announced its plans to sell its Sanyo unit to the Chinese white-goods firm Haier last week (see Haier Acquires Sanyo). According to Reuters:

China’s Haier will buy Panasonic Corp’s Sanyo Electric washing machine and refrigerator units in Japan and Southeast Asia for about $130 million, in a move that will give the Chinese appliance giant better access to the world’s third-largest economy, sources said.

At face value, this news seemed rather uneventful. Companies sell divisions all the time. It is not at all uncommon for companies to divest small divisions in an effort to restructure operations and rationalize businesses in order to focus on more strategic, and profitable, business segments.

However, there were several facets of this deal that caught my attention.

1. Although M&A deals have increased in recent years, it is still relatively rare for large Japanese firms to divest assets.
2. Not only did a large, Japanese firm (Panasonic) decide to sell a division, but it sold the division to a foreign firm
3. And finally, not only did Panasonic decide to sell to a foreign buyer, but to a Chinese buyer (Haier) no less. Given the history of tempestuous relations between China and Japan, this struck me as most surprising.

Given that background, it will be interesting to follow this deal in the coming years to see whether Haier is able to capitalize on this purchase to make inroads in the broader Asian white-goods market…

I have, for some time, had an interest in Chinese acquisitions of Western firms (see Hurdles to Chinese Investment). I have been following the recent spate of Chinese acquisitions in the auto industry, and especially, the acquisition of Volvo by Geely (see Chinese Acquisitions in the Auto Industry).

With that in mind, I was delighted to see an in-depth look at the Geely-Volvo deal that recently appeared in the Wall Street Journal (see Chinese Begin Volvo Overhaul). The article details the difficulty that Geely has had trying to shift Volvo’s image from a safety-oriented brand an ultra-luxurious brand.

When Volvo Car Corp. debuted its newest design recently, it turned heads with an edgy look that departed from the staid style that has been its hallmark. The upscale sedan has sleek curves and pale purple LEDs in its grille in a bid to plant the Swedish company more firmly in the luxury segment.

The car represents a compromise between competing visions of Volvo’s future. On one side is Volvo’s European chief executive, Stefan Jacoby, and on the other, the company’s hard-charging new Chinese owner, Li Shufu.

In the nearly 10 months since the acquisition was completed, Mr. Jacoby and Mr. Li have worked to reconcile their visions and differing management styles…One central area of contention: Mr. Jacoby wants to focus on safety and fuel-efficiency with smaller cars, while Mr. Li believes Volvo must expand aggressively into luxury cars to compete with BMW, Mercedes and Audi.

“Volvo and Mr. Jacoby can take the moral high ground and stick with the company’s tradition of understated, more modest style,” Mr. Li said in a March interview, but [Mr. Li believes] the brand has no future in China unless it caters to flashier tastes.

I’m not entirely sure I agree with Mr. Li on this one.

Personally, I think it will be very difficult to try to reposition Volvo to compete head to head with BMW, Mercedes, Audi, and Lexus. Not only do the latter brands all share a reputation for the highest quality among the mass market brands, but they have a stranglehold on the market in China (together they account for 90% of the luxury market).

What has traditionally made Volvo unique (from a strategy perspective) is its ability to differentiate as a niche producer of high-end (though not ultra-luxurious) family saloons with a reputation for safety.

Does Volvo’s portfolio need a styling facelift? Absolutely! But trying to overhaul the entire organizational image and reposition the company to compete in the ultra-luxury segment of the market is a high risk proposition. This is especially so because it comes at a time when Volvo’s operations are troubled to begin with, and they operate in a segment of the industry plagued with overcapacity.

In addition to Geely’s plans for Volvo, the WSJ article provides a remarkably candid account of the post-acquisition management clashes in both organizational, and national, culture that typically occur in cross-border deals of this type.

Friction between Geely and Volvo was evident early on, at a meeting in spring of last year at Volvo’s headquarters in Gothenburg, Sweden…About 40 Geely executives were there to get an overview of the Swedish company. One senior Geely executive felt the information Volvo was providing was insultingly simplistic. “Do you think we’re a bunch of amateurs?” he exploded, before storming out of the room, and taking the next available flight back to China, according to a personal familiar with the matter.

…distrust lingered. In September, on the eve of a trip to Sweden for his first Volvo board meeting, Mr. Li told a Journal reporter in Beijing that Geely planned to quickly build as many as three assembly plants in China to jumpstart Volvo sales. At the time only a small number of Volvos were made in China, at a Ford joint-venture plant. By the time Mr. Li arrived in Gothenburg, the resulting article had set Volvo executives and directors on edge, fearing that their new owner was adopting a risky, overly-aggressive approach.

The Volvo executives expressed their concern in a meeting with Mr. Li. Mr. Jacoby, fearing the situation could spin out of control, brought Mr. Li and a translator into his second-floor corner office. Mr. Jacoby pressed the point that Volvo needed to proceed judiciously in building manufacturing capacity in China to preserve its quality and its image. “We solved this very much on a one-on-one basis,” Mr. Jacoby said in a recent interview. “We didn’t want to do this in a big public setting and embarrass one or the other.”

Although it seems that Geely and Volvo have been able to work through their differences thus far, I remain somewhat skeptical of the prospects for success of this deal. I therefore continue to stand by my comment from the related blog post (see Chinese Acquisitions in the Auto Industry) where I mused:

…given the auto industry’s ills, I wonder whether these Chinese acquirers will be able to derive value from their tired, beaten, and battered Western subsidiaries

Only time will tell…

I have been teaching courses on International Strategy for more than a decade now, and I often find myself in the unenviable position of trying to dispel common myths about globalization. I’ve found the task especially difficult in an era in which many students come to class having only been exposed to Thomas Friedman’s well written, but often misinformed, best seller on the subject – The World is Flat.

I was therefore pleasantly surprised when I opened my digital issue of The Economist last week to find the work of Pankaj Ghemewat highlighted (see The Case Against Globaloney). Ghemewat, one of the leading scholars in the area of International Strategy, has done some interesting fact-based work on the realities of globalization. As I have long tried to convince skeptical students, the realities are far more modest than Friedman, and many in the mainstream media, would like for us to believe.

According to the article:

…[E]verybody seems to agree that globalisation is a fait accompli: that the world is flat, if you are a (Tom) Friedmanite, or that the world is run by a handful of global corporations, if you are a (Naomi) Kleinian.

Pankaj Ghemawat of IESE Business School in Spain is one of the few who has kept his head on the subject. For more than a decade he has subjected the simplifiers and exaggerators to a barrage of statistics. He has now set out his case—that we live in an era of semi-globalisation at most—in a single volume, “World 3.0”, that should be read by anyone who wants to understand the most important economic development of our time.

Mr Ghemawat points out that many indicators of global integration are surprisingly low. Only 2% of students are at universities outside their home countries; and only 3% of people live outside their country of birth. Only 7% of rice is traded across borders. Only 7% of directors of S&P 500 companies are foreigners—and, according to a study a few years ago, less than 1% of all American companies have any foreign operations. Exports are equivalent to only 20% of global GDP…

What about the “new economy” of free-flowing capital and borderless information? Here Mr Ghemawat’s figures are even more striking. Foreign direct investment (FDI) accounts for only 9% of all fixed investment. Less than 20% of venture capital is deployed outside the fund’s home country. Only 20% of shares traded on stockmarkets are owned by foreign investors. Less than 20% of internet traffic crosses national borders.

And what about the direction rather than the extent of globalisation? Surely Mr Friedman (author of “The World is Flat”) and company are right about where we are headed even if they exaggerate how far we have got? In fact, today’s levels of emigration pale beside those of a century ago, when 14% of Irish-born people and 10% of native Norwegians had emigrated…

Mr Ghemawat also explodes the myth that the world is being taken over by a handful of giant companies. The level of concentration in many vital industries has fallen dramatically since 1950 and remained roughly constant since 1980: 60 years ago two car companies accounted for half of the world’s car production, compared with six companies today…

This sober view of globalisation deserves a wide audience. But whether it will get it is another matter. This is partly because “World 3.0” is a much less exciting title than “The World is Flat” or “Jihad vs. McWorld”. And it is partly because people seem to have a natural tendency to overestimate the distance-destroying quality of technology. Go back to the era of dictators and world wars and you can find exactly the same addiction to globaloney.

I’ve long been a fan of Pankaj’s work. I think it’s among some of the most provocative, carefully conducted work in the field (full disclosure: he is a frequent visitor to the Stern School). That notwithstanding, if you haven’t already, check out of the full Economist article (The Case Against Globaloney); and for those of you interested in the full monty, you can find his book here (see World 3.0) to judge for yourself.

Maybe, just maybe, this will finally make my job a little easier…

Fascinating read in the March 2011 issue of Wired magazine documenting an increasing trend among U.S. small businesses: They seem to be bringing manufacturing work that had been outsourced to China back stateside (see Small Businesses Buck Trend, ht Jon).

According to Wired:

For US firms, the decision to manufacture overseas has long seemed a no-brainer. Labor costs in China and other developing nations have been so cheap that as recently as two or three years ago, anyone who refused to offshore was viewed as a dinosaur, certain to go extinct as bolder companies built the future in Asia. But stamping out products in Guangdong Province is no longer the bargain it once was, and US manufacturing is no longer as expensive. As the labor equation has balanced out, companies—particularly the small to medium-size businesses that make up the innovative guts of America’s technology industry—are taking a long, hard look at the downsides of extending their supply chains to the other side of the planet.

“Companies are looking to base their decisions on more than just costs,” says Simon Ellis, head of supply-chain strategies practice at IDC Manufacturing Insights, a market research firm. “They’re looking to shorten lead times, to reduce the inventory they have to carry.” When accounting giant KPMG International recently asked 196 senior executives to list their top concerns for 2011 and 2012, labor costs ranked below product quality and fluctuations in shipping rates and currency values. And 19 percent of the companies that responded to an October survey by MFG.com, an online sourcing marketplace, said they had recently brought all or part of their manufacturing back to North America from overseas, up from 12 percent in the first quarter of 2010. This is one reason US factories managed to add 136,000 jobs last year—the first increase in manufacturing employment since 1997.

The US certainly isn’t on the verge of recapturing its past industrial glory, nor can every business benefit by fleeing China. But those that actually build tangible goods should no longer assume that “Made in the USA” is an unaffordable luxury. Unless a company is hell-bent on selling the cheapest goods possible, manufacturing at home makes more sense than it has in a generation.

This is not inconsistent with the anecdotal evidence that I have gathered from my interactions with managers. I have found that managers typically overestimate the benefits of offshore outsourcing (i.e., the ability to access cheap labor) and underestimate its costs (e.g., those born out of cultural, political, economic, and regulatory differences across countries). Unfortunately, many only learn the hard way – they commit to the outsourcing strategy before they discover the costly mistake.

The article continues:

Once they do [outsource], these businesses often realize something profound: China isn’t the great deal they expected. A January 2010 survey by the consulting firm Grant Thornton found that 44 percent of responders felt they got no benefit from going overseas, while another 7 percent believed that offshoring had actually caused them harm. One big reason for this growing dissatisfaction is quality…In addition to quality issues, subcontracting also exacerbates a second major problem with Chinese manufacturing: the lack of safeguards on intellectual property…Finally, sheer distance remains an intractable problem.

The Wired article provided a nice read, touched on some important points, and offered some interesting vignettes. I encourage you to take a look for yourself.

That said however, the issue is not all that new. It is reflective of a long-standing debate in the international business literature, and reminds me of a similar article written in the Harvard Business Review nearly 25 years ago (see Manufacturing Offshore is Bad Business).

Although I agree that there are compelling business reasons to consider offshore outsourcing, it is also important for managers to recognize that the practice is not without strategic consequences.

As I’ve mentioned before, although the auto industry seems to have stabilized in the wake of the financial crisis (and I see that as a good thing), overcapacity continues to be the major, long-term problem facing automakers (see Auto Industry’s Big Little Problem).

An article in last week’s issue of the Economist reiterated that concern (see Danger Ahead).

According to the Economist:

THE mood at the Detroit motor show this year was very different from the dark days of 2009. Then, bosses of American car companies wondered if their firms would survive. Now, thanks to $60 billion of federal finance and the cold shower of bankruptcy to wash away their debts, General Motors (GM) and Chrysler are still alive, while Ford’s canny financial manoeuvring before the crisis allowed it to clean up its act and roar back to record profits.

Yet the industry’s problems are not behind it. The American rescues averted catastrophe, but they—along with continued European subsidies—have exacerbated the overcapacity that has dogged the sector for years. The car industry can produce 94m cars a year, against global demand of 64m. Unless that changes, it will never return to health.

I agree. Unless massive productive capacity is eliminated from the industry or demand explodes by 50% (not very likely), there will need to be another shake out in the industry.

The interesting thing about the article is that for many years we’ve been told by industry participants and observers that growth in China would help ameliorate the overcapacity concerns. However, as the Economist article astutely points out, it’s not clear that demand growth in China and/or other emerging markets will finally rid the industry of its overcapacity problems. This is because upstarts in those emerging markets continue to add capacity to the industry, and it’s unclear that demand growth in the emerging world will continue at its torrid pace.

Developments in China are likely to make things worse still for rich-world companies. China too has a surplus of car manufacturers, excess capacity and a problem with demand. Annual sales growth is forecast to fall from 30% to around 10%…

And the issues are not limited to the U.S., China, or India. Europe’s automakers face similar overcapacity and productivity problems.

…tough labour laws and government stakes in some firms—a German Land, Lower Saxony, owns 20% of VW, for instance, and the French government owns 15% of Renault—discourage them from shedding workers. As a result, despite the biggest crisis in living memory in the industry, firms are failing to rationalise.

The question then remains: What gives? Where will the much needed capacity rationalization come from??

This has all the makings of a multi-country “my industrial national champion is more important than your industrial national champion” kind of a spat.

Interesting article in yesterday’s NY Times (see China’s Race for Patents) echoing my sentiment from several months ago about the dangers for developing countries of falling into a commodity trap (see Taiwan’s Lessons for China).

According to the NY Times article:

As a national strategy, China is trying to build an economy that relies on innovation rather than imitation. Clearly, its leaders recognize that being the world’s low-cost workshop for assembling the breakthrough products designed elsewhere — think iPads and a host of other high-tech goods — has its limits.

Absolutely. I’ve been arguing this for awhile. There’s only so much development that a model based on cheap labor and export-led growth can deliver. As I pointed out in my previous post drawing similarities between Taiwan and China:

Taiwan’s overall economic development over the past 50 years has been nothing short of spectacular. And there is no doubt in my mind that China is trying to emulate elements of Taiwan’s development strategy. However, a strategy centered almost exclusively around manufacturing (whether it be in high tech or other industrial goods) comes with some serious risks.

The problem with such a strategy is that it relegates developing country firms to junior partner status, dependent upon a system in which they manufacture (for export) the designs of others. In the extreme, this results in a commodity trap.

The key for countries like China is to transition, at some point, from an economy that simply manufactures the goods that are designed and developed elsewhere to one in which innovation, creativity, and high value-added services take root. Unfortunately, these transitions are difficult, and take an inordinate amount of time.

As the NY Times article emphasizes:

…can China become a prodigious inventor? The answer, in truth, will play out over decades — and go a long way toward determining not only China’s future, but also the shape of the global economy.

“The leadership in China knows that innovation is its future, the key to higher living standards and long-term growth,” Mr. [David] Kappos [Director of the USPTO] says.

Despite China’s inevitable rise, Mr. [John] Kao [an innovation consultant] said, the United States has a comparative advantage because it is the country most open to innovation. “American culture, more than any other, forgives failure, tolerates risk and embraces uncertainty,” Mr. Kao says.

Many innovative products and technologies, he says, will be made elsewhere. “But America’s future lies in being the orchestrator — the systems integrator — of the innovation process,” Mr. Kao said.

In many respects I agree with Mr. Kao. It will take a long time for developing countries like China that rely on manufacturing for export to close the innovation gap with the West. I have discussed these issues in various blog posts (see Emergence of Emerging Market Innovation, China Attracting High-Tech Research, China Alternative Energy, and Globalization Discontents).

At the very least, China’s leaders recognize, and openly acknowledge, the issue. And the first step in any solution lies in problem recognition.

For those of you who have read my blog, you know that I am generally skeptical of of acquisitions (see Great Shareholder Ripoff and Why M&A Deals Go Bad), and even more so when it comes to foreign acquisitions in developing markets like Russia (see Doing Business in a Developing Country or Russia and the BRICs).

Given that background, you probably might have guessed that my initial reaction to Pepsi’s recently announced acquisition of Wimm-Bill-Dann would have been that it was a terrible idea (see Pepsi’s Russian Challenge). However, if you thought that about this acquisition, you’d have been mistaken…

Pepsico’s special relationship with Russia began in 1959. Richard Nixon was showing Nikita Khrushchev around the American National Exhibition in Moscow. He made him stop at a kiosk hawking Pepsi-Cola. A young executive named Donald Kendall thrust a cup of dark fizz into the Soviet leader’s hands…

Half a century later, Mr Kendall, who later became Pepsi’s chief executive, flew back to Moscow with Indra Nooyi, who has the job today, to receive Vladimir Putin’s blessing for Pepsi’s takeover of Wimm-Bill-Dann, Russia’s biggest food company. They won the Russian president over by talking about the billions of dollars Pepsi has invested in Russia. It was the first American consumer-goods maker to enter the Russian market, 15 years after Khrushchev first sipped its wares. On December 2nd Pepsi announced that it would buy 66% of Wimm-Bill-Dann for $3.8 billion and launch a mandatory tender offer for the rest of the company.

Just to prove that I don’t think all acquisitions in developing markets are a bad idea, I really do believe that this one stands a chance.

Provided that Pepsi did not overpay for Wimm-Bill-Dann, Pepsico should be able to profitably leverage its 30+ years of operational experience in Russia, along with its strong global distribution network to increase Wimm-Bill-Dann’s sales. In addition, it should be able to derive value from Wimm-Bill-Dann by combining it with Nidan Lebedyansky (its previous acquisition in Russia) to capitalize on the fast-growing Russian alternative/nutritional beverage market.

My call then: Better than 50/50 odds of success.

For those of you who read my blog, you know that I’ve had an interest in Tata’s acquisition of Jaguar and Rover. When it was announced, I failed to see the value proposition in the combination of Tata and JLR, and I remain somewhat skeptical of JLR’s ability to provide value to Tata (for background see Jaguar/Rover Revisited, Jaguar/Rover Update, and Buyer’s Remorse).

Irrespective of my opinion, it was with great interest that I read this week’s Economist, which contained an article on Tata’s progress with those previously beleaguered brands (see Tata Motors’ Boss Moves Up a Gear).

After a torrid couple of years in which demand for JLR’s pricey models evaporated…2010 has seen at least a partial recovery in sales and profits…

After the success of the mid-size XF and with heavily revised Range Rovers and the radical new XJ saloon just launched, JLR’s product line-up has never looked in better shape.

MY COMMENT: I will give that to them. Tata Motors is performing better now than in 2009. They are profitable again, with net income of around $550 million. However, a look under the hood suggests that profitability was not bolstered much by results at JLR (Jaguar Land Rover). A good chunk of Tata Motors’ profitability came from a gain booked on the partial sale of Tata’s stake in Telco Construction Equipment. JLR’s net profit was reported at around $20 million. That’s very small (less than 5% of total profit for a brand that represents greater than 50% of Tata’s entire automobile enterprise), …but it’s admittedly greater than zero.

Another thing that I will say about Jaguar and Land Rover: Their new models are stylish. They are good looking cars. And boy have they been marketing the heck out of them in the US. Everywhere I turn I feel like I see/hear another JLR advertisement – on TV, radio, billboards, and even through the internet (e.g., pandora radio). This is more than I ever remember Ford promoting those brands.

So Tata Motors is definitely making the investment. The question remains: Will the pricey advertising campaigns pay off, or are the brands already too far gone??

Nevertheless, I will admit there are definitely some things for the optimists to get excited about.

Back to the article:

One of the biggest puzzles Mr Forster [the Chief of Tata Motors] has to solve is how to replace the legendary Land Rover Defender…The new vehicle will have to be cheaper to make (and sell) than the current “Landie” to make it competitive with Japanese rivals in developing-country markets…[and] come up with a product capable of finding at least 80,000 buyers a year—four times as many as the current Defender. There is a good chance that, to keep costs down, the new model will be made in India.

MY COMMENT: Um wait. From what I remember of the original deal, Tata agreed not to shift production out of the UK, and made pledges not to cut staff or close plants. It’s unclear to me therefore how many of those 80,000 cars they’ll be able to assemble in India.

The new-model blitz is in impressive contrast with the sluggish pace of development under JLR’s cash-strapped previous owner, Ford.

MY COMMENT: Yes, I agree the new models (especially the Jaguar XF/XJ and the Land Rover Evoque) are impressive. However, lest we forget, these models were designed and developed under the previous owner, Ford. What matters most is what comes next, …in the generation of models that follow. We’re still several years away from seeing the fruits of any design efforts under Tata Motors.

And one of the big takeaways from the article:

Apart from economic uncertainty in its traditional markets, there is, however, one big cloud on the company’s horizon: ever-tightening fuel-efficiency and emissions rules.

MY COMMENT: Really?? That’s it? Fuel-efficiency and emissions rules? That’s the best you can come up with?

C’mon, JLR’s downside risks are far greater than that. For example:

1. How will JLR compete with the Japanese (Acura, Infiniti, Lexus) on price or the Germans (BMW, Audi, Mercedes) on perceived quality? My view is that JLR’s models are too expensive to effectively compete with the Japanese manufacturers. They just don’t have the volume. And they are not as highly regarded as the German brands. They just don’t have the prestige, and as a result must settle for lower margins. In this sense then, JLR is stuck in the middle.
2. The auto industry continues to be saddled by mass overcapacity. Coupled with what I suggested in point #1, it’s not entirely clear to me how Jaguar and Land Rover can survive the inevitable industry shakeout.
3. What happens if/when the global economy slows again (especially in Europe and the US) and sales of durable goods decline? JLR is already teetering on the verge. Even a modest economic slowdown could spell the end to the brands.
4. JLR still carries a hefty debt burden that Tata Motors is working through. Even with a restructuring of that debt, a turnaround of JLR is a tall order, and $3 billion in debt is not chump change. It’s reasonable to ask whether Tata will ever earn enough (even if JLR remains profitable) to provide a reasonable return on investment.
5. As in my previous posts, I still wonder about Tata’s ability to derive synergies from JLR, to rationalize JLR’s operations, and right two long-uncompetitive brands.

But who knows. Tata Motors might just prove me wrong. After all, JLR is marginally profitable (for now). And Tata Motors certainly picked a qualified leader in Carl-Peter Forster to lead the group.

Only time will tell…

I’ve just now been catching up on reading since returning from Iceland. In perusing the periodicals I most enjoy, I came across an interesting article about high tech in Taiwan (see Taiwan’s Tech Firms Conquer the World). The article, aside from providing an interesting read in its own right, holds some important lessons for the People’s Republic of China.

Taiwan is now the home of many of the world’s largest makers of computers and associated hardware. Its firms produce more than 50% of all chips, nearly 70% of computer displays and more than 90% of all portable computers.

This is, no doubt, quite an achievement.

Acer, for example, surpassed Dell last year to become the world’s second-biggest maker of personal computers. HTC, which started out making smart-phones for big Western brands, is now launching prominent products of its own.

Much of the credit for the growth of Taiwan’s information technology (IT) industry goes to the state, notably the Industrial Technology Research Institute (ITRI). Founded in 1973, ITRI did not just import technology and invest in R&D, but also trained engineers and spawned start-ups: thus Taiwan Semiconductor Manufacturing Company (TSMC), now the world’s biggest chip “foundry”, was born. ITRI also developed prototypes of computers and handed the blueprints to private firms.

Taiwan’s overall economic development over the past 50 years has been nothing short of spectacular. And there is no doubt in my mind that China is trying to emulate elements of Taiwan’s development strategy. However, a strategy centered almost exclusively around manufacturing (whether it be in high tech or other industrial goods) comes with some serious risks. As the article explains,

This strength, however, is also Taiwan’s weakness. Most firms are junior partners in the world’s IT supply chains, making things others have developed. They are good at incremental innovation, mostly related to manufacturing…many of them are stuck in a “commodity trap”, cautions Dieter Ernst of the East-West Centre, a think-tank in Honolulu. Profit margins, he says, are razor-thin and do not allow adequate investment in R&D and branding. The Taiwanese industry is particularly weak where the most valuable intellectual property is created these days: in software, services and systems.

Hmmm, a commodity trap!

That’s an appropriate moniker, and exactly the position that China (and many other developing economies) risks finding itself in as it continues its commitment to manufacturing and export-oriented growth. I have discussed these issues in various blog posts (see Emergence of Emerging Market Innovation, China Attracting High-Tech Research, China Alternative Energy, and Globalization Discontents). The key for countries like Taiwan and China is to transition from an economy that simply manufactures the goods that are designed and developed elsewhere to one in which innovation, creativity, and high value-added services take root. Unfortunately, for developing countries, those transitions take an inordinate amount of time.