New Frontiers in Regional Science: Asian Perspectives 17 Hitoshi Hirakawa Nobuhiro Takahashi Ferdinand C. Maquito Norio Tokumaru Editors Innovative ICT Industrial Architecture in East Asia Offshoring of Japanese Firms and Challenges Faced by East Asian Economies New Frontiers in Regional Science: Asian Perspectives Volume 17 Editor in Chief Yoshiro Higano, University of Tsukuba Managing Editors Makoto Tawada (General Managing Editor), Aichi Gakuin University Kiyoko Hagihara, Bukkyo University Lily Kiminami, Niigata University Editorial Board Sakai Yasuhiro (Advisor Chief Japan), Shiga University Yasuhide Okuyama, University of Kitakyushu Zheng Wang, Chinese Academy of Sciences Yuzuru Miyata, Toyohashi University of Technology Hiroyuki Shibusawa, Toyohashi University of Technology Saburo Saito, Fukuoka University Makoto Okamura, Hiroshima University Moriki Hosoe, Kumamoto Gakuen University Budy Prasetyo Resosudarmo, Crawford School of Public Policy, ANU Shin-Kun Peng, Academia Sinica Geoffrey John Dennis Hewings, University of Illinois Euijune Kim, Seoul National University Srijit Mishra, Indira Gandhi Institute of Development Research Amitrajeet A Batabyal, Rochester Institute of Technology Yizhi Wang, Shanghai Academy of Social Sciences Daniel Shefer, Technion - Israel Institute of Technology Akira Kiminami, The University of Tokyo Advisory Board Peter Nijkamp (Chair, Ex Officio Member of Editorial Board), Tinbergen Institute Amsterdam Rachel S Franklin, Brown University Mark D Partridge, Ohio State University Jacques Poot, University of Waikato Aura Reggiani, University of Bologna New Frontiers in Regional Science: Asian Perspectives This series is a constellation of works by scholars in the field of regional science and in related disciplines specifically focusing on dynamism in Asia Asia is the most dynamic part of the world Japan, Korea, Taiwan, and Singapore experienced rapid and miracle economic growth in the 1970s Malaysia, Indonesia, and Thailand followed in the 1980s China, India, and Vietnam are now rising countries in Asia and are even leading the world economy Due to their rapid economic development and growth, Asian countries continue to face a variety of urgent issues including regional and institutional unbalanced growth, environmental problems, poverty amidst prosperity, an ageing society, the collapse of the bubble economy, and deflation, among others Asian countries are diversified as they have their own cultural, historical, and geographical as well as political conditions Due to this fact, scholars specializing in regional science as an inter- and multi-discipline have taken leading roles in providing mitigating policy proposals based on robust interdisciplinary analysis of multifaceted regional issues and subjects in Asia This series not only will present unique research results from Asia that are unfamiliar in other parts of the world because of language barriers, but also will publish advanced research results from those regions that have focused on regional and urban issues in Asia from different perspectives The series aims to expand the frontiers of regional science through diffusion of intrinsically developed and advanced modern regional science methodologies in Asia and other areas of the world Readers will be inspired to realize that regional and urban issues in the world are so vast that their established methodologies still have space for development and refinement, and to understand the importance of the interdisciplinary and multidisciplinary approach that is inherent in regional science for analyzing and resolving urgent regional and urban issues in Asia Topics under consideration in this series include the theory of social cost and benefit analysis and criteria of public investments, socio-economic vulnerability against disasters, food security and policy, agro-food systems in China, industrial clustering in Asia, comprehensive management of water environment and resources in a river basin, the international trade bloc and food security, migration and labor market in Asia, land policy and local property tax, Information and Communication Technology planning, consumer “shop-around” movements, and regeneration of downtowns, among others Researchers who are interested in publishing their books in this Series should obtain a proposal form from Yoshiro Higano (Editor in Chief, higano@jsrsai.envr tsukuba.ac.jp) and return the completed form to him More information about this series at http://www.springer.com/series/13039 Hitoshi Hirakawa • Nobuhiro Takahashi • Ferdinand C Maquito • Norio Tokumaru Editors Innovative ICT Industrial Architecture in East Asia Offshoring of Japanese Firms and Challenges Faced by East Asian Economies Editors Hitoshi Hirakawa Kokushikan University Tokyo, Japan Nobuhiro Takahashi Osaka City University Osaka, Japan Ferdinand C Maquito Temple University Tokyo, Japan Norio Tokumaru Nagoya Institute of Technology Nagoya, Japan ISSN 2199-5974 ISSN 2199-5982 (electronic) New Frontiers in Regional Science: Asian Perspectives ISBN 978-4-431-55629-9 ISBN 978-4-431-55630-5 (eBook) DOI 10.1007/978-4-431-55630-5 Library of Congress Control Number: 2016957389 © Springer Japan 2017 This work is subject to copyright All rights are reserved by the Publisher, whether the whole or part of the material is concerned, specifically the rights of translation, reprinting, reuse of illustrations, recitation, broadcasting, reproduction on microfilms or in any other physical way, and transmission or information storage and retrieval, electronic adaptation, computer software, or by similar or dissimilar methodology now known or hereafter developed The use of general descriptive names, registered names, trademarks, service marks, etc in this publication does not imply, even in the absence of a specific statement, that such names are exempt from the relevant protective laws and regulations and therefore free for general use The publisher, the authors and the editors are safe to assume that the advice and information in this book are believed to be true and accurate at the date of publication Neither the publisher nor the authors or the editors give a warranty, express or implied, with respect to the material contained herein or for any errors or omissions that may have been made Printed on acid-free paper This Springer imprint is published by Springer Nature The registered company is Springer Japan KK The registered company address is: Chiyoda First Bldg East, 3-8-1 Nishi-Kanda, Chiyoda-ku, Tokyo 101-0065, Japan Preface Will Asia continue growing in the twenty-first century? How will Asia change its economic structure? What kind of interdependence will Asia and developed countries have? Entering this century, there have been prolific discussions on Asia’s future Much research by international institutions, such as the World Bank, the Asian Development Bank, and the OECD, predicted that in the first half of this century, the Asian region will occupy the dominant position in the world economy On the other hand, there are indications that Asia’s growth will be fraught with difficulties A World Bank study in 2007, “an East Asian Renaissance”, discussed necessity of “looking for strategies to move to rich country status” Another World Bank study in 2012, “China 2030” estimates that out of 101 middle-income economies in 1960, only 13 countries became high income economies by 2008 It calls this phenomenon the “middle income trap” Many researchers have become highly interested in whether or not Asian countries could escape this trap The issue has also been cited from a population composition perspective Not a few Asian countries are now going towards aging societies The ratio of working population to non-working population has been decreasing or will start decreasing in many Asian countries, including China This implies a shift from the so-called population bonus to the population onus phase is occurring in Asia In retrospect, Asia’s growth for more than half a century was achieved through the globalization of manufacturing Multinational companies, mainly Japanese and the U.S., engaged in the offshoring of manufacturing processes amidst the intensification of international competition East Asian countries gained a foothold on growth and development by taking advantages of a large number of low-wage labor force Some manufacturing firms in East Asia have been changing their business model In the 1980s, Taiwanese firms manufactured products for U.S firms In the 1990s, Taiwanese firms started establishing their factories in China at the large scale and exported the products to the U.S and Japanese firms from China In the 2000s, along with the growth of the Chinese economy, Taiwanese firms increased v vi Preface the R&D investment for their subsidiaries in China and provided more products for the Chinese market On the other hand, Japanese manufacturing firms established many factories in China These firms produce components in Japan, assemble them in China, and export their products to Japan, America, and Europe In the 2010s, they are transferring their factories from China to Southeast Asia due to the rise in labor costs Entering the 1990s, service activities also came to be vigorously transferred across national borders due to the further development of Information and Communications Technology (ICT) U.S and European ICT firms aggressively adopted this business model Becoming an offshoring destination for software outsourcing and call centers, India acquired the latest technology for software development Leveraging its relatively less accented English capability, the Philippines became an offshoring destination for call centers and other business process outsourcing China also became the offshoring destination for software outsourcing, call centers, data entry, and other business process outsourcing for Western and Japanese firms Firms in Vietnam and other East Asian countries are imitating the business strategies of Indian and Chinese firms The changes in offshoring phenomenon are dynamic, and its impact on Asia is deepening As Chap shows, some Japanese manufacturing firms are outsourcing the design process to their Vietnamese subsidiaries by taking advantage of ICT Japanese headquarters often have difficulty in hiring young and excellent CAD (Computer Aided Design) engineers, while their Vietnamese subsidiaries hire excellent engineers locally ICT allows the communication between headquarter and subsidiaries, and the easy transfer of the design from Vietnam to Japan at a low cost The able Vietnamese engineers are now indispensable for the Japanese parent firms This fact shows that offshoring promotes the business activities of the firms in advanced economies The foreign firms provide products and services with lower cost and better quality by using offshoring The above story also shows that East Asia is now emerging as a region for supplying a large number of skilled workers required for the business activities in developed economies Advanced countries face the shrinking of the middle class, which normally is the source of intellectual labor The emerging countries in East Asia, whose development phases vary from country to country, supply large amounts of human resources, not only the conventionally low-waged but also of the intellectual sort Offshoring brings technology transfer Without technology transfer, firms in developing economies are often not able to supply for the products and services with which the clients in advanced economies are satisfied Technology transfer encourages the emergence of the knowledge-based economy in East Asia Western and Japanese firms are also targeting the potentially huge service market of offshoring destinations of East Asia As we mentioned, Asia emerged as an economic zone that saw the rise of the middle class Firms in advanced countries increase their investment in Asia, which accelerates further economic growth and technology transfer As a result, the development of service activities in Asia is one of the important factors to promote the growth of the world economy Preface vii This book deals with the development of ICT industry in East Asia and focuses on the effects of offshoring of software development, business process, and manufacturing, especially by Japanese ICT firms We analyze how the offshoring has affected the local industry, how ICT firms in advanced countries have taken advantage of offshoring, and how the local countries have tried to promote the development of the ICT industries We will show that offshoring has had a significant impact on the development of the ICT industry and ICT-based service activities in East Asia, and that the interdependence between developed countries and emerging East Asia has been becoming stronger This research suggests that the relationship between Japan and East Asian emerging countries are moving towards the integration in intellectual as well as manual activities This book consists of ten chapters Chapter provides an overview of the offshoring of global ICT-based services The variety of services has been offshored to developing countries Knowledge process outsourcing activities, such as business consulting, business analysis, market intelligence, and legal services are also offshored East Asia is the major destination of the offshoring Many East Asian countries, such as China, the Philippines, and Vietnam, have been becoming offshoring destinations, following India Chapter shows that the offshoring of Japanese ICT vendor and user companies has been gradually increasing and discusses the reasons behind such increase The offshoring of these companies goes mainly to East Asia This chapter also discusses that East Asian countries are in the process of forming an economic zone of knowledge-based economy Intellectual processes and white-collar jobs are being transferred to East Asia, giving rise to quality upgrading through the accumulation of knowledge Chapter analyzes the current state of Japanese ICT firms’ software development and other business activities in East Asia Japanese ICT firms have implemented offshore software development in China at a large scale This chapter examines its influence on the improvement of the technology in the Chinese software industry At the same time, Japanese ICT firms plan to expand their offshore development and software business in Southeast Asia However, these firms are poor at management of foreign subsidiaries This chapter discusses the reasons for the poor international management Chapter investigates the offshoring of the Japanese manufacturing industry through the case studies of Japanese die and mold firms in Vietnam Digitalization makes possible the decoupling of design and production processes However, designers cannot design functional dies and molds unless they understand production processes Therefore, Japanese headquarters relocate to Vietnamese subsidiaries not only simple design and production activities but also integration activities between design and production that are highly skill-intensive This chapter conceptualizes this transfer as “comprehensive offshoring.” Chapter examines the development of the ICT/BPO (Business Process Outsourcing) industries in Dalian, China, which is noted for being the destination of offshore software development and BPO of Japanese and Western ICT companies This chapter analyzes the critical factors for competitiveness of Dalian’s ICT viii Preface industrial clusters based on Michael Porter’s Industrial Cluster Theory (also known as the Diamond Framework) The chapter also discusses that due to the rise of labor costs and depreciation of the Japanese yen, Dalian’s offshore industry is now at the stage of searching for a new way of development Chapter overviews the development of the ICT/BPO industries in Vietnam Very early in this century, the Vietnamese government embarked on the provision of ICT infrastructure and the promotion of the software industry, and has become one of the most attractive global offshoring destinations The country has especially attracted the attention of Japanese firms as the offshoring destination due to the rapid rise of the labor cost in China Vietnam’s software industry is collaborating with Japan in strategically targeting Japan’s ICT-based services offshoring In addition, the small- and mid-sized software firms are proliferating at a tremendous rate, and the government has been supporting the expansion of the ICT/BPO industries Chapter analyzes the BPO industry in the Philippines driven by U.S and European offshoring The industry is a leading source of economic growth of the country This chapter presents the current state of the BPO industry and examine whether the Philippine BPO industry can bring about shared growth in the country In addition, Japanese ICT firms will play an important role to promote the development of the industry in the future This chapter discusses how Japanese firms overcome their weakness vis-a-vis Western firms, and shows the possibility that their business activities may alleviate the middle income trap of the Philippines Chapter provides a macro perspective of the ICT sector in the Philippines The analysis focuses on two structural phenomena that have been associated with the middle income trap: early deindustrialization and product trap This chapter uses the Kaldorian Laws to study the ICT software sector, and uses product space proximity and input-output tables to study the ICT hardware sector The analysis indicates the possibility of the premature deindustrialization, and the possibility of the product trap for the economy in general, and for ICT-related manufacturing industry, in particular Chapters and 10 analyze from both macro and micro perspectives Taiwanese ICT hardware industry Chapter tracks the growth of this industry from a macro perspective The industry established the cross-strait division of labor with mainland China Consequently, Taiwanese ICT manufacturers have been increasing R&D in China in order to quickly respond to clients’ demands They also need to continue developing high value added products This chapter shows that Taiwanese ICT hardware industry has transformed its business models to adjust to the change of economy and the technological improvement Chapter 10 focuses on the Original Design Manufacturing (ODM) business of the Taiwan’s ICT hardware industry Taiwanese firms received technology transfer from U.S firms on ODM contracts, which enabled them to become the world’s leading personal computers manufacturers Along with the falling of global demand for personal computers, they shifted their business to internet servers, and then Preface ix started creating their private brands of servers This means that Taiwanese firms have been becoming competitors of U.S ICT hardware firms This chapter reviews how Taiwanese original equipment manufacturing (OEM) firms have changed their business models Tokyo, Japan Osaka, Japan Tokyo, Japan Nagoya, Japan Hitoshi Hirakawa Nobuhiro Takahashi Ferdinand C Maquito Norio Tokumaru 10 The Development of Taiwanese ICT ODM Companies Table 10.1 The combined global shipments of desktop and notebook computers Year 2011 2012 2013 2014 Shipment (thousand of unit) 365,364 351,060 316,465 315,866 219 Growth (%) 4.12 À3.91 À9.85 À0.19 Source: Gartner Press Release (2012b, 2013, 2014b, 2015) ODM business, most companies did not launch a private brand business and remained as behind-the-scene players This type of success through staying in the background is unique to Taiwanese companies and is also observed in their other businesses such as semiconductor fabrication.2 10.4 The Shrinking of the Market of Notebook Computer With the emergence of tablet devices, the market of notebook computer is gradually shrinking The combined global shipments of desktop and notebook computers have been declining significantly (Table 10.1) The volume of notebook computers produced under contracts is also expected to decline in the future; the 2015 volume is forecasted to decrease by % from the previous year (Commercial Times, 13 Dec 2014) Under these circumstances, companies that had mainly operated in the notebook ODM business in Taiwan are increasing their percentage of non-notebook businesses Specifically, non-notebook businesses that are increasing in share are tablet devices and servers The following sections will look at these one by one 10.5 The Shift to Tablet Devices Below, the shift to tablet devices among Taiwanese ODM companies will be examined 10.5.1 Situations for Taiwanese ODM Companies Shifting to the Tablet Device Business The global shipment of tablet devices has been growing strong, from an order volume of 60.01 million in 2011 to 116.34 million in 2012 and to 195.43 million in For more details on the growth through ODM contracts, refer to Nakahara (2004) 220 Y Nakahara Table 10.2 Major contract companies manufacturing tablet devices Size 5–8 in Company Amazon Product Kindle Apple Kindle Fire (7 in.) iPad mini Google Lenovo Nexus – Asus Samsung B&N (Barnes & Noble) – MeMO Pad Inocia B1– – – – RIM (Research In Motion) Amazon Apple Google Microsoft HP Lenovo PlayBook Kindle Fire HD iPad Retina display model Nexus 10 Surface Slate7 – Samsung – Acer 9–11 in ODM company Quanta Honhai Quanta Honhai Pegatron Wistron Compal Quanta Compal Wistron Pegatron Quanta Compal Wistron (In-house) Pegatron Inventec Quanta Honhai Honhai Samsung Pegatron Compal Compal Wistron (In-house) Note: — shows that the product name is unavailable Source: Commercial Times, 28 Nov 2012, 25 Dec 2012, 26 Feb 2013, 24 Jun 2013; United Daily News, 31 Dec 2012; Nikkei Monozukuri, Mar 2013, p 88 2013 (Gartner Press Release 2012a; 2014a) As a result of this, Taiwanese ODM companies that had been engaged mainly in the notebook contracting business in the past are quickly shifting to the tablet device business Table 10.2 shows the contractors of popular tablet devices that are currently on the market, these include Taiwanese companies such as Quanta, Pegatron, Wistron, Compal, and Inventec that had operated mainly in the notebook ODM business in the past Next, I will look at the order situations at each company Quanta has won contracts with major companies such as Amazon and Google Quanta’s shipments of tablet devices were in the order of 14 million in 2012, which was the highest among Taiwanese companies (United Daily News, 31 Dec 2012) Pegatron is allocating three out of its seven factories in Shanghai for manufacturing Apple products including the iPad mini (Commercial Times, 24 Dec 2012) The 10 The Development of Taiwanese ICT ODM Companies 221 company also has contracts with Microsoft, Asus, and Barnes & Noble (B&N) for a total of 4.7 million tablet devices (United Daily News, 31 Dec 2012) and is actively seeking contracts with other companies in order to avoid the risk of being dependent on one client Wistron has contracts with Asus and Apple (Economic Daily News, Sep 2012) Compal terminated 150 employees in Taiwan in October 2012 due to a slump in tablet devices (Nikkei Monozukuri, Feb 2013, p 89) However, aiming to make a comeback, they secured a tablet contract with Hewlett-Packard in 2013 (Commercial Times, Aug 2013) followed by an iPad mini contract with Apple (Commercial Times, 24 Jun 2013) 10.5.2 Risks Inherent in Shifting to Tablet Devices The Taiwanese ODM companies that are shifting to tablet devices face some risks inherent in this shift The first is the risk of being affected by sluggish sales of tablet devices The current tablet device market is in a state where the landscape of the industry has not been solidified due to various follower companies, such as Amazon and Google, still challenging Apple at the top Among the challengers, there are cases of companies that entered the market but ended up with very poor sales In such cases, the Taiwanese company contracted to manufacture tablet devices for them would be affected significantly For example, although Quanta had a contract to manufacture tablet devices for Research In Motion (RIM), the company had to stop production for this tablet at their Taoyuan factory in Taiwan and terminate 1000 workers due to poor sales of the product (Nikkei Monozukuri, Mar 2013, p 88) The first Surface model released by Microsoft in 2012 also succumbed to poor sales because the price was high and the sales channels were insufficient (Nikkei Monozukuri, Mar 2013, p 86) However, it is said that the impact on Pegatron, a Surface contractor, was relatively minor since they also had a large iPad mini contract with Apple (Commercial Times, 27 Dec 2012) Therefore, the strategy to secure multiple clients rather than being dependent on only one client in order to offset risks is necessary for tablet devices The second risk is the fact that the unit price is low Tablet devices are contracted at a lower unit price compared to notebook computers Even though some say that the variation of construction and design is small, since the internal structure of a tablet device is simple to begin with (Nikkei Sangyo Shimbun, 18 Jul 2013), according to the general manager of Compal, “the profit on four tablets only amounts to the profit on one notebook” (Commercial Times, 23 Jun 2012) In the past, Taiwanese ODM companies handled not only the assembly but also the development—which is a high value-added process—under notebook computer contracts By the 1990s, they had honed their development skills and evolved from 222 Y Nakahara being OEM companies, contracting only the production during the 1980s, to ODM companies, that undertook the development as well (Nakahara 2006, pp 130–148) However, things are different with tablet devices For example, it is said that, in the case of Asus Nexus 7, Quanta’s profit per unit is lower than that of a notebook computer because Asus leads the development, and the only process that Quanta oversees is the assembly (Nikkei Monozukuri, Mar 2013, p 90) Thus, this means that the ODM arrangement used for notebook contracts reverted to OEM contracts for tablet devices Moreover, the price of tablet devices began dropping early as well The prices are declining because of some companies that sell low-priced notebook computers, such as Acer and Asus, considered low-priced tablet devices from Amazon, Google, etc., and released products that were largely priced even lower at the same time The price reduction spurs competition to lower contract unit price as well However, companies contracted to manufacture low-priced tablet devices sold at US$199 per unit, for example, face a situation where they almost cannot make any profit since the parts alone are said to cost close to US$150 to US$200 (Economic Daily News, 15 Nov 2012) The third risk is the emergence of Chinese companies Chinese companies are coming to the forefront in low-end tablet device contracting For example, Malata, which is headquartered in Xiamen in Fujian Province, is rapidly expanding its tablet device business, after deciding in 2013 to withdraw from the business of manufacturing contracted notebook computers and focus its resources on manufacturing tablet devices In 2013, Malata was increasing its shipments of tablet devices to an order of million, an increase of 60 % from the previous year Malata ranked fourth in the world tablet market in 2012 and surpassed Wistron (2.5 million), Compal (1.6 million), and Inventec (1.2 million) That is, Malata has become a threat to Taiwanese companies In addition, BYD secured a contract in 2013 to manufacture tablets to be sold by Hewlett-Packard at US$89 to US$99 and began shipping in the third quarter of 2013 (Commercial Times, 24 Jun 2013) These Chinese companies are competitive because of their relatively low unit price It is said that a Chinese company quoted a price of US$35 at an international PC trade fair, “Computex Taipei,” held in Taiwan at the beginning of June in 2013, even though the going market contract unit rate for a 7-in tablet was US$45 to US $50 at the time (Commercial Times, 24 Jun 2013) The fact that tablet devices are not required to have the same level of quality and durability as notebook computers has also become tailwind for Chinese products to make rapid progress Leading companies such as Hewlett-Packard, Dell, and Toshiba are already shifting their tablet device orders to Chinese companies incrementally (The Nikkei, Jun 2014) Acer and Asus are also said to be planning to contract orders to Chinese companies (Commercial Times, 12 Feb 2014) As a result, Taiwanese ODM companies are facing Chinese companies coming to the forefront armed with low prices and closing the gap As described above, there are various risks in shifting to tablet devices 10 The Development of Taiwanese ICT ODM Companies 10.6 223 The Shift to the Server Business Meanwhile, Taiwanese ODM companies have started shifting to the server business as well Here, there are two patterns being followed The first is to take orders as ODM and the second is to take orders directly from end users (i.e., take orders for private labeling) It seems that many Taiwanese companies are focusing on the latter The private labeling business would therefore become a private brand business that the Taiwanese ODM companies could not previously accomplish with notebook computers.3 The following section will look at these patterns 10.6.1 State of the Server Business Among Taiwanese ODM Companies Among Taiwanese ODM companies, the front-runner in the server business is Quanta At Quanta, Barry Lam, the chairman of the board, began spearheading joint research with the Massachusetts Institute of Technology (MIT) around 2004 Before others in the industry, the company also began working on server research by establishing a cloud computing division within the company in 2009 (Commonwealth, 22 Feb 2012, pp 40–48) Those efforts began yielding specific results, such as Facebook and Google ordering data center servers, in around 2011 (Commercial Times, Jun 2011) In 2012, Quanta established QCT (Quanta Cloud Technology), a US subsidiary, to undertake server manufacturing for end users Though I will describe the details in the next section, more and more companies that operate a large data center are choosing their own server specifications and ordering these from manufacturers Quanta established a subsidiary in order to further promote its own brand by targeting those clients (Nikkei Computer, 30 Aug 2012, p 5; Economic Daily News, 14 Mar 2013) In 2012, QCT’s operating revenue from private brand products grew by 143 %, and their global server market share reached 14.8 % (30 Magazine, Jan 2014) Quanta also built a new server factory in Fremont, California, in the same year (Nikkei Computer, 11 Jul 2013, p 114) and became the first Taiwanese company to obtain Microsoft’s Hyper-V Cloud Fast Track4 certificate while securing a contract with Microsoft (Economic Daily News, 15 Nov 2012) Hsieh and Shie [2012] stated that appropriate policy promotion by the government was essential for Taiwanese companies to develop private brands The Taiwan government has been promoting “Branding Taiwan” since 2005 (Newsletter of Investing Taiwan, Republic of China, Nov 2005), which was expanded to “Branding Taiwan Campaign the Second Phase” in 2012 Led by the Industrial Development Bureau in the Ministry of Economic Affairs, the government is striving to promote private brands Corporate cloud (private cloud) offered by Microsoft is actually sold by companies chosen as partners (Microsoft Japan, 2013) 224 Y Nakahara Furthermore, in the same year, Quanta joined the Open Compute Project (OCP) led by Facebook (Economic Daily News, May 2012) Facebook built a huge data center in Lulea˚, Sweden, in 2013 It appears that the air conditioning and servers installed at the center were designed in-house by Facebook (Nikkei Computer, 11 Jul 2013, p 56) and manufactured by Quanta (Business Today 2013) QCT already has a base in Beijing In addition, in order to increase orders for data center hardware from Chinese Internet companies, such as the e-commerce company Alibaba and the social networking service company Tencent, they are planning to establish bases in Hangzhou, where Alibaba is headquartered, and in Shenzhen, where Tencent is headquartered (EMSOne News 2014) QCT opened a base in Tokyo in December 2014, and it appears that QCT plans to develop customers in both Japan and China (QCT Press Release 2015) Since it also seems that the recent trend has been to introduce products to the Japanese market directly from manufacturers, QCT is expected to serve a wide range of customers, from those who sell in the thousands to those who sell in the dozens (ASCII 2015) As for Compal, they established a US subsidiary, Compal Communications, to offer products such as servers, storage, and network equipment necessary for data centers Whereas Quanta targets large clients, Compal seems to target service providers, government agencies, and companies that not require special product customization (Economic Daily News, May 2012) 10.6.2 Background for the Shift to the Server Business There are probably several factors driving the shift to the server business among Taiwanese ODM companies The first factor is that large end users (companies with large data centers such as Facebook and Google) are increasingly demanding more customized servers (Economic Daily News, 14 Mar 2013) In the past, servers were often provided by major brand companies such as IBM, Dell, and Oracle (Nikkei Computer, 13 Jun 2013, pp 74–81) However, the servers provided by these brand companies were mostly the standard types As end users began seeking more customized servers as they were no longer satisfied with standard servers for operating large-scale data centers, end users began designing servers in-house and contracting Taiwanese ODM companies to manufacture them This, in turn, became an opportunity for Taiwanese companies (Commonwealth, 22 Feb 2012, p 43) The second factor is a packaged deal that combines servers with low-margin, high-volume tablet devices As described earlier, tablet devices have a low unit price Therefore, companies are all trying to sell tablet devices along with servers in order to offset the low profit on tablet devices For example, Quanta sells both servers and tablet devices to Amazon and Google (Economic Daily News, 15 Nov 2012) 10 The Development of Taiwanese ICT ODM Companies 225 10.6.3 Growth of Direct Orders to ODM Companies Table 10.3 shows changes in revenue and market share by server vendor from the third quarter of 2012 to the third quarter of 2014, as well as growth in revenue per year As mentioned earlier, the server market share for direct orders to ODM companies is still small, 8.9 %, as of 2014 However, we can see that revenue has been growing significantly, with a growth rate of 45.2 % from 2012 to 2013 and 44.2 % from 2013 to 2014 10.6.4 Feasibility of Developing Private Brands in the Server Business and Its Risks Next, the feasibility and risks of developing private brands in the server business will be examined It seems that the server business could be an opportunity for Taiwanese ODM companies to utilize the hardware manufacturing technology they already developed through notebook computer contracts and to promote their private brands, moving away from ODM and selling directly to end users This transition to private brands in the server business is different from the situation in the personal computer business in which most companies remained in the background as ODM contractor However, this involves the risk of losing clients This is because launching a private brand for servers means competing with existing clients and could not only alarm clients but also cause a loss of server sales as well as a loss of other sales such as notebook computers For example, Quanta ended up competing with Dell, its client, after launching its own brand in the server market With the third largest share in the global server business as of 2012 (in the Chinese market, its share is the largest at 60 %), Dell is a major manufacturer in the server business (Nikkei Computer, 13 Jun 2013, p 80) and it was selling servers to Baidu However, when Baidu also began buying from Quanta, Dell and Quanta ended up as competitors In 2014, Dell, therefore, stopped contracting Quanta to manufacture not only servers but also notebook computers (Commercial Times, 26 Aug 2013).5 Such a paradox, in which a company ends up competing with existing ODM clients when launching a private brand business, also occurred in the PC business For those Taiwanese companies wanting to launch a server product under a private brand, determining how to handle this paradox is a major issue Marius A Haas, the Chief Commercial Officer and President of Enterprise Solutions at Dell Corporation, visited Taiwan in November 2012 and stated that Dell would cut its orders if the contract manufacturers focused on private brands and competed with Dell This remark was beginning to put more effort into its private brand (Economic Daily News, Nov 2012) 16.5 100 2075 12,559 Source: IDC Press Release (2013) and (2014) Vendor HP IBM Dell Cisco Oracle ODM Direct Others Total Q3 2012 market share (%) 26.6 27.9 16.6 3.3 4.7 4.3 Q3 2012 revenue (million dollar) 3339 3502 2086 419 588 540 1983 12,151 Q3 2013 revenue (million dollar) 3390 2822 2070 599 503 784 16.3 100 Q3 2013 market share (%) 27.9 23.2 17.0 4.9 4.1 6.4 Table 10.3 Corporate family, worldwide server systems vendor revenue 2344 12,736 Q3 2014 revenue (million dollar) 3371 2320 2266 786 520 1130 18.4 100 Q3 2014 market share (%) 26.5 18.2 17.8 6.2 4.1 8.9 À4.4 À3.2 3Q2013/3Q2012 revenue growth (%) 1.5 À19.4 À0.8 43.0 À14.5 45.2 18.2 4.8 3Q2014/3Q2013 revenue growth (%) À0.6 À17.8 9.5 31.2 3.4 44.1 226 Y Nakahara 10 The Development of Taiwanese ICT ODM Companies 227 In addition, the private brand business for server products could lead to a manufacturing contract without value-added development As previously mentioned, what drives Taiwanese companies to pursue private labeling is the increased number of end users operating large data centers, choosing their own server specifications, and then placing these orders with manufacturers In those cases, large companies, such as Facebook, seem to be designing the servers in-house In other words, if Taiwanese companies are contracted only to manufacture and not to design these servers, they are reverting to manufacturing-only contracts in the server business, without being able to work on the higher value-added design process (even though they had already evolved to undertake the ODM of notebook computers including design) 10.6.5 Spin-Off Trend in the Server Business and Its Risks Some companies try to take the step of a business spin-off in response to this situation where they would be competing with their ODM clients if they launch a private brand This type of spin-off has also been done with PC products For example, Acer spun off their ODM business as Wistron in 2001 in order to focus on its private brand business, because a client with a long-term ODM contract, who accounted for 80–90 % of Acer’s sales at the time, demanded that Acer reorganize its private brand and ODM businesses and suspend its ODM contract at the same time (Chen et al 2009, p 23) Based on Acer’s experience, Yang and Cheng (2003) concluded that concurrent operation of the ODM and private brand businesses was difficult and that companies must always separate these two businesses This conclusion might apply to the server business as well It appears that Inventec is making a move to spin off its server division Inventec was initially putting off entering the server business since launching a private brand would upset its clients However, the company changed its policy in 2013 after obtaining consent from its clients and entered the data center server market, winning a contract with Google It is said that the company then began considering the spin-off and, as a preliminary step, integrated the cloud division with its ICT division, creating a cloud computing solution center (Commercial Times, 22 Oct 2013) However, spin-offs carry some risks For example, it is said that there were many employees at Wistron who felt uneasy about launching this new, no-name company (when Acer spun off Wistron) and that there were concerns about diminished commitment and motivation among the employees toward the new company Wistron addressed this situation by taking measures such as keeping Acer’s compensation and evaluation criteria policies (Chen et al 2009, pp 33–34) As described above, since spin-offs are risky, appropriate subsequent management becomes extremely important 228 10.7 Y Nakahara New Developments in the Notebook Computer Business Meanwhile, there are new developments in the notebook computer business at Taiwanese ODM companies, meaning that the Global Production Network is undergoing a significant change These will be addressed below The first development is the shift to inland China In the past, Taiwanese companies had Chinese manufacturing bases for notebook computers mainly in south and east China along the coastal areas Those locations are gradually shifting inland, particularly to Chongqing There are several reasons for the shift to Chongqing The first is the city’s generous support of such moves (Commercial Times, 16 Aug 2012) The city of Chongqing is providing support by establishing divisions such as supply chain offices and distribution offices as agencies to help parts manufacturers expand to the city, appointing a former senior officer of Shenzhen customs who is familiar with the electronic and electrical machinery industry, providing subsidies, and so on The second is the low procurement cost of materials, which is declining further, following investments by many Taiwanese parts manufacturers as a result of this support from the city For example, a total of 60 companies supplying packaging materials, batteries, keyboards, etc to Quanta have already expanded to the Chongqing Bishan Industrial Park (Economic Daily News, 17 May 2013) The third is that labor costs are cheaper there compared to the coastal areas (Commercial Times, Jan 2013) The fourth is that Chongqing, which is located closer to the center of the Eurasian continent, could potentially facilitate distribution to Europe as freight distribution by rail using the New Eurasian Land Bridge—known as the Silk Road of the twenty-first century—from Chongqing to Europe might become possible (Economic Daily News, 22 Apr 2013) Freight shipments from China to Europe used to take 35 days by sea from Shanghai; however, that time has been shortened to 15 days because of the new Eurasian Land Bridge that opened in 2011 The volume of international freight shipments from Chongqing has increased to 10,000 TEU (20 ft standard containers) or US$2 billion ever since (Economic Daily News, Jul 2014) Based on the above, Chongqing seems to have become an ideal location to establish a manufacturing base As a result, Chongqing again increased the volume of personal computer production in 2014 This production volume in 2014 was 64 million units, the volume of notebook computers increased by 15 % year-onyear, and one in three personal computers produced worldwide was made in Chongqing (The Central News Agency, 18 Jan 2015) Next is Chengdu Compal’s Chengdu factory manufactures Dell products for the European and American markets In the future, the company plans to consolidate the Kunshan factory, which mainly manufactures Dell models for the Chinese market, with the Chengdu factory (Commercial Times, 28 Aug 2013) The second new development is joint ventures with Chinese companies 10 The Development of Taiwanese ICT ODM Companies 229 Compal and Lenovo—a Chinese company with the third largest PC market share in the world—jointly founded LCFC, a joint venture company that manufactures and sells contracted PCs in Hefei in Anhui Province of China The positions of the chairman of the board and the chief executive officer were both filled by individuals from Lenovo (Anhui Daily, 28 Sep 2011) According to Compal, this unusual joint venture took place because it became difficult to cover all expenses to construct a new factory on its own due to increasing competitive pressures and a more complicated manufacturing process for PCs (Financial Times, 28 Sep 2011) The third new development is the increased manufacturing activities in emerging countries such as Brazil As clients of Acer, Asus, and others develop the Brazilian market, Taiwanese ODM companies are increasing production of notebook computers in Brazil (Commercial Times, 18 Feb 2013) For example, Quanta is building more factories in Brazil since Asus increased orders placed with Quanta’s Brazilian factory for products to be sold in South America such as Brazil Compal’s Brazilian factory is also manufacturing notebook computers for Acer, Asus, and Lenovo It is said that the volume of shipments in 2012 was as much as 1.8 million Furthermore, investment in Southeast Asia and South Asia is also increasing According to the Taiwan Electrical and Electronic Manufacturers’ Association, an industry association, Taiwanese companies invested more in Southeast Asia in 2014 The trend indicates that Taiwanese companies are increasingly eager to invest in the countries in Southeast Asia and South Asia, particularly in Indonesia and India Investments began flowing into Myanmar for the first time in 2014 One reason for that is the large young labor force that is expected to provide cheap labor and high consumption Compal, a subsidiary of the Kinpo Group, contracts some of their orders out to a factory in Thailand set up by Cal-Comp, another subsidiary of the Kinpo Group It seems that both the growing demand in the ASEAN market and increasing labor costs in China, where Compal has their manufacturing base, were factors in this decision The basic salary of workers in Thailand ranges from 12,000 to 15,000 Baht per month, which is about the same as in China.6 The fourth point on new developments is investment returning to Taiwan While the percentage of Taiwanese company investment that goes to China has been declining every year since 2010, from 53.02 % to 40.28 % in 2014, investment within Taiwan increased to 47.12 % in 2014 from 37.20 % in 2010, exceeding investment in China Chee-Chun Leung, cofounder and Vice Chairman of Quanta Computer, commented in May 2014, “China is drastically increasing the minimum wage every year The annual increase is 15 % or more in large cities and the rate of wage increase is the fastest in the world.” He said that his organization has hence Meanwhile, in March 2013, Compal suspended the production of notebook computers at the factory that they had built in 2011 in Vı˜nhPhu´c in northern Vietnam and in which they had invested US$500 million It is said that Compal did so because the production efficiency of that factory did not improve, due to lumbering infrastructure development, issues in supply chain building, and inadequate employee performance (Commercial Times, 14 Mar 2013) 230 Y Nakahara already begun to seriously look into returning their production to Taiwan since labor costs in China—their largest production base—will exceed Taiwan’s as early as 2015,7 suggesting that they might move as soon as they can secure a labor force, among other requirements8 (Economic Daily News, May 2014) These developments imply a geographic transformation of the Global Production Network for notebook computers 10.8 Conclusion I have looked at the growth through ODM contracts in 1990s and current development of Taiwanese ODM companies and the issues inherent in that development The following summarizes what I have addressed in this paper so far First, technology transfer from the companies from developed countries through ODM during the 1990s enabled Taiwanese companies to grow, which, in turn, led to the growth of the entire personal computer industry Second, Taiwanese ODM companies are shifting to the tablet device business and server business as the shipments of notebook computers decrease Third, companies are shifting to the tablet devices However, this approach carries certain risks including low unit costs, reverting to OEM contracts from ODM contracts, and competition from Chinese companies that are quoting even lower prices and thus catching up with Taiwanese companies Fourth, companies are also shifting to the server business In this development, private labeling is increasing However, simultaneously, these companies face the risk of competing with existing clients and losing sales opportunities for other products such as notebook computers Fifth, new trends such as shifting production bases to inland China, establishing joint ventures with Chinese companies, and increasing production activities in emerging countries like Brazil, are also emerging in the notebook computer business Thus, going forward, what kind of strategies should Taiwanese ODM companies follow? In the tablet device business that Taiwanese companies shifted to due to the shrinking market for notebook computers, these companies cannot seek stability by Leung attributes this increase to the fact that companies in China must bear the cost of insurance as well as that of room and board for employees Insurance costs are incurred toward the so-called five insurances and one fund, which include a pension, medical insurance, unemployment insurance, worker’s compensation, maternity leave, and one housing reserve fund (Economic Daily News, 14 May 2014) Leung stated that it is necessary to determine or arrange for some requirements, such as employing enough labor and automating production, in order to return to Taiwan because there is no guarantee that they can secure factory workers in Taiwan, even if a good salary rate is offered, because the workforce’s education level is relatively high (Economic Daily News, 14 May 2014) 10 The Development of Taiwanese ICT ODM Companies 231 relying only on this business since they are faced with situations such as low profitability, declining prices, and Chinese competition In addition, there are situations in which they are not contracted for development Furthermore, in terms of the server business they have also shifted to, we see similar instances where these companies cannot undertake any high, value-added processes since they are not involved in product development There is also the risk of competing with existing clients, similar to the case of the notebook computer business Under these circumstances, in order for Taiwanese ODM companies to secure stable earnings and grow in the future, it seems that they need to aim to engage in higher, value-added processes and non-hardware businesses For example, under the server business, they should undertake not only manufacturing but also development and expand to its related solutions business (cloud business) instead of only providing hardware while diversifying production bases for the notebook computer business and securing a certain level of earnings in the tablet device business In 2010, the Taiwan government designated the cloud business as one of the four major smart industries, aiming to develop nonmanufacturing sectors In the same year, the government also formulated the Cloud Computing Industry Development Plan and established the Cloud Computing Association in Taiwan (CCAT) to promote the cloud business For Taiwanese ODM companies that had a tendency to limit themselves to providing hardware, these initiatives around the cloud business could be a breakthrough I believe we need to continue carefully monitoring future development among these companies References Akino S (2013) Taiwan erekutoronikusu jutaku seizokigyo no seicho ni kansuru kenkyu (A Study on the development of electronics contract manufacturers in Taiwan) J Asian Manag Stud 19:51–61 (in Japanese) ASCII (2015) Kuraudo ni saitekina HW wo teikyo, nihon hojin setsuritsu no Quanta kanbuni kiku (“We will provide the best hardware for cloud computing” Interview with CEO of QCT Japan) http://ascii.jp/elem/000/000/962/962944/ Accessed 13 Feb 2015 (in Japanese) Business Today (2013) How Facebook made Quanta redesign its servers http://businesstoday intoday.in/story/how-facebook-made-quanta-redesign-its-servers/1/198037.html Accessed Sept 2013 Chen Y, Imura N, Hirano M (2009) Taiwan kigyo no saisei process wo tsujita kyosoyui no saikochiku – Acer/Wistron no keisusutadi (restructuring competitive advantage through rebuilding process of Taiwanese firm: a case of Acer/Wistron) KIU J Econ Bus Stud 15 (2–3):19–48 (in Japanese) Cheng J, Duh C, Hu H (2000) Pingpai zchan chuangzao iengxiang zh ianjiou- Uoguo zxyuen diannao ziou pienpai chanshan shzheng fenxi (The research of antecedents of brand equity—an empirical analysis of own branding and manufacturing firms of computer products in Taiwan) J Bus Adm 47:81–106 (in Chinese) Domberger S (1998) The contracting organization: a strategic guide to outsourcing Oxford University Press, Oxford 232 Y Nakahara EMSOne News (2014) Kuanta, Aribaba Tensent no sohonzan ni kyoten, deta senta no shoki nerai (Quanta to establish bases in the home cities of Alibaba and Tencent: eyeing business opportunity for data center products) http://www.emsodm.com/html/2014/06/12/ 1402543938531.html Accessed 12 June 2014 (in Japanese) Ernst D (2002) Global production networks and the changing geography of innovation systems: implications for developing countries J Econ Innov New Technol 11(6):497–523 Ernst D, Kim L (2002) Global production networks, information technology and knowledge diffusion Ind Innov 9(3):147–153 Gartner Press Release (2012a) Gartner says worldwide media tablets sales to reach 119 million units in 2012 http://www.gartner.com/newsroom/id/1980115 Accessed 13 Mar 2014 Gartner Press Release (2012b) Gartner says worldwide PC shipments in fourth quarter of 2011 declined 1.4 percent; 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