Business,Development | June 2, 2015 Written by Andrew Tylecote. It is widely agreed that ‘latecomer firms’ (LCFs) and their economies should catch up through cooperation (‘linkage’) with what Mathews (2006) calls ‘incumbents’. The cooperation revolves around the sourcing of incumbents, and their technology licensing: they buy goods from, and sell technology to, LCFs. This creates a sort of ladder upwards; first the LCF produces relatively simple goods under licence, then it reaches OEM status, taking complete responsibility for manufacture – and subsequently adds design and marketing, getting its own brand. South Korea and Taiwan provide examples. I shall argue that mainland China has made a strategic mistake in accepting this pattern as largely suitable for its own development (Liu and Tylecote 2015). Size matters, and so does governance. Size: South Korea and Taiwan (each with less than 50 million people) could profit from opportunistic insertion of relatively few firms in a few sectors, into ‘global value chains’. Their success on world markets generates export income which pays for imports in other sectors. Mainland China, with 1.3 billion people, faces different arithmetic. Where it succeeds it cannot export (let us say) fifty times more than its home market, as Taiwan can: so it must succeed in many more sectors. Moreover in each of those sectors it will have many more latecomer firms needing to catch up. But the linkage model is driven by the convenience of incumbents whose strategy is suited by partial or complete withdrawal from manufacture (or not manufacturing in the first place, as with Qualcomm with the mobile phone technology that it licensed to Samsung et al.). For every sector in which this may suit ‘incumbents’, there is another where it seems not to. In motor vehicles and aero-engines, the final assembly stage, and the manufacture of core components, are clearly of strategic importance. No incumbent will give them up in order to focus on design and marketing. So linkage may not give latecomer firms entry to such sectors. And even in those sectors where it does, the number of firms given entry is a function of incumbents’ needs. As trade barriers fall, fewer incumbents looking to outsource need to source from any given country – even mainland China. Where they do, one mainland Chinese firm in each product area may well suffice. What are the others to do? What if their numbers far exceed those of incumbents seeking partners? In the 1990s, of course, globalisation had not gone so far. The mainland Chinese market was protected, and that gave the central government and the firms it favoured, considerable leverage with which to promote linkage. If leading foreign firms wanted access to this large, fast-growing market, they would have to get it on government terms – which were almost always, a joint venture with one of the main central-government-owned firms. So if linkage with incumbents was key, these firms got it. They had then only to leverage it and learn from it, in Mathews’ terms; in mine, they had only to go from static technological capability to dynamic (Xiao, Tylecote and Liu 2013) . Only? It is seductively easy to learn to make what an incumbent is willing to show how to make, if it will also provide whatever equipment and licenses are required: that is, a complete bundle of technologies. It is easy to learn, because one need not learn much. Now the Korean late-comer firms, like Hyundai in motor vehicles, typically started with a technology bundle: that was indeed the first stage. But they rarely bought a second bundle: the next stage was unbundled: getting licenses, equipment, training, individually from whomever would supply them on attractive terms – the most attractive including freedom to develop the technology. Alongside that, these firms began programmes of R&D intended to free them from even such dependence, as soon as possible (Lee and Lim 2001). Whereas whatever R&D the favoured Chinese firms might embark upon, to make a good impression, what they generally settled into were dependent strategies – in which one infusion of bundled (and slightly dated) technologies was followed a few years later by another, and another (Liu and Tylecote 2009). How can we explain the difference? Largely in terms of ownership and governance. The Korean firms which succeeded in high and medium-high sectors were controlled by entrepreneurial founders/families (albeit backed by government) with a high degree of engagement and expertise (Lee and Lim 2001; Tylecote 2007) and a long-term vision for their firms’ development. They seized every opportunity for independent technological development. The mainland Chinese firms which were expected to follow their lead were run mostly by bureaucrats with very different personal goals – promotion within the bureaucracy – and could achieve these by the advances achieved by buying another bundle from their foreign partners (Liu and Tylecote 2009; a situation which can be understood in terms of a principal-agent problem in which the ultimate principal is remote and the information asymmetry accordingly extreme (Cai and Tylecote 2008). What the mainland Chinese firms now need (in addition to the sorely-limited foreign ladder) is a domestic ladder, with rungs provided by domestic customers. The obvious model is Japan – the last East Asian ‘developer’ more comparable in size (Liu and Tylecote 2015). But Japan in 1950-80 was ruthless in protecting its domestic markets both from imports and from the subsidiaries or joint ventures of ‘incumbents’. At the same time its firms found it easy to get licenses on generous terms – in an age of weak patent protection. China has signed the TRIPs agreements on IPR and joined the WTO. The only Chinese firms which now have effective, though informal, protection are those state-owned firms which sell to other state-owned firms (and the state itself). But the innovative private firms which most need such a ladder, and from which the Chinese economy has most to gain, have the least access to such preferential purchasing – and indeed any other support. Professor Andrew Tylecote is an Emeritus Professor of the University of Sheffield Management School and visiting Professor at the Centre for Research on Technological Innovation at Tsinghua University, Beijing. Image Credit: CC by Cory M. Grenier /Flickr. Is China playing a long game in the South China Sea? Why do many Chinese SOEs fail to achieve their ambitions?