The pace of innovation in Asia ex-Japan's technology industry has kept it a volatile but exciting sector for portfolio managers. But fund managers can't just look at the pure technology these companies generate, says Guan Shao-ping, senior investment manager at Credit Agricole Asset Management in Hong Kong. Increasingly important to the investment decision is the tech company's business model - its mindset, really - and how it fits into the emerging trend of brand names and industry leaders coming from Asia. And the biggest question is what kind of models Chinese tech companies will adopt.
Markets such as Korea, Taiwan and India have seen global brands evolve in the likes of Samsung (for memory, display, sets, digital consumption), LG (handsets), TSMC or UMC (foundries), Acer (PCs), Infosys and Wipro (IT services), plus a complex supply chain throughout East Asia. These companies have mastered the core technology, manufacturing and distribution. Only the best can take the industry to the next level, however, by focusing on areas like intellectual property or IT consulting, Guan says.
While identifying companies with standout technology has become straightforward, fingering those with the right business model is more challenging. "The test is how a company performs in all business cycles, not just on a boom-bust level," Guan says. "Leaders need to become an organized cluster with comparative advantages." National industrial policies and the formulation of industry standards play an important role in shaping these models.
For such clusters to be sustained, the flagship companies have to gather enough momentum to allow the whole fabric of companies to cruise ahead, Guan says, a task that includes identifying key markets, good execution, and enough luck and pluck to build a strong capital base so they can reinvest in technologies and upgrade the cluster without relying on capital markets.
Asia has seen two distinct business models emerge. The Korean version has, since the Asian financial crisis, improved on the Japanese concept of vertical integration and own-brand manufacturing, while Taiwan's version emphasises outsourcing, specialisation and integration among like companies.
Guan says the Korean version is stronger, with Samsung the uber-tech company that drives suppliers' technology, wins priority in terms of supplier flexibility and access to product as well as advantageous timing to the market. "Samsung is the sector," Guan says.
In contrast, TSMC, Taiwan's flagship company, has no advantage versus its competitors in either sourcing equipment or materials from suppliers, and it sells to the same customers like IBM or Motorola on an equal basis to, say, UMC. This model allows for one foundry's developments and relationships to quickly spread, so there is no cycle in which a competitive advantage is sustainable.
Guan believes this model, although it has clearly been successful, is beginning to suffer from excess competition and the loss of pricing power; nor does consolidation seem likely. "The clear path of the Samsung cluster's sustainable development is notably absent in all Taiwan clusters' prospects," he says.
That means investors in Taiwan companies must be equally nimble and short-term in their outlook, endlessly searching for the next component maker serving the Greater China supply chain. Taiwan investments are subject to cycles and seasons. Only in Korea can investors take a secular bet, Guan argues.
Entering this picture is China. Will it follow Taiwan's small scale, specialized model? Or Korea's mid-sized, vertically integrated style? Or will it look beyond, to an American or Japanese model based on huge national companies that aggregate efficiency, marketing and brand power, and massive supply chains?
Guan reckons China will be a mix. "From a top-down perspective, China can only, at the end of the day, follow the US model," he says. "Protection won't work given its huge market size without damaging other parts of the economy." Moreover, China is attracted to the key advantage of US companies, their ability to throw their weight around to formulate global standards. On the other hand, both American and Japanese companies have a history of pitfalls - take Japan's failure in the 1990s to create a standard in high-definition TV. Can China really develop the standard for a technology or application?
For example, China's now trying to create standards in areas like WiFi, 'enhanced versatile discs' and 3G telecoms.
These attempts remain on the fringe of the global standards game, Guan says, and he says China is bound to make a lot of costly mistakes. But this is a risk inherent in this business model, and China's business community is aware of it. "They will still do it, as the alternative - passivity - is even more unacceptable from their national interest point of view, because the market is so big," Guan reckons.
For now, China lacks the intellectual depth or market reach to forge a global standard. In the meantime, it is looking to Taiwan's outsourcing model to build a domestic supply chain. Indeed, Taiwanese managers, which have always thrived in environments lacking respect for intellectual property, are running most of the mainland's suppliers.
But lousy IP protection and the Taiwanese model are deterrents to China's adopting a US-style model. Chinese firms must learn to build brand equity and formulate industry standards, Guan says, so he expects China to develop a US-Taiwan hybrid.
As a portfolio manager, he is looking for niche component suppliers in Taiwan and Korea with decent entry barriers that can leverage onto the deepening tech infrastructure in Greater China; and for Korea's consumer brand leaders.
"China is moving up the value chain and becoming a force in tech, but this progress depends on access to capital," Guan says. "Technology is a global industry. China's growth is driven by its export trade sectors, whose companies are less constrained by China's political legacy. These companies need an international standard of execution, and the government has enacted export-friendly policies. China can't afford to lose out as it merges into the international economy. So there won't be any conflict between politics and the tech sector. The lack of respect for property rights, however, is a fundamental problem for intellectual property. It's a matter of when, not if, for China to address these IP issues, if it is to protect the development of its long-term technology."
