COMMENTARY | COLUMNISTS | PHIL BAKER

Made in the USA?

As President Bush gave a speech last month on the shipping docks of a U.S. manufacturing firm, championing U.S. labor, he was surrounded by a backdrop of boxes, whose labels boldly stated "Made In USA." However, on closer examination, the labels were actually covering print on the boxes reading "Made In China."

While the discovery was embarrassing to the White House, it is just the continuation of a 20-year trend of manufacturing migrating from the United States to China. No business has felt the impact of this manufacturing migration in recent years more than the computer hardware industry. But even with manufacturing moving off shore, American companies were consoled by the fact that they were still the brains behind the designs of these products, if no longer the muscle in building these products. However, product design and engineering are now moving overseas as well, impacting America's leadership of innovation in this industry.

It is easy to understand why products with high labor content costs, such as clothing, leather goods and sneakers, have been moving to manufacturing localities in China, Indonesia, Hong Kong and Vietnam. With labor rates that rarely reach higher than $1 an hour, these products can retail for less than half the cost if made domestically.

In the case of most of today's electronic products, including notebook computers, mobile phones, PDAs and MP3 players, labor component costs are only about 5 percent of the total cost of the product, the rest being primarily material costs. Cheap labor is no longer the major inducement in attracting the high-technology industry to build products in the Far East. Taiwan, and more recently China, have developed expertise in engineering that is equal to or surpasses that found in the United States. They are able to bring products quickly from concept to production, they have intimate knowledge of manufacturing, strong technical savvy, a strong work ethic and they focus on customer service. These factors are the reasons that Chinese companies are chipping away at the United States and other industrial countries' competitive advantages, even when labor costs are no longer an issue.

How did all of this happen? The technological revolution going on in China is directly tied to the success of Taiwan. The founders of the major Taiwanese electronic manufacturers, such as Quanta and Inventec, began their life as manufacturers in the 1980s, competing strictly on price, bidding to build pocket calculators and other consumer electronic products, where labor costs would be low and volume high. These companies did not have a large market for their goods in Taiwan nor were they effective in marketing their products directly to the U.S. consumer. Therefore, they developed their OEM and, more recently, ODM business models, which flourish today. (OEM stands for Original Equipment Manufacturer -- making a product to their customers' specs, and ODM stands for Original Design Manufacturer -- making a product of their own design for their customers to sell.) The nature of their business was to focus on their manufacturing efficiencies and to provide top service to their customers. They did what they did best, manufacture the products, and relied on their worldwide marketing partners to do what they did best, sell the products.

As the computer industry developed and the demand for notebooks increased, these companies took on laptop manufacturing. With their economies of scale, strong infrastructure and talented work force, Taiwan became the world's leading manufacturer of notebooks. But manufacturing strength alone would not ensure Taiwan's long-term success. Products would eventually move to countries with even lower labor costs. The government initiated a program to strengthen the domestic computer industry by targeting and funding strategic product areas for development, establishing industry, trade and technology organizations, and funding strategic projects. These companies began to take on the design and engineering of their products, as well. In addition, companies chose to take a long-range approach and were not focused on quarterly results. They would make investments of costly equipment without an immediate payback. They took on projects that would likely lose money, but would give them the opportunity to gain experience, particularly in product design, and attract new business.

As a result, these companies are now able to design many of the notebooks they manufacture, including many of the components that go into them. U.S. companies that affix their logos often never touch their products. A customer orders a Dell, HP or other name brand laptop, the order is electronically sent directly to the factory in Taiwan or China, is built to order, and is sent directly to the customer by FedEx a few days later.

The Taiwan manufacturers are now moving this model to China, but on a more massive scale, particularly in Shanghai where there are a great number of technology graduates, a newly created modern infrastructure of highways, buildings, facilities and housing, and the same strong entrepreneurial attitude. "Mega Parks" are being created where in one location are all the subcontractors, including the molders, suppliers of packaging and components, everything that is needed to build a computer. Each company has set up design centers staffed with thousands of hardware and software engineers.

Because these companies are making similar products for many companies, they have been able to develop enormous economies of scale and have been able to design and build products at lower cost and with greater reliability than anyone else, and at the same time bring new designs to market in less than six months. In January alone, Quanta Computer manufactured 700,000 notebook computers. Their customers include Apple (Nasdaq: APPL), Dell (Nasdaq: DELL), Gateway (NYSE: GTW), HP (NYSE: HPQ) and others. Over 70 percent of the world's notebooks are made by the top half dozen Taiwan companies, an increasing number in their China factories. Quanta, Inventec and others are even designing and manufacturing laptops for most of the Japanese companies, including Toshiba (PNK: TOSBF), Sharp (PNK: SHCAF), NEC (Nasdaq: NPNY) and Sony (NYSE: SNE).

There is now little need for U.S. companies to rely on their own engineering to design and build their products. HP's "Invent" moniker has little meaning when it comes to computers. They, like most of these other computer companies, are providing the marketing and distribution for products engineered and built by others.

Where does this leave the U.S. computer industry? How do we stay competitive in a world that is becoming "commoditized" both in manufacturing and in intellectual capital? We don't. Without having had a national policy to shore up our technology capabilities over the past two decades, and Wall Street's short-term focus on IPOs and quarterly returns, we have lost our ability to compete in this industry. This means better and less expensive products for you and me, but like so many other products, the computer, invented in the United States, will be engineered and manufactured elsewhere. This is certainly an economic loss, but it is having positive political ramifications by helping to form closer connections between China and the western world, and between China and Taiwan.


Baker is San Diego's Ernst & Young Consumer Products Entrepreneur of the Year in 2000 for successfully bringing to market Think Outside's folding keyboard for the Palm and other PDAs. He also has developed and marketed consumer and computer products for Polaroid, Apple, Seiko and others. He is the holder of 30 patents. He can be reached at phil.baker@sddt.com.

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