ED 251 301 TITLE INSTITUTION SPONS AGENCY REPORT NO PUB DATE GRANT NOTE AVAILABLE FROM PUB TYPE EDRS PRICE DESCRIPTORS IDENTIFIERS ABSTRACT DOCUMENT RESUME SE 045 251 The Competitive Status of the U.S. Electronics Industry. National Academy of Engineering, Washington, DC. Committee on n' -hnology and International Economic and Trade Iss, .; National Academy of Sciences - National Researuas Council, Washington, DC. Commission on Engineering rnd Technical Systems. National Academy Jf Sciences, Washington, D.C.; National Science Foundation, Washington, D.C. ISBN-0-309-03397-7 84 79-02702 143p. Nitional Academy-Press, 2101 Constitution Avenue, N.W., Washington, DC 20418 ($10.95). Reports - Research/Technical (143) MF01 Plus Ppstage. PC Not Available from EDRS. *Competition; Electronic Equipment; *Electronics; Financ %1 Support; Human Resources; *Industry; Influences; *International Trade; Policy; *Semiconductor Devices; Technology; *Telecommunications *Computer Industry; Industilal Development; Japan This eight-chapter report is one of seven industry-specific studies conducted to identify global shifts of industrial technological capacity on a sector-by-sector basis, to relate those shifts in international competitive industrial advantage to technological and other factors, and to assess future prospects for further technological change and industrial development. The methodology of the studies included a series of pUnel meetings involving discussions between experts, resource personnel, and government agency and congreszional representatives. Chapters 1, 2, and 3 examine, respectively, the chalien§e to United States' leadership in electronics, financial and human resource constraints, and barriers to international trade. Chapters 3 to 7 focus respectively on: the semiconductor industry (considering its size, structure, and international position, the semiconductor manufacturing process, and bases for competition); the computer industry (considering its size, structure, and international position, its changing economics, and bases for competition); the telecommunications industry (considering its size, structure, and international position, developments in transmission technology, and bases for competition); and the consumer electronics industry (examining its size and international position and the factors of Japanese success in the industry). Chapter 8 considers research, capital formation, human resource, and international trade policy options for the U.S. electronics industry. (JN)
Transcript
ED 251 301
TITLE
INSTITUTION
SPONS AGENCY
REPORT NOPUB DATEGRANTNOTEAVAILABLE FROM
PUB TYPE
EDRS PRICEDESCRIPTORS
IDENTIFIERS
ABSTRACT
DOCUMENT RESUME
SE 045 251
The Competitive Status of the U.S. ElectronicsIndustry.National Academy of Engineering, Washington, DC.Committee on n' -hnology and International Economicand Trade Iss, .; National Academy of Sciences -National Researuas Council, Washington, DC. Commissionon Engineering rnd Technical Systems.National Academy Jf Sciences, Washington, D.C.;National Science Foundation, Washington, D.C.ISBN-0-309-03397-78479-02702143p.Nitional Academy-Press, 2101 Constitution Avenue,N.W., Washington, DC 20418 ($10.95).Reports - Research/Technical (143)
MF01 Plus Ppstage. PC Not Available from EDRS.*Competition; Electronic Equipment; *Electronics;Financ %1 Support; Human Resources; *Industry;Influences; *International Trade; Policy;*Semiconductor Devices; Technology;*Telecommunications*Computer Industry; Industilal Development; Japan
This eight-chapter report is one of sevenindustry-specific studies conducted to identify global shifts ofindustrial technological capacity on a sector-by-sector basis, torelate those shifts in international competitive industrial advantageto technological and other factors, and to assess future prospectsfor further technological change and industrial development. Themethodology of the studies included a series of pUnel meetingsinvolving discussions between experts, resource personnel, andgovernment agency and congreszional representatives. Chapters 1, 2,
and 3 examine, respectively, the chalien§e to United States'leadership in electronics, financial and human resource constraints,and barriers to international trade. Chapters 3 to 7 focusrespectively on: the semiconductor industry (considering its size,structure, and international position, the semiconductormanufacturing process, and bases for competition); the computerindustry (considering its size, structure, and internationalposition, its changing economics, and bases for competition); thetelecommunications industry (considering its size, structure, andinternational position, developments in transmission technology, andbases for competition); and the consumer electronics industry(examining its size and international position and the factors ofJapanese success in the industry). Chapter 8 considers research,capital formation, human resource, and international trade policyoptions for the U.S. electronics industry. (JN)
The Competitive Statusof the
U.S. ElectronicsIndustry
A Study of the Influencesof Technology in Determining
International IndustrialCompetitive Advantage
Prepared by tte Electronics Panel,Committee on Technology and
International Economic and Trade Issues
of the Office of the Foreign SecretaryNational Academy of Engineering
and the Commission on Engineering andTechnical Systems, National
Research Council
John G. Linvill, ChairmanAnnette M. La Mond and
Robert W. Wilson, Rapporteurs
NATIONAL ACADEMY PRESSWashrngton, D. C. 1984
3
National Academy Press 2101 Constitution Avenue, N.W. Washington, D.C. 20418
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NOTICE: The project that is the subject of this report wasapproved by the Governing Board of the National ResearchCouncil, whose members are drawn from the Councils of theNational Academy of Sciences, the National Academy ofEngineering, and the Institute of Medicine. The members of thecommittee responsible for the report were chosen for theirspecial competences and with regard for appropriate balance.
This report has been reviewed by a group other than theauthors according to procedures approved by a Report ReviewCommittee consisting of members of the National Academy ofSciences, the National Academy of Engineering, and the Instituteof Medicine.
The National Research Council was established by theNational Academy of Sciences in 1916 -to associate the broadcommunity of science and technology with the Academy'spurposes of furthering knowledge and of advising the federalgovernment. The Council operates in accordance with generalpolicies determined by the Academy under the authority of itscongressional charter of 1863, which establishes the Academy as aprivate, nonprofit, self-governing membership corporation. TheCouncil has been the principal operating agency of both theNational Academy of Sciences and the National Academy ofEngineering in the conduct of their services to the government,the public, and the scientific and engineering communities. It isadministered jointly by both Academies and the Institute ofMedicine. The National Academy of Engineering and the Instituteof Medicine were established in 1964 and 1970, respectively,under the charter of the National- Academy of Sciences.
This project was supported under Master Agreement No. 79-02702between the National Science Foundation and the NationalAcademy of Sciences.
Librtfry of Congress Catalog Card Number 83-83127International Standard Book Number 0-309-03397-7
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Printed in the United States of America
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Participants at Meetings of the Electronics Panel,Committee on Technology and
International Economic and Trade Issues
Panel
3OHN G. LINVILL (Chairman), Professor, Department ofElectrical Engineering, Stanford University
FERNANDO 3. CORBATO, Professor of gpmputer Science andEngineering, Massachusetts Institute of Technology
THERESE FLAHERTY, Assistant Professor, Harvard UniversityBusiness School
EUGENE I. GORDON, Director, Lightwave Devices Laboratory,Bell Laboratories
WILLIAM C. HITTINGER, Executive Vice-President, Research andEngineering, RCA Corporation
3OSEPH C. R. LICKLIDER, Professor, Massachusetts Institute ofTechnology
ROBERT N. NOYCE, Vice-Chairman of the Board, INTELCorporation
DANIEL I. OKIMOTO, Assistant Professor, Department ofPolitical Science, Stanford University
M. KENNETH OSHMAN, President and Chief Executive Officer,ROLM Corporation
MICHAEL RADNOR, Director, Center for the Interdisciplinary
Study of Science and Technology, Northwestern Uni VersifyWILLIAM V. RAPP, Vice-President, Project Services Group, Bank
of AmericaROGER S..SEYMOUR, Consultant*
Rapporteurs
ANNETTE M. LaMOND, Consultant-Economics and CompetitiveStrategy, Cambridge, MA
*Formerly, Program Director, IBM Corporation
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ROBERT W. WILSON, Consultant-Economics and. CompetitiveStrategy, Weston, MA
Additional Participants
JOHN ALIC, Project Director of International Security ofCommerical Programs, Office of Technology Assessment, U.S.Congress
CLAUDE BANDY, Science and Electronics Division, U.S.Department of Commerce
ARDEN L. BEMENT, 3R., Resource and Advanced Technology,U.S Department of Defense
NAZIR BHAGAT, Office of Productivity, Technology, andInnovation, U.S. Department of Commerce
JOHN CARR, Japan-United States Economic 'Relations GroupFRANK CAUFIELD, Kleiner Perkins Caufield & ByersJACK CLIFFORD, Office of Producer Goods, U.S. Department of
CommerceLIAM FAHEY, Center for the Interdisciplinary Study of Science
and Technology, Northwestern UniversityPETER F. FROST, Office of Advanced Technology, U.S.
Department of StateJAMES GANNON, NBC News, New YorkJEFFREY A HART, Professional Staff, President's Commission
for a National Agenda for the EightiesPHIL MARCUS, Office of Producer Goods, U.S. Department of
CommerceEGT.L.S MILBERGS, Director of Productivity, Technology, and
Innovation, U.S. Department of CommerceJOHN McPHEE, Office of Producer Goods, U.S. Department of
CommerceSUMIYE OKUBO, Policy Analyst, Division of Policy Research and
Analysis, Scientific, Technological, and International Affairs,National Science Foundation
SAUL PADWO, Director of Licensing, Office of ExportAdministration, U.S. Department of Commerce
WILLIAM 3. PERRY, Under Secretary of Defense for Researchand Development, Office of the Secretary of Defense
ROLF P. PIEKARZ, Senior Policy Analyst, Division of PolicyResearch and Analysis, Scientific, Technological, andInternatiorlal Affairs, National Science Foundation
ALAN RAPOPORT, Policy Analyst, Division of Policy Research. and Analysis, Scientific, Technological, and InternationalAffairs, National Science Foundation
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ROBERT SCACE, Chief of Semiconductor Materials, PiocessingDivision, U.S. Bureau of Standards
TED SCHLIE, Acting Director, Office of CompetitiveAssessment, U.S. Department of Commerce
Consultant
BENGT-ARNE VEDIN, Resegch Program Director, Business andSocial Research Institute, Stockholm, Sweden
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Staff
HUGH H. MILLER, Executive Director, Committee on Technologyand International Economic and Trade Issues
MARLENE R. B. BEAUDIN, Study Director, Committee onTechnology and International Economic and Trade Issues
ELSIE IHNAT, Secretary, Committee on Technology andInternational Economic and Trade Issues
STEPHANIE ZIERVOGEL, Secretary, Committee on Technologyand International Economic and Trade Issues
Committee on Technology andInternational Economic and Trade Issues (CTIETI)
Chairman
N. BRUCE HANNAY, Nation41 Academy of Engineering ForeignSecretary and Vice - President, Research and Patents, BellLaboratories (retired)
Members
WILLIAM J. ABERNATHY, Professor, Harvard UniversityGraduate School of Business Administration and Chairman,CTIETI Automobile Panel
JACK N. BEHRMAN, Luther Hodges DistingUished Professor ofInternational Business, University of North Carolina
CHARLES C. EDWARDS, President, Scripps Clinic and ResearchFoundation and Chairman, CTIETI Pharmaceutical Panel
W. DENNEY FREESTON, 3R., Associate Dean, College ofEngineering, Georgia Institute of Technoiogy and Chairman,CTIETI Fibers, Textiles, and Apparel Panel
.3ERPIER A. HADDAD, Vice-President, Technical PersonnelDevelopment, IBM Corporation tretired)
MILTON KATZ, Henry L. Stlmson Professor of Law Emeritus,Harvard Law School
RALPH LANDAU, Chairman, Listowel Incorporated* andVice-President, National Academy of Engineering
JOHN G. LINVILL, Professor, Department of ElectricalEngineering, Stanford University and Chairman, CTIETI
Electronics Panel
*Formerly, Chairman of thr Board, Halcon-SD Group.
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RAY McCLURE, Program Leader, Precisions EngineeringProgram, Lawrence Livermore Laboratory and Chairman,CTIETI Machine Tools Panel
BRUCE S. OLD, President, Bruce S. Old Associates, Inc. andChairman, CTIETI Ferroiss Metals Panel
MARKLEY ROBERTS, Economist, AFL-CIOLOWELL W. STEELE, Consultant-Technology Planning and
Management*MONTE C. THRODAHL, Vice-President, Technology, Monsanto
Company
_fp
*Formerly, Staff Executive, Corporate Technology Planning,General Electrl Company
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Preface
In August 1976 the Committee on Technology and InternationalEconomic and Trade Issues examined a number of technologicalissues and their relationship to the potential entrepreneurialvitality of the U.S. economy. The committee was concerned withthe following:
Technology and Its effect on trade between the UnitedStates and the other countries of the Organization for EconomicCooperation and Development (OECD).
Relationships between technological innovation and U.S.productivity and competitiveness in world trade; impacts oftechnology and trade on U.S. levels of employment.
Effects of technology transfer on thq development of theless-developed countries (LDC.5) and the impat of this transfer onU.S. trade with these nations.
Trade and techoplogy exports in relation to U.S. nationalsecurity.
In its 1978 report, Techno Tr and the U.S. Ecomtra,*the committee conclu t state o net on s competi-tive position in world trade is a reflection of the health of thedomestic economy. The committee stated that, as a consequence,the improvement of our position In international trade dependsprimarily upon improvement of the domestic economy. Thecommittee further concluded that one of the major factorsaffecting the health of our domestic economy is the state of
*National Research Council, 1978. Technology: Trade, and theU.S. Economy. Report of a workshop held 9t Woods Hole,Massachusetts, August 22-31, 1976. National Academy ofSciences, Washington, DX.
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industrial innovation. Considerable evidence was presented 'duringthe study to indicate that the innovation process in the UnitedStates it not as vigorous as it once was. The committee recom-mended that further work be undertaken to provide a moredetailed examination of the U.S. government policies andpractices that may bear on technological Innovation.
The first phase of the study based on the originalrecommendations resulted In a series of published monographsthat addressed government policies in the following areas:
The International Technology Transfer Process.*The Impact of Regulation on Industrial Innovation.*The Impact of Tax and Financial Regulatory Policies onIndustrial Innovation.*Antitrust,. Uncertainty, end Technological Innovation.*
This report on the electronics industry is one of seven industry-specific' studies that were conducted as the second phase of workby this committee. Panels were also formed by the committee toaddress automobiles; ferrous metals; machine tools; pharmaceu-ticals; fibers, textiles, and apparel; and civil aviation manufactyring. The objective of these studies was to (I) identify gobal shiftsof industrial technological capacity on a sector-by-sector basis;(2) relate those shifts In international competitive industrialadvantage to technological and other factors, and (3) assess futureprospects for further technological change and industrial_development.
As a part of the formal studies, each panel developed (I) abrief historical description of the industry, (2) an assessment ofthe dynamic changes that have been occurring and are anticipatedas occurring in the next decade, and (3) a series of policy optionsand scenarios to describe alternative futures for the industry.
The methodology of the studies Included a series of panelmeetings involving discussions between (1) experts named to thepanel, (2) invited experts from outside the panel who attended asresource persOns, and (3) government agency and congre;sionalrepresentatives presenting current governmental views andsummaries of current deliberations and oversight efforts.
The writing of this report was done primarily by Dr. AnnetteM. LaMond, with assistance from Dr. Robert W. Wilson. 'Dr.LaMond and Dr. Wilson were responsible forproviding the industry
*Available from the National Academy of Engineering, Office ofthe Foreign Secretary, 2101 Constitution Avenue, N.W.,Washington, D.C. 20418
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and policy research and resource 'assistance necessary to investi-gate the issues developed by the panel, as well as producing aseries of drafts, based on the panel deliberations, which werereviewed and critiqued by the panel members at each of theirthree meetings.
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Contents
I THE CHALLENGE TO U.S LEADERSHIP INELECTRONICS
2 FINANCIAL AND HUMAN RESOURCE CONSTRAINTS 8
Industry Structure and Innovation, 9Funding for Research and Development, 11Investment in Production Capacity, 13Technical Personnel, 17
3 BARRIERS TO INTERNATIO' !AL TRADEU.S. Electronics Industry fez,* Balance, 29Tariff Barriers, 32Non-tariff aarriers, 33Opening Markets to International Competition, 36
4 THE SEMICONDUCTOR INDUSTRYIndustry Size and-International Position, 40,r\Industry Structure, 42The Semiconductor Manufacturing Process, 43Bases for Competition: A Case Study of the Random-
Access Memory, 47
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39
5 THE COMPUTER INDUSTRY 57
Industry Size and International Position, 38Industry. Structure,. 60Bases for Competition, 63The Clanging Economics of the Computer Industry, 70
6 THE TELECOMMUNICATIONS EQUIPMENT INDUSTRY 73
Industry Size and International Position, 76Industry Structure, 79
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Developments in Transmission Technology, 80Bases for Competitions A Case Study of SwitchingEquipment, 83
7 THE CONSUMER ELECTRONICS INDUSTRYIndustry Size and International Position, 94The Ingredients of the Japanese Success in Consumer
Electronics, 99
8 POLICY OPTIONS FOR THE U.S. ELECTRONICSINDUSTRY
Research Policy, 105Capital Formation Policy, 108 .Human Resource Policy, 110International Trade Policy, 114Shaping an Electronics Industry Policy, 117
93
104
BIOGRAPHICAL SKETC E4S 123
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Tha Competitive Statusof the
U.S. ElectronicsIndustry
The Challenge to U.S.Leadership in Electronics
The security and prosperity of the United States during theremaining years of this century and beyond will depend increas-ingly on the strength of its electronics industry. Despite itsextraordinary growth over the past three decades, electronicsremains an emerging industry, promising a continuing stream oftechnological innovation with enormous international stakes.Based on size alone, electronics already ranks as one of theleading industries in the. United States. As shown in Table 1-1,the value of product shipments in the industry's major segmentsreached nearly $100 billion In 1980, up from $8 in 1938. Bythe mid-1980s the industry is expected to generate over $150billion in annual sales.'
The dollar value of industry shipments, however, is only apartial reflection of the central role of electronics in our society.Education, health care, safety, environment, work activity,recreation, entertainment, life style, and aspirations are allfundamentally enhanced by electronic tt :hnology. The micro-processor as an alternative to mental drudgery is transformingsociety today much as the introduction of the lebw-horsepowermotor did by eliminating physical drudgery.
The national defense also rests increasingly on the edgeprovided by electronic technology. No longer is numerical'strength the sole determinant of a nation's military strength.4Military capability In command, control and countermeasure,surveillance, guidance, missile seekers, and communications isdetermined by the design, manufacture, and application of stateof the art electronics technology.
During the past decade, Japan launched an unprecedentedchallenge to the technological leadership of the United States. inthe next decade, the United States will face Increasing competi-tion from other countries in eastern Asia and western Europe.Unless the nation rallies to the challenge, the technologically
1
TABLE 1-1 Value of Product Shipments for Major Electronic Industries, 1958-1980
-Sum of Control and Processing Equipment. Testing and Measuring Equipment, Nuclear Electronic Equipment, and Medical Electronic Equip-rent from Electronic Market Data Book.`Prior to 1967, figures are from Electronic Market Date Book, 1969ddition.cControl and Processing Equipment and Testhsg and Measuring Equipment only. Prior to 1967, source appears to severely undecestimaul sales
csmtrol and processing equipment.and Measuring Equipment only.
SOURCES: Data for 1958-1990 from US. Department of Commerce, U.S Indira 's/ Outlook, 1982, 1980,1979, 1976, 1915, 1974, 1969,1966,1965, and 1964 (millions (Washington, D.C.: U.S. Government Printing Office).
Ra
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preeminent position of the U.S electronics industryhistoricallyits chief competitive strengthwill gradually be eroded. -
Although the United States remains the world technologyleader in basic electronits research, the dimensions of the foreignchallenge are clearly drawn. Japan now dwarfs its internationalcompetitors in consumer electronics and has taken direct aim atstrategically important markets in semiconductors, computers,and computer-related equipment. Indeed, the Japanese have beenespecially successful in closing the technological gap with U.S.firms in advanced computer memory technologya high-volumeand rapidly growing product area in which the United States wasdominant only five years ago.
The Japanese challenge in semiconductor technology is par-ticularly ominous. Integrated circuits have taken on enormousstrategic Importance as they have become larger and larger com-ponents of complete electronics systems. Advances in microelec-tronics are the driving force behind advances in systems tech-nology. At the same time, advances in system architecture designrequire increasing interaction between the development of soft-ware and integrated circuit hardware. While the current strengthof the -U.S. industry in software is a major asset in integratedcircuit apd systems competition, this strength will be eroded withfurther decline in our Integrated circuit market share. The U.S.position in semiconductor technology is thus crucial to U.S. com-petitiveness across the entire spectrum of electronics markets.
Japan's current success in electronics lies in the carefulselection and purchase of foreign technology, the speed and extentof its adoption, and the ability to refine purchased techzlogy. Todate, the technical accomplishments of the Japanese electronicsindustry have been the greatest in high-volume products, processengineering, and quality control. For all of its progress in hard-ware, however, the Japanese industry is widely agreed to lag Inthe development of software and systems technology. In com-puters the Japanese position remains a secondary one, despitemore than a decade of government-sponsored R&D and industrypromotion.
Although knowledgeable observers caution that it would be amistake to underestimate what the Japanese can do throughplanning, engineering, and working together on large, long-termprojects, some others question the ability of the Japanese to movefrom their past reliance on imports of foreign technology to a newlevel of innovation. They cite the societal pressures to conformto group expectations as well as the dkfficult environment facedby would-be entrepreneurs in Japan." Further, although thequality of primary and secondary education in Japan is very highjfunding for higher education has historically stood at low levels.*
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Graduate training is largely for academic careers, and the systemof compensation at major firms offers little incentive to undertakegraduate study before entering the work force. Although Japan-ese firms attempt to make up for ,.ese deficiencies by elaboratein-house training programs, th4 question remains as to whetherJapan will produce a sufficient supply of highly trained specialistscapable of advanced research.
Answers about Japan's ability to take the technological lead inelectronics from the United States must await the outcome of thenext years. A strong Japanese effort, however, will undoubtedlybe encouraged by Japan's highly favorable domestic environment.The Japanese electronics industry operates from an economic basethat affords it significant competitive advantages visa vis U.S.electronics firms. These advantages derive from the Japanesepattern of high savings and high investment, pride in acquiringtechnological skills and emphasis on quality, supportive, laborrelations and work-force quality, and stable, competent govern-mental bureaucracy. Also favoring the Japanese effort is theclear recognition on the part of the Japanese government andbusiness community that there is an overriding need for innova-tion and a broad consensus that the national interest requires thatmajor efforts be concentrated in this area.
One of the Japanese electronics industry's greatest advantagesin moving to a higher level of innovation derives from the stable,low-interest rate environment that has prevailed in Japan sincethe end of World War II. In contrast, U.S. interest rates not onlyhave frequently been higher than Japanese rates, but also, havemoved in a highly erratic fashion. Over the past decade, theinterest rate differential between Japan and the United States haswidened, ranging between 7 and 10 percent in recent years.Lower interest rates, combined with the high debt-equity ratiospermitted by the Japanese financial system, have given Japanesefirms a substantial cost-of-capital advantage. This cost-of-capital advantage translates into a significant Japanese pro-duction cost advantage--one that has increased as equipmentprices have escalated. For example, the Semiconductor IndustryA;sociation has estimated that the overall advantage In theproduction of integrated circuits due strictly to a lower cost ofcapital, given an assumed cost.of-capital advantage of 50percent, would be 12 percent.5 In addition, by lowering projecthurdle rates, low capital costs increase the number of projectsthat can be undertaken. Beyond the cost-of-capital advantage, ofcourse, Japanese firms derive other cost advantages fromfavorable depreciation schedules and assorted tax credits.
lower capital costs have thus stimulated a high rate ofcorporate investment in the Japanese electronics industry.Further, a lower user cost of capital for all Japanese industry has
19
meant relatively more Investment generally, which has, in turn,increased the demand for electronics products and spurred inducedinvestment, e.g., in automation and robotics. In a volume-sensitive industry such as electronics, increased demand has notonly improved Japan's competitive cost position, but also reducedthe risks involved in a technology leap-frog strategy.
The high rate of investment encouraged by low capital costshas been central to the Japanese electronics industry's advancesin productivity, product quality, and product development. Theeffects of this high investment sate can be seen_ throughout theindustry. In consumer electronics, investment in the redesign oftelevision receivers reduced the number of parts in Japanese setswell below the number in U.S. products, with great benefits interms of both manufacturing cost and product reliability. Simi-larly, the Japanese were able to sustain their investment in devel-opment of video cassette recorders (VCRs) long after U.S. firmshad dropped such efforts, and Japanese firms now dominate worldVCR production as a result. In the semiconductor industry, theJapanese began to invest heavily in automating the labor-intensive stages of production in the early 1970s, while the U.S.industry looked to offshore production in low wage-rate countriesto achieve cost savings. One result was the widely reporteddifference in Japanese and U.S. product quality in 4K and 16Krandom-access memories (RAMs). Further, in 1978, when demandfor the dynamic 16K RAM overwhelmed the capacity-limitedoutput of U.S. suppliers, Japanese manufacturers, possessed withample production capacity, moved in to fill the void.
The emergence of the Japanese electronics industry as a majorcompetitor raises a formidable challenge to the technologicalleadership of the U.S. industry. This challenge comes at a timewhen U.S. electronics firms face constraints on their ability toinvest in new plants and equipment and to sustain the research anddevelopment' effort needed to stay abreast of rapid technologicalchange. The threat posed by these problems is heightened by pro-tectionist policies that restrict the access of U.S. firms to worldmarkits and, since mid-1980, by the combination of an, overvalueddollar and undervalued yen that has in effect created a majorbarrier to U.S exports.
The objective of this report is to assess the influences oftechnology on the international competitive position of the U.S.electronics industry. The number of products, markets, and firmsin the U.S. electronics industry Is, of course, too large to permit adetailed review of each segmenteff the industry. Rather, tilefocus of the study is placed on four broad product groups:integrated circuits, computers, telecommunications equipment,and consumer video equipment. Taken together, these productgroups illustrate the dimensions of the problems raised. by high
6
capital'costs, shortages of technical personnel, and trade barriersto foreign markets.6
The strategic role of the integrated circuit industry is high-lighted throughout the report. Integrated circuits have becomelarger and larger Components of complete electronic systems. Atthe same time, close interaction between integrated circuitmanufacturers and systems producers has become 'Increasinglyimportant in designing competitive new equipment. Continuedleadership in microelectronic hardware and software technologywill thus be crucial to U.S. competitiveness in major equipmentsectors such as computers, telecommunications, industrial con-trols and robotics, and consumer electronics in the years ahead.Yet, it is the integrated circuit industry that currently faces themost severe pressures on its human and financial resource base.
The report is organized as follows. The next chapter describesthe financial and human resource problems That confront the U.S.electronics industry. Chapter 3 discuses international trade andmonetary barriers facing U.S. electronics exports. The next fourchapters examine in greater detail the U.S. position and the basisfor international competition in integrated circuits, computers,telecommunications equipment, and consumer video equipment.Finally, Chapter 8 provides an overview of the problems andpolicy options faced by the United States in shaping a competitivepolicy for the electronics industry.
The policy-related discussions in Chapters 2, 3, and 8 are basedon the industry analyses in Chapters 4 through 7. Readers who areprimarily interested in policy issues can focus on the introductionsto Chapters 4 through 7, which contain summaries of the industrystudies. For those readers interested in a particular industry, theindustry chapters can be read Individually and without extensivereference to other sections of the report.
NOTES
1. See, for example, "U.S. Markets," Electronics, 13 January1983.
2. See, for example, William 3. Perry and Cynthia A.Roberts, "Winning Through Sophistication: How to Meet theSoviet Military Challenge," Technol2gy Review, July 1982, and"Killer electronic weaponry: 'ripping the balance in militarypower," Business Week, 20 September 1982.
3. Alt Rough the pressure to conform Is often viewed asoppressive to innovation, it can be argued that the supportivegroup context in Japan allows creative risk-taking because thecosts of failure are less extreme than in the more punitive workclimate in the United tes. It can also be held that the
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processes of research and discovery in modern industry areinherently more a group activity than an individual activity.
4. Nevertheless, engineering and science attract many of3apan's top students. In electrical engineering, bachelor's Sk.greegraduates increased to 19,572 in 1979, up from 11,335 In 1970, andthe enrollments are growin,g.
5. Semiconductor Industry Association, The InternationalMicroelectronic Challenge, May 1981.
6. Major electronics sectors not examined in the reportinclude radio and television communications, and test, control,and medical electronics. Many of the products in these sectorsare sold in relatively small and specialized markets. This charac-teristic lessens the pressure from foreign competition for tworeasons. First, it is difficult for foreign (or domestic) firms toachieve substangal economies of scale from mass production.Second, domestic firms possess a competitive advantage based onproximity to customers, particularly in highly specialized productareas, such as test equipment. The degree to which these factorsfavor domestic firms, however, varies by product and can changeover time. For example, foreign competition, particularly by3apanese producers, has become more intense in televisionbroadcast equipment as the industry has moved toward moreportable equipment and as program originators at other than thenetwork level adopt equipment with lower cost and transmissionquality.
Even in the industry segments analyzed in the followingchapters, it has not been possible to address ail products anddevelorments of potential competitive significance. For example,one omission in the semiconductor chapter is power circuitry, anarea that is central to advances in automation, robotics, and
computer control of factory processes.
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,,z0=tir;:51-LT,
2Financial and
Human Resource Constraints
The U.S. electronics industry has had a remarkable record oftechnological progress, marked by a continual flow of newproducts and steady advances in manufacturing processes. Overthe past three decades, electronic devices have not only replacedmechanical systems and enhanced features in ixistinti products,but also created new products, services, and even industries. Atthe same time, continued Improvement in product performancehas been accompanied by dramatic reductions in product cost.The speed per unit cost of a typical IBM computer, for example,Increased nearly a million-fold between 1953 and 1979.
This innovative behavior is Linkql to a unique Industry struc-,ture that has supported both basic reserych and subseqtentdevelopment efforts. The industry's strength in basic researchhas been sustained by large, progressive firms that possess theresources and incentives to undertake long-term commitments torisky projects with uncertain commercial outcomes. At the sametime, smaller, entrepreneurial firms have played a central role,both in Introducing new products and in ac mierating the pace ofinnovation by existing firms.
The rapid pace of innovation and diffusion that has given theU.S. electronics industry world technological leadership, however,is threatened by growing financial and human resource pressures.Many observers question whether. in the present investment cli-mate In the United States, Internal sources of funds and externalcapital markets /teen support the investment in Innovation andexpansion of production capacity necessary for the U.S. elec-tronics industry to remain a vigorous international competitor.Similarly, shortages of highly trained engineers and computerscientists, particularly on university faculties, may compromisethe ability of the industry to design and manufacture state of theart electronic components and systems.
This chapter examines the capital and human resource con-straints confronting the U.S. electronics Industry. The first
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section reviews the historical contribution that the unique struc-ture of the U.S. industry has made to the in a perfOrmance
Thof U.S. firms. The following two sections di the increasingProblems faced by the industry in funding t investment inresearch, development, and production capacity needed totranslate advances in scientific knowledge into marketableproducts. The final section addresses the issues surrounding thesupply of technically trained personnel.
INDUSTRY STRUCTURE AND INNOVATION
The phenomenal growth of the U.S. semiconductor, computer, andtelecommunications equipment industries. over the past threedecades has taken place with little direct government involve-ment. Rather, the development and diffusion of technologicalinnovations have been encouraged by an Industry structure thatencompasses both large, vertically integrated firms and a host ofsmaller, entrepreneurial firms. The U.S. industry, unlike Its inter-national counterparts, has historically been characterized byrelatively easy conditions of entry. As a result, entry by entre-preneurial firms has accelerated the pace at which advancesoriginating in large industrial and university research laboratorieshave been translated into commerical innovations.
The innovative contributions made by entrepreneurial firms. inthe U.S. electronics industry have been founded on the strength ofthe United States in basic or fundamental research.'Fundamental research projects in electronics involve long timehorizons, typically running from 5 to 10 years, and - uncertaincommercial outcomes. To sustain the motivation of -esearchersover such long time periods, a firm mint provide the opportunityto publish interim results and to communicate with researchers atother institutionsrpThe length of time required for a fundamentalresearch project, together with exchange between researchers,increases the probability that research results will diffuse toother firms before commerical returns can be realized.2 Mostfundamental research has been conducted in universities or infirms such as AT&T, General Electric, IBM, and RCA, which arelarge enough to capture a remunerative portion of the ultimatebenefits. Although smaller firmi do account for somefundamental research, their share is disproportionately small.
- Small entrepreneurial firms in the U.S. electronics industryhave nevertheless; served -to speed -the- development and diffusionof . technological innovation. Entry by such firmihas- beenencouraged by the existence of a well-developed venture capital.market. In contrast, In Japan a corporate finance system thatrelies largely on commercial bank loans, together with the
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absence of a significant venture capital market, has deterredentry by entrepreneurial firms, producing an industry structurethat is dominated by large, vertically Integrated firms.)Similarly, in western Europe relatively difficult entry conditionshave prevented indigenous entrepreneurial firms from assumingthe role they have played in the United States.
Entry by new firms in the United States has also been facili-tated by a high degree of personnel mobility. Unlike its Japaneseand western European counterparts, the U.S. electronics industryis characterized by a pattern of entrepreneurs leaving establishedfirms to form new ventures and of experts being recruited awayfrom a firm by its competitors. Such mobility is particularly rarein Japan where lifetime employment at major -firms serves toinhibit "jobhopping."4
In the U.S. semiconductor industry, for example, relativelyeasy entry has promoted the rapid exploitation of new ideas byentrepreneurial firms and has accelerated the adoption of majorinnovations by existing firms. During the 1960s and early 1970smore than 50 new firms, financed by readily available venturecapital; entered the semiconductor industry. The presence ofthese entrants has been a major force in the industry, encouragingrapid diffusion of technical knowledge and spurring intensecompetition among industry participants. t,
New entry has also contributed to the innovative vigor of theU.S. computer and telecommunications industries.' From astructure dominated by a small number of mainframe manufac-turers in 1960, the computer industry has been transformed bysuccessive waves of new entrepreneurial firms in minicomputers,peripheral equipment, distributed data processing and, mostrecently, 'personal computers. The growth in demand for mini-computers a decade ago spawned about 40 new companies; a waveof entry since 1977 has brought an estimated 140 new companiesinto the industry.6 Examples of entry in the telecommunicationsequipment industry are less abundant, but have increased with thereduction in regulatory barriers that began in 1968 with the.Carterfone decision. Indeed, in recent years, entry has speededthe development of major innovations such as digital PBXs andcommunications systems designed for the office of the future.
Advances in electronics technology over the next decadeinareas such as component integration, computer architecture, andopto-electronics--will continue to create opportunities for sus-tained innovation by both large and smaller specialist firms. Theability of U.S. firms to invest in research, development, andproduction capacity is a prerequisite for long-run competitive-ness. The following sections discuss the capital .and humanresource problems that must be hurdled by the U.S. industry if itis to remain a vigorous competitor in world electronics markets.
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FUNDING FOR RESEARCH AND DEVELOPMENT
The rapid rate of technologicr..1 change In electronics requiresvery/high levels of R&D spending relative to ether manufacturinginOstries. Many advanced electronics products have lifetimes asshort as five years due to technological ratner<*than physicalobsolescence. As a result, the ratio of R&D to sales in thecomputer, semiconductor, and telecommunications equipmentindustries exceeds 5 ;percent. Specialized integrated circuitmanufacturers devote percentages of sales to R&D that fag in the8 to 10 percent range.? These figures stand in contrast to ailaverage research intensity ratio of 2 percent for all U.S. manu-facturing firms.
Research and development costs across the electronics indui-try have risen rapidly as advances in integrated circuit design andmanufacturing techniques have made it possible to put an everincreasing number of transistors on a single chip. Initially, inte-grated circuits (ICs) were general building blocks that were incor-porated into complex logic systems by designers with expertise innetwork theory, component properties, and practical knowledge ofeffective design techniques. Software technique'* were limited to7nmputers and the minimization of parts in logic system designs.
Greater circuit density has resulted in IC components taking onan increasing number of system functions. Large-Scale Integration(LSI), which began in the early 1970s, fundamentally changed thedesign process as components assumed tar& functional blocks ofsystem operation and allowed software design of complex logicsyStems. 151 made software an integral part of system design andcost. The portion of R&D spent on software development hasincreased over time and today accounts for over 50 percent of theR&D budget of most computer and telecommunications equipmentsyStems manufacturers. With rising system complexity, few pros-pects for increased programmer productivity, and continuingshortages of software engineers, it is likely that software costswill continue to escalate.
As device fabrication techniques have improved, Very Large-Scale Integration (VLSI) has become feasible. The complexity ofVLSI circuitry, even in more straightforward applications such asRAMs, has resulted in very high design costs. The task of testingand designing software for nonmemory VLSI devices with pro-grammable functions promises to be even more expensive than forthe LSI generation products and will .fequire IC producerundertake an increasing role in software development themselv
Research and development costs have thus risen rapidly, par-ticularly for complex systems, as the importance of software inproduct development has grown. High capital costs and shortagesof highly trained personnel, however, may be making it more
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difficult for even relatively large firms to finance long-termcommercially oriented R&p. Given these considerations, nationalgovernments in many countries are increasingly willing to finance'research in electronics.
In part, increased government interest in electronics Yeflectsits growing national security and defense importance. Forexample, rapid and accurate information transmission is a majordeterminant of defense performance. Indeed, Pulse Code Modulation (PCM) transmission, microwave and satellite communications,and packet switching were initially developed for militaryapplications.
Governments, however, are also responding to public percep-tions of the future role of the electronics industry. It is widelybelieved that technological developments in these industriesbe key factors in future industrial growth. The electronics-basedindustries are seen not only,as increasingly important in terms ofoutput, but also as having vast implications for improving pro-ductivity in other industries.
The governments of France, West Germany, the UnitedKingdom, and Japan have all undertaken major electronics R&Dprograms in an effort to stimulate innovation and therebycontribute to the international competitiveness of their nationalindustries. These funding programs have been aimed at corn-merital applications of advanced microelectronics technology,particularly in the -areas of computer and telecommunicationsresearch. Funding' by foreign governments for advanced semi-conductor research alone has been estimated at $1.6 billion overthe 1978 to 1981 period.8.
The/Japanese government's efforts to encourage innovation inthe electronics industry provide a widely noted example of acoordinated national approach to industrial innovation anddiffusion. Since the mid-1960s, MITI's Agency of IndustrialScience and Technology has sponsored a national R&D programfor commercially oriented projects that would not be undertakenby private firms because bf the magnitude of\he investmentretiuired; long-term gestation, and high risk. Under thisprogram, projects are carried out cooperatively by universities,government laboratories, and industry. Projects funded under thenational research program include the $400 million, four-yearVLSI project, which sKeatly strengthened Japan's internationalcompetitive position."' .43cfgo of great potential competitivesignificance is the recently completed Pattern InformationProcessing System (PIPS) project, which covered both electronicimage processing and speech recognition."
The most extensive involvement of the Japanese governmentin a particular industry,. however; involves computers." Thestatutory basis for these measures is the 1971 law, "Temporary
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Measures for the Promotion of Specified Machinery Industries,"which authorizes the government to formulate an improvementplan for individual industries. Currently, MITI is launching itslatest Super Computer Project, .an eight-year effort to coordinateand focus Japanese research in the Josephson junction and ingallium arsenide integrated circuitstwo key component areas inwhich ?apan has signalled its intention of topping U.S. tech-nology. 13 Other government efforts to enhance the competitiveposition of the computer Industry are focused on software.development, where Japan lags behind the United States. Finally,MITI's recently announced 10-year, $450 million Fifth GenerationComputer Project aims to develop a prototype of a new family ofmachipes, designed especially for artificial intelligence applica-tions.14 Even if the -Fifth Generation project falls short of itshighly ambitious goals, most observers expect that the focus andconsensus provided by the. project will give a major boost to theJapanese computer industry.
In addition to the national R&D projects, the Japanese govern-tnent supports industrial technology through the activities of thenational research laboratories, including MITI's EiectrotechnicalLaboratory and Nippon Telegraph and Telephone's ElectricalCommunications Laboratory. Special tax concessions also serveas encouragements to industrial R&D. These' tax incentivesinclude accelerated depreciation for the construction of researchfacilities and pilot plants and initial expense of research asso-ciations, as well as partial tax exemptions for corporate profitsoriginating in receipts from sale of technology abroad. Such
measures, together with MITI's ability to coordinate andinfluence, !lave had a far-ranging influence on the internationalcompetitiveness of the Japanese industry.
INVESTMENT IN PRODUCTION CAPACITY
Rapidly changing technology calls for a continuing high rate ofcapital formation within the electronics industry, placing steadyupward pressure on capital-output ratios across the industry. Atthe same time, the risk element associated with investment in theelectronics industry is increasing due to greater uncertainty aboutmarket shares and profit margins. This uncertainty threatens theability of the industry to adjust Its capital stock to newopportunities.
The magnitude of the requirements for new capital formationin the electronics-based industries is illustrated in Table 2-1,which shows the increase in the ratio of new investments to valueof shipments for several electronics industry groups between 1977and 1980. Although capital requirements have increased acrossall segments of the electronics industry, the increase has been
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TABLE 2-1 New Capital Expenditures as a Percentage of Shipments forMajor Electronics Industries, 1977 and 1980
SOURCE: U.S. Department of Commerce, 41fniari Surrey of Manufisctures: Statisticsfor Industry Groups and Industries, 1977 and 1980.
most dramatic in the semiconductor industry. Since the end ofthe 1975 recession, U.S. semiconductor firms have dramaticallyexpanded their production facilities. Further, they have had toretrofit existing facilities with new production equipment sincethe rate of process equipment obsolescence is exceptionally high.For example, the Semiconductor Industry Association (SIA) esti,mated that the average age of capital equipment In 1979 for asample of merchant semiconductor companies was less than fiveyears.
With the evolution of integrated circuits, the increasedcomplexity of necessary production and test equipment has madenew IC production capacity very costly. For example, increaseddensity requires high-resolution equipment for transferring ICdesigns on to silicon. Traditional photolithography techniques aregiving way to more costly electron beam and X-ray techniques. Inaddition, the increased complexity of some circuit designs isdependent on computer-aided design methods, which require morecomplex hardware and software than that required in the designof earlier, less-sophisticated devices),
These developments, combined with intense competition toincrease product performance-price ratios, have resulted in a
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dramatic increase in the semiconductor Industry's capital-outputratio. In the 1960s, $1.00 of capital equipment generatedapproximately $10.00 of sales. Today, the ratio of capital to newsales is approximately one-to-one. By 1990 $1.00 of new capitalinvestment is expected to generate only $0.50 of apw sales.
The capital intensity of systems manufacture has Increasedless rapidly than. that required for IC production. Systemsmanufacture has historically been an assembly process in whichcomponents are placed together on printed circuit boards, and theboards are then connected together and to other devices, such aspower supplies and display tubes, within an enclosure, typically ametal cabinet. Testing occurs at various points In the assemblyprocess. The cost of test Auipment has increased as IC compo-nents have become more complex and now represents a majorcapital investment for systems manufacturers. In addition to testequipment, capital eqUipment for plant automation, e.g., for dipsoldering and component insertion, has become common to systemmanufacture.
As capital intensity increases, the struggle for competitiveleadership in high-volume electronic products is increasingly beingwaged on the production line. If U.S. producers are less ablefinancially to undertake necessary investment in plant andequipment, foreign producers are likely to increase capacity tosupply increases in demand, and U.S. producers will lose marketshare. Indeed, the availability of capital required for investmentin plant and equipment and the willingness of producers to commitfunds even during a downturn in the business cycle can be criticalfactors. For example, a cutback In investment for plant andequipment by U.S integrated circuit manufacturers was theprincipal cause of the industry's capacity problems in the late1970s. The capacity-limited production of U.S. manufacturers, inturn, provided Japanese producers with the opportunity toincrease worldwide market share.
The large investment in production capacity required tosupport future U.S. growth in the electronics industry is aparticular problem for small producers. The cost of necessarygrowth is more easily financed by large, diversified producersfrom internally generated funds or external capital markets. In
contrast, small and medium-sized producers are likely to havemore limited Sources of internal funds and face less attractiveterms on external funds. Indeed, at a time when interest ratespersist at high levels, raising sufficient capital has been a problemeven for large electronics firms.
The availability and cost of capital have caused particularproblems for the U.S. semiconductor industry, where lower thanaverage profitability has made it diffictslt to finance increasedrequirements for capital internalfy.16 In the _face of intense
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competition, benefits from increased automation and more effi-cient equipment have not re.-Ailted in increased profits, but havebeen passed on to the customers in the form of lower prices. Asleading producers have placed new advanced equipment intooperation, other producers have followed In order to maintainmarket share. Given the volume-sensitive nature of the industry,increased automation has thus resulted in dramatic price reduc-tions rather than increased profitability.if
_Finally, the rising capital intensity of the electronics industryhas increased the Importance of international differences incapital costs as a determinant of the competitiveness of U.S.,firms. The lower cost of capital in Japan has proved to be animportant competitive advantage for Japanese firms, particularlyin the semiconductor industry. In 1980, for example, the cost ofcapital facing Japanese semiconductor companies was enirnatedto be 9.3 percent compared to 17.5 percent for U.S. firms.l°
The cost-of-capital differential between Japan and the UnitedStates is largely attributable to two factors. First, the institu-tional structure of the Japanese economy allows Japanese firmsto operkte with much higher degrees of debt leverage than U.S.firms." If U.S. semiconductor firms had a ratio of debt-to-equity as high as that of Japanese firms, over two-thirds of the1980 difference in cost of capital would be eliminated. Second,the cost of long-term debt in Japan is lower than in the UnitedStates, reflecting tightly controlled capital markets, higherJapanese saving rates, lower inflation, and less restrictivemonetary policies.20
Differential capital availability and costs affect the competi-tive position of U.S. firms in two major ways. First, capital costshave a direct effect on manufacturing cost that is proportional tothe capital intensity of the manufacturing process. Moreover, tothe extent that a firm enjoys lower capital costs, it will possess agreater ability to expand production capacity in anticipation offuture demand. Second, capital costs have an obvious Impact opproject choice. If foreign firms have a lower cost of capital thanU.S. firms, they will be able to undertake some Investmentprojects that must be rejected by U.S. firms because the expectedrate of return is below their cost of capital. As a result, foreignfirms facing lower capital costs will tend to build a larger produc-tion base and sales volume than U.S. firms. Larger volume Inturn, may offer an important advantage in funding future R&D.41
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TECHNICAL PERSONNEL
Electronic products and services embody an unprecedentedamount of human knowledge and technically sophisticated labor.Scientists, engineers, and technicians are required for the R&Dprocess, while production engineers and technicians are needed toImplement new product and process technology. Selling newproducts involves technical skills in both the supplier's sales andservice force and the customer's organization. Indeed, a largeproportion of the electronics industry's §ales force is composed ofengineering graduates. Similarly, service personnel may rangefrom technicians to engineers, depending on the complexity of theproduct. In many cases, technically knowledgeable people withinpurchasing organizations are a prerequisite for the successfulcommerical introduction of advanced electronics products.
In the late 1970s, the U.S. electronics industry confronted aser.ious shortage of technical personnel. In part this shortagetraced to cutbacks in military and space funding of R&D andprocurement that occurred in the late 1960s. Beginning in 1968,real-dollar federal investment in R&D and in science and engi-neering education, including support for graduate fellowships,began to decline. These declines marked an end to the rapidexpansion of university science and engineering departments. Inaddition, the 1970-1971 recession cut sharply into the demand forengineers. As a result, many students considering engineeringswitched to other alternatives, and universities trimmed theircapacity for engineering education.
These trends are reflected in Table 2-2, which shows thenumber of electrical engineering degrees awarded at all levels inthe United States over the 1969 to 1980 period. The number ofbachelor's degree electrical engineering' graduates increased until1972, when the students who entered in 1968, before the cutbacksin government funding, would have matriculated. The number ofmaster's degree and Ph.D. graduates also turned down after 1971and 1972, respectively. By 1977, the number of electrical engi-neering degrees granted was at a low point. However, as rapidgrowth in the electronics industry generated increased demand forengineers following the 1970-1971 recession, enrollments began toincrease once more. The number of bachelor's degrees awardedhas increased since 1977, and recently the number of master'sgraduates has increased slightly, though Ph.D. production hascontinued to decline.22
The supply of experienced personnel trained in computerscience is also critically short at all degree levels.23 Trends forcomputer professionals have been similar to electricalengineering: namely, rising undergraduate enrollments anddecreasing Ph.D. production. However, while, the number of
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TABLE 2-2 Annual Electrical and Electrimic Engineering Graduates in theUnited States, 1969-1980
graduates in this area increased by over 10 percent per yearduring the 1970s, the initial .base was small. Thus, despite recentincreases in computer science enrollment, the National ScienceFoundation estimated in 1981 that there were 54,000 openings inthe United States for bachelor's degree graduates, but only 13,000graduates.2*
Expansion of the supply 86 well-trained electrical engineersand computer professional) faces a critical roadblock as a resatof the decline in the number of Ph.D. graduates in the 1970s. i2University engineering and computer science departments areseriously short of both junior and senior faculty, with littleprospect for early improvement. According to the AmericanCouncil on Education, more than 1500 faculty positions in thenation's accredited schools of engineering-10 percent of thetotal-were unfilled in the 1980-1981 academic year, and almosthalf of those posts had been vacant for more than a year. Inelectrical engineering and computer science departments, thevacancy rate is estimated at 16 percent, with openings In nearly50 percent of the faculty positions in solid-state electronics,computer engineer', and digital systems.
One reason for tne decline in the number of Ph.D. graduatesand the shortage of engineering faculty is the impressive salariesand benefits. that bachelor's degree engineqrs have been able tocommand in industry in recent years. In contrast, academicelectrical engineering and computer science department salariesare some 25 to 100 percent below industry levels. The net result
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has been a reduction In the ability of universities to provideeducation in engineering computer science, althoughundergraduate demand in areas Is more Intense than ever.
Several factors in addition to noncompetitive salaries con-tribute to the problem of attracting and retaining qualified facultymembers. In recent years the attraction of being able to workwith graduate students and conduct research in an atmosphere ofacademic freedom has been tarnished by difficulties in obtainingresearch support, problems of inadequate equipment and facil-ities, the instability of government funding for research, andrecently by-government pressure to restrict scientific publication.Further, the current shortage of graduate students and facultymembers creates unusually heavy teaching loads, which makeacademic jobs less attractive for those interested in research.
An important additional problem in engineering education Is asevere lack of, the equipment required for instructional purposes.Much of the laboratory equipment and physical facilities beingused for both teaching and research purposes in university engi-neering and computer science departments was acquired duringthe 1960s. The obsolescence of this ,equipment, implies that, partof the education that undergraduate engineers and computerscientists receive is Itself obsolete vis i via current industrialpractice. For example, the apparatus needed, to teach computer-aided design/computer-aided manufacture (CAD/CAM) methods- -the source of important productivity gains for some large corpor-ations over the past decal --Is. generally unavailable in engineer-ing schools. While this situation may not pose an insurmountableproblem for a larger employer who can afford on-the-job trainingfor new personnel, It may have adverse effects on smaller com-panies that depend upon new graduates for information about thelatest developments In engineering practice. Recently, the situa-tion has improved somewhat with graduate research centersinitiated through a combination of government and industrialsupport. However, much of the ground lost during the 1970s mustnow be regained at sharply higher cost.
Accelerating change in electronics technology has also createdproblems in continuing education and retraining of engineeringprofessionals. Engineering technology is advancing so rapidly thatthe half-life of a professional's kruinviedge base is now estimatedat two to five years. An engineer whose only continuing educa-tion consists of occasional brush-up courses does not have achance of staying technically current. At present, however,continuing education for engineers is spread among a variety ofsources, including industrial firms, consultants, professionalsocieties, and colleges and universities, with little or no coor-dination. There has been virtually no federal support forcontinuing education, in part because the costs of industrialprograms have been regarded as business expenses.
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TABLE 2-3 Electrical Engineering Graduates per Million Population
1965 1970 1975 1977
France 20 34 28 33Japan 82 133 162 18S
United Kingdom 32 46 45 46Unified spices - SS 67 66West Gennany 16 11 48 109
SOURCE: Semiconductor Industry Association, The Inienrational MeraelectionkCialleue, May 1981.
There is curr.mtly considerable concern about the relativetrends in the education of engineers and computer professionals inthe United States as compared with other highly indystrializedcountries. Japan and West Germany are producing match largerproportions of engineers than the United States, as indicated inTable 2-3.26 At the same time, these countries are educating asubstantial majority of their secondary school populations to apoint of considerable scientific and mathematical literacy. Incontrast, the United States has placed decreasing priority onscience and mathematics for secondary. students not intending tomajor in science or engineering.
Japanese graduates in electrical engineering at all degreelevels have incrsased dramatically in the postwar period, as shownAl Table 2-4.27 Indeed, the number of Japanese graduates Inelectrical engineering surpasses the U.S. level both on a percapita basis and in absolute terms, even though Japan has onlyone -half the ponulation base of the United States. The rapidincrease in Japanese engineering enrolimentuttowever, has beencriticized by scholars of higher educatidir for having beenaccomplished by Increasing student-faculty ...ratios andeconomizing on university resources per student."' Moreover,Japanese engineering education is highly abstract wip. little or nopractical laboratory experience. Nevertheless, two features ofthe Japanese system may mitigate the effect of educating largenumbers at low cost in the universities: the, rigor of high schoolinstruction in mathematics and the post-udversity training thatlarge companies provide for their engineers.47
Large Japanese firms invest heavily in training newly gradu-ated engineers given the incentives provided by the lifetimeemployment system. Indeed, the Japanese investment in trainingis known for its elaborate character, including in-house trainingprograms, company technical institutes, university graduate
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TABLE 24 Annual Electrical Engineering Graduates in Japan, 1969-1979
education, as well as rotation through a variety of jobs.30 In thecontext of lifetime employment, such training yields benefits byreducing both recruitment c2fts and resistance to technologicalchange and job reassignment."
The U.S. electronics industry also faces shortages in thenumber of skilled technicians who pros ide support for engineersand computer science professionals. Other industrializedcountries such as Japan and West Germany place heavy emphasison training technicians in special vocational schools. These coun-tries not only offer technicians good jobs but also considerablesocial status as well. In contrast, technician training in theUnited States has largely been a haphazard enterprise,accomplished through a combination of on-the-job training, a fewtechnical institutes, vocational training in secondary schools, andhigh-grade, very high-cost educational programs in the armedforces. Although two-year community colleges have begunrecently to play an importunt role in technician training, thesecolleges share a number of problems with tle higher educationsystem with respect to faculty and equipment.'2
Finally, the basic scientific and mathematical education of allU.S. citizens is at issue. There is a growing discrepancy betweenthe science and mathematics education acquired by high schoolgraduates who plan to follow scientific and engineering careers,and those who do not. Although scientific and technologicalliteracy is increasingly important in our society, more studentsthan ever before are dropping out of science and mathematicscourses after the tenth grade, and this trend shows no signs ofabating. This trend has troubling Implications not only for the
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size of the future pool of technical personnel but also for theability of the United States to lenerate and incorporate techno-logical change in its production and utilization of goods andservices.
NOTES
1. The term "basic research" as defined by the NationalScience Foundation covers "projects which represent originalinvestigation for the advancement of scientific knowledge andwhich do not have specific commercial objectives, although theymay be in fields of present or potential interest to the reportingcompany." Many firms thtis prefer the term "fundamentalresearch," i.e., research on difficult problems, often with long-runhorizons and uncertain outcomes, but in some cases specificcommercial objectives, to describe their research activities.
2. Communication and language barriers generally makediffusion of new knowledge between countries slower thandiffusion within a country.
3. MITI, however, has recently proposed new measures tomake it easier for new ventures to raise capital. Further, foreigncompanies are Increasingly interested in promoting new Japaneseenterprises. See, for example, "Japan: Smoothing the way forventure capital," Business Week, 11 October 1982.
4. Nevertheless, the number of individuals leaving largeJapanese electronics firms to set up their own companies hasincreased in recent years. See, for example, "The exodus thatshook the establishment," Business Week, 14 December 1981.
5. A major factor contributing to entry and innovation inthese industries in recent years is the low cost and flexibility ofoff-the-shelf components, such as microprocessors, memories, andperipheral devices. By buying standard parts from manufacturersthat sell them in large volumes, new ventures can take advantageof both economies of scale and new technology without incurringthe full burden of R&D costs. Cheaper computing power has alsoencouraged startups by paving the way far the development ofmore standard software. The combination of a unique architec-ture and software can be used to create systems that solvegeneric problems, address special uses such as portability, or meetthe needs of particular users.
6. "Computer= The incredible explosion of startups,"Business Week, 2 August 1982.
7. "Annual survey of corporate R&D expenditures," BusinessWeek, various years. The lower ratio of R&D to sales for systemscompanies compared to integrated circuit firms reflects in partthe higher level of sales revenue required for sales and serviceactivities In end-user markets.
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8. For example, the French government is launching afour-year project to give selected microelectronics companies andlaboratories $500 million In funding for R&D. At the same time,the government is increasing its spending for research in dataprocessing and computers to $350 million in 1982, up from $270million in 1981. In telecommunications, the government-financedresearch has, led to major achievements in widening applicationsfor electronic digital switchin . See, "Data processing: Pitfallsin France's vast R&D plan," Badness Week, 23 November 1981;"France spends billions on goal of becoming a leader in tech-nology," The Wall Street 3ournal, 14 September 1982; U.S.International Trade Commission, Competitive Factors InfluencinWorld Trade in Integrated Circuits, ngton D.C., November1979; and Semiconductor Industry Association, The InternationalMicroelectronic Challenge, May 1981.
9. Selection of national research projects begins withsuggestions from companies, universities, and governmentlaboratories; further modifications are made by MITI. Finalapproval is given by an agency advisory council comprisingrepresentatives from the universities, industry, and public.Projects are managed by an agency development officer, withvarious tasks assigned to companies, government laboratories, anduniversities. Each is reimbursed its full costs, with companiesoften further benefiting from a three-year, nonexclusive royaltydiscounted or reduced license of patents resulting from theprojects.
Although all research results are published, the nationalR&D projects benefit the participating companies far more thanothers. While outside companies can license the patents, whichare held by the government, participating companies pay less forthem. Moreover, an outside company that wants to duplicate anypatented development cannot obtain the essential details from thecompany that did the original work.
A second separate agency program provides subsidies forother industrial research that is considered important to theeconomy, but unlikely to be carried out without governmentassistance. Proposals originate with companies, who pay half thedevelopment cost. Patents, designs, and research results belong'exclusively to the developing company. However, this program isrelatively small.
See Merton 3. Peck, "Technology," in Asia's .New Giant,Hugh Patrick and Henry Rosovsky, eds., The Brookings Institution,Washington, D.C., 1976.
10. Of the $400 million funding for the VLSI project, two-thirds consisted of government loans to Je repaid from profitsrealized through the application of VLSI technology developedthrough the program and one-third of government subsidies. In
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addition, MITI provided a technical laboratory where researchersfrom the five leading Japanese semiconductor firms workedtogether to develop the new materials and production techniquesnecessary for VLSI circuitry. Over 700 patents were generated bythe project. Nevertheless, some observers credit the specificMITI VLSI project work less than the national consensus Itprovided in response to which Japanese firms did the jobinternally. See, for example, U.S. International TradeCommission, Competitive Factors Influencing World Trade inIntegrated Circuits, Washington, D.C., November 1979, andSemiconductor Industry Association, The InternationalMicroelectronic Challenge, May 1981.
11. Under the PIPS project, MITI's ElectrotechnicalLaboratory . developed the basic technology of nonkeyboardcomputer input devices, and applications were carried out byFujitsu, Hitachi, Mitsubishi, NEC, and Toshiba. See, for example,"Electronics research: A quest for global leadership," BusinessWeek 14 December 1981.12. In the 1960s, the U.S. computer industry exerted a majordemand-pull influence on U.S. semiconductor technology. Whenthe Japanese computer industry failed to perform this role, theJapanese government moved to speed progress in the computerindustry and simultaneously push faster development of relztedsemiconductor technology.
13. The Super Computer Project is an "entrusted project,"meaning that the government will bear the total expense. See, forexample, "Electronics research: The quest for global leadership,"Business Week, 14 December 1981; "Japan's super computer push,"The New York Times, 28 October 1982; and "With stakes high,race is on for the fastest computer of all," The New York Times,1 February 1983.
14. "A fifth generation: Computers that think," BusinessJeek December 1981; and "West wary of Japan's computer
Electronics, 15 December 1981.15. Increased product sophistication, coupled with inflation,
has also driven IC production equipment prices up sharply Inrecent years. From 1975 through 1980, the price of a waferfabrication module increased at an annual compound rate of neatly40 percent and is expected to continue at that rate through 1985.The price of a mask aligner, nearly $500,000 in 1981, is expectedto reach $1 million in the next few years. By 1980, a typical semi-conductor production line, which required an investment of only $1
million in 1965, cost as much as $50 million. U.S. Department ofCommerce, U.S. Industrial Outlook 1981, Chapter 26; and "Rollingwith recession in semiconductors," Business Week, 21 July 1980.
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16. Capital problems, however, are not limited to the semi-conductor industry. See, for example, "Computers: A capitalcrunch that could change the Industry," Business Week, 23 March1981; and "Moving away from mainframes: The large computermakers' strategy for survival," Business Week, 15 February 1982.
17. Indeed, the poor financial performance of the U.S. semi-conductor industry and depressed conditions in the U.S. stockmarket have led to a growing foreign interest in the industry.Acquisitions of U.S. semiconductor firms by foreign systemsmanufacturers since 1975 include: the U.S. Philips Trust's acqui-sition of Signetics, Siemens' acquisition of 80 percent of theequity of Litronix and 20 percent of the equity of Advanced MicroDevices, Robert Bosch's purchase of 25 percent of the equity ofAmerican Microsystems, and Schiumberger's acquisition ofFairchild Camera and Instrument.
18. Chase Financial Policy, U.S. and Japanese SemiconductorIndustries: A Financial Comparison, as cited in SemiconductorIndustry Association, The International MicroelectronicChallenge, May 1981.
19. U.S. semiconductor firms have debt-to-equity ratios ofless than 25 percent on average, while four of the Japanesesemiconductor firms analyzed in the Chase study maintaineddebt-to-equity ratios of 150 to 230 percent. In contrast to U.S.firms, Japanese semiconductor firms are able to employ highleverage ratios because of their affiliation with large industrialgroups, Japanese lending practices, and a supportive governmentpolicy. Chase Financial Policy, v. cit.
High debt-to-equity ratios have allowed Japanese firms tolower their producton costs and, therefore, increase their pricecompetitiveness. Following years of booming sales, however,some of Japan's major electronics manufacturers are relying lesson bank borrowing to finance their growth and more on long-termbonds and even common stock. As Japanese firms strengthentheir financial positions, they will be able to take greater risks,e.g., in research funding, than they have been able to in the past.See, for example, "How Japan will finance its technologystrategy," Business Week, 14 December 1982; and "Japan's latestcorporate advantage," The Wall Steet Journal, 16 September 1982.
20. One of the important Tnstitutionai factors responsible forthe high savings rate in Japan is the special treatment of taxationon capital income. Small savers are encouraged through fullexemption of taxes on interest income up to the first 9 billion yen(approximately $40,000). Favorable tax treatment is also accord-ed the capital income of large savers, which can be separatedfrom labbr income and is taxed at a maximum rate of 35 percenton interest and dividend income and 16 percent on some bonds.Further, taxation on capital gains is virtually zero in Japan.
40
.0"
26
21. Larger sales _volume provides the potential for a higherlevekof cash flow with which to finance R&D projects. Internallygenerated funds and stockholders' equity are used for nearly allR&D projects. One reason for this is that the output of R&D isintangible and, in contrast to capital equipment, does not providephysical collateral for a loan or bond issue. Another reason is thatR&D projects are typically more risky: than capital investmentprojects and, therefore, better suited to financing by equity andinternal funds than debt.
22. It should be noted that one-third of all engineering Ph.D.candidates are foreign nationals, two - thirds of whom are in theUnited States on student visas. Although many of those in thelatter category may remain in the United States, the total numberof new Ph.D.s who enter the labor force each year will be less thanthe number who receive their degrees. Science and EngineeringEducation for the 1980s and Beyond, prepared by the NationalScience Foundation and the U.S Department of Education,October 1980.
23. Entry-level computer programmers, however, are now Inoversupply as a result of the dramatic increase in the number ofpeople retraining for computer programming jobs. See, forexample, "Jobs for programmers begin to disappear," BusinessWeek, 16 August 1982.24. Faced with a continuing shortage of computer program-mers, computer firms are working on ways to streamline andsimplify the programming process. See, for example, "Computercompanies develop devices to ease programming," The Wall StreetJournal, 25 June 1982.
25. See, for example, National Science Foundation and U.S.Department of Education, Science and Engineering Education forthe 1980s and Beyond, October 1980; Pat Hill Hubbard, Plan forAction to Reduce En ineerin SuM7TnData, American Electronics Association, Palo Alto, California,October 1984. and James Botkin, Dan Dimancescu, and Ray Rata,"High Technology, Higher Education, and High Anxiety,"Technology Review, October 1982.
26. In considering cross-national comparisons in engineering,one must be cautious because educational systems are not paralleland may be quite dissimilar. For example, the group labeled"engineers" in one country may include an unknown number ofthose termed "technicians" in the United States.
27. In Japan, 20 percentof all bachelor's degrees and about40 percent of all master's degrees are granted to engineers, andthese figures have been stable for the past decade. This compares;with a figure of about 5 percent at each degree level in th7United States.
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14
27
28. Merton 3. Peck, "Technology," in Hugh Patrick and HenryRosovsky,(eds.), Asia's New Giants The Brookings Institution,Washington, D.C., 1976.
29. For example, the size of the electrical engineeringfaculty at Tokyo University has expanded only slightly over thepast two decades, and Its physical" plant has changed little sincethe 1950s. See, "Japan's strategy for the 80's: Why industry muststep in to train engineers," Business Week, 14 December 1981.
30. For example, at Japan's largest consumer electronicscompany, a design engineer's training includes a tour of duty in thecompany's retail outlets, selling and servicing products, followedby an assignment in the factory, working on the assembly lines.When he is finished, he has a "personal appreciation" for what thepublic wants and, presumably, for how best to design a product forproducibility and reliability. "American manufacturers strive forqualityJapanese style," Business Week, 12 March 1979.
31. Although It is difficult to assess the value of Japanesetraining practices, It Is likely that the Japanese engineer Is morefamiliar than the U.S. engineer with the capabilities and problemsof his own company. On the other hand, the Japanese engineermay be less familiar with practices in other companies anduniversity research in his specialty. Some observers thus believethat fhe Japanese career pattern is better suited for applying andimproving technology, which often involves, close working rela-tionships with production engineer, than for major technologicalinnovation., 32. In addition, two-year community colleges also face someunique problems: low faculty retention rates; increased compe-tition from comprehensive colleges and universities searching forstudents; decreased funding from the local sources on which thecolleges heavily rely (financing of two-year colleges comesheavily from local tax sources); and poor preparation inmathematics on the part of students, which absorbs considerableresources for remedial teaching.
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3Barriers to
International Trade
In recent years, U.S. electronics firms have increasingly looked toforeign markets, and a greater number of foreign firms havebegun to compete in the United States. With rising investmentrequirements for R&D and production capacity, success in worldmarkets has become an important determinant of a firm'slong-run commercial viability. Maximum access to foreignmarkets is necessary to keep production costs as low as possibleand to . recover large R&D costs associated with productdevelopment. Further, markets that are sheltered give producerslocated in them the opportunity to engage in price discrimination,e.g., by setting high domestic prices to fund R&D and low priceselsewhere to gain export market share. Increasing trade barriersto expoetts.in Europe, Latin America, and Asia have thus become aserious concern for U.S. electronics manufacturers.
This chapter provides an overview of the international tradeproblems faced by the U.S. electronics industry. A more detaileddiscussion of particular problems in major industry segments iscontained in Chapters 4 through 7. The first section of thechapter contrasts the strong historical contribution of electronicsto the U.S. merchandise trade balance with the problems posed bythe current overvaluation of the U.S. dollar in world currencymarkets. The extraordinary global strength of the dollar since1980 has in effect created a barrier to U.S. exportsone that goesfar in explaining the recent escalation of protectionist sentimentin the United States. The second and third sections examine someof the tariff and non-tariff barriers that confront U.S. firmsseeking to gain access to foreign markets. The ch-pter closeswith a note on the need for major reform of the internationalmonetary system. Unless the dollar's value comes down, U.S.electronics exports will be handicapped regardless of the U.S.success in eliminating barriers to trade.
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43RY,
\29
U.S. ELECTRONICS INDUSTRY TRADE BALANCE
The U.S. electronics Industry has historically made a substantialpositive contribution to the U.S. merchandise trade balance. By1980, for example, the combined trade balance In the four majorelectronics industry product groups shown In Table 3-I-- electroniccomponents, consumer electronics, electronic computing equip-ment, and telephone and telegraph equipmentwas a $3.3 billionsurplus. In contrast, the overall U.S. merchandise trade balancewas a $27.7 billion deficit.
The U.S. trade position, however, varies across segments of theelectronics industry. One sectorradios and television receivingsetshas shown large deficits, particularly with the Japanese.Electronic components have shown surpluses, despite extensiveoffshore assembly operations of U.S. firms and the recent increaseof Japanese market share in computer memories. Electroniccomputing equipment has contributed large trade surpluses. Aswith the semiconductor industry, the computer industry operatesan extensive international network of assembly and manufacturingplants. As a result, exports do not fully portray the strength ofthe U.S. industry's competitive position. Trade in telecommuni-cations equipment has also produced consistent surpluses, thoughthese have been moderate, particularly in relation to U.S.production.
In 1981, the size of the U.S. electronics trade surplus declineddue largely to the combination of a strong U.S. dollar and a weakJapanese yen. The unanticipated persistence of high interestrates in the United States during the recent recession, coupledwith political and financial uncertainties elsewhere, kept thedollar strong, leading to a decline in U.S. price competitiveness.At the same time, restrictive Japanese capital market proceduresserved to keep Japanese interest rates low and the yen weak. Asa result, Japanese exports gained a substantial price advantageand increased share in foreign markets. As shown In Table 3-2,for example, the Japanese trade balance with the United Statesimproved in each of the industry segments noted above.
If the Japanese system of formal capital market controls andinformal guidance were completely relaxed, many observersbelieve that Japanese Interest rates would rise, and the yen wouldappreciate. However, all agree that result would take time.There is no money market in Japan and only a limited range \\ofgovernment securities. Further, many banks, the major source offunds for the bond market, insist that the bonds they buy besecured by collateral. Thus, in the transition period, greaterinternationalization of the yen is likely to weaken it further, asJapanese investors continue to.pursue the opportunity for higherreturns abroad and foreign borrowers of low-interest yen converttheir loans into dollars.
SOURCE: Premed by Bureau of Economic Analysis, U.S. Department of Commerce.
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Sharp improvement in the Japanese trade position and deter-ioration in that of the United States and western Europe haveincreased trade tensions worldwide. National governments nowface intense pressure to support their domestic producers byrestricting access to their home markets. For example, Francerecently imposed a series of stiff administrative measures to stemforeign imports ranging from video tape recorders to heavymachinery. The following two sections describe some of themajor tariff and non-tariff barriers faced by U.S. electronicsproducers.
TARIFF BARRIERS
Tariffs remain a barrier to the free flow of electronics productsin world markets, particularly in the European Economic Com-munity (EEC), where the jatest multilateral trade negotiationsfailed to achieve a reduction in duties. Tariff rates facing U.S.electronics exports in most major foreign countries exceed thecorresponding U.S. duty. In 1981, for example, U.S. tariff, rates onintegrated circuits stood at 3.8 percent, while the correspondingrat's facing U.S. exports ranged from a 10 percent ad valoremrats imposed by Japan to the 17 percent common external rate othe EEC to rates as high as 30 percent in some Asian countries.2
High tariffs are most burdensome,for products where the localindustry has reached an essentially equal leyel of technology. Insuch cases, a substantial tariff duty either reduces the pricecompetitiveness of the product or forces the exporter to absorbthe added cost. Where no equivalent local product exists, high-tetchnology products are not usually excluded by high tariffs.Indeed, the EEC selectively suspends duties on products for whichproduction is inadequate or nonexistent in its member states.Once production is adequate, however, the suspension is lifted andU.S. exports are then placed at a competitive disadvantage. Thetechnological edge possessed by the U.S. electronics industry isthus an essential factor in successful export sales.
A further tariff-related barrier impeding U.S. exports toEurope is created by the "rules of origin" _governing nnnagricul-tural trade between the EEC and the European Free TradeAssociation (EFTA). These rules limit the amount of importedmaterial an item may contain and still receive duty-free treat-ment when it is exported within the EEC/EFTA area. The ruleapplied to electronic equipment limits the value of importedcomponents in a finished product to less than 5 percent. Thislimitation discourages European electronics systems producersfrom using imported semiconductor devices since it can restrict
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6-
their potential market or increase their selling cost in otherEuropean countries.
In Japan, U.S. exports face tariff barriers related to Japanesecustoms valuation practices. If Japanese customs officials feelthat the invoice value of Imported products does not reflect nor-mal value in trade, they raise this value for tariff duty purposes.This practice, called "customs uplift," is alleged by U.S. industryobservers to be arbitrary and inadequately explained, as well astime-consuming and expensive.
NON-TARIFF BARRIERS
Non-tariff barriers in Europe and Japan pose an increasinglyserious problem for U.S. electronics firms. As described below,these barriers arise from many sources, including restrictions Ingovernment procurement, "buy-national" attitudes in privateindustry, obstacles to the establishment of foreign subsidiaries,standards, closed-end market and distributor practices, Importlicensing, financial controls, customs procedures, documentationprocedures, and various non-tariff charges.
Restrictions in Government Procurement
Restrictions in government procurement affect all segments ofthe electronics industry, but have their most serious impact onthe telecommunications equipment industry. However, therefusal of foreign state-owned telecommunications agencies touse foreign-made equipment or equipment containing significantquantities of imported components also has a negative impact onthe integrated circuit industry because the use of integratedcircuits in telecommunications equipment Is large and growingrapidly.
Barriers to sales of U.S.-produced equipment posed by foreignpost telephone and telegraph (PTT) authorities are twofold.Approval procedures for equipment purchases by these agencies,mainly in developed countries, are designed to limit the use ofimported equipment. In addition, standards and specifications aregeared to locally produced equipment and are often arbitrary,undefined, or unavailable. These difficulties reinforce prevailingpolicies in Japan and western Europe that require local sourcingof equipment and components, unless they are not availablelocally.
None of the European PTT authorities is subject to the gov-ernment procurement code negotiated during the Tokyo Round
under the General Agr ement on Trade and Tariffs (GAIT). In
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France, for example, telecommunications equipment procurementis reported to be restricted to a preferential list of suppliers thatgives highest priority to locally owned companies, followed byforeign subsidiaries located In France, followed in decreasingpreference by the extent of French ownership. Until 1981, theJapanese PTT authority, Nippon Telegraph and Telephone (NTT),also refused to purchase foreign-made telecommunications equip-ment or equipment using foreign components. However, as aresult of bilateral negotiations with the United States, NTT'sprocurement has now been made more accessible to foreignsuppliers. To date, however, NTT procurement from foreignsources remains an infinitesimal portion of the utility's annualbudget.4
Private Industry Purchases
Reluctance or refusal by private companies in foreign countries topurchase imported electronics products is often cited as a seriousnon-tariff barrier facing U.S producers. In some cases, suchreluctance is attributable to the difficulties created by othertrade barriers, such as foreign exchange controls, importlicensing, and standards barriers.
Such restrictions are found In many countries, but they aregenerally regarded as most serious In Japan. Indeed, a "buynational" psychology is said to pervade much of Japanese indus-try. For example, in recent submissions to the U.S. InternationalTrade Commission, four major U.S. semiconductor manufacturersreported that Japanese firms that use and distribute integratedcircuits will generally purchase imported components only whenthey are unavailable from a Japanese supplier.
Obstacles to Establishment of Foreign Subsidiaries
Manufacturing and sales subsidiaries foreign countries aregenerally viewed as essential to assure access to the market. Aformal sales presence in a country is useful in providing technicalservice as well as in assuring customers with respect to service,product reliability, and delivery. In addition, foreign manufac-turing subsidiaries may be necessary to overcome such barriers astariffs, buy-national policies, and attitudes on the part of publicand private enterprises, or any competitive edge based on lowlocal factor costs. Moreover, as discussed above, access toimportant foreign PTT markets also requires local productionfacilities in many cases.
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Foreign government policies that prohibit or impcde directinvestment in subsidiary firms or joint ventures may thus pose asignificant non-tariff barrier. Difficulties in establishing saltsand manufacturing subsidiaries In Japan have been particularlytroublesome for U.S. firms. Until 1975, the Japanese, with rareexceptions, effectively prohibited both the construction offoreign-owned plants in Japan and foreign investments in existingJapanese companies..5 A measure of the effectiveness of Japan'sprotectionist policies with respect to foreign investment is that,while U.S. semiconductor firms had established 46 subsidiaries inEurope by 1974, Including 18 manufacturing operations, only oneU.S. semiconductor firm possessed a manufacturing operation inJapan. Even now, establishment of foreign-owned opergtions inJapan remains difficult and, therefore, will continue to limit U.S.exports.
Standards
Technical product standards can also pose trade barriers in caseswhere they are difficult to identify or comply with. Standardshave frequently been cited by U.S. producers as a significantbarrier to exports to Japan.6 For example, foreign producers arenot allowed to participate in the formulation of Japanese industrystandards, and are generally not notified in a timely fashion orconvenient manner of the nature of changes In mandatorystandards. In addition, provision for overseas testing ofcomponents destined for Japan is lacking, and application ofstandards to imports is uneven. NTT standards for electronicequipment and components are often based on design, rather thanperformance, placing outside suppliers, not well acquainted withNTT design specifications, at a disadvantage. Moreover, equip-ment development for NTT is conducted by local suppliers,making some of the designs proprietary information and closingthe contracts to all other suppliers.
Import Licensing
Another potential non-tariff barrier involves Import licensing. If
licenses are not automatically granted, the costs, delays, anduncertainties associated with compliance can detract from thecompetitiveness of imported goods relative to domestic products.Brazil is often cited as an example of a country where complexand time-consuming import licensing procedures constitute abarrier to trade. In addition, licensing may be used to administer
36
quantitative restrictions on Imports, a practice that is followedmainly in developing countries.
Financial Controls
Foreign exchange controls and other regulations on the method ortiming of payment for iinports make trade more difficult byincreasing the administrative and financial cost of selling over-seas. Required prior deposits of up to several times the value ofthe Imported shipment are, In effect, a tax on the transaction,tying up .working capital without payment of interest and exposingthe deposit to adverse exhange-rate changes during the monthsthat the deposit is held. Such practices are most common indeveloping countries, mainly for monetary reasons.
Customs Procedures and Documentation
The documentation required of importers in order to take posses-sion of merchandise at point of entry varies from country tocountry. The industrialized western countries generally have fewrequirements, while Japan and most developing countries requiremore complex documentation. Although , documentation is notgenerally processed In a discriminatory manner, complex require-ments and slowness of procedures in some countries can causedelay and expense that detract from the competitiveness ofimported goods.
Complex and time-consuming customs documentationrequirements and procedures in Japan are viewed as a significanttrade barrier by U.S. exporters. The Japanese Customs TariffLaw not only involves extensive paperwork and delays, butprocedures vary by location. In addition, Japanitse customsofficials may impose customs clearance charges in excess ofimport duties, commodity taxes, and documentation fees.
OPENING MARKETS TO INTERNATIONAL COMPETITION
Escalating trade tensions between the United States, Japan, andthe EEC have not only frustrated efforts to liberalize existingtrade restrictions, but thcy have also led to a proliferation of newtrade barriers. Tariffs--the main bargaining target in past gen-eral trade liberalization efforts such as the Tokyo Roundare nolonger the major obstacles to trade. Non-tariff barriers have nowbecome the main trade deterrents, and they are far harder toeliminate because their impact on trading partners varies greatly,
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leaving less room for multilateral trade-offs. For example, theUnited 'States is substantially open to foreign competition. Incontrast, U.S. companies face formidable trade barriers in Japan.Japanese officials have long resisted U.S. demands that theJapanese market be opened to U.S. exports, arguing that suchdemands ignore Japan's fundamental vulnerability in an increas-ingios.utroubled world economy. Similarly, the EEC is far lessanxious than the United States to lower trade barriers. Europeansfear that their domestic electronics industries will be wiped outby more advanced U.S. and Japanese rivals If the EEC agrees tocurb subsidies and open Its markets to more foreign competition.
Efforts to resolve the current trade conflict without funda-mental reform of the International monetary system will meetwith Wit success. Progress toward ;per world trade must ad-dress the underlying causes of the repeated, and severe, exchange-rate misalignments that have periodically emerged between thedollar and the yen and other currencies. There is no inherentreason why these problems cannot be resolved effectively. It isessential, however, to move quickly to begin the process ofadjustment if the mounting pressure for protection in the UnitedStates and elsewhere is to be headed off.
NOTES
I. Since late 1980, the spread between U.S. and JapaneseInterest rates has typically ranged between 7 and 10 percent. inMay 1982, for example, the prime rate in the United States was
16.30 percent; Its equivalent in Japan was 6.65 percent. Suchinterest rate differentials are generally seen as evidence thatJapan's capital markets are closed. If Japanese money marketswere unrestricted, foreign borrowers would, in theory, raisemoney in Japan to take advantage of the ,lower cost of funds and,
thereby, force Japanese interest rates higher.Despite slow and steady liberalization over the past
decade, Japan's capital markets remain the most tightly con-trolled of any major economy. In addition to fixing the price ofall government bondsat artificially low rates according to mostobservers, the Ministry of Finance is also empowered to set limits.on the amount of foreign currency domestic and foreign banks canconvert into yen and to control the number and size of foreignbond offerings in Japanso-called samurai bonds. Further,through a regular system of informal consultations, the Ministryof Finance controls the volume and price of overseas loans byJapanese banks and the purchase of foreign securities by domesticInsurance and security firms.
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Until recently, decisions on which foreign firms couldborrow in Japan were determined by strict rules set down byTokyo's Capital Market Committee, which represents Japan'sbanks and security houses and is strongly influenced by theMinistry of Finance. In addition, foreign firms' seeking money inthe Tokyo market had either to prove they were financing specificJapanese exports or to sell yen-denominated bonds to Japaneseinstitutional investors. The bond market was In effect closed toall but the most creditworthy companies offering large issues, $50million or more and confined to just one foreign issue eachquarter.
See, for ixamp-e, "Is Japan _holding the yen down?"Business Week, 8 March 1982; "Are the Japanese rigging the yen?"Fortune, 31 May 1982; "Japan's capital market has U.S. critics,"The New York Times, 1 June 1982; "Borrowing yen will be a littlebit easier," Business Week, 31 May 1982; and "Borrowers are eagerto get yen loans but must grapple with Japan's delays," The WallStreet Journal, 7 July 1982.
2. In the latest round of Multilateral Trade Negotiations,Japan and the United States, established a formula designed toharmonize reciprocal duties on semiconductors by 1987. In thatyear, a final rate of 4.2 percent will be achieved through agradual staging of reductions over a period of eight years.
3. For a detailed discussion of the non-tariff barriersdescribed in this section, see U.S. International Trade Commis-sion, Competitive Factors Influencing, World Trade in IntegratedCircuits, Washington, D.C., November 1979; and Organization forEconomic Cooperation and Development, TelecommunicationsEquipment Industry Study, Pacis, October 1981.
4. See, for example, "High-technology gateway: Poreignersdemand a piece of NTT's $3 billion market," Business vieek, '9August 1982.
5. The Impediments to successful direct Investment in Japanby U.S. companies range from difficulties in recruiting able andexperienced engineers to preferential access for Japanese firmsto capital, government guarantees, special tax incentives, loans,and subsidies. For example, a significant barrier to entry to theJapanese market is posed by the Inability of foreign companies toacquire Japanese companies. The difficulty in acquiring Japanesecompanies is due partly to Japanese law, which requiresunanimous approval by the board of the company to be acquired,,thus effectively blocking any unfriendly takeover. Culturalfactors, however, also make the sale of a Japanese companyunusual, except in cases of near bankruptcy or other financialdifficulty. See, "Japan's aversion to selling companies may beultimate barrier to U.S trade," The Wall Street Journal, 23 March1982.
6. The electronics standards certification process in theUnited Kingdom is also reported to constitute a barrier to importsof integrated circuits.
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4The Semiconductor Industry
p
$ustalned innovation in semic onductor technology has been cen-tral to the strength of the U.S. electronics industry. Since theInvention of the seminal semiconductor device, the transistor,over three decides ago, the state of the art in microelectronicshas advanced at a phenomenal rate. New developments haveproilded better performance at lower costs. As each newperformance/price threshold has been attained, the number offeasible applications for semiconductor technology has multiplied.
As discussed in Chapters 2 and 3, however, the future techno-logical leadership of the U.S. 'semiconductor industry is threat-ened by increasingly severe financial and human resource con-straints as well as by mounting protectionist sentiment both leeFeand abroad. At the same time
'the 3apanese semi or
industry has been successful in closing the technological gap withU.S. firms in several critical high-volume, high-growth productareas. These developments also threaten the position of U.S.firms in electronits equipment markets given the need for closeinteraction between systems producers and IC maneacturers indesigning and producing competitive new equipment.
Thid chapter reviews the position and problems facing thesemiconductor industry. Section one describes the size andinternational position of the U.S. semiconductor industry.Although international trade has steadily increased in importance .
to U.S. semiconductor firms over the past decade, the U.S.Industry has slipped from a position of dominance to beingstrongly challenged. This challenge has come not just fromforeign competitors, but from fore governments that havefocused on their local industries Or development and offered
, law-cost financing, trade protect and other: measures to help.develoo thorn. . i
The second and third sections of the chapter examine the U.S.industry structure and the semiconductor manufacturing process.In contrast to Europe and Japan, a large jortion of U.S. produc-
39
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40
tion is accounted for by firms with relatively low degrees of ver-tical integration. Easy conditions of entry in the noncaptive ormerchant sector have historically promoted the technologicalcompetitiveness of the U.S. im'ustry. In recent years, however,dramatic. increases in the complexity and cost of integratedcircuit manufacturing have encouraged a stream of mergers,acquisitions, and joint ventures that have altered the structure ofthe industry.
The final section of the chapter provides an assessment of thedynamics of U.S.-Japanese competition in random- access com-puter memories. Several of the factors discussed in Chapters" 2and 3Japan's joint government/industry VLSI research program,its favorable financial environment, and its protectionist trade andinvestment policieshave been major ingredients of the Japaneseindustry's success. Japan's semiconductor industry has also beenpromoted by Its dominant position In consumer electronics.Whether the Japanese industry is able to make further competi-tive inroads in the years ahead will depend on the combinedresponse of U.S. industry, government, and universities.
INDUSTRYSIZE AND INTERNATIONAL POSITION
The U.S. semiconductor industry has historically served threedistinct customer groups -- consumer, industrial /commercial, andmilitary. The computer industry today is the single largestcustomer of the U.S. semiconductor industry, accounting forapproximately 40 percent of semiconductor pr9duction, a sharethat has been fairly constant for 20 years. share ofsemiconductor output consumed by military and aerospace appli-cations has declined dramatically from 50 percent in 1960 toapproximately 10 percent in recent years. The remaining portion,which has increased from roughly 10 percent to 50 percent today,is divided among telecommunications equipment, process controland test equipment, and consumer products, such as automobiles,calculators, television sets, and video games.
The value of U.S. product shipments of semiconductors andrelated devices increased from $2.4 billion to $9.1 billion between1972 and 1981, an average growth rate of 16.2 percent.2Inflation-adjusted growth, however4 was even higher, given pricede "nes in important product lines.'
": he semiconductor industry is highly dependent on inter-national trade. In 198!, U.S. exports of semiconductors were $3.5billion, and imports stood at $3.3 billion. Over the 1972 to 1981period, exports increased at a 25 percent annual rate in currentdollar terms, while imports went up at a 29.2 percent rate.4
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4I
Between 1972 and 1981, exports as a percentage of productshipments rose from 19.9 percent to 38.3 percent, while importsas a percentage Of new supply (product shipments plus imports)rose from 12.3 percent to 26.5 percent? Imports as a percentageof total trade increased gradually over the period from 41.2percent to 48.4 percent, reflecting an increase in U.S. offshoreoperations and heightened competition from Japan, particularly inthe random-access memory segment of the industry.
Because a single semiconductor device is frequently shippedbetweerl several countries before it is a completed manufacturingproduct, a review of the trade data can be misleading. U.S.semiconductor firms began to establish offshore operations in the1960s jn order to be more cost-competitive and to overcomeforeign trade barriers to U.S. exports. Accordingly, U.S. importdata must be interpreted with care since it consists not only ofimports of foreign products, but also of the reimportation ofcompleted devices originally exported as sub-assemblies. In fact,these sub-assemblies represent as much as 75 percent of the valueof imported integrated circuits.6
The U.S. semiconductor industry has also faced increasingcompetition from the Japanese semiconductor industry. Althoughthe domestic Japanese semiconductor market has grown dramati-cally over the past decade and is now the second largest in theworld, U.S. exports to Japan face formidable trade barriers.Since 1977 the United States has had a deficit in total integratedcircuit trade with Japan.7 In 1978 the United States ran a $3.7million trade deficit with Japan in integrated circuits. By 1980that deficit had reached nearly $300 million. Even in advanced.Metal-Oxide Semiconductor (MOS) integrated circuits, where U.S.firms have been technology leaders, U.S. exports to Japan in-creased by only $25 million between 1975 and 1980. Conversely,Japanese exports of advanced MOS ICs to the United States wentfrom practically nothing in 1975 to $120 million in 1980.
In contrast to the U.S. semiconductor industry's lack of suc-cess in Japan, U.S. firms currently supply half of Europe's totalsemiconductor demand and more than 60 percent of its Integratedcircuit consumption. While the protectionist policies of theJapanese government effectively prohibited the establishment ofU.S. manufacturing subsidiaries until recently, U.S. semiconductorfirms made significant investments in Europe beginning in the late1960s. As discussed in Chapter 3, this movement was influencedby high European tariffs as well as by pressure from Europeangovernments to establish local production facilities. In somecases, establishing a manufacturing facility was a prerequisite toobtaining access to segments of particular national markets, e.g.,communications in the United Kingdom and computers in France.Currently, four U.S. firms, all with major European production
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facilities, are among the 10 largest European semiconductorproducers.8
U.S. semiconductor firms, however, are likely to face in-creased competition in Europe over the next decade. Japaneseelectronics firms have recently moved to establish semiconductorproduction facilities in Europe. Moreover, in addition to thehistorical protectionist barriers in western Europe, national gov,ernments particularly those in France, West Germany, and theUnited Kingdom, have moved to assist their local industries indeveloping capabilities in advanced microelectronics, e.g., throughdirect governmental support, preferential purchasing arrange-ments, and acquisition of U.S. technology.
INDUSTRY STRUCTURE
The U.S. semiconductor industry has moved through three phasesin its 30-year history. The first phase, which started with thedevelopment of the transistor and continued through the 1950s,saw the evolution of basic semiconductor-technology. This evolu-tion permitted greater mechanization of the transistor manufac-turing process, improved performance and reliability, increasedproduction rates, and lowered unit costs, resulting in turn in lowerprices and greater sales volume. The second phase was ushered inwith the introduction of the integrated circuit. During this phase,which lasted through the early 1970s, the number of semiconductorelements on a single IC chip increased steadily through medium-scale integration to the early stages of large-scale integration,where as many as 10,000 component elements were fabricated ona single chip; The third phase, which began in the early 1970s, hasbeen characterized by advances in large-scale and very large-scale integration, notably the incorporation of logic and memoryon the same chip, that have yielded dramatic improvements in thecost and performance of the latest electronic equipment.
The initial phase of the semiconductor industry's developmentbegan with the establishment of semiconductor divisions by majorelectronic tube manufacturers. Production in these new facilitieswas for either internal use (captive) or for the open market (mer-chant). Western Electric and IBM established captive facilities--aresult of court decree in the first case and corporate choiceinformed by antitrust considerations in the latter. Large tube andequipment manufacturers such as RCA, General Electric, andSylvania established semiconductor operations to supply both theirinternal needs and the open market. In addition, Texas. Instru-ments and Motorola, though not tube manufacturers, folloted asimilar pattern and are now major merchant producers.
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Three important factors encouraged the development of thesemiconductor industry in the 1950% The first was the U.S.military's interest in the technology.' For a limited time, theU.S. military was a major sponsor of the development of newdevices. Further, the military's willingness to pay a premium forquality and reliability helped the industry to bear the cost ofrefining and debugging its products. Second, the establishment ofliberal technology licensing policies broadencKI the industry'stechnological base and encouraged its expansion.I°
The introduction of the integrated circuit in the early 1960swidened the reach of semiconductor technology, enabling theindustry to reduce its unit costs and thereby its dependence onmilitary demand. The growth of the computer industry and itsprice-sensitive demand for ICs created opportunities for entry bynew producers. Entry of new firms was also encouraged by theavailability and cost of capital, the availability of labor, and thetechnological capability of the individuals forming new companies.The 1960s thus witnessed an influx of new entrants, including someof today's leading merchant producers such as Advanced MicroDevices, Intel, Mostek, and National Semiconductor. An impor-tant spawning ground for new ventures during the 1960s wasFairchild Instrument and Camera, the innovator of the planarprocess that made integrated circuitry commercially feasible.Fairchild's Semiconductor Division itself had only been estab-lished in 1957.
The new entry phenomenon that characterized the semicon-ductor industry in the 1960s was critical in stimulating competi-tion in product design, price, service, and quality. Further,because the advent of IC technology opened new opportunities forproduct differentiation, new entrants were able to exploit marketniches overlooked or underdeveloped by established firms. Asshown in Table 4-1, new entry and the dynamics of competitionled to a marked decline in the concentra: ion of IC shipmentsbetween 1965 and 1978.
After the early 1970s, however, the tate of new entry into thesemiconductor industry slowed dram4cically, while the number ofmergers and acquisitions increased." These trends are attrib-utable to three factors. First, the capital equipment and R&Dexpenditures necessary to keep up with the latest technology haveincreased the cost of entry. Rising capital costs, coupled withchanges in the late 1960: in the tax treatment of capital gains,increased the difficulty of forming new ventures. Second, theevolution of semiconductor technology has encouraged systemsmanufacturers to integrate backwards. As individual ICs havetaken on the capability of complete electronic systems, systemsproducers have sought to acquire merchant semiconductor firms asa means of incorporating proprietary designs, assuring a reliablesource of supply, and capturing the increasing value added
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TABLE 4-1 Concentration of U.S. Integrated Circuit Shipments
Number ofCompanies
Percent of Total Shipments
1965 1972 1978 1982
4 largest companies 69 S3 49 47
8 !swot companies 91 67 70 64
20 largest companies' 99 94 90 84
50 bused companies 100 100 100 100
SOURCE: The Semiconductor Industry Association. The ititensational Atheroehsetranie
Chdlenje, Cupertino, CA, May 1981, and Dataquest.
associated with the design and production of large-scaleintegration devices. Finally, acquisitions by foreign electronicsfirms were encouraged by the weakness of the U.S. dollar in the1970s and, until recently, by the depressed state of the U.S. stockmarket. These factors made it cheaper to buy technology (andU.S. market share) through the purchase of existing companiesthan to gain it through in-house development or adaptation of thelatest technologies.
Recently, however, the rate of entry into the semiconductorindustry has increased with an influx of new companies specialk-ing in the design or production of custom integrated circuits.ThisThis wave of entry has been encouraged both by the increasedavailability of venture capital following the 1978 revision of thecapital-gains tax law and by the increased demand for custom cir-cuits generated by the move to VLSI technology. Existing com-panies have also formed custom divisions, spurred by the need forcloser interaction between systems manufacturers and IC pro-ducers created by the increased costsand opportunitiesof VLSItechnology.I3 In some cases, the design work is performed by thecustomer with the IC manufacturer providing only a deviceprocessing or foundry service.
The size of the independent merchant sector of the U.S. semi-conductor industry is unique compared to Europe and Japan. Themajor foreign producers of ICs (other than U.S. subsidiaries) aregenerally part of vertically integrated electronic equipment com-panies. Leading European producers are the Netherlands-basedconsumer electronics firm, Philips, and the West German-basedindustrial electronics firm, Siemens. Similarly, the major Japa-nese IC producers -- Nippon Electric, Hitachi, Toshiba, Mitsubishi,Matsushita, and Fujitsuare also manufacturers of electronicsystems.
The vertically integrated structure of foreign semiconductorindustries is an advantage to the extent that it facilitates closeinteraction between component and systems divisions and makes
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capital available from internal funds outside the IC division.Nevertheless, the size and sophistication of the U.S. merchantsector offers the industry as a whole important strengths thatforeign industries lack. These include the merchants' ability toachieve low-cost volume production by standardizing designs formany customers' needs, the role of merchant Rrod,.ucers in accel-erating the pace of technologi .1. advance," the ability ofcaptive companies to rely on merchant supply for peaks in theirdemand,I5 and the promotion of a strong IC production equipmentindustry. It is thus difficult to view either U.S. merchant orcaptive producers in isolation. Rather, the health of one dependson the other, and the strength of the U.S. electronics industrydepends on the two together. Indeed, increasing recognition ofthe interdependence between component suppliers and systemsmanufacturers is reflected in a wave of cooperativeinitiativesmajor joint ventures, technology exchanges, andownership agreementsamong computer, communications, andsemiconductor firms.' 6
THE SEMICONDUCTOR MANUFACTURING PROCESS
The manufacture of semiconductor devices requires mastery ofhighly complex production techniques. What makes the processeconomic is the use of mass production techniques.. Basically,semiconductor manufacturing is a batch process with a largenumber of precise operations involving heat Meatment andmultiple stages of chemical deposition and etching."
Circuit designs are first transferred to a "mask," which is usedas a template in the device fabrication process. A number ofidentical integrated circuits are then created on a single circularwafer of silicon. Even in the most successful wafer fabrication,some of the integrated circuits will have defects. Problems suchas impurities may prevent a particular integrated circuit fromfunctioning properly. It is therefore necessary to conduct exten-sive testing of the fabricated circuits at each stage. One round oftesting is conducted before the wafer is cut into individual chips,and the defective chips are marked. After cutting, the defectivecircuits are discarded and the good ones sent on for bonding intopackages that protect the integrated circuits and provide elec-trode connections for insertion into printed circuit boards.Another round of testing is conducted after the assembly intopackages.
Because of the complexity of the production process, only apercentage of the devices out of the total number fabricated areactually acceptable at the end of the manufacturing sequence.The ratio of successful devices to the batch total is referred to as
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the "yield." Yield is a measure of the efficiency of the productionprocess. For the first commercial runs of the most sophisticatedtypes of integrated circuits, the initial yields have historicallybeen low. However, over time, improvements in yield are madeas production experience is cumulated. A recently introducedmethod of increasing yield for some high-density ICs is to build inredundant components and use laser beams to make new circuitswhen certain portions of the chip are found to be defective. As aresult of such process improvements, yields for mature productstypically become quite high. This phenomenonof increasingyields over the life of a productis one of the basic underpinningsof the learning curve in semiconductor manufacturing.
The strength of the learning curve in this industry provides astrong incentive to either be the manufacturer with the firstwidely accepted design, or if not the originator, to build volumerapidly with a lower priced copy or variation of the widelyaccepted design. By increasing volume, a manufacturer reducesits costs and either increases its profit or is able to cut prices andbuild further volume. The only war to escape the pressure ofother firms moving down the learning curve, in essence, is tocreate a new learning curve by making a product advancesufficiently great to obsolete much of the previous product.
Another aspect of IC production that puts downward pressureon price is the ease with which devices can be disassembled,analyzed, and functionally replicated. Although some protectionis available through patents and copyrights, the litigation processis time-consuming compared to the pace of competition. In anycase, patent protection is relatively weak, as it is in other areasof electronics, due in part to the high degree of interdependencyamong different inventions and components of a system. There-fore, there is considerable cross-licensing of IC patents andwillingness to allow otter firms to produce or second source aparticular design. This willingness is reinforced by purchaserrequirements for second-source protection.. Since the cross-licensing is well institutionalizeddue in part to AT&T's adoptionof an open-licensing policy in the 1950sthe major competitorsneed not necessarily actually disassemble another firm's device tocopy it, but merely obtain a license to get the design. Typically,they would then not produce an exact copy, but rather a compat-ible device, with their own improvements added. Nevertheless,the potential for copying does result in some actual instances ofthat practi -e and also contributes to the willingness of firms tolicense widely.
Finally, as discussed in Chapter 2, the advent of large-scaleand very large-scale integration technology has substantiallyIncreased the capital investment required to manufactureadvanced integrated circuits. These technologies have required
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new production equipment, whereas prior semiconductor genera-tions could be produced by equipment already in place. For exam-ple, the 16K RAM could be produced with basically the same typeof equipment that had been used to,. produce the predecessordevice, the 4K RAM; in contrast, the equipment necessary to gofrom the 16K RAM to the 64K and beyond Is different and morecostly. Similarly, equipment used in other phases of production israpidly escalating in cost. Testing in particular has become morecostly as product quality competition has Intensified, and thedevices themselves have become more complex and difficult totest. Available estimates inate that testing costs hive in-creased from about 10 percent of total cost to 25 percent.I5
BASES FOR COMPETITION:A CASE STUDY OF THE RANDOM-ACCESS MEMORY
High-volume products, such as MOS memory devices for com-puters, have great strategic importance to the internationalcompetitive position of the U.S. industry. Profits orf high-volumeproducts help finance the research required for new products.Further, because MOS memory devices are one of the largestsemiconductor product groups in terms of sales- volume, theseproducts stand at the cutting edge of IC technology. It is an areain which production techniques have been advanced and refinedand, therefore, have led the way technologically to greater ICdensity and complexity. A company that is not involved in MOS
. memory technology risks its positiqq in the semiconductorindustry, even as a specialized supplier. 17
Until the late 1970s, the U.S. semiconductor industry wasunchallenged in IC technology and markets. Because the U.S.computer industry was the largest in the world, and becausecomputers used the most advanced ICs, it was difficult to Imaginehow the dominant position of the U.S. semiconductor industrymight ever be seriously threatened. In contrast, the Japanese hadconcentrated on integrated circuits for consumer electronics andhad little capability for circuits used in computer and telecom-munications equipment. In 1976, however, as part of a generaleffort to develop those industries, the Japanese launched their
four-year, joint government /industry VLSI program to producemore complex integrated circuits.
The dynamic Random-Access Memory, a high-volume, stan-dardized product, was an ideal first target for the Japanese. Itallowed them to capitalize on their traditional strength (low-costmanufacturing) and to minimize their relative weaknesses (innova-tion and distribution/support services). In addition, capital andtechnical personnel problems hampered the competitive reactions
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of U.S. semiconductor firms, aiding the Japanese assault, first in16K and later in 64K RAMs.
The ability of the Japanese to compete successfully in state ofthe art computer inemory devices was dramatically demonstratedin the 16K RAM.20 When introduced in late 1976, the 16K RAMwas considered the most advanced semiconductor memory devicein volume production. Three U.S. companies began shipping the16K RAM to customers in late 1976. In 1977 they were joined bytwo other U.S. and two Japanese companies. The Japanese fol-lowed an entry strategy based on second sourcing the 16K designof Mostek, the U.S. market leader.
A complex interaction of market factors characterized the1978 to 1980 period. Demand was exceptionally strong due to thestrength of the U.S. economy and an unanticipated requirement byIBM and others for a substantial quantity of 16K RAMs. Duringthe 1974 to 1975 recession, however, U.S. semiconductor firmshad cut back sharply on capital spending for production capacity.By 1979 demand for the 16K RAMs picked up to the point where itoverwhelmed the capacity-limited output of U.S. manufacturers.
In addition, the demand for the 16K RAM was very price-sensitive because, like other high-volume semiconductor products,the device was characterized by standard specifications. Toimprove their market position, Japanese suppliers repeatedlylowered their prices. In late 1977 prices of the 16K RAMS rangedfrom $16 to $18; by late 1978 prices had fallen to the $5 to $6range. This price pressure led several U.S. firms to discontinueRAM production. Moreover, early U.S. buyers of Japanese 16KRAMs, notably Hewlett-Packard, reported that Japanese RAMshad a lower frequency of defects than domestic ones. Thanks toaggressive automation, the Japanese thus took the lead in setting16K RAM yield, quality, anci reliability standards. By the end of1979 the Japanese had garnered over 40 percent of U.S. sales of16K RAMs.
In anticipation of the 64K RAM, U.S. semiconductor manufac-tArers moved to neutralize the Japanese advantages in productioncapacity and quality. Moreover, most U.S. merchant firms pur-sued design strategies that sought to minimize the size of the dieon a 64K RAM, since die size potentially allows the manufacturerto incoase the number of usable chips obtained from eachwafer." In contrast, the Japanese chose a conservative designapproach, adapting and improving a design that had been used inMostek's 16K RAM. As a consequence of designing larger cells onlarger dice, the Japanese were more successful than their U.S.counterparts in avoiding technical problems and establishingvolume production. By the end of 1981, the Japanese held anestimated 70 percent of 64K RAM sales, and only two U.S. firms,Motorola and Texas Instruments, had begun volume production.22
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Most observers, however, expect U.S. semiconductor manufac-turers to improve their product designs and production efficiencyand, therefore, to increase their market share as sales of 64KRAMs expand.23 Until recently, users had little incentive toreplace 16K RAMs in their products because recession and com-petition combined to cause a dramatic, collapse in the prices ofthe older generation products. However as the pzice of 64KRAMS has also plummeted, demand has exploded." By 1983worldwide sales are forecast to be nearly $1 billion --a figure thatwould make the 64K the largest selling product in semiconductorhistory. The booming demand for 64K RAMs, by creating tightsupplies and stretched deliveries among some suApliers, has thusprovided a market opening for late U.S. entrants.4)
The competitive position of U.S. suppliers may also be aidedby U.S. users in the computer industry. Reluctant to rely com-pletely on Japanese suppliers such qs Hitachi, Fujitsu, and NEC,which are also competitors, U.S. *stems manufacturers havereportedly waited to qualify U.S. firms on their list of approved64K ,ZAM suppliers, even though the qualification process involvessubstantial costs. In addition, U.S. semiconductor firms retain theadvantage of being broad-based suppliers, while Japanese productofferings are more limited.
Nevertheless, with their success in 64K RAMs, Japanese semi-conductor manufacturtr, have enhanced their competitiveness insuccessor generations." By gaining early experience in makingthe complex 64K RAM, the Japanese are widely expected tocapture a substantial share of 256K sales. in. early 1983, at leastfour of the top Japanese semiconductor manufacturersHitachi,NEC, Fujitsu, and Toshibawere reported to be sending samplesof their 256K RAMs to potential customers. Indeed, industryobservers believed that some Japanese producers were alsoprepared to begin mass production and mass marketing.27 Incontrast, not one of the traditional U.S. memory manufacturerswas close to starting volume production.
Problems in the three major areas discussed in Chapters 2 and3availability of technical personnel, cost of capital, andrestricted access to foreign marketshave had a major impact onthe competitiveness of U.S. RAM manufacturers vis I vis theJapanese. High staff turnover resulting from shortages of keytechnical personnel contributed to the difficulty experienced byU.S. firms in achieving their sophisticated 64K design objectives.The 64K effort has required longer range planning and greaterteam work than previous products. Accordingly, prob:ems inkeeping design teams together have hindered the efforts of U.S.semicoNuctor firms, particularly those located in SiliconValley."
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Personnel continuity is also Important on the production side.The need for training and retraining of workers has placed atitrainon U.S. semiconductor manufacturers that is minimized under thelifetime employment systems of large Japanese electronics firms.Indeed, the greater continuity of Japanese workers In their jobs isfrequently cited as an important factor in explaining the highquality of Japanese ICs.
At this time, however, the most pressing problem for U.S.firms arises from Japanese capital-cost advantages. For example,U.S. semiconductor firms increased investment spending slowlyfollowing the sharp cutback made during the 1975 recession. Incontrast, investment spending by Japanese firms accelerated in1976, spurred by a boom in consumer electronics sales. Japanesefirms were, therefore, able to take advantage of the rapid growthin demand for 16K RAMs in the late 1970s. The Japanese semi-conductor industry is again reported to be engaged in a majorinvestment campaign.29 This investment surge comes at a timewhen U.S. semiconductor manufacturers, suffering from weakmarkets, high capital costs, and aggressive Japanese, competition,have had to reduce operations and delay many investmentprograms.
Restricted access to the Japanese market has also contributedto the Japanese success in winning RAM market share. Accordingto the Semiconductor Industry Association, Japanese prices for16K RAMs in the United States were some 20 to 30 percent belowlevels in Japan in 1979. Such price discrimination is difficult toachieve without a sheltered market. The higher prices in Japanthus contributed to R&D and capital investment for the 64Kgeneration, while the lower price in the United States succeededin denying revenue to U.S. firms for future product developmentand production capacity. (The problem of restricted access to theJapanese market is, of course, compounded by the vertical tiesbetween Japanese IC producers and systems equipment manufac-turers.) Although the Japane have eased restrictions on ICdirect investment considerably since 1979 (as was done for con-sumer electronics in the early 1970s), the restrictions were notlifted until the Japanese industry was established as a formidablecompetitor.)u
The Japanese success in 64K RAMs also raises fundamentalquestions about the ability of U.S. firms to counteract Japanesecompetition in other segments of the IC industry. In micro-processors, the Japanese lag U.S. manufacturers .in circuit designskills and software technology. The Japanese leadersNEC,Hitachi, and Matsushitaso far have only bein able to capturemarket share in relatively low-value, low-power microprocessors.In 4-bit microcomputers, used mainly in consumer eleCtronicsproducts that require relatively little in the way of software
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support, large volume has enabled the Japanese to capitalize ontheir highly automated production techniques and their largedomestic market for consumer - oriented components. In the morecomplex 8-bit and 16-bit microprocessors, which go into com-puters and office machines and require larger amounts of soft-ware, Japanese manufaclyrers are currently either copying orlicensing U.S. designs." Nevertheless, MITI is currentlycoordinating a joint software development program that shouldnot be underestimated in its ability to give the Japanese industrya competitive boost.
Although the Japanese are currently weak in microprocessorsand other logic circuits, Yapanese semiconductor manufacturersmust diversify into these areas or their memory business maysuffer to the extent that customers prefer dealing with broad-linesuppliers. Moreover, some observers believe that Japanee firmswill begin to develop more complex microprocessors when a largevolume export market in personal computers materializes.Indeed, the Japanese lag is expected to narrow as standardizedsoftware and system designs are adopted for microprocessorapplications, particularly in personal computers.
Finally, an important factor supporting the Japanese drive todevelop their competence in integrated circuit technology is thecountercyclical support afforded by the strength of the consumerelectronics industry in Japan. Indeed, consumer electronics hasbeen the driving force behind the development of the Japanesesemiconductor industry. in 1981, for example, Japanese consumerelectronics, led by worldwide demand for home video cassetterecorded, accounted for 50 percent of Japan's semiconductoroutput.3' By contrast, just 15 to 20 percent of U.S. and Europeansemiconductor production goes into consumer goods., Consumerelectronics sales have thus bolstered Japanese semiconductorproduction during periods when the more heavily computer-dependent U.S. industry has suffered slowdowns.
NOTES
1. Robert W. Wilson, Peter K. Ashton, and Thomas P. Egan,Innovation,. Competition and Government Policy in the Semi-conductor Industry, A Charles River Associates fesearch Study.D. C. Heath & Co., Lexington, Massachusetts, 1980.
2. in contrast to the.1912 .to 1981 period as ,a whole, thevalue of product shipments in 1981 increased by only 2.0 percentin current dollars (2.5 percent in 1972 dollars). U.S. Departmentof Commerce, U.S. Industrial Outlook 1982, Government PrintingOffice, Washington, D.C., 1987.
(
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3. The U.S. Department of Commerce reports an averageinflation-adjusted growth rate of 19.3 percent for the 1972 to1981 period. However, the government price index seriouslyunderstates the rate of price decline and, therefore, the inflation-adjusted growth rate, due to the rapid rate of product change, thesharp price declines in new products relative to older products,and the lag in incorporating new products into the governmentprice index.
4. The increases in U.S. exports and imports in 1981, 1.5percent and 4.3 percent, respectively, also stand in contrast to the1972 to 1981 period as a whole. U.S. Department bf Commerce,U.S. Industrial Outlook 1982, Government Printing C:fice,Washington, D.C., 1982.
5. U.S. Department of Commerce, U.S. Industrial Outlook1982, Government Printing Office, Washington, D.C., 1982.
6. In 1978 imports of semiconductors under the special tariffprovisions of items 806.30 and 807.00, which enable U.S. manufc-turers to reimport products paying duty only on the value addedby their offshore facilities, amounted to $1.5 billion. U.S. Inter-national Trade Commission, Competitive Factors InfluencingWorld Trade in Integrated Circuits, November 1979.
7. U.S. Department of Commerce, U.S. Industrial Outlook1,982 Government Printing Office, Washington, D.C., 1982; and
iInternational Microelectronic Challenge, The SemiconductorIndustry Association, Cupertino, California, May 1981. The US.Department of Commerce may underestimate U.S. exports toJapan to some degree because U.S. firms export to Japan fromtheir offshore facilities as well as directly from the UnitedStates. Nevertheless, these measures of the trade balance Insemiconductors do not Include semiconductor components inelectronic equipment imported into the United States fromJapan. In 1978, for example, the value of *he semiconductorcontent contained in electronic equipment exported by Japan tothe United States has been estimated to be almost three times thevalue of visible component exports. World SemiconductorIndustry in Transition 1978-1983, Arthur D. Little, Cambridge,Massachusetts, 1980.
8. The International Microelectronic Challenge, TheSemiconductor Industry Association, Cupertino, California, May1981.
9. The earliest ICs were based on bipolar semiconductortechnology, which possesses properties that are well suited tomilitary applications, especially for equipment operating underharsh environmental conditions. Metal-Oxide Seiniconductor(MOS) ICs, which appeared in the mid-1960s, operate at lower'speeds than their bipolar counterparts, but consume less power./Lower power consumption permits a denser packing of circuit
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elements since less heats has to be dissipated. As a result of thisdensity advantage, MOS devices have gained primacy in cornmer-,cial computer applications. Although bipolar technology remainsimportant in many applications due to Its performance advan-tages, advarKed complementary MOS. (C-MOS) technology ofsmall dimensions is expected to surpass bipolar in terms of.speed.
10. The major U.S. technological innovators In the semicon-ductor industry have followed a liberal licensing policy, whichrecognizes the difficulty of maintaining Industrial secrecy inIndustrial environment where mobility of scientists and engineershas been high and results of semiconductor research were widelyavailable. For a discussion of technology licensing during theearly years of the industry, see John E. Tilton, InternationalDiffusion of Technology; The Case of ,Semiconductors, TheBrookings Institution, Washington, D.C., 197i.
11. The net effect of the acquisitions and merged over thepast decade on the ownership interests of U.S. merchant ICproduction has been dramatic. In 1970 there was no foreignownership f..Ii any significance;. by 1978 nearly one-fifth of totalU.S. merchant IC production was concentrated in firms withsignificant foreign ownership. Likewise,, the proportion ofproduction under the control of large parents (excluding TexasInstruments and Motorola) went from a negligible amount to 11percent by 1978. The International Microelectronic Challenge,The Semiconductor Industry Association, Cupertino, California,May 1981. Merchant firms acquired since 1978 include Synertek(Honeywell), Fairchild Camera & Instrument (Schiumberger),Mostek (United Technologies), Siliconix (Westinghouse), andIntersil (General Electric).
12. See, for example, "New starters m Silicon Valley,"Business Week, 26 3anuary 1981.
13. In addition to the activity in custom devices, existingmerchant manufacturers, e.g., Intel, National, Ti, and Motorola,are attempting to integrate forward into office automa.ionequipment. See, for example, "Intel may soon compete with itscustomers," Business Week, 22 March 'I9 and "Motorola's newstrategy: Adding computers to its base In electronics," BusinessWeek, 29 March 1982.
14. On the subject of technological change, one study foundthat over 80 percent of the major semiconductor innovationsbetween 1960 and 1977 were introduced by merchant companies.(See Wilson, et al., opt cit.) Although some of these Innovationswere built on research advances made at captive companies, themerchant sector has been effective at accelerating the process oftechnological change. The captive producers, in tin, benefitboth from having the technology advance further and from theavailability of advanced devices from outside sources.
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15. Most captive IC production is run near capacity, with peakneeds of IC devices bought from merchant producers. Thus, themerchant companies tend to suffer sharper cyclical fluctuation indern-nd than captive producers.
i6. For a listing of recent cooperative agreements, see "IBMand Intel link up to fend off the Japanese," Business Week, 10'January 1983.
17. For a more detailed description of the semiconductormanufacturing process, see U.S. Department of Commerce, AReport on the U.S., Semiconductor Industry, Government PrintingOffice, Washington, D.C., 1979.
18. The International Microelectronic Challenge, The Semi-conductor Industry Association, Cupertino, California, May 1981.
.19. rry Sanders, president of Advanced Micro Devices, hasexplained the importance of computer memories as follows: "Theway to drive down costs for almost any integrated circuit is tomake computer memories. They are the single part with thehighest volume, and the process art you acquire producing themcan be applied to everything else. By making complex parts, youalso learn how to make your simpler consumer circuits performbeaer." As quo' in Bro Uttal, "Europe's wild swing at thesilicon giants," For July 1980.
20. This account of Japanese competition in 16K and 64K1-2ANis draws on the following sources: "Japan's ominous chipvictory," Fortune, 14 December 1981; "Japan's strategy for the'80's," Business Week, 14 December 1981; "Rolling with recessionin semiconductors," Business Week, 21 July 1980; "Can semicon-ductors survive big business?, Business Week, 3 December 1979;"Japan's big lead in memory chips," The New York Times, 28February 1982; chip makers' glamorous new generation,"Business Week, ober 1980; "A chance for U.S. memories,"Business Week, . March 1982; "Two chip-making giants 'gear upfor recovery," Business Week, 31 May 1982.
21. The size of the die in a chip, however, is not of greatsignificance to users since packaged chips of a particular type areall the same size.
22. Motorola, like the Japanese companies, followed a conser-vative design strategy. TI, which adopted a more complex design,was later than Motorola in establishing volume production.
23. For example, IBM selected Intel to provide second-generation 64K RAM design and process technology. AlthoughIBM already makes its own 64K RAM, Raters new 64K RAM offerssuperior speed, redundancy, and a sophisticated process tech-nology known as "direct-step-to-the-wafer." "Intel wins memory-ct job from IBM, a major coup in Japan-dominated field," The%; Street Journal, 2 September 1982.
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24. To solidify their market position, the Japanese haverepeatedly lowered prices. As recently as March 1981, prices for64K RAMs were $28; by March 1982, prices had dropped to the $6to $10 range, with further price reductions' anticipated. Indeed,some observers believe that, at such levels, Japanese prices werebelow the cost of production.
25. To be profitable at the current low price levels, new 64Ksuppliers, as well as other suppliers, are attempting to redesigntheir products to reduce costs and improve product reliability.Only firms with the lowest manufacturing costs will be able tocompete for sales of 64K RAMs.
26. The Japanese Will enjoy a significant Adt.antage if theirdesigns become de facto product standards. To the extent thatother firms incur higher costs as a result, the standard setter willbe able .o exploit its cost advantage to expand market share andto finance future product development.
27. Although the major Japanese sepiconductor manufac-turers are pushing ahead with developmen of the 256K dynamicRAM, they face a strategic dilemma. If /they move too aggres-sively into the 256K, sales of 64Ks will/collapse. Nevertheless,competition among the Japanese companies may lead them tomass produce the 256Ks sooner than they might have hoped.
28. The ease in obtaining venture capital is exacerbating theturnover problem by prompting increasing numbers of key employ-ees from established manufacturers to leave and form new com-panies. See, for example, "Technology: Venture capitalists raidSilicon Valley," Business Week, 24 August 1981.
29. See, "Capital investment )fl semiconductors expanded byJapan," The New York Times, 1 April 1982. The Japanese semi-conductor industry is guiding its investment plans to guard againstprotective action by foreign governments, For example, theJapanese are increasingly investing in semiconductor productionand assembly facilities in the/United States.
30. Until the liberalization measures, the Japanese effec-tively prohibited both the construction of foreign-owned plants inJapan and foreign investment in existing Japanese semiconductorcompanies. The sole exception, Texas Instruments, was able toestablish a manufacturing presence in Japan in the late 1960s dueto its ability to withhold key IC production patents from theJapanese unless access was granted. Without these patent rights,exports of Japanese products using ICs could have been challenged.
31. However, in October 1981 NTT- announced the develop-ment of a 32-bit microprocessor, only month after Intel, BellLaboratories, and Hewlett-Packard announced their own designs.
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'N\ 32. For example, in the first half of 1981 MITI estimated thatJapa se semiconductor production was up 24 percent, while U.S.produc on for 1981 as a whole was down 2 percent, See,"Semico ductors: Consumer electronics provides the foundation,"Business Week, 14 December 1981,
71
5The Computer Industry
The three-decade history of the U.S. computer industry has beenone of extremely rapid technological change. Order of magnitudeincreases in computing power have been accompanied by order ofmagnitude decreases in cost per calculation. Computers havebeen used on a far broader and deeper scale than predicted bygovernment or business in the early years of the industry. U.S.firms have been leaders in computer product and applicationdevelopment throughout the post-World War II period.
This chapter examines the competitive position of the U.S.computer industry. The first section describes the overall sizeand international position of the U.S. industry. U.S. firms accountforan impressive share of both domestic and international computersales, though Japanese firms have captured large market shares insome low-cost peripheral equipment products. Nevertheless, theefforts of our trading partners, particularly Japan, are focuseddirectly on taking the competitive lead from the United States.
The second and third sections of the chapter present an over-view of the history of the industry and the underlying technologi-cal developments in semiconductor logic and memory. Newentrants have had an important influence on the structure of thecomputer industry, particularly in pioneering new product seg-ments. Changes in the industry's structure have also been closelyrelated to the evolution of semiconductor technology. Forexample, the entry of new firms producing personal computerswas made possible by developments in integrated circuit micro-processors.
The final sections examine the bases for competition in thecomputer industry, with particular emphasis on the relative U.S.position in software development, production capabilities, anddistribution networks. The nature of competition in the Industryis changing as the economics of volume production have turnedproducts such as computer memories and microcomputers essen-
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tially into commodities, thereby heightening the importance ofcustomer-tailored software and service. The U.S. strength insoftware development and distribution will thus continue to be animportant competitive advantage. Nevertheless, the ability of theJapanese to close the software gap must not be underestimated.
INDUSTRY SIZE AND INTERNATIONAL POSITION
The computer industry has been one of the most remarkablegrowth industries of all time. The value of computers and relatedequipment shipped in the United States was just over $1 billion in1958, growing to $4.2 billion in 1968, and $16.6 billion in 1978.Shipments in 1981 were estimated by the U.S. Department ofCommerce at over $30 billion, giving the industry a compoundannual rate of growth of 18.8 percent between 1972 and 1981. Anexplosion of the customer base is expected in the 1980s. Oneforecast predicts that the value of industry shipments will reach$74.8 billion by 1985.1
Exports of computer equipment and parts, an important itemin the U.S. balance of payments, rose 20 percent in 1981 to anestimated $8.8 billion.'' This increase was less than the 30percent annual rate of growth enjoyed between 1976 and 1980 dueto the adverse effects on U.S. computer exports of theovervaluation of the U.S. dollar in relation to the Japanese yenand downturns in key western European markets. In addition, thevalue of exports showed a shift toward a greater percentage ofparts over equipment. For example, Jreland and Hong Kong haverecently emerged as important importers of U.S. computerequipment due primarily to the buildup in these countries of U.S.assembly facilities, particularly those established by sevnalleading U.S. minicomputer and microcomputer firms. Imports ofcomputing equipment and parts grew, rapidly in 1981, rising anestimated 38 percent to $1.6 billion.) As a result, the ratio ofimports to new supply (product shipments plus imports) increasedfrom 0.045 to 0.052. Canada ani Japan remained the leadingsuppliers, while imports from the United Kingdom and France fellbelow their 1980 levels. In the case of Japanese exports to TheUnited States, joint marketing ventures between Japanesesuppliers and U.S. distributors helped to boost the 1961 level.Finally, parts assumed a larger share of Imports from manyEuropean countries and represented more than 90 percent ofimport value from Hong Kong and Mexico. U.S. subsidiaries Inmany of these countries were significant contributors to theseshipments.
The competitive strength of the U.S. computer industry, bothdomestically and internationally, is highlighted by comparison of
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TABLE. 5-1 1980 Trade Ratios for Computer Equipment of PrincipalNations
SOURCE: Official government statistical publications of each country. As Presented inthe U.S. Department of Commerce, US Into Outlook 1982, Washington, D,C.:U.S. Government Printing Office.
1980 trade ratios for six principal nations shown in Table 5-1.While West Germany, the United Kingdom, and Italy exceeded theU.S. export-to-new-supply ratio, the United States had the lowestimport-to-new-supply ratio of the six, reflecting the U.S. indus-try's dominant hold on its domestic market. Japan's ratios showthe second strongest domestic position, but relatively low inter-national sales.
Table 5-1 does not portray the full strength of the U.S. com-puter industry because overseas subsidiaries of U.S. computermanufacturers contribute significantly to the computer produc-tion and trade of most of these countries. For example, in thecase of computer exports from the United Kingdom, as much as70 to IN percent is estimated to come from U.S.-owned operationsthere. While U.S. production accounted for 40 percent of the$12.8 billion in exports of the six principal trading countries in1979, the U.S. Department of Commerce estimates that the UsS.-owned share would be 60 to 70 percent, or about $8 billion.
This strong U.S. position is also reflected in company-levelcomparisons of the leading computer firms in these six countries.In 1980 the worldwide computer revenues of the top eight U.S.computer firms reached an estimated $43.7 billion, a 15.7 percentincrease over 1979. Comparable revenues from eight foreigncounterparts in 1980 were an estimated $10.0 billion, up 17.1percent over the previous year. The relative commitment ofthese U.S. and foreign firms to computer products can be seen inthe fact that in 1979 the computer-related revenues as a percentof total revenues represented 73 percent and 21 percent for theU.S. and foreign firms, respectively.6
The leadership of the United States in computers, coupled withthe realization that this industry is an increasingly critical sectorof a nation's economy, has motivated both developed and develop-ing countries alike to create or strengthen their own industries. In
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several cases, governments have encouraged joint ventures,licensing, and acquisitions as a means of rapidly acquiring thenecessary technology. Recently, as the technical proficiency ofJapanese firms has advanced, they have become alternativesources to U.S. computer firms for new technology. Japanesecompanies, for example, are principal participants in joint ven-tures with indigenous firms in the Brazilian government's effortsto create a minicomputer industry.
Japanese computer manufacturers have become increasinglyaggressive in the smaller QECD countries and in developingcountry markets, where they have reportedly offered deep pricediscounts to buy market share. For example, in Spain, Australia,and Brazil the Japanese have provided substantial discounts tocentral banks and government agencies to replace IBM computerswith Japanese plug-compatible machines, which can run on IBMsoftware, but offer more processing power at a lower price. Oncethe public sector replaced its IBM computers with Japanesemodels, the private sector followed, though at higher prices.'
Japanese computer companies are also forming alliances withseveral European computer and business equipment firms for themarketing of their large-scale to very large-scale computer pro-cessors. These cooperative efforts have given Japanese com-panies market access without the expense of establishing distri-bution and maintenance networks and allowed the European firmsto avoid the high costs of developing production capability in thismarket sector.
INDUSTRY STRUCTURE
The U.S. computer industry has historically been an internationaltechnology leader. During the 1940s, laboratory work in computertechnology was undertaken in both the United States and Europe;however, the U.S. industry quickly progressed from theoreticaladvances to develop computer products to sell in the market-place. In 1951 a U.S. company, Remington Rand, produced theworld's first commercially available, large-scale electroniccomputer, the Univac I. Other first-generation U.S. computerswere the Univac II ana IBM 701 and 702. During the 1950s, largeU.S. corporations acquired first-generation vacuum tube com-puters to handle accounting and payroll functions. The federalgovernment was another important customer. Indeed, the firstUnivac I was installed at the U.S. Bureau of the Census.
In the late 1950s, transistorized second-generation computersappeared on the market in the United States. These included theIBM 7090 and 1401, RCA 300, Control Data Corporation CDC
et,
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1604, Burroughs 3500, and Univac 1108 II. Second-generationcomputers were characterized by their use of transistors,advances in logic, and introduction of magnetic core memories.Data entry was on punched cards, and output was through lineprinters. Systems software and compilers came into use. Thesecomputers, which operated in a batch mode, were utilized in abroader range of applications than first-generation machines.
By 1960 six U.S. mainframe manufacturersBurroughs,Control Data, Honeywell, IBM, National Cash Register (NCR), andSperry Univachad all entered the industry, and IBM had emergedas the industry's dominant firm. Two other entrants in the earlyperiod, General Electric and RCA, later withdrew from theindustry. Xerox Corporation withdrew from the industry in 1975.
Third-generation computers were introduced in tne mid-1960s.Technological advances in electronic components were central inthe development of this generation. These computers incorporatedintegrated circuit technology, larger and faster memories, modu-larity in design, and time-sharing capabilityfeatures that reducedcomputing costs by an order of magnitude. Representative modelsincluded the IBM 360 series, RCA Spectra 70 series, Burroughs6500 system, NCR 500, CDC 6000 series, and Digital EquipmentPDP-6.
The fourth-generation computer systems introduced in the1970s feature large-scale integrated circuitry in logic and memorycomponents, standardized communications systems, networking,remote diagnostics, mass storage, data base orientation, and dis-tributed processing. These systems offer a continuing decline inthe cost of calculations coupled with increased computing speed.As hardware costs have declined, the design and manufacture ofthe fourth- generation systems have become increasingly auto-mated. This development has in turn invited entry by low-costproducers selling mainframe systems that can operate withsoftware written for IBM machines. The so-called IBM plug-compatible manufacturers, including Amdahl, Fujitsu, and Hitachinow account for a growing share of U.S. mainframe computersales.
Since the early 1970s, minicomputers and microcomputershave become powerful enough to perform many tasks that onlylarge mainframe systems could handle before. The low cost andconvenience of these small computers have thus created a newdemand for low-priced word and data processing equipment. Whenthe mainframe computer manufacturers delayed their response tothis new market opportunity, firms such as Digital Equipment,Data General, Hewlett-Packard, Tandem Computer, and WangLaboratories were able to make major penetrations into themainframe customer base by offering products with price andperformance characteristics that the mainframe manufacturers
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did not offer. Moreover, as minicomputer and mainframemanufacturers move into the fast-growing office automation andcommunications market, mainframe computers will increasinglyplay a background role in information processing. As a result,mainframe manufacturers are currently faced with majorchallenges as they replogram their product and marketingstrategies.8
As computer prices have fallen and business applicationssoftware has proliferated, sales of low-end microcomputers havebeen transformed from hobbyist orientation into one of thefastest-growing segments of the computer industry. Pioneered byfirms new to the computer industry (e.g., Apple Computer, TandyCorporation's Radio Shack Division, and Commodore Inter-national), personal computer sales increased from $77 million in1976 to an estimated $4 billion in 1982. One forecast predictsthat sales of personal computers will reach $20 billion by 1986.9Attracted by burgeoning demand, recent entrants include majorcomputer and business equipment firms, semiconductormanufacturers, and a host of small, newly formed companies.
While currently emphasizing the small business user, thosepersonal computer firms that have begun to establish distributionnetworks are positioning themselves for the future growth of thehome information market. As the home information marketevolves, it will encourage entry by firms outside the computerindustry. Consumer acceptance of these systems will be deter-mined not only by ease of use but also by the ability to perform awide range of functions such as security, environmental manage-ment, home ent, tainment and education, and access to remoteinformation services. Thus, competitors may come from indus-tries as diverse as consumer electronics,' telephone equipment andservices, and cable television.
These changes in the relative growth rates of different seg-ments of the computer industry have been marked by the emer-gence of small, young firms, many of which have introduced suchtechnological innovations as the minicomputer, the microcom-puter, and a wide variety of storage and terminal devices. In 1967the top 50 firms represented 98 percent of the value added of theindustry; by 1977 this share stood at 85 percent. Since 1977, thecomputer industry has witnessed an unprecedented number ofstartups, spurred by expanding demand, readily available venturecapital, steady reduction in component costs, and the develop-ment of standard software systems.
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BASES FOR COMPETITION
Competition among computer firms has traditionally focused onhardware product features, including quality and reliability,supporting services, and price. Increasingly aggressive pricecompetition has quickened the pace at which technologicaladvances have been incorporated into new product offerings.Price competition is also driving an industrywide move to developlow-cost product and distribution techniques. At the same time,however, emphasis is shifting to software. Fueled by userdemands for complete solutions to problems rather than justcomputing tools, computer firms are turning their attention tomore sophisticated systems software. Even minicomputer andmicrocomputer manufacturers, which formerly emphasized thehardware features of their machines, are now stressing the soft-ware support behind their products. Each of these bases forcompetitionsoftware, production, and distributionis examinedbelow.
Software
Software programs, or the instructions that guide equipmentthrough its tasks, are the necessary partners in any computersystem. Because of the increasing complexity and cost ofcreating software, many manufacturers have gradually separatedthe price ,i2f software from that of equipment, so-calledunbundling.") This unbundling has spread from applicationsprograms, written for particular user-oriented tasks such aspayroll accounting, to systems software, the programs governingthe management of the computer system.
During the 1980s, software is expected to receive greateremphasis both from the user and from computer firms. Users willbe seeking ever more sophisticated applications, exemplified bysuch trends as computer networking and distributed processing. Inresponding to these market forces, computer firms are directingmore of their internal resources into software development. Mostfirms already have more than half of their development staffsworking on software.
The U.S. computer industry currently enjoys a wide lead overthe Japanese in software technology." Except in Japan itself,Japanese manufacturers rely on software purchased from U.S.software houses or hire U.S. programmers. Indeed, the Japanesemanufacturers' difficulty in developing software is an importantfactor in explaining why the Japanese have lagged in buildingcomputer sales in the United States.
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Both the Japanese government and the coin 'mtter industry,however, have moved to bridge the softWare gap." Since 1979MITI has undertaken several Important software policy initiatives,including (I) the establishment of a government-f willed softwaretechnology research center, (2) grants to computer manufacturersto develop new operating systems software, and (3) grants to inde-pendent software houses for the creation of new applicationssoftware packages, as well as a 40 percent tax deferral on soft-ware revenues for the first four years of a program's life. At thesame time, Japanese computer manufacturers have increased themagnitude of financial and manpower resources committed tosoftware development. IThis increased commitment is reflected inthe expanding number of software subsidiaries opened by majorJapanese manufacturers as well as in the rapid growth ofindependent software hoiises in Japan.
The success of the Japanese computer industry in overcomingthe software development problem is likely to vary by industrysegment. In personal computers, where the competitive oppor-tunities faced by the Japanese manufacturers are ranked highest,software is increasingly being written in standard ways that makeit relatively easy to use on different machines. For example, thewidespread adoption of the CP/M operating system designed byDigital Research made the CP/M a de facto standard for the firstgeneration of 8-bit microcomputersry adopting standardoperating systems, the Japanese manufacturers of microcom-puters will thus be able to avoid an enormous investment insoftware, since their customers have access to thousands ofoff-the-shelf programs written for computers made by othermanufacturers.13 While this strategy is likely to facilitate theirefforts in the United States, reliance on a standard operatingsystem will not differentiate the personal computers of Japanesemanufacturers from those of their competitors.
In large computers, most Japanese manufacturers accept IBMoperating systems as a standard and design central processors andperipheral products able to run programs designed for IBMmachines. In the United States, for example, Hitachi markets itshardware through National Advanced Systems, a U.S. subsidiary ofNational Semiconductor that does much of the work in making theHitachi computers compatible with IBM programs. Similarly,Fujitsu sells hardware to Amdahl, a company that pioneered theIBM-compatible computer concept. To date, however, theprogram-compatible strategy of the Japanese has enjoyed Itsgreatest success in Japan. In 1979, for example, Fujitsu isreported to have surpassed IBM's Japanese subsidiary in salesvolume.14 Worldwide, program-compatible computersmost ofwhich are made by Japanese firms or include a large proportion ofJapanese parts--are estimated to have more than doubled theirshare of mainframe sales to 19 percent from 1977 to 1980.15
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The IBM-compatible strategy, however, may not be viable inthe long term, particularly if IBM adopts a new computer archi-tecture or lowers its price umbrella. In 1979, for example, IBMintroduced its 4300 series computers at a price that competitorsfound difficult to matcha move generally regarded as a responseto potential competition from the Japanese. Another threat tothe viability of the Japanese IBM-compatible manufacturers Is thepossibility that IBM will change its basic operating system. Sucha departure has often been discounted since IBM and its customers
\ have more invested In software than hardware. Nevertheless, bothIBM and its customers would likely be willing to render obsolete
\their software investment in the current architecture for a'radically new and better computer.
Although IBM-compatible suppliers have shown an impressiveability to adopt the standards established by the system suppliers,system manufacturers are likely to increase the sophistication andcomplexity of standards in ways that will make ,achieving thiscompatibility increasingly difficult. in particular, the trendtoward the use of microcode (rather than wired logic) to run amachine's operating system makes it possible to change amachine's nature after it has been installed; this ability providesnew degrees of flexibility for the system manufacturer to changeand enhance its interconnect standards. For example, IBM's series3081 computers, introduced In late 1981, contain a new internalstructure, called XA for "extended architecture," that allows forpost-shipment microcode changes that will be time-consuming,difficukti and expensive or IBM-compatible manufacturers tomatch.1 b
The Japanese have been least successful in penetrating thefast-growing market for minicomputers, where there is littlestandardization of software, and proprietry software is developedinternally. *Like mainframe customers, minicomputer userstypically 'require customized software for many applications, butthey want it at a lower price. Accordingly, the profit marginsderived friim the smaller systems are usually not large enough tojustify the investment in software development that the Japanesemanufacturers would need to achieve a'substantial market share.
Even in \Japan, Digital Equipment, Hewlett-Packard, and DataGeneral are the largest suppliers of minicomputers, just as theyare in the United States. Although NEC Information Systems, aU.S. subsidiary of Nippon Electric, has marketed its Astra line ofminicomputeks in the United States since 1979, almost all of thesoftware is produced by independent U.S. companies that buy theequipment from NEC and then write the software. (NEC esti-mates that 35 percent of the total value of the complete Astrasystem is produced in the United States.) Reliance on outsidesoftware, however, raises the problem of quality controla
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crucial isNe in a market that increasingly demands high-qualitysoftware.
Finally, U.S. researchers currently lead the Japanese in thedevelopment of software for the artificial ilelligence (Al)systems that are expected to become the basis of the "secondcomputer age."18 A growing number of U.S. companies, includingHewlett-Packard and Digital Equipment, have established Alresearch laboratories, while several leading Al scientists havestarted their own companies. Companies testing Al expertsystems include Digital Equipment, IBM, Bell Laboratories, Xerox,and Texas Instruments. Nevertheless, the aim of Japan's recentlyannounced 10-year, $450 million Fifth Generation ComputerProject is to develop a prototype of a new family of machinesdesigned especially for AI applications.I9 If successful, Japanesecomputer manufacturers would establish themselves as leaders inthe commercialization of Al and, thus, leapfrog U.S. competitors.While many observers believe the Japanese goals are highly, if notoverly, ambiflous, the program is likely to give the Japanesecomputer industry a major competitive boost, even if the projectfalls short of its objectives.
Production
The computer industry has been transformed in recent years bythe declining cost of computing power. As discussed in Chapter 4,the manufacturing costs of semiconductor memory and logic havedropped rapidly o'er the past decade. Moreover, the costs ofsome major peripheral equipment items, rticularly disk drives,have dropped almost as rapidly.20 The in ensity of competition inthe computer industry has, in turn, fore manufacturers to passthrough much of the decline in compo t costs to consumers interms of increasing performance-price r tios for new models (andselective price cuts for old ones).
While increasing performance-pric ratios have created anever-expanding market, they also me n that a firm must be alow-cost producer in order to be a via le competitor. Mainframecomputers that were once low-volume, and-crafted products withhigh profit margins have become high-volume, mass-producedproducts with slim profit margins. Since a manufacturer cannotprevent competitors from copying its technological advances, oneof the chief selling points of a computer is the amount of comput-ing power offered at a given price, a factor that is highly depen-dent on production efficiencies. Indeed, the importance ofproduction efficiencies was dramatically illustrated in 1979 whenIBM introduced its 4300 series of mid-sized mainframe computersat a price so low that the resulting competition cut severely intothe profits of plug-compatible machines.
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In the face of the changing economics of the computer indus-try, U.S. mainframe manufacturers are investing heavily in auto-mating their factories. Moreover, as the proportion of custom
mcircuitry in computers has risen, manufacturers have alsoIncreased their Investment in custom .logsic chips necessary toimprove the performanceprice ratios of their machines. Short-ages of custom chips or poor quality can bring automated,assembly-line production' to a halt. 'Indeed, problems with anIndustrywide shortage of semiconductor memory.: and in-houseproduction of proprietary circuits contributed to the widespreadproduction delays experienced by. computer manufacturers in1980.2' ,
The shift to low-cost, high-volume computer hardware, par-ticularly in the Modules at the heart of the newer. IBM computers,also requires a very large computer-based system and equipmentdesign capability. Cost pressures are thus likely to render itincreasingly difficult for even a large 'competitor to continuedesigning and manufacturing a full range of products. Moreover,the product lines of computer manufacturers increasingly sharekeyboards, memories, and other major components as manufac-turers seek to achieve economies of scale. Computer manufac-turers are therefore choosing to buy components of subsystemsfrom other suppliers, to establish specialized, jointly ownedsubsidiaries (e.g., Computer Peripherals, Inc., jointly owned byControl Data, NCR, and International Computers Ltd.), or toestablish cooperative arrangements, particularly on a multi -national basis. Even IBM has tended Id buy components andperipheral devices from other suppliers more than it has in thepast (e.g., printers from Qume and Dataproducts) and, indeed,buys most of the parts for its personal computer.
The transformation to high-volume, assembly-line productionhas not been an easy one for the computer industry. As they haveraced to introduce new equipment with state of the art technol-ogy, U.S. manufacturers have experienced problems in the produc-tion process not only .for mainframe computers but also fox datastorage devices, minicomputers, and computer terminals.2' Theproblem lies in the increasing complexity of custom logic circuitsand the resulting increase in the difficulty of correcting designflaws and software problems. The potential cost of such delays is,of course, magnified by the growing number of competitors in themarket. The new economics of the industry have thus increasedthe importance of producing cheimly with a quick iesignturnaround time. ,-.1
One possible outcome of the transition to a high-volume,mass-market business is that those, manufacturers that cannotmake the large investment in plant and equipment may norsurvive. IBM, for example, invested more than $4 billion in new
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plant and equipment between 1976 and 1980. At the same time,IBM's aggressive response to the plug-compatible manufacturersrapid product change and price-cutting--has eroded the price andperf,, -nce advantages that non-IBM-compatible mainframefirm. ,. traditionally had over IBM.23 The changing economiesof th'. . ,mputer industry have thus begun to cut into theprofitability of second-tier mainframe competitors' such asBurroughs, Sperry Univac, NCR, and Honeywell. Some observerspredict that the number of fully integrated computermanufacturers will be substantially smaller by the end of thedecade.
The shift to low-cost, high-volume computer products,however, may assist Japanese computer manufacturers in winningU.S. market share. Just as in the automobile and consumerelectronics industries, the traditional manufacturing skills andreliability of Japanese firms give them an advantage at thelow-pri9ed end of the product spectrum, which can later be usedas a l4sis for launching a competitive assault on large syStemsmarkets 'where it margins are higher. The Japanese areexpected to rig competitors in electromechanical pe-ripheral device. as printers, display terminals, and disk-me7ory storage devices. Japanese manufacturers have alreadycapkured more than half of U.S. sales of low-priced originalequipment manufacturer (OEM) printers.24 Moreover, theJapanese are expected to move aggressively into personalcomputers where they enjoy low costs for components such assemiconductors and keyboards.25 Matching the low cost ofJapanese manufacturers will be critical for U.S. personalcomputer manufacturers.
Distribution
Over the past three decades, U.S. mainframe manufacturers havesucceeded in building strong marketing and service structures.For this reason, as well as the intricate and deep dependency ofusers on system-specific software, brand loyalty is probablystronger in large computer systems than in any other segment ofthe industry'. Indeed, no firm in the industry inspires the loyaltythat Itih1 C7c...S with its almost legendary service and support.
Given the cost of establishing new marketing service systems,most foreign firms seeking to sell larger computer systems in theUnited States have used third-party vendors to distribute theirproducts. Of the Japanese computer mnanufacturers, only NEChas been willing to incur the investment necessary ,o set up a U.S.subsidiary with direct sales, maintenance, and support scaff. Incontrast, both Fujitsu and Hitachi have chosen to enter the UnitedStates in partnership witha U.S. company.26
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While the use of partners, third-party system houses, anddealers has helped the Japanese plug-compatible manufacturers tobuild market share without the expense of setting up a salesnetwork, long-term success will require an investment in building
a direct sales organization. However, the cost of such marketingorganizations would add to the cost of Japanese computers.Ultimately, this will raise strategic problems for Japanese manu-facturers, who use the fact that their products cost less thanIBM's as a major marketing tool.
In the low-priced minicomputer and microcomputer productareas, computer hardware costs have dropped so dramaticallydue to reductions in the costs of integrated circuits--that it is notpossible to follow the traditional industry practice of selling. bydirect sales contacts and still maintain profit margins. Comptitermanufacturers have thus intensified their efforts to developlow-cost channels of distribution for low-priced products.
Establishing low-cost distribution channels is perhaps thegreatest problem faced by manufacturers of personal computers.Traditionally, computer manufacturers have sold through theirown direct sales forces or through third-party system houses.
These marketing strategies, however, are too costly when dis-tributing products that sell for less than $10,000. Accordingly,manufacturers of personal computers are experimenting with avariety of selling outlets and techniques, including office equip-ment dealers, consumer electronics stores, computer specialtystores, department stores, and even mail-order catalogues.2"Increasingly, however, personal computer retailing is splitting intotwo major channels: general-merchandise stores and consumerelectronics stores, which sell low-cost, popular home equipment,and specialty stores, which offer more sophisticated products and
service for business users.28As more manufacturers have introduced personal computers,
the industry has become increasingly distribution- and service-
limited. Manufacturers relying on independent retailer distribu-tion channels have in some cases been limited by constraints in theavailability of dealer shelf space. Even Xerox, which introducedits personal computer in 1981, has' reportedly been faced with ashelf -space squeeze. in the home computer segment of the mar-ket, however, retail chains--from toy stores and discount houses
to television rental operationsare expanding to take up the slack
as prices fall.Although the retail distribution channel for personal com-
puters is closer to that of consumer video and audio.equipmentproducts in which the Japanese are strongthan it is to largecomputers, personal computers involve considerably; more educa-
tion, training, software, and post-sale support. The best distri-bution channels for the provision of such support are thus still
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being explored. One consequence has been that Japanese entry inthe United States has moved slowly as the Japanese learn aboutthe market.29
Distribution cost pressures have also increased for minicom-puters and superminicomputers. In the 1970s minicomputerstypically sold through computer systems houses or originalequipment manufacturers (OEMs).50 (OEMs, often small,entrepreneurial concerns, act as middlemen by designing com-puter software, acquiring peripheral equipment, and sellingcomplete systems to their customers.) Reliance on the OEMsallowed minicomputer manufacturers to avoid the expenseassociated with the sales and service organizations required tosell directly to customers who demand complete, fully assembledsystems. Increasingly, however, minicomputer buyers are bypass-ing the OEMs to avoid a markup on their computer systems. Todo so, minicomputer manufacturers are moving to expand thecapability of their sales and service organizations to deal withrelatively unsophisticated customers instead of the techno-logically astute OEMs.
THE CHANGING ECONOMICS OF THE COMPUTER INDUSTRY
The traditional competitive strength of the leading firms in theU.S. computer industry has been based on their ability as low-costproducers with strong customer relationships to develop and selltechnologically innovative hardware. Marketing and distributionhave been important, facilitating sales with the assurance thatcustomers would receive adequate service. Nevertheless, themarket leaders have been those that drove down the price ofhardware and added new features.
The nature of competition in the industry, however, is chang-ing as the economics of volume production have turned productssuch as computer memories and microcomputers essentially intocommodities where only a handful of companies can profit overthe longer term. In a growing number of markets, state of the arthardware is less important than providing a total system solutionspecifically tailored for the customer's needs. Today softwaretypically accounts for 50 percent of a computer product's devel-opment budget and can go as high as 80 percent.
Computer firms have thus begun to focus on identifyingspecific customer needs and designing software to fulfill them. Incontrast, hardware designs and development have become lessimportant as the significance of a competitor's introducing slightlybetter hardware has declined. Indeed, some new computer firmshave decided to go outside for almost all their components,concentrating their attention on software, sales, and service.Even IBM has increased its purchases of outside components and
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equipment. Increasingly, success will go to the companies thatoffer the most useful software and the best customer service andsupport, not necessarily the most powerful hardware or the lowestprice.
NOTES
1. U.S. Department of1982, and "U.S. markets:Electronics, 13 January 1982.
2. U.S. Department of1982.
3. Ibid.4. U.S. Department of
1981.5. U.S. Department of
1982.6. U.S. Department of
1981.7. See, for example, "Japan's strategy for the 80's: A
worldwide strategy for the computer market," Business Week, 14December 1981.
8. "Moving away from mainframes: The large computermakers' strategy for survival," Business Week, 15 February 1982.
9. Sales of home c iputers are still small compared withsales to business, but they are growing rapidly. One estimate isthat computers were in only one -half of 1 percent of U.S. house-holds in 1981, but will be in 2 percent by the end of 1982. Whileone-third of the computers now in homes are the more-expensivemodels, most new growth is expected to come primarily in theless-expensive models. See, for example, "The home ,.computerarrives," The New York Times, 17 June 1982; "U.S. markets: Dataprocessing and software," Electronics, 13 January 1983; U.S.Department of Commerce, U.S. Industrial Outlook 1982.
10. IBM has led the industry in introducing separate pricing ofsoftware. However, while unbundling of hardware and softwarebegan over 10 years ago, software prices remain below costs--afactor that has exacerbated the recent earnings problems ofmainframe computer manufacturers. See "Computers:. Fallingbehind in mainframe output," Business Week, 20 October 1980.
11. The Japanese lag in software development is attributableto several factors. Language presents a software problembecause the Japanese normally write by using a minimum of 2000Chinese ideograms--or kanji--too many for normal computerprograms to accommodate. As a result, programming is done withEnglish words and English versions of Japanese syllables.Japanese productivity in software thus lags the United States.
Commerce, U.S. Industrial OutlookData processing and software,"
Commerce, U.S. Industrial Outlook
Commerce, U.S. Industrial Outlook
Commerce, U.S. Industrial Outlook
Commerce, U.S. Industrial Outlook
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The Japanese lag in software development is also linkedto the slow development of a. independent software induitry inJapan. Recently, however, the growth of independent softwarehouses has accelerated, spurred both by the unbundling of Japa-nese hardware and software sy3tems and by the increased rate atwhich Japanese computer manufacturers have subcontractedsoftware development projects to outside firms.
12. See "Japanese strategy for the 80's: Attempting toovercome the U.S. lead in software," Business Week, 14 December1981; and "Japan: A big push to rival the U.S. in software,"Business Week, 5 October 1981.
13. The Japanese did not appreciate the importance ofapplications programs when- they designed their first-generationdesk-top computers with 8-bit microprocessors. Most of the newgeneration of Japanese 16-bit microcomputers will be able to usethe same software as IBM's personal computer. See, for example,"Japan: A lame debut for personal computer exports," BusinessWeek, 14 June 1982.
14. "The 'Japanization' of an IBM subsidiary," Business Week,6 April 1981. it should be noted that IBM moved early to establisha position of strength in the Japanese mainframe industry beforetwo key competitors, Fujitsu and Hitachi, could gain dominance.Still holding almost 25 percent of the market, IBM is denying itsJapanese competitors both production experience and cash .39develop the distribution and software capabilities essential tosuccess in the United States.
15. "Moving away from mainframes: The large computermakers' strategy for survival," Business Week, 15 February 1982.
16. The demand for information about technological develop-ments in IBM's computer architecture was underscored recentlyby charges that Hitachi, one of Japan's leading computer com-panies, conspired to buy secrets stolen from IBM. See, forexample, "Competitors have sought IBM's secrets for years viacourts, research, hiring," The Wall Street Journal, 25 June 1982;"IBM watchers process data on the big firm to divine its program,"The Wall Street Journal, 23 July 1982; "Computers: IBM's mimicsstruggle to keep pace," Business Week, 20 September 1982.
17. For ;example, reliance on outside applications softwareproviders has caused well-publicized problems for Prime Com-puter. See, "Computers: A big challenge at Prime Computer,"Business Week, 21 December 1981.
18. See, for example, "Artificial intelligence: The secondcomputer age begins," Business Week, 8 March 1982.
19. The Japanese have special reasons for pursuing Al. First,the written Japanese language poses severe problems for theJapanese in attempting to close the software gap with the UnitedStates. The idea of an Al-based fifth-generation computer thus
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has special appeal to the Japanese. Second, in the mid-1970s,MITI directed Fujitsu, Hitachi, and eventually Mi'subishi intomaking computers to run on IBM software. This symbioticstrategy helped the Japanese industry compete with IBM's System370, but increased its vulnerability whenever IBM launched newproducts or cut prices. The fifth-generation project's unconven-tional goals thus offer a means of reducing dependence on IBM.Finally, due in part to over $125 million in subsidies from MITI forits VLSI program, Japanese electronics firms are now at least asskilled as their U.S. counterparts in manufacturing densely packedintegrated circuits that are essential to fifth-generation com-puters. See, for example, "A fifth generation: Computers thatthink," Business Week, 14 December 1981; and "Japan: Herecomes Computer Inc.," Fortune, 4 October 1982.
20. Magnetic disk storage units, which act_ as slower, auxiliarys "rage to high-speed semiconductor main memory, have sub-stantially increased in performance and decreased in price forseveral decades, with order of magnitude improvements stillanticipated. For example, since the mid-1950s when disk storageUnits began to appear, storage capacity, as measured by thenumber of megabytes per spindle, has increased by an average ofabout 25 percent, per year. In contrast, price, as measured bymonthly base charges per megabyte, has declined by almost 20percent per year.
21. Also contributing to production delays in 1980 wereproducer miscalculations with respect to the magnitude ofcustomer demand.
22. These production glitches have delayed new productdelivery schedules by as much as a year for firms ranging fromIBM, NCR, Honeywell, Burroughs, Digital Equipment, andMagnuson, to Apple .Computer. See, for example. "Computers:Falling behind in mainframe output," Business Week, 20 October1980; "Computers: Snafus that delay new products," BusinessWeek, 1 June 1981; "Computer design may save Magnuson,"Business Week! 15 February 1982.
23. See, for example, "Moving away from mainframes: Thelarge computer makers' strategy for survival," Business Week, 15February 1982; "IBM's aggressive pricing," The New York Times, 9August 1982; "No. I's awesome stre -egy," Business Week, 8 June1981.
24. 'See, for example, ',peripherals: Japan's swift success inprinters," Business Week, 31 August 1981.
25. For example, low-power consumption C-MOS semicon-ductors will be key components in the design of personal com-puters that are portable, compact, and battery-driven. AlthoughC-MOS semiconductor technology was originally advanced by U.S.semiconductor manufacturers, several Japanese manufacturers
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have reportedly made major investments in C-MOS assembly lines.and are said to be well down the C-MOS learning curve. "Informa-tion processing: A worldwide strategy for the computer market,"Business Week, 14 December 1981; "The big fights for computersates," The New York Times, 1 August 1982; and "New integratedcircuits may spur semiconductor industry," The Wall' StreetJournal, 18 February 1982.
26. Fujitsu and Hitachi have followed a similar mainframesales strategy in Europe, where Fujitsu has established technologyand markiting agreements with ICL in Great Britain and Siemensin West Germany, and Hitachi with Olivetti in Italy and BASF inWest Germany.
27. IBM, which introduced its personal computer in mid-1981,is investing heavily to test alternative distribution channels. Itsdistribution strategy calls for a three-pronged marketingapproach: use of its direct sales force to sell personal computersto corporations for use by managers; distribution through inde-pendent retailers, who are supported by point-of-sale materials,warranty reimbursements, and a hotline to answer 'questions; andestablishment of a company-owned chain of computer stores toattract small business owners. "IBM joins tht race in personalcomput-..rs," Business Week, 24 August 1981.
28. For example, Tandy Corporation's Radio Shack Division iscurrently opening a new chain devoted exclusively to computersales in addition to its chain of consumer electronics super-markets.
29. To date, Japanese manufacturers of personal computershave concentrated on their home market, where they hadachieved an estimated 75 percent share in 1980. Their successreportedly stems from their pricing strategies, the inability oftheir U.S. competitors to produce enough uniti to meet the rapidexpansion in Japanese demand, and the lack of U.S. productscapable of storing and retrieving the approximately 2000characters of the written Japanese language. U.S. Department ofCommerce, U.S. Industrial Outlook 1982; and "The big fight forcomputer sales," The New York Times, 1 August 1982.
30. An exception to the general reliance on OEMs in the 1970swas Prime Computer, which conceived a strategy of sellingdirectly to computer users.
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6The Telecommunications
Equipment Industry
In the 1970s, the telecommunications equipment industry enteredinto a period of accelerating change, mainly as a result bf devel-opments in the industry's technology. New products and technol-ogies have led to rapid growth in private equipment markets, andnew export markets for telecommunications equipment haveemerged. Moreover, as markets have opened up, new firms havebeen encouraged to enter the equipment industry, thus acceler-ating the innovation process. Even in those parts of the equipmentmarket dominated by telecommunications providers, new tech-nologies have led the service providers to expand their range ofsuppliers.
This chapter examines the influence of these developments onthe structure of the U.S. telecommunications equipment industryand its international competitive position, with special emphasison switching equipment. The organization of the chapter is asfollows. The first two sections provide an overview of the U.S.industry and its international position, including problems faced byU.S. firm. world markets. In contrast to the semiconductor andcomputer 1,1,austries, U.S. telecommunications equipment manufac-turers have primarily been oriented to domestic sales. This orien-tation is attributable in part to barriers created by the structureof national telecommunications service systems and related politi-cal and national security considerations. The low relative U.S.export share is also due in part to the fact that, until recently,Western Electric, the largest U.S. manufacturer, focused almostexclusively on domestic sales to the Bell System operatingcompanies.
The third section discusses major developments in transmissiontechnology. The introduction of microwave, satellite, and opticalfiber transmission has had important effects on industry structure.In addition, the shift to digital transmission ip telephone plantssaid the groundwork for digital' switching, which has emerged as
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an area of intense international technological rivalry andcompetition. .
The fourth section analyzes the bascts for competition in alcentral office switches and 'private branch exchanges (PBXs). Thesection's conclusions are similar in three aspects to those foundthe previous chapter on the computer industry. First, ra.01
change in digital integrated circuits has promoted change in thestructure of the switching equipment industry. Second, softwareis an increasingly important determinant of switching equipmentcompetitiveness. The success of U.S. manufacturers is directsxlinked to the strength of the U.S. industry in software develop-ment. Indeed, the most-successful foreign switching equipmentfirms competing in the ,United States have established U.S. designand manufacturing operations. A third similarity with the com-puter industry is the critical role that distribution and servicenetworks play in competitiveness. Foreign firms seeking to enterthe United States thus face the reqpirement for an investment in
-"distribution and service capabilities, the magnitude bf which mayserve as a barrier to entry.
INDUSTRY SIZE AND INTERNATIONAL POSITION
The equipment used in telecommunications networks is tradi-tionally classified into three functional groups. Terminalequipment, normally located on the customer's premises, is usedto originate and receive signals. Transmission equipment carries*he signals between terminal stations and central offices andbetween switching centers. Switching equipment, located incentral offices and on customer premises, links the terminals orswitching nodes in the network.
Because the demand for telecommunications equipment is aderived demand, dependent on the demand for telecommunica-tions equipment services, the organization of the telecommunica-tions services industry has a major impact on the structure of theequipment industry. In virtually every developed country, theprovision of telecommunications services has historically beenorganized as a monopoly. Equ pment sales within countries havealso been highly concentrated with the share of the four largestfirms in industry sales typically being above 70 percent. In con-trast to other electrc*nics -based industries, small, specialized firmshave played only a minor role in the prevision of telecommunica-tions equipment. Through their procurement practices, serviceproviders have traditionally acted to perpetuate this industrialstructure, protecting equipment suppliers from both domestic andforeign competition.
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The United States is the world's lax gest consumer of telecom-munications equipment and services. In 1972 the value of U.S.shipments of telephone and telegraph equipment was $4.5 billion;by 1981 the rapidly evolving information 4ge had pushed the valueof industry shipments up to $12.2 billion.' The industry's growthin the 1980s will be sustained by the continuing transition fromthe present partially analog, partially digital telecommunicationnetwork to all digital. The pace of this change will be set by theeconomics of furnishing traditional telephone service, which willremain dominant over the next decade in terms of commoncarrier investment and revenues.
U.S. exports of telephone and telegraph equipment wereestimated at 453 million in .1981, up 17.2 percent from $557million in 1980.5 Similarly, U.S. imports were approximately $495million in 1981, up 17.6 percent from $421 million in 1980. TheU.S. telecommunications equipment trade surplus in 1981 was thus$158 million, up 16 percent from the 1980 surplus of $136 million.Table 6-1 compares the telephone and telegraph equipment andparts exports of the 10 principal competitor nations.
Historically, telecommunications equipment manufacturers inmost countries have primarily been oriented to domestic con-sumption, with exports accounting for a small part of total out-put.4 In the 1970s, however, exports of telecommunicationsequipment manufacturers rose dramatically. Many of the majorcountries of destination for the European exporters iri 1980 weredeveloping nations, some of which have launched multimilliondollar projects to modernize and expand their communicationsinfrastructures.5 These include Saudi Arabia, South Korea,Taiwan, Mexico, and Argentina. By contrast, about 70 percent ofCanada's exports and 32 percent of Japan's e:cports went to theUnited States. The principal countries of destination for U.S.exports were Canada, Taiwan, and the United K, ngdom.
Western Electric, the largest supplier of telephone and tele-graph equipment in the world, has traditionally neither exportednor imported its products. Until recently, Western Electricdirected its entire productive capacity toward meeting therequirements of the Bell System operating companies and the U.Sgovernment.6 Thus, while Bell System innovations have offeredcontinued improvement in the cost, quality, and availability ofservice in the United States, the overall impact of U.S. telecom-munications technology in world markets has been low relative tothe high level of domestic telecommunications development. In
contrast, telecommunications equipment manufacturers in WestGermany, France, Sweden, the United Kingdom, and Japan havebeen major exporters.7
Although Western Electric is likely to mount an aggressivemarketing drive overseas following the implementation of the
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TABLE 6-1 Telephone and Telegraph Equipment and Parts Exports ofPrincipal Nations
SOURCE: Official government statistical publications of each country. As presented inthis U.S. Department of Commerce. U.S Inthant21 Outlook 1982 Washington, D.C.:U.S. Government Printing Office.
A Ida Consent Decree of 1982, foreign telecommunicationsmanufacturers will remain strong competitors. The nature ofnational telephone systems is such that they are frequentlyconstructed in building-block fashion, that is, they often start withthe basic telephone and telegraph equipment and build up to thecomplex, sophisticated, total telecommunications network. Oncethe basic equipment has been purchased, the follow-on equipmentmust be compatible (i.e., manufactured to the samespecifications). Therefore, it is frequently furnished by theoriginal manufacturer.
Another problem faced by U.S. manufacturers selling abroadarises from the differences between ,North American technicalstandards based on Bell System practices and the InternationalTelephone and Telegraph Consultative Committee (CCITT)recommendatiops used in most countries, with the major excep-tion of Japan.° The significance of differences in technicalstandards, however, will diminish as U.S., Japanese, and Canadianmanufacturers play an increasingly active international role and asCCITT -based manufacturers seek to sell in the United States.Some companies, for example, are attempting to design switchingsystems in which the bulk of the equipment is compatible witheither CCITT or Bell standards.
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Finally, protective policies and practices pose significantbarriers' to importation of U.S. telecommunications equipmentinto many foreign countries. In most countries, with the majorexception of Canada, the telephone and telegraph system isgovernment-owned and operated. 'Foreign telephone systems,particularly in Europe, the United Kingdom, and Japan, tradi-tionally have channeled their purchases to favor their ownnational economies, i.e., to locally owned companies or toforeign-owned companies with local manufacturing facilities.9Even the developing countries have established "buy local"policies as they have generated enough demand to support localmanufacture. I u
Although protective policies have largely precluded the impor-tation of U.S. telecommunications equipment where there iscompetition from local manufacturers, U.S. firms have been ableto export domestically produced equipment in specialized high-technology areas. U.S. telecommunications equipment firms havealso enjoyed marketing success in foreign countries where theyhave established manufacturing facilities. For example, foreignplants are the bases of the foreign sales volume of ITT and GTE."
Mutual reciprocity between trading partners may increase asforeign telephone authorities ill many countries open sales ofcustomer equipment.12 For example, the British and Canadiangovernments recently took steps to open customer equipmentsales to foreign manufacturers. Sales of interconnect equipmentmay eventually provide an avenue for direct sales to the postal,telegraph, and telephone authorities overseas. Another poten-tially significant development is the three-year bilateral agree-ment signed by Japan and the United States in 1980 to permit U.S.suppliers to compete with Japanese manufacturers and otherforeign countries in the supply of equipment to Nippon Telegraphend Telephone.' 3
INDUSTRY STRUCTURE
The structure of the U.S. telecommunications equipment industryclosely parallels the structure of the telephone service industry.Trace .ionatly, both the Bell System and GTE have relied heavily,though not exclusively, on their captive suppliers. AT&T, whichserves over 80 percent of the country's telephones, accounts for aproportionately large share of equipment sales through its manu-facturing subsidiary, Western Electqc.14 GTE, with approxi-mately W percent of the tiation's phones, accounts for a similarproportion of equipment sales through its manufacturing arms.
The remaining portion of the U.S. industry is composed of anumber of independent manufacturers. Suppliers offering broad
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lines of telecommunications equipment include ITT, NorthernTelecom, and NEC America. ITT is the second largest producerof telecommunications equipment in the world. However, morethan two-thirds of its sales and manufacturing operations are inwestern Europe. Northern Telecom, the manufacturing subsidiaryof Bell Canada, has substantially expanded its U.S. operations inrecent years, particularly its marketing of digital central officeswitches. NEC recently established U.S. production facilities forcentral office switches and PBXs, though it imports other prod-ucts ranging from key telephone systems to microwave equip-ment. Other major suppliers of telecommunications equipment innarrower product areas include Collins Radio, Farinon Electric,Lynch, and TRW Vidar in transmission equipment; Plessey inswitching equipment; and ATI/Fujitsu, Mitel, ROLM, and TIE inPBXs and key telephone systems.'3
The non-affiliated equipment manufacturers have historicallysold largely to independent telephone companies and privatebuyers. The latter group of customers has been a source ofgrowing overall market share for independent manufacturers sincethe 1968 Carterfone decision permitted interconnect sales. In1969 the Bell System and the independent telephone companiestogether accounted for nearly all of the telephone equipmentpurchased in the United States; by 1981 sales of telephoneequipment to private buyers accounted for over 10, percent oftotal industry sales.," The independent manufacturers have alsoincreased sales to hell and GTE operating companies, and theirshare may increase further in the future with the divestiture ofthe Bell operating companies from AT&T.I7 However, theindependents will face increased competition for their traditionalcustomers from Western Electric, which, following the 1982 Con-sent Decree, has new incentives to sell to non-Bell companies aswell as to enter markets other than telecommunicationsequipment.
DEVELOPMENTS IN TRANSMISSION TECHNOLOGY18
Several important changt telecommunications technology haveaffected industry structure ...d competitiveness. One of the mostrecentthe shift tb digital, switchingis the subject of a casestudy in the following section. However, the groundwork for theshift to digital switching was laid by the shift to digital transmis-sion in the telephone plant that began in the early 19605 whendigital trunk carrier systems were introduced. At first, 'thesesy:tems were installed in metropolitan-area telephone networks,where they relieved trunking shortages without the high cost ofinstalling additional cable pairs in cities. Later it was found that
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81 -the economics of digital transmission could also be realized in
medium- and long-haul trunKing.. Today, a growing proportion ofthe intercity and local interoffice transmission in major nationaltelephone networks is performed by digital carrier systems.I9
The potential for explosive growth in digital data transmissionhas also contributed to the incentive to develop digital switchingsystems. In addition, data transmission has inspired considerable°jockeying for competitive position among computer and telecom-
, munications equipment manufacturers in areas ranging from local--area networks to private branch exchanges. In the 1980s, how-ever, only a minority of subscribers connected to the nationaltelecommunications network will need digital data transmission.Thus, over the near term, digital data service will continue to beprovided in many cases by the special treatment of existing localloops, e.g., at the subscriber premises or locl exchange.
Although copper cables remain the centOr of the transmissionnetwork, technological advance has expanded the range of trans-mission media. ,In addition to the development of the digital trunkcarrier, other potable developments in transmission technology
include terrestrial microwave and satellite communications, both
of which are *uited for either analog or digital transmission.These two teOnologies have promoted entry into long-distancetelecommuniiitions service and increased the derived demand forindependent ?Manufacturers' equipment. A third development,optical fiber transmission, is notable for its return to a land-basedmedium and its suitabiliy only for digital transmission. Further-more, optical fiber technology is expected to produce a newgeneration of telecommunications switches, based on light ratherthan electrical impulses.
In the 1940s, microwave developed as an alternative to coaxialcable for long-haul transmission. Microwave transmission has had
a major impact on industrial structure.- Previously a small number
of copper, cable producers dominated the point-to-point transmis-sion equipment industry; by 1978;' however, microwave radio
accounted for over 75 percent of annual' expenditure on long-haultransmission equipment by U.S. common carriers.
The development of satellite communications overcame someof the limitations of terrestrial microwave systems, creating amajor new competitor to cable and microwave systems in. long-
haul and intercontinental transmission. Since the 1965 Intelsat-Isatellite, space communications costs have steadily declined whilethe range and quality of space communications services havegrown. Although Bell Laboratories was involved in the initial workon satellite communications, satellite technology was essentiallydeveloped by U.S. aerospace manufacturers under contract from
the U.S. National Aeronautics and Spate Administration (NASA)
and the U.S. Department -of Defense. Indeed satellite equipment
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manufacture is still primarily oriented to military purposes, sincemilitary satellites account for 70 percent of all satellite launch-ings. As a result, the satellite equipment industry is dominated byU.S. aerospace manufacturers with a long history of defensework: Hughes Aircraft, Ford Aerospace, TRW, RCA, and GeneralElectric.
The development of optical fib. nsmission during the pastdecade also promises to affect the :ture and performance ofthe telecommunications industry. The major initial areas ofapplication over the next decade are 'ikely to be interofficetrunks (i.e., the high-density cables Liking urban exchanges),long-haul transmission, and local data transmission links tohigh-volume users. However, optical fibers may also serve as thebasis for distributing a broad range of communications signals inaddition to conventional telephony, though the economics ofbroadband distribution systems remain uncertain.
The basic material in optical fibers is silica, which is cheaperand more widely available than the copper used for conventionalcables. Moreover, optical fibers are suited for digital pulse codemodulation (PCM) transmission. Optical fibers also have anumber of major advantages over other terrestrial transmissionmedia: more than three times the capacity of a coaxial cable ofgiven dimensions; greater resistance to corrosion than metal wire,but less attenuation of ,mmunications signals so that fewerregenerators are requireu on long routes; immunity to electricinterference, which makes fiber more reliable than metal wire inareas where high current may be passing; and greater securitybecause of the difficulty of illegally tapping the traffic flow.
The production of optical fiber equipment basically involvestwo product groups, the optical fibers themselves and the opto-electronic components used to transmit and receive signals alongthese fibers. An early lead in optical fibers was taken by WesternElectric and Corning Glass, which hold many of the basic patentson the fiber optic manufacturing process. Recently, however, anumber of major telecommunications firmsincluding AT&T, ITT,NEC, Northern Telecom, and Philips--have developed processesthat are reported to be subitantially different from thosepatented by Corning Glass.
Two types of materials are used to transmit signals alongoptical fibers: light-emitting diodes (LEDs) and lasers. LEDsanarea in which the Japanese hold a technology leadare primarilyproduced by electronic component manufacturers, including thecomponent divisions of telecommunications equipment manufac-turers. Lasers, on the other hand, are produced by a number ofsmall, highly specialized firms and by space-defense manufac-turers. Consequently, it will not be easy for telecommunicationsequipment manufacturers to directly enter laser production,though some are doing so through acquisitions of specialized firms.
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While much important early work in fiber optics was done inthe United States, NTT and its Japanese suppliers have played anactive role in development work on glass fibers, LEDs, and
receivers. Moreover, NTT's closed procurement policies havesheltered its suppliers by excluding foreign firms. At the sametime, Japanese firms have been able to build volume by pursuinghighly aggressive price strategies for the provision of completetelephone systems in developing country markets outside NorthAmerica and Eurone.20 The Japanese are thus building anextremely strong position in a product 'ale that is expected togrow rapidly in the next decades.
BASES FOR COMPETITION:A CASE STUDY OF SWITCHING EQUIPMENT
Switches are in several ways the heart of modern telecommuni-cations systems. The "star" architecture that dominates tele-communications design places a switch at the node where multipletransmission lines intersect. The capacity of these switchesranges from under 100 lines in the smallest PBXs, used forbusiness applications, to more than 100,000 lines in large tele-phone company central offices.2I In addition to their physicallocation in the system, today's switches control most of thefunctions of modern telecommunications systems. These func-tions range from traditional lanes such as providing dial tone,ringing, and busy signals, it, advanced features such as callforwarding and least-cost toll routing.
Since the mid-1960s, electronic switching has found wideacceptance. The earliest electronic switching systems used wiredlogicspecial purpose circuitry, with modules of memory andlogic, tailored specifically to the application of the telephonesystem. Wired logic has now been replaced in new product designby stored program control (SPC) in which computer-likeprocessors perform necessary switching functions. With SPC,changes can be mace in customers assignment, class of service,and options by changing hardware connections. The first SPCswitching system was introduced by Western Electric in 1965;since then, more than 40 SPC switches have been developed bytelecommunications equipment manufacturers around theworld.22 Until the late 1970s, however, most SPC central officeswitches still utilized electromechanical elements in theswitching matrix to achieve connections between telephonecircuits.
Several factors combined during the past decade to push tele-communications switching into digital technology. One factor wasthe rapid decline in cost and increases in performance of digital
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integrated circuits. Closely related to this was the increasing baseof knowledge in computer software techniques. A third importantconsideration was the widespread use of digital transmission sys-.ems, discussed earlier, that provided a more economical interfacewith digital than analog switching. Although analog switchingremains common due to the large Installed base of older equ.p-ment, most manufacturers' latest product offerings incorporatedigital techniques.
Equipment manufacturers' R&D costs have escalated with thetransition to digital technology. During the late 1970s, forexample, ITT spent some $300 to $600 million on its yet to becompleted 1240 switching system.23 This investment standsseveral orders of magnitude above the $30 to $40 million that ITTspent in the early 1960s on its Pentaconta switching systemasystem whose commercial life was nearly 20 years. Similarinvestments in the development of fully digital switching systemshave been made by telecommunications equip'. ..:nt manufacturersaround the world, some of which have spent more than $600million.24
In the face of rising R&D requirements, telecommunicationsequipment manufacturers have sought to increase their inter-national sales." Moreover, as growth in demand for switchingequipment has slowed in major producing country markets, firmsthat have traditionally oriented their operators toward domesticconsumption have intensified their efforts to expand internationalexport market share. Notable examples include Canada'sNorthern Telecom and Japan's Nippon Electric, Oki, Hitachi, andFujitsu. Until recently, this strengthened export orientation wasalso encouraged by strong demand for telecommunicationsequirment in the developing countries, particularly in theOrganization of Petroleum Exporting Countries (OPEC) area.26Exports to developing countries, however, are not expected toexpand as rapidly in the 1980s as they did in the 1970s.27
Conapetition between switching equipment manufacturers willthus focus increasingly on OECD countries,. Further, increasedcompetition will be encouraged by the technological character-istics of electronic switching systems. The flexibility of SPCswitching has made it easier to adapt systems developed for orrnetwork to the technical characteristics of other networks.2However, switching technology will continue to require anunderstanding of large-scale network behavior that is highlycountry-specific, anJ thus a major barrier to entry into nationalmarkets will continue to exist.
Competition in the United States will also undoubtedly beintensified by the implementation of the 1982 AT&T ConsentDecree. Domestic manufacture, however, will remain far morecompetitive than importation for three major reasons. First, the
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design and development of new switching systems is an ongoingprocess, iniolving continuing interaction between designers and
network managers. Telephone companies cannot limit themselvesto screening new equipment once it has been designed; rather theymust identify new equipment needs and assist manufacturers inmeeting these needs. 'Moreover, telephone companies requiresources of equipment supply that will be available over the longterm to supply compatible equipment for subsequent expansionand modernization.
A second factor favoring U.S. manufacture is the rapid pace oftechnological change in the United States. By the end of 1979,there were approximately 300 million telephone main stations inthe world. Of these, 100 million were in the United States.Because of its magnitude, the U.S. telephone system dominatesU.S. telecommunications and strongly influences developmentsworldwide. Consequently, competitors will find it highly advan-tageous to locate in the United States in order to anticipatetechnological developments and to design, produce, and success-fully market new products that will meet customer needs.
Finally, the economics of the design and production _processfavor a U.S. manufacturing location over importation. 1/ VLSI
logic circuits, for which the U.S. semiconductor industry is theworld leader, account for an increasing share of the total directcost of switching equipment. As the number of switching func-tions integrated into one semiconductor package continues to rise,the component parts of switching equipment will increasinglyresemble the finished product. Telecommunications equipmentmanufacturers seeking to stay close to the forefront of semicon-ductor technology have thus placed increasing emphasis onintegrated circuit design and production, either by acquiringsemiconductor manufacturers or expanding their own captiveoperations."
For foreign firms other than the Canadians and the Japanese,the barriers to importation into the United States are heightenedby the differences between U.S. and CCITT technical, standards.The importance of local requirements with their strong softwarecomponent is perhaps the strongest argument for a U.S. manufac-turing location. It has been estimated that conversion of switchesoffered by established European manufacturers would require twoto three years of effort. Indeed, in 1979, CIT-Alcatel, the pioneerin European digital switching, initiated a switch developmenteffprt in the Unifed States that had not been completed by theen of 1982.
The importance of U.S. manufacturing capacity is demon-strated by the pattern exhibited by foreign firms marketingcentral office switches in the United States. The largest foreignparticipants, Northern Telecom, NEC, and Plessey, have estab-
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lished or acquired U.S. manufacturing facilities. Two otheientrants, Fujitsu and CIT-Alcatel, have also announced that theywill rely on U.S. manufacturing operations. Even ITT, which is amajor supplier of switches in western Europe, designs and manu-factures switches for U.S. sales domestically.
The design and manufacture of electronic PBX systems alsorequire expertise in hardware, solid-state switching, telephony,and software. As In the case of central office switches, produc-tion economics favor U.S. manufacture of PBX equipment overimportation, particularly for large systems. The need to antici-pate technological development in the U.S industry, as well as totailor product software to customer needs, is highly important incompeting for market share."' Foreign firms that have estab-lished U.S. manufacturing operations include Northern Telecom,Mite', NEC, Fujitsu (American Telecom Inc.), Oki Electronics,Hitachi, and Siemens.
The Carterfone decision in 1968 and subsequent FCC rulingspermitted sales of terminal equipment directly to customersreferred to as interccnnectionin addition to the existing prac-tice of leasing equipment from the telephone operating com-panies.32 Since the Carterfone decision, there has been sustainedentry into the industry. In 1969 there were only four PBXmanufacturers in the United States; by 1980 there were over 30.33
The first wave of entrants were established foreign manufac-turers represented by U.S. distributors with responsibility forinstallation and maintenance. These firms, which included L. M.Ericsson, Hitachi, and NEC, were quick to exploit the relativelysluggish marketing program of the telephone companies as well asthe perceived nonmodern nature of U.S. manufacturers' step-by-step PBX equipment. By 1974 foreign suppliers had garnered asmuch as 16 percent of the interconnect sales.4
,The invasion of foreign manufacturers slowed in the mid-1970swhen the introduction of U.S.-designed electronic systems madethe older crossbar technology systems of Japanese manufacturersobsolete. The electronic PBXs of North American manufacturerssuch as ROLM, Western Electric, and Northern Telecom offeredboth extensive flexibility and appealing Fpeciai features and,therefore, were far easier to sell than the more iimited crossbarsystems. Sales of the less expensive crossbars, However, havecontinued in less sophisticated applications.
Foreign firms marketing PBX systems in the United Stateshave also found it necessary to invest in building distributionorganizations. As in the comouter industry, a strong distributionnetwork for marketing and service is essential if a PBX manufac-turer is to be a viable competitor. Since telephone switchingequipment problems must be repaired Immediately, sales and
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service distributors must be able to guarantee the availability ofparts and trained repairmen. Interconnect si ,pliers must demon-strate that they can supply round- the - clot.: service and main-tenance to match the telephone companies. Such servicecapabilities require that individual distributors be both wellmanaged and well capitalized.
Almost by definition, the U.S. distributors, which intiallymarketed the products of foreign manufacturers, were smallcompanies that could only offer regional and, sometimes, unsatis-factory service. When matched against large firms, such asAT&T, ITT, General Dynamics, and GTE, small independentdistributors found themselves at a competitive disadvantage. Thisdisadvantage appears to be particularly strong in the competitionfor large system accounts since national companies show a prefer-ence for eealing with a single equipment representative ratherthan a number of small firms scattered across the United States.Since the mid-1970s, foreign manufacturers have thus attemptednot only to catch up technologically but also to improve their U.S.distribution networks.
The changeover to digital technology since the mid-1970s hasincreased entry into telecommunications switching, resulting inintensified product competition. The competition accompanyingthe digital changeover has also accelerated the innovationprocess. For example, in the 1960s, it took six to eight years todevelop a new PBX system; by the 1980s the development periodwas three to five years. At the same time, product lifetimes havedeclined as new generations of equipment enter the marketplaceeach year; current trends suggest replacement rates of between10 percent and the 20 percent level standard in the computerindustry."
NOTES
I. For a discussion of the impact of the organization of tele-communications services on the structure of the telecommunica-tions equipment industry in the OECD countries, see Organizationfor Economic Operation and Development, TelecommunicationsIndustry Equipment Study, October 1981, pp. 23-43.
2. IrAustry shipments increased by only 7.3 percent in 1981to $12.2 lion, .a slowdown that is attributable in part to theimpact of high interest rates on plans of telephone companies toconvert from electromechanical to electronic switching. U.S.Department of Commerce, U.S. Industrial Outlook 1982.
3. tALd...._s.
4. Vie- major exceptions are Sweden's L. M. Ericsson and theNetherlands' .N. V. Philips, both of which have a limited domesticmarket.
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5. As discussed in the OECD's recent telecommunicationsstudy, competition for developing country sales has been greaterthan in the OECD countries for two reasons. "First, domesticproduction in developing countries is much more limited, so thatpreferences for domestic producers have beefless of an Imdi-ment to trade. Second, existing networks in the developingcountries are either very small or almost totally legacies ofcolonial rule, so that network compatibility problems have arisento a lesser degree." OECD, 22. cit., p. 47.
6. In 1978 Westerti Eiktrie established a new subsidiary(Western Electric International, reorganized in 1980. as AT&TInternational, an unregulated subsidiary of AT&T) to sell tele-communications equipment and related services in the rest of theworld. Major sales have been made to Saudi Arabia (for construc-tion of a microwave network), South Korea (for local and tollswitching systems), and Taiwan (for toll switching systems).
7. Domestic sales available to non-U.S. firms are smaller byseveral orders of magnitude than those available to firms oper-ating in the Uniteci States. Acquiring or defending competitivepositions in the smaller OECD countries and in third world coun-tries is therefore a more important objective of their corporatestrategy. These firms have rarely sought to compete in othermajor countries an a broad-line basis since aggressive behaviorwould expose them to retaliation in their home market. Rather,if they do compete in these countries, it has been on the basis ofhighly specialized products. OECD, 22. cit., p. 34.
8. CCITT standard-sett usually lags behind Bell stan-dards. In some cases the C TT standards are improvements onearlier Bell standards. In others they may be necessitated bydifferent foreign iritrastructures such as metric spacing ofrepeaters. In still other cases, the foreign differences mayreflect economic (e.g., protecting domestic equipment producers)or political (e.g., non-American), rather than technical, consid-erations. In addition to CCITT standards, foreign countries alsohave their own national technical standards, which are notuniform.
9. PTTs in Europe and Japan not only buy their equipmentfrom these selected national manufacturers but also set thestandards for the equipment and provide financial support forresearch and development programs.
For example, Japan's Nippon Telegraph and TelephonePublic Corporation (NTT) maintains a very close relationship withits Japanese suppliers through joint R&D programs, direct invest-ment in manufacturing companies, and interlocking of seniorexecutives as a result of many ex-NTT staff entering into industryexecutive positions following retirement from NTT. Moreover,with its historically closed procurement policies, NTT has helped
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to stabilize prices and production for Japanese manufacturers.NTT also advances its Japanese suppliers part of the equipmentpurchase price, in effect providing interest-free loans. The resultof this government support has reportedly allowed Japanesemanufacturers to be highly aggressive in export pricing. See"Japan: The coming assault on communications markets."Business Week, 14 December 1981.
10. For example, in Brazil, Mexico, and Argentina traditionaltelecommunications equipment suppliers--Ericsson, ITT, andSiemensare currently being forced to give up control of theirin-country manufacturing facilities in order to continueparticipating in these countries.
11. Due to local manufacturing operations, ITT and GTE havehistorically enjoyed strong positions in Europe. For example, in1925 ITT acquired the International Western Electric Company,which held a strong position in European telephony and haddeveloped extremely close ties with service providers. ITT hascapitalized on these ties, while attempting to create similar tiesin third world countries. Although they have in some cases shareda common core technology, ITT subsidiaries have therefore beenrelatively autonomous, often acting as domestic rather thaninternational firms. OECD, cm. cit., p. 35.
12. For a discussion of moves toward liberalization of trade intelecommunications equipment, see OECD, 92, cit.
13. Although NTT has taken steps to open procurement toforeign firms since January 1981, U.S. telecommunicationsequipment manufacturers have reportedly been highly tentative inapproaching NTT. See, for example, "Why the U.S. still has notcracked NTT," Business Week, January 1982. Through mid-1982the only significant breakthroughs were by Motorola, which hasbeen placed on NTT's approved supplier list for mobile telephoneequipment, and ROLM, which has been placed on NTT's approvedsupplier list for PBXs. "Motorola hurdles a Japanese barrier,"Business Week, 7 June 1982, and ROLM Press Release, 29 MarchT2.
14. Western Electric's exact share is subject to debate,depending on what types of equipment are included and what datasources are used. Western's share, however, has declined some-what since the mid-1970s due to factors such as increasedcompetition for sales of equipment to private businesses and themore rapid growth of equipment demand by independent telephonecompanies (not served by Western) than by Bell operatingcompanies.
15. Many of the independent suppliers are subsidiaries of largecorporations, some of which are foreign. Collins is a division ofRockwell International; Farinon, a subsidiary of Harris Corpora-tion; and Vidar, formerly a subsidiary of United Telephone, is now
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part of TRW. Lynch. Is partially owned by the large French sup-plier, CIT-Alcatel. Stromberg-Carlson, until recently a broad-linesubsidiary of General Dynamics, had its central office and privatebranch operations sold to United Technologies, which in turn soldthe central office switching business to Plessev of the UnitedKingdom. American Telecommunications, Inc. and Fujitsu have aU.S.-based PBX joint venture. Mite!, of Canadian origin, manu-factures a large proportion of its equipment in the United States.TIE, a U.S. company, obtains some of its key telephone equipmentfrom an affiliate in Taiwan. In addition to these companies, sev-eral other large foreign companies have gairied small U.S. marketshares in microwave equipment and PBXs through imports, andsome, such as Siemens, have U.S. manufacturing and R&Doperations.
16. U.S. Department of Commerce, U.S. Industrial Outlook1982.
17. Although some observers have raised the issue of thecoordination and overall quality of the nation's transmissionnetwork following AT&T's divestiture of the local operatingcompanies, this problem does not stem from the identity of theequipment manufacturers. Rather it arises from the incentives ofequipment purchasers and the fact that the technical quality ofthe local telephone network is an excludable public good. "Net-work degradation" can occur if either (1) local access pricing isnot sufficiently responsive to permit the local operating com-panies to recoup the benefits of enhanced local network quality,or (2) antitrust or state regulatory restrictions impair the abilityof the operating companies to jointly determine interconnection/quality standards. Although the post-divestiture industry struc-ture permits a central staff mechanism for research funding andcoordination, this does not guarantee that problems will notoccur, particularly with respect to local pricing.
18. The description of developments in transmission tech-nology in this section is based largely on OECD, og. cit., pp. 49-58.
19. In subscriber loops the conversion to digitaTtransmissionwill proceed rather slowly. There is less technical or economicincentive for this conversion than in the case of switching orlong-haul transmission.
20. Countries in which the Japanese have built optical fibersystems include Argentina, Brazil, Taiwan, Hong Kong, and SaudiArabia. See, for example, "Japan's strategy for the 1980's: Thecoming assault on communications markets," Business Week, 14December 1981, and "Japanese now target communications gearas a growth industry," The Wall Street Journal, 13 January 1983.
21. The mnallest Wriaos, ranging down to two lines, aretypically key telephone systems that take their name from the
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switch or "key" used in early versions. Modern key systems havepush buttons built Into the telephone, each of which is connectedto a central rack containing electronic circuitry that providestejephone functions, such as ringing, intercom, and call`forwarding.
22. OECD, 22. cit., pp. 46.23. "IT&T: -Groping for a new strategy," Business Week, 15
December 1980, as cited in OECD, 22. cit., p. 46.24. Switch manufacturers pursuing digital development
programs include Western Electric, ITT, L. M. Ericsson, Siemens,GTE Automatic Electric, Nippon Electric Company, Fujitsu,Hitachi, Thomson-CSF, CIT-Alcatel, Northern Telecom. Plessey,and Stromberg- Carlson.
25. For a discussion of the competitive pressures surroundingexport sales, see OECD, op. cit., pp. 46-47.
26. While intra -OECD exports of telecommunicationsequipment increased by a factor of 3.5 over the period 1970 to1978, exports of this equipment from the OECD countries to theoil-exporting developing countries increased by a factor of 9 andto the other developing countries by a factor of 4.5. Telecom-munications Equipment Industry Study, OECD, 2E, cit., p. 46.
27. For a discussion of OECD export opportunities in thedeveloping countries, see OECD, 92. cit., p. 47.
28. OECD, 22. c_ it., p. 48.29. The benefits of U.S. manufacture are also indicated by
comparison of manufacturing labor costs. Though a relativelysmall portion of total costa, direct labor costs are currently lowerin the United States than in Canada or weste!n Europe.
30. The OECD has estimated that telecommunications equip.-ment manufacturers account for 15 to 20 percent of worldsemiconductor production and for 10 to 15 percent of worldsemiconductor consumption. Rfeent acquisitions of semicon-ductor firm interests by telecommunications equipmentmanufacturers, particularly important for European firms thathave been weak in the serrficpnductor field include: AdvancedMicro Devices (Siemens), Litronix (Siemens), SEMI (GTE), andSignetics (Philips). OCED, 22. cit., p. 49.
31. As in the computer Industry, software has taken onincreasing importance in recent years. For example, ROLM, oneof the most highly successful PBX manufacturers, attributes itsmarket position to its lead in developing special feature softwareaimed at solving customer problems such as route optimization tocut toll costs and controls to monitor long-distance calling. Some50 percent of ROLM's development staff is currently working insoftware, double the percentage of seven years ago. See "A hotnew challenger takes on Ma Bell," Business Week, 12 February1979, and "Japan: Coming assault on the communicationsmarket," Business Week, 14 December 1981.
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32. The 1968 Carterfone decision permitted customerequipment to be connected to the public telephone network. Thiswas followed the next year by an authorization for protectiveinterface devices, which allowed AT&T to charge customers forcouplers supplied by the company to interface between datacommunications and telephone lines. In 1977 a registrationprogram eliminated all need foi protective devices.
Outside the United States, greater restrictions have beenplaced on competition. However several countries, IncludingJapan, Canada, and the United Kingdom, are moving to ease theseconstraints.
33. U.S. Department of Commerce, U.S. Industrial Outlook1982.
34. Gerald W. Brock, The Telecommunications jndustry: The.,Dynamics of Market Structure, Harvard University Press,Cambridge, Massachusetts, 1981.
35. OECD, m. cit., p. 67.
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7The Consumer
Electronics industry
U.S. firms were pioneers in consumer electronics technology and,until the 1960s, accounted for the largest share of world revenuesand profits. In 1955 U.S. product shipments in consumer eit.c-tronics were valued at $1.5 billion; Japanese firms produced only$70 million.' Nearly three decades later the situation is reversed,with Japanese revenues in consumer electronics more than twicethose of U.S. manufacturers.
This chapter compares the performance of the U.S. consumerelectronics industry with the competitive successes of the Japa-nese industry. The organization of the chapter is as follows. Thefirst section describes the dimensions Of the U.S. Industry, Itsproducts, size, growth, and international position. The secondsection examines the dynamics of internlitlanal competition incolor television receivers, which represent the largest share ofconsumer electronics sales. Despite an early U.S. lead, U.S. firmstoday produce far fewer color television sets than do their Japa-nese counterparts. The initial penetration of Japanese firms inthe United States was built on a foundation of labor-costadvantages, exploitation of mass merchandise distribution
"-`systems, specialization in small product sizes, and governmentprotection. Ultimately, however, the Japanese establishedworldwide dominant position based on aggressive technology,investment, and marketing strategies.
The third section of the chapte reviews the emergence ofvideo cassette recorders (VCRs), growth product used inconjunction with television sets., U.S. ...firms are conspicuouslyabsent from the list of major velopers and manufacturers ofconsumer video recorders. In tract, several 3apanese firmsundertook sustained long-term development efforts that wereultimately rewarded with commercial sycceSs.
The final section evaluates the ingcedients of "the Japanesesuccess in consumer electronics. The availability of a well-trained work force and a favorable' environment for cg..ital
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investment facilitated Japanese efforts to develop new products,such as the VCR, and to take the lead in advancing color tele-vision technology in key areas, such as the application of inte-grated circuitry and automated manufacturing. At the same time,rowever, industry protection was critical to the development ofthe Japanese color television industry, contributing to the abilityof Japanese firms both to fund research and capital investmentand to pursue aggressive pricing strategies that weakened thefinancial position of their U.S. competition.
INDUSTRY SIZE AND IN t ERNATIONAL POSITION
The output of the U.S. consumer electronics industry consistsprimarily of entertainment productstelevision receivers, videodisk players, automobile radios, phonographs, radio - phonographcombinations, stereo compact systems, high-fidelity system com-ponents, autosound systems, loud speakers, microphones, andrelated products. During the last two decades, the composithanand product orientation of the industry has changed substantially.The monochromatic and audio segments of the industry havegrown slowly, while the color television segment has expandedrapidly. In 1981, for exa7-4.!1, sales of color television receiversaccounted for 58 perce U.S. consumer electronics industryshipments.2
Conspicuous by their absence from the list of U.S. consumerelectronics products are consumer radios, audio tape-recorderplayers, and video cassette recorders. Production of radios andaudio tape recorders, which began to shift to Japan and elsewherein the Far East in the 1950s, no longer exists in the United States.Volume production of VCRs originated in Japan, with some paral-lel development by Philips in Europe. The United States does notproduce any VCRs at this time.
In 1981 total U.S. sales of consumer electronics products,supplied by domestic industry shipments and impprts, were $9.8billion. Of this amount, imports-85 percent of which came fromthe Far East--stood at $5.9 billion. During the 1972 to .1980period, U.S. imports rose at a 12.8 percent compound annual rate.
The majority of consumer electronics products imported intothe United States are in finished form. These include televisionreceivers, audio an video tape recorders, radios, high fidelitycomponents, and loudspeakers. A significant portion of Imports,however, are color receiver printed circuit boards with mountedcomponents destined for assembly with cabinets and picture tubesin the United States. Japanese firms produce these boards andtuners in Japan for assembly in the United States, and U.S. manu-
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facturers produce them in Mexico and the Far East for their U.S.plants.
Exports of consumer electronics products were $1.1 billion in1981.4 Exportsprincipally television receivers (assembled andunassembled), automobile radios, loudspeakers, amplifiers, andsound recorders and playersincreased at a compound annual rateof 19.9 percent between 1972 and 1981. This rate, which was dueprimarily to the start of color broadcasting and adoption of theU.S. transmission standard in several Latin American countries, isnot expected to be sustained in the face of increasing competitivepressure from the Far East.
Recent increases in U.S. consumer electronics shipmentslargely reflect the establishment of U.S.-based productionfacilities by foreign manufacturers following_ the negotiation oforderly marketing agreement (OMAs) with Japan in 1977 and withTaiwan and Korea in 1979.1 In 1975, 3 out of 13 U.S. colortelevision producers were foreign-owned; by 1980 foreign-ownedfirms accounted for 9 out of 15 firms in the U.S. industry. Of thenine foreign firms, seven are Japanese, one Taiwanese, and oneDutch.
Color Television
U.S. firms pioneered the development of color television in the1940s and 1950s. RCA, the major contributor, began colortelevision sales in 1954.6 Color television, however, was slow towin widespread acceptance. Not only was color television a newmode of entertainment, but, at the time it was introduced, only afew programs per week were broadcast in color. Indeed RCA didnot earn a profit on its color television sales until the early1960s. By 1961 the only major color television manufacturerswere RCA, Packard Bell, Magnavox, and Zenith, all of which hadestablished reputations in monochrome television.
Color television, however, took off in the United States in the1960s. Sales increased from $47 million in 1960 (of $797 milliontotal TV receiver sales) to $2 billion in 1969, or 80 percent of alltelevisions 'sold.7 Although the color television was a U.S.innovation, the spectacular growth in color television sales in the1960s did not cement the position of U.S. firms as leaders in theworld television manufacturing industry. Instead, by 1969,Japanese firms were well on the way to displacing U.S. firms asthe dominant worldwide producers of video equipment.
Just as their own domestic demand began to grow rapidly inthe. mid-1960s, Japanese firms began marketing color televisionsin the United States. Their initial penetration was made inprivate-label sales, where established U.S. brand names anddistribution networks could be used and where low prices based on
96
Japanese labor-cost advantages' were important. In 1964, forexample, Toshiba signed a high-volume sales contract with Sears,Roebuck dc Comnny. Japanese manufacturers also reportedlygave dealers higher profit margins as an incentive to promoteJapanese products. As a result, Japanese firms achieved quickdomination of the lowest cost distribution channels.
The Japanese private label penetration coincided with a shiftin the structure of U.S. television distribution. Sales throughmass-merchandise stores increased substantially in the mid- andlate-1960s. This shift in distribution was facilitated by theincreasing reliability of television sets, which reduced both theneed for trained servicemen and the existing advantage of U.S.manufacturers with established service networks. As a result,private-label sales increased from approximately 13 percent ofthe U.S. total in 1966 to over 20 percent by 1970.
The early Japanese success in the United States was also aidedby a void in the product line of U.S. firms in small-screen sets. Asin other industries, Japanese firms specialized initially in smallermodels, partly due to the nature of their domestic demand, whichemphasized small, portable home furnishings. Moreover, U.S.firms in the face of a booming market for color television in themid-1960s concentrated on larger, more profitable models.
RCA, the industry's technological leader in the 1950s and1960s, shared its color television technology under license withfirms around the world. RCA's willingness to license Japanesefirms rather than to use its patents as a wedge to enter theJapanese market stands in sharp contrast to the strategies pursuedby IBM in computers and Texas Instruments in semiconductors.Although this licensing policy generated significant income overthe years for RCA, it also facilitated entry into the industry byJapanese firms.
Sony's introduction of its Trinitron system in 1968 gre.. tlyincreased the picture quality of small-screen color sets. At thesame time, Matsushita began placing increased emphasis on itsPanasonic brand in the United States. The increase in the Japa-nese share of U. color television sales from the late 1960sthrough the mid-1970s largely corresponds to the success of thebrand-name products of Sony and Matsushita, including thelatter's acquisition of the Quasar brand from Motorola in 1974.
The Japanese gains in the 1970s were also based on their earlyapplication 2f integrated circuit technology and related processinnovations. ° Despite some exceptions, the Japanese televisionreceiver industry as a whole appears to have adopted integratedcircuitry faster than the U.S. industry. This solid -state designgave Japanese sets an advantage in reliability and compactnessover the sets of the lagging U.S. firms. Related to their adoptionof integrated circuitry, Japanese firms also moved aggressively to
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reduce the number of components and adopt automatic insertiontechniques. These process innovations offset escalating Japaneselabor and material costs and the appreciation of the yen that hadby 1974 closed much of the gap between the price of Japanese andU.S. sets in the United States.
In 1975 the Japanese share of U.S. color television sales stoodat 24 percent, with the Sony and Matsushita (Panasot is andQuasar) brands accounting for 14 percent. In contrast, in 1968,only 11 percent of U.S. color sales, largely under private label,were accounted for by Japanese imports. By 1976 much of theremaining share of private-label production was taken over byJapanese firms, increasing the Japanese share of U.S. sales toapproximately 33 percent.
Three of the U.S. brands that declined in the face of Japanesecompetition in the 1970sMagnavox, Philco, and Sylvaniahavebeen acquired by Philips, the dominant European producer. Thatgives Philips the third largest U.S. market share, after RCA andZenith. RCA and Zenith maintained their U.S. market shares ofapproximately 20 percent each during the 1970s, though theirprofitability declined. The only other U.S. brand name producer isGeneral Electric, which has increased its U.S. market share inrecent years.9
Mounting concern in the United States over the rise in Japa-nese imports culminated in the negotiation of an OMA with Japanin 1977. This agreement resulted in a 25 percent drop In importsfrom Japan in that year and a continuing drop through 1980. An1979 additional OMAs were concluded with Taiwan and Korea.)In 1981, when the OMA with Japan lapsed, imports of completereceivers increased an estimated 52 percent, an increase that islargely attributable to the combination of the overvalued U.S.dollar and the undervalued Japanese yen.
Although Japanese imports dropped between 1977 and 1980,the OMA with Japan yielded little change :1 Japanese marketshare. Instead the OMA resulted in a change in the location ofproduction as Japanese manufacturers acquired or built produc-tion facilities in the United States. Indeed, the number of U.S.-owned firms declined from 18 in 1968 to 5 In 1981, while thenumber of foreign-owned companies increased from none to 9.11U.S. plants with Far Eastern ownership now supply 30 percent ofU.S. industry shipments of color TV receivers.
Japanese penetration of European sales occurred later than inthe United States, but has reached similar proportions. (TheEuropean color television industry, unable to agree on a technicalstandarrd until 1966, did not grow significantly until the early1970s.)12 In 1971, 95 percent of Japanese color exports went tothe United States; by 1974 nearly 30 percent went to Europe.Japanese gains in Europe have increased further in recent years,
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particularly since the expiration of patents on the PAL colorbroadcast system, which was the system adopted in West Germanyand the United Kingdom. PAL patent licenses included restric-tions limiting the size of imported sets to 19 inches or less, whichis smaller than the most popular European sets. Japanese firmshave also set up production and assembly facilities in Europe, asthey did in the United States, and entered into joint ventures withEuropean firms.
Consumer Video Cassette Recorders
Video recording, like the transistor and color television, was aU.S. invention. The first practical video tape recorder bringingimportant changes in the broadcasting of TV programs was intro-duced by Ampex Corporation in 1956.13 The Ampex machine,called the Quadruplex, generated worldwide sales and set thestaldard for broadcasting use for two decades. Although RCAbegan producing video tape machines in 1959, Ampex contined todominate sales to broadcasters.
The Quadruplex machine was a massive, complex, and expen-sive machine filling a large console and two equipment racks and
selling for $50,000 in its monochrome version. The complexitywas necessary to produce a signal that met the stringent require-ments of broadcast use. Experiments with an alternativeapproach, later termed helical recording, however, led todevelopments that promised recorders that were much simpler tomake and use than the Quad machines. Early hellcats produced
pictures that would look quite adequate in quality for the generalpublic, but which were inadequate for broadcasters. Although itwas clear that the helical design might be suitable for a host ofuses outside of broadcasting, less clear was which of many pathsto follow in developing the technology, how to develop newmarkets for the resulting products, and how good a business itwould be once products and markets were developed.
The home video cassette recorder was developed step by step
over 20 years, interactively by nearly a dozen companies world-wide. During the 1960s, firms in the United States, Japan, and
Europe participated in the technical and commercial development
of helical recording. Outside Japan the leaders were Philips,
which dominated European professional and broadcasting sales of
video recorders, and Ampex, which extended its broadcast leader-
ship in the United States with a line of professional and Industrial
units. However, neither Philips nor Ampex was focusing on aconsumer product at this time. None of the leading U.S. con-
sumer electronics firms invested significantly in video recordinguntil after 1970.
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In Japan, on the contrary, eight or more companiesincludingall leading consumer electronics manufacturerslaunched aggres-sive efforts to develop helical video recording technology. Sonyand Matsushita, among the first to succeed in marketing a con-sumer product, held the goal of achievifig a design suitable for theconsumer market from the very beginningeven though they soldtheir first-generation products to other types of users.
By 1970 the first-generation helical cassette machines- -developed by RCA and Cartravision in the United States, Philipsin Europe, and by several companies in Japanwere ready fordemonstration. Despite optimistic predictions that the age ofcartridge television in the home had arrived, It took an additionalfive years to develop and market the first successful video cas-sette recorder. The only commercially successful products at thisstageoffered by Philips and Sonywere destined for professionaland industrial use.
Then, in 1975, Sony launched the now-legendary Betamax.Within two years, Japan Victor, adopting some of Sony's innova-tions and,,adding some variations of its own, perfected an alter-native design. Termed VHS (Home Video System), it was adoptedby Japan Victor's parent firm, Matsushita, and now shares thebulk of world sales with Sony's Beta format. Matsushitaannounced the production of their two millionth VHS machine inlate 1980; Sony's sales of the Betamax reached 750,000 units in1980 alone. The sole competitor to these product formats is aninnovative Philips design manufactured also by Grundig and sold inEurope.
Sony, Japan Victor, and Matsushita made many importantinnovative contributions to the development of the VCR. Never-theless, their Betamax and VHS machines also contain manyelements invented by firms such as Ampex, Philips, and Toshiba,whose success in the VCR field has been more limited. Substan-tial and sustained development efforts over a lengthy period witha consumer product as the ultimate goal, rather than superiorinventive performance, thus appears to have been the criticalingredient in the success of the three current market leaders.Moreover, each of these firms maintained a strategic commit-ment that kept development going, even when prematurelycommercialized consumer products failed. At the same time, theywere investing in the development of advanced manufacturingtechniques and the expansion of production capacity.
THE INGREDIENTS OF THE JAPANESE SUCCESSIN CONSUMER ELECTRONICS
U.S. manufacturers, in the view of many observers, mademiscalculations in corporate strategy and management practice,
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not only in the case of color television and video cassetterecorders, but also in the earlier cases of monochrome TVs andtransistor radios U.S. firms such as Zenith and RCAwere responsible for most of the major advances in colortelevision technology throughout the 1960s and 1970s, the Japa-nese focus on manufacturing issues such as higher productivity,improved quality, and reliability enhanced their cost competitive-ness. Even when domestic demand was brisk, they built positionsin export markets, beginning with the largestthe United Statesand aiming at market segments overlooked by the U.S. industry.After initial success, they broadened their product lines anddeepened penetration.
The ability of Japanese consumer electronics firms to under-take long-term commitments to innovation strategies with uncer-tain payoffs has been facilitated by the three major factorstheavailability of a well-trained work force, low capital costs, andindustry protectionthat provide the potential for Japanese suc-cess in other segments of the electronics industry. First, as dis-cussed in Chapter 2, Japanese firms have beer ?hie to draw on aneducated and stable work force, including a high proportion ofelectrical engineering graduates. For example, a U.S. Depart-ment of Commerce survey found that Japanese consumer elec-tronics firms in the early 1970s employed roughly twice the R&Dmanpower as U.S. firms, desRie R&D spending that was atapproximately the U.S. level." In the context of lifetimeemployment, this human resource base has served as an importantasset for Japarese innovators.
Second, favorable capital costs and availability have supportedJapanese consumer electronics companies in the pursuit of greaterquality and efficiency in the exploitation of export markets and inthe development of novel products that promise long-term ratherthan short-term results. Japanese firms made commitments toconsumer applications of video recording 15 years before thedemand actually could be tapped. They persisted in their effortsto develop the basic technology, even when prematurely intro-duced consumer products failed. Moreover, in both video record-ing and color television, they invested significantly in advancedmanufacturing processes that offered high quality and pro-ductivity.
Finally, Japanese firms received important benefits from theirlocation in Japan. The Japanese consumer electronics industrywas protected until Japanese firms were well established In termsof technology and production scale. By 1970, for example, pro-duction volume of color television in Japan exceeded the U.S.level. Yet investment was restricted, and the Japanese tariffremained above the U.S. level. In addition the Japanese marketwas protected during the 1960s and early 1970s by a myriad of
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non-tariff barriers, including the distribution system, thecommodity tax, and the availability of foreign exchange.'6
In all of their consumer electronics product lines, Japanesefirms thus served a large, protected domestic market that pro-vided cash flow and revenue growth. Moreover, the Japanesemarket was not fragmented; the leading firms had large shares,giving them a significant scale of operations. This large, concen-trated, and protected domestic market allowed Japanese firms topursue a two-tier pricing strategy in Japan and the UnitedStatesa factor that precipitO4d the color television dumpingcontroversy. Low U.S. prices %eakened the ability of U.S. manu-facturers to fund R&D and capital investment; high Japaneseprices strengthened the financial position of their Japanesecompetitors. Thus while U.S. manufacturers also possessed alarge and concentrated market, they lacked two things theJapanese had from the startaccess to an even larger foreignmarket using the same technical standards (the United States) andprotection against import competition. Perhaps more important,they lacked an aggressive public policy mechanism to invokeagainst discriminatory pricing.
NOTES
I. Richard S. Rosenbloom and William J. Abernathy, "TheClimate for Innovation in Industry: The Role of ManagementAttitudes and Practices in Consumer Electronics," Researchpolicy, forthcoming.
2. U.S. Department of Commerce, U.S. Industrial Outlook1982.
3. Ibid.4. 10. U.S. exports go mainly to Canada and Latin
America. 'Recent export growth has been concentrated primarilyin Latin America.
5. The increased internationalization of the U.S. colortelevision industry is also reflected in related-party transactionsas a percentage of total transactions. (These transactions aredefined as a measure of the flow of material between parent firmsand foreign subsidiaries.) Between 1975 and 1979, related-partytransaction figures for incomplete receivers and subassembliesfrom Japan, Taiwan, Singapore, and Mexico ranged from 68.7percent to 99.8 percent. Japan showed the largest increasefrom68.7 percent in 1975 to 91.3 percent in 1979, reflecting the shiftin the later stages of the Japanese manufacturers' productionprocess to the United States. U.S. Department of Commerce,U.S. Industrial Outlook 1982.
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6. This description of the evolution of the color televisimindustry draws on the following sources: Donald G. Fink, "Per-spectives on Television: The Role Played by the Two NTSC's InPreparing Television Services for the American Public," Proceed-ings of the IEEE, September 1976; Michael Radnor, et "IiTiFeU.S. Consumer Electronics Industry and ForeAln Competition,Northwestern University Center for the interdisciplinary Study ofScience and Technology, Evanston, Illinois, May 1980; CharlesRiver Associates, International Technological Competitiveness:Television Receivers and Semiconductors, prepared for theNational Science Foundation, 1979; Merton 5. Peck and Robert W.Wilson, "Innovation, Imitation, and Comparative Advantage: ThePerformance of Japanese Color Television Set Producers in theU.S. Market." in Herbert Giersch, ed., Emerging Technologies:Consequences for Economic Growth, Structural Change andEmployment," J. C. B. Mohr, Tubingen, West Gerr ;any, 1982.
7. Electronics Industries Association, Electronic IndustriesYear Book, Washington, D.C., various years.
8. The Japanese industry's move to ICs was aided by theJapanese government's decision to reduce the high commodity taxon solid-state color television sets and by a cooperative R&Deffort to apply ICs to television receivers that began in 1966 andinvolved researchers from industry, the universities, andgovernment laboratories.
9. "TV: A growth industry again," Business Week, 23February 1981.
10. The share of imports of color television receivers fromcountries other than Japan increased from less than 2 percent in1976 to 9 percent in 1980, reflecting increased offshore sourcingby U.S. and Japanese firms as well as some increases by firmsbased in Korea and Taiwan.
11. U.S. Department of Commerce, U.S. Industrial Outlook.12. As a result of the European delay in adopting technical
standards for color broadcasting, European demand was sup-pressed until well after the period normally required for tech-nology to flow abroad. As a result, the U.S. industry's earlyinnovative lead in color television did not give U.S. firms anadvantage in Europe.
13. The description of the development of the VCR In thissection is based on Rosenbloom and Abernathy, 92. cit.
14. See, for example, J. C. Abegglen and W. V. Rapp, "TheCompetitive Impact of Japanese Growth," in Jerome B. Cohen,Pacific Partnership: United States -- Japan. Japan Society, Inc.,Lexington, Massachusetts, 1972; U.S. General Accounting Office,"Color Television," United States-Japan Trade: Issues andProblems, September 1979; "Japan's strategy for the F0s,"business Week 14 December 1981.
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15. U.S. Department of Commerce, The U.S. ConsumerElectronics Industry, U.S. Government Printing Office,'Washington, D.C., 1975.
16. For a discussion of these trade barriers as they relate tothe case of color television, see U.S. General Accounting Office,"Color Television," United States-japan Trade: Issues andProblems, September 1979.
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8Policy Options for the
U.S. Electronics Industry
The U.S electronics industry's record of growth and innovationover the past three decades has been remarkable; continuedsuccess in the 1980s, however, zannot be taken for granted.Internationally, the world has entered a new era of fierce com-petition in which U.S. firms find themselves competing againstforeign governments that have targeted their domestic industriesto surpass U.S. technology leaders. Domestically, the overall U.Seconomy faces considerable uncertainty. At the same time, pres-sure on state and federal budgets will make more difficult theinvestment in education and research that is needed to strengthenthe Industry's infrastructure.
These domestic and international challenges demand coordi-nated policy responses by industry, government, and universities.They call for a new emphasis on specific industrial policies thatwill encourage the flow of Investment to new and innovativetechnologies. These include (a) policies to ensure adequateresearch and development by U.S. firms; (b) investment policiesthat foster a steady flow of capital for new ventures as well asfor expansion and modernization; (c) education policies designedto develop the engineers, computer scientists, technicians, andtechnologically aware citizens needed for today's society; and (d)international trade and monetary policies that promote fairaccess to world markets.
This chapter outlines the building blocks of an industrialstrategy designed to encourage technological innovation andinvestment in electronics. The following four sections address therange of research, capital formation, human resource, and inter-national trade and monetary policy options from which a compre-hensive U.S. competition policy for the electronics industry maybe forged. The Enid section provides a postscript to the report.
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RESEARCH POLICY
A strong technological position is vital if the U.S. electronicsindustry is to maintain its long-run competitiveness in the face ofa persisting Japanese cost-of-capital advantage. Essential to theU.S. Industry's continued technological leadership Is A high levelof basic or fundamental research. Such research involves longtime horizons, uncertain commercial outcomes, and the possibilityof low appropriability and, therefore, places substantial disincen-tives before all but the very largest firms.' As discussed inChapter 2, however, the ability of even the largest firmsand theuniversitiesto maintain their historical commitrr ent to long-term fundamental research is threatened by both high capitalcosts and shortages of engineers and computer professionals atthe doctoral level.
Technological innovation also requires a commitment toapplied research and product development if basic scientificadvances are to be translated into marketable products. Here,too, the ability of the electronics industry to undertake sustainedinvestment is hindered by high capital costs and shortages ofwell-trained engineers and computer professionals. Indeed,applied R&Despecially developmentconsumes the major shareof industrial R&D expenditures, while innovation-related capitalInvestment requires an even higher level of spending beyond theR&D stage. It is at these investment-intensive stages that theJapanese electronics Industry, with its cost -of- capital advantageand Its strong supply of engineers, poses the greatest challenge toU.S. firms. _ -.-
The technological leaderstrip-of-the-UM-eectronics industry incommercially oriented R&D also faces a challenge based on thegrowing willingness of foreign national governments to financeresearch in electronics. Pressures toward increasing this involve-ment are coming from several directions. First, R&D costs,particularly in the area of software development, have increasedacross all segments of the elettronics industry as integratedcircuit design and manufacturing techniques have advanced.Further, intensified international competition has made it moredifficult for some firms to finance long-term commerciallyoriented R&D. At the same time, increased government Interestin electronics reflects its growing national security and defenseimportance, its future role in terms of output and employment,and its productivity-enhancing impact on other industries.
The governments of France, West Germany, the UnitedKingdom, and Japan have all funded major commercially orientedelectronics research programs aimed at enhancing the inter-national competitiveness of their national industries. Such directfunding overcomes the disincentives faced by private firms in
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financing research with long gestation periods, namely, uncer-tainty with respect to commercial outcomes and appropriability.Moreover, as demonstrated by the 3apanese, cooperation byprivate firms in joint research efforts does not mean that suchfirms will not be fiercely competitive In subsequent development,production, and marketing efforts.
In contrast to the national commerical R&D policies of othermajor industrialized countries, U.S government electronicsresearch funding is overwhelmingly oriented to Its nationaldefense and aerospace programs? Although commercialdevelopment has not been an objective of these programs, theyhave nevertheless exerted a major continuing influence on thecompetitiveness of U.S. electronics products ranging from com-puters, lasers, fiber optics, radio and television equipment, torobotics and communication satellite technology.
Large-scale defense and aerospace contracts have providedU.S electronics firms with a ready demand, for which they haveexpanded production and thereby gained valuable experience,know-how, and scale economies. Moreover, the willingness of theU.S. Department of Defense (DOD) to pay a premium for qualityand reliability has helped electronics firms bear the cost of refin-ing and debugging their products. Due in part to the demand ofthe DOD and the National Aeronautics & Space Administration(NASA) for faster and more reliable semiconductors, the U.S.semiconductor industry was able to reduce its unit costs quicklyduring the 1960s, solidifying its position as a world technologyleader.
Other influences associated with defense and aerospacefunding have been less beneficial. The successful marketing ofnew products requires long lead times during which firms canapply new technologies and make sure they have adequate capital,labor, and productive capacity to meet anticipated demand.
'Defense and NASA programs, however, are subject to relativelysudden changes in national security needs and prevailing politica.Between 1967 and 1974, in the wake of Vietnam, defense-relatedR&D declined by $3.7 billion (in constant 1972 dollars), drasticallyreducing the nation's demand for scientists and engineers. In con-trast, the rise in defense spending since 1981 threatens to createbottlenecks in the production of key subcomponents and capitalgoods and shortages of engineers and scientists in advancedelectronics.
Finally, commercialization requires that new technology betransferable to commercial uses at relatively low cost. Since the1960s, however, military to logical requirements have beenincreasingly divergent from commercial applications. As a result,many observers expect that commercial spillovers from DOD- andNASA-funded research will be relatively small)
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Although the U.S. government has provided little direct fund-ing for long-term research with commercial objectives, substan-tial indirect support has historically been provided under the guiseof federal policy toward the structure of the telecommunications
. Bell Laboratories, for example, has received steady,-term funding for Its basic research budget under license
contract fees paid by the Bell operating companies and, therefore,indirectly by most of the U.S. population. in the form of telephoneservice and equipment charges. Bell scientists have been able topursue research interests with great latitude and publish researchresults freely. This favorable working environment has, in turn,attracted the top scientists that have made Bell Labs one of thepreeminent research laboratories in the world.
The modus operandi of Bell, Labs,. however, will change as aresult of the 1982 Consent Drove, e between AT&T and the U.S.Department of Justice (1303).4 The divestiture of AT&T's localservice operating companies will eliminate a major source of BellLab's funding for basic research. This change could force BellLabs to reduce the magnitude of its basic research or the latitudeenjoyed by its researchers. Such changes would diminish BellLab's ability to attract top scientists and to push technologyacross as many fields and at the same rate that It has done in thepast.' Moreover, under the recent consent decree, AT&T will nolonger be required to follow an open-licensing policy.6
The next years will tell whethels the corporate tradition oftechnology that exists in AT&T will sustain Bell Labs' commit-ment to basic research. Other cooperative approaches to basicresearch, however, are to increase, due to a growing num-ber of advocates in industry, government, and the universities. Inthe palt, U.S. firms have avoided cooperative research due in partto the effect of antitrust laws, despite the fact that there appearsto be little reason to expect that cooperation between partici-pants in the earliest stages of research will diminish competitionin their subsequent product development effort*. Although theDO3 has the power to grant approval to joint research venturesthat make them immune to federal antitrust prosecution, suchimmunity does not -extend to treble-damage antitrust 'action bycompetitors against the participants. Recelit moves to modifythe antitrust laws offer a more equitable approach, immunizing anapplicant from any retroactive prosecution from the time theD03 approves a specific venture until the project is completed orthi Department considers it injurious to the competitive balancefor the venture to continue 'and, thus, revokes any futureimmunity.
Major firms in both the semiconductor and the computer Indus-, tries have recently proposed electronics research ventures as a
means of better utilizing R&D dollars and manpower. One such
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venture, the Microelectronics and Computer Technology Corpora-tion, has been formed by a group of electronics firms led byControl Data Corporation to conduct joint long-range programs;e.g., in microelectronics packaging, .advanced computer architec-ture, computer-aided design and manufacture, and software pro-ductivity.? Participants will either be shareholders, who willfinance one or more technology programs, or associates with morelimited involvement.
Another joint research venture, the Semiconductor ResearchCooperative, has been established by the Semiconductor IndustryAssociation as an affiliate nonprofit research cooperative thatwill fund basic research at U.S. universities.8 Contributions byparticipants are to be assessed at one-tenth of 1 percent of theirannual sales of semiconductors, with no one company bearingmore than 10 percent of the total annual budget. Although suchjoint funding reduces the disincentives associated with basicresearch, particularly for smaller firms, it does not eliminatethem since research findings are expected to be published and,thus, freely available. Nevertheless, participants in thecooperative are likely to have a lead-time advantage overcompetitors in the commercialization of technological advances.
Finally, tax legislation passed in 1981 provided increasedfinancial incentives for commercial R&D. The key provision,which began in 1981 and runs through 1985, was ,a 25 percent taxcredit for certain incremental R&D expenditures (above theaverage outlay for the previous three years) in the United States.(Salaries of support staff and the cost of nonsalary benefits forresearchers do not qualify for the tax credit.) Tax benefits werealso extended to companies donating certain kinds of equipmentto universities for research. Many industry observers, however,believe that these changes do not provide a major stimulus toR&D, though they may bias the system in the right direction.Additional proposals thus call for expanding the incremental R&Dtax credit to include every category of R&D expenditures as wellas research grants to universities for projects related to a firm'sbusiness. As discussed below, such incentives offer the advantageof directly encouraging greater industry-university cooperation inlong-term research.
CAPITAL FORMATION POLICY
The U.S. electronics industry's need for capital has growndramatically in recent years. The industry must invest in newproduction capacity, not only to meet demand for advancedproducts, but also to upgrade existing facilities rendered obsoleteby the t apid change in process technology. At the same time, the
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capital intensity of production has grown substantially," first in themanufacture of integrated circuits and, more recently, in com-puters and computer-related equipment.
Failure to provide a satisfactory climate for long-run risktaking in an industry that is as research intensive as electronicswill severely penalize the future competitiveness of the industry.In the face of record high interest rates, however, U.S electonicsfirms have experienced Increasing difficulty in raising capital toinvest in the R&D and production capacity necessary to keep upwith rapidly changing technology. In contrast, Japanese firmsface a highly favorable domestic environment for investment inproduct innovation and production capacity. Due to both a highdomestic savings rate and a tightly controlled capital market,interest rates in Japan have been generally lower than those inthe United States and western Europe.° Low interest rates, Inconjunction with the high debt-to-equity ratios pertnitted by theJapanese financial system, have given Japanese firms a
cost-of-capital advantage that has allowed them to follow moreaggressive capital investment strategies than their internationalcompetitors.
Low capital costs give Japanese electronics firms an edge inprice-sensitive standardized produtts where high-volume manu-facturing skills are essential. The ability of Japanese firms toinvest in automated production capacity, often well in advance ofanticipated demand, has been a critical ingredient of the Japanesesuccess in products ranging from color television receivers tolow-priced computer peripheral equipment and strategicallyImportant MOS computer memories. By establishing themselves In
such high-volume products, the Japanese have, in turn, moved into
a position from which they can challenge the U.S. technologicallead In lower volume, large system products across a broadspectrum of the electronics Industry.
In the face of the Japanese challenge, policies to create amore favorable climate for capital formation in the United States,
such as tax incentives to stimulate savings and investment, have
become the focus of increasing attention. The full impact of such
policies goes beyond the scope of this report to the reindustrial-ization of the nation; nevertheless, one policydepreciationreformgoes to the heart of the unique capital formation needsof the electronics industry. In the semiconductor industry, forexample, the equipment used to manufacture integrated circuitsbecomes technologically obsolete long before the end of its physic
cal life. Process innovations are so frequent that, on average,existing process techniques have been superseded by new Innova-
tions every two years. Yet the U.S. tax code--despite the reforms
of 1981continues to discriminate against industries where theeconomic life of equipment can be substantially less than the
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permissible tax-based life, which is based on physical rather thantechnological obsolescence.
Reforms of the depreciation system in the United States thuswould require recognition of the rapid technological obsolescencein the electronics industry. One such reform could Involve thecreation of a category for equipment with a high rate of techno-logical obsolescence, combined with a reduction in the penalty fortaking the investment tax credit over a short time period. Asecond reform, an increase in the first-year depreciation allow-ance, would provide a substantial incentive for new capitalinvestment.
General policies to encourage growth and innovation, such asdepreciation reform, offer an advantage in that they do notrequire the government to pass judgment on the merits of aparticular investment. Any tax or depreciation schedule insupport of new investment has the effect of raising the overalllevel of technology, but leaves the judgment of the usefulness ofspecific technologies to the entrepreneur and the marketplace.Indeed many observers stress that general tax policies rather thanaffirmative actions in support of particular technologies havebeen the cornerstone of Japan's highly successful industrial policy.
Finally, policies that affect the availability of venture capitaland equity capital investment, such as the tax treatment ofcapital gains, employee stock options, and corporate dividends,can play an important role in the electronics industry given itshigh research requirements, growth, and risk relative to otherindustries." Such policies are particularly important to smallerfirms that do not have easy access to capital markets, especiallywhen they are seeking to enter the industry on the basis ofrelatively high-risk innovations. In 1969, for example, theintroduction of more restrictive tax treatment of capital gainscontributed to a dramatic reduction of entry by new firms in thesemiconductor industry. Only following revision of the capitalgains tax law in 1978 did the number of new ventures again beginto climb.
HUMAN RESOURCE POLICY
The response of the U.S. electronics industry to the opportunitiesand challenges of the decades ahead will depend critically on itsability to attract sufficient numbers of engineers, scientists, andtechnicians of the highest possible quality. Since World War II thegrowing complexity of electronics technology etas generated anever increasing demand for engineers and computer professionals.Yet in the critical field of electrical engineering, the UnitedStates produced only 14 percent more bachelor's degree graduatesin 1980 than it did in 1970, while the number of master's degreegraduates decreased by 12 percent, and the number of doctorates
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awarded decreased by 40 percent. Trends for computer profes-sionals have been similar; namely, rising undergraduate enroll-ments and declining Ph.D. production. These trends are distress-ing, particularly in comparison with .apan, which has long beengraduating more engineers per capita than the United States andnow graduates more in absolute terms.
Although market forces have worked to ease shortages at thebachelor's level, they have simultaneously exacerbated theshortage of qualified faculty in engineering schools and computerscience departments. As electronics firms have expanded theirresearch efforts, they have lured faculty members away fromacademic research into well-paid positions in industry. At thesame time, industry is making such attractive job offers to bathelor's degree recipients that many who would once have gone tograduate school now opt for positions in industry.
Several factors in addition to noncompetitive salaries con-tribute to the problem of attracting and retaining qualifiedfaculty members: difficulties in obtaining research support,problems of inadequate equipment and facilities, and theinstability of government funding' for research and fellowships.Further, the current shortage of graduate students and facultymembers creates unusually heavy teaching loads, which makesacademic jobs less attractive for those interested in research.The net effect has been a reduction in the ability of universitiesto provide education in engineering and the computer professions,although undergraduate demand for these areas is more intensethan ever. Unless the problem of faculty erosion is alleviated,many engineering schools and departments that educate computerprofessionals may be forced to reduce their enrollments duringthis decade.
Compounding the seriousness of the shortage of qualifiedfaculty is a severe lack of equipment. At the undergraduate level,for example, equipment required to teach computer-aided designand manufacturing methods is generally unavailable in engineeringschools. Consequently, a good deal of the bachelor's instructionbeing offered may in fact be obsolete. At the graduate level, theincreasing cost and relatively short useful life of experimentalfacilities, particularly in the integrated circuit area, pose substan-tial barriers to the educational process.
The strained capacities of engineering and computer sciencedepartments reflect the changing requirements of industry. Assuch, they call for closer industry-university cooperation inanticipating and preparing for future demands. Universities mustrecognize the special research needs of their engineering and
computer science faculties. One alternative is to adapt engineer-ing schools to the so-called medical school model, wherebyfaculty members would be allowed more liberty to supplement
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their salaries and gain access to specialized research facilities inindustry." At the same time, universities can allow facultymembers increased opportunities to undertake rfrarch projectswith the sponsorship and participation of industry.'
Industry, provided with appropriate incentives by government,can take important steps to respond to the shortage of faculty andequipment. Steps discussed above include the formation of con-sortia to support university research groups and the provision ofmoney, equipment, and personnel in exchange for university-conducted research. Given adequate capacity and safeguards,companies can make their unique research facilities available touniversity faculties. Firms can offer cooperative arrangements sothat university faculty members can engage in industrial research,while industrial engineers serve in university departments.
In the past two years, the electronics industry has taken sig-nificant steps to increase Its support for engineering education.In 1981 the American Electronics Association recommended thatelectronics firms give 2 percent of their annual R&D expendituresto help universities hire more engineering faculty and purchasecomputer equipment. Since then, a growing number of firmsControl Data, General Electric, Hewlett-Packard, IBM, Xerox,Wanghave introduced fellowship programs, equipment grants,and other means of helping universities train electrical andcomputer engineers.
Although greater corporate support can make an importantcontribution to alleviating the shortage of qualified faculty andobsolescent equipment, the government must continue to be themajor contributor to the process. Federal agencies, such as theNational Science Foundation (NSF), DOD, and NASA, can assistthe universities in areas ranging from the purchase of equipmentto the development of incentives to encourage students in gradu-ate engirnering and computer programs to enter universityteaching." State governments can increase their support foruniversity electronics programs, and a growing number have doneSO.
Restoring engineering and science education as a nationalpriority will require a new partnership among federal, state, andlocal governments, and private interests. One model is a "High-Technology Morrill Act" that would authorize matching grants fornonfederal initiatives, not just from state governments but alsofrom high-technology industries.° Industrial grants, for example,could stimulate grants in accordance with a designated formulafrom both state and federal governments. Such an act wouldcreate a long-term funding mechanism for engineering andscience education, one in which industry and universities togetherwould play a major role in determining where investments ineducation should be made.
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Even with a concentrated effort by industry, universities, andgovernment, it will take three to five years before the size of theexisting engineering work force can be Increased with new gradu-ates. Therefore, In the near term, industry and academic leadershave called for new efforts to Increase the productivity of thepool of experienced engineering talent. The pace of technologicalchange has been so rapid that practicing engineers are finding itmore and more difficult to stay abreast of the latest technicaldevelopments. Too many engineers leave the profession each yearfor better paying and more influential jobs in management. Thistrend must be reversed and a solution found so that more talentedpeople stay in the field to cope with Increasingly demandingtechnical problems. One approach that deserves careful exami-nation is the recent Massachusetts Institute of Technologyproposal for a nationyjde council to promote lifelong educationfor working engineers. I*
Beyond policies to support professional science and engineer-ing education is the need for a program designed to strengthen thescientific and technological education of all U.S. citizens. Therole of science and technology is increasing throughout society inbusiness, in government, in the military, and in occupations andprofessions where it never before intruded. Today people in awide range of nonscientific and engineering occupations andprofessions must have a greater understanding of technology thanat any time in history. Yet, over the past 15 years the U.S. educa-tional system has placed declining emphasis on science andmathematicsin contrast to other industrialized countries. Morehigh school students than ever before are dropping out of scienceand mathematics courses after the tenth grade, and this trendshows no signs of abating. Unless reversed, the current trendtoward virtual scientific and technological illiteracy will not onlyundermine the competitive strength of the U.S. electronicsindustry, but the social fabric of the nation as a whole.
A renewal of a national commitment to excellence andinternational primacy in science, mathematics, and technologywill require a coordinated program to (a) increase public aware-ness of the need for excellence in science and technology and (b)help the schools fulfill their role In formal science and technologyeducation.. Initiatives in the first area must be directed at society
as a whole and, thus, will depend on the cooperative and comple-mentary activities of many sectors, including business andindustry, the federal government, state and local governments,community organizations, and university and industrial scientistsand engineers. In the second area, specific programs must focuson schools, helping them do a better job of producing graduateswho are prepared to function in an increasingly technology-oriented society. To this end, educational experts have proposed
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major initiatives aimed at improving curricula, introducing newelectronic technologies, helping teachers, and increasing aware-ness of career opportunities in science and technology. Althoughsuch measures are not a panacea, they can go a long way towardstrengthening the nation's science and engineering cgpa6ilities.t
INTERNATIONAL TRADE POLICY
Foreign markets account for over half of the total value of balesIn the electronics industries analyzed in this report. This factalone marks the importance of international trade for U.S. firms.The changing economics of the electronics industry, however, haveheightened the importance of international trade, not only to U.S.firms, but also to electronics firms worldwide. Maximum accessto world markets is essential to keep production costs as low aspossible, particularly in high-volume products where learningcurves and scale economies may be substantial. Similarly, Ikelarger the potential market, the more easily escalating researchand development costs can be recovered .
Japan and other major producing countries have responded tothis situation by placing greater weight on implications forinternational competitiveness when framing national policies. Forexample, public subsidies for long-term research in microelec-tronics are seen in many countries as a means of Improving theinternational competitiveness of _domestic suppliers. At the sametime, however, competitive pressures have intensified as the num-ber of countries seeking to maintain or build a domestic capabilityin electronics hr s increased. National governments have thussought in some cases to further the cause of their domestic indus-tries by restricting access of foreign competitors through bothtariff and non-tariff barriers. In Japan, foreign firms face a for-midable number of non-tariff barriers, not the least of which isJapan's propensity not to import. Impediments to successfuldirect investment in Japan by foreign firms range from difficul-ties in recruiting able and experienced engineers to preferentialaccess for Japanese companies to capital, go meatment guarantees,special tax Incentives, loans, and subsidies." In the EuropeanEconomic Community (EEC), firms from nonmember countriesface punitive t (though the EEC selectively suspends dutieson products fr which production Is inadequate or nonexistent inmember states), highly restrictive rules of origin that limit thevalue of imported components in a finished product to less than 5percent, and discriminatory government procurement policies inindividual member states.
Other trade-distorting actions include subsidization of exports,countertrade requirements that require a supplier to take goods
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that it would not otherwise buy, asyL the application of politicalpressure on potential purchasers.l° The United States, forexample, provides tax subsidies to the foreign subsidiaries of U.S.firms through domestic international sales corporations as well aslow-interest rate financing to purchasers through the U.S. Export.Import Hank. Such measures can transform international compe-tition between firms into competition etween countries. A caseIn point is provided by the .lecommunications equipment indus-try, where OECD countries have traditionally been closed toforeign producers, and exports to non.OECD countries rest on a
real:feely small number of very large contracts.preference for domestic production will, in the long run
be self - defeating If restricted market access distorts or hinder!:the role of competition n diffusing the benefits of technologicalinnovation." Most countries are too small on their own tosupport broad -line domestic manufacturers in major segments ofthe electronics industry. However, in an industry as large aselectronics, there is considerable room for intra-industry special-ization without industry protection. Indeed,, the potential forspecialization has increased with the rapid advance of electronicstechnology.
To be effective, trade liberalization must involve some agree-ment as to the rules of the game for international competition inthe electronics industry, as well as the adoption of a bettermechanism for settling bilateral disputes within GATT. In manycountries the electronics industry has benefited from direct andIndirect financial support. Public involvement in electronics willcontinue in the years ahead as goverdments seek to promotelegitintete social and economic policy objectives, e.g., by orga-nizingOinancing, and carrying out basic research in electrceics.Such support, however, will adversely affect trading relationsbetween countries If it distorts or hinders international competi-tion. For example, the refusal of the Japanese government toallow U.S. subsidiaries or U.S.-Japanese joint ventures to partici-pate in its VLSI project caused considerable resentment in theU.S. semicondiictor industry. To avoid resentments and frictions,agreement is therefore needed as to what constitutes appropriatesubsidies and countervailing duties.
Rather than sliding into protectionism, the Unliled States mustorganize so that it can expand trade, keep it fair, 'itselfcompetitive. Eight U.S. cabinet departments curr tly havestatutory roles in international trade policy: State, Treasury,Agriculture, Defense, Commerce, Labor, Transportation, andEnergy. In addition, there are five importantagencies Involved in trade policy plus the Office of the U.. TradeRepresentative within the Office of the President. The time hascome to clarify and consolidate responsibility for foreign trade
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policy within one agency. Otherwise, divided authority willIncreasingly confuse both domestic and foreign trade interests,thwarting an aggressive U.S. posture on unfair pricing and othernon-tariff barriers.
The trading efforts of U.S. firms have also been inhibited byrestrictive laws and regulations, such as the Foreign CorruptPractices Act, numerous export controls, and confusing antiboy-cott legislation, despite the fact that trade policy ha.: not workedwell as an instrument of foreign policy. Indeed, the specter ofU.S trade sanctions has increased the local sense of vulnerabilityin Japan and western Europe, adding fuel to protectionist sen-timent. In the long run, sanctions may d costly damage to theU.S. reputation as a dependable sepplier among customers all overthe world. Review and clarification of restrictive U.S. laws andregulations are essential to eliminate Insignces where they placeU.S. firms F a competitive disadvantage.
Finally, progress toward freer world trade must address theunderlying causes of the repeated, and severe, exchange-ratemisalignment that have periodically emerged between the dollarand the yen." 4xchange-rate misalignments go far in explainingthe recent escalation in international trade tensions. Over thepast three years, the yen has become substantially undervalueddramatically improving Japan's price competitiveness In the worldeconomy. At the same time, the dollar has become substantiallyovervaluedundermining U.S. competitiveness both in Japan andelsewhere. From its IOW in late 1978 to its highs of August 1981and .April 1982, the dollar rose by 35 to 40 percent against theyen. Meanwhile Japanese inflation ran about 20 percentage pointsless than U.S. Inflation. The price competitiveness of the UnitedStates in world trade visa vis Japan thus deteriorated by 50percent or more within three years.
The result has been disastrous for U.S. exports. The strengthof the U.S. dollar has in effect created an export barrier for U.S.products. Part of the problem Is the excessively high interestrates that have made dollar investments enormously attractive,sustaining the dollar at an artificially high level. The role of theU.S. Federal Reserve System in determining the value of worldcurrencies thus merits careful examination. The impact of itsdecisions is no longer merely domestic but worldwide. At thesame time, the world monetary systemespecially the dollar'srole as the world's principal reserve currencyrequires study andreform if massive exchange-rate misalignments are to be avoidedin the future. Unless the dollar's value comes down, U.S. elec-tronics exports will be severely handicapped, regardless of anysuccess in eliminating other barriers to trade.
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SHAPING AN ELECTRONICS INDUSTRY POLICY
A program to enhance the competitiveness of the U.S electronicsindustry requires major policy initiatives In research and develop-ment, capital formation, education and training, internationaltrade, and monetary reform. The costs and benefits of policies Ineach area must be debated in an open public forum in order toachieve a broad-based consensus involving the industry, govern-ment, and universities. Such agreement is necessary if policies topromote the industry are to be formulated and administered withan understanding of their combined effects.
Nor can a competitive policy for the electronics Industry beseen In a vacuum Independent of the economy as a whole.Upgrading and improving the competitiveness of other industrieswill provide an important stimulus for the electronics industry.Indeed electronics-based technologies, e.g., CAD/CAM androbotics, are frequently the key to Improving productivity in otherindustries. Modernization and rationalization in other industrieswill Increase the demand for both electronic systems and com-ponents, leading to lower costs and prices and further increases indemand.
Since this NAE panel study was initiated In 1980, notable stepshave been taken to move to a constructive dialogue about thelong-term strategic issues confronting the U.S electronics indus-try. The industry has proposed major reforms to help it adjust andcompete in increasingly competitive international markets. Theefforts of firm., in the computer and semiconductor industries topromote cooperative research are indicators of the growing sup-port for the development of a national program to achieve long-term technological objectives. Industry-university cooperationhas increased, and new corrective proposals have been advanced,particularly by leading engineering educators. Both the federaland state governments have introduced tax reforms aimed atinvigorating the climate for innovation by electronics firms.
Much remains to be done. Capital costs for the increasinglycapital-intensive electronics industry must be controlled. Agreater share of the U.S. GNP should be devoted to savings,investment, and innovation. A national policy for privateinvestment that would permit more rapid capital recovery andencourage entrepreneurial investment is much needed, as areefforts to eliminate disincentives to saving. The U.S. governmentneeds to develop and convey long-term policy intentions to thepublic to build confidence for saving and investment.
Future shortages of technical personnel are likely to hinder theability of the electronics industry to innovate and, hence, maintainIts competitiveness. JThe U.S. educational system has faltered asthe number of new engineering doctorates, has declined. The
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number and quality of technical graduates must increase to keeppace with the growing num 'mss of engineers and computer pro-fessionals in Japan and other competitor nations.
Trade barriers to U.S. exports Into competitor nations must bereduced. The United States is viewed by Its competitors as themost attractive of world electronics markets and has been tar-geted in the national plans of Japan and Feance for their directattack. The United States must pursue a more effective programto promote fair trade among international competitors or face theinevitable protectionist pressure to increase U.S. barriers toimports. Finally, U.S. trade policy must be coordinated with itsInternational monetary policy.
The U.S. government, working with Industry and the univer-sities, must develop a statement of national goals for the elec-tronics Industry. This nation has, traditionally had an aversion toany effort associated with national planning, particularly if it isto be done by government. Yet other nations are, within theirsystems; clearly planning and marshalling major resources toenhance the long-term International competitiveness of theirindustries. The published Japanese plans, articulated by MM, arebut one example. The challenge to the United States is to for-mulate an industrial policy that will foster the ability of itselectronics firms to compete vigorously in world markets.
NOTES
1. On the question of appropriability, for example; industryobservers are currently debating whether the nation's patent andcopyright laws should be modified to afford increased protectionto innovations in semiconductor circuitry and computer microcode.
2. The federal government accounts for approximately 30percent of all U.S. R&D funding, two-thirds of which is devoted todefense and space. The missions of DOD and NASA, however, arestrongly developmental In nature. In 1980, for example, basicresearch support accounted for 3 percent of the DOD's researchfunding and for 9 percent of NASA's. Although other federalgovernment agencies, e.g., the National Science Foundation andthe National Bureau of Standards, fund electronics research, thesesources are small in magnitude compared to defense and space.National Science Board, Science Indicators 1980.
Foe a discussion of the Influences of the research fundingof DOD Eind NASA, see Robert B. Reich, "Making IndustrialPolicy," Foreign Affairs, Spring 1982, and Nestor E. Terieckyj,"Analyzing Economic Effects of Government R&D ,Programs,"National Planning Association working paper, 8 December 1981.
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3. Another factor limiting the commercialization of bothdefense and other government-funded research has been restric-tions with respect to the licensing of resulting patents. ChangesIn federal patent policy in 1980, however, have it possible toobtain exclusive licenses for development achieved while workingunder federal contract. This change may encourage industrialresearch that might have been foregone in the past when Its fruitswould pass immediately into the hands of competitors.
4. See, for example, "The organizational switches at BellLabs," The Wall Street 3ournel, 19 July 1982, and "Sell Labs: Thethreatened star of U.S. research," Business Week, 3 3uly 1982.
3. The top researchers lost from Bell Labs would presumablypursue their research activities at other institutions. However, Itis debatable whether the same number of people working togetherin particular areas with the freedom from funding pressures andfrom other constraints (e.g., academic teaching loads andacademic committee responsibilities) that have traditionallycharacterized Bell Labs could be assembled in other settings.
6. Under the 1956 antitrust consent decree, AT&T wasrequired to license Bell Labs' patents to other companies on anondiscriminatory basis. Such open licensing has facilitated entryby new firms across all segments of the electronics industry.Although AT&T will no longer have to license Bell Labs patentsunder the terms of the new consent decree, its licensing policy Islikely to remain relatively open for several reasons. Cross-licensing is highly institutionalized in electronics due in part tothe systems nature of products (with interdependent patents heldby different firms) and in part to the ease with which other firmsan invent around a particular patent. In addition, other large
patent holders such as IBM follow open-licensing policies. Finally,overly restrictive licensing `Could provoke antitrust challenges.Indeed antitrust actions initiated during the 1940s and 1930scontributed to the widespread licensing that currently prevails inthe electronics industry.
7. After a start-up period, the annual budget of the Micro-electronics and Computer Technology Corp. Is expected to be $30to $100 million. "U.S. electronics firms form venture to stemchallenge by 3apanese," The Wall Street Journal 26 August 1982.
8. The Semiconductor -Research Cooperative expects tospend $6 million in the first year and $10 to $13 million in itssecond year. While the universities would hold all patents andissue licenses, a participant's financial contributions would beconsidered as prepayment of royalties. "Semiconductor makersexpand research fund," The New York Times, 14 April 1982.
9. Tax incentives, of course, are only effective If corpora-tions are subject to a egnificant corporate tax. To the extentthat effective U.S. tax rates are more moderate than comparable
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Japanese tax rates, tax incentives will be a less potent policyinstrument in the United States than in Japan.
10. Although Japan has recently moved to ease its restrictivecapital market policies, its capital markets remain the mosttightly controlled of any major economy. See, for example, Wethe Japanese rigging the yen?" Fortune 31 May 1982; "Is Japanholding the yen down?" Business 8 March 1982; "Borrowingyen will be a little bit easier," Business Week, 31 May 1982; and"Borrowers are eager to get yen loans but must grapple withJapan's delays," The Wall Street Journal' 7 July 1982.
11. Such tax policy changes have typically been made inresponse to the strength of lobbying efforts by interested parties.In 1976, for example, Congress eliminated favorable tax treat-ment of employee stock options--a significant part of the com-pensation that small, growing firms use to attract and holdtalented employeesin the absence of effective lobbying effortby growth companies. See, for example, "Lobbyist say options taxbreak is needed to spur bmovation, and Congress responds," TheWall Street Journal, 1 July 1981.
12. There is considerable debate about whether and to whatextent engineering schools should adopt this organizational modeland divorce themselves from their traditional association withfaculties of arts and sciences. This debate focuses on the appro-priate content of the engineering curriculum, particularly theoptimum balance between science-based training and training inengineering design, development, and production.
13. A major catalyst in the spectacular expansion of high-technology industries along Route 128 around the rim of Bostonand in Silicon Valley south of San Francisco was the presence ofmajor research universities willing to allow faculty to work withprivate business.
14. The National Science Foundation is especially crucial toscience and engineering education. Recently, the NSF's educationbudget has been subject to sharp cutbacks, declining from $70million in fiscal year 1981 to $20 million in 1982 and $13 millionin 1983. The proposed budget for 1984, however, would reversethis trend.
13. For a discussion of this and other policy propose* see,James Botkin, Dan Dimancescu, and Ray State, "High Technology,Higher Education, and High Anxiety," Technology ReviewOctober 1982, and U.S. Department of Education and NationalScience Foundation, Science and Engineering Education for the1980s and Beyond, October rho.
16. The MIT proposal recommends a council that wouldconsist of participants drawn from the universities, privatecompanies, research organizations, and professional societies andwould be run by a board of directors composed of chief executives
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of member organizations. As proposed, Its basic mission would beto present a range of approaches by acting as a clearinghouse forinformation about educational needs, resources, and wastingindustry-university cooperative programs. Beyond that, it isproposed that the council (1) take an active role In securing moreIndustry and university commitments to new educational programstailored to the needs of working engineers, (2) raise and distributefunds for new programs, (3) identify and enlist services of engi-neers and university faculty members in developing new coursesof study, and (4) organize, monitor, and evaluate pilot teaching ofnewly developed courses. See 3ames D. Bruce, William M. Siebert,Louis D. SmuUln, and Robert M. Fano, Life! Cooperativeon&Education, MIT Department of Electrical Engineering andComputer Science, October 1982.
17. In May 1982 Japan announced a package of trade reformsdesigmid to liberalize its domestic market in response to mountingpressure from the United States and the European EconomicCommunity. Since then, however, the Japanese have made littleprogress in implementing these measures. The resulting U.S.frustrations over trade have, in turn, spawnedhighly protectionistproposals in Congress to require reciprocity and higher U.S.-madecontent in imported products. See, for example, "Japans U.S.reprisals loom as; trade reforms stall," Business Week, 23 August1982. In 3anuary 1983, reacting to mounting criticism, Japanannounced still another package of measures designed to dis-mantle its non-tariff barriers to trade by simplifying productstandards and certification procedures Again, however, thelegislation necessary to implement such reforms may take monthsor years. "'Japanese adopt another package to open market," TheWall Street 3ournal, 14 Jarusary 1982.
18. The role of countertrade has increased In recent years,spurred by government efforts to maintain exports to recession-shrunken markets and to narrow balance -of- payments deficits.For U.S. policy makers, the proliferation of such practices poses adilemmas whether to try to halt the spread of countertPade orhelp U.S. firms to get their share. See, for example, "Newrestrictions on world trade," Business Week, 19 July 1982.
19. Protectionist measures that restrict access to somemarkets also limit the Innovation incentives and funding ability ofprivate firms located outside those markets. Firms based inrestricted markets face both their own . protected domesticdemand plus demand in the open market. To the extent thatprotected firms face a larger potential sales base than outsidefirms, they will possess a greater incentive to innovate. Inaddition a large protected sales base enhances the ability of firmslocated in such markets to fund R&D, to achieve scale andlearning curve economies, and to engage in international price
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discrimination. Price discriminati6n, or "dumping," reduces theability of firms in the more open markets to fund R&D becauselower prices reduce their profitability.
20. One promising development, however, ois the 1982 ExportTrading Company Act, which reduces two _hurdles that posedimpediments to the formation of export trading companies in theUnited States. (Under the new °legislation, an export tradingcompany is defined as any group of companies and banks that joinsforces with the specific objective of selling goods and servicesabroad.) First, the new law removes a major deterrent to jointexport ventures by offering the possibility of prior certification ofan antitrust exemption. This antitrust exemption will allowtraders to take advantage of economies of scale; one firm, forexample, might represent a number of manufacturers selling thesame product abroadhandling marketing, packaging, andwarehousing; arranging transportation and insurance; preparingdocuments for customs; distributing goods; and servicing foreigncustomers on behalf of the sellers after the sales are made.Second, the measure also amends the longstanding prohibitionbarring banks from investing in commercial enterprises. Bank-holding companies, with their considerable financial strength, mayfor the first time take a direct equity interest in export tradingcompanies, thereby increasing the access of export tradingcompanies to export services and financing. The new law willthus serve to reduce the costs and risks of international trade,particularly for small and medium-sized firms that wouldotherwise be inhibited from exporting by financial constraints andlack of familiarity with foreign markets, customs, and laws.
Although export trading companies existed in the UnitedStates prior to the new legislation, those firms have typicallybeen thinly Capitalized ventures specializing in one or two exportservices such as insurance, ocean shipping, finance, licensing, ormarket research and development. Two of the leading U.S.exporters are actually Japanese trading companies, Mitsui andMitsubishi, which are licensed to sell U.S. goods as part of theirworldwide activities.
21. For a detailed discussion of foreign exchange rate policyproblems, see C. Fred Bergsten, "What To Do about theU.S.-Japan Economic Conflict," ForgifelAgairs, Summer 1982.
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Biographical Sketches
FERNANDO JOSE CORBATO is Professor of ComputerScience and Engineering at the Massachusetts Institute ofTechnology. He holds a B.S. and a Ph.D. from the CaliforniaInstitute of Technology and the Massachusetts Institute ofTechnology, respectively. He has been with the MassachusettsInstitute of Technology since 1936. Dr. Corbato is a Fellow of theInstitute of Electrical and Electronics Engineers and receivedtheir W. W. McDowell Award in 1966. He is a member of severalhonorary and professional organizations, including the NationalAcademy of Engineering, and was co-author of The CompatibleTime Sharing System and Advanced Computer Programming.
THERESE FLAHERTY is an Assistant Professor at theHarvard Busimiss School. She received a B.A. from TuftsUniversity and a Ph.D. from Carnegie Mellon University. Beforejoining the Harvard faculty, Dr. Flaherty was Assistant Professorof Economics at Stanford University. Her special areas of
410. Interfst are in economics, industrial organization, andmanagement of technology in global companies. She has publishedseveral articles related to internationa) competition in thesemiconductor industry.
EUGENE 1. GORDON as Dir.pctor of the Lighpvave &vicesLaboratory at Bell Laboratories. He took a B.S. degre from CityCollege of New York and a Ph.D. degree from the MassachusettsInstitute of Technology. He joined Bell Laboratories in 1957. Dr.Gordon serves as chairman of the Working Group on Imaging andDisplay Devices of the Advisory Group on Electron Devices forthe Office of the Director of Defense Research and Engineering.He is a member of a nymber of professional and honoraryorganizations, incl the National Academy of Engineering.He is a Fellow of t Institute of Electrical and Elect%nicsEngineers and recei their 1975 Vaidimir M. Ivorykin Award.
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Dr. Gordon is the author of 43 published articles and holds 23patents.
WILLIAM C. HITTINGER is Executive Vice-President ofResearCh and Engineering at the RCA Corporation. He holds aB.S. from Lehigh University, did graduate studies at StevensInstitute, and was awarded an honorary doctorate degree inengineering from Lehigh University. Before joining RCA in 1970,Mr. Hittinger served as President of Bellcom, Incorporated and ofGeneral Instrument Corporation. He is a member of severalprofessional and honorary organizations, including the NationalAcademy of Engineering, is a Fellow of the Institute of Electricaland Electronics Engineers, and is the author of many publications.
ANNETTE LAMOND is a consultant specializing in industrialorganization economics. She holds a B.A. degree in economicsfrom Wellesley College, an S.M. in management from theMassachusetts Institute of Technology, and a Ph.D. in economicsfrom Yale University. Dr. La Mond is a member of Phi BetaKappa and is the author of several books and articles, including apaper on the competitive status of the U.S. semiconductorindustry to be published by the Harvard Business School.
JOSEPH C. R. LICKLIDER is Professor of ElectricalEngineering and Computer Science at the Massachusetts Instituteof Technology. He received A.B. and A.M. degrees fromWashington University and a Ph.D. from the University ofRochester. Dr. Licklider was a Vice-President of Boit Beranek &Newman Incorporated, and Director of Behavioral Science andInformation Research for the Advanced Research Project Agencyof the U.S. Department of Defense. He is a member of theNational Academy of Sciences and a fellow of several professionalorganizations. In 1954 Dr. Licklider received the Franklin V.Taylor Award from the Society of Engineering Psychologists.
JOHN G. LINVILL is Professor of Integrated Systems andDirector of Industrial Programs at the Center for IntegratedSystems at Stanford University. He holds an A.B. from WilliamJewell College and S.B., S.M" and Sc.D. degrees from theMassachusetts Institute of Technology. Ls professionalexperience was yith the Massachusetts Institute of Technologyand Bell Telephone Laboratories before joining StanfordUniversity in 1955. He is an active participant in manyprofessional and honorary organizations, Including the NationalAcademy of Engineering. He was awarded an honorary doctoratedegree in applied sciences by the Catholic University of Louvain,Belgium, and has received two awards for development of the
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Opticon, a reading aid for the blind, as well as the John H.McAulay Award from the American Association of Workers forthe Blind and the Education Medal from the Institute of Electricaland Electronics Engineers. Dr. Linvill holds nine patents, hasauthored or co-authored seven books, and has published numerousarticles and technical reports,
ROBERT N. NOYCE is Vice-Chairman of the Board of IntelCorporation. He received a B.A. at Grinnell College and a Ph.D.at Massachusetts Institute of Technology. He has worked withPhilco Corporation artd Schack ley Semiconductor Laboratory. Dr.Noyce was one of the founders of Fairchild Semiconductor, where,as Research Director, he was responsible for the initial develop-ment of the Silicon Mesa and Planar transistor lines. When thecompany became a division of Fairchild Camera and InstrumentCorporation, he was elected a Vice-President of the Corporation.Dr. Notice was awarded the Stuart Ballantine medal from theFranklin Institute and is a Fellow of the Institute of Electrical andElectronics Engineers, a member of the American PhysicalSociety, and a member of the National Academy of Engineering.He holds 15 patents.
DANIEL I. OKIMOTO is Assistant Professor of PoliticalScience at Stanford University. He has studied at the Universityof Tokyo and holds a B.A. from Princeton University, an M.A.from Harvard University, and a Ph.D. from the University ofMichigan. Before assuming his present position, Dr. Okimoto wasaffiliated with The RAND Corporation and Seikel University. Hewas a Mellon Foundation. Fellow at the Aspen Institute forHumanistic Studies and a National Fellow at Hoover Institution/.He is a member of various professional organizations and is authoror co-author of numerous publications.
M. KENNETH OSHMAN is President and Chief ExecutiveOfficer of ROLM Corporation. He received B.A. and B.S. degreesfrom Rice University and M.S. and Ph.D. degrees from StanfordUniversity. His area of specialization is electrical engineering.Before founding ROLM Corporation, Dr. Oshman was employed byGTE Products, Inc. Dr. Oshman was the recipient of the Entre-preneur of the Year Award, Peninsula Chapter of the StanfordUniversity Business School Alumni Association in 1977; theOutstanding Engineer Award, Texas Society of ProfessionalEngineers in 1964; and the Engineering Alumni Award, RiceUniversity in 1963. He is a member of the National Academy ofEngineering.
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MICHAEL RADNOR is Director for the Center for the Inter-disciplinary Study of Science and Technology and Professor in the3. K. Kellogg Graduate School of Management at NorthwesternUniversity. He holds a B.S. degree and a Diploma from theLondon School of Economics, a B.Sc. degree and a Diploma fromthe Imperial College of Science and Technology at LoncktnUniversity, and a Ph.D. degree from Northwestern University.Prior to joining the faculty at Northwestern University, hisprofessional experience included senior manufacturing engineerfor Westinghouse Electric and Vice-President and GeneralManager of Tann Controls Company. Dr. Radnor served asprincipal investigator and principal author of a study of the U.S.consumer electronics industry for the U.S. Department ofCommerce. He is author or co-author of numerous books andmany articles. Dr. Radnor holds membership In a number ofprofessional organizations.
WILLIAM V. RAPP is Commercial Officer with theInternational Trade Administration of the U.S. Department ofCommerce. He took a B.A. at. Amherst College, an M.A. atStanford University, and an M.A and Ph.D. at Yale University.Dr. Rapp has served as a Vice-President with the Bank of Americaand with the Morgan Guaranty Company. His expertise is Ininvestment banking.
ROGER S. SEYMOUR is currently a consultant after retiringas Program Director for Corporate Staff Commercial Relations,IBM Corporation. Mr. Seymour holds a B.S. In Industrial adminis-tration from Yale University.
ROBERT W. WILSON is a consultant specializing in Industrialorganization economics. He received an S.B. degree in physicsfrom the Massachusetts Institute of Technology and a Ph.D. Ineconomics from Yale University. He is the author of severalarticles and books concerning competition, regulation, andtechnological change. Prior to establishing a consulting practice,Dr. Wilson was an economist with the Antitrust Division of theU.S. Department of Justice.
X41
This report on the electronics industry is one of seven industry-specific studies (listed below) that were conducted by theCommittee on Technology and International Economic and TradeIssues. Each study provides a brief history of the industry,assesses the dynamic changes that have been occurring or areanticipated, and offers a series of policy options and scenarioes todescribe alterntive futures of the industry.
The Competitive Status of the U.S. Auto Industry,ISBN 0-30943289-X; 1982, 203 pages, $13.95
The Competitive Status of the U.S. Machine Tool Industry,ISBN 0-309-03394-2; 1983, 78 pages, $5.95
The Corretitive Status of the U.S. Fibers, Textiles and ApparelComplex, ISBN 0-309-03395-0; 1983, 90 pages, $7.95
The Competitive Status of the U.S. Pharmaceutical Industry,ISBN 0-309-03396-9; 1983, 102 pages, $8.95
The Competitive Status of the U.S. Ferrous Metals Industry,ISBN 0-309-03398-5; approx. 135 pages, $9.95 (prepublicationprice), available Spring 1984
The Competitive Status of the U.S. Civil Aviation ManufacturingIndustry, ISBN 0-309-05399-3; approx. 120 pages, $9.25(prepublication price), available Spring 1984
Also of interest ...
International Competition in Advanced Technology: Decisions forAmerica ". . .should help mobilize Government support for thenation's slipping technological and international trade position...Leonard Silk, the New York Times. A blue-ribbon panel created bythe National Academy of Sciences takes a critical look at thestate of U.S. leadership in technological innovation and trade.ISBN 0-309-03379-9, 1983, 69 pages, $9.50
Technology, Trade, and the U.S. Economy, ISBN 0-309-02761-6,1978, 169 pages, $9.75
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