Changes in Industrial Leadership and Catch-up by Latecomers:

the Catch-up Cycles

Franco Malerba

UNU-Merit Conference nov. 26-28 2014

MOBILE PHONES

2

7.1 9.7 10.5

12.6 12.7 11.8 13.4

16.3 19.5

17.6 17.7

22.0

35.0 35.1 34.7

30.7 32.5

34.8 37.8 38.6

36.4

28.9

23.8

19.1

2.9 5.0 7.5

0.0

5.0

10.0

15.0

20.0

25.0

30.0

35.0

40.0

45.0

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

(%)

Source: Gartner presentation

2

STEEL (1)

Sources: 1900-79 – Mitchell (1995, pp. 456-62, 1992, pp. 417-19); 1980-2010 – World Steel Association

0

20

40

60

80

100

120

140

160

1940 1950 1960 1970 1980 1990 2000 2010

Cru

de s

teel

pro

duct

ion

(mm

t)

US Ja…

Stage I II III IV

STEEL 2

0

5

10

15

20

25

30

35

40

45

1970 1980 1990 2000 2010

Cru

de s

teel

pro

duct

ion

(mm

t)

Nippon Steel (Japan) POSCO (Korea)

Stage I II III Sources: 1973-4, POSCO – Song (2002, p. 150); others – World Steel Association

In several sectors there have been successive catch-ups and changes in industry leadership..

And often companies come from the same country, supported by the same national innovation system

• Mobile phones: Motorola -> Nokia -> Samsung and Apple

• Steel: U.S. Japan Korea (partly) China

• Automobile: Germany U.S. Japan Korea partly China

• Shipbuilding: U.S. Britain Japan Korea partly China

• Semiconductor (memory chips): US-> Japan -> Korea

Franco Malerba

Joint work with Keun Lee

Three basic questions:

• Why do successive catch-up cycles occur?

• What are the factors that lead to successive changes in industry leadership in a sector ?

• Why are there differences across sectors?

Franco Malerba

Factors affecting catching up: emerging views

• Capabilities: Key role of domestic firms in catching up: learning, capabilities and strategies are fundamental for catch-up

L. Kim, K.Lee,

• National innovation systems: Importance of institutions and the relevance of national innovation systems for catch-up

C. Freeman; B.A. Lundvall; R.Nelson

• But major differences across sectors exist. Evidence from: -Sources of industrial leadership: Mowery and Nelson (1999); -Sectoral systems and economic development: Malerba and Nelson (2012)

Franco Malerba

Looking for explanations for successive catch-up cycles: our starting point

• For an explanation, we need a firm, a country and a sector view • and consider diverse factors

• A starting point is the concept of Sectoral Systems of Innovation

(Malerba, 2002), that highlights sectoral dimensions and sectoral differences, that has firms as central actors and in which country variables may affect the performance of firms in a specific sector Building blocks of sectoral systems: – Firms: learning, capabilities, strategies – Other actors: universities, research centers, users and consumers,

suppliers, financial organizations, government agencies… – Knowledge base and technologies – Institutions (public policy, IPRs, regulation…) – Systemic effects: interactions and interdependencies

Franco Malerba

Initial idea

• Leapfrogging and Window of Opportunity (Perez and Soete 1988) “Techno-economic paradigm changes can be windows of opportunity for late-comers. They may bypass the old paradigm and jump into the new paradigm and thereby leapfrog”

Three windows of opportunities at the sectoral level for catch-up

1) Radical change in the knowledge base and technologies a. New Techno-Economic Paradigms (Perez and Soete 1988) b. Generations of new technological trajectories, disruptive innovations Analogue Digital: Korean Digital TV (Lee, Lim and Song, 2005) 2) Changes in Demand a. Changes in demand conditions Emergence of Chinese market with specific demand b. Business Cycle Downturns

TFT-LCD Industry (Mathews, 2005) 3) Changes in government intervention/regulation

Examples: Indian pharmaceutical industry (Guennif and Ramani, 2010) - Telecom in China, India, Brazil and Korea (Lee, Mani and Mu, 2011)

Franco Malerba

Crystal cycles and Late Entries during Downturns

LCDs Market Growth, 1990 - 2003

0

1

2

3

4

5

6

719

90 Q

1Q

319

91 Q

1Q

319

92 Q

1Q

319

93 Q

1Q

319

94 Q

1Q

319

95 Q

1Q

319

96 Q

1Q

319

97 Q

1Q

319

98 Q

1Q

319

99 Q

1Q

320

00 Q

1Q

320

01 Q

1Q

320

02 Q

1Q

320

03 Q

1Q

3

US$

billi

on

-20

-10

0

10

20

30

40

50

60

70

80

%

Quarterly LCDs Revenue Quarterly Growth Rate (By Value)

Second dow nturn1995-96 Koreanfirms enter

First dow nturn1993-94 NewJapaneseentrants

Third dow nturn1997-98Taiw anesefirms enter

1997-98Asianfinancialcrisis

Fourth dow nturn2001 NewTaiw aneseentrants

Downturns in business cycles as windows of opportunity Mathews, 2005

Downturns provide a time for economic cleansing and entries • Set a brake on incumbents • Release of resources provides opportunity for challengers –

newcomers and latecomers • Technology Transfer and Knowledge Access become easier and

cheaper Provide opportunity for fast followers to create supply chain and to

move up in rankings Strategy for challengers – timing of entry, making use of released

resources and knowledge; Example: 2008/9 Global Crisis window for China

Windows are always doomed to open sooner or later… but firms and countries may or may not be able to catch them Windows are always doomed to open as new technologies may be introduced, demand may change and government may start playing a major active role in catching up Leadership change and success in catch-up depend on a combination of windows of opportunities with capabilities and strategies of incumbents firms and of catching up firms

Learning and Capabilities

For Catching up Firms: learning and capabilities are key drivers of catching up • This process is gradual and may take a long time • It is based on production and R&D investments and on human capital

investments • See the work of L. Kim (1997), K. Lee and others • Learning and the accumulation of capabilities by firms may be affected

by national factors (education, public policy of support, diffusion policies….)

For incumbent firms Winners’ curse/ trap (not necessarily mistakes): the leaders tend to be complacent and entrenched with current success. They do it also by an obvious choice, given the uncertainty of new technologies or new markets and given fixed investments whose life cycles have not finished yet

Franco Malerba

Lee and Lim (2001) Path of the Forerunner: stage A --> stage B --> stage C --> stage D

1. Path-Following Catch-up: stage A --> stage B --> stage C --> stage D

e.g. PC, some consumer goods, and machine tools industries in Korea

2. Stage-Skipping Catch-up: stage A -----------------> stage C --> stage D

e.g. Hyundai's fuel-injection engine development (cf. carburator engine)

Samsung’s 64K DRAM prod. technology; 256K DRAM design technology

3. Path-Creating Catch-up: stage A --> stage B --> stage C' --> stage D'

e.g. Korea’s CDMA and digital TV development

C and C‘ represent different or competing technologies

Also the strategies of catching up firms may prove quite important

Industry Catch-Up Cycles

In a sector: 3 possible Windows of Opportunity, 3 possible Strategies, 3 possible Cycles

In a sector, each cycle is that of a leading firm or a collection of firms in a nation. A new cycle replaces an old cycle

The empirical evidence of successive catch-up cycles

Successive catch up cycles have occurred in several sectors. 8 sectors have been examined by a group of researchers. In all the 8 cases examined, catching up firms have developed advanced capabilities through a continuous learning process and deployed successful strategies . In addition, windows of opportunities opened up and allowed a change in leadership.

Franco Malerba

• Mobile Phones (Claudio Giachetti and Gianluca Marchi) • Aircraft (Daniel Vertesy) • IT Services (Sunil Mani) • Cameras (Hank Kang and Jaeyong Song) • Semiconductors (Shin Jang-sup) • Steel (Jehoon Ki and Keun Lee) • Wine (Roberta Rabellotti and Andrea Morrison) • Games (Yuko Ahoyama and Hiro Izushi)

Successive changes in industrial leadership: the 8 sectors examined

• Steel industry: Keun Lee and Jeehoon Ki Technological windows (basic oxigen furnace and continuous casting) allowed a leadership change from US to Japan. A demand window (global steel industry downturn) plus a government window generated a leadership change from Japan to Korea • Camera industry: Jaeyong Song and Hoyseok Kang A technological window (rangefinder/portable camera) allowed a leadership change form Germany to Japan. A new technological window in terms of a radically new trajectory (compact system camera) generated a change from Japan to Korea • Semiconductors (memory chips) Shin Jang-sup In the various generations of DRAM chips, demand windows (business cycles) plus stage skipping strategies allowed a first leadership change from US to Japan, and then a second change from Japan to Korea

• IT services Sunil Mani, Aborted catch up from US to Ireland and then sustained catch-up from US/Ireland to India • Mobile phones Claudio Giachetti and Gianluca Marchi A technological window (digital phones/GSM) and a regulation window allowed the shift from US (Motorola) to Europe (Nokia). A new technolological window (smart phones) allowed the shift from Europe to US (Apple) and Korea (Samsung) • Regional jets Daniel Vertesy Government windows allowed a change in leadership from UK to Netherlands (Fokker), then to Canada (Bombardier) and then to Brazil (Embraer)

Franco Malerba

• Wine Roberta Rabellotti and Andrea Morrison Demand windows and technology windows allowed first the catching up of US and Australia and later on a coexistence of leadership of France and Italy • Games Yuko Ahoyama and Hiro Izushi A demand window (market crash) allowed a change in leadership from US to Japan (Nintendo and Sony). Later on a technology window (new ICT and software) and a demand window allowed a leadership change from Japan to US again

Franco Malerba

A first understanding of successive catch-ups

• Successive catch-up cycles are a combination of (a) windows of opportunities coupled with (b) domestic firms capabilities and strategies

• More than one window can be relevant for catching up in a specific stage.

• Entry by latecomers often takes the form of public-private partnership, SOEs or OEM/sub-contracting, often induced by public industrial policy

• Gradual catch-up is led by cost advantages, associated with lower wage costs and to the adoption of new capital equipment. It tends to be concentrated in low-end segments (path-following strategies)

• Rapid catch-up is triggered with a shift of technology and demand

conditions, combined with strategy of a path-creation or stage-skipping

Finding 1: Windows are different • Technology windows: Camera: Japan SLR camera replacing German RF; Cell phone: shift from analogue to digital (from Motorola to Nokia) Steel: innovations of BOF and CC: US -> Japan • Demand Windows India IT service: Y2K and dot.com boom Korean steel: downturns after oil shocks New World Wines: rise of new inexperienced consumers from the UK, the USA and the Scandinavian countries; then lately rise of Asian markets • Government Windows: Korean steel, Brazilian mid-size jets; Nokia (EU standard)

Finding 2 : Incumbent Traps are frequent Likelihood of leadership change increases when the technology windows are

combined with ‘incumbent/winner trap ‘ behavior In their early days, new technologies are often more costly, less productive, and less reliable. Thus, the incumbents who command the highest productivity from the existing technologies feel no reason to adopt new technologies. They are complacent with the current success and dominant technologies. It is not certain whether the choice by the incumbents is simply a mistake or an ex ante rational decision-making, given uncertainty of new technology or the new market, and given their fixed investments in technologies and products whose life cycle has not finished Examples: Motorola tried to improve further the existing analogue telecommunication technologies despite arrival of digital technologies. Steel: American steel firms did not adopt the BOF; because they constructed many mills with the old method and thus the useful economic life of them did not end yet when the BOF started to be put into commercial operation in the 1950s

Finding 3: Also upturn can be a windows? • Downturn = window for a stage-skipping entry with lower costs

• Upturn = window for a leapfrogging because of higher possibility of

incumbent lock-in (trap) with existing technologies (during upturn)

Then we may have a sequence of catch-up strategy a) path-following entry b) upgrading during downturn for up-to-date technology c) leapfrogging during upturn for emerging technologies

Finding 4: Sectoral Specificities of Windows and Leadership Dynamics

• Sectors differ in terms of the type of windows that most frequently open up and in the type of catch-up cycle.

1) In sectors with technology windows (semiconductors and mobile phones)

• high probability of radical replacement of incumbent by new entrants. 2) In other sectors (wine and auto) with demand windows. • new firms often co-exist with old incumbents rather than replace them

completely

Finding 5: Are windows endogenous ? • Windows may also endogenously created by actors

• the current leaders may try to innovate into the direction of competence-

enhancing way. -> If the leaders succeed, they are more likely to maintain their leadership in the next generations. -> persistence in leadership

• Ex 1) Samsung’s memory chip business: leader since the 1992; while industry

had several leadership changes before the rise of Samsung.

• Ex 2) Canon’s continued leadership in Camera

Finding 6: The Perverse Effects of Macro Conditions Longer term changes in macro-variables can be a factor for both rise and decline of a country.

1) Low wage rates in emerging countries = an initial window for ‘learning

by doing’ in FDI/OEM ; but wage rates tend to rise with a country success 2) Exchange rates: under-valued as subsidy to exports. • But values of currencies are expected to appreciate eventually if a

country succeeds in exporting and thereby records trade surpluses. • Ex: 1 Japanese Yen = 2.7 Korean Won in 1980; 5.8 Won in 1988; 7.4 Won in 1996; 10 Won in 2000.

History friendly modelling of catch up cycles

Joint work with Fabio Landini and Keun Lee

Franco Malerba

We have developed a history-friendly simulation model of catch-up, which is general enough to investigate the role of different windows of opportunities and of the speed and type of domestic firms learning From the history to the model to more general considerations Cases with two successive changes have been modelled. Mobile phones: from US to Europe to Korea and US Camera: from Germany to Japan to Korea

Simulating catch-up cycles by ‘history-friendly models’

2nd generation technology

3rd generation technology

1st generation technology

Franco Malerba

We have examined firms in two countres: a leader country and a follower country. Firms in both countries learn. Learning is cumulative and systemic, and affected by the national innovation system. Firms may sell in one country only or on both countries Three types of windows are examined: technology, demand and policy. Windows open at a certain time during the evolution of an industry

‘History-friendly’ calibration:

radical change in leadership after technology shocks Evolution of total market shares: -> Leadership changes

Experiment 1 – no Lock-in effects

-> reduce the intensity of lock-in (incumbent trap) effects

-> no leadership change: = Aborted catch-up (failure to catch-up)

Experiment 2: Smaller Size of the window • reduce the size of windows

-> no immediate leadership change but co-existence

Experiment 3 – Change the Shape of technology space

Increase the degree of linearity in the technology space (less radical innovation; examples in traditional sector (eg Wine; autos)

=> No radical market disruptions , and co-existence of firms

The main results of the HFM

• Windows of opportunities do affect catch-up. When they are absent or too small, catch up is very difficult to succeed

• In the case of a technology-based window, the size of the window matters in a non trivial way

• Learning is an important factor in catching up, particularly when new opportunities are created

• Catching up greatly benefits from the combination of different windows at the same time.

• Policy intervention is important in favoring the exploitation of technology-based and demand-based windows

Franco Malerba

Conclusions

We are confident that the empirical evidence and the appreciative theorizing proposed here centered on: (a) sectoral systems (b) windows of opportunities (c) firms capabilities and strategies will provide a useful inroad to a better understanding of the factors that affect not only catch-up in general, but also: • successive catch-up cycles in the same industry and • their differences across industries.

Franco Malerba

The two cases

Franco Malerba

Mobile phone industry:

Until the beginning of the 1990s Motorola (US) dominated the analog-based cell phone sector; with the emergence of digital technologies, Nokia (Finland) dethrones Motorola, which tended to stay along with analog technologies; In the smart phone Era, finally, Samsung (Korea) dethroned Nokia. Two shifts in the techno-economic paradigm, causes two waves of successive catch-up.

Camera industry:

Until 1959 German companies (Leica, Contax) dominated the rangefinder camera market; The emergence of analog and digital single lens camera led Japanese companies (Nikon, Canon) to take industrial leadership away from Germany; In the Era of compact system camera, finally, Korean companies (Olympus, Panasonic, Samsung Elec) are the new industry leaders. Once again, two technology shifts led to two leadership change….

Memory chip segment in semiconductors: similar case

Firm-level effects:

• Firms are born with a technology that allow them to search a restricted potion of the technology space; over time new technologies emerge and firms have the chance to adopt them;

• Firms have heterogeneous capabilities: Higher capabilities allow firms to look for better techniques and improve market share;

• Demand is vertically segmented: the higher the firm’s capabilities and technical merit, the higher the product quality, the higher the market share;

• Firms have a competitive advantage in serving their national market.

History-friendly Model

Country-level effects:

• System of innovation: the higher the average value of the technique in a country, the higher the probability that firms of that country find better techniques;

• Lock-in effect: the probability that a firms of a given country perceives a new technology decreases with the country’s market share using the old technology;

• Learning: firms improve their capabilities over time; the growth of a firm’s capabilities is faster the higher the average level of capabilities in the firm’s country

History-friendly Model

market of country A

market of country C

firms of country A

firms of country C

(innovation activities)

(market activities)

firms of country B

market of country B

r0 r1 r2 …

rJ

r3 r4 Technology space

Structure of the model:

History-friendly Model

The main results of the HFM

• Windows of opportunities do affect catch-up. When they are absent or too small, catch up is very difficult to succeed

• In the case of a technology-based window, the size of the window matters in a non trivial way

• Learning is an important factor in catching up, particularly when new opportunities are created

• Catching up greatly benefits from the combination of different windows at the same time.

• Policy intervention is important in favoring the exploitation of technology-based and demand-based windows

Franco Malerba