Unlocking Chinese Innovation Through Cost Leadership

Prof.Dr.Hora Tjitra & Daisy ZHENG,
Tjitra Management Consulting
www.SinauOnline.com
High-Tech at a Low-Cost
Unlocking the Chinese Innovation Power

Innovation in China vers.1.1 /2010-07
China goes High-Tech?

From the low-cost manufacturer to the high-tech at a low cost

Chinese Innovation Policy
• At the Danfos 2009 summit' s opening ceremony, China' s
Premier Wen Jiabao hailed the scientific and technological
innovation, calling it "an improvement pillar."
"We will make China a country of innovation. We will seek
breakthroughs in key technologies that are vital to industrial
transformation and upgrading, ..."
• For government officials like Wan Gang, China' s Minister of
Science and Technology, how to turn the technological
innovation into real economic growth is their concerns.
"Government should be a driving force in the process,
especially when the new technology first appears in the
market,... "
• One of the targets set in the National Guidelines for the Medium-
and Long-term Plan for Science and Technology Development
(2006-20) is to raise the ratio of R&D to GDP to 2% by 2010 and
to 2.5% or more by 2020. This is an extremely ambitious target,
as it implies the need for R&D expenditure to increase by at least
10-15% annually.

The Rise of Chinese Scientific (and Engineering) Publications
5
• A total of 78,200 Chinese papers were included in the
international Engineering Index (EI)
— an indicator of papers in engineering fields
— rising by 16.2 per cent from 2006 at the first rank. Chinese EI
papers accounted for 19.6 per cent of worldwide output in the
field.
• Meanwhile,in the Science Citation Index (SCI)
— the indicator for science publications
— Chinese papers rose from a ranking of fifth to third in the
world,after the United States and the United Kingdom,and
surpassing Germany and Japan.China had 94,800 papers in the
SCI,accounting for 7.5 per cent of the world's total.
• The number of citations for Chinese papers is also increasing,
although less than the growth in the number of publications.
Between 1998 and 2008,the 570,000 Chinese papers indexed by
SCI were cited 2.65 million times,putting China tenth globally
— an increase from thirteenth last year.

What is Innovation and how to measure it?
6
• Following Schumpeter (1934),contributors to the scholarly literature on innovation typically distinguish
between invention,an idea made manifest,and innovation,ideas applied successfully in practice.
• In many fields,something new must be substantially different to be innovative,not an insignificant change,
e.g.,in the arts,economics,business and government policy.In economics the change must increase value;
customer value,or producer value.
An innovation is a new way of doing something. It may refer to incremental and emergent or radical
and revolutionary changes in thinking,products,processes,or organizations.

Key indicators in the Chinese Science &Technology (OECD,2009)
DSTI/DOC(2009)1
Figure 1. Key indicators in the Chinese S&T indicator system
I
N
P
U
T
S
Financial & capital inputs
(Section 2)
! R&D funding & expenditure
! Technology adoption
! Venture capital
Input-output linkage
(Section 3)
! Technology market
! Science parks & incubators
! Product Innovation
! Process Innovation
Key performers and
their interactions
(Section 1)
! R&D funding
! Co-operation in R&D projects
! Joint participation in national
and local S&T programmes
! Outsourcing
! Co-patenting & co-publications
S&T outputs
(Section 3)
! High-tech products
! High-tech exports
! New products
! New production processes
! Publications & citations
! Patents
Human capital inputs
(Section 2)
! R&D personnel
! Human Resources for Science
and Technology (HRST)
! Students and graduates
O
U
T
P
U
T
S
Other socio- economic outputs
(Discussion in the summary)
! Job creation
! Productivity improvement
! Spill-over within & between sectors
LINKAGE & INTERACTION
Policy & market environment
! S&T policy
! Regulatory/legal framework
! Transformation of the NIS
Infrastructure
! ICT development
! Educational system
! Financial system
! Research system
General purpose technologies
(Section 4)
! ICT
! Biotechnology
! Nanotechnology
CRITICAL INFRASTRUCTURE AND ENVIRONMENT

G20 - Global Innovation Index
8
- Innovation Inputs:
Included government and fiscal policy,
education policy and the innovation
environment.
- Innovation Outputs:
Included patents,technology transfer and
other R&D result; business performance
such as labor productivity and total
shareholder returns; the impact of
innovation on business migration and
economic growth.
March 2009,produced jointly by BCG,NAM & MI

The Rise and Rise of China - Unlocking Innovation in China
9
• China is the biggest gainer among all economies,developed and emerging.
• Its innovation performance will improve by 11% and it will rise from 54th to 46th
place between 2004-08 and 2009- 13.
• India will move up four places,whereas the rankings for the two other BRIC
countries,Brazil and Russia,remain unchanged.
8
a small expected decline in US performance, the region will make little progress in closing the innovation
gap with Japan and the US over the next ﬁve years.
The rise and rise of China
China is the biggest gainer among all economies, developed and emerging. Its innovation
performance will improve by 11% and it will rise from 54th to 46th place between 2004-08 and 2009-
13. India will move up four places, whereas the rankings for the two other BRIC countries, Brazil and
Russia, remain unchanged.
China leaps forward, Russia falls back
Rank of innovation index
Source: Economist Intelligence Unit.
2009-13
2004-08
2002-06
China
India
Brazil
Russia
46
54
59
54
56
58
49
49
48
39
39
37

The Chinese Cost Innovation in Global Competition
10
High Technology
at LOW COST
Product variety and customization
at LOW COST
Specialty product
at LOW COST and High Volume
Ming Zeng & Peter Williamson, 2007

Just a COPYCATS? - 5Cs of Chinese Innovation
11
1C : Copy
The line between copy and “inspiration”, “benchmark”, “best practice”, “proven
model”is thin,and is often in the eye of the beholder.
2C : Competition
Would a company innovate as much without competition? Think about
government-run monopolies and you might get a hint. China has a handful of
local copycats, those unable to innovate on top of what they copy do not stay
long after they burn the initial investment money.
3C : Combination
People looking at “Chinese iPhone” for the first time are generally
underwhelmed by its looks and functionality.
4C : Constraints
Compare “write a romantic message” and “write a romantic message in 140
characters”. Do you feel more creative with the latter? Constraints support
creativity.
5C : China
So far, none of the above criteria was specific to China. Some are shared by all
countries and some mostly by developing economies. Where could be the
“China factor”?
As the world’s factory, China understands clearly that the higher value in the
chain is in consumer-facing innovative products.
Apple iPhone, HiPhone, HiPod, SciPhone, TiPhone,
GiPhone, iOrgane, Meizu M8, iPhome
Source:

Cost Innovation Through Process Flexibility
Situation at the very beginning (in 1995)
• The estimated cost of establishing a NiCad production line using industry-standard processes was $1 million.
• The international market leader was planning to replace NiCad batteries with Li-Ion technology,which costs much more than NiCad.
But BYD had only $300,000 in start-up capital.
?How to solve the problem of capital shortage?
Broke the automated production processes down and replaced expensive
machines with manual procedures that could be completed by ordinary workers.
!Amazing business result!
• BYD could produce a NiCad battery for a total cost of $1,compared with costs of $5 to $6 incurred by rivals in Japan.
• BYD could introduce new products simply by adjusting key equipment and retraining workers.
Rechargeable batteries
Now,
BYD ranks 2nd in global market share and serves for big customers such as:

Recombinative Innovation
Creating new,improved models by recombining existing ideas and technologies in novel
ways,rather than by developing additional products internally from scratch.
European ones used less water American ones were usually faster
Asian ones generally made
better use of electronic sensors
Haier decided to combine the best of all three:
The result was a washing machine that used only half the water of conventional machines,
achieved close to 50% improvement in cleaning power at twice the speed,and also
reduced the wear and tear on garments by 60%.
Haier Washing Machine ranks 1st in global market share in 2009.

A disruptive innovation was born: a product better fit for mass-market purposes,at a fraction of the cost!
• More importantly,the machine cost around $20,000 to build,which was especially attractive to many second- and
third-tier hospital with limited budgets.
• Meanwhile,GE and Philips had to cut between $100,000 and $150,000 off the price of their machine.
• The Chinese took over 50% market share in the DDR segment.
Betting on Low-Cost,Disruptive Technologies
DDR system is to transform an X-Ray scan into a digital signal capable,which could be processed by a computer.
Line scan
• Works well for standard X-Ray
procedures such as chest scans
and medical examinations
• Cannot be used for real-time
application,such as a beating
heart imaging
There are two types of DDR system:
Flat-panel imaging
• Can be used for real-time
applications
• Higher cost
• Mainly for high-end users
Market leader
Decided to discard the line scan technology,and
concentrate on developing more advanced flat-
panel machines for high-end users
• The machine cost around $150,000 to $200,000 to build.
• Planned to sell a single machine at the price between $300,000 and $400,000
The China Aerospace Science and Technology Corporation (CASC) acquired line-scanning technology from Russia in 1998
when Russia was having economic difficulties.
A group of CASC engineers used this technology,initiatively targeted for other applications,to develop a DDR X-Ray machine.

How did they get“here”so fast?
15
Domestic factors:
• Access to low cost talent at all
skill level
• Access to state assets and IP
at a discount
• Exceptional management
autonomy
• Strong incentives to success
Benefits of Globalization:
• Outsourcing open the gates
• Modular product and services
• Concentration and
Internationalization of Retailing
• Globalization of the markets for
talent and services

Chinese R&D Investment comparing with others - OECD
16
R&D Spending in the higher
education in 2007
DSTI/DOC(2009)1
Figure 6. Higher education R&D expenditure by field of science (%)
Source: MSTI database, March 2008.
Important and active role in science and technology diffusion
The higher education sector plays an important role in establishing academia-industry linkages, taking
advantage of its research capacity in key subjects with a strong applied orientation, its S&T human
resources, as well as its R&D infrastructure and facilities. There are various channels through which
technology diffusion and commercialisation of R&D results take place:
! Direct participation in the technology market: the share of the higher education sector in total
contract value in the technology market was almost 8% in 2005.
! Co-operation with the business sector: the business sector is outsourcing an increasing share of
R&D activities to the higher education sector. In 2006, business-funded R&D expenditure was
RMB 10.1 billon, accounting for 36.6% of total R&D expenditure in the higher education sector.
This share was 4.2 percentage points higher than in 2000. At the same time, higher education
institutions and industrial enterprises have jointly participated in a broad range of national S&T
programmes supported by the government, such as the 863 programme, the Torch programme,
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DSTI/DOC(2009)1
Figure 9. Business R&D expenditure by selected industry (%)
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Source: MSTI 2007/2 (OECD, 2007b).
R&D Spending in the business
in 2007

R&D Investment and its type of activities
17
R&D intensity, measured as R&D expenditure as a percentage of gross domestic product (GDP) has
also increased since 1995, as shown in Figure 22. In an international comparison with OECD countries, the
R&D intensity in China is still low. This gap is even larger if comparing the high-tech industries only,
which is discussed in more detail in Section 3. Taking the rapid growth of the Chinese economy into
account, increasing R&D intensity is a serious challenge. In the National Guidelines for S&T
Development, the target was set to raise the R&D to GDP ratio from the level of 1.23% in the year 2004 to
2% by 2010 and to 2.5% or more by 2020. This is an extremely ambitious target, particularly taking the
growth rate of GDP into account. Implicitly, this means R&D expenditure needs to increase at least
10-15% annually, if not more, in order to hit the target. Consequently, this will need a large number of
R&D personnel to carry out the corresponding large-scale increase in R&D activities.
Figure 22. R&D expenditure as a percentage of GDP
Note: The R&D ratios for China were calculated using the adjusted GDP based on the National Economic Census in 2004.
Source: MSTI 2007/2 (OECD, 2007b).
Figure 23 shows the breakdown by sector of performance of R&D expenditure in Japan, the United
States, the EU and China. It shows that the business sector in China accounts for a similar percentage of
total R&D expenditure as in the OECD countries, unlike what is found in most developing countries.
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DSTI/DOC(2009)1
R&D expenditure can be broken down by type of activity into basic research, applied research and
experimental development. In the comparison between 1995 and 2006, the increase in R&D expenditure is
driven by an increase in experimental development (see Table 12). It reflects, to some extent, the level of
technological sophistication of R&D activities as well as the structural shift, in which the business sector is
an increasingly important performer of R&D in China. The share of basic research and applied research
combined is much lower in China, standing at 22% in 2006, compared to the OECD countries with an
average level of 50%. It may imply another challenge ahead for China, namely to obtain a better balance
between market-driven/market oriented S&T and long-term S&T capacity building.
Table 12. R&D expenditure by type of activity, as a percentage of total GERD
Basic research Applied research Experimental development
1995 5.2 26.4 68.4
2006 5.2 16.8 78.0
Source: MSTI database, December 2007.
Figure 25 contrasts the picture for China with that for Japan and the United States, where a much
larger share of R&D is devoted to basic research.
Figure 25. R&D expenditure by type of activity, 2005 (%)
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Note: For the United States and China: as a % of current cost; for Japan: as a % of total R&D expenditure.
Source: MSTI database, March 2008.

The types of R&D expenditures
18
DSTI/DOC(2009)1
50%.6
In recent years, as a result of improved living standards and the development of various forms of
incentive policies, the Chinese share of labour cost has increased from 17.1% in 1987 to 23% in 2006,
substantially lower than in OECD countries (see Figure 26).
Figure 26. R&D expenditure by type of cost, 2005/2006
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Note: (1) Average for 21 OECD countries for the year 2005 or the nearest year available. Data for China are for 2006.
Source: MSTI database, December 2007.
On the other hand, operational expenses account for a large share of total R&D expenditure, and have
experienced a relatively large increase in recent years. Taking into account the large supply of S&T and

Will the Future favor Cost Innovation?
19
Changing Size of the China Market
Maturing of the Product Life Cycles
Increasing Modularization
Ming Zeng & Peter Williamson, 2007

@ Tjitra,2010
Thanks You
Any comments & questions
are welcome
Contact me at hora_t@sinauonline.com
20
www.SinauOnline.com
paper presented at the seminar national in Feb 2010
at the universitas widyatama,Bandung - Indonesia

Unlocking Chinese Innovation Through Cost Leadership

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