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J Technol Transfer (2007) 32:87–107 DOI 10.1007/s10961-006-9002-2

Competing with MNEs: developing manufacturing capabilities or innovation capabilities Xudong Gao Æ Ping Zhang Æ Xielin Liu

Published online: 5 October 2006  Springer Science+Business Media, LLC 2006

Abstract A challenge facing local firms in China is the selection of effective technology strategies to compete against MNEs in the era of globalization. The existing literature suggests two alternatives, developing strong manufacturing capabilities or developing innovation capabilities, but provides no clear answer to the question of how to select one strategy or the other. This paper explores this issue by introducing two concepts: ‘‘barriers to appropriability’’ and ‘‘opportunities for improvement.’’ We develop four propositions to specify the boundary conditions for local firms to choose their technology strategies and analyze two local firms’ technology strategies to illustrate two of the propositions. We find that development of strong manufacturing capabilities will not necessarily be an effective strategy for local firms competing against MNEs. If there are opportunities for improvement, it might be possible for local firms to compete against MNEs by developing innovation capabilities and core technologies. Keywords Catch up Æ Globalization Æ Innovation capability Æ Manufacturing capability Æ Technology strategy JEL Classification

M10

X. Gao (&) School of Economics and Management, Tsinghua University, Beijing 100084, China e-mail: gaoxudong@em.tsinghua.edu.cn P. Zhang Hisense Group, 17 Donghai Xilu, Qingdao 266071, China e-mail: zhangping@hisense.com X. Liu National Research Center for Science, Technology, and Development, Ministry of Science and Technology, Beijing 100038, China e-mail: liuxl@nrcstd.org.cn

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1 Introduction China’s joining the WTO has led to a new round of debate, in the past few years, over what types of technology strategies are effective for local firms (Lu & Mu, 2003; Zhang, 2001a; Zhao, 2003). Many people argue that the best choice is to develop manufacturing capabilities by buying technology from multinational enterprises (MNEs) and making China a manufacturing center for the world market. Others argue that, to compete with MNEs, it is critical to nurture innovation capabilities and develop core technologies, and that, in this era of globalization, local firms will not be able to develop competitive advantages by buying technology and developing manufacturing capabilities—it is critical to nurture innovation capabilities and develop core technologies in order to compete with MNEs. The existing literature on technological catch-up offers important insights but no conclusive answers to this debate. For example, many studies find that it is possible for local firms to compete against MNEs by developing strong manufacturing capabilities (Amsden, 2001; Amsden & Chu, 2003; Kim, 1997, 1998; Westphal, Kim, & Dahlman, 1985). South Korea’s catching-up process is a typical example supporting this argument (Kim, 1997). The development of the consumer electronics and home appliance industry in China also indicates that development of strong manufacturing capabilities is a viable choice when competition from MNEs is not strong (Xie, 2001; Zhang, 2001b). There are also studies in the existing literature on technological catch-up suggesting that, when there are windows of opportunity, it is possible for local firms to compete with MNEs by developing innovation capabilities and core technologies (Perez & Soete, 1988). Lee and Lim (2001) show that some firms in South Korea actually have followed multiple technology strategies to catch up: path following, path skipping, and path creating. Some firms in China are also able to compete against MNEs by developing indigenous innovation capabilities. Founder, Great Dragon, Huawei, ZTE, and Datang are some examples (Shen, 1999; Wang, 1999; Zhang, 2000). In effect, the existing literature on technological catch-up examines local firms’ technology strategies from a resource-based perspective (Barney, 1986; Dierickx & Cool, 1989; Penrose, 1959; Kogut & Zander, 1995; Leonard-Barton, 1995; Makadok, 2001; Peteraf, 1993; Pisano, 1994; Prahalad & Hamel, 1990; Teece, Pisano, & Shuen, 1997; Wernerfelt, 1984), and studies local firms’ technology strategies by comparing the technological resources of local firms with those of MNEs. The basic argument is that local firms should choose to compete against MNEs by developing strong manufacturing capabilities, because local firms do not have core technologies while MNEs do. Only when there are windows of opportunity should local firms try to compete against MNEs by developing innovation capabilities and core technologies. From a resource-based perspective, the existing literature on technological catchup leaves several important questions unanswered: • The bulk of the existing literature has been conducted under the assumption that: MNEs have knowledge-based assets, unique resources, and core technologies, while local firms do not. Local firms are therefore advised to focus on developing strong manufacturing capabilities. However, we know little about the difficulties MNEs face when trying to compete in a host country’s market. This is an important issue, given the accumulating evidence that MNEs are unable to make

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full use of their superior technological resources in host countries (Buckley & Casson, 1976; Gao, 2003; Hymer, 1976; Wang, 1999; Xu, 2002; Zaheer & Mosakowski, 1997). • The existing literature generally has not examined systematically the potential for local firms to develop innovation capabilities and core technologies, although some authors have pointed out that local firms might be able to catch up in emerging technologies (Hobday, 1990; Lee & Lim, 2001; Perez & Soete, 1988). Given the accumulating evidence that local firms can compete with MNEs by reinventing (not buying) mature technologies or by developing new technologies, it is important to explore in a more systematic way the opportunities for local firms to improve their technological resources and the effect of these opportunities on the choice of technology strategies (Cusumano, 1985; Gao, 2003; Shen, 1999). • A large portion of the existing literature has been conducted mainly in countries such as South Korea and Japan where, because of protection of the local markets, competition from MNEs was limited, especially in the early stages of local firms’ development. We still have only a limited understanding of the impact of direct competition between local firms and MNEs on local firms’ choice of technology strategies. Developing a better understanding of the real gap in core technologies between MNEs and local firms is critically important to an examination of what the effective technology strategies are for local firms. In this paper, we explore this issue by introducing two concepts: ‘‘barriers to appropriability’’ and ‘‘opportunities for improvement.’’ We define ‘‘barriers to appropriability’’ in terms of the difficulties MNEs have in using their superior technological resources in a host country’s market. Barriers to appropriability arise when there are factors that constrain MNEs’ ability to fully utilize their superior technological resources to compete with local firms. We define ‘‘opportunities for improvement’’ as opportunities for local firms to improve their technological resources. Opportunities for improvement arise when there are factors helping local firms to develop innovation capabilities and core technologies. Our analysis is organized as follows: • We first introduce the concepts of barriers to appropriability and opportunities for improvement. • We then develop propositions that local firms can use to choose their technology strategies to compete with MNEs. We also use two cases to illustrate two of the propositions. • We conclude with a discussion of opportunities for additional research.

2 Barriers to appropriability and opportunities for improvement 2.1 Barriers to appropriability The existing literature has long recognized that there exist ‘‘liabilities of foreignness,’’ and that MNEs’ superior technological resources will not necessarily lead to competitive advantage when they globalize their businesses (Buckley & Casson, 1976;

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Hymer, 1976; Lou, 2000; Zaheer & Mosakowski, 1997). In this paper we introduce the concept of barriers to appropriability to further examine the difficulties MNEs have in using their superior technological resources to compete with local firms. We identify five kinds of barriers to appropriability: regulatory, information, resource, coordination, and commitment. Although there is overlap between the concepts of barriers to appropriability and liabilities of foreignness, the differences are crucial. The concept of liabilities of foreignness mainly covers two kinds of barriers to appropriability: regulatory and information. The other three kinds of appropriability barriers (resource, coordination, and commitment barriers) are not really covered by the concept of liabilities of foreignness. These three types of barriers to appropriability mainly arise from factors such as competition between MNEs themselves, the huge size of MNEs, and MNEs’ low commitment to the specific host country market. These factors are not necessarily specific to operating in a foreign market. They could also influence MNEs’ utilization of technological resources in regional markets of their home countries. We find it necessary to introduce the broader concept of barriers to appropriability in order to provide a better understanding of the difficulties facing MNEs when they compete with local firms in a foreign market. Let us examine in detail the five kinds of barriers to appropriability. Regulatory barriers (host or home country government regulations) are the most obvious barriers preventing MNEs from using their superior technological resources in host country markets (Dunning, 1992; Hymer, 1976). The development of the Japanese automobile industry shows that regulatory barriers prevented US and European automobile companies from using their superior technological resources in the Japanese market. Leading US and European automobile firms had more advanced technologies than Japanese automobile firms, both before World War II and at its end. Yet superior technological resources did not create competitive advantages for the US and European automobile firms. Before World War II, Japanese government regulations did not allow foreigners to be the major shareholders in Japanese automobile firms. Mainly because of this policy, Ford and GM, the two dominant leaders of the Japanese automobile industry before World War II, had to leave Japan. After World War II, the Japanese government basically prohibited the import of small cars until the early 1970s, when local firms had developed international competitiveness (Cusumano, 1985). Information barriers arise from MNEs’ relative unfamiliarity with the unique characteristics of a host country’s business environment. These characteristics include customers’ tastes, business customs, supporting industries, the culture, and the legal system (Buckley & Casson, 1976; Dunning, 1992; Hymer, 1976; Zaheer & Mosakowski, 1997). Because of their unfamiliarity with customers’ tastes, it’s hard for MNEs to customize their products to meet local market demand. Similarly, MNEs will find it difficult to work with wholesalers and retailers if they are not familiar with the business customs of the host country. Lack of familiarity with material or parts suppliers will also make it difficult for MNEs to choose the most appropriate products and processes. Resource barriers arise from resource constraints, especially financial resource constraints, that face MNEs when they try to employ their superior technological resources in a host country. Although a commonly accepted view in China is that MNEs have the advantage in financial resources, in many cases this is not true. In fact, many MNEs face strong competition, mainly from other MNEs (Lester, 1998;

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Mowery & Nelson, 1999; Womack, 1991). The result is that many MNEs often have low profit margins and have to operate on tight budgets. On the other hand, local firms actually might enjoy higher profit margins. For example, according to the State Commission of Economy and Trade, the 512 key local enterprises in China had much higher average profit margins in 2001 than the Fortune 500. The profit/sales ration for the former is 6% compared to 2.8% for the latter. Accordingly, it might be not easy for MNEs to find the financial resources to invest in a host country, even through they have superior technological resources. Coordination barriers arise from the complexity of coordinating activities within MNEs (Bartlett & Ghoshal, 1989; Carroll, 1993; Chandler, 1962; Dunning, 1992; Doz, 1986; Freeland, 1996; Studer-Noguez, 2002). For example, Chandler (1962) has shown that a firm needs to create new organizational structures in order to effectively manage its geographic expansion and diversification. Freeland (1996) further shows that it is not easy to make a multi-divisional structure effective. He points out that GM intentionally violated the axioms of efficient organization to create managerial consent. Doz (1986) also shows that coordinating business units around the world is a complex and costly process for an MNE. Because of the great complexity of coordination, it is not easy for MNEs to transfer superior technological resources from one country to another. Commitment barriers come from MNEs’ low commitment to a host country market. For many MNEs, the home country market is of strategic importance (Bartlett & Ghoshal, 1989; Studer-Noguez, 2002). Home country markets might be the key sources of revenue and profits. Also, superior technological resources might be developed mainly in the home country. In contrast, because a host country might be of peripheral importance in contributing to revenue and profits, or creating superior technological resources, MNEs might have little commitment to the host country’s market. This is supported by empirical studies (Amsden, 2001; Amsden & Chu, 2003; Gao, 2003; Zhang, 2000). For example, Amsden (2001) finds that foreign direct investment plays a trivial role in the early stages of many latecomer countries’ industrialization and development. Amsden and Chu (2003) also find that, though leading firms in Taiwan have increased their market share in mature high-tech industries, these firms were nationally owned large-scale firms rather than MNEs. Gao (2003) finds that MNEs in China’s telecom equipment industry chose to focus on the high-end market, operate in well-developed big cities, and ignore the lessdeveloped cities and regions. They also chose to focus on transferring superior technological resources developed in their home country, without sufficiently adapting them to meet local market needs. Low commitment to the host country’s markets makes it hard for MNEs to effectively employ their superior technological resources. 2.2 Opportunities for improvement Although the existing literature on technological catch-up emphasizes the huge gaps in technological capabilities between local firms and MNEs, and the difficulties of local firms developing technological capabilities, there is evidence showing that local firms can compete with MNEs by developing new technologies, reinventing mature technologies, or transferring technologies. We introduce the concept of opportunities for improvement to further explore the potential for local firms to improve their technological resources.

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First let’s look at four kinds of opportunities for improvement in the development of emerging technologies: learning, cultural, incentive, and organizational opportunities. Learning opportunities arise because entry barriers are low when a new technology is emerging. A key feature of emerging technology is that the entry barriers are not high—this offers opportunities for many firms to try many different ways of developing the technology (Perez & Soete, 1988; Tushman & Rosenkopf, 1992; Utterback, 1994). For this reason, when technologies are just emerging, local firms might be able to develop equivalent or even better technologies than those developed by MNEs (Gao, 2003; Hobday, 1990; Lee & Lim, 2001; Perez & Soete, 1988; Wang, 1999). Cultural opportunities are the corporate culture advantages that local firms might have over MNEs in perceiving and developing emerging technologies. Some studies have shown that a leading organization tends to develop the NIH (not invented here) syndrome, believing that it has a monopoly on knowledge in its field and fails to consider seriously the possibility that other organizations might produce important new ideas (Cohen & Levinthal, 1990; Hamel, Doz, & Prahalad, 1989; Katz & Allen, 1982). A typical example is GE. In the late 1970s, GE’s Major Appliance Business Group (MABG) did not believe that Matsushita and other Japanese firms could develop better refrigerator compressors, even when GE’s Canadian subsidiary was about to buy Matsushita’s products (Magazine & Patinkin, 1989). Given that local firms are followers and are thus less established, they should be less subject to an NIH syndrome. Accordingly, local firms might be able to take advantage of MNEs’ less favorable culture to perceive and develop emerging new technologies. Incentive opportunities come from the greater incentives that local firms might have, compared to MNEs, to develop and use emerging technologies. Many studies have shown that incumbent firms are reluctant to develop and use emerging technologies because these technologies might cannibalize their existing businesses (Foster, 1986; Henderson, 1993). Local firms, as followers, should be less worried about the cannibalization effects and should have greater incentives to develop and adopt new technologies. Local firms can take advantage of MNEs’ lack of interest in developing and adopting emerging technologies. Organizational opportunities arise from the greater structural flexibility of local firms. Many studies have shown that incumbent firms’ existing organizational structures and procedures have developed to support existing strategies and operations. It is therefore difficult for incumbent firms to change these structures and procedures and allocate necessary resources to support the development and utilization of emerging technologies, especially when the emerging technologies are competence-destroying (Christenson & Rosenbloom, 1995; Clark, 1985; Henderson & Clark, 1990; Tushman & Rosenkopf, 1992), when the technologies are not well aligned with current corporate strategies (Burgelman, 2002), or when the technologies fall out of the existing value network (Christensen & Bower, 1996). Given that local firms are followers, they should be less locked into existing organizational routines and existing value networks, and should be in a more advantageous position to develop and use emerging technologies. Now we turn to a discussion of opportunities for improvement in mature technologies. Here we identify two kinds of opportunities for improvement in mature technologies: reinvention and adaptation opportunities.

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Reinvention opportunities are the possibilities for local firms to reinvent mature product and process technologies. For leading firms such as MNEs, further investment in mature product and process technologies usually leads to diminishing returns (Perez & Soete, 1988). For local firms, however, reinventing mature technology is of critical importance when MNEs are unwilling to sell mature technology, or when the cost of buying mature technology is too high. In these circumstances, it is desirable for local firms to invest in reinventing mature technologies. Conditions that are conducive to the reinvention of mature technologies are: • Much information about mature technologies is widely available. For example, it is possible to collect pertinent information by reading academic publications and industrial publications, examining patent data, and studying products that embody these technologies. • Application of new tools, such as computer integrated manufacturing systems (CIMS), makes the process of reinventing mature technologies less time consuming and costly. Empirical studies also show that reinvention of mature technologies can be a very effective way for local firms to improve their technological capabilities and technological resources. One example is Toyota. After World War II, when many Japanese automobile firms chose to tie up with foreign companies, Toyota chose to build its car business by studying foreign cars and pursuing independent product development. Toyota’s strategy turned out to be very effective and it soon became the leading automobile firm in Japan (Cusumano, 1985). Another example is the leading domestic telecom equipment firms in China. These firms have been very successful in reinventing products, such as digital switches and backbone routers, by collaborating with domestic research institutes and universities (Gao, 2003; Shen, 1999). A third example is the development and application of computer integrated manufacturing systems (CIMS) in China. This has helped many local firms to improve their product design, development, and manufacturing capabilities. Beijing No. 1 Machine Tool Plant actually won the CASA/SME 1995 Industry Leadership Award because of its impressive achievements in developing and applying CIMS technology to improve its technological capabilities (Wu, 2001). Adaptation opportunities are the possibilities for local firms to improve their technological capabilities by adapting mature technologies to the local environment. The literature on technological change and technology transfer has shown that both product technology and process technology are developed to solve particular problems in particular technical, business, social, and political contexts (Iansiti, 1998; Tushman & Rosenkopf, 1992; Utterback, 1994). Technology also has implicit and tacit aspects, rather than being fully specified (Pavitt, 1985). Technology must be adapted and modified to fit new contexts or environments. The need for adaptation creates opportunities for local firms to improve their technological capabilities. There are two possible situations. When there are barriers to MNEs adapting technology, local firms have an opportunity to develop better technologies and gain competitive advantage. Even when there are no barriers for MNEs, the process of adaptation takes time and this could give local firms more time to improve their technological capabilities. Empirical studies show that adaptation opportunities can help local firms improve their technological capabilities. For example, Amsden and Hikino (1993) found that

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adapting existing technologies to the local environment is an important way that local steel firms have improved their technological capabilities in Japan, South Korea, India, Brazil, and other late-industrializing countries. Toyota’s development of the lean production system is another example (Cusumano, 1985). Toyota started to make cars by adopting the Ford production system. However, the original Ford system was designed for mass production of limited product lines and had fundamental flaws. First, only the final assembly line achieved anything resembling a continuous flow. Second, it was unable to accommodate consumer preferences for product diversity. Recognizing these flaws, Toyota began to adapt the Ford product system in 1948. By the mid-1950s, four of the most important techniques of Toyota’s famous lean production system were in place. In addition to internal development of emerging technologies and mature technologies, the third opportunity for local firms to improve their technological capabilities is to transfer technology. One important means of technology transfer is to buy production machinery from suppliers. According to Pavitt (1985), sources and patterns of technological progress vary among sectors. In supplier-dominated sectors and scale-intensive or production-intensive sectors, machinery suppliers play crucial roles in technological progress and it is possible for local firms to improve their technological capabilities by buying production machinery from suppliers. Many Japanese firms in the petrochemical and steel industries have been very successful in buying production machinery from suppliers to close the technological gaps between themselves and leading US and European firms, or even to leapfrog these leading companies (Dertouzos, Lester, Solow, & the MIT Commission on Industrial Performance, 1989; Hikino, Harada, Tokuhisa, & Yoshida, 1998). Technology transfer can also play an important role in helping local firms to develop emerging technologies, reinvent mature technologies, or adapt technology to the local environment. Emerging technology examples are Samsung, which became as a major player in CDMA by transferring technology from Qualcomm (Chung & Lee, 1999), and Sony, which developed its famous Trinitron by transferring technology from the US (Lyons, 1976). In mature technologies, technology transfer played a significant role in helping many local firms in Japan, South Korea, and China to improve their technological capabilities (Amsden & Hikino, 1993; Cusumano, 1985; Gao, 2003; Lee & Lim, 2001; Liu, 2001; Zhang, 2001a). 3 Choosing technology strategies to compete with MNEs From the resource-based perspective, a firm’s competitive advantage comes from its superior resources. A firm is therefore advised to choose its strategy based on its resources (Barney, 1986; Dierickx & Cool, 1989; Penrose, 1959; Peteraf, 1993; Prahalad and Hamel, 1990; Teece et al., 1997; Wernerfelt, 1984). We believe that, although a firm should consider not only its technological resources, it makes sense to analyze local firms’ technology strategies by focusing on comparing the local firms’ technological resources with those of MNEs, when choosing its technology strategy. This is based on two observations: • Existing literature on catch-up has shown that one key difference between local firms and MNEs is that local firms do not have core technologies while MNEs do (Amsden, 2001; Amsden & Chu, 2003; Hymer, 1976; Kim, 1997, 1998; Westphal et al., 1985).

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• Some anecdotal evidence shows that it is very hard for local firms in China to develop core technologies—but some firms are extremely successful in developing other competencies, such as marketing capabilities (Gao, 2003; Sun, 2001; Xu, 2002). Based on the analysis of barriers to appropriability and opportunities for improvement in the previous section, we now turn to the development of specific propositions concerning local firms’ choice of effective technology strategies. First let’s look at the situation when there are high barriers to appropriability. Under these conditions, it will be difficult for MNEs to use their superior technological resources to gain a competitive advantage over local firms. For example, high barriers to appropriability will make it hard for MNEs to set up manufacturing facilities in the host country. As a result, MNEs will not be able to enjoy the benefits of low labor costs, familiarization with the local business and social environment, and adaptation of their technology and products to the local market. Even if MNEs were able to export their products to the host country, they would have to pay high tariffs and their products are not customized to meet the local market demands. In these circumstances, local firms can compete against MNEs by developing strong manufacturing capabilities, even when it is hard for local firms to develop their own core technologies because there are few opportunities for improvement. This is because local firms will enjoy all benefits of low labor costs, familiarity with the business and social environment, and adaptation of technology and products to the local market. They also do not have to pay extra taxes (tariffs). Accordingly, the development of strong manufacturing capabilities will make it possible for local firms to offer low-cost, mature products with adequate quality to compete against MNEs. This might help to explain how many Japanese and Korean firms have been able to compete with MNEs by developing strong manufacturing capabilities in protected domestic markets (Amsden, 2001; Dertouzos et al., 1989). When there are many opportunities for improvement, local firms can still compete against MNEs by developing strong manufacturing capabilities and, in addition, compete against MNEs by developing innovation capabilities and core technologies. The existence of opportunities for improvement might help local firms narrow the gap in core technology between themselves and MNEs. In these circumstances, local firms can offer not only low-cost, mature products but also advanced and new products. This might help explain how Founder and some telecom equipment firms in China have been able to compete against MNEs by developing core technologies and offering advanced products (Gao, 2003; Shen, 1999; Wang, 1999; Zhang, 2000). The discussion above leads to the following two propositions: Proposition 1: When there are high barriers to appropriability and many opportunities for improvement, the strategy of developing strong manufacturing capabilities is not the only choice. The strategy of developing innovation capabilities also would be an effective way for local firms to compete with MNEs. Proposition 2: When there are high barriers to appropriability and few opportunities for improvement, the strategy of developing strong manufacturing capabilities is the most effective way for local firms to compete against MNEs. The strategy of developing innovation capabilities is unlikely to succeed. Next, let’s look at the situation of low barriers to appropriability. In this situation, it will be easy for MNEs to use their superior technological resources in the host

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country to compete with local firms. For example, low barriers to appropriability will make it easy for MNEs to set up manufacturing facilities. As a result, MNEs will be able to enjoy the benefits of low labor costs, familiarization with the local business and social environment, and adaptation of their technology and products to the local market. When barriers to appropriability are low, it will be hard for local firms to compete against MNEs by developing strong manufacturing capabilities, because local firms will have no advantages in producing low-cost, mature products. Local firms might be able to survive in some niche markets that MNEs find unattractive. When barriers to appropriability are low, local firms might be able to compete against MNEs by developing innovation capabilities and core technologies if there are opportunities for improvement. This is because the existence of opportunities for improvement might help local firms narrow the gap in core technology between themselves and MNEs. The foregoing discussion leads to the following two additional propositions: Proposition 3: When there are low barriers to appropriability and many opportunities for improvement, the effective strategy for local firms competing with MNEs is to develop innovation capabilities. The strategy of developing manufacturing capabilities will not be effective. Proposition 4: When there are low barriers to appropriability and few opportunities for improvement, neither developing manufacturing capabilities nor developing innovation capabilities will be effective strategies for local firms to compete against MNEs in the mainstream market. It might be possible for local firms to survive in some niche markets. The four propositions introduced above are summarized in Table 1. 4 Case illustration of the framework 4.1 Research methodology Although we have developed four propositions, in this paper we choose to illustrate only Propositions 1 and 3, covering the choice of effective technology strategy when there are many opportunities for improvements. Our emphasis is on the importance of developing innovation capabilities and core technologies, which has not been well studied in the existing literature. To illustrate Propositions 1 and 3, we follow a ‘‘pattern-matching’’ case study method suggested by Yin (1989). In this research method, the proposition to be illustrated is the benchmark against which data and patterns are examined. If the data support the prediction, the proposition is confirmed. Otherwise, the proposition should be rejected. Table 1 Barriers to appropriability, opportunities for improvement, and technology strategies

High barriers Low barriers

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Many opportunities

Few opportunities

P1: Innovation or manufacturing P3: Innovation, not manufacturing

P2: Manufacturing, not innovation P4: Niche market strategy


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For example, if the data show that a local firm can effectively compete against MNEs by developing innovation capabilities and core technologies, in an environment of high barriers to appropriability and many opportunities for improvement, then Proposition 1 is confirmed. On the contrary, if the data show that a local firm cannot do so in that environment, Proposition 1 should be rejected. Similarly, if the data show that a local firm can compete effectively against MNEs by developing innovation capabilities and core technologies in an environment of low barriers to appropriability and many opportunities for improvement, Proposition 3 is confirmed, but if the data show that a local firm can effectively compete against MNEs by developing strong manufacturing capabilities in that environment, Proposition 3 should be rejected. To illustrate Proposition 1, we needed to select a firm that has relied mainly on developing innovation capabilities in an environment of high barriers to appropriability and many opportunities for improvement; to illustrate Proposition 3, we needed a firm that has relied mainly on developing manufacturing capabilities in an environment of low barriers to appropriability and many opportunities for improvement. We selected two companies, Dawning (http://www.dawning.com.cn/) and Hisense (http://www.hisense.com.cn/), to illustrate the two propositions. Dawning is a high performance computer (HPC) producer. Hisense is a home appliance and consumer electronics firm, with TV sets as its main business. Dawning has relied on developing strong innovation capabilities to compete with MNEs. Hisense has relied mainly on developing strong manufacturing capabilities to compete with MNEs. In the HPC industry, the barriers to appropriability are high, and there are many opportunities for improvement. In the TV set industry, the barriers to appropriability were relatively high before the 1990s but declined quickly over time, and there are many opportunities for improvement. Data was collected mainly through interviews, although archival data was used as well. Interviews focused on the two firms’ technology strategies and their effectiveness, and on the barriers to appropriability and opportunities for improvement in the two industries. Interviewees include top management (CEO, senior VP), board members (Chair and Vice Chair of the Board of Directors), middle level managers (mainly R&D managers), R&D researchers, and manufacturing engineers. Interviews ran from about an hour to as long as 4 h, but typically lasted 90–120 min. We took extensive notes during interviews because most of the interviewees preferred not to be taped. We stopped when we believed that we had collected sufficient data—it turned out that we had 21 interviews with 11 people. In the following, we describe the two companies’ technology strategies, discuss the effectiveness of these strategies, and relate the effectiveness of the two strategies to our propositions. 4.2 Dawning’s technology strategy and its effectiveness Dawning is the leading local firm in the HPC industry in China in both market share and technological innovation. Dawning originated with the setting up of the National Intelligent Computer Research Center by the Institute of Computing Technology at the Chinese Academy of Sciences in 1990. The Research Center was set up to develop key technologies in the area of high performance computing, one of the key technology areas supported by the ‘‘863’’ Program, the high tech program that China started in the late 1980s.

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Since economic reform, many firms in China have been able to buy technology from MNEs, but Dawning has not had the opportunity to buy core technologies to enter the HPC industry. Accordingly, Dawning’s technology strategy has been ‘‘to develop core technology internally.’’ More specifically, Dawning’s technology strategy has four elements: • • • •

Avoid technologies that are too radically new. Avoid technologies in which incumbents have dominant advantages. Focus on technologies that are emerging. Focus on software technologies.

The first element is to avoid developing technologies that are too radically new. For example, although intelligent computing was the hot topic when the National Intelligent Computer Research Center was set up in 1990, Dawning did not believe that intelligent computers would be developed in the near future and decided not to focus on this technology. Instead, Dawning chose to develop HPCs based on parallel computing. The second element is to avoid developing technologies in which MNEs, such as IBM, HP, and Sun, have dominant advantages. For example, from the very early days of its development, Dawning decided not to compete in areas such as CPU and storage because it believed that MNEs have dominant advantages in these technologies. The third element is to focus on emerging technologies. For example, the key technology for their first product, Dawning 1, was parallel computing technology. In the early 1990s, when Dawning 1 was under development, parallel computing technology was not mature and there was no commonly accepted industry standard. Similarly, in the mid 1990s, when cluster technology began to emerge, Dawning seized the opportunity and successfully developed its own core technologies such as the cluster operating system (system software that connects many CPUs and makes them work together at high speed). The fourth element is to focus on software technology. Dawning believes that it has advantages in software technology—one reason for the fast successful development of Dawning 1 was that the key technology for this product is software. In fact, most of Dawning’s key technological innovations are software intensive: the UNIX operating system, the cluster OS, and other system software. To implement its strategy of developing core technologies internally, one of the key measures Dawning has taken is to attract highly talented people. For example, Mr. Li Guojie, former Chairman of Dawning, is a member of the Chinese Academy of Engineering. Mr. Xu Zhiwei, the key designer of Dawning 2000, was a professor at University of Southern California before joining Dawning. Though every effort has been made to improve their salaries, Dawning believes that money is not the only thing that attracts and motivates the firm’s highly talented people. A more important and more effective approach is to create an environment where employees feel that they are doing something challenging, big, and important. One way to create such an environment is to articulate the firm’s mission clearly. Dawning’s mission is to develop China’s own HPC industry. Dawning’s people are primarily motivated by this mission, rather than by money. In fact, many of them could have much higher salaries at other high tech firms.

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Dawning has developed strong innovation capabilities and a series of core technologies. For example, Dawning 1,000 embodied several technological breakthroughs. The wormhole routing chip creatively exploited a combination of asynchronous and synchronous modes, and was one of the most advanced routing chips in the world when it was developed in 1995. Similarly, the parallel optimizing compiler was assessed as one of the most advanced systems in the world by experts from MIT and McGill University. Dawning also developed its own cluster operating system in Dawning 2000 and Dawning 3000. Today, Dawning is ahead of foreign firms in cluster OS and some SUMA (scalability, usability, manageability, and availability) technologies. An Asian Technology Information Program Report, based mainly on Dawning’s technological achievements, also points out that ‘‘when focusing on Chinese R&D, small through moderate-sized systems (but not the largest), and on system software, tools, and some related applications of HPC, the Chinese are coming up from behind but are very near equality with the West’’ (ATIP 00.025). The development of innovation capabilities has made it possible for Dawning to succeed in an industry with high entry barriers. The HPC industry was dominated by MNEs. As a latecomer, Dawning faced a lot of barriers in entering this industry. In the early stages, people did not believe that Dawning would be able to make high quality products and refused to give opportunities to Dawning. For example, many big companies and government agencies have procurement lists specifying which companies’ HPCs they are willing to buy. For a long time, Dawning was not on these lists and was not able to sell their products to these organizations. In some cases, organizations set unreasonable conditions. For example, one trading firm said it would buy Dawning’s superserver only if Dawning agreed to pay any losses incurred when the server had problems, although they never required this of MNEs. Dawning has succeeded in overcoming high entry barriers by providing highquality products using the core technologies it has developed. For example, because Dawning was not on the Ministry of Railway’s procurement list, it donated its machines to a university attached to the Ministry, for use in conducting research. By using the machine, the university and the Ministry recognized Dawning’s capability in making high quality HPCs. A particular opportunity for Dawning to show its capability came when an MNE’s HPC was down at a railway station. Because the MNE could not offer timely service, Dawning suggested that the railway station use Dawning’s product while the MNE’s HPC was being fixed. It turned out that Dawning’s product was better than the MNE’s and the railway station decided to buy the Dawning machine. 4.3 Explaining the effectiveness of Dawning’s technology strategy The effectiveness of Dawning’s technology strategy supports Proposition 1. That is, when there are high barriers to appropriability and many opportunities for improvement, the strategy of developing innovation capabilities can be effective for local firms competing against MNEs. The strategy of developing strong manufacturing capabilities, suggested by the existing literature, is not the only choice. The first condition is that there are high barriers to appropriability in the HPC industry. The major barrier is regulatory. Specifically, the US government does not allow industry leaders, such as IBM, Sun, and HP, to sell their advanced HPCs in

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China. On the one hand, this regulatory barrier makes it impossible for China to buy the very high-end HPCs that are of critical importance in areas like weather forecasting, oil exploration, gene engineering, and military use. On the other hand, this regulatory barrier also makes it hard for MNEs to use their superior technology to gain competitive advantage in the Chinese HPC market. This helped to create a demand for Dawning’s products, especially at the high end of the market. Another barrier is commitment. HPC industry MNEs do not see strategic importance in the Chinese market—one result is that the services provided by the MNEs are limited. The commitment barrier has prevented MNEs from taking advantage of their superior technology in the Chinese HPC market. As mentioned, an MNE’s failure to provide timely service for its HPC gave Dawning the opportunity to demonstrate superior quality and persuade the railway station to buy Dawning’s products. The second condition is that there are many opportunities for improvement in the HPC industry. For instance, when the National Intelligent Computer Center began to develop Dawning 1, the key technology, parallel computing, was not mature. Similarly, in the mid-1990s, cluster technology, the key technology for Dawning 2000, Dawning 3000, and other more advanced products, was just emerging. These opportunities for improvement provided the opening for Dawning to develop innovation capabilities and narrow the gap in core technologies between itself and MNEs. Dawning’s technology strategy effectively seized the opportunities for improvement to develop its own innovation capabilities and core technologies. As discussed, when it was founded in 1990, the National Intelligent Computer Center chose to focus on the development of parallel computing technology. Because parallel computing technology was not mature, Dawning had the opportunity to develop its own core technology. Because parallel computing technology was not too radically new, as was intelligent computing technology, Dawning was able to develop it in a shorter time. The result was the successful development of Dawning 1. This product helped Dawning build its reputation as the leading Chinese company in the HPC industry and was the basis for Dawning’s moving up to more sophisticated products and markets. Another example is Dawning’s decision to focus its R&D on cluster technology in the mid-1990s. Because cluster technology was just emerging at that time, Dawning was able to develop its own cluster operating system (OS) in Dawning 2000 and Dawning 3000. Dawning was also very successful in developing new technologies to improve product quality in scalability, usability, manageability, and availability (SUMA). Today, in fact, SUMA is considered the industry standard. The development of innovation capabilities and core technologies not only makes it possible for Dawning to compete head-to-head with MNEs, but also creates strategic opportunities for Dawning. To some extent, the rules of the game have changed since Dawning’s technological breakthrough in Dawning 3000. The HPCs that the US government allows to be exported to China are one level below Dawning’s most advanced products. Consequently, Dawning is competing with itself rather than with the more powerful MNEs. This creates an opportunity for Dawning to earn a high profit margin and further fuel its technological innovation. If Dawning can seize this golden opportunity, it will be possible for it to further narrow the technological gap between itself and MNEs.

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4.4 Hisense’s technology strategy and its effectiveness Hisense is one of the leading local firms in the consumer electronics and home appliance industry, with TV sets as its main business. It was founded in 1969 and entered the color TV industry in 1984. The short-term goal of the company is to realize sales revenue of 50 billion Yuan by 2005 and become one of China’s top three electronics firms. The long-term goal of the firm is to become a world-famous company and make Hisense a globally known brand name. Hisense’s technology strategy is to buy technology and develop strong manufacturing capabilities. More specifically, its strategy has three characteristics: • Buy advanced technologies from MNEs. • Develop strong technological absorptive capabilities. • Develop an effective quality management system. The first characteristic of the company’s strategy is buying advanced technologies from multinationals. Although buying technology from foreign firms is a common practice for local firms, Hisense has a policy of buying only advanced technologies, believing that this is more effective in competing with local firms and in catching up with MNEs. For example, Hisense started color TV production in 1984 through SKD/CKD assembly, as did other local firms, but took a different approach. Facing the choices of buying technology from a Hong Kong firm for $1.5 million or from Matsushita for $3 million, Hisense chose to buy from Matsushita, which had more advanced technologies. Similarly, when Hisense decided to enter the large screen TV set segment in 1993, it decided to buy Toshiba technology because it was more advanced than that of other firms. When it entered the flat screen TV and projection TV markets, Hisense made similar choices. The second characteristic of the company’s technology strategy is developing strong technological absorptive capabilities. Hisense believes that the consumer electronics and home appliance industry is characterized by rapid changes in product features, functions, and performance. Buying advanced technologies from MNEs is not enough in itself. It is critical to develop a strong capability to absorb these technologies and be able to continuously develop new products to meet market changes. Hisense has adopted several policies to develop technological absorptive capability: • In 1992, Hisense set up the Hisense Technology Center, the company R&D department, to promote technological progress in the company by absorbing technologies bought from outside. At that time, few local firms in China had their own R&D departments. The establishment of the Hisense Technology Center showed the company’s determination to improve technological capability. Today the Hisense Technology Center is recognized as one of China’s most advanced enterprise technology centers in the consumer electronics and home appliance industry. In 2002, the Hisense Technology Center was ranked sixth among the 289 Enterprise Technology Centers certified by the State Commission of Economy and Trade. • Hisense proactively hires people with advanced degrees. In 1992, the company only had two employees with Master’s degrees and 400 with Bachelor’s degrees. In 1999, it had 42 employees with PhD degrees, more than 260 with Master’s

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degrees, and more than 2,800 with Bachelor’s degrees (31% of all employees). Hisense is the only local company with so many PhD employees in the consumer electronics and home appliance industry. • Hisense very actively motivates its R&D people to innovate. One policy has been to significantly improve R&D people’s bonuses. Before 1992, as in other local firms, there was little difference between the bonuses of R&D people and of other employees. In 1992, Hisense changed its policy and made bonuses of R&D people at the Hisense Technology Center much higher than those of other employees. The third characteristic of Hisense’s technology strategy is developing an effective quality management system. Hisense believes that ‘‘high quality will not necessarily make a firm prosper, but low quality will surely destroy the firm.’’ This belief has led Hisense to take action to build an effective quality management system so that its products are of high quality. In addition to applying high quality control standards in the manufacturing process, Hisense believes it is important ‘‘to design in high quality,’’ using advanced technology at the design stage. Hisense also does extensive small batch productions to evaluate product quality at the Hisense Technology Center, before going to large batch production in the manufacturing plants. Furthermore, Hisense has policies to ‘‘force’’ itself to make high-quality products. Since 1996, price wars have become the key weapons of many competing consumer electronics and home appliance firms. In many cases, Hisense refused to join a price war, believing that price wars are not good for quality improvement and the firm’s long-term development. Hisense also chooses not to spend a lot of money on advertising, believing that word of mouth more effectively communicates the high quality of its products. Hisense has developed strong manufacturing capabilities. First, Hisense has developed the ability to monitor and select technologies. In 1993, when Hisense decided to enter the large screen TV set segment, it compared technologies from different MNEs and selected the most appropriate ones. Second, Hisense has developed a strong ability to absorb and adapt technologies to meet local market demand. For example, although Hisense was not the first local firm to buy flat screen TV technology, in 1997 it became the first to locally mass produce flat screen TV sets, when this new market was emerging in China. A key reason is that Hisense had spent the necessary time and resources to absorb the technology the company had bought. By developing a strong technology absorption capability, Hisense also was able to decrease the negative impact of price competition by quickly introducing new products when, after 1996, price wars became the key weapon for many firms to compete. Eighty-five percent of Hisense’s 1998 sales revenue was from new products. The development of strong manufacturing capabilities has helped make Hisense one of the leading local firms in the TV set industry. In 1999, Hisense was named a ‘‘Well-Known Brand in China’’ by the State Administration for Industry and Commerce (SAIC). In 2001, Hisense’s TV sets, refrigerators, and PCs were named ‘‘Well-Known Products in China’’ by the SAIC. In 2001, Hisense also became one of the five winners of China’s ‘‘National Quality Management Award’’ granted by the National Association of Quality. Hisense is also the only firm in the consumer electronics and home appliance industry to win the ‘‘National Quality Award’’ for four successive years.

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Although Hisense has become one of the most competitive local firms and an industry leader in China, it still has many difficulties competing with MNEs. For example, at the high end of the market, Hisense still has to rely on MNEs to supply key technologies. At the low end, the situation has changed since Hisense and other local firms were able to capture market share from MNEs before the mid-1990s. MNEs are quickly localizing production in China and are now able to initiate price wars to compete with Hisense and other local firms, even at the lower end of the market. 4.5 Explaining the ineffectiveness of Hisense’s technology strategy The relative ineffectiveness of Hisense’s technology strategy supports Proposition 3. That is, when there are low barriers to appropriability and many opportunities for improvement, the strategy of developing strong manufacturing capabilities will not be effective. The first reason for the ineffectiveness of the strategy of developing strong manufacturing capabilities is declining barriers to appropriability. There were relatively high barriers to appropriability, mainly regulatory, before the mid-1990s. Until then, the local market was protected by high tariffs. Before the mid-1990s, there were also high commitment barriers. MNEs were slow to localize their production and, as a result, did not have strong manufacturing capabilities in China. Hisense and other local firms were very successful in capturing market share and making profits by buying technology and developing strong manufacturing capabilities. The problem is that barriers to appropriability declined quickly after the mid-1990s. For example, tariffs dropped sharply when China was trying to join the WTO. More importantly, MNEs speeded up their production localization in China. Localization made it possible for MNEs not only to utilize their superior technology directly in China to produce high-end products, but also to make low-cost products for the low-end market by enjoying the benefits of low labor cost and familiarity with the local market—advantages once enjoyed only by the local firms. In these conditions, development of strong manufacturing capabilities is no longer sufficient for Hisense and other local firms to compete against MNEs, even at the lower end of the market. The second reason for the ineffectiveness of developing strong manufacturing capabilities is that this strategy makes it difficult for Hisense to develop strong innovation capabilities and core technologies by seizing opportunities for improvement. There have been many opportunities for improvement in the TV set industry since the mid-1980s. For example, digital technology has been applied in TV sets for a long time. Projection TV, PDP, and LCD also employ many emerging technologies. The problem is that Hisense, like other leading local firms, has chosen to focus on developing strong manufacturing capabilities. Because of this strategic choice, Hisense did not start to develop core technologies until the late 1990s, when it became increasingly difficult for it to buy more advanced technologies from MNEs. The result is that Hisense has not been able to seize the opportunities for improvement that lie in developing its own core technologies, and has to rely heavily on MNEs for key technologies. This makes it hard for Hisense to compete against MNEs on the high-end market.

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5 Conclusion The existing literature provides no conclusive answer to the question of what the effective technology strategies are for local firms to compete against MNEs. In this paper we have explored this issue by introducing two concepts: barriers to appropriability, and opportunities for improvement. We discussed specific kinds of barriers to appropriability and opportunities for improvement, and developed four propositions to specify the boundary conditions for local firms choosing their technology strategies. We also analyzed the different technology strategies of two local firms, Hisense and Dawning, to illustrate two of the propositions. We find that the application of the concepts of barriers to appropriability and opportunities for improvement shows promise in the analysis of local firms’ technology strategies when competing with MNEs. The propositions help to specify the boundary conditions for local firms choosing their technology strategies. This paper provides new insight into the analysis of effective technology strategies for local firms in competition with MNEs: • The strategy of developing strong manufacturing capabilities will not necessarily enable local firms to compete effectively against MNEs. When barriers to appropriability are low, it is not difficult for MNEs to gain strong local manufacturing capabilities. Only when barriers to appropriability are high will local firms be able to compete against MNEs by developing strong manufacturing capabilities, because the high barriers to appropriability in the host country make it difficult for MNEs to set up manufacturing facilities to use their superior technological resources to gain a competitive advantage over local firms. • The strategy of developing strong manufacturing capabilities is not necessarily the only choice, let alone the best choice, for local firms to use to compete against MNEs. When there are opportunities for improvement, it might be possible for local firms to compete against MNEs by developing innovation capabilities and core technologies. This is of crucial importance for local firms in this era of globalization. The scope of this paper is limited and further research is needed: • This paper analyzed two firms’ technology strategies to illustrate two of the four propositions developed. By studying more cases, future research could illustrate and test the four propositions in a more systematic and sophisticated way. • This paper focused mainly on the analysis of two kinds of environmental factors, barriers to appropriability and opportunities for improvement. Firms (local or MNE) might develop different technology strategies based on different strategic postures toward the two environmental factors. Some firms might be insensitive to these factors, while others might be not only aware of these factors but also proactively creating and using these factors (Chen, 1996; Grimm & Smith, 1997). Future research could analyze these interactive competitive behaviors between local firms and MNEs. • Recognizing the crucial importance of technological resources for local firms, this paper focused on the relationship between technological resources and technology strategies. Future research could further examine the impact of other kinds of resources on the selection of technology strategies.

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• This paper introduced two concepts, barriers to appropriability and opportunities for improvement, to study local firms’ technology strategies. Future research could explore whether it is possible to extend these two concepts to the analysis of local firms’ corporate strategies. Acknowledgments The authors want to thank the MIT Sloan School of Management and the MIT Industrial Performance Center for providing financial support for this study, and thank Dawning and Hisense for providing the opportunity for us to do the case studies. We also want to thank George Farris, Richard Lester, Yadong Lou and all other reviewers for their insightful comments and suggestions. Special thanks go to Mingfang Li for his excellent leadership and professional commitment in organizing this special issue.

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