Control and coordination

The governance structures that determine whether control over international

production networks is centralized or decentralized are highly sensitive to peculiar

features of national institutions and markets. There is a broad

consensus that Japanese companies, once they moved abroad, were less obsessed

with equity control than American companies.This is a reflection of important differences in the domestic capital markets of both countries and the fact that Japanese firms have had, until quite recently, ample access to patient capital. Some observers also claim that Japanese firms, especially in East Asia, are more willing to engage in joint  ventures and other forms of inter-firm cooperation than American companies because of domestic relations with suppliers. “[A]ccustomed to operating in their home market through an extensive network of cooperation agreements, [Japanese firms] show a higher propensity to enter partnerships in Asia than American

firms”.

As long as their objective was the penetration of protected domestic markets,

Japanese subsidiaries in Asia had relatively strong local roots; local content was

substantial, and this gave rise to a first generation of domestic support industries.

At the same time, these subsidiaries often had considerable leeway with respect to

the main objective: how to reap the windfall profits available in highly protected

domestic markets.

The Matsushita group provides an example. Its core company Matsushita

Electric Industrial (MEI) arguably is “…the company most deeply involved in

East Asian electronics, and most representative of the Japanese approach.”

. Matsushita’s involvement in East Asia started in the early 1960s with minority joint ventures strictly targeted at heavily protected domestic markets. The so-called “mini-Matsus” originally produced simple products like batteries, radios, electric fans, rice cookers and other low-end home appliances, small TV sets and some related components. As minority joint ventures, most of these local affiliates had considerable decision autonomy not only for employment, work practices, and salary, but also on how to organize production, support services (quality control and maintenance) and procurement. Decision autonomy was probably most pronounced in the choice of marketing approaches and distribution channels. Considerable local linkages developed from these investments, and local value-added increased sharply, often, however, at the expense of cost efficiency and quality.

Once their objective shifted from the penetration of domestic markets to

exports, Matsushita increasingly relied on 100 percent affiliates or at least majority

joint ventures. Local linkages declined as components were procured either

directly from Japan or from Matsushita’s affiliates within the region. This general

pattern has been followed by all Japanese electronics firms: as they shift to export

platform production, they close their Asian production networks to outsiders by

centralizing almost all strategic decision-making and high value-added activities in

Japan. Until a few years ago, sourcing components from independent local

suppliers played a very marginal role, and was restricted to technically simple lowend

components and support activities; almost all high value-added components

were imported from Japan.3 This heavy dependence on Japan appears to have

reached its peak by 1992.4 Between fiscal year (FY) 1991 and FY 1992, East Asian

affiliates of Japanese electronics firms increased their procurement from Japan from

less than 40 percent to nearly 47 percent, much higher than the average share of

38 percent reported for all industries. While the share of intra-regional

procurement has stagnated at around 15 percent, there has been a substantial

decline in local purchases from nearly 44 percent to less than 37 percent.

The closed and Japan-centered nature of the Asian production networks of

Japanese electronics firms extends well beyond the sphere of procurement.

Japanese electronics firms rely much less on local managers and engineers in their

Asian affiliates than their American and European counterparts do, leaving Asian

affiliates little scope for autonomous decisions. Japanese electronics firms routinely

engage in sound and systematic “on-the-job” training. Most of the training

however remains restricted to simple operational capabilities required for

production and maintenance.6

We also find only a limited transfer of the Japanese production model to Asian

affiliates of Japanese electronics firms. In most affiliates, seniority-based wage

systems, job rotation, “life-long” employment, quality control circles, and just-intime

(JIT) management approaches play an insignificant role. Often a crude

Fordism prevails, at least during the initial phase of production.7 This contrasts

with the situation in the United States and Europe, where Japanese firms have

made serious attempts to transfer key elements of their domestic production

system and to adapt them to the peculiarities of local institutions and labor

markets. In contrast to the situation in Asia, Japanese IPNs in the United States

and Europe have undergone a certain limited convergence with the investment

patterns of American and European firms (Abo 1993; Encarnation and Mason

1994; and Gittelman and Graham 1994).

The issue of governance structure thus leaves us with a few puzzles. In contrast

to a general perception that Japanese firms are more willing to engage in

partnerships in East Asia, we find that this has not been the case in the electronics

industry. Early partnerships serving local markets gave way to highly centralized

and closed governance structures as production moved toward exports for third

markets.

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The Asian production networks of Japanese electronics firms

Like their American counterparts, Japanese electronics firms have developed

substantial international production networks (IPNs) in Asia.1 This article

examines how far Japanese firms have cloned key features of American IPNs or

developed substantially different international production activities. As we shall

see, there have been substantial differences that mirror important characteristics of

the respective national political economies. Those differences have had significant

competitive effects.

I proceed in four steps. First, I provide an overview of the internationalization

of the Japanese electronics industry up to 1991, i.e. before the bursting of the

bubble economy. I briefly describe two peculiar features of Japanese IPNs that

distinguish them from the networks established by American firms —their closed

and Japan-centered governance structures and their asymmetric trade relations.

Second, I discuss some of the causes for these differences. Although nationality is

only one factor determining the nature of Japan’s IPNs, aspects of domestic

industrial organization do spill over into foreign operations.

In the third section, I describe the factors that are gradually forcing Japanese

firms to open up their Asian production networks. While the “bursting of the

bubble economy” and the yen appreciation have acted as powerful catalysts, more

fundamental forces are also at work. The closed and Japan-centered nature of the

country’s production networks originally was a great strength. It enabled Japanese

electronics firms to rapidly ramp up export platform production in Asia and to

sustain international market share expansion. Yet it also came at a heavy cost. Farreaching

changes in the domestic production system associated with yen

appreciation and recession forced rapid changes in IPNs. Of equal importance,

however, were changes within East Asia. As the region improved its production

and innovation capabilities and became a leading growth market for electronics

products and services, Japanese firms needed to exploit these opportunities.

I conclude with a brief review of some recent changes in the organization of

Japanese production networks in Asia. Overall, the Japanese case suggests that

changes in the organization of international production are path-dependent.

Industry- and product-specific factors, firm-level characteristics and locational

advantages of the host economies matter, but the significance of national

characteristics persists.

The Asian production networks of Japanese electronics firms during the early 1990s

Three distinctive features characterize the Asian production networks of Japanese

electronics firms prior to the early 1990s: (1) heavy geographic concentration; (2)

closed, headquarters-centered governance structures; and (3) asymmetric trade

links with East Asia (Ernst 1994a). While the first feature constitutes an important

similarity with American IPNs in the electronics industry, the other two features

do not.

Locational patterns

As Encarnation (1995) has shown, Japanese investments in general are more

geographically dispersed across Asia than American ones. This was also true for

the electronics industry, because until the mid-1980s Japanese affiliates produced

primarily for protected local markets. Once the focus shifted to export-platform

production, Japanese electronics firms invested heavily in “mega-plants”

concentrated in a handful of industrial sites in Malaysia, Taiwan, Singapore, and

Thailand. In 1993, these four countries together accounted for two-thirds of all

Japanese affiliates in Asia: Malaysia had the highest share (24 percent), followed by

Taiwan (17 percent), Singapore (13 percent), and Thailand (12 percent).2

With regard to location, similarities thus have been stronger than differences; US

electronics firms have also concentrated their Asian production networks in

Singapore, Malaysia, Taiwan, and Thailand. For both Japan and the United

States, Singapore often is the apex, performing critical support and coordination

functions; Taiwan and South Korea are suppliers of precision components and

sources of OEM (original equipment manufacturing) supply; and Malaysia and

Thailand are the preferred locations for volume manufacturing.

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CPNs and the future of competition

Wintelism and CPNs have been very important to the outcome of competition in

the electronics industry. They were the principal means by which the US

electronics industry recovered from its mid-1980s nadir in competition with

Japanese firms to re-emerge as the global technical and market leader by the

mid-1990s; they were also the enablers that permitted indigenous electronics producers to emerge and prosper in the rest of Asia. Wintelism shifted the

industry’s product market strategies away from final assembly and toward the

distinctive value-added products backed by standards strategies in which American

innovations and entrepreneurial companies were strong. Simultaneously, the

American CPNs created an alternative supply base in Asia, an alternative to

reliance on Japanese competitors for underlying component technologies and

manufacturing capabilities. By exploiting an ever more intricate and flexible

division of labor based not on cheap factor endowments but on increasing local technical specialization in Asia—a division enabled by Wintelist product strategies—CPNs helped to lower production costs and turnaround times while keeping pace with rapid technological progress and responding rapidly to unpredictable market

shifts. Also, the networks spawned Asian-based direct competitors to Japanese

firms in several of their stronghold  markets (e.g. memory chips, consumer

electronics, and displays).

Taken together, Wintelism and CPNs enabled a new generation of US firms to

pioneer a new form of competition in electronics: one that grew out of the

distinctively American market environment and was adapted to overseas

opportunities. It is a form of competition in which “core assets” are the

intellectual property and know-how associated with setting, maintaining, and

continuously evolving a de factomarket standard, a process that requires perpetual

improvements in product features, functionality, performance, costs, and quality.

And the core managerial skill has become orchestrating the CPN itself: managing

the continuously changing sets of external relationships and melding them with

the relatively more stable core of internal activities in order to access relevant

technologies, design, develop, and manufacture the products, and get them from

product concept to order fulfillment in minimal time.

For Wintelist American firms the innovations in product concept and corporate

organization appear to have fulfilled the single most important strategic imperative

of competition in high-technology markets: developing and sustaining monopoly

niches, whether through ownership and control of a de factostandard or by

maintaining a differentiated product through the ability to add performance,

functionality, features or to improve costs faster than their competitors.

Profitability and market capitalization in electronics are almost purely a function of

achieving such market structures, high where a quasi-monopoly position can be

maintained in fast-growing markets, low or non-existent everywhere else. As Intel

and Dell demonstrate in components and PC distribution, and Sony and

Symantec demonstrate in their recent struggles with content creation (Columbia

Pictures) and software, respectively, profits can be won or lost at any point in the

value-chain if the market is structured accordingly. Future competitive battles in

electronics will continue to center around the creation of and defense against a

quasi-monopoly position, as the concerted attack by Silicon Valley on Microsoft’s

position and practices demonstrates.

It is also instructive that traditionally vertically integrated assemblers like HP,

Motorola and, more recently, IBM have been the first among the traditional players to embrace the new form of competition. That fact suggests the hypothesis that in a globalizing world economy, new, epochal forms of competition like those described here will increasingly originate in a firm’s ability to exploit location-specific advantages  at its point of origin and to fill in complementary elements as necessary with relationships that exploit locationspecific advantages elsewhere. Thus, for example, the shape and character of US firm CPNs clearly reflect the advantages they derive from their point of origin in the US launch market: the setting, maintenance, and evolution of de factostandards set in the domestic US launch market was the principal instrument used by US firms to structure and preserve control over their inter-firm networks. So long as US firms maintained that role in the division of labor—by defining and executing an evolutionary path for improved performance, functionality, and cost that kept customers and licensees locked in to their standards—it was extremely difficult for other firms in the network to challenge for the lead. US networks could be relatively decentralized because control over standards enabled devolution of responsibility for significant value-added to partners without fear of losing the ability to orchestrate the network. By contrast, with control residing in their domestic-based manufacturing and core-component technologies, any significant devolution of responsibility by Japanese firms over those competencies to outside partners risked creating a direct competitor. Japanese networks had to be centralized to avoid that outcome.

For most firms, new forms of competition are initially linked to the domestic

point of origin because that is where development of new product or process

concepts and associated launch market opportunities are most developed, where

local capacities and technical specialization are still exploited most fully, where the

initial patterns of constraint and opportunity to which firms respond are first set. But, increasingly, the future of competition will lie in the ability to exploit

complementary capabilities originating elsewhere in the world, to combine them

effectively and thereby generate innovations in strategy and organization.

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Regional supply base

By the end of the 1970s, US electronics firms were almost completely dependent

on Japanese competitors for the supply of the underlying component technologies

(for example tuners, picture tubes, recording heads, miniature motors) necessary

to produce consumer electronics products. In most cases, thoroughgoing

technology dependence was a first step toward market exit. US firms were far

enough removed from the technological state of the art to impede new product

development, and, as a result, their principal competitors could dictate the timeto-market, product cost, and feature quality. Under those circumstances, profits

were minimal if any were to be had at all. By 1980 most major US firms had

exited the consumer segment of the market, and the remaining players like GE

and RCA survived largely by putting their brands on Japanese OEM production.

A few years later, even RCA and GE, who had created most of the consumer

electronic technologies that Japanese firms perfected, left the business.

The loss of the high-volume demand of consumer electronics eroded the US

supply basefor the other segments of the electronics industry, and threatened them

with an equally, competitively constraining architecture of supply. The supply base

is the local capability to supply the component, machinery, materials, and control

technologies (e.g. software) and the associated know-how that producers use to

develop and manufacture products. The architecture of supply is the structure of

the markets and other organized interactions (such as joint development) through

which underlying technologies reach producers. In effect, US producers of

industrial electronics such as computers and communications were in danger of

becoming dependent on their Japanese competitors for memory chips, displays,

precision components, and a wealth of the other essential technologies and

associated manufacturing skills that went into electronic systems. The only

alternative to increasing dependence on a closed oligopoly of rivals was to make

the supply architecture more open and competitive. In conjunction with government policies and local private investors in Asia, US firms gradually turned

their Asian production networks into a flexible alternative to Japanese suppliers.

The transformation from affiliates based on low-cost labor to an alternative

supply base occurred in three stages: an initial stage from the late 1960s to late

1970s during which US firms established their presence through foreign direct

investments; a second stage in which their Asian affiliates developed extensive

local relationships in the shadow of the dollar appreciation from 1980–5; and a

third stage from the late 1980s through the early 1990s, when the technical

capabilities in their regional production networks were significantly upgraded and

local affiliates gained global product responsibilities. The US progression from

simple assembly affiliate to technologically able Asian production network

contrasts sharply with the development pattern of Japanese investments in the

region over the same time period. A brief review of key developments in each of

the three stages will highlight the differences.

After an earlier round of market access investments by a few large US MNCs

(notably IBM, GE, and RCA), most US electronics firms in the 1960s sought not

market access but cheap production locations in Asia. US investment was led by

US chipmakers, then consumer electronics and calculator producers, and finally,

toward the end of the 1970s, producers of industrial electronic systems like

computers and peripherals. Most of the US investments in this first stage

established local assembly affiliates. Cheap but disciplined Asian labor permitted US firms to compete on price at home and in Europe. Right from the start, then, the

Asian affiliates of US electronics firms were established as part of a multinational

production network to serve advanced country markets. Japanese investment was often turnkey, with knockdown kits exported from Japan for local final assembly and sale in the local affiliate’s domestic market. While the Japanese and US investments in this first stage were both oriented to simple assembly and superficially appear similar, the vastly different markets being served pulled their respective investments in divergent directions.

Consider the resulting logic of sunk investment for the two sets of firms. Because

their Asian affiliates were integrated into a production operation serving advanced

country markets, US firms upgraded their Asian investments in line with the pace

of development of the lead market being served, the US market. In essence, they

upgraded in line with US rather than local product cycles. By contrast, Japanese

firms were led to upgrade the technological capacities of their Asian investments

only at the slower pace necessary to serve lagging local markets. As local US

affiliates became more sophisticated through several rounds of reinvestment, a

division of labor premised on increasing local technical specialization developed

throughout the US firms’ global production operations. Local needs began to

diverge from those elsewhere in the United States and the overall operations and affiliates of firms were sought out, and, where necessary, local partners were

trained to meet them.

To be sure, the growth of local autonomy and relationships was constrained by

overall corporate strategies (e.g. where economies of scale dictated a global rather

than local sourcing arrangement), but over time US investments still led to greater

technology transfer and increasing technological capabilities for locals. By

contrast, stuck in developing market product cycles, offshore Japanese affiliates

benefited from no such incentives to upgrade and no need to develop local supply

relationships. Japanese firms served the domestic and US markets wholly from

home. Whatever their lagging Asian affiliates needed could be easily supplied from

Japan. As local Asian markets demanded the marginally more sophisticated goods

whose product cycles had already peaked in the advanced countries, the entire

production capability for those could also be transferred from Japan. Overall, less

technology was transferred, and even that remained locked up within the Japanese

firms’ more limited circle of relations.

Thus, during the second stage (1980–5) US-owned assembly platforms were

upgraded and enhanced technically to include more value-added, e.g. from

assembly to test in chips, from hand to automation assembly techniques, from

simple assembly of PCBs to more complex subsystems and final assembly in

industrial electronics. As they gained more autonomy, US affiliates began to

source more parts and components locally (a range of mechanical parts, monitors,

discrete chips, and power supplies). As US affiliates developed and as the US

industry exited the consumer segment, local electronics producers in places like

Taiwan began to concentrate more and more of their own investment (and their

government’s attentions) on industrial electronics. As these developments

occurred, the contour began to appear of an ever more elaborate and deepening

technical division of labor between US and Asian-based operations, bound

together in production networks serving US firms’ advanced country markets. In

essence, a new supply base was being created in Asia under the control of US and

local, but not Japanese capital.

Indeed, while Asia’s indigenous electronics capabilities (excluding Japan)

developed in close symbiosis with the strategies and activities of American

MNCs, they were driven by local private investment and supported by

government policies. Outside of Korea (where the chaeboldominated domestic

electronics development), resident ethnic Chinese investors played the principal,

private entrepreneurial role in the China circle, Singapore, and later in Malaysia,

Indonesia, and Thailand. During this period, in the NICs (and later in Southeast

Asia) governments provided a panoply of fiscal and tax incentives, invested

heavily in modern infrastructure, generic technology development, and the

technical upgrading of the work force, engaged in selective strategic trade

interventions, and in some cases, even provided market intelligence and product

development roadmaps. The aims were both to plug into the developing

multinational production networks in the region and to use them as a lever

toward autonomous capabilities. The result, by the end of the 1980s, was burgeoning indigenous electronics production throughout the region, with most

of it outside of Korea, under the control of overseas Chinese (OC) capital.

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The new terms of competition

In this new epoch, firms located anywhere in the temporarily disintegrated value chain can control the evolution of key standards and in that way define the terms of competition not just in their particular segment but in other segments and often, critically, in final product markets as well. Market power has shifted from the assemblers such as Compaq, Gateway, IBM, or Toshiba, to key producers of components (Intel); operating systems (Microsoft); applications; interfaces (Netscape); languages (Sun’s Java); and to product definition companies such as Cisco Systems. What all of these firms have in common is that from quite different vantage points in the informatics value-chain they all own key technical specifications that have been accepted as de fact product standards in the market. Each beat rival standards. In winning, each created a universe of licensees who produce to its standard and add value to its use, just as applications software firms such as WordPerfect, PC assemblers such as Compaq, peripherals producers such as Canon, or content providers such as Grolier’s all produce to Microsoft’s Windows operating system standards. Each standard owner maintains a growing installed base of customers who use the products that conform to the standards. Each has been careful to evolve the standards by adding incremental improvements in performance, functionality, features, quality, or costs within product generations and dramatic improvements between generations (while remaining backwardly compatible with past versions). In that way, each has effectively “locked in” their customer base and their licensees in the sense explored earlier. Given the customer’s investment in all of the conforming products and in how to use them effectively, the customer will normally be unwilling to switch to competing standards unless they offer truly radical and compensatory improvements in price, performance, and functionality. Switching will not occur unless it is even more costly to stay put.

Each Wintelist standard-holder has also effectively shaped the terms of competition in its core market segment. Once the competition to create an open but-owned de factostandard is initially settled, the losers’ strategies must shift to one (or a combination) of a relatively limited menu of alternatives. These include strategies: to sell into the market created by the standard-holder and to differentiate products on traditional bases of cost, performance, functionality, reputation, control of marketing and distribution, after-sales services and the like; to wrest control of the standard over time by evolving it ahead of the creator (as Intel and Microsoft did to IBM); to devise a competing alternative standard that can wrest part of the overall market away from the incumbent (as Microsoft is successfully doing to Netscape in the browser market); to force greater openness and less opportunity to exercise the prerogatives of ownership, by causing industry standards bodies or public policies to embrace a de fact standard and setnon-discriminatory conditions on its use (as happened with Local Area Network standards and in the UNIX operating system market), and always to confine the standard-holder to the markets he currently dominates, if necessary via antitrust attack (of the kind currently focused on Microsoft).

Competitions to set and control the evolution of de fact standards do not always lead to dominant, Wintelist winners, but they do tend in that direction. A briefexploration of the economic characteristics of standards competitions will suggest why. All standards are carriers of technical information in a codified form, around which related industrial and consumption activities can coalesce with heightened predictability and lowered risk: those who produce or use products that implement the standard form of a complementary and reinforcing community or network. The universe of conforming products constitutes the standard network’s installed base. In general, the bigger the network the greater the benefits for users and producers (i.e. network externalities or simply, “network effects”). Thus, for example, Microsoft’s standard PC operating system, Windows 95, drew together a variety of producers of complementary products from PCs and peripherals to applications software and information services into a network with all of the users whose computers run the operating system. The universe of such machines is Microsoft’s installed base for Windows 95. Network effects made adopting Windows 95 increasingly attractive as others jumped aboard (the so-called bandwagon effect), and, consequently, Windows 95 became the dominant PC operating system within only one or two years of its introduction.

As the Microsoft example implies, Wintelist standards are more than mere information vectors. In facilitating the organization of related industrial activities and in creating opportunities for consumption, standards also shape market structure and the terms of exchange. Standards shape market structure, among other ways, by altering relative costs among producers, inducing demand pattern changes, raising or lowering entry barriers, creating opportunities for economies of scale and scope, facilitating a division of labor, and generating opportunities for network externalities in both production and use. For example, World Wide Web standards and the Netscape Navigator family of browsers for interfacing with the Web have had all of these effects. Their adoption altered costs among existing players, facilitating market entry by some, making market entry more expensive for those with other approaches (e.g. CompuServe or Prodigy, who had built expensive proprietary approaches), and ultimately forcing even Microsoft to reorient its entire PC strategy around integrating its operating system with Internet Explorer, its competing browser. By focusing demand from content creators, information services providers and potential consumers on a single set of standards, they permitted a wide range of new software and equipment producers (including those, such as Cisco, who produce the underlying infrastructure equipment) to reach additional scale and prosper. They facilitated an increasingly intricate division of labor, for example permitting specialization in production, before and after production of content, in point casting, and tailored delivery of information services and content, in the production of a growing variety of complementary software (browser plug-ins) and equipment (network computers). Perhaps most important, they are facilitating the emergence of communities of users that cross national boundaries and of a truly global network.

The coexistence of large potential gains that rise with size, manipulable costs, and influence over market structure and the terms of exchange give to standards battles many of the characteristics of competitions to develop and commercialize new technologies.

Because market conditions are anything but the perfectly competitive equilibrium of neoclassical models, choices of standards are highly dependent on initial starting points, available resources, market context, and event sequence. Advantages can accrue to early movers (whether innovators or imitators, producers or users) who in turn can influence the choices of later players as the market structure shifts. The timing and pattern of developments—choices made by both producers and especially lead-users— can significantly influence the choice of standards in ways that are difficult to reverse (so-called “path dependence”). Seemingly small choices can have big consequences, as occurred with Sony’s choice of focusing the initial recording capability of its Betamax VCR around hour-long TV shows rather than the multiple-hour sporting events that initially drove surging sales of the rival VHS standard. This small choice proved decisive in negating Sony’s early lead in installed bases. As installed bases and the size of the associated standards network grows, players can acquire monopoly-like market power with lock-in. This is true even for products conforming to more open standards, wherever producers can maintain the differentiable features thus creating market niches over which they can act like a quasi-monopolist. Indeed, equipment from almost all producers of open computer platforms that run some version of UNIX will inter-operate better within the brand than across brands, even though all brands conform to the common standards.

The economic characteristics outlined permit multiple competitive equilibrium to emerge, but Wintelist open-but-owned standards tend toward quasi-monopoly or oligopoly outcomes. Such standards permit the standard owner to manipulate its competitive environment in unprecedented ways. The aim is to establish a quasimonopoly position, maintain high and rising barriers to entry and with them high and rising switching costs for one’s locked-in customers, thus reaping standards based rents in the market. By favoring one set of producers or users at the expense of another—which can only be done when evolution of the standard and access to it is controlled through ownership—standard holders can directly influence the allocation of available benefits.

The actions of one standard owner thus directly influence the returns to a rival.16

Market competition consists of strategic thrusts over pricing, licensing, and other assets that anticipate and forestall rival moves while attempting to structure the market to the standard owner’s advantage. As market power begins to accrue with installed bases, the possibilities for manipulation grow commensurately. Over time, there are large opportunities for entry deterrence and competitive preemption of rivals: enormous up-front sunk costs associated with creating an alternative to the existing standard (as the Power PC alliance of IBM-Apple Motorola showed in its futile attempt to dislodge Microsoft-Intel dominance), existing scale and scope economies that must be overcome, the likelihood that the established standard holder will engage in pre-emptive investment (as Intel has done), and predatory pricing (Microsoft’s offering of Internet Explorer for free).

In essence, Wintelist standards competitions are market processes in which the players vie for the available consumer and producer surpluses stemming from the achievement of standardization. The winners—like Microsoft and Intel in PCs— establish de factostandards monopolies and become wildly profitable as more and more of the available surplus accrues to them through consumer lock-in and exit of competitors. And those circumstances can tolerate a high degree of user dissatisfaction, as essentially all users of Microsoft operating systems are by now aware: barely adequate performance or functionality is in most cases more than sufficient to continue the locked-in relationship, especially where a large investment in complementary products such as applications programs and associated learning has occurred. In those circumstances, upgrades and follow-on need not be better or even as good as a rival’s products; they need only be adequate to deter the switch.

Such Wintelist strategies effectively attenuate the link between market power and the ownership of the assets of production that characterized the prior era of competition, and at the extremes, as with a firm like Cisco Systems, can completely decouple control of final markets from the ownership of manufacturing assets. For Wintelist firms, the ownership and manipulation of their de fact standards are considerably more effective barriers to entry than the barriers of scale and vertical control over technology and production in the prior era because they are far harder to duplicate. It still remains true that you cannot control what you cannot produce. But the ways of implementing and controlling production have changed. Wintelism has an organizational counterpart: a distinctive system of production, the cross-border production network.

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The origins of Wintelism

Wintelism’s roots can be traced to the merchant character of the domestic US semiconductor industry, the first crucial step in the disintegration of the electronics industry’s value-chain and one strongly influenced by policy. After incubation period during the 1950s in which several critical technical developments were diffused by antitrust constraints on Bell Laboratories and by military spending, government defense and space procurement at premium prices provided the initial launch market for the new technology in the 1960s. As costs fell with large-scale federal procurement, initial commercial applications spun off into the computer industry where antitrust constraints further prevented IBM from monopolizing the application of the technology. Through antitrust-induced licensing, labor mobility (in typically flexible US labor markets), tax-advantaged venture capital, and federal procurement contracts, the policy helped to foster the emergence of “merchant” chip firms who specialized in developing and selling semiconductor components to assemblers of final products.

Because their basic role was to diffuse chip technology as widely as possible, merchant semiconductor firms fostered other specialized producers throughout the electronics value-chain. In effect, they pioneered and instigated a gradual process of vertical disintegration throughout the American electronics industry. Final assemblers no longer needed to be vertically integrated into component production on the IBM=ATT model. Instead, they could focus on system definition and assembly. Specialization in one part of the value-chain bred specialization in other parts: throughout the 1960s and 1970s, specialized producers of semiconductor equipment and materials emerged, as did producers of software and systems integrators higher up the value-chain. The whole process was accelerated by the competitive entry of Japanese producers who helped to eliminate traditional vertically integrated players from the US market.

In the struggle to break loose from IBM’s dominant model and to react to Japan’s ascent, new product strategies emerged. The pioneering product was, of course, the PC. But the extraordinary pace of technical progress and ever improving price/performance soon made the underlying microelectronics technologies increasingly pervasive, transforming just about everything from telecommunications switches to automobiles and medical instruments. By the mid-1980s, new electronics product markets began to converge on a cost effective, common technological foundation of networkable, microprocessor based systems, of which the PC was only emblematic.

Such systems enabled a dramatic shift in the character of electronics products: from the prior era’s proprietary systems built to fully open or closed standards, to the Wintelist eras “open-but-owned” systems built to “restricted” standards. In the new systems, key product standards, especially the interface specifications that permit interoperability with the operating system or system hardware, are owned as intellectual property but made available to others in the value-chain who produce complementary or competing components, systems, or software products. Hence the systems are “open-but-owned.” The relevant technical standards are licensed rather than published, with either the universe of licensees, the degree of documentation of the technical specifications, or the permissible uses, restricted in some fashion. Very often, changes can be made unilaterally by the standard holder in ways that affect availability and timing of access to the interface specification, as Microsoft is routinely accused of doing by its licensee competitors. Open-but-owned systems combined competitive elements from both product types of the prior era. The standards are licensed in order to create commodity-like competition around system elements chosen by the licensor (e.g. around assembled PCs built to Intel processor architecture standards), whereas their evolution is controlled by the owner to build an installed base and to lock in customers and the value-added licensees.

The shift to open-but-owned systems was accelerated by two factors that helped to spread and consolidate Wintelist business strategies. From the supply side, the increasing cost and complexity of continuing innovation made it increasingly difficult for any one company, even IBM, to maintain ownership and control over all of the relevant technologies. The increasing expense of technological advance demanded specialization to maintain the pace of innovation. But the specialized technical elements had to fit together at the end of the day into workable systems. The former demanded ownership to recoup costs; the latter demanded openness for system integrity.

Second, and more critical, major industrial users in the United States, such as banks, brokerages and insurance companies, aerospace, automobile and petrochemical producers, began aggressively to move their business operations onto integrated corporate data communications networks, a process that was well under way by the early 1980s. In pioneering such complex hybrid networks (i.e. using an integrated mix of owned and purchased facilities and services), major corporations were inevitably operating in a multivendor environment as they attempted to tie together computer systems from some vendors with communications systems from others, with databases and software from still others. Consequently, they began to demand that all of their vendors deliver increasing levels of interoperability in the complex systems being delivered.

Again, American public policy set the context: over three decades from the 1950s through the 1980s, US policy gradually deregulated American Telephone and Telegraph Company (AT&T) and introduced competition into the domestic US market for communications services and equipment. That, in turn, provided the communications facilities and services from which industrial users would piece together their information networks. Industrial demand stimulated a burst of innovation in both development and usage of network equipment and services, creating broad market opportunities for new firms such as Cisco Systems and Novell. Users could pick and choose among the most innovative equipment and services from multiple vendors to knit together their information networks. But the pieces from multiple vendors had to fit together; they had to be open enough to enable end-to-end interoperability of the corporate communications infrastructure. Suppliers responded with open-but-owned systems: “open” at the interface to permit interconnection of systems from other vendors, but “owned” to reap a return from innovation. In short, users demanded highly functional and interoperable systems, US policy stimulated provision of them, and both further encouraged the value-chain specialization with open-but-owned standards that are the hallmarks of Wintelism.

But the move to open-but-owned systems and value-chain specialization was legitimized, as perhaps it only could have been, by IBM with the IBM PC. In order to get to market fast and to exploit a market window opened by Apple (who had adopted a quite traditional proprietary systems strategy), IBM pieced together the first open-but-owned PC using its own proprietary BIOS (basic input-output system) and a variety of components and software from numerous third-party vendors. It invited cloning to establish the market. Once firmly entrenched, IBM intended to bring the product back in-house and make it increasingly proprietary. It presumed that its brand conjoined with a traditional strategy of unsurpassed scale, and vertical control of technology and manufacturing would fend off the clones. It was wrong. Unfortunately for the computer giant, it permitted key standards in its PC to be owned by others (especially Intel for the microprocessor architecture, and Microsoft for the operating system) who innovated at the furious pace that focus and specialization permitted. Gradually, they took control of the evolution of the PC’s key standards. In concert with the clone-makers, Intel and Microsoft wrested control from IBM of the PC itself. Strategies to set and control the evolution of de facto standards were developed. Business speed (e.g. rapid product cycles, fast time to market) was rewarded. Wintelism was born.

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The origins of Wintelism and the new dynamics of competition

During the 1990s, the terms of competition in the electronics industry have shifted away from the big final assemblers such as IBM and Siemens, whose past dominance was built through vertically integrated control of technologies and manufacturing. The character of the shift in market power is suggested in the advertisements of PC producers such as IBM, Toshiba, Compaq, or Siemens Nixdorf, whose systems are nearly identical and which emphasize components or software that have become  de fact market standards—“Intel Inside,” or “Microsoft Windows installed”—rather than unique features of their own brands. The pre-Wintel electronics industry was dominated by assemblers, i.e. systems producers who designed, marketed, and assembled the final product, with almost all value-chain functions carried out in-house, and principally within the producer’s home country. Such producers, e.g. GE, RCA and IBM, prospered with quite traditional advantages of scale and vertical integration. IBM dominated the computer segment of the electronics industry and extended its franchise into Europe and Asia in pursuit of new markets. Similar strategies produced dominant players such as Western Electric and Siemens in the telecommunications segment of the market.

Also starting in the 1960s, in the course of attempting to emulate IBM in structure and strategy, Japanese producers such as Matsushita and Hitachi began to overturn established American positions in the consumer electronics market. Similar to Toyota and other Japanese car manufacturers, they did so by applying lean production principles in order to innovate in traditional consumer electronics products with all solid-state televisions. As in car manufacturing, adoption of lean production techniques enabled Japanese electronics firms to create new and distinctive market segments by the late 1970s, such as the Walkman, VCR, and Camcorder. By the early 1980s, Japanese firms were poised to challenge US leadership in other electronic markets. Here too, however, the dominant market position still lay with the final product assemblers who controlled consumer product definition, the most important underlying component technologies, and usually both the supply and the distribution chains. Their competitive strength was the ability to manufacture high quality at consumer price points with some degree of product variety.

By the early 1980s, essentially all electronics product markets were dominated by large-scale producers such as IBM, Siemens, Matsushita, NEC, and Toshiba. They produced fully proprietary systems whose key product standards—i.e. the technical specifications that describe the system architecture and enable the pieces of the system to inter-operate as a whole and with each other—were either fully “closed” or fully “open.” A fully open standard is one in which the technical information necessary to implement the standard is in the public domain, fully available on a non-discriminatory and timely basis to anyone. This was the case with most consumer and many communications interface standards such as TV or fax broadcast standards. With the relevant technical information in the public domain, products such as TVs and radios built to such open standards became commodities in which scale, quality, and cost were the defining features of competition in highly contested markets.

By contrast, telecommunications and computer firms built to “closed” standards in which the relevant technical information was owned as intellectual property and not made available to anyone other than through legally permissible reverse engineering. IBM’s mainframe computers epitomized such proprietary, closed systems. Here, too, vertical control over technologies and manufacturing was essential, especially in the early stages of competition when new systems were introduced. But once established in the market, competition centered on developing an installed base of customers who could be locked in to a firm’s product line. In the open standards case, lock in was impossible; with all products built to implement the same standard, users could seamlessly switch between them. With closed standards, the costs of switching could be very high indeed, requiring, for example, rewriting an existing base of software and retraining all users. Large installed bases were decisive over time in these competitions, as all of IBM’s competitors discovered. Firms who had them had lower per unit costs for succeeding generations than the competition, since such costs (e.g. of development or marketing) could be amortized over more locked-in users. In sum,  with both  closed and open systems, vertical control over technologies and manufacturing was the key to market success. For closed systems, it was necessary to lock customers into proprietary standards; for open systems, it permitted firms to compete on implementation, quality, and price.

This era of proprietary systems built to open or closed standards lasted until the early 1980s. Throughout there were shifts in market structure, attacks on established incumbents, a myriad of new entrants, and, not least, significant policy interventions, including trade protection, antitrust actions and government procurement, that shaped market outcomes. Some of those changes, such as the emergence of independent (so-called “merchant”) component suppliers, began to undermine the logic of competition rooted in ownership and vertical control of technology. These firms created the evolutionary ground for the emergence of Wintelism. 

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