Chapter 1
Supporting Industries in Vietnam from the Perspective of Japanese Manufacturing Firms
Vietnam Development ForumIn early 2006, the Vietnam Development Forum (VDF) organized aseries of hearings between the Ministry of Industry (MOI) and Japanese manufacturing firms operating in Vietnam1. Through these hearings, the MOI team,which was drafting the supporting industry master plan, directly exchanged
information and views with the concerned Japanese firms.
The targeted sectors were Japanese assemblers and parts suppliers
belonging to electrical goods and electronics, motorbikes, and automobiles2.
These were important sectors for the development of supporting industries, aswell as the sectors specifically mentioned in the Japan-Vietnam Joint Initiative.
We sent letters to all Japanese FDI firms operating in Vietnam in these sectors,
which numbered 55. Among them, we were able to hear from 32 firms, which
included 15 electrical and electronics firms, 14 motorbike firms, and 9 automobile firms3. By region, 19 firms were located in the North and 13 firms werelocated in the South. In addition, we visited one Vietnamese assembler, twoVietnamese parts suppliers, and one Taiwanese parts supplier, all of which hadbusiness relations with Japanese assemblers. We also heard opinions of Japanese industrial experts.
Hearings were conducted from late February to early April 2006.
Intensive hearings were organized in the week of March 6 in the North, and inParticipants from VDF were Kenichi Ohno (project co-leader), Mai The Cuong, Ngo Duc Anh,
Junichi Mori, Pham Truong Hoang, and Kohei Mishima. Participants from MOI were Nguyen
Anh Nam (team leader), Mai Tuan Anh, Pham Gia Thuc, Pham Tung Lam, and Duong Hong
Quan.
2Hearings with Vietnamese firms and firms of other nationalities, including China, Taiwan, Korea
and EU, were conducted separately by MOI without our help.
3
These add up to 38 firms due to overlapping. Six firms supplied parts to both automobile assemblers and motorbike assemblers.
11Vietnam Development Forumthe week of March 13 in the South. Different hearing styles were used, fromformal meetings to factory visits, informal exchange and email correspondence,
to adapt to the preferences and time constraints of the companies. In semi-structured interviews, we generally inquired about the current situation of parts
localization and desired policy measures for supporting industry promotion. We
also received comments on the draft supporting industry master plan, if any. All
information was treated as confidential and no company name was to bereleased.
This report was compiled by VDF using the inputs from the interviewed firms. VDF takes full responsibility for its content. No statement or
analysis in this report should be construed as a consensus view among Japanese
FDI firms. In fact, opinions often differed among the three sectors, and evenamong firms belonging to the same sector. Arguments presented below aremajority views, or common denominators, among Japanese FDI firms operatingin Vietnam, as selected by VDF.

1. Current situation of local procurement
Vietnam’s supporting industries are relatively undeveloped. For
Japanese FDI firms in manufacturing, Vietnam’s local procurement ratio was
22.6% in 2003, while the ratios of Malaysia and Thailand were 45% or higher4.
However, the progress of local procurement differs significantly across thethree sectors studied.
The motorbike sector is most advanced in localization, with the average local procurement ratio of 75%5. This figure includes internal parts production by assemblers, sourcing from local suppliers, and sourcing from FDI suppliers in Vietnam. Although motorbike assemblers continue to stress the importance of developing supporting industries further, the degree of their localization is much higher than the other two sectors.
In the electrical and electronics sector, local procurement is rising at

According to JETRO, local procurement of the manufacturing sector in 2004 was 47.9% in Thailand, 45.0% in Malaysia, 38.3% in Indonesia, and 28.3% in the Philippines. See JETRO (2005).
5This figure was provided by a motorbike assembler during the intensive hearing week.
42

Supporting Industries in Vietnam from the Perspective of Japanese Manufacturing Firms

some FDI firms. In 2002, most consumer electronics assemblers were unable todomestically source even relatively simple plastic and metal parts. Now, however, one TV assembler reports that it is able to buy virtually all plastic parts
from (mainly FDI) suppliers in Vietnam. At present, local procurement for TVs
seems to range from 20% to 40%, depending on the producer (Mori, 2005: 28).
Similarly, a computer device producer said that it had increased its number ofdomestic suppliers from 7 in 2002 to 45 in 2006. As a result, local procurementof this firm rose from 5% in 2004 to 30–40% in 2006. However, there are otherproducers who continue to have low local procurement. One TV assembler still
maintains complete knock-down (CKD) production because imported parts arecheaper than domestic parts. Overall, the current localization level is still far
below what Japanese firms desire for attaining competitiveness. Even for manufacturers who have raised local procurement of plastic parts significantly inrecent years, finding electronics parts, molds, and metal processes such aspressing, forging, and plating, remains very difficult. An assembler of home
appliances said that it could not find any high-valued components in the domestic market. Although this firm has achieved a local procurement ratio of 70% in
terms of number of parts, its localization is only 30% in value. This implies that
localization has been concentrated in low-value parts.
As for the automobile sector, progress is slowest among the three sectors, with local procurement ratios of 5–10% (Japan Finance Corporation for
Small and Medium Enterprises [JASME], 2004). While some bulky or laborintensive parts, such as seats and wire harnesses, have been localized, mostother parts continue to be imported. Furthermore, automobile manufacturers in
Vietnam are currently beset with serious short-term problems such as secondhand car imports, a special consumption tax, and related uncertainty in thedomestic market6. These problems prevent auto-makers from making long-term
strategic plans. Compared with motorbikes, automobiles in Vietnam are at amuch lower level of demand size and development, which severely limits

6

The special consumption tax on passenger vehicles rose from 40% to 50% in January 2006, andthe import ban on second-hand passenger cars will be lifted on May 1, 2006. Domestic new car
sales in the first quarter of 2006 fell 32% compared with the same period last year due to the waitand-see attitude of consumers.

3

Vietnam Development Forumstrategic options to overcome these problems. Within the automobile sector,
trucks and buses have higher local procurement ratios than passenger cars
because the upper-structure of buses (passenger areas) and trucks (cargo storage) can be built locally by Vietnamese companies.

2. Key factors and relations for competitiveness
By the standards of Japanese manufacturing, competitiveness depends
on quality, cost and delivery (QCD). For Japanese parts producers in Vietnam,
the crucial aspects that need to be improved are cost and delivery, while quality
guarantee is taken for granted. To reduce cost and quicken delivery, a healthy
development of supporting industries is essential.
In mechanical assembly-type manufacturing, which is considered inthis report, parts cost looms large in the total production cost of final assemblers. For instance, one consumer electronics assembler said that parts accounted for 80% of the production cost while labor accounted for only 2%. Moregenerally, the parts cost usually occupies 70–90% compared with the labor costof less than 10%. Thus, cost competitiveness cannot be attained unless the cost
related to parts procurement is reduced. By importing Malaysian or Thai parts,
producers in Vietnam incur additional costs in transportation, storage and handling. Unless most parts are made in Vietnam, they cannot compete effectively
against Malaysian or Thai assemblers, who can use these parts without additional costs.
Furthermore, Japanese assemblers require high-frequency, on-time
delivery of parts in order to minimize inventory and production lead time. Normally, daily or even hourly deliveries are required. Unlike some Vietnamese
firms which hold large inventories as a safety buffer, Japanese firms always
consider inventory as a cost to be avoided as much as possible. To achieve zero
inventory, Toyota developed the Just-In-Time system (also known as the kanban system) in the 1950s, which has spread widely to other Japanese firms.
Quick and frequent delivery is impossible if parts are imported every few
months, or if it takes days to bring parts to the factory. For this reason, final
assemblers want suppliers to be located near them. One Japanese consumer
electronics company recently visited Vietnam to consider the possibility of4Supporting Industries in Vietnam from the Perspective of Japanese Manufacturing Firms

building a factory there, but gave up the idea after observing the weaknesses of
supporting industries in Vietnam.
For Vietnamese parts suppliers, on the other hand, the most crucial
aspects that must be improved are quality and delivery. Even if their parts arecheap, Japanese assemblers will never buy them unless these two factors areguaranteed. At present, there is a significant gap between Japanese assemblers
and Vietnamese suppliers regarding the acceptable standards in quality anddelivery, which will be discussed later.
Supporting industries consist of both FDI firms and Vietnamese
firms. Realistically, parts localization must begin with first attracting a large
number of FDI suppliers to Vietnam, followed by a gradual strengthening ofVietnamese suppliers. FDI firms must inevitably be a large part of supporting
industries in the early stage of Vietnam’s industrialization.
Demand size is the pre-condition for attracting FDI suppliers to Vietnam. Large demand is crucial for cost reduction and FDI attraction, which aremutually related. Without sufficient demand, parts makers cannot lower production cost (the reason will be explained below) and become competitive.
Therefore they will not invest in Vietnam. Overcoming the demand size problem must be the top priority in the development of supporting industries.
Once this problem is solved, our survey has shown that there are four
additional areas that must be enhanced in order to accelerate the growth of supporting industries: (i) high-quality industrial human resources, (ii) attractive tax
and tariff policies, (iii) stable policy environment, and (iv) overcoming theinformation and perception gaps between FDI assemblers and Vietnamese suppliers.
The basic relationship among demand size, the development of domestic suppliers (both FDI and Vietnamese), and the three elements of competitiveness is illustrated in Figure 1. Four areas that must be improved are also shown in
the figure. The remainder of this report will explain these components in detail.

3. Why demand size is important
Large demand size is crucial for supporting industries because theyrequire relatively large minimum orders to enter the market. This reflects the5Vietnam Development Forum

Figure 1. How to achieve agglomeration and competitiveness in parts industries
Stable policy
Tariff & tax
Industrial humanenvironment
policies
resources

FDI inflow,
cost reduction

Cost
FDI
Suppliers

Demandsize
Domestic demand(to assemblers)
Parts export

Three elements ofcompetitiveness

Delivery
Local
Suppliers
Quality
Overcoming
information &perception gaps

fact that, generally speaking, supporting industries are more capital-intensive
than final assembly, which tends to be highly labor-intensive. One auto parts
supplier stated that supporting industries would develop naturally even without
any promotion policy, if there was a sufficient demand.
Supporting industries such as molding, metal processing and plastic
injection require expensive machines and relatively few workers compared withassembly. Moreover, these machines are indivisible (one cannot purchase onetenth of a machine). Once machines are installed, the capital cost for the factoryis the same whether they are operated 24 hours a day and 365 days a year, or
only part of the time. Thus, the unit capital cost (total capital cost divided by the
number of products produced) declines inversely with the volume of production. For example, a factory making 600,000 plastic parts per year is likely to
enjoy efficiency while a factory producing only 2,000 parts per year can hardly
survive. That is why FDI parts makers need assurance that there is a large
demand (or there will be a large demand in the near future) before investing in
Vietnam.
This is in sharp contrast to final assembly, which relies on a large
amount of unskilled labor without any sophisticated machines. For such opera-

6Supporting Industries in Vietnam from the Perspective of Japanese Manufacturing Firms

Figure 2. Declining unit cost in supporting industries

Unit
cost

Capital-intensive

Labor-intensive

Production
volumetion, the unit cost is almost constant since there is no sunk capital cost. To double the production volume, all that is needed is to use twice as many workers,
tables, tools, and expand the factory space accordingly.
In the motorbike sector, domestic demand in Vietnam reached 2.02
million units in 2004, ranking third within Association of Southeast Asian
Nations (ASEAN) after Indonesia and Thailand7. It is normally said that many
motorbike parts suppliers begin to enter the market if the minimum orderexceeds 200,000 to 300,000 units (Mishima, 2005: 218). A domestic demand of
2 million units per year is sufficient to entice a number of FDI parts makers tocome to Vietnam and compete with each other. Indeed, motorbike assemblers
are now able to source many metal and plastic parts from both FDI and local
suppliers. However, they still import engine parts or produce them in-house.
The domestic market of consumer electrical and electronics is growing rapidly, but its absolute size remains small compared with those of other
ASEAN countries. For example, the annual sale of TVs is around 1.4 to 1.5
million sets in Vietnam, while Thai consumers buy 2.2 to 2.4 million sets per

7

The Vietnamese figure comes from the Ministry of Police and the Ministry of Industry (unpublished data). Within ASEAN, the largest motorbike market is Indonesia (3.08 million in 2003) followed by Thailand (2.11 million in 2005). See Mishima (2005), p. 215.

7

Vietnam Development Forumyear8. If exports are also included in calculating the market size, Vietnam looks
even smaller. Vietnam produced 2.2 million TV sets in 2003 (General Statistics
Office [GSO], 2005: 339)9, whereas Malaysia produced 9.9 million sets andThailand produced 6.5 million sets in 2004 (News Net Aisa [NNA], 2005: 79).
Because of the small market in Vietnam, Japanese parts makers prefer to export
parts from their existing factories in Malaysia or Thailand to Vietnam, rather
than taking the risk to invest in Vietnam. While some plastic suppliers havealready entered the Vietnamese market, there are few electronic parts suppliers
because the latter require larger minimum orders. One TV assembler said thatits sister factory in Malaysia could purchase almost 100% of the parts domestically, including electronic components, but that remained impossible in Vietnam.
Small demand size is far more serious an issue for the automobile
industry. In 2005, domestic demand for new passenger cars was about 35,000
units while Thailand produced over 1 million cars. According to one car manufacturer, a minimum order of 400,000 units is necessary to enjoy scale merit,which is roughly the market size of Indonesia or Malaysia. Despite the small
market, Japanese car makers have maintained their production facilities in Vietnam because they expected growing demand in the future in a country with apopulation of over 80 million. However, many Japanese car assemblers are disappointed that demand for new cars has been shrinking in recent years due topolicy reasons, such as the rising special consumption tax and the liberalizationof second-hand car imports. In addition, they are concerned that worsening traffic congestion and accidents may impede the healthy growth of the car market.
Moreover, without proper policy, increased traffic would cause environmental
damage, especially air pollution, as severe as in Bangkok or Jakarta.

Figures provided by a consumer electronics assembler during the intensive hearing weeks. Since
the number of TV manufacturers is almost the same in Vietnam (7 companies) and Thailand (6companies), the average market size for each assembler is smaller in Vietnam than in Thailand.
9
However, production of 2.2 million looks too large in comparison with the domestic market of
1.4–1.5 million sets (note that Vietnam exports very few TV sets).
88Supporting Industries in Vietnam from the Perspective of Japanese Manufacturing Firms

4. Possibility of export
One way to overcome the problem of small domestic demand is tofind export markets. For parts suppliers, this can be done indirectly by supplying to domestic assemblers who may export finished products in large quantity,
or directly through parts export.
In electrical and electronics, bulky finished products such as washingmachines and refrigerators may not be suitable for export, unless domestic
products are sufficiently low-cost to offset high logistics cost associated with
export. On the other hand, compact products such as computer peripherals andhi-fi stereos are normally produced in one location and distributed to the global
market. For instance, one computer device assembler in Vietnam exports 1.2
million printers per month under the privileges of being an export processing
enterprise (EPE). Another consumer electronics manufacturer, which currently
focuses on the domestic market, has a plan to convert its factory into an export
base, provided that the policy environment improves to make cost reduction
possible.
The most desired policy for cost competitiveness in electrical andelectronics is the reduction of parts tariffs to zero, or at least to a level lower
than the Common Effective Preferential Tariffs (CEPTs) on finished products(5% or less). Several consumer electronics manufacturers stated that further
tariff reduction on parts and materials was necessary for survival and preparing
brighter future plans. However, a number of the manufacturers added that, evenwith zero parts tariffs, domestically assembled finished products would still be
Figure 3. Possibility of export

9Vietnam Development Forumslightly more expensive than those produced in Malaysia or Thailand. This wasdue to the high logistics cost of having to import a large number of parts. One
consumer electronics assembler hoped to reduce such cost by rearranging theflow of imports for minimum inventory and quick delivery. This might beeffective in the short run, but increasing local procurement would be preferable
in the long run. If final assemblers expand production strongly, existing suppliers will receive larger orders, and it will be also easier to invite more FDI parts
makers to invest in Vietnam.
Another way to increase export is through direct parts export. For
this, again, it is essential that the parts in question be internationally competitive. Only those parts that satisfy the following conditions can be considered forexport. First, they must achieve cost competitiveness by using Vietnam’s comparative advantage—diligent and cheap labor—to a full extent. Second, partsand materials used in parts production must be low-cost, and their tariffs mustalso be zero or very low. Third, the product must be relatively compact andhigh-value. Fourth, there should be an efficient logistics system to minimize thefinancial and time cost of export. In sum, exportable parts must be labor-intensive, compact, and high-value. Moreover, they must be parts that do not require
strict Just-In-Time delivery. In Vietnam, wire harnesses for cars, which fit thisdescription, are now directly exported in large volume. But such parts are still
very few.
One important thing to remember is that the decision to export is notin the hands of the Japanese general director in Vietnam. The output, imports
and exports of each overseas subsidiary are part of the global strategy of Japanese multi-national companies (MNCs). They are decided by the headquarters ina way that contributes to the positioning of the entire business group in the
global value chain and production network. Cost competitiveness is absolutely
necessary to be selected by the headquarters to be an export base. Many Japanese firms in Vietnam, especially those without an EPE license, do not think thatthey currently have production cost low enough to be an export base. That is
why they urgently request a further reduction of import duties on parts andmaterials. While CEPTs on finished products became 5% or less in January
2006, many imported parts from non-ASEAN countries are still subject to Most
Favored Nation (MFN) tariffs higher than 5%. Recently, import tariffs on elec-

10Supporting Industries in Vietnam from the Perspective of Japanese Manufacturing Firms

tronic parts were lowered in response to the request of Japanese and Korean
assemblers in Vietnam, but the average parts tariff remains at 6.6%.
Similarly, when a Japanese subsidiary in Vietnam proposes to export
parts directly, such a plan must be consistent with the overall global strategy ofthe headquarters. Japanese wire harness companies initially came to Vietnam tosupply assemblers in Vietnam. They subsequently turned to export markets
because the domestic market was too small for profitability, and this re-orientation was approved by their headquarters.

5. High-quality industrial human resources
Once the demand size problem is overcome, the most crucial factor
for the long-term development of Vietnam’s manufacturing industries is thefostering of Meisters, a German term for highly skilled masters of manufacturing. In Vietnam, industrial weaknesses are often attributed to the lack of financial resources to buy modern equipment. However, the majority view among
Japanese firms is that high-quality industrial human resources are much more
important than high-tech machines. One Vietnamese firm supplying plastic
parts to Japanese and American firms remarked that highly skilled workers, not
new machines, were essential, and second-hand machines operated by goodworkers were superior to brand-new machines operated by poor workers. Similarly, a Japanese expert stated that simple assembly or routine machine operation could not generate international competitiveness, because anyone in any
country could do it. Another Japanese expert stressed the importance of professional spirit to pursue 100% product quality at all times, without stopping at
99%. According to him, this one-percent gap was the source of difference
between competitive FDI suppliers and uncompetitive local suppliers.
There are different types of Meisters contributing to various types ofmanufacturing processes. They include:• Line leaders who can manage and improve the entire production
process in a factory, rather than just one skill. In Japanese, such
workers are called tanoko (multiple-skilled workers).
• Very experienced molding engineers who can design, produce andadjust moldings for perfection, and who can feel even minute dif-11

Vietnam Development Forum

ferences of several microns with their hands.
• Super assemblers in cell production who can assemble a whole
product by themselves, and therefore can suggest the way to
improve the designs of individual parts for efficient assembly.
While the importance of human resource development is widely
talked about, the precise reason why this is so important is not well recognizedor shared. High-quality industrial human resources are essential in advancing
manufacturing beyond the levels reached by Thailand and Malaysia (“breaking
the glass ceiling”), as well as in coping effectively with the China challenge.
From the perspective of business architecture theory, Professor
Takahiro Fujimoto of Tokyo University argues that ASEAN countries, especially Thailand and Vietnam, should master integral manufacturing rather than imitating China’s modular manufacturing. Integral manufacturing requires parts to
be designed uniquely for each product, and to be mutually adjusted continuously for high performance. In contrast, modular manufacturing uses common parts
which are put together in flexible combinations to create new products quickly.
For developing countries, modular manufacturing is easer to implement but has
associated drawbacks such as oversupply, depressed prices, low profitability,
and the lack of incentive for technological improvement10.
Japan is a country of integral manufacturing, but it faces high wages
and an aging population. In 2007, many experienced workers will begin to
retire (the so-called “year 2007 problem”). Japan is desperately seeking ayoung, developing country partner in integral manufacturing but has foundnone so far. On the other hand, ASEAN countries need high skill building
beyond simple assembly in order to sustain growth and compete with China. If
Vietnam learns to become such a partner, with long-term vision and strong

10

Integral manufacturing in developing countries is an issue drawing much attention in Japanese
academic circles. It is also one of the hottest research topics at VDF in both Hanoi and Tokyo. See
Ohno, K. (2006). The Economic Development of Japan: The Path Traveled by Japan as a Developing Country. Tokyo: GRIPS (pp. 213–216), and Ohno, K. (2006). Integral Manufacturing: The
Way Forward for Vietnam, in Ohno, K. (Ed.), Industrial Policy Formulation in Thailand,
Malaysia and Japan: Lessons for Vietnamese Policy Makers. Hanoi: The Publishing House ofSocial Labour. In addition, VDF organized a symposium with Prof. Fujimoto’s research team on
July 13, 2006 in Tokyo.

12

Supporting Industries in Vietnam from the Perspective of Japanese Manufacturing Firms

Figure 4. Modular manufacturing vs. integral manufacturing
Modularmanufacturing

Integral
manufacturingPartsinterface

Parts are common and canbe used for any model

Each product has uniqueparts, specifically designed

MeritsQuick results and flexibility

Endless pursuit of quality

Demerits

No differentiation, excess
entry, low profit, lack of R&D
Institutional Openness, quick decision
requirements making, flexible outsourcing

Much energy and timeneeded to achieve results
Long-term relations, building
internal skills & knowledge

Performance

Time

Time

aspiration for high quality, Japan and Vietnam can form a strategic alliance in
integral manufacturing. In such a case, the Japanese government and business
community will surely assist Vietnam through ODA and technical assistance.
Other ASEAN countries are already asking for such help11.
To supply a large number of high-quality engineers, existing programs should be enhanced and new programs should be added through bothpublic and private efforts. The following measures were suggested by Japanesefirms and experts.
First, existing training programs should be fully utilized. For example, one molding supplier has sent five Vietnamese workers to Japan for training with the support of the Association for Overseas Technical Scholarship(AOTS), a Japanese official agency. One automobile parts supplier has sent
most of its middle-class engineers and managers to its group factories in
ASEAN under its own training program. In addition, many Japanese firms
organize internal competitions such as the QC Circle Olympics and the Skill
Olympics, in which workers belonging to the same business group in different

11

Thailand is linking up with Ota Ward of Tokyo, an area with many high-tech SMEs, to transfer
manufacturing skills. In Indonesia, Japanese FDI firms set up a new association in Jakarta tostrengthen the molding industry in February 2006.

13

Vietnam Development Forum

countries meet in one place to compete for high performance.
Second, the Vietnamese government should support training programs offered by firms. The draft of the Master Plan for the Development ofSupporting Industries in Vietnam in the Period of 2006-2015 with a Vision to2020 proposes to subsidize 50% of the cost incurred by the training activities ofindividual firms. Many Japanese firms welcomed this proposal. One company
asked for the precise definition of “training and education.” It wanted to knowwhether all types of training, both external and internal, would be supported.
Third, a system to promote and certify industrial Meisters should beestablished. Japan has Meister systems at national, prefectural (provincial), andfirm levels, which together encourage good engineers to do better and be socially recognized. For example, one of the top companies in Japan (an electronic
device manufacturer) has an internal Meister system for lens polishing, painting, and electrical wiring. Meister candidates are nominated by each department
and are classified into three ranks A, B, and C. The company then sends Aranked engineers to the Meister license offices of the central or local government. If they successfully receive Meister certificates from the government, thefirm will additionally award them with internal Meister titles and a bonus of
500,000 yen (about US$4,200). Meisters in this company are required to train
two successors for two years.
Fourth, collaborative training programs between FDI firms and local
suppliers should be encouraged. Such programs promote technical transfer tolocal firms, and provide opportunities for both sides to know each other andwork together. One of the most successful programs in collaborative training is
the Penang Skills Development Centre (PSDC) in Malaysia (Mori, 2005:
44–67). During our survey in Vietnam, many Japanese firms expressed interestin participating in such programs. They hoped that practical vocational training,
if properly conducted, would increase the supply of skilled workers and slow
down wage inflation. A number of Japanese firms said that they would send
their experienced engineers as instructors or make their equipment available forsuch training, if the government made a serious effort to initiate such programs.
Fifth, practical engineering education must be strengthened in highschools, industrial colleges, and universities. A motorbike parts supplier complained that the results of sending their workers to Japan for training were less14

Supporting Industries in Vietnam from the Perspective of Japanese Manufacturing Firms

than expected, because Vietnamese workers lacked basic skill and knowledge
for absorbing advanced technology. One computer device assembler proposedthat the government should pay more attention to basic but highly demanded
skills such as production engineering and efficient factory management, rather
than pursuing flashy words like IT, high-tech, and biotech. An electronics component producer also suggested bolstering practical skills and knowledge inmolding and pressing with precision.

6. Job hopping as an impediment to skill development
One important issue related to human resource development is job
hopping. For integral manufacturing, engineers with high skills and deep
knowledge of the production process must stay in one firm. However, Vietnamese workers who are trained by a company or have acquired some skills
often move to another company in search of higher salaries or better working
conditions. This prevents accumulation of highly specific skills and reduces
incentives for companies to train their workers. Even in labor-intensive garment
production and food processing, job hopping causes problems for personnel
management. But for supporting industries which rely on experienced engineersand expensive machines, job hopping is fatal. This phenomenon is not unique toVietnam; many developing countries report high job turnovers.
In Vietnam, several Japanese molding companies aim to establish an
integrated manufacturing system within a factory from design to marketing.
They train their workers to become full-fledged engineers who know how tomake molds from A to Z. However, their plans are often frustrated by middleclass engineers quitting without mastering high-level techniques. One Japaneseexpert criticized this trend because workers were losing the opportunity to
become excellent engineers in favor of short-term gains.
In Vietnam at present, there seem to be two macro reasons forincreased job hopping. First, an increased inflow of FDI is creating labor shortages, especially in localities where FDI is concentrated. An automobile parts
supplier in the North said that, as the industrial zone in which the company was
located was getting fully occupied, rising labor demand began to cause a highjob turnover and wage increase. The second reason is a shift in economic struc-15

Vietnam Development Forumture. In and around Ho Chi Minh City, service industries are expanding rapidly
and absorbing a large amount of the workforce. An electronic parts maker in Ho
Chi Minh City said that the average turnover of first-year employees had
increased dramatically in recent years, from less than 1% to 40–50 % at present.
However, not all firms report high job hopping. Among the firms wevisited, some said they had kept their workers successfully with very low
turnovers, even less than 1% per year. One reason seems to be location. An
automobile parts supplier in the suburbs of Hanoi explained that it was locatedin an area where labor demand had not risen very much and where most of theworkers were local, not migrant, with no intention of moving far. Another reason seems to be company policy toward employees. A plastic parts supplierdescribed its worker incentive programs, such as generous benefits, transportation allowance, and delicious lunches. Workers tend to be loyal to companies
which treat them well. The salary level is often not the decisive factor. It is necessary to study the conditions under which workers stay longer with one company, to minimize unnecessary job hopping.

7. Tariff reduction and tax incentives
The general director of a consumer electronics manufacturer statedthat tariff reduction and tax incentives were standard policy instruments for promoting supporting industries. Many firms we interviewed agreed. These measures are also widely practiced in other East Asian countries for encouraging
SMEs and supporting industries.
Many electrical and electronics firms requested that import duties onparts and components be quickly lowered preferably to zero, or at least to lessthan 5%, which was the CEPT rate for finished ASEAN products. This reduction was needed to avoid the situation of a reverse tariff structure in which tariffs on components were higher than tariffs on finished products. Otherwise,assemblers in Vietnam would lose cost competitiveness against ASEAN
imports. ASEAN imports that threaten production in Vietnam are often the
products of local subsidiaries belonging to the same Japanese business group.
From the viewpoint of the Tokyo headquarters, there is no reason to assemble
TVs and audio-visual equipment in Vietnam if such assembly incurs high parts

16

Supporting Industries in Vietnam from the Perspective of Japanese Manufacturing Firms

tariffs in addition to high logistics cost. It would be more efficient to export
them from the existing factories in Malaysia or Thailand, where local parts areavailable and production scale is large, to serve the Vietnamese market.
Tariff reduction would have two favorable effects. First, it would
enhance cost competitiveness of assemblers and could turn Vietnam into anexport base of certain finished products. Second, liberalization of parts importwould increase intra-industry parts trade and encourage Vietnam to specializein the production of certain parts to be exported globally. Advanced ASEAN
countries have already actively participated in East Asia’s production networkand found certain core components to specialize in. For example, Malaysia specializes in cathode-ray tubes (CRT) and Thailand specializes in compressors
used in air-conditioners and refrigerators.
In addition, a number of firms wanted import duties on raw materials
to be reduced. More than one parts supplier urged import tariff reduction on
high-quality industrial materials which were not produced in Vietnam. Several
metal parts suppliers complained about the recent tariff increase on cold rolled
steel from 0% to 7%, to protect the new Phu My cold rolling mill in the South.
This is forcing domestic metal users to raise their prices. The problem is thatthe quality of Phu My’s cold rolled steel is still below standard and Japanesefirms must continue to use imported cold rolled steel at a higher tariff. If the
Phu My mill improves quality and delivery speed to a level acceptable to Japanese firms, the problem may be ameliorated.
Capacity building of customs officers is also called for. Several firms
complained that common products available in Vietnam (steel pipe for construction, for example) and high-tech materials unavailable in Vietnam (raremetal precision tube for molding, for example) are charged at the same tariff
rate to protect the former. Japanese firms wanted popular products and highquality industrial materials be distinguished in the tariff schedule. In somecases, different tariffs were levied on the same product depending on the whimsof the customs official in charge. In general, customs officers do not have sufficient knowledge to distinguish and classify fundamentally different products.
Another important promotion measure is tax incentives. Preferential
tax treatment should be provided to encourage supporting industries. Thisshould be applied to both FDI and local suppliers without regard to17

Vietnam Development Forumnationality12. Corporate tax exemption and reduction, tax deduction for machinery purchases, subsidies for R&D, and the like, will accelerate investment insupporting industries. Neighboring ASEAN countries already provide such tax
incentives under well-focused national campaigns for promoting SMEs andsupporting industries.
For example, Thailand introduced preferential treatment for supporting industries in 1993–94. Targeted products and processes included molding,jigs, forging, casting, industrial tools, cutting, grinding, sintering, heat treatment, surface treatment, machining centers, electronic connectors, Ni-Cd andrechargeable batteries, and plastic engineering. Firms engaged in any of these14 activities were given the following privileges: (i) 8-year corporate tax
exemption regardless of location; (ii) 50% import tariff reduction for machinery
import for projects located in Zones 1 and 2 (inside and near Bangkok), (iii)
100% import tariff exemption for machinery import for projects located in Zone
3 (rural areas); and (iv) exclusion from foreign capital restriction by 1996
(JICA, 1995: 2-2-4).
Some Vietnamese policy makers are worried that further reduction ofparts tariffs and provision of tax incentives, proposed by FDI firms, may bringnegative results. Main concerns include: (i) a decrease in fiscal revenue; (ii)
how to promote domestic parts industries under zero tariffs; (iii) how to avoid
the situation where producers in other sectors demand similar special treatment;and (iv) the risk of Vietnamese producers being wiped out under the dominanceof FDI parts makers.
With regards to these issues, Japanese experts and firms replied asfollows. For the fiscal revenue effect, a detailed study on the long-term, indirect
impacts of tax and tariff reduction was needed. If such policies activate FDI andgrowth, the overall revenue effect might well be positive through increased
income, more traffic and port charges, income multiplier effects on other sectors, and so on. On the second issue, it was noted that financial incentives were
only one of the factors determining parts investment. As argued above, the12Equal treatment of domestic and foreign firms is one of the key requirements of the World Trade
Organization (WTO). More generally, none of the policy measures considered in this report violates WTO rules.

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Supporting Industries in Vietnam from the Perspective of Japanese Manufacturing Firms

availability of large demand and highly skilled engineers is more important.
Supporting industries can grow strongly even without protective tariffs if theseother conditions are met. Because parts industries also use parts, high parts tariffs may not promote parts industries, depending on the precise structure ofsuch tariffs.
As to the third and fourth issues, the concerns were understandable
but prioritization and natural selection were inevitable. One consumer electronics assembler felt that mobilization of resources to targeted sectors was necessary and desirable, and supporting industries, which were the base for all
machinery industries, should be recognized as a key sector that warranted special support. In addition, elimination of a large number of Vietnamese firms,
hitherto weak and protected, is inevitable under globalization. It is part of thenatural selection process for Vietnam to become more competitive. Japanesefirms expect at least some local firms to survive and grow. Almost all Japaneseassemblers hope to increase transactions with local firms to reduce cost anddiversify suppliers. For instance, one Japanese molding firm expressed interest
in increasing subcontracts with Vietnamese suppliers. Japanese firms hope tobuild a new system of cooperation and division of labor with Vietnamese firms
under an increasingly open and competitive environment. The necessary condition for this is that Vietnamese firms make serious efforts in QCD.
At present, FDI firms often criticize policies, and the government inturn complains about the lack of promised performance by FDI firms. This acrimonious relationship is harmful to the healthy development of Vietnameseindustries. To improve the situation, one Japanese expert proposed a “give-andtake” deal between the government and Japanese FDI firms, in which the former seriously improves policies in accordance with business demands while thelatter set targets for production, export, cost reduction, localization, and so on,
conditional on the implementation of good policies. The government must
understand that business performance depends on not only enterprise effort but
also many external factors, including policies, and that business targets should
not be interpreted as commitments that can lead to penalties when they are notachieved. One Japanese firm did not like this idea since the proposal sounded
like “socialist planning,” and some were similarly concerned that numerical targets might bind their businesses. However, others were open to such an idea.

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8. Unstable policy environment
Complaints about unpredictable policies are nothing new in Vietnam.
Everyone agrees that this is perhaps the most serious impediment to FDI in
Vietnam. We must emphasize this well-known weakness because it is also negatively affecting the growth of supporting industries. Policy instability has threemain features: (i) the lack of communication with businesses; (ii) ambiguity ofthe policy purpose; and (iii) sudden implementation. The Vietnamese government was sharply criticized when it suddenly enforced import quotas on motorbike parts in 2002, which caused serious damage to motorbike assemblers andsuppliers. The special consumption tax on automobiles also continues to causemuch confusion and chagrin. Japanese firms feel that the Vietnamese government has not learned much from these experiences. They are afraid that similar
problems will occur in the future.
Even when we were conducting the survey, some Japanese firms
were unable to meet us because they were engulfed in new policy-related problems which had the same features described above. Specifically, the increase inminimum wages in February 2006 caught most Japanese firms unpreparedbecause the government did not give them sufficient prior information13. Some
Japanese firms in the South suffered wildcat strikes in the wake of confusioncaused by the minimum wage hike. Some firms also criticized the requirementthat wages be raised 7% after initial training. For some workers, short-term
training is hardly enough. For example, at least a few years of training is needed
to produce good engineers. Uniform, compulsory requirement for wage
increase ignores differences among labor types.
Japanese automobile manufacturers and their suppliers were severely
hit by the announcement on the liberalization of second-hand car imports which
would start on May 1, 2006. The purpose of this policy was unclear. Some producers wondered if the government wanted them to leave Vietnam, or was justapplying pressure to reduce car prices. The explanation that used-car imports
were required for World Trade Organization (WTO) accession was not persua-

13

The minimum wages were raised from US$45 to US$55 in Hanoi and Ho Chi Minh City, fromabout US$35 to US$50 in smaller cities, and from US$31 to US$45 in the rest of the country.

20Supporting Industries in Vietnam from the Perspective of Japanese Manufacturing Firms

sive to some observers. Automobile assemblers tried to assess the long-term
impact of this policy but implementation details were not yet revealed. Meanwhile, new car sales dropped sharply in the first quarter of 2006 as consumers
waited for price decreases in May. Some production lines stopped.
There are two reasons why policy instability curbs the inflow of foreign parts producers. First, unlike big-name assemblers, most Japanese suppliers are SMEs with relatively small capital and little international experience.
They have little know-how in coping with policy uncertainty and working witha foreign government. They are extremely afraid of any failure in the factoryabroad, which may lead to the bankruptcy of the parent company. Observing
this situation, one Japanese material supplier advised the Vietnamese government to assure Japanese SMEs full support. Drafting a good supporting industry
master plan is the best way to do this.
Furthermore, unstable policy lowers the evaluation of Vietnam in theeyes of the MNC headquarters. In any Japanese corporation, the global strategy
is made at the headquarters, while a factory in Vietnam plays an assigned rolein it. Oftentimes, Japanese general directors stationed in Vietnam are very eager
to expand their factories and contribute to Vietnam’s industrialization. But theheadquarters usually does not care much about Vietnam, which is only a verysmall piece in the global business game. This gap in enthusiasm toward Vietnam is called ondosa (temperature gap), implying that the factory in Vietnam is
hot but the headquarters remains cool. General directors must get an approval
from the headquarters for expanding the factory, introducing new models,
exporting to the global market, and so on. But persuading Tokyo becomes very
difficult when the Japanese media are full of news about continuing policy
inconsistencies in Vietnam. The general director of an electrical and electronics
assembler said that he was doing everything to invite group companies to Vietnam, but he could not convince the headquarters under the present circumstances.

9. Information and perception gaps
For strengthening local capability, Vietnamese suppliers must work
together with FDI assemblers. However, two problems impede fruitful business

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cooperation between Vietnamese and FDI firms.
The first problem is the information gap. Although most FDI assemblers are desperately looking for local suppliers, they do not know where good
Vietnamese parts makers are located. Many Japanese firms use telephone directories and workers’ personal connections to look for potential suppliers. One
company said that it had to visit 100 firms to find one good supplier. All this is
too costly and time-consuming for private firms. A number of Japanese firms
noted that local suppliers did not actively approach them. Local suppliers generally do not seem to know how to build business relations with Japanese firms,
and lack the confidence to do business with them.
One way to bridge the information gap is to create a supporting industry database. Many Japanese firms said they would welcome such a database. In
fact, several organizations, including the Vietnam Chamber of Commerce andIndustry (VCCI) and Vietbig, have already produced yellow page-type databases, providing information on company names, contact addresses, and main
products14. However, a mechanical listing of hundreds and thousands of companies is not enough. FDI firms want to reduce time and cost in narrowing down
potential suppliers. This requires either explicit ranking or implicit recommendations by the database provider. Moreover, information must be accurate andupdated frequently. In most databases, listed firms are asked to update information by themselves, but it is doubtful if this can guarantee speed and objectivity.
A good database needs careful design and much commitment on the part of thedatabase provider.
The second problem is the perception gap. Even if the two sides findeach other, there is a wide gap between what Japanese firms require as minimum standards in quality, cost and delivery (QCD), and what local firms consider acceptable. The Vietnamese side complains that Japanese firms are too
fussy about little things while the Japanese side rejects local parts which they
say are below the required levels. One reason for this is that local firms have

14

VCCI’s Vietnam Business Directory is available in book form and on CD-ROM. Vietbig, a jointstock company, publishes its database in a book as well as on a website: www.yellowpages.com.
vn/index.asp. In Thailand, the Board of Investment’s Unit of Industrial Linkage Development(BUILD) is responsible for maintaining a supplier database.

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Supporting Industries in Vietnam from the Perspective of Japanese Manufacturing Firms

had little exposure to global market competition while Japanese firms are
already fiercely competing with American, European, Korean and Chinese
firms. Another important reason is that the integral manufacturing of Japanesefirms, which requires long-term cooperation and endless pursuit of perfection,is at odds with the modular manufacturing of copied products practiced by mostVietnamese firms.
Vietnamese suppliers lack knowledge of the Japanese production system. For example, they send catalogs and product samples to JETRO or Japanese assemblers and expect to receive orders from this contact. But Japanesefirms never accept such casual contacts. In the case of automobiles, designingof a new model starts at the R&D center in Japan three years prior to mass production. Parts suppliers are required to participate continuously in this designin, working closely with assemblers and other parts makers. To join this system,
Vietnamese firms must send Japanese-speaking engineers to Japan for threeconsecutive years. In the case of electronics and motorbikes, the situation is not
as rigorous as that for automobiles, but assemblers still must perform quality
tests and get an approval from the headquarters before trying new part suppliers.
One Vietnamese firm supplying key metal parts to Japanese firms
said that it took three years to become a business partner of a Japanese motorbike assembler, a process that contained different interaction phases. Other
Vietnamese firms which supply to Japanese firms echoed that it took them
about two to three years before receiving the first order. Until then, they had tosend a large number of samples, which were rejected repeatedly, forcing themto improve quality step by step. This was a very costly and frustrating process.
But once trust is built, Japanese firms teach suppliers well and assure stablebusiness relations and large orders.
Two Vietnamese firms, which have successfully built business relations with Japanese assemblers, offered three lessons for newcomers. First, thetop priority is a sincere attitude toward business. Even if a firm’s initial ability
is low, Japanese firms will provide help as long as general directors make aserious effort to learn from the Japanese firm and meet high requirements (similarly, a large Japanese computer device assembler stated that it would first lookat the attitude of the general director when choosing local suppliers). Second,23

Vietnam Development Forumeach firm should accurately assess and honestly admit its weaknesses. If local
suppliers cheat or overstate production capacity or technology, the Japaneseside will immediately find out and will never trust them again. Finally, commitment to quality is crucial. The quality problem is what FDI firms are mostafraid of because problems with quality would destroy their reputation in the
global market.

10. Industrial and safety standards
Finally, we would like to touch upon two additional issues not introduced earlier: quality and industrial standards and unavailability of raw materials.
Vietnam needs to create safety and industrial standards at least to thelevels of neighboring ASEAN countries15. The current absence of industrial andsafety standards impedes the development of supporting industries in three
ways. First, import of low-quality finished products hinders the business expansion of domestic assemblers. A consumer electronics manufacturer stated that
low-quality imported products had eroded the market of high-quality productsthat it produced. Indirectly, this also reduces local parts procurement. Second,
import of low-quality parts and components may crowd out domestic suppliers.
A tire supplier said that low-quality tires had flooded the domestic market
because Vietnam did not have a consistent standard to grade the strength oftires. Third, domestic suppliers face difficulty in establishing their own quality
standards. A Japanese motorbike parts supplier said that they followed Japan
Industrial Standards (JIS), but Vietnamese suppliers would not adopt any quality control system because they were not familiar with any system either athome or abroad.
Furthermore, the government should provide timely information on
environmental laws in developed countries, to which Vietnamese products may
be exported. For instance, the EU introduced the law on the Restriction of Haz-

15

For example, Malaysia has Jabatan Bekalan Elektrik (JBE) and Standards Industrial ResearchInstitute Malaysia Bhd (SIRIM), and Thailand has Thai Industrial Standards Institute (TISI) as
national safety standards.

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Supporting Industries in Vietnam from the Perspective of Japanese Manufacturing Firms

ardous Substances (RoHS) in January 2006, which prohibited import of products containing any of six specified substances16. Although Vietnam has not
adopted a similar environmental restriction, most FDI firms have chosen to
abide by ROHS for domestically sold products as well as exports. As a result,they now require Vietnamese parts and material producers to also follow
ROHS. However, the latter still lack the knowledge and technology to comply.
One Taiwanese motorbike parts supplier noted that it was unable to find any
local supplier of trivalent chrome, which was to replace the banned hexavalentchrome in metal plating, and therefore could not switch to the ROHS standard.

11. Unavailability of raw materials
Some assemblers and suppliers emphasized the importance of raw
material industries. As long as Vietnam relies on the imports of flat steel, plastic materials, industrial chemicals, paint, refined oil products, and so on, competitiveness in terms of cost and lead time cannot be realized against thosecountries that have these materials.
However, raw material industries are extremely capital-intensive, farmore so than the supporting industries which we have been considering. Before
investing in expensive equipment, there should be a sufficiently large industrial
demand to ensure efficient operation and low cost. According to one manufacturer of printed circuit boards (PCBs), China could invest a huge amount in thematerial industries of PCBs because it had hundreds of PCB assemblers thatused them. In Vietnam, there are only three PCB assemblers. Thus, it would
take a few decades before domestic demand for PCBs rose sufficiently to justify
producing the raw materials. Until then, tariff reduction, or even tariff exemption, on the raw materials of PCBs is the appropriate policy.

16

Cadmium, lead, hexavalent chrome, mercury, PBB, and PBDE.

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