Tech Floods Into Malaysia Safe From Natural Disasters, Island of Penang Attracts Manufacturers By JAMES HOOKWAY

PENANG, Malaysia—At first glance, this lush island looks like any other Southeast Asian vacation spot. Visitors flying in catch sight of sandy atolls before skimming past palm-shaded beaches and fishing boats bobbing in turquoise waters.

Last year's natural disasters in Japan and Thailand caused a global breakdown in the technology supply chain. This has many companies looking elsewhere to manufacture everything from car parts to hard-disk drives. The WSJ's Patrick Barta explains. Then Penang's true nature reveals itself. Hangar after hangar at the bustling airport is decked out in the liveries of shipping companies DHL International GmbH, United Parcel Service Inc. UPS and FedEx Corp., each dedicated to flying out boxes of LED displays, chip sets and other sophisticated electronics. Following last year's earthquake in Japan and floods in Thailand, global manufacturers are looking to Penang and elsewhere to broaden their supply chains for everything from car parts to semiconductors to hard-disk drives. The expansion is creating a growth spurt in countries that already were seeing investment climb as China's labor market overheats, putting this tropical state and places like it on the global investment map. Penang's leader, Chief Minister Lim Guan Eng, is banking on another bumper year for investment in 2012 after taking steps to eliminate red tape—for example, pushing the construction of new industrial parks to make it easier for companies to expand here. "We had fallen off the radar screen, so we went back to the drawing board," says Mr. Lim. "It just takes a little time to shake off the rust."

James Hookway/The Wall Street Journal A street in Georgetown on Penang, which expects another big year. Last year was a watershed for companies operating global supply chains. At the height of the disasters in Japan and Thailand, companies relying on the kind of just-in-time supply chains pioneered by Toyota Motor Cowere left scrambling for alternative suppliers. The hardware industry was hit especially hard by the months of flooding in Thailand, with disk-drive maker Western Digital Inc. and electronics companies Sony Corp. and Toshiba Corp. among those forced to temporarily shut down plants there. At one point, global prices for disk drives doubled before Western Digital and other manufacturers began boosting production in Malaysia in the immediate aftermath of the floods. Now the California company is expanding across Malaysia in a five-year, $1.2 billion effort to whittle down its dependence on Thailand. A new Malaysian plant is expected to open this year. Chip maker Intel Corp., audio company Bose Corp. and electronic-equipment makers National Instruments Corp. and Agilent Technologies Inc. are among those that have also begun expanding operations here. "Longer term, many multinational companies are preparing better for natural disasters and supply-chain disruptions, and they now see Penang and Malaysia as an attractive location," said Heng Huck Lee, managing director at local contract manufacturer Globetronics Technology Bhd. Investing here does carry some risk. Malaysia is entering a period of political turbulence in which the long-ruling National Front faces stiffer competition from an opposition alliance. That means state governments run by opposition paries, such as in Penang, could face policy conflicts with Kuala Lumpur. But those tensions are relatively minor compared with those of some of Malaysia's neighbors. The country sits safely away from the so-called Pacific Ring of Fire, mostly unaffected by the earthquakes and volcanoes that can afflict countries such as Japan and Indonesia. Malaysia also is less likely to fall victim to the kind of flooding that left Thailand's economy flailing last year.

Also helping Penang's appeal are an international air hub and strong logistics infrastructure, including inexpensive and reliable supplies of electricity and pristine water. The move to spread risk isn't necessarily requiring more money given the speed at which wages are rising in production hubs such as China and Thailand, where sharply higher minimum wages were introduced in April. And expanding into countries with lower taxes and logistics costs could actually reduce a manufacturer's spending, said Stan Aronow, a research director at technology consulting firm Gartner group. The cost for the manufacturers' customers: "Not much, if at all," he said. In Malaysia, foreign direct investment reached 7.5 billion ringgit ($2.37 billion) in the first quarter, up 15% from a year earlier. Many of the inflows were generated by Penang, an old haunt for pirates that has seen an investment boom in recent years. The state's inflows hit a record 12.2 billion ringgit in 2010 after a prolonged slump and reached 9.1 billion ringgit last year, even as Mr. Lin tried to contain the inward rush of money to prevent the economy from overheating. Investment and manufacturing are surging in the Philippines, too, as companies spread their risk. The economy there grew at a 6.4% annual rate in the first quarter—the fastest pace in years. Some companies have been operating in Penang for years. Intel co-founder Andy Grove came to Penang to build a factory in the 1970s and was followed by a host of Japanese and Western investors. Penang later lost some of its swagger as global tech companies planted stakes in less-expensive China. But as wage inflation approaches 20% a year on China's industrial seaboard, Penang's old guard is ramping up production. For example, Intel of Santa Clara, Calif., is expanding operations by scaling up a large research and development hub, which now employs more than 2,000 engineers, some of whom are the children of Intel employees hired in the 1970s and '80s. Thousands more are employed in Intel's test and assembly plants. The world's biggest chip maker has invested more than $4 billion in Malaysia over the years. "We've always had a view on how to make sure we have diverse locations," says Intel's Southeast Asia director, Uday Marty. This is partly to ensure that the chip maker's plants are close to customers and to let Intel tap engineering talent around the globe. "You also want to safeguard against things such as natural disasters," Mr. Marty said. Write to James Hookway at james.hookway@wsj.com A version of this article appeared July 19, 2012, on page B4 in the U.S. edition of The Wall Street Journal, with the headline: Tech Floods Into Malaysia.