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Beyond OEM, Straight to the World


Taiwan's SMEs are beginning to evolve away from their traditionally passive roles as contract manufacturers, aggressively redefining their position in the global supply chain.



Beyond OEM, Straight to the World

By Elaine Huang
From CommonWealth Magazine (vol. 370 )

Taiwan’s small- and medium-sized enterprises (SMEs) once took pride in saying of themselves: “We were the first to set out into the world.”

With their 007 briefcases in hand, they scoured global markets on their own for orders. But for the most part, SMEs dutifully played their roles within the global supply chain as contract manufacturers, relying on trading companies to distribute products into new markets.

But this commercial model to penetrate new markets has been undergoing a quiet transformation. Taiwan’s SMEs are applying the manufacturing prowess they’ve developed over the years to re-position themselves for the better.

Heading Out into the World

A noted observer of the development of Taiwan’s SME clusters, Tunghai University Department of Sociology professor Chieh-hsuan Chen was surprised to discover that Taiwanese SMEs’ new model builds on the old. In the past, local SMEs were positioned in the global supply chain as contract manufacturers, stressing supplier cluster networks with flexible divisions of labor. That model has now evolved toward greater vertical integration of their manufacturing and distribution operations.

“It’s a case of going multinational and using the entire world. They are projecting their core strengths outside their borders,” Chen says.

He believes that Taiwanese SMEs, with a long history of OEM business, have reached an economic scale large enough in global terms to seek out markets on their own. They can now consider relying on their strengths to build overseas distribution channels and sell their products directly to markets, leaving behind their former role as simple contract manufacturers.

This revolution in the mind-sets of Taiwanese SMEs ?w going from passive to proactive actors in the market ?w has changed their positioning in the global supply chain.

SMEs are starting to seize the initiative in developing new markets overseas.

“They no longer just hand over manufactured goods to trading companies, collect their money, and then that’s it,” says UPS International Inc., Taiwan branch general manager Gary Wu. Now they have control over the decision-making process, he argues, which gives them a competitive edge in gaining a foothold in those new markets.

By all accounts then, Taiwan’s SMEs are transforming themselves from passive to proactive players, projecting themselves into new overseas markets.

Case Study 1: Formosa Tools Co., Ltd.

Sculpting Their Own Garden

Formosa Tools Co., Ltd, based in Jhanghua County, Taiwan, had its “Formosa” brand recognized at the end of March as one of the “Taiwan Top 10 Global Brands.” It is one of those SMEs taking new steps to expand its operations overseas. The company has been loading equipment and materials from its 20,000 square-meter factory into containers and shipping them to Thai Binh province in northern Vietnam, where it hopes to open a new factory in early May to coincide with the company’s traditionally slow sales period from April to August. The first phase of the project consists of a 50,000 square-meter plant that will generate annual sales of an estimated US$30 million, a total that would equal Formosa Tool’s current sales and make it the largest Taiwanese business in northern Vietnam.

Eschewing trading companies and contract manufacturing, Formosa Tools general manager Tony Hsu has targeted large retailers to gain traction in overseas markets.

Founded in 1974, Formosa Tools is Asia’s most prominent garden tools manufacturer and was the first such Taiwanese enterprise to set up offices and distribution warehouses in Europe and the United States.

“They insist on staying away from trading companies and rejecting OEM business. They develop their own products and target big markets and large chain retailers as their prime marketing channels,” observed Walter Yeh, Taiwan External Trade Development Council’s executive vice president.

In its early days, Formosa Tools built its business on sickles. To develop a marketing strategy, company chairman Hsu Chin-tun traveled to Europe, the U.S. and Japan and discovered that the garden tools in these consumer markets were all made by domestic suppliers. None came from Taiwan, and no trading companies seemed interested. Formosa Tools decided to dedicate itself to manufacturing, and had a large, well known trading company handle export sales. Before long, however, the trading company took the products Formosa Tools was designing and had them made at lower prices to improve their margins.

The resilient Hsu absorbed the blow and from that point on refused to rely on trading companies to promote overseas sales. Formosa Tools, with a big production volume and NT$100 million in sales, decided to rely on itself to gain footholds in markets abroad.

Hsu wanted to attack the world’s biggest market ?w the United States ?w and traveled to Los Angeles to set up an office with eight employees and a distribution warehouse. To make the most efficient use of time, he bought three Panasonic fax machines, which then in the early 1980s each cost tens of thousands of Taiwan dollars. After visiting countless stores and exhibitions, “my father handed to me at least 200 name cards from potential customers in the U.S. alone,” recalls Formosa Tools general manager Tony Hsu.

Going Directly to Big Retailers

The turning point in Formosa Tools’ efforts to sell directly to the U.S. came when it hooked up with K-Mart. In 1986, with the Taiwan dollar appreciating rapidly, trading companies were unable to meet K-Mart’s price points, and Formosa Tools stepped into the void.

“It really wasn’t worth it for us to ship, but my father said without any hesitation that if the trading companies couldn’t fill the orders, we would. Four months later, we delivered on schedule to K-Mart,” Tony Hsu recalls.

After that, Formosa Tools took over all of K-Mart’s direct orders for garden tools.

“At the time, the profit margin was nearly 50%. For every item we sold, we were earning another one,” the younger Hsu remembered.

With trading companies no longer marking up its sales prices, Formosa Tools had a competitive pricing advantage. But with the rise of China, cutthroat competition over manufacturing costs and sales prices erupted. Relying on its track record with K-Mart, Formosa Tools began to directly approach big distributors.

Aside from the “Formosa” brand of his father’s era, Tony Hsu developed another brand called “Garden Pals” that also targeted the U.S. market. To differentiate the two brands, Formosa Tools invested 3 percent to 5 percent of its sales annually on research and development, coming up with new materials and functions for their products. They imported specialty steel from Japan, hoping it would create added value.

“If you go to their showroom, you will see a really diversified product line,” observes Hai-ping Tsui, deputy director of the Metal Industries Research & Development Center’s Regional R&D Service Department.

Soon, however, Tony Hsu discovered that companies that focused only on honing their manufacturing processes would always be playing catch-up. He needed to find a way to gain insight into customers’ needs if he wanted to grab opportunities before others did.

“You have to assume you are a department of the customer’s company and have to come up with a solution,” says Tony Hsu, demonstrating a service attitude rarely seen in traditional industries.

Changing their focus away from manufacturing and adopting integrated service concepts opened another boom period for Formosa Tools.

In its show room, Formosa Tools displays an innovative and diversified product line that has benefited from yearly expenditures of 3-5 percent of the company’s revenues on research and development.

‘Wal-Mart Hero’

The younger Hsu, in his early 30s at the time, was Formosa Tools’ “U.S. representative.” His presence there coincided with the rise of Wal-Mart in the 1990s, a development that led to the consolidation of America’s retail sector. Wal-Mart found itself attracted to Hsu’s approach of tailoring solutions to customers that included price point, marketing, and point-of-purchase display elements.

Hsu came up with a unique garden tool display concept tailored for Wal-Mart called the “Pretty Damn Quick (PDQ) display” that revolutionized how garden tools were presented in U.S. stores. Hsu became a “Wal-Mart hero.” The retailing giant, which had only been buying three products from Formosa Tools, immediately took on 40 items, with annual purchases soaring from US$3 million to more than US$10 million.

“At that time, we took away about half of the business of Wal-Mart’s other garden tool suppliers,” Hsu says.

Formosa Tools had established a model for penetrating new markets, setting up new branches and directly targeting retailers with tailored solutions. Hsu copied that model in attacking the European market, setting up a logistics center in the Netherlands, and even a distribution warehouse in Australia.

“But you can’t copy your sales strategy in different markets. Salesmen need to do their homework. They have to understand the markets’ needs even more than the customers’ buyers,” Hsu says, again stressing his proactive nature that has allowed him and his company to continue to seize the initiative in their business dealings.

Case Study 2: Kung Lung Batteries Industrial Co., Ltd.

‘Wild Chicken’ Theory Wins New Market

Twelve years ago, many shareholders opposed the decision by Kung Lung Batteries chairman Y.M. Lee and his son Lee Jui-hsun to establish a plant in Vietnam. Today, they can’t believe their eyes.

With many catching “Vietnam fever” in recent years, Kung Lung Batteries has become a hot “Vietnam-concept stock.” Its consolidated revenues in 2006 totaled NT$1.33 billion, a three-year high, and its EPS (earnings per share) rose five-fold. Kung Lung Batteries is one of the three biggest lead acid battery manufacturers in both Taiwan and Vietnam.

Kung Lung has already transformed its headquarters in the Nangang Industrial Park in Nantou County into its research and development center. During a recent visit by reporters, the production lines there were busy making sealed lead acid batteries for the world’s largest uninterruptible power supply company in the world, APC (American Power Conversion). More than four types of products were being assembled on the two production lines ?w all with different specs.

“I deliberately followed an unorthodox road,” Lee laughs.

Lee got his start in business exporting sweaters, but in 1990 decided to join with a friend who worked in a battery factory to launch Kung Lung, which was to specialize in the production of lead acid batteries. At the time, the automotive market was Taiwan’s biggest and most lucrative for lead acid batteries, but it was already dominated by Taiwan Yuasa Battery Co., Ztong Yee Industrial Co., and other companies affiliated with Japan. With little opportunity to gain a share of the Taiwanese automotive aftermarket, Kung Lung targeted export sales. Lee deliberately avoided the product lines of the big suppliers and ended up specializing in products the large manufacturers ignored, such as lead acid batteries for scooters and electric-powered carts. He also took on customers’ special orders and, as a result, now has a product line of over 400 items.

A late entrant to the Taiwanese market, Kung Lung Batteries chairman Y.M. Lee developed products and markets that were ignored by others in the industry, forging a path of profits for his company.

Lee’s unorthodox road enabled the small-scale Kung Lung to earn a surprising 100 percent return on capital annually after being in business for just a few years. But he also understood that the lead acid battery sector was mature technologically, and regardless of his company’s efficiency, the profit margins would always be limited. So he took advantage of his company’s profitability, sufficient capital and steady export sales to carve out new markets on his own.

In 1995, Lee tagged along with the management of Sanyang Industry Co., Ltd. on a trip to Vietnam. When he saw the streets of Ho Chi Minh City full of motorbikes, he was astonished. It was as though he had discovered a new continent.

“In Ho Chi Minh City alone, there are 2 million motorbikes, and 4 million in the country. As long as I could get 20 percent of the market, that would be enough to keep the company in business.” Lee had found the balm to soothe all his anxieties.

At that time, most of the world’s lead acid battery makers were flocking to China to set up plants, lured by the 13 percent tax rebate offered by the Beijing government. Nobody considered Vietnam, except for Lee, who calmly followed through on the “wild chicken theory” he espoused.

“China has a market of 1.3 billion people but it’s turned into a bloodbath. It’s like a turkey ?w big but not easy to raise. Vietnam is like a wild chicken ?w small but easy to nurture.”

Attacking Virgin Territory

Lee’s strategy in attacking Vietnam’s virgin lead acid battery market would change the way Kung Lung Batteries normally did business. Instead of continuing on with its model of operating as a contract manufacturer and exporting its production, the company decided to develop a brand for new markets and establish outlets to meet domestic demand levels.

Lee sent his son, Lee Jui-hsun, to Vietnam to develop this new frontier. For Lee Jui-hsun, who had just finished his studies in Britain, Vietnam was quite a culture shock.

“It took me three days to fly from London to Vietnam. The feeling I had when I got off the plane was that I had returned to Taiwan’s countryside decades earlier. There was no road lighting at night,” recollects the son, who is now the general manager of Kung Lung’s Vietnam operation, Le Long Vietnam Co., Ltd.

Lee Jui-hsun’s apprenticeship got off to a rough start. He was having trouble selling batteries imported from Taiwan, racking up sales of only 800 batteries a month.

“The shareholders were bashing us, wondering if we hadn’t lost our minds in going into Vietnam,” Lee Jui-hsun recalls. With Kung Lung in Taiwan earning a 100 percent return on capital annually, the Vietnam operation was seen as the “prodigal son of the business.”

Not long after, Lee Jui-hsun faced an even bigger challenge. Unfamiliar with the local legal code, Kung Lung had neglected to get its trademark approved, and then its invoices and accounting records ran into problems. Adding to the younger Lee’s woes were a language and communications barrier, and a strike in the plant caused by a dispute over when New Year’s bonuses were to be issued.

“In six months, our factory was closed by the authorities three times. It was a real loss of face,” Lee Jui-hsun admits. But he persevered, and vowed he would not return to Taiwan as long as the Vietnam operation remained unsuccessful.

To turn things around, Lee Jui-hsun decided to go local. He hired local salespeople to penetrate the market and became familiar with Vietnamese regulations to stay out of legal trouble. He followed his staff around to gain a better understanding of local needs and customs, and tweaked his product pricing and presentation accordingly, even paying close attention to the colors on the company’s packaging.

“In Vietnam, when you raise the price, people buy a lot more. When the price falls, fewer people buy. The logic is different, and if you don’t get a first-hand look at the market, you’ll never understand,” says Lee Jui-hsun, who eventually led his sales team into two Vietnamese cities and firmly established the Kung Lung subsidiary as the top foreign lead acid battery supplier in the market.

Kung Lung in 2006 had consolidated sales of NT$1.33 billion, becoming one of the three biggest lead acid battery manufactures in both Taiwan and Vietnam.

“Kung Lung entering Vietnam is like when the Japanese-backed Taiwan Yuasa Battery entered the Taiwan market. It soon became the leading lead acid battery brand in most people’s minds,” one analyst observes.

Although international lead prices have increased five-fold over the past two years, diluting Kung Lung’s profits, its move to Vietnam is now looking much better after China last year ended its tax rebate for lead acid batteries. The company’s operations in Vietnam are growing by the day, with a staff that is now seven times larger than its counterpart in Taiwan. The factory expansion undertaken less than two years ago is already running at full capacity.

“Strategy is really important. When facing competition from other countries, if you choose the wrong market, you can fail very quickly,” says the younger Lee, who now returns to Taiwan once a month, having successfully learned the tricks of the trade in a market that nearly defeated him.

Translated from the Chinese by Luke Sabatier