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Taiwan's Businesses Learn to Build IP Value

Managing Intellectual Property
June 1, 2008

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Taiwan has developed a strong reputation as an outsourcing hub for manufacturing, particularly in the electronics industries. But with other countries in the region competing fiercely on price, a number of companies are looking to develop their own brands and IP strategies to move up the value chain. The best known example so far is the notebook computer maker Acer, which is now the third largest computer maker in the world by sales. Horng-Dar Lin reveals the strategies Taiwanese companies are using, such as spinning off a separate company to do the manufacturing for overseas brand owners, developing new distribution chains and using patent portfolios more aggressively to carve out a niche in the market.

For more than twenty years, Taiwan has been recognized as one of the world's leading original equipment and original design manufacturers, especially in electronics. For example, in 2007 11 categories of informationtechnology products manufactured by Taiwanese companies were ranked number one in world sales by the Institute for Information Industry of Taiwan. These products included motherboards, notebooks, liquid crystal display monitors, computer monitors, digital subscriber line customer premise equipment and wireless local area network area devices – not to mention Taiwan's highly successful semiconductor industry.

This success derives mainly from effective cost control and extensive investment in innovation. Nonetheless, while original equipment manufacturing (OEM) and original design manufacturing (ODM) is still a thriving business, Taiwanese companies are feeling increasing pressure from competitors to keep cutting costs. In fact, some financial institutes even predict that, if these companies don't develop better approaches to cost control, the old OEM/ODM business model might only generate 3% to 5% of net profit in the near future, a performance that might get even worse over time.

The companies know this, and most of them have been trying to adopt new strategies to continue their growth and increase their net profits. For example, some are moving their factories to areas with lower labour costs and tax burdens, such as western China and Vietnam. Others are trying to get into new emerging markets, such as Russia and the Middle East; and some are integrating with other companies to reduce costs further through mergers, acquisitions and cross-investments.

But knowing that such business arrangements have their limitations, many Taiwanese companies are also focusing on revamping their IP strategy. Although these IP reforms might not be readily apparent to the press or the public, they are no doubt essential to these companies' future and might produce a new look for Taiwanese companies in the next few years. There are some clear trends in the strategies that these companies have adopted which can act as a model for other Taiwanese companies, or for manufacturers in other countries looking to move beyond OEM and ODM manufacturing.

The Dangers of Running on Two Feet

Johnny Shih, chairman of ASUSTek Computer, publicly announced that ASUS will spin off its manufacturing business in 2008. This was big news in Taiwan's IT community, for Shih had said many times that ASUS can outrun its competitors because the company has two feet – manufacturing for other companies and developing its own brand. No-one outside ASUS can be sure why it decided to reorganize its corporate structure, but some local news outlets suggested that a major brand client had withdrawn a large manufacturing order.

Companies that have their own brands and manufacture for others face a tricky situation: the more business the manufacturing companies can get from brand companies, the stronger they become, especially if the manufacturing company's own brands are also strong. But the brand-owning companies doing the outsourcing fear that they are helping potential competitors. This creates an invisible limit for companies that that try to stand with two feet.

About 10 years ago, another famous Taiwanese company, Acer Computer Corporation, reached this limit, so it decided to spin off its manufacturing division (Wistron Corporation) in 2001 and focus its efforts on brand development so that both sides of the company could maintain their success. After that reorganization, Acer has gradually become the third largest brand-name personal computer company in the world. Now ASUS is doing exactly the same thing, and most market analysts believe that the ASUS brand will be as successful as the Acer brand through this reorganization in the near future.

There is no clear guideline regarding when and how a company trying to run on two feet should reorganize its corporate structure. But while these companies are still using their manufacturing experience and resources to develop their own brands, they will know when and how (with a little pressure from their manufacturing clients). And we will soon see more companies follow the routes established by Acer and ASUS.

Four Channel Distribution

In May 2008, HTC Corporation launched a revolutionary product – HTC Touch Diamond – in London. Market analysts believe that HTC could easily sell over 4 million Diamonds through different channels within a year, and that this Diamond phone will be the only meaningful competitor to the iPhone 3G device made by Apple.

About two years ago Peter Chou, CEO of HTC, announced that it will be developing its own HTC brand. HTC's stock price dropped significantly, as many investors didn't believe that a Taiwanese OEM/ODM company was capable of developing a successful brand to compete with other major brand phone companies, such as Nokia, Motorola and Sony-Ericsson. They also suspected that HTC's brand clients, such as HP and Palm, would exert pressure on HTC to abandon one of its two feet, and that this pressure would affect HTC's revenue. But they were all wrong. HTC's earnings a share (after tax) were NT$57.85 ($1.87) and NT$50.48 ($1.63) in 2006 and 2007 respectively, and stock analysts all agree that the earnings a share of HTC in 2008 will grow to around NT$60 ($1.94). In addition, while HTC remains highly profitable, it has become the third or fourth brand in the smartphone market throughout the world.

Two unique things are contributing to HTC's success. First, HTC sells its phones via four channels: OEM/ODM for brand phone companies, OEM/ODM for mobile phone operators, co-branding agreements with mobile phone operators, and its own brand. With these four feet HTC can easily and efficiently distribute its resources to maximize profits and develop the HTC brand simultaneously, as the cooperation with cellular operators largely reduces entry barriers to brand markets. Secondly, HTC's advanced technologies in smartphone design and manufacturing, in particular in integration with WinCE, the operating system behind Microsoft's Windows mobile platform, provide it with a very strong position when negotiating with brand clients. These brand clients have no other options and hence cannot exert any pressure on HTC, even though they know that HTC might be able to replace, or has already replaced, their market positions. 

Building a Patent Portfolio

While other Taiwanese OEM/ODM companies, such as ASUS and HTC, are developing their brands, Foxconn Electronics (also known as HonHai Precision Industry), in contrast, is keeping its focus firmly on the OEM/ODM business. Terry Kuo, chairman of Foxconn, once went as far as saying: "We will never ever develop brands." However, this doesn't mean that Foxconn only extracts profits by controlling costs – the avenue of survival for many OEM/ODM companies. Instead, it looks to its patent portfolio.

People might know that Foxconn is the largest electronics manufacturing services company, but fewer know that Foxconn holds more than 14,000 granted patents worldwide. This remarkable patent portfolio protects Foxconn and its clients effectively, and allows it to be the only company consistently ranked among the top 10 in the Business Week IT100 since 2002. But this is not enough for Foxconn. In 2007 the company announced that it will implement a new, more aggressive, IP strategy, in contrast to its existing defensive approach. Although it was just an announcement with no details, given Foxconn's patent portfolio there is no doubt the company will realize more value from its past innovation investment soon.

And in the meantime, Foxconn has been promoting its own name as a business-to-business brand for several years. This is another clever brand approach for an OEM/ODM company, as it won't irritate its brand clients, but enables it to distinguish itself from other competitors, keep its leading position and obtain value from its company's good reputation. Perhaps one day we will see products everywhere branded with Foxconn inside or like Designed by Apple – manufactured by Foxconn.

In the past, most Taiwanese companies believed that one of the best ways to protect their inventions was to get as many patents as possible. This might have been the correct approach, especially given the need to raise IP consciousness internally. Nevertheless, if companies provide improper incentive plans, the patents they get could be narrow, fragmentary and ultimately useless. Patent quantity is not everything, as sometimes patents can cause a financial drain instead of positive cash flow.

Taiwan Semiconductor Manufacturing Corporation (TSMC) knows this very well. If you check the patent applications filed by this leading foundry company, you will see the numbers have declined gradually over the last few years. Since TSMC would never slow down its R&D investment, this decline suggests that TSMC is now focusing on getting stronger patents rather than getting more patents. And we can be sure that TSMC is doing what it declared in its 2007 annual report: "We have worked continuously to improve the quality of our intellectual property portfolio and to reduce the cost of maintaining it."

Another good example is MediaTek Inc, which uses strategic considerations and close alignment with business objectives to improve its IP management. For example, in January 2008, MediaTek acquired the wireless chip division of Analogue Devices Inc and got core technologies and patents in the GSM mobile phone standard and various mobile data services including GPRS, EDGE and the 3G cellular networks W-CDMA and TD-SCDMA. Most market analysts believe that, in addition to getting ADI's R&D team and IP, MediaTek will now be capable of entering the China market, as ADI has established good business and technology relationships with Datang, a major China communication company, and TD-SCDMA is a China 3G standard. In other words, the China market drove this transaction.

At the same time, more Taiwanese companies are now fighting in another battlefield – the WiMAX Forum, a standards organization for telecommunications technology. In the past, Taiwanese companies rarely led or joined any standards organizations, and therefore lacked the proper channels to maximize their IP value or avoid any potential risks. But this time more than 20 Taiwanese companies have joined the WiMAX Forum. No one knows if any Taiwanese companies will successfully lead the setting of standards, but at least they all know that such a standards organization is the battlefield where they can go or need to go.

Taking the Fight to the Opposition

Although Taiwanese companies have learned a lot of lessons from international IP litigation, they still have the reputation of being reluctant to file suits against IP infringers, unless they need to file a countersuit or counterclaim to get a better negotiating position. But two recent cases are changing this impression.

In December 2006, Topower Computer Industrial, a Taiwanese company that designs and manufactures power supplies, filed an investigation request with the United States International Trade Commission (ITC) alleging that many Taiwanese competitors are infringing one of its US patents. The technology involved is simple, but Topower was tough enough to fight for it in the ITC. According to public information published on the ITC website, this investigation (number 590) was closed after all respondents defaulted, settled with Topower, or got consent orders from the ITC. Because settlement terms are confidential and the market is not big enough, no-one can be sure if Topower received enough to compensate it for the legal fees paid to US attorneys in this investigation. But at least Topower stopped other competitors from selling infringing products in the US to some extent and successfully sent a strong signal: don't infringe our patents.

Another remarkable case involves CpuMate Inc, a Taiwanese company providing thermal modules for PCs, notebook computers and servers. On January 22 2008, CpuMate filed a complaint against IBM in the US District Court for the Southern District of Texas, seeking a permanent injunction and damages. This litigation greatly surprised the IT community in Taiwan, because no-one believed that the tiny CpuMate, with a registered capital of only $17 million, would dare to challenge IBM, and that's why the local news described this litigation as a war between a shrimp and a whale. But suing IBM seems to be just the beginning, because in April 2008 CpuMate filed another complaint against Acer in the same court, and more lawsuits are expected. Both the Topower and CpuMate cases indicate that Taiwanese companies know how to enforce their IP and how to enforce it aggressively.

After more than 20 years of OEM/ODM experience and countless IP litigation, it is time for Taiwanese companies to develop a new approach to their IP management, and the new look is coming soon. I also believe that it will resemble the type of society Taiwan has become – flexible, diversified and courageous.

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