Hon Hai: Sharp's New Pass to the World
Long the standard-bearer of the global LCD panel industry, Sharp has fallen on hard times. But it has been given new access to the global supply chain by teaming up with the Taiwan-based Hon Hai Group.
Hon Hai: Sharp's New Pass to the WorldBy Elaine Huang
From CommonWealth Magazine (vol. 494 )
A ruthless shift in power in the Asian electronics industry is underway. Just days before Takashi Okuda was set to take over as Sharp Corp.'s president on April 1, he announced that his company was teaming up with the Taiwan-based Hon Hai Group, the world's leading electronics manufacturing services provider.
In an unprecedented deal, the Taiwanese conglomerate acquired a 9.88-percent stake in Sharp to become the company's biggest shareholder. The group and its chairman Terry Gou also obtained a 46.48-percent stake in Sharp subsidiary Sharp Display Products Corporation and its liquid crystal display (LCD) plant in Sakai – the only 10th-generation flat panel plant in the world.
Sakai, located on the outskirts of Osaka in the Kansai region, was Japan's earliest free port and gained prosperity during the Shogun era under legendary leader Toyotomi Hideyoshi (1537-1598). More recently, it has harbored the aspirations of Sharp, the country's leader in LCDs.
In 2009, Sharp opened its Green Front Sakai, an advanced manufacturing complex that would become its manufacturing base for LCD displays and solar modules and panels. It is four times the size of Sharp's core, fully integrated LCD TV production facility in Kameyama, located about 90 kilometers northeast of Sakai. Within the Green Front Sakai facility sits an integrated energy management center that monitors the energy used and emissions generated during the production process.
The Sharp Display Products plant, which features the world's only Gen 10 production line and produces the world's biggest LCD TV screens at 60 inches, manifests the company's global leadership in LCD technology.
Yet Sharp predicted in March a consolidated loss of 290 billion yen (NT$103.75 billion) for the fiscal year ending that month, the highest in the company's 100-year history. The figure was 61 percent higher than the NT$64.44 billion net loss posted for fiscal 2011 by Taiwan-based Chimei Innolux Corporation, the world's third largest maker of LCD panels by revenue, behind Samsung Electronics Co. and LG Display Co.
The numbers reflected the waning of Sharp's technological pride, which has been bruised by bloated inventories of large panels and capacity utilization at Sakai falling to below 50 percent.
Once envisioned as the paragon of LCD technology, the Sakai facility suddenly represented the dead end of "Sharp culture," a symbol of massive losses.
Japan's Closed Model Runs Its Course
Speaking to throngs of Japanese media, Okuda admitted in announcing the Hon Hai alliance on March 27 that Sharp's success model had become obsolete. "In the past, Sharp pursued its own vertical integration system, but the environment has grown increasingly tough, and going it alone in global markets has led to limitations."
"Industry insiders have often said that Sharp is a technology-oriented company but that it's lousy at doing business," says David Hsieh, vice president for the Greater China market at DisplaySearch, a market research firm specializing in the digital supply chain.
When Sharp first announced it was getting into LCD TVs in 2000, the focus of most global technological vendors at the time was still on money-making notebook computers and monitors. But the Japanese company became fixated on establishing its technological edge, emerging as the first company in the world to build 6th-generation, 8th-generation and 10th-generation production lines and defining global standards for 32-inch, 46-inch and 60-inch LCD TVs. Those steps, however, were solely in support of Sharp's own brand.
Sharp once counted Philips, Sony and Chinese television factories among its flat panel clients, but those relationships with external customers never lasted for long.
The origin of Sharp's failure can be traced back to when the company first got involved in LCD panels and established a "self-use" policy. For decades, Sharp had spawned a culture of doing everything in-house and never adjusted it, becoming like an A+ engineering student with his nose forever in a book. Its penchant for keeping technology locked in-country stood in stark contrast to Samsung, which understood how to leverage technology into market share.
"If you want to do everything in house, there's one condition: your brand has to be strong enough to have a sufficient presence in the end user market," says Richard Watanabe, a partner at PricewaterhouseCoopers Taiwan and its Japan business leader.
But as Samsung and LG emerged victorious in emerging economies and divvied up the lion's share of end markets, Sharp's own panel capacity suddenly became underutilized. That, combined with the appreciation of the Japanese yen in recent years, the European sovereign debt crisis and plunging LCD TV prices, led to a sharp deterioration in Sharp's finances. In the end, it had no choice but to sell Hon Hai a stake in the business to stop the bleeding created by its massive financial black hole.
Opening the Closed Hon Hai Pass
This partnership is unprecedented in history. Hon Hai Group chairman Terry Gou admitted at the recent Boao Forum for Asia on Hainan Island that he and Sharp had been in touch for nine months during the secretive process.
The seeds for the deal were planted back in July 2011, when Hon Hai signed a licensing contract with Sharp to arrange for the transfer of technology to Chimei Innolux, in which the Hon Hai Group has a stake. Gou pondered then whether it might not be more worthwhile to directly team up with Sharp, but the Japanese company showed little appetite for the idea.
Six months later, however, Sharp's finances had gone from bad to worse. Because the Japanese government had already funded the creation of Japan Display, which merged the financially ailing small and medium-sized display units of Hitachi, Toshiba and Sony, it did not have the resources to deal with the even bigger Sharp money pit. With Sharp in desperate need of cash, Hon Hai was presented with an opportunity.
Gou revealed that after the two parties met for the first time in Hong Kong last year, they followed that up by getting together at the beginning of each month at a designated location to discuss long-term strategic cooperation.
Helping Gou from within Hon Hai's ranks were Chuang Hong-jen, the company's investment chief and a former Innolux Display Corp. chairman, who played a key role behind the scenes, and Tai Cheng-wu, the company's Japan expert and president of Hon Hai's Consumer Product Business Group, who helped negotiate the breakthrough.
On the Sharp side, Okuda, who previously headed Sharp's LCD TV division, was given the authority to negotiate with Hon Hai by Sharp chairman Katsuhiko Machida, and in the end clinched the partnership.
"Sharp and Hon Hai will build a new vertical integration model," Okuda said on March 27. In the future, the two companies will work as one in research and development, manufacturing, and purchasing to exploit economics of scale, a strategy that includes increasing the Sakai plant's capacity utilization.
From Sharp's perspective, the combined investment by the Hon Hai Group and Gou himself represents a capital injection of roughly 130 billion Japanese yen and is more than simply a short-term financial stopgap. The biggest incentive of this "marriage" with the world's leading electronics assembly is that it will give Sharp what it most desperately lacks at present: a huge outlet for its products.
Through Hon Hai, Sharp will obtain a pass that connects it with different customers around the world and opens up the closed culture it had so long espoused.
While the deal clearly presents Sharp with many potential benefits, there's also plenty in it for Hon Hai.
Playing the Apple Card
In mid-February, Samsung Electronics Co. said it was considering spinning off its money-losing LCD business to prevent it from dragging down the company. Gou has his own hot potato – Chimei Innolux, which posted a net loss of NT$64.7 billion last year. So why would the Hon Hai chairman want to touch another depressed panel plant when even Samsung plans to get out of the business?
The answer: Hon Hai is hoping to move up in the supply chain to gain control of more critical components and develop more value.
"Chairman Gou has never abandoned his LCD dream," said a senior executive in the industry, citing Hon Hai's acquisition of Innolux, then Innolux's merger with Chi Mei Optoelectronics and now the purchase of a stake in Sharp.
With Apple Inc. becoming Hon Hai's biggest customer, accounting for more than 20 percent of its revenues, "Terry Gou needs more than ever to gain control of display technology," the executive said.
Aside from changing the high-tech industry's profit model by integrating hardware and software and making money on software services, Apple has engendered another change in the sector's game rules by relentlessly upgrading the resolution of its display panels.
The biggest difference, for example, between Apple's new iPad introduced in mid-March and the previous-generation iPad2 was the new device's high-resolution Retina display that has four times as many pixels as its predecessor.
Though Chi Mei's panel technology was good enough to break into the iPhone and iPad supply chains, it was excluded from the new iPad because of bottlenecks in elevating its technology further. Sharp, on the other hand, is the global leader in display resolution technology, and even Apple clearly appreciates the Japanese company's technological capabilities. Rumors were widespread last year that Apple would invest heavily in Sharp's new US$1.2 billion Kameyama No. 2 LCD manufacturing facility, though some suggested late last year that it was simply making an advance payment on future display shipments rather than investing in the plant.
In fact, if Sharp had not come under pressure from its disastrous financial forecast in March, a Taiwanese company would never have been able to acquire a stake in it. But the two companies' ties with Apple may have also helped clinch the alliance.
"Sharp is one of the three LCD panel suppliers for Apple Inc.'s iPad along with Samsung Electronics Co. and LG Display," wrote Kirk Yang, the head of Asia ex-Japan tech hardware research at Barclays Capital in Hong Kong, in a research note on the deal.
"As Samsung is already a competitor to Apple while LG could potentially become one, it is possible for Sharp, a non-Apple competitor, to gain market share with Apple, which could allow Hon Hai to benefit by supplying mechanical parts and components," the analyst wrote.
Implicit in Yang's report was Apple's growing wariness of Samsung, and Gou clearly perceived that Apple would move closer to Sharp.
From this perspective, the "marriage" between Sharp and Hon Hai could very well be a mutually beneficial "win-win" partnership.
"(This) appears to be one of the best Hon Hai strategic investments in its history," Yang wrote in the research note.
At the Boao Forum, Gou bluntly rejected the opinion of many observers that the deal represented Hon Hai's bid to join with Japan in fighting Korea.
"It is focused on the cooperative synergies of China, Taiwan and Japan. For Taiwan's high-tech sector to join with Japan and then make use of China as its own hinterland, I believe we won't lose to any place in the world," Gou said.
This deal marks the beginning of a new model of cooperation between Taiwan and Japan. But for this partnership to blossom, it will still depend on whether or not the two companies' competing corporate cultures – Hon Hai's openness and aggressiveness against Sharp's closed, conservative style – can find a way to mesh.
Translated from the Chinese by Luke Sabatier