On November 1, 2005, SPRIE invited Jimmy Lee, Vice President and General Manager, Timing Solutions, Integrated Device Technology (IDT) to speak at SPRIE's seminar series on the rise of China in innovation. Lee shared his experience in running a full-blown integrated circuit (IC) product development center in China together with an informative account of China's rise in the IC industry.

The globalization of the IC industry and the rise of China

The commoditization of semiconductor technology is marked by the encapsulation of previously proprietary technologies into commercially available equipment and software design tools. This has substantially lowered the entry barrier for IC design. It has enabled the emergence of a new generation of companies in the Far East in backend assembly and testing as well as IC design. The process is further helped by advances in communication technology that eases access to and sharing of information across geographies. Meanwhile, the IC industry is shifting from being technology-driven to application/market driven. The integration of product development and market has become an important differentiator in global competition. These industry changes are coupled with changes in the worldwide market, mostly noticeably the rise of Asia as a significant market.

China is rising quickly as a significant player in IC. It has a huge pool of talent and many "returnees" - those who grew up in China, were educated in the West and have returned to China to work; they are essential in transferring competence from the West to China. China also enjoys substantial cost advantage while having fairly decent productivity. Starting from the 1990s, the government has invested heavily, and issued extensive regulatory incentives, to promote the semiconductor industry. As a result, according to Lee, in 2004, there were 102 IC test and assembly companies, 50 foundries and 457 IC design companies operating in China. They generated a total revenue of $4.4 billion.

IDT's product development venture in China

IDT is a major IC design company. Its workforce of 3,700 (1,500 in U.S.) has designed 1,300 IC products in 15,000 configurations. In fiscal year 2005, the company garnered a revenue of $645 million, 25% of which went into R&D. In the late-1990s, frustrated by the high turnover and the shortage of talent in Silicon Valley, it opened up an operation in

China. China's abundant and low-cost talent pool provided an opportunity. The company was also attracted to its budding telecommunication market, an area IDT had wanted to get into.

Luckily for IDT, "it just so happened that Newave Technology Corporation was available." Newave was the first IC design start-up in China. Founded by several Chinese returnees in 1996, the company had 100 some engineers developing telecommunication IC for the China market. In 2001, IDT acquired Newave for $85 million. At the time of acquisition, Newave was working on two products but its revenue was very small. Since then, Lee built it into a successful product development center.

Challenges for setting up a product development center in China

Setting up and operating a product development center in China is full of challenges. Lee grouped them into two areas.

The first is organizational challenges, from defining the mission of the organization to every aspect of human resource management: recruiting, training, retention, etc. From the beginning, the mission was to be a self-sufficient, whole product development center. "They basically have the responsibility to develop the entire product from the specification to the manufacturing transfer and they also have the entire infrastructure such as HR, finance and legal to be self-sufficient to support the local needs." Such positioning is crucial in China because the competition for talent is extremely intense and this generation of young engineers is very ambitious, many wanting to start their own business sometime in their life. They are often impatient with long-term strategy. Therefore, "if you want to have top-notch talent working for you, you have to challenge them constantly in technical areas." Picking the right leader is also a key. IDT decided that this person had to be born in China, grew up in China, be western trained and have worked in western companies. Such a combination is ideal because there are a lot of subtleties that are culture specific and one has to be born and grow up in China to get it. In the technical area, IDT hired a few long-term expatriates from headquarters. They are the real masters in their respective fields in IC design. This is where the leverage comes from: "You use one super high power master technical guy to leverage the intellectual labors of the local engineers," said Lee.

The second challenge stems from social-cultural differences. A few examples: communications is a big issue, not so much because of language barriers but because of differences in culture and the level of professionalism. As Lee stated, "...it's more of the mindset. It's very difficult at the beginning to teach them how to communicate, when to communicate and what to communicate." Secondly, social-culture norms shape a different level of standard in decision-making and judgment call. Lee needs to put a lot of effort into teaching the local engineers how to think from the customer's perspective. Thirdly, employees are loyal to individuals rather than the corporation. These social-cultural differences are an area where there is no shortcut. They have to be overcome with training. Training means taking every opportunity to educate the local workforce: formal training programs, informal one-on-one coaching, ongoing training-by-doing, training over hundreds of conference calls over the past 4-5 years, you name it. "To some extent, this is sort of the brainwashing process," commented Lee. "There is no shortcut. You just have to put in a lot of TLC - tender, loving care. This is very challenging."

IDT's positive experience in China

While IDT "did run into many, many of those challenges," its overall effort in China has been extremely positive. The local team now manages a dozen of products, which involves some original work. The headquarter team is using some of the intellectual property generated by the folks in China. The local team even presented a paper in this year's IEEE ISSC Conference. It is the first paper coming out of China presented at such a prestigious conference. Productivity and cost advantage are also evident. Lee estimated that "for the team here in the United States to develop the same number of products will probably take them twice as long in time and probably cost 4-5 times more. This is really a good deal for the company."

Future outlook

Looking ahead, Lee highlighted a few issues that will shape China's IC industry. Overall, it will be a fertile ground for IC product development because of the talent pool. The job market will remain red hot with rapid increase of wages and high turnover rates. There will be hundreds of start-ups because of the low entry barrier. However, many will lack management experience and business acumen. Duplication of investment and engineering effort for the same market will result in the industry consolidating into dozens of medium size companies. In ten years time, these survivors will become significant suppliers to domestic IC demand in emerging applications such as wireless communication and digital TV. All in all, as Lee pointed out, "one needs to marry the best of the East and the West to create a world-class company."

Over the last several decades, there has been a strenuous debate about policies for economic development between the Washington Consensus promoted by the major international financial institutions and the revisionist political economists . Followers of the former view advocate free and unfettered markets buttressed by institutions to protect property rights. The revisionists argue that development involves social and political processes not adequately captured by the narrow prescriptive focus of the Washington Consensus.

In confronting globalization, there is also a new split among the revisionists themselves. Whereas the Washington Consensus welcomes globalization as a boon to developing countries through expanding the scope of market forces, the revisionists divide over the prospects for developing countries under globalization. The optimists, such as Ernst and Saxenian, see transnational networks as providing opportunities for developing countries to continue to learn the skills and competencies necessary to further their progress. The pessimists of the revisionist camp, such as Stiglitz and Strange, see globalization eroding the capabilities of the state or state-societal alliances necessary for development.

Using the case of technological upgrading (one aspect of economic development) in China's information technology (IT) industry, I demonstrate that opportunities for development exist under globalization. These paths to development are not simply the result of picking the right international networks to join nor are they due to the continued efficacy of state action. They also do not arise from well-developed market institutions within China. China's development success in spite of low levels of state industrial policymaking capacity and very incomplete market institutions tells us that other developing countries similarly unequipped can develop even in this globalized world.

In China's IT industry, two local institutional variables, firm operational strategies and state-firm relations, have interacted with the technology flows present in global networks to create opportunities for certain types of firms to upgrade. A firm's operational strategy (OS) determines its motivation to upgrade in China as opposed to doing so elsewhere. The relationship of firms to the state determines their sources of finance i.e. whether or not they can access functioning financial institutions.

The relationship of firms to the state determines their sources of finance and these sources of finance in turn impact their ability to upgrade. Sources of finance that provide credit with hard budget constraints give firms incentives to upgrade. Firms have hard budget constraints when they do not receive free help in covering their own financial obligations. With hard budget constraints forcing firms to meet their financial obligations, firms have to remain competitive to survive. For technology firms, a critical part of their competitiveness is their technology so they have every incentive to improve their technologies to keep pace with competitors. Finance that provides credit with soft budget constraints deprives firms of the incentives and even the capabilities to upgrade. Firms have soft budget constraints when they do not have to pay for some or all of their financial obligations themselves. These firms can rationally expect to survive even if not competitive because others are willing to bail them out. A third possibility is no source of finance. Firms without financing will not be able to invest in technological development.

There are four types of firms in China: the favored domestic firms, the neglected domestic firms, the hybrid foreign-invested enterprises (FIEs) and the regular FIEs. Financing and motivation have varied across firm categories. Due to different state-firm relations, FIEs rely on foreign finance and domestic firms do not. Hybrid FIEs differ from regular FIEs because the hybrids have a China-based operational strategy. This operational strategy (OS) is a mix of interests and ideational factors that causes these firms to perceive China either as the vital center of their operations (the China-based OS) or as just another location among many (the non-China-based OS). Thus, variation in firm-state relations (finance) and operational strategy (motivation) determine the variation in technological upgrading.

This thesis finds that the two types of FIEs are more likely to contribute to upgrading in China than the two types of domestic firms. Among the FIEs, the hybrid FIEs are more likely to contribute than the regular FIEs though the discrepancy is not as large as it is between the FIEs and domestic firms.

The hybrids are the most successful upgraders because they have both disciplined finance (i.e. credit with relatively hard budget constraints) from foreign financial institutions and the motivation to upgrade in China due to their China-based OS. The unsuccessful domestic upgraders lack finance (neglected domestic firms) or financial discipline (the favored domestic firms) due to their particular relationships to the state. The regular FIEs have the capabilities to upgrade due to their financial discipline and access to transnational technology networks, but undertake less upgrading in China than the hybrids because they lack the China-based operational strategy.