Saturday, February 13, 2010

Paper on Parade: Technological innovations and industry clustering in the bicycle industry in Taiwan

My Taiwan-made Giant bike (blue), and Drew's Salsa La Cruz (orange), a bike sold as a US brand but whose frame and many other components are made in Taiwan, resting in Changhua as Drew and I wait out a rain squall.

This installment of our periodic blog feature, Paper on Parade, looks at Technological innovations and industry clustering in the bicycle industry in Taiwan (Technology in Society 31 (2009) 207–217)(LINK) by Chen, Lin, Chang, and Liu, originally published in one of my favorite journals, Technology and Society. As an avid biker, I found this paper particularly interesting.

This paper explores the interplay of two forces, technological innovation, and industry clustering, in the bike industry in Taiwan. The latter idea, clustering, is an old one in sociological and economic studies of industry and was first proposed by the immortal English economist Alfred Marshall in the early 20th century. Marshall noticed that in England and elsewhere, certain industries were associated with certain locales. Individuals in these areas grew up with the industries norms and practices "in the air". An important aspect of these industrial districts was that the relations between the firms were governed by social norms and networks that enabled firms to source information, capital, labor, and technology.

This idea basically lay dormant until the 1970s when a group of Italian scholars revived it to learn about how Italy worked. In Italy, as in modern Taiwan, industries -- many of them the same industries as in Taiwan -- occur in clusters, such as the machinery cluster around Bologna or the furniture industry cluster that occupies an arc around the city of Venice.

Such clusters typically occur in industries marked by rapid product and technological change, often seasonal, such as textiles or computer parts. The firms in them are small and highly specialized, performing only the manufacture of one part, or one step in the product manufacturing process. Typically the industry is export-oriented. Clustering has been demonstrated repeatedly to have all sorts of positive effects, speeding technology development and dissemination, lowering search and information costs, and so on.

Taiwan abounds in such clusters. In the north there is the massive computer industry cluster. In Taichung there is a sporting goods cluster. In San Chung outside Taipei there is a cluster of mold and die and machine tool firms. Central Taiwan is also home to Giant, the largest bike maker on earth, and the subject of this paper: Taiwan's bike and bike component makers. Chen et al begin with a description of the current situation:
Until China’s recent emergence as an economic power, Taiwan was the world’s leading bicycle manufacturing country. Most people assumed that large orders by original equipment manufacturers (OEMs) helped Taiwan attain this position, but they did not realize that considerable technological innovation has enabled Taiwan to attract foreign customers who place orders with Taiwanese bicycle companies. Ongoing technological innovations by those bicycle manufacturers and component manufacturers have never stopped, and R&D expenditures have remained constant at about 2% to 5% of sales.

While most OEM orders were transferred to bicycle manufacturers in China, Taiwan’s bicycle manufacturers and bicycle component manufacturers took advantage of their technical expertise and manufacturing technology to build their own brands. For example, Maxxis is the largest bicycle tire manufacturer in the world; the roller chain made by KMC accounts for 70% of world market share; bicycles made by FSA are highly favored in Europe; and the bicycle brakes made by PROMAX, particularly its mechanical disc brakes, account for 90% of world market share.
Chen et al divide the industry's history into six stages: Assembly (1946–1951), Import substitution and stagnation (1952–1968), Export-oriented production (1969–1974), Growth (1975–1986), Upgraded manufacturing (1987–1991), and Globalization stage (1992 to present). The war boosted local makers by removing Japanese competition, but makers copied Japanese parts. After the KMT instituted an import substitution policy in the early 1950s (under which imports were restricted and things were either made in Taiwan or not purchased), only 12 bike components could be imported. Local brands received government support, but counterfeiting was rife and people bought scooters instead. The energy crisis of the early 1970s drove US purchases of Taiwan bikes, rising from just 100,000 units in 1970 to 1 million units by 1972. Unfortunately many were low quality and Taiwan's image suffered. By 1986 Taiwan had passed Japan to become the number 2 maker of bikes, with a capacity of 10 million annually.

Moving off of Chen et al for a moment, the energy crisis, by dramatically increasing the popularity of bikes in the wealthy US, drove the development of bikes as a high differentiated consumer product and keyed the rise of Taiwan bike makers, led by Giant. During the 1960s Schwinn was the market and technology leader in the US. However, as bicycling rose in popularity in the 1970s due to the OPEC oil price shocks, bicycles themselves became more of a popular and highly differentiated consumer product, with consumer market trends driven by high-end machines. New models were introduced at higher rates, with shorter lead times and production cycles. To combat rising production costs, Schwinn shifted its production to Taiwan. Upham (2006) observed:
But to produce bikes in Taiwan, Schwinn had first to teach the Taiwanese how to produce such high quality bikes. Therefore, in 1981 it shipped its best engineers and its most sophisticated machinery to Taiwan and began training the workers at Giant plants in the art of making fine bicycles (which involved the use of both machine and hand labor).(p54)
Within a few years Giant was shipping Schwinn models to the US under a generic brand name, selling them for 15% less than Schwinn. By offshoring production, Schwinn’s design engineers lost the technological abilities they needed to stay competitive in a market where minor design modifications, often made on the shop floor, created market leverage in a market where demanding high-end consumers determined what was hip and what was square. By contrast, Taiwan, through Giant's vast network of suppliers in central Taiwan, acquired these abilities, and the potential to dominate what was then the world's largest bike consumer market.

Turning back to Chen et al, after 1987 pressure from other low-cost producers forced Taiwan into an upgrade-or-die position, so the government took the lead in upgrading the industry. This enabled Taiwan to move into its present dominant position in high end bicycles. Chen et al observe:
Table 2 shows the growth of exports in Taiwan’s bicycle industry from 1993 to 2006. In 1996, exports reached a peak of some 9.5 million bicycles, but by 2006 this number had decreased to 4.31 million. The average price per exported bicycle rose from $103 in 1993 to $200 in 2006, owing to the fact that Taiwanese bicycle manufacturers changed their business models to fit today’s dynamic environment, and are now exporting their high-price and high-quality bicycles to the market [2]. The result is that Taiwanese bicycle companies have moved to the top position. Moreover, they have moved away from the role of OEMs, instead becoming original design manufacturers (ODM) or original brand manufacturers (OBM), thereby striving to be specialized value-added bicycle manufacturers.
They also summarize the effect of government programs on technology acquisition:
Beginning in late 1984, the Industrial Technology Research Institute of Taiwan (ITRIT) was charged with implementing the Carbon–Fiber Bicycle Development Project, funded by the Taiwanese government. Initially, many Taiwanese bicycle companies participated in this R&D project but they later withdrew for financial reasons. However, GIANT continued to participate, thus reaping substantial benefits. It was a great opportunity for GIANT to upgrade its technological capabilities, but it was not easy to manufacture the carbon–fiber bicycle frame. Although GIANT continued to lead the Taiwanese bicycle industry, any failure that might result in a loss of its huge R&D investment would be devastating. However, in 1988 the first carbon–fiber bicycle was successfully developed, manufactured, and sold by GIANT, and by 1993 its annual production capacity had reached 100,000 bicycles. Later, the Materials Research Laboratories (MRL) and ITRIT transferred the technology for manufacturing carbon–fiber bicycle frames to other Taiwanese bicycle manufacturers. It is clear that the Taiwanese bicycle manufacturers relied on the Taiwanese government and semiofficial institutions before they accumulated enough resources to engage in R&D projects on their own [5].

As GIANT began to mass-produce carbon–fiber bicycles (before that, only some Italian and French bicycle manufacturers produced handmade carbon–fiber bicycles), Merida took the lead in developing the first aluminum alloy sport bicycle in 1993. Moreover, in 2002 Taiwan Hodaka applied a new magnesium alloy (also used in missiles) to develop advanced bicycle frames. Taiwanese bicycle manufacturers went to great effort to upgrade their capabilities, but that investment enabled them to obtain international competitive advantage and to succeed in the world markets.
The government's role in providing R&D and technology guidance to the local industry extended beyond helping it develop frame building technology. Chen et al describe the development of modular parts, a key to constructing modern bikes, as driven by government programs:
Taiwanese bicycle and bicycle components manufacturers modularize their bicycle components to improve quality control of their products. Modularization means integrating several related components into one unit or system. The best example is the integrated bicycle hub created by the R&D Center of Taiwan’s bicycle industryda front fork, disc brake, and V-brake as one oil pressure disc braked creating the world’s first modular bicycle unit. In today’s uncertain and complex business environment, modularization of components is essential for managing the growing complexities associated with product varieties, costs, time, and quality.
The government then helped local suppliers modularize and standardize their componentry, lowering manufacturing costs, and enabling makers to acquire more advanced technology skills. Not only does the government have a system of labs supporting the industry, there are also a semi-official labs under the aegis of the industry that receive government funding and to which the government often hands off projects.

The fact that the industry is clustered enables many positive effects. Chen et al note:
The center-satellite plant systems are located primarily in the middle part of Taiwan, including GIANT (mainly in Taichung County) and Merida (mainly in Changhwa County). These manufacturers integrated the needed component manufacturers to form their own center-satellite plant systems. For example, GIANT put together the largest center-satellite plant system by combining a total of 21 component manufacturers. With such close integration of center factories and satellite factories, these manufacturers are able to shorten their operations processes, decrease transaction costs, increase competitive advantage, and upgrade the R&D capabilities of the entire Taiwanese bicycle industry [37].
The networks that tie together the small supplier firms with the large central factories enable the transmission of technologies and information that keeps everyone up to date, with lower costs and at greater speed. The preference of Taiwanese for such clusters is a strong factor in their dominance of so many industries with product characteristics similar to those of bikes. These cluster effects also spillover to firms not in the central factory's production network, since they too can take advantage of the techology, labor, and information available to Giant. For example, the small town of Dajia, home to Giant, is also home to OEM frame makers like Maxway, which makes frames for well-known brands like Jamis, Salsa, and Surly, and boutique makers like Rikulau that specialize in steel and titanium frames.

What does the future hold? Obviously there is nothing happening in this industry here in Taiwan that China or some other low-cost producer cannot replicate. Taiwan has already destroyed many European and American makers; a friend of mine told me that he visited a local factory recently and was told he could photograph production here but not there, since in that part of the factory, the company is making bikes for European brands that do not want their customers to know the frames are made in Taiwan. Giant has already offshored low-end production to China -- a devastating blow to central Taiwan's suppliers -- and as China climbs up the technological ladder, it seems likely more will follow. How long can Taiwan's dominance last?

Nevertheless, we are living in a Golden Age of Bikes here in Taiwan, and I for one propose to get my money's worth! Hope to see you on a bike soon!

Upham, S. P, 2006, Innovation and the Interrelatedness of Core Competencies: How Taiwan’s Giant Bicycles broke into the US Bicycle Market. Managing Global Transitions 4(1): 41-62


P. S. said...

Enjoyed the summary. It has occurred to me that the need for constant, incremental evolution in bicycle design seems well-suited to the personality of Taiwanese, who are eternally flexible and curious. I wonder if that has been a factor in their success.

I was also interested to learn that ITRIT funded carbon frame development. The technology is not easy. I know a very senior technical guy at Boeing who advised the leaders that they were taking the wrong approach to the 787 wing-body design. He (an avid cyclist) pointed out that the bicycle makers were way ahead of Boeing in certain analysis techniques, and recommended that Boeing talk to them to get some insight. Boeing did not, and the very problem that this guy foresaw happening, did happen, and Boeing lost a year and $3 billion while redesigning the 787.

Stefan said...

Well the problems of Taiwan today, are the problems of China tomorrow.

Taiwan has already walked the path which China wants to pursue now. Producing cheaply (with low labor costs, and significant damage to the environment) and copying proven designs. Once they've reached the point where they become the technological leaders, the path forward is no longer clear. You don't know in advance if costly R&D (like carbon fibre) will pay off, your expenditure in developing new products becomes significant and harder to calculate at the same time, rising living standards eliminate the labor cost advantage. As a result growth goes down, unemployment goes up.

It's not clear how to move forward from there - other technology leaders like Japan, Germany or the US have not developed a clear answer either. They might console themselves with the thought, that the best any competitor can hope for, is to reach the same position sooner or later.

Michael Turton said...

PS and Stefan, excellent comments.

Karl said...

"rain squall" is redundant. You should just say "squall".

Anonymous said...

I think there is a very interesting observation to be made regarding Taiwanese and Chinese industrial culture. China's is based on the Soviet model, while Taiwan's is a Japanese model. The result is omnipresent in the quality of the products.

Anonymous said...

ITRI is so huge, but it's really borderline commercial in that it brings in so much revenue each year. Too bad the major campus is in Hsinchu. The southern extension in Tainan I bet is a lot more fun.

Anonymous said...

Back in the 70's, another organization "Metal Industries Research & Development Centre" also did research in hand brazed frames which was required to build high quality thin walled tubing frames at that time. KHS sent a team to Japan for special training, some of the team ended up working WheelKing, the maker of my first Reynolds 531 frame. My second frame (which is also my current frame) was hand brazed at KHS using a Japanese made CroMoly tubing.

Those were the days when I was the main person writing bicycle articles in Taiwan.

KHS chairman (now over 100 whom was still living the last time I met with his son) was the head of the Bicycling Association at that time and hosted some international events, two of which I provided support in.


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