Corporate leaders need courage when making decisions, none more so than when Ray Chen, the president of Taiwan-based electronics contractor Compal Electronics Inc., set his company on a course that many critics believe will have an unhappy ending.

Last year, Compal and China's leading computer brand Lenovo Group Ltd. set up a joint venture in Anhui province called Lienpal (Hefei) Ltd. in which Lenovo has a 51 percent stake and Compal a 49 percent stake. Lenovo sees Lienpal as its biggest in-house notebook design and manufacturing center.

This year in August, another major Chinese electronics brand – Huawei – came calling, hoping to "use" Compal's plant in Brazil to assemble smartphones to take advantage of tax breaks. The two sides have not ruled out cooperating more closely in the future.

The two moves left Compal as the Taiwanese electronics contractor most closely bound to Chinese brands and caused an uproar among its major rivals, especially peeved over the joint venture with Lenovo that could have major implications for them.

Other Compal customers have rebelled against the close ties between Compal and Lenovo. J.T. Wang, the chairman of Acer, one of Compal's biggest clients, was extremely unhappy over the move and threatened to cut Acer's orders to the supplier.

In fact, Lenovo previously discussed the joint venture with Wistron Corp., a major Taiwanese contractor that started out as an Acer subsidiary, but Wistron rebuffed the offer. "It took a lot of effort for us to finally split away from Acer and become a contract manufacturer in our own right. How would it be possible for us to turn back and ‘get married' to another branded vendor?" asks a senior Wistron executive.

Compal's Motivation

Chen has heard the criticism and even understands where it's coming from. "I'm not an idiot. Do they really believe I didn't think about these issues beforehand?" he told CommonWealth Magazine. "They can't get their hands on any of the grapes, so they're just calling the grapes sour."

The shrewd Chen was willing to risk offending other customers by dancing with the Chinese wolves because he had no other choice.

Compal, and Taiwan's other major contractors – Pegatron Corp., Quanta Computer Inc., Inventec Corp. and Wistron – are at heart notebook computer specialists, rising to prominence because of their ability to design and assemble notebooks cheaply at consistent quality levels.

But the rising popularity of mobile devices has eroded the market for notebooks and desktop PCs, cutting into these companies' earnings and forcing them to rethink their strategies.

The point was driven home to Chen last year, when global notebook shipments contracted for the first time in history. By October 2012, Chen was anticipating a further 10 percent decline in notebook shipments in 2013, a forecast that had Compal executives under intense pressure to find solutions.

Other contractors, such as Quanta and Wistron, have dealt with the weakening notebook market by diversifying their product lines. At Quanta, for instance, notebooks have fallen to 70 percent of the company's product mix from the previous 90 percent, with cloud computing products picking up the slack. But notebooks still account for over 80 percent of Compal's mix, the highest among the five major Taiwanese contractors.

"It's like other people have three cards in their hand. Even if two of them are no good, there's still one good one. But Compal has always had only one card to play," the vice president of one mechanical components company says of Compal's predicament.

Compal's bottom line tells the story. The company's net after-tax income in 2012 was the lowest in 10 years, an indignity that the proud Chen found hard to bear.

Instead of playing the safer move of "diversification," Chen took the riskier option of placing all his chips on his core notebook business and decided to join hands with Lenovo in pursuit of growth.

The Chinese brand is one of the few PC and notebook vendors gaining ground in an otherwise stagnant market. According to market research firm Gartner, Lenovo overtook HP as the world's largest PC company in the second quarter with a global market share 0.2 percentage points higher than its American rival.

"Ray Chen's strategy is obvious. He's placing his bets on notebook makers with growth potential," says Sean Yang, NAND flash assistant vice president at market researcher DRAMeXchange.

"When opportunity knocks, of course you have to answer the door," says Chen, who set his sights on Lenovo's strong growth in its home market. "Our (notebook) mix has remained the highest. We have no room for retreat," he admits.

Lenovo ‘Interviews' Top Compal People

Lenovo approached Compal, its supplier of 15 years, to set up Lienpal in 2011.

The timing coincided with declining notebook growth at Compal's other major customer, Acer, which was feeling the pinch of huge inventories in its Europe, Middle East and Africa operations left behind by ousted CEO Gianfranco Lanci. Chen had reserved capacity at Compal's Kunshan factory for Acer orders, but when Acer did not come through, "Compal was in bad shape. Its production lines were idle, leading Ray to declare at an investors conference that he wanted to restructure production and felt it necessary to tie Compal more closely to Lenovo," says an analyst.

Lenovo's push to set up a joint venture with Compal in Anhui was carefully evaluated, and even the choice of the city Hefei in Anhui as the new venture's site was itself significant.

Hefei has received strong support from Chinese president Xi Jinping and was where Lenovo Group chairman Yang Yuanqing went to school. It also boasts a rich pool of engineering talent from local universities. In addition, of all the major electronic appliances made in China, one-third are produced in Anhui. In selecting Hefei to be its biggest notebook manufacturing base, Lenovo also saw the potential to cultivate its own component supply chain nearby.

Motivating Lenovo to do the deal was its sense that the quickest way to learn from Taiwan's assembly expertise was to directly "use" talent from Taiwanese suppliers.

Once the partnership was confirmed, the two companies agreed that Compal would send more than 100 of its R&D engineers to Hefei to help Lienpal build manufacturing and management systems from the ground up. This group of engineers immediately became "Lienpal" people, under the management control of major shareholder Lenovo.

To ensure the "caliber" of Lienpal's workforce, Lenovo sent its own people to various Compal divisions to scout the talent available, with marketing, R&D and quality control staffers "interviewing" their Compal peers.

"There were several rounds over many days. The talks were nonstop," says one former Compal executive who was assigned to Lienpal, recalling that when the discussions were done for the day, Lenovo employees worked into the night to compile the day's findings and brief Yang.

"They (Lenovo) knew our (Compal) divisions quite well and had a clear handle on the backgrounds of our R&D engineers," the former executive says.

"Lenovo was basically conducting interviews. Even if Compal wanted to send second-tier talent, it would not have been able to. Compal was basically hemorrhaging talent," says an executive at another contractor, worried that once Lenovo builds up its strength, it will deal a major blow to all Taiwanese contractors, including Compal.

Chen rejects that argument, saying that most of the people sent to Lienpal were those who had long been responsible for handling the Lenovo account, and he insisted that the partnership will not affect the resources his company devotes to other customers.

Maybe Chen has to believe he can win because he had no other choice but to work more closely with Lenovo. The prospects for growth in notebook sales at Compal's two other major customers, Dell and Acer, were limited, and new businesses, such as making servers on a contract basis, had yet to generate clear results.

One of his competitors says, however, that it would be unwise to underestimate Chen. Not long after Compal was established, its factory nearly burned to the ground. Chen then put most of his effort into sales, with considerable success. Just as the company was finally getting back on its feet, Hewlett-Packard acquired Compaq, torpedoing Compal's sales for a full half year. Yet Chen led the company through these and other storms.

"After going into business with Lenovo, Chen did not lose even one notebook customer," says the competitor with a healthy dose of respect for Chen's abilities.

At present, nearly half of Lenovo's outsourced notebook orders have been placed with Compal, indicating that Chen is still holding his own in his dance with the wolves. But the threat remains, as seen in a report released at the 18th National People's Congress in March. The report said China should insist on following a new path of innovation with Chinese characteristics and plan and promote innovation with a global vision.

The steps it listed to achieve the goals were "introduce, digest, absorb and re-innovate," a blueprint that essentially urges Chinese companies to grab foreign technology and make it their own.

If the day should ever arrive when China fully accomplishes its national strategy of promoting independent innovation at home by gradually "introducing, digesting and absorbing" outside technology, and "the customer becomes the enemy," this would be the nightmare that every Taiwanese electronics contractor, including Ray Chen, has always fervently hoped to avoid.

For now, however, Chen believes he and Compal can come out ahead, as he expressed in an interview with CommonWealth Magazine, excerpts of which appear below.

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Q: Compal controls key contracting technology and know-how. Why then did Lenovo get a 51 percent share of Lienpal to become the controlling shareholder?

A: This market is decided by Lenovo. They decide how many orders they want to give to Lienpal, so they were the ones who became the majority shareholder. They will be running the show and (Lienpal's) financial results will appear on their consolidated statement. We will use the equity method (of accounting) and won't have to consolidate its results into our financial statements.

Q: Even though you are not the majority shareholder, you still sent Compal's elite people over there.

A: Our share is only 2 percentage points less than theirs, so it's okay. If I didn't cooperate with them at the time, they would have approached another company, and it would have taken up the opportunity.

Q: But other contractors don't seem to have a favorable view of this joint venture, because Lenovo is too dominant.

A: Let me tell you. They can't get their hands on any of the grapes, so they're just calling the grapes sour.

Q: But Lenovo's goal is to increase its in-house production to 50 percent. Are you not concerned that this will affect Compal's orders?

A: Of course I thought about that at the time. Discussions on the project had been completed, and the two parties already had letters of mutual consent. Lenovo's orders shifted to Lienpal, but the volume handled by Compal was kept stable. That's definitely a win. To us it's a big win, and to them it's a big loss. (Laughs) Lenovo is now No. 1 in the global PC market, and you absolutely have to take advantage of the opportunity. I often say that when opportunity knocks, if you don't grab it quickly, you will lose a chance for success.

Managing customers is actually quite simple. We have made notebooks for 20 years, and of all of my customers, none have ever reached the point where I lost them. The only exceptions are companies that were merged or disappeared. The strategy we follow in choosing customers is first to look at their growth potential. Second, once (we've) identified a client as a strategic customer, we go all out to support it. The more we work on the relationship, the longer it lasts. With Dell, for example, we've already worked with it for 17 or 18 years. We've also worked with HP for more than 20 years. We started cooperating with Lenovo in 1999, well before they bought the IBM personal computer group.

Q: Was there any internal debate about not focusing excessively on notebooks?

A: You still have to be focused and do things more effectively, but I do want to develop some new businesses. Now that my roots are protected, the new businesses can be developed and grow as expected. Take servers for cloud computing. We are the only one of the four major contractors that did not get involved in this field, and now we are looking for a good, experienced team to take the leap. Our strategy is to serve as a contract manufacturer for branded server vendors. We don't want to grab any of our customers' business. Preserving our core is very important. We can't hurt our core business to get a new business going. (Laughs)

Translated from the Chinese by Luke Sabatier