NATIONAL IT POLICYAsia Computer Report '97Jason
Dedrick and Kenneth
L. Kraemer The following is a report from a research trip taken in January 1997 to Seoul, Korea and Hong Kong. KOREA Personal computer market Korea's personal computer market reached 2 million units in 1996, up from 1.5 million in 1995, roughly tying China as Asia's second largest market (Japan was first at 8 million units). The market has grown rapidly in the past few years as strong price competition has made PCs more affordable. The market is said to be about 65% business and 35% home users. Samsung is now the leading brand in Korea, with 28% of the market, followed by Trigem at 18%, Sejin at 13% and LG Electronics at 10% . The keys to success in Korea's PC market have traditionally been distribution and service. The big Korean electronics companies, Samsung, Hyundai, LG and Daewoo have nationwide chains of dealers that handle only their brands. PC specialist Trigem has its own network of 350 exclusive dealers across the country as well. Korean PC makers offer levels of training and support that are unheard of in the U.S. Most vendors give free training to anyone, even if they don't purchase that vendor's PC. Trigem broadcasts training classes to remote classrooms around Korea. Product guarantees run from two years to lifetime coverage. Foreign PC makers are nearly absent from the Korean market. During the 1980s, they were kept out by a near total ban on PC imports which lasted until 1988. There is still an 8% tariff on PCs, peripherals and most components, and a 15% tariff on motherboards. These remaining official trade barriers will come down according to World Trade Organization rules by 1998, but the distribution system remains a formidable barrier to entry. Also, most foreign companies are not used to providing the levels of service and support that Korean customers are accustomed to, and present price levels leave little room to compete purely on price. A new force in the Korean IT market is Internet fever. Major newspapers have articles about the Internet every day, and a booklet section every week. There are electronic versions of newspapers on the net, and newspapers help schools set up their own Internet newspapers. PC vendors also now offer free classes on Internet use. There are five ISPs operating in Korea, the largest of which is HiTel, run by Korea Telecom. Access is still expensive, around $80 a month for unlimited use, but interest is strong and demand has grown rapidly. Korea's PC industry The Korean PC industry has been in decline for years, having hit its peak in both sales and exports in 1989. Although domestic market growth has helped the industry rebound the past three years, exports continue to decline and Korea is not a major international competitor in PCs. Recent stories in the local press have touted a resurgence in the Korean industry and even a challenge to Taiwan's leadership in the region. However, a look at the plans of leading vendors suggests such forecasts are probably overly optimistic. Samsung Samsung has aggressively sought market share in the past few years, passing Trigem in 1994 and extending its lead in the market since then. Samsung sold 600,000 PCs in Korea and exported another 75,000 in 1996, and forecasts total sales of 1 million units in 1997, with 300,000 exported. Samsung's notebook PCs were a big hit in Korea and the company is now launching its Sens line of notebooks in the U.S. market. Some analysts argue that the company used profits from its huge DRAM business (Samsung leads the world in DRAM production) to subsidize its market share drive, and that the drop in DRAM prices will make this impossible to sustain. Samsung is now focusing on design, and has plans to offer new products tailored to different segments of the market. The big story for Samsung in PCs is not in Korea, however, but in Irvine, California. That, of course, is the home to AST Research, a former high flying PC maker that will soon be a subsidiary of Samsung. AST has suffered nearly $700 million in losses over the past two years, and CEO Ian Diery was replaced by Samsung's own Y.S. Kim. Kim has been busy implementing his plans to turn AST around, but in February, Samsung announced it would offer $162 million to buy out the remaining 51% of AST that it didn't own. Samsung feels that if it is going to continue to pump money into AST, it should have complete control. Some analysts argue that Samsung would be better off cutting its losses in AST and concentrating on its core semiconductor and consumer electronics businesses. But most everyone agrees that it would be unthinkable for Samsung to allow AST to sink. TrigemTrigem made the first Korean PC in 1981, made the first IBM-compatible in 1984, and has been the local market leader for most years since then. Trigem is also the most international of Korea's PC makers, with 33% of its revenues and 40% of unit sales coming from overseas. Trigem made $200 million in the U.S. and $100 million in the U.K. in 1996, but decided to close down its unsuccessful European operation in Germany. In addition to its PC business, Trigem makes motherboards for IBM, Olivetti and Epson, sells ink jet and laser printers with its own Korean software and controller boards, and has various service businesses in Korea. Trigem has been the main victim of Samsung's price war, as it lost market share and fell into the red as its margins were squeezed. Samsung's ability to cross-subsidize its PC business with profits from DRAMs, and its ability to sell to family members within its own large chaebol (conglomerate), give it a competitive edge over Trigem in the domestic market. Trigem's notebook sales slumped to 30,000 units (compared to 100,000 for Samsung) due to lack of investments in engineering, manufacturing and dealer development. Trigem is not surrendering, however. It is investing in developing its own notebook PCs rather than just sourcing from Taiwan. It is also investing in distribution, providing better support for its Korean distributors, and focusing on the retail market in the U.S. through retailers such as Sears and Staples. Trigem can also hope that Samsung's problems with falling DRAM prices and AST might give Trigem some breathing room. LG/IBM LG/IBM is a joint venture between two also-rans in the Korean PC market. LG Electronics (formerly Lucky Goldstar) is a leading producer of consumer electronics and household appliances both in Korea and in international markets. However, LG had little success in PCs, never placing higher than a weak third place in the Korean market. LG was actually considering abandoning the PC industry, but decided that PCs were going to be the key driver for multimedia technologies that were critical to its future electronics business. LG felt that it could not make it on its own, and decided to look for a strategic partner that could provide necessary PC technology. IBM was likewise having no success in the Korean PC market, with less than a one percent market share. Although it dominates the mainframe market, IBM has been unable to develop a successful marketing and distribution system for PCs. The two companies saw in each other what they hope will be a logical match. LG offers the distribution network and strong local brand name that IBM needed, while IBM provides technology and a good brand name for computers in general that LG lacked. LG and IBM are now selling all of their PC products in Korea under the LG/IBM name. LG is making all the desktops and IBM makes notebooks (using the Thinkpad name) and servers. The joint venture sells only in the Korean markets, and has no plans to export under the LG/IBM name. LG's own export plans do not include PCs, but the company is looking at other platforms such as handheld PCs and digital wireless, and is developing a Windows CE product for export. Daewoo Daewoo was Korea's first big PC exporter, producing PCs for Leading Edge during the 1980s and early 1990s. Leading Edge was a well-regarded brand name, but ran into financial trouble and faced bankruptcy in 1988 as a result of lawsuits brought by its dealers. Leading Edge was rescued by Daewoo, which bought out the company in 1989. But Daewoo never succeeded in turning Leading Edge around and finally sold it in 1995. Without Leading Edge to provide marketing capabilities, Daewoo could not survive in the U.S. market. Daewoo is now trying to increase its share of the Korean PC market, where its share has fallen from 10% in 1991 to 5% in 1996. The company feels that the shift to multimedia PCs in the long run will work in favor of skilled manufacturers like itself. Hyundai Better known for its automobile and semiconductor businesses, Hyundai has become a marginal player in the PC business after a promising start. Hyundai was actually the first Korean company to make a dent in the U.S. market with its own brand name PCs, and had around 3% of the market by 1989. But the company was unable to keep up with the accelerating product and technology cycles in the 1990s and finally pulled out of the U.S. PC market in 1993. It is now concentrating on the Korean market, where it has less than a 10% market share. Hyundai feels that it must be in the PC business to participate in the convergence of computers, communications and consumer electronics that will define its future markets. The PC division now operates more like an independent company and is following the Taiwanese model of emphasizing speed and responsiveness to the market. Previously, Hyundai tried to produce most of its components in-house, but is now outsourcing until it improves its own capabilities. Hyundai is still active in the European market and hopes to re-enter the U.S. market when it can be more competitive. Like Samsung, Hyundai also made a major purchase of a U.S. company when it bought disk drive maker, Maxtor. So far Maxtor has been a money loser, but with Hyundai's backing, it will have time to try to catch up on the product development cycle where it has lagged for years. The results of major Asian acquisitions of U.S. firms have not been very promising, (including LG's acquisition of Zenith and NEC's Packard Bell investment), so Hyundai is trying to buck the trend with Maxtor. Sejin Sejin operates larger electronics outlets than the usual single-vendor dealership, offering a variety of local and national brand PCs, in addition to its own brand. Other PC vendors claim that they actually have refused to sell to Sejin, so Sejin stores just buy a few models from dealers to display in their stores and once in the store, customers are encouraged to buy Sejin's own models. In any case, the value of its distribution network enabled newcomer Sejin to grab 12% of the local market in just one year. Summary Korea's PC makers have firm control over the domestic market through their control of the distribution system. The situation is similar to the Japanese market, except the Korean market is less than one-third the size of Japan. Korea also does not offer the longer term growth potential of China. For foreign vendors, the best chance to crack the Korean market probably would be through a joint venture or strategic alliance with a partner who has an established distribution network. LG/IBM is one such example, as is a long-standing joint venture between Hewlett Packard and Samsung. Over time, Korea's market will open up as it complies with WTO rules and joins the OECD. Also, the success of Sejin should lead other retailers to offer a selection of different brands, and local users will need less training and support as they gain experience. So the longer term prospects for foreign vendors look somewhat better. The growth of the PC market and rise in Internet usage should also create opportunities in software, services and information content, but products will have to be tailored to the Korean language and culture. The Korean PC industry has limited presence outside its own market, and shows little inclination to change. Korean companies still earn most of their profits at home and generally use OEM business to get rid of excess capacity. They don't see any profit in challenging Taiwan for the big OEM business of U.S. and Japanese vendors. As for targeting foreign markets with their own brand names, only Samsung and Trigem show any interest, and Samsung will probably use AST as a vehicle for most of its international sales. The Korean companies are not likely to become serious competitors in the global PC market in the near future, but in DRAMs and other components, the story is different altogether. Semiconductors and components Last year's 75% drop in DRAM prices was a boon to PC users everywhere, not to mention PC makers and software companies. It was a disaster for Korea, however, coming at a time when Samsung was the world's number one DRAM producer and Korean electronics companies were heavily dependent on DRAM business for revenues and profits. After years of rapid capacity expansion, the Koreans finally slowed investment and even announced production cutbacks in February. The Korean chipmakers would like very much to reduce their dependence on commodity memory chips, so they are moving to diversify into products such as ASICs and microprocessors. For instance, Samsung is making microprocessors based on AMD designs, and also has an agreement with DEC to produce Alpha processors. But for the next few years, the main business of the Korean industry will be memories, at least until they develop stronger design skills and flexible manufacturing processes needed in the non-memory business. Korea's next big challenge to Japan is coming in the flat-panel display industry, where the big chaebol are all investing heavily. The flat-panel business fits the capabilities of the Korean companies very nicely, being a high-volume industry that requires a lot of capital and strong mass manufacturing skills. It also has an overlap with the chaebols' consumer electronics businesses, as the technology can be applied to televisions and other consumer devices. For the PC industry, Korean investment is good news, as it should push LCD prices down and lower the cost of the most expensive component of notebook computers. HONG KONG The big news in Hong Kong is also political, as the territory prepares for transition to Chinese rule this July. Beijing's decision to revoke some of Hong Kong's civil rights laws even before the transition caused strong reaction from pro-democracy groups and concern in the U.S. and Britain. Local business people and government officials express optimism that the transition will be smooth, and that business conditions will actually be better once the period of uncertainty is past. But foreign investors are waiting to see what will happen, not only in Hong Kong, but now also in China in the wake of Deng Xiaoping's death. On the economic scene, Hong Kong continues to expand its twin roles as gateway to China and manager of southern China's manufacturing industry. Government officials estimate that Hong Kong companies now employ over 5 million workers in southern China, producing everything from toys and clothing to PCs and peripherals. Hong Kong's skills in trade, finance, marketing and business management complement China's engineering skills, low-cost labor force and large domestic market. Computer market Hong Kong's PC market is estimated by IDC at 340,000 units in 1996, making it a bigger market than much larger countries such as Thailand or Malaysia. PC penetration is about 35 per 100 population, third highest in Asia after Japan and Singapore. The Hong Kong business market is divided between a highly computerized big business sector and a more technologically backward small business market. Big financial institutions, trading companies and other multinational corporations are heavy users of IT, which is a key to their international competitiveness. On the other hand, Hong Kong's thousands of small retailers, manufacturers, trading companies and other family businesses have been slow to adopt IT. Government efforts to develop an electronic data interchange system for customs documents, called Tradelink, have been bogged down for years, as big companies had their own systems and most small companies didn't even have PCs. The situation is changing in the small business sector as younger, computer literate people become involved in family businesses and bring them into the information age. The government has chosen computers and information services as a strategic industry, and is now promoting IT use in small companies. Computers are already common in the classroom, and the household market is served by a multitude of tiny outlets in several electronics markets. PC Industry: Managing Production in Southern China Hong Kong has lost most of its local manufacturing industry, but it has only moved a few miles across the border to Guangdong Province. Hong Kong companies provide design, operations management, marketing and finance to support production in Chinese plants. China provides land, low-cost labor and an abundant supply of engineering talent. The Shenzhen special economic zone has over 300 companies producing computer products, including IBM, Compaq, Conner, TEAC, Epson, and Great Wall. According to non-complete statistics from the Shenzhen city government, in 1994, Shenzhen produced 45,000 CPU, 6 million expansion cards, 600,000 chassis, 300,000 keyboards, 1 million hard drives, 250 million floppy disks, and 3.5 million heads. But that's only part of the picture, as nearby cities such as Dongguan and Guangzhou are also major production centers for the computer industry. Hong Kong's V-Tech has its main factory in Dongguan, producing PCs, cordless phones and other wireless devices, and various electronic games. AST also has its main plant in Dongguan, but maintains management functions in Hong Kong. In addition, there are many Taiwanese companies producing PCs, motherboards and peripherals. Political tensions between Taiwan and the mainland have not prevented the Taiwanese from investing in China, but they keep a low profile. In the words of one supplier, "They stay under water. You never know they're there until they need help, and then they surface." Production in China is still labor intensive and low-tech; for example, most companies use hand soldering rather than surface mount technology. But companies are now beginning to invest in more advanced process technologies to upgrade their production in China. Another function that Hong Kong provides is based on circumventing China's tariffs and other trade restrictions. For instance, most of the PC production in China is exported, in order to get favorable tariffs on imported components. Much of it only goes as far as Hong Kong, however, from where it is shipped back across the border, with payments made to customs officers to avoid the tariff. Major multinational corporations eschew such practices, but even their products can find their way into China through intermediaries, sometimes before the products are even introduced officially. The process of avoiding tariffs adds cost and inefficiency, but creates lucrative opportunities for many people, including officials, so the tariffs are not likely to be removed soon. Legend Computer One of the best cases that illustrates the symbiotic relationship of Hong Kong and China is the Legend family, which includes Hong Kong Legend and Beijing Legend. Beijing Legend is a quasi-state-owned enterprise in China, affiliated with the Chinese Academy of Sciences. Originally called New Technology Development, Inc., the company was reorganized as Beijing Legend in 1989. Hong Kong Legend was formed in 1988 as a joint venture of Beijing Legend, DAW (a Hong Kong computer dealer) and China Technology Trade Ltd., a mainland company operating in Hong Kong. Hong Kong Legend went public in 1994, selling 27% of its shares on the Hong Kong market, while Beijing Legend and DAW kept 42% and 31% respectively. The management of the two companies is closely linked. Three of the five executive directors for Hong Kong Legend are from Beijing Legend, and the chairman of Hong Kong Legend is the president of Beijing Legend. Beijing Legend is the number two PC vendor in China, with 6.9% of the market in 1996. It also operates a PC distribution business that sells Hewlett Packard and Toshiba brand products. Hong Kong Legend supplies components to Beijing Legend in semi-knockdown form for reassembly in China, where they are sold through Beijing Legend's distribution channels. Hong Kong Legend also has its own distribution channels in China that sell AST and Kingston products. In addition, it designs and makes motherboards and add-on cards. A subsidiary called Techwise makes bare motherboards. The rationale for the original relationship between DAW and Beijing Legend was described by one analyst as "borrowing a boat to go to sea." In this case Beijing Legend was borrowing a proverbial boat from DAW to gain access to foreign markets. Beijing Legend provided the technical expertise from the Chinese Academy of Sciences, access to the China market, and low-cost production. DAW provided knowledge of foreign markets and connections with multinational companies such as IBM and 3Com, whose products it sold in foreign markets. The joint venture started as a distributor, then moved into motherboard design and manufacturing in 1989. In 1991, they started making Legend brand PCs in China. In 1994, they used capital raised in the public offering to begin PCB production. One-hundred percent of the manufacturing output from China is exported to Hong Kong, then some is returned to China for the local market. The relationship between the two companies has gotten closer over time. After July 1, Hong Kong Legend will no longer be treated as an offshore company in China, and the two will likely merge more of their businesses. The China market offers opportunities for all kinds of hardware, as well as software and services, and much of the companies' future growth will be on the mainland. But even after the transition to Chinese rule, Hong Kong is expected to be a center for finance, marketing and other business operations for the Legend group. CHINA The death of Deng has overshadowed other events in China, and the next year will certainly be a critical time for China's political and economic development. Jiang Zemin appears to be in control, having consolidated his power with both the Communist Party and the People's Liberation Army. Jiang's first big test will be the takeover of Hong Kong, which will have a great impact on his standing within the Chinese leadership, on relations with the U.S., and on future negotiations with Taiwan. Internally, Jiang will have to deal with economic challenges such as the need to restructure state enterprises and the increasing regional disparity in wealth, as a few provinces reap most of the benefits of China's extraordinary growth. Whatever its outcome, the post-Deng transition is now underway and the business community can begin to judge what the future political environment will look like. The market The size of China's PC market is a subject of considerable disagreement, thanks to the great difficulty of gathering data in such a large, diverse country. For 1996, Dataquest puts the market at 1.66 million units, while IDC reports 2.1 million shipments. While in Hong Kong, we heard estimates ranging from 1.4 million to 3 million units. What is not in question is that the market is growing very fast, jumping by 39% according to IDC and 53% according to Dataquest (Both companies' press releases are available from IDG China at http://www.idgchina.com). The Chinese market has become a wide open competition, with no company having more than a 10% market share. The top four vendors are IBM, Legend, Hewlett Packard and Compaq, each with 6-7% of the market, while former leader AST has about 5%. The top 10 companies combined have only 44% of the market. This is because China is a very decentralized market, much of which is served by small local assemblers who put together no-name clones and provide services and support to local users. These shops offer very low prices and reach customers who can't afford brand name PCs, but they also put price pressure on the premium brands. Price competition is generally intense as vendors battle for market share in what they perceive to be a huge future market. Market growth is being driven mainly by government procurement and by the big banks and financial institutions. Business, government and education account for nearly 90% of the market, with consumers accounting for the remaining 10%. The government's "Golden" projects include plans for large-scale networks for government administration and financial services. Some of the big state-owned banks have thousands of branches, and will require huge investments in all kinds of hardware, software and services in order to be computerized and networked. Provincial governments are another big market, as many of China's provinces are larger than most countries in the world. The consumer and small business markets are growing fast, but on a small base. Consumers must decide between PCs and other household goods such as refrigerators, air conditioners, VCRs and camcorders that most households still lack. But PCs have an appeal for their educational value, as Chinese families seek the best in education for what is often an only child. For small business owners, PCs can do double duty for work and education/entertainment. The consumer market is potentially large, but may be difficult to tap profitably. The problem for major vendors is developing the distribution channels to reach a diffuse market and providing training and support for both resellers and end users. Companies doing business in China have historically been blinded by the potential of its huge market, and failed to understand how few Chinese households really have the income for big ticket items. According to our own estimates, perhaps 1.5 million households have the income to afford a $2,000 PC, although lowering the price to under $1,000 raises the number to over 5 million. That explains the strategy of companies such as Acer, which is selling its low-cost AcerBasic PC in China, and the IBM/Great Wall joint venture, which is making the low-end PC100 in Shenzhen for sale in China. It also explains the large market share of local PC assemblers, whose prices are around $1,000. Companies also tend to underestimate the costs of doing business in China. As one analyst put it, you need to see China as ten markets, rather than one big market, and develop different strategies for each market that you decide to enter. It is even more important to do careful market analysis and target regional markets within China that have the necessary income, education and infrastructure. Fortunately, those three tend to go together, and are concentrated in the Beijing and Shanghai areas and in the southern coastal region. Networking and communications So far, computer networking and Internet use are not common in China, but there is great interest in the potential of computer networks for tying together a geographically dispersed population of 1.2 billion. There has been a lot of attention paid to the China Internet, a sort of nationwide intranet that is being developed with the idea of getting the benefits of the Internet but limiting interaction with the outside world. Software and services China's software market has been a bone of contention in U.S.-China disputes over intellectual property rights. A study conducted by International Planning and Research for the Software Publishers Association and the Business Software Alliance found that China has a 96% piracy rate, in spite of publicized government crackdowns on street-level dealers. This suggests that the market for legitimate software is limited, but there is still money to be made in software and services. Government agencies and enterprises have made some efforts to use legitimate software. For more sophisticated programs it is often worth the cost to be legal and get vendor support. At the consumer and small business level it is probably impossible to compete with CD-ROMs that offer dozens of programs for under $20. However, many vendors now bundle simple software and offer training and other services as part of the package in order to sell hardware. The increased availability of Chinese language applications has been a factor in increasing consumer PC sales. Some of the major software companies have begun to contract with Chinese companies for programming, including localization for the Chinese market. Many of the companies are set up by faculty at leading universities such as Beijing University, and hire students to do the work. Programmers are abundant and skilled in China, although few have any experience in project management or other higher level functions. A potentially lucrative market in China can be found in services. Systems integration, networking and custom software development markets are growing rapidly (albeit from a small base) as businesses and government agencies develop new information systems. There are large local service companies in the major cities, many of which are joint ventures between Hong Kong and Chinese companies. Foreign service providers find it difficult to succeed in China, as they lack knowledge of the local market. The only solution is to make a long-term commitment and train local people to develop needed skills. All service providers also face the problem that Chinese users do not like to pay for services, and feel they should be included in the price of the hardware.
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