Taiwan's Next Mainstream
The '2.5 Generation' Industry
Often overlooked because they cannot be conveniently pigeonholed, these shadow warriors have long been consulted by the likes of mogul Terry Gou. Who are they?
The '2.5 Generation' IndustryBy Benjamin Chiang
From CommonWealth Magazine (vol. 444 )
For decades, they've been underestimated and overlooked, described as "trade agents" or "machinery repairmen." Even their families are not clear what business they're really in.
But when Taiwan Semiconductor Manufacturing Co. (TSMC) sought to draw a roadmap to develop a 20 nm process or AU Optronics wanted to promote saving energy and reducing carbon emissions, they both entered into partnerships with these shadow warriors.
One such warrior's command post, a 72-square-foot office near the Taipei rapid transit system's Shilin Station, is nondescript from the outside but actually overflows with commendations from Taiwan's top electronics vendors, such as AUO, United Microelectronics Corp., and ProMOS Technologies.
"Every year Trane Taiwan helps electronics plants save billions in electricity costs. We don't sell air-conditioning units. We sell energy-conservation planning services," says a proud Frank Hwang, the country leader of Trane Taiwan.
Taiwan's industrial structure is currently undergoing a major shift from second-generation industry (manufacturing) to third-generation industry (service). In the midst of this structural upheaval, a transitional "2.5 generation" industry has taken shape, playing a supporting role in the upgrading of the country's manufacturing sector and its expansion into global markets.
"The second- and third-generation sectors are being pulled toward the middle simultaneously, meaning the time is right for Taiwan's 2.5 generation industry," observes Woody T.J. Duh, the director general of the Ministry of Economic Affairs' Industrial Development Bureau.
This 2.5 generation industry is like the center point of a funnel, directing the value chain that connects upstream suppliers with downstream manufacturers.
"We have to understand technology even better than factories while at the same time staying on top of market information," says Hsieh Ching Fu, the chairman of factory automation provider Kenmec Mechanical Engineering Co. As soon as they take on a job, enterprises like Kenmec immediately help expand the customer's capacity and efficiency exponentially, Hsieh asserts.
Master Cross-industry Integrators
Even in the Internet age where information is more widely available than ever, these vendors belonging to the obscure 2.5 generation sector not only remain indispensable, but are playing a more important role than ever.
"The Internet is no substitute for a wealth of experience in cross-industry integration," stresses Wah Lee Industrial Corp. chairman and CEO Ray C. Chang. The crucial technology these vendors have amassed in integrating industries and products is like an industrial technology treasury, which can be drawn up at a moment's notice to handle the emergencies of their customers in the manufacturing sector.
For a long time, however, Taiwan has only placed a premium on the output of the manufacturing sector and not on "the integration service value of the invisible, in-between vendors," Wah Lee spokeswoman Lulu Huang says frankly. Investors only pay attention to manufacturers with factories, and consequentially, the corporate value of 2.5 generation companies, which do not have production lines, has been underestimated, she contends.
Electronics distributor WPG Holdings has launched an acquisition offensive recently, announcing that it would buy the Asia-Pacific region's second leading semiconductor component distributor Yosun Industrial Corp. and the Hong Kong-based passive component distributor AIO Components.
WPG Holdings' strong service capabilities – its ability to satisfy customer requests no matter how big or small -- typifies why players in this virtual niche are so robust.
Although WPG Holdings is an unusually large member of the 2.5 generation club, with annual sales exceeding US$10 billion, its management system is extremely detailed and specialized. Whether it's an order from semiconductor giant Intel, "bandit phone" manufacturers throughout China or a school laboratory, WPG can fill it precisely and deliver it without delay.
The ability of 2.5 generation businesses to gather firsthand market information is another leading indicator of the industry trend.
"We clearly understand what our customers want. We supply them with the newest materials and technology in a timely manner and help shorten their product development curve," says Topco Scientific Co. chairman J.W. Kuo.
Topco Scientific, which represents foreign suppliers of semiconductor and optoelectronics materials in Taiwan, has more than 600 customers. When Taiwan's semiconductor makers were preparing to invest in 12-inch wafer fabs, few noticed that Topco Scientific had already brought together foreign material suppliers and local chip makers to jointly develop essential photoresist, quartz and wafer components, helping customers adjust their process parameters.
Ahead of the Customer's Curve
Successful 2.5 generation businesses know they must stay a step ahead of their customers, helping manufacturers introduce new technology and avert the land mines of the mass production stage.
Wah Lee, which began as an importer of industrial chemicals, occupies a drab office located near Taipei Songshan Airport. It is the secret base from which it has helped many major electronics companies develop innovative products.
When Hon Hai Group founder Terry Gou was in the early phase of building his electronics manufacturing empire, he visited Wah Lee's office on nearly a weekly basis.
"Wah Lee helped Hon Hai by improving its knowledge of tooling and materials. We assisted Hon Hai in developing its line of plastics injection molding machines, and we even introduced Hon Hai to some of its customers," Wah Lee's chairman Chang says with a laugh.
Aside from offering their customers training and education, 2.5 generation enterprises also help introduce foreign customers to Taiwanese manufacturers. When Taiwan's printed circuit board industry was just getting off the ground, Wah Lee brought PC board manufacturers Compeq Manufacturing, Gold Circuit Electronics, World Wide Electronics (now Unimicron Technology) and others to trade shows in Japan.
Despite working on a steady 3-5 percent commission as the sales agent of overseas materials producers, Wah Lee's gross margin has risen above 10 percent. Theoretically, a trading agent working strictly on commission usually sees its profitability decline over time, so how has Wah Lee increased its margin and never suffered a loss in 42 years?
"Staying ahead of customers and developing technologies that improve processes" is the key, says Chang. When Chi Mei Optoelectronics (now Chimei Innolux) wanted to expand into large-size TFT-LCD panels, it approached Wah Lee, Taiwan's biggest engineering plastics agent, for help in developing heat-resistant diffusers and diffuser film.
Wah Lee has also played a supporting role as a 2.5 generation enterprise in the thriving LED-backlit display market. Though it only represents raw materials, it has developed a technically strong materials development team. Wah Lee's team showed its effectiveness in tackling the key challenge in determining whether an LED-backlit display can save power: making sure the LED light source's reflection and diffusion are uniform.
"Wah Lee used software to design hundreds of diffusion patterns applied to light guide plates that evenly diffused the light from individual LEDs over the whole panel," says Chang, who has an insatiably penchant for talking about advanced technology.
Wah Lee vice chairman and deputy CEO Chun-Yin Chen stresses that the company facilitates the flow of information between Taiwan's wafer factories and Japanese material suppliers and gets involved in its customers' processes.
"We don't just buy and sell high-tech materials. We also have a semiconductor R&D team that directly moves into customers' plants, assisting them with development and pre-production testing," Chen says.
Wah Lee, for instance, informed its Japanese suppliers of TSMC's timetable for introducing advanced process technology and told them to develop photoresists and other materials needed by the world's biggest contract chip maker. Today, Wah Lee is the biggest vendor of photoresists for the 20 nm process in Taiwan.
Wah Lee is like a department store for high-tech technologies and materials, where customers can find anything they're looking for. "We don't provide end products, but we have all the components and materials customers want," Chang says.
Long seen as the preserve of "grease monkeys," the machinery industry has also quietly evolved into a 2.5 generation sector.
At a time when many machinery companies remained attached to the traditional model of selling equipment and providing after-sales service, Fu Chun Shin Machinery Manufacture Co. (FCS), based in Tainan County's Guanmiao Township, has already developed "knowledge-based services," selling customers a complete service package.
FCS president Po-hsun Wang says the company developed its turnkey solution model to help companies deal with the challenges of putting together a complete production line. Businesses wanting to invest in a mineral water business, for example, have to purchase equipment to make the water bottles or containers. If a customer sought to buy the necessary equipment on its own, it would need to look around for a range of machinery, from preform molding equipment to bottle capping machines.
FCS organized a turnkey services team that develops a set of machines tailored to the customer's needs. Members of the team are then dispatched to teach the customer how to use the equipment and are responsible for the line's maintenance and repair.
"In the past when we sold single machines, one machine might only be worth NT$5 million, but now, our turnkey solutions can earn NT$30 million," Wang says.
Talent the Biggest Bottleneck
These 2.5 generation enterprises emphasize turnkey service experience, with most adopting mentoring systems that require the long-term training of employees.
"It takes at least five years to make the grade," says Hwei-Nan Yih, chairman of IT systems integration provider Advanced Control & Systems. According to Yih, if they are to provide technical services, and convince clients to follow their advice, they must possess a deeper understanding of a full range of production processes than the customer's factory engineers.
David Chou, director of the Market Intelligence and Consulting Institute, echoes Yih's view. "For a company to become a 2.5 generation enterprise, it must have cross-industry integration capabilities," Chou says.
But that's easier said than done, Yih contends. "The biggest bottleneck in developing a 2.5 generation company is talent," he says, because while most people are interested in working in the high-tech and service industries, they lack interest in the obscure 2.5 generation sector.
And Taiwan's existing education system cannot be counted on to produce cross-discipline talent, as it is designed to train specialists within specific fields.
"You have no choice but to cultivate your own cross-industry talent," says Trane Taiwan country leader Hwang, who explains that having thorough knowledge of an air-conditioning system's main unit is not enough to survive in the air-conditioning business today.
It's even more important, he says, to be able to help customers save energy and cut carbon emissions. Trane prepares its employees to take the U.S. green-building LEED AP exam to earn professional green building credentials, a move it believes is necessary to satisfy customers in the future.
Ultimately, Taiwan's 2.5 generation industry has quietly fueled the rapid upgrading of the manufacturing sector. But in doing so, it has also created for itself a completely new operation model of service innovation that has made it a true invisible champion.
Translated from the Chinese by Luke Sabatier
The 2.5 Generation Sector at a Glance
What is the 2.5 generation industry?
Many people describe the manufacturing sector as the 2.0 generation industry and the service sector as the 3.0 generation industry. The 2.5 generation sits in the middle, providing services founded on manufacturing skills. Many major manufacturers must turn to 2.5 generation vendors for help when they build a new plant or enter a new field.
Helping Upstream Suppliers
2.5 generation companies are like octopuses, seizing hold of market opportunities at both ends. With one hand, they grab hold of the many upstream suppliers of components and materials, offering them the latest market information and helping them get a jump on developing new products.
Helping Downstream Manufacturers
With the other hand, they grab hold of downstream customers in the manufacturing sector, introducing the latest production technology and helping them improve the efficiency of their production lines.
Why are 2.5 generation companies so important today?
As the factors of production in Taiwan have become less competitive than in other emerging economies, this process has inevitably led the country's basic manufacturers to relocate offshore. If Taiwan wants to retain part of its manufacturing base, it must find a way to integrate manufacturing with the service sector.
Who are the 2.5 generation industry players?
In the past, 2.5 generation enterprises were considered to be blue-collar companies or trade agencies, and, as a result, their value was seriously underestimated. The 2.5 generation industry spans such sectors as machinery and equipment, electronic component distribution or representation, systems integration and engineering contracting.
How have 2.5 generation companies quietly earned big profits?
The 2.5 generation industry's biggest asset is its experience in cross-industry integration, which always remains a cut above the customer's. These companies, generally with limited capital, act behind the scenes as facilitators and are rarely seen, but they quietly earn money and rarely post losses.