21COE, University of Tokyo

MMRC Discussion Paper No. 48

MMRC
DISCUSSION PAPER SERIES

MMRC-F-48

Architecture-based Advantage
of Firms and Nations:
New Global Alliance between Japan andCatch-up Countries
Manufacturing Management Research Center
Koichi Ogawa
Graduate School of Economics, University of Tokyo
Junjiro Shintaku
Manufacturing Management Research Center
Tetsuo Yoshimoto
September 2005

21COE, University of Tokyo

MMRC Discussion Paper No. 48

Architecture-based Advantage of Firms andNations:
New Global Alliance between Japan andCatch-up Countries
Manufacturing Management Research Center
Koichi Ogawa
Graduate School of Economics, University of Tokyo
Junjiro Shintaku
Manufacturing Management Research Center
Tetsuo Yoshimoto

September 2005

Abstract
Competitive advantage of Japanese firms and of catch-up countries’ firms has been discussed
through the case study on optical storage products. The dynamic change of product architecturefrom integral to modular mode has brought out the latent potential of catch-up countries. The more
modular the architecture is, the larger the market shares of catch-up countries’ firms and thesmaller the market share of Japanese firms are. The analysis shows that the competitive
advantage/disadvantage of the catch-up countries’ firms depends not on the direct labor cost but on
the overhead cost, in which the patent royalty accounts for the most portions. Based on thecontrastive position in the product architecture and in the patent royalty, authors propose that Japanand the catch-up countries promote the architecture-based global alliance for symbiotic
co-prosperity, in which the power of integral architecture and of modular architecture are combined
into one joint venture company.
Keywords: competitive advantage, comparative advantage, product architecture, technology
diffusion, catch-up country, Chinese firm, global alliance, patent royalty, intellectual property,
1Ogawa, Shintaku, Yoshimoto
optical storage, CD, DVD.

1. Introduction
The aim of this paper is to analyze empirically the competitive advantage of Japanese firms and ofcatch-up countries’ firms, and to propose a new global alliance model between Japan and thecatch-up countries. The product architecture theory first appeared in US and Japan as a powerful tool
to analyze the competitive advantage of firms and has even been applyed to the comparativeadvantage of nations. US firms have been successful in the modular architecture products such as
computers and digital networks, while Japanese firms have been successful in the integral
architecture products such as automobiles, key parts/components, and key materials. According to theindustry analysis by Fujimoto and Shintaku (2005), Chinese firms have been and will continue to bevery competitive in the modular products.
The dynamic change of product architecture from integral to modular mode has been
accelerated by the innovation of micro-processor and microcode technology, and this dynamicchange has brought out the latent power of catch-up countries. However, they faced the following
three problems: (1) heavy legal claims for patent royalty from advanced countries, (2) many products
were less value-added products which are made of costly key parts imported from advanced countries,and (3) labor cost is not a key factor of the competitive advantage. These are typical trade conflicts
between catch-up countries and developed countries which we can see many examples in our history,
and will always come to the surface as a firm in a catch-up country becomes conspicuous bycompetitive products in the market.
In this paper, the authors introduce first the architecture-based analysis of optical storage
products and then take the Chinese DVD player as an example to compare empirically thecompetitive advantage of Japanese firms and the catch-up countries’ firms. Based on comparative
analysis, the authors propose a new type of global alliance for symbiotic co-prosperity model
between Japan and the catch-up countries.

2. What is Product Architecture
Product architecture is a basic design concept for the product and can be classified into two basic
types: modular architecture and integral architecture. A distinctive feature of the modular architecture
includes “open design rule”, “open standard”, “low barriers to entry”, and “less interdependency
among components”. The typical examples of modular products are bicycle, PC, packaged software,2Architecture-based Advantage of Firms and Nations

cellular phone, Dynamic-RAM, CD-ROM, VCD, and DVD player. A distinctive feature of theintegral architecture includes “closed design rule”, “closed or de-fact standard”, “high barriers toentry”, and “strong interdependency among components”, which are represented by passenger car,backup tape drive, DVD-RAM, CPU, optical pickup, magnetic head, printer head and so on. Fromthe management aspect, it can also be defined that the modular architecture is a very powerful designconcept to make a profit by cost reduction and volume production in a global environment, while theintegral architecture concept will create a high gross margin because the philosophy of the design isto restrict many of the technologies, the intellectual properties, and know-how within the product.
Figure 1 shows a “smile curve” analysis of the DVD industry: Japanese firms have been very
Figure 1. Smile-curve Analysis of Product Position

Added Value

IntegralIntegralJapanese Firms

Movie Contents(US & EU Firms)

Market Share of Japanese Firm
-Patent/License >80%
-Key Module/Material> 80%-Manufacturing Equipment>70%

Branded Media/Recorder(Japanese Firms)

In DVD market-OPU>95%-LD/Lens>99%-Injection Molding>70%-Polycarbonate>70%-Dye material > 80%

Korea+ China/Taiwan Firms
Modular

OEM Drive/Player（Korean &Chinese/Taiwanese Firms）

Assembling/
Manufacturing

Source: Interview with the industry, 2004.

Figure 2. Architecture-based Position of DVD Drive
Integral

Modular
DVD Player DVD-ROM

DVD+R/RW

DVD-R/RW

DVD±Ｒ／ＲＷ

DVD-RAM

Major Player Change (as of 4Q/2004)
Japanese to

Chinese firms

Japanese to
Taiwanese/Korean firms

Japanese firms havebeen top players

Market Growth(ＤＶＤ±Ｒ/ＲＷ）

1998
DVD Player
DVD-ROM

ＳｕｐｅｒＭｕｌｔｉ（DVD-R/RW)（±R/RW)+RAM
DVD-RAM（ＤＶＤ＋Ｒ／ＲＷ）

Time since market opening

3

Ogawa, Shintaku, Yoshimoto

competitive in the domain of key materials, key parts, and branded products, while
Chinese/Taiwanese firms are very strong in low-cost assemble/manufacturing and non-branded OEM
and/or ODM products. Among various kinds of DVD drives, Chinese firms have very large market
share in DVD video player because it is a typical modular product, while Japanese firms have large
market share in the DVD-RAM and the super-multi DVD drive as is shown in Figure 2 because it is
a comparatively integral product. According to the authors’ analysis on the DVD industry, it has beenconcluded that the more modular the architecture is, the larger the market share ofChinese/Taiwanese firms is and the smaller the market share of Japanese firms is.

3. Modular Architecture Drives Market Growth and New Entrants from
Catch-up Countries
The product architecture of CD and DVD drive was initially integral mode when they first appearedin the market, and then changed to modular mode in a process of market development and volume
production (Ogawa, 2005). Engineers should have integral technological knowledge such as focusing
and tracking of optical pickup and reading/writing a variety of media in order to develop the newconcept of the products. These integral technologies are based on long term R&D investment andcollaboration among experienced engineers.
According to our investigation, the innovation of micro-processor (MPU) and micro-code
technology has radically changed the architecture from the integral to the modular mode. The
digital-servo technology of CD-ROM drive and the write strategy of CD-R drive are typicalexamples of such innovation. The chipset of the digital servo and the software package of the write
strategy have been available in the Asian-Pacific market since 1994 and 1998 respectively. These twotechnologies have played critical roles for the modularization and provided new business opportunity
for catch-up firms, such as Samsung and LG in Korea, and BenQ and Lite-On in Taiwan in the
mid-1990s. They could go into the CD-ROM/CD-R drive business because they can buy themodularized key components like software package and/or LSI chipset that contain the sophisticatedintegral technologies inside.
Because the modularization of the drive technology reduced interdependency between key
technologies/key parts and most of them became available in the market, even catch-up firms who
did not have deep background of optical storage technology, could manufacture CD-ROM/CD-R
drives in the mid-1990s. This is one of the major reasons why Korean and Chinese/Taiwanese firms
have quickly become top players in the world-wide CD and DVD market in a few years. It is said
4Architecture-based Advantage of Firms and Nations

that more than 50 firms in Taiwan, Hong Kong, and Korea had entered into CD-ROM business since
1994 and had developed a huge market in the PC environment as is shown in Figure 3.
The radical effect of modularization in the PC industry of US in the 1980s, has also been
observed in the CD and DVD industry of Asian-Pacific arena in the mid-1990s. The change of

Figure 3. Market Expansion after Product-architecture Change
in Computer Market Environment
N ew 5 0+ firm s in
A sian-P acific A rena

1 2 0
Volume Shipment (million)

1 0 0
8 0

C D -R O M D rive
D igital Servoin 1 99 4

6 0

CD -R D rive
W rite Strategy
in 1998

4 0
2 0
0

1 s t

3 rd

5 th

7 th

9 th

CD-R O M :1991, 0.88 m illion un it/year
CD -R ;
19 96 , 0.9 2 m illion un it/year

Sources: TSR (2004) and authors’ interview with Giga-Stream Inc. and opticalstorage industry, 2004.

Figure 4. Effect of Product-architecture Change on Market Share by Country
120

Ｉｎｔｅｇｒａｌ Ｍｏｄｅ

Modular Mode

100
Market Share (%)

80

Japanese +EU’s Firms
CD-ROM Drive60
CD-R/RW Drive

40
20

China/Taiwan + Korean Firms

0
91/'95

92/'96

93/'97

94/'98

95/'9996/'0097/'01

98/'0299/'03

Product-architecture change of
CD-R/RW by Write Strategy in 1998
CD-ROM by Digital Servo in 1994

Source: Authors’ interview with Giga-Stream and optical storage industry, 2004.

5

Ogawa, Shintaku, Yoshimotoproduct architecture to the modular mode has brought out the latent power of the catch-up countries.
The modular architecture was very powerful to popularize the CD and DVD product not only in
US/EU/Japan but also in BRICs’ (Brazil, Russia, India, and China) countries and has grown into aworld-wide market up to over 800 million units of CD and DVD drive per year and 30 billion piecesof CD and DVD media per year in 2004. We have observed almost the same phenomenon in the PC
industry of the 1980s and the 1990s.
The architecture change from the integral to the modular mode has accelerated the technology
diffusion from front-runner countries to catch-up countries. Figure 4 shows the sudden drop of
market share of Japanese and European firms. While keeping the product architecture at the integral
mode, or until the time when the digital servo chipset and write strategy software became available in
the Asian-Pacific market, the share of CD-ROM and CD-R drive by the Japanese and European firms
have exceeded 90%. But the market share suddenly dropped after the architecture changed intomodular mode as is shown in Figure 4. It is interesting to mention that this relation between front
runner firms and catch-up firms is the same with the relation between IBM and clone PC
manufacturers such as Compaq and Dell in the late-1980s.

Figure 5. Dynamic Change of Product Architecture and Contribution to Market GrowthIntegral
CD-ROM

Product Architecture
Modular

CD-R/RW
DVD
Video/ROM

Post DVD
Writable
DVD

1998
1994

Write
Strategy

DigitalServo
Year since Shipment/Accumulated Volume

Market Growth

7~10%
Overhead ofMarket-entry Firm

13~15%
20~35%
Year since Shipment

6

Architecture-based Advantage of Firms and Nations

The transition of the market share in CD-ROM is almost the same with CD-R/RW. The similar
trend has also been observed in DVD player, DVD-ROM drive, and writable DVD drive. The trend
will be the same with HD DVD drive of post DVD. This is the power of the product architecturechange which has accelerated Japanese and European firms to withdraw from the market in most
optical storage products in the past 20 years. The relation between market growth and dynamicchange of the architecture is schematically summarized in Figure 5.
According to the authors’ investigation and analysis, the number of Japanese scientists/engineers
who have contributed to the world authorized major international symposium on optical memory
called ISOM, has been about ten times larger than that of Korean and Taiwanese. But the market
share of actual products of Japanese firms in the PC market environment has decreased to 22-23%,
while the market share of Korean and Taiwanese firms together has rapidly increased up to 77-78%
since 1994. The authors believe that it is very important for Japanese firms to understand the reason
why many of the Japanese firms who have developed almost all of the technologies, the products, theinternational standard, the new applications, and even most of the patents, have been forced towithdraw from the market when the architecture changes into the modular mode.

Figure 6. Market Share of Optical Pick-up by Country (year 2004)
JPN: 93%
Korea:
6.5%
Taiwan 0.5%

100
90

JPN:
67%
Korea: 19%
China; 10%
Taiwan: 4%

80
60

30
20
10
0

Korea
+Taiwanfor PC
PCmarket

270Million

K+C+T

Total

40

Japan

Japan
In Consumer Market

50

Japan
In Computer Market

Market share(%)

70

JPN: 75%
Korea: 13%
China; 7%
Taiwan: 5%

Korea+China+Taiwan

for Consumer
A/V market

550Million

Total
820Million

Sources: TSR (2004) and interviews with Nomura Research Institute Ltd. (NRI) and OPU
suppliers.

7

Ogawa, Shintaku, Yoshimoto

4. Sustainability of Competitive Advantage in Integral Architecture
The optical pickup (OPU) is a core component of the CD and DVD drive. The role of OPU is similar
to Intel CPU’s in PCs. The product architecture of OPU first appeared as integral mode, and remains
the same integral mode even today. The integral architecture has also enabled Japanese OPU
manufacturers to maintain over 70% market share as is shown in Figure 6. The same trend has also
been observed in many key parts/materials and manufacturing equipments in DVD products (SeeFigure 1). Even among the DVD drive families, Japanese firms have a very large market share in theslim type DVD drive and the super-multi DVD drive, because these are comparatively integral
products (See Figure 2). It can be concluded that the more integral, the larger the market share ofJapanese firms, and the smaller the market share of Chinese/Taiwanese firms (See Table 1).

Table 1. Share of Japanese Firms in Optical Storage Industry in 2003
Drive*

Optical Pickup

CD-ROM

5.25%(54.49%)

92.50%

CD-RW

5.64%(40.53%)

94.00%

DVD-ROM

10.27%(78.13%)

98.20%

DVD-W

67.60%(87.17%)

82.80%

Note*: The numbers in parentheses include share of joint venturecompanies between Japanese firms and Korean and Taiwanese firms.
Sources: TSR (2004) and field survey by authors.

5. Architecture-based Global Alliance in Asian-Pacific Arena
Figure 7 summarizes the product architecture position of Asian countries in the optical storage
industry. It should be emphasized that Japanese firms which are positioned in the domain of integral
architecture products and components cannot exist in the market without modular products ofChinese/Taiwanese and Korean firms. On the other hand, most of the modular products cannot be
manufactured nor shipped to the market without the integral components from Japanese firms. In
other words, many firms of the optical storage industry in Asian-Pacific arena have been and willcontinue to be in symbiotic business relationship.
Each country has a unique and strong position in their product architecture. Their position will
not change quickly because it originates in the business culture and the characteristics of each nation.
Based on their different unique advantages in the product architecture, Hitachi of Japan and LG
8

Architecture-based Advantage of Firms and Nations

Electronics of Korea have started a new joint venture company called HLDS in 2000 (Ogawa, 2003;
Yoshimoto, Shintaku & Ogawa, 2005). Hitachi takes charge of the integral technology and products,
while LG is responsible for the modular technology and products. In other words, the power of theintegral architecture and the power of the modular architecture have been combined into one
company (See Figure 8). Since 2003, only three years after the company started, HLDS has been
number one CD/DVD drive manufacturer in the world and has grown into a very profitable company.

Figure 7. Position of China/Taiwan, Korea and Japanin Product Architecture of CD/DVD Families
ModularIntegral

India
VCD ,Audio-CD
CD-R media, DVD Media (OEM)CD-ROM, DVD-Player
Read Only Pickup
Single DVD Recorder
CD-R/RW Drive ,Digital ChipSet
Rec-DVD Drive

Super-multi Drive
Read-only Optical Pickup
HDD DVD RecorderJapan Brand Media
Slim Drives
Analogue Chipset
Writable- Optical Pickup
MiniDisc, MO
Motor, Micro-optics
Laser, Micro-Lens, OEIC

China

Taiwan
Korea

Positionof JapanFigure 8. Hitachi-LG: Global Vertical Integration Model- - C o m b in e d p o w e r o f m o d u la r ＆ in t e g r a l a r c h it e c t u r e in t o H L D S -M o d u la rA r c h it e c t u r e
P ro d u cts

C D - R O M D r iv e
C D - R / R W , C o m b o D r iv e
D V D - P la y e r
D V D R e co rd er
D V D ± R / R W D r iv e

HLDS

D V D S u p e r - m u lt i D r iv e
S lim - t y p e D r iv e

L G E le c .G r o u p( In v e s t m e n t : 4 9 % )P a t e n t L ic e n s e

In t e g r a l
A r c h it e c t u r e
P ro d u cts

B r a n d e d M e d ia
C h ip S e t
O PU, Laser
N e x t G e n e r a t io n P r o d u c t s

F u t u r e T e c h n o lo g y

9H it a c h i G r o u p(5 1 % )Ogawa, Shintaku, Yoshimoto

6. Competitive Advantage and Vulnerability of Chinese Firms
Figure 9 shows the market growth and the rapid progress of Chinese firms in the world-wide DVD
player market. The market growth has been strongly dependant on the sales price (See Note 1). In
other words, the higher price products with better performance have been restricted to the nichemarket domain. Japanese firms have first developed most of the products and were the top players
while the product architecture was the integral mode. It was a profitable business but the market size
was very small, because the sales price was very high.

Figure 9. Rapid Progress of Chinese Firms in DVD Player Market
160

Shipment (millions of units)

140
120

Worl d-w ide
Market100

C hinese F irms

80
60
40
20
0
９７
Market Share

９８

９９

００

０１

０２

０３

０４

1998

1999

2000

2001

2002

2003

2004

Chinese Firms
Japanese Firms

95%

90%

０５
2005
(forecast)

10%

25%

40%

40%

45%

49%

75%

65%

45%

42%

31%

22%

Note: Chinese firms defined here includes joint venture companies between
Chinese and Taiwanese firms.
Sources: TSR (2004) and authors’ interview with Giga-Stream and optical storage
industry, 2005.

Figure 10. Contribution of China-made Loader to Rapid Progressof Chinese DVD Player
Market share of Chinese DVD in the World(%)

50
45
40
35
30
25
20
15
10
5
0

2004

2002

2003

2001

2000

0

20

40

60

80

Ratio of China-made Loader
10Unit in Chinese DVD Player(%)

Source: TSR (2004).

100

Architecture-based Advantage of Firms and Nations

The integral mode of the DVD player has gradually changed into the modular mode in theprocess of market development (see Figure 5). The modular mode has provided new business
opportunity for the catch-up firms like Chinese firms to join the new market, because the change into
the modular mode has accelerated technology diffusion from front-runner firms to the catch-up firms.
In the case of Chinese DVD player for example, many Chinese firms have been able to start
assembling the loader unit (see Note 2), since the product architecture has been further modularizedby combining the chipset of Taiwan and the optical pickup of Japan into simple solution-kit which
Taiwanese firms and Japanese firms have jointly provided. Figure10 shows an emblematic potential
brought out by the product architecture change, in which the China-made loader unit has greatly
contributed to the rapid progress of Chinese DVD player since the key parts have been further
modularized into the solution-kit (See Note 3).
According to authors’ investigations and interviews to the DVD industry people, Chinese firms
have not joined the DVD standardization activity nor contributed to the technology development.
However, as has been observed in Taiwanese and Korean optical storage industry since 1994, it did
not always require deep technical backgrounds for the Chinese firms to startup business of themodularized DVD product. As the modular mode advances, price of the product radically drops,
because the barriers to entry become very low and many catch-up firms can easily enter into thebusiness. The modular mode inevitably brings excessive price competition. This is one of the major
reasons why the top player has gradually been replaced by catch-up firms such as Korean firms andthen by Chinese firms. This is the power of the modular architecture.
The replacement of the top player shown in Figure 4 and Figure 9 originates in the difference ofthe total business overhead cost. In the case of DVD player for example, competitive advantage of
the Chinese firms originates in very small overhead which is estimated to be 5-7% smaller

than

Korean firms (see Note 4) and 10-20% smaller than traditional Japanese firms. With the lower retailprice and then the smaller gross margins, almost all of the Japanese firms and even Korean firms will
not be able to compete in the DVD player market. This is the reason why Japanese firms have been
forced to withdraw from the market, and Chinese firms have been pushed into top player in themarket. As can be expected from Figure 9, the Chinese firms shall soon take more than 50% of theword-wide market share. It is projected by the industry people that Chinese firms will take 80% of
the share in the DVD player market by year 2010 if the overhead is kept small as it is.
What is the vulnerability of Chinese firms? Chinese DVD industry, as a typical example of thecatch-up country-industry, has faced the following three problems:
11Ogawa, Shintaku, Yoshimoto1) heavy legal claim for patent royalty from front running countries,2) most of the value-added key parts and modules have been and will continue to be imported fromfront running countries, and3) labor cost is not and will not be a key factor of comparative advantage and/or competitive
advantage of China/Chinese firms.
It will become very difficult for Chinese firms to run the DVD business by paying all of theroyalty which have been claimed from front runner countries, because the percentage of the relative
amount of the royalty will become unreasonably higher and higher as the retail price of the DVD
player becomes lower and lower. It is a noteworthy fact that, in a case of a major DVD manufacturer
in Taiwan, the ratio of the royalty was estimated to be over 50% of the total overhead in year 2004
(Note 5) and have become almost impossible to continue the business if they would keep paying allof the claimed royalty.
It has been said that Chinese/Taiwanese firms should establish their patent claims to rank with thefront running countries, as it would be indispensable to invest in bringing up talented people in thelong run, but it would invariably increase the overhead of the firm. On the other hand, if
Chinese/Taiwanese firms would continue to pay the license fees, it also would certainly increase thetotal overhead of business operations. The Chinese/Taiwanese firms need to solve this dilemma. As it
has always been very difficult for the firm in the modular product business environment of any
country to make affordable investments in key parts development on long-term business strategy, it
has been and will be very difficult for the Chinese/Taiwanese firms to get out of the modularity trap.
This is because modular products such as VCD and DVD player have been in excessive pricecompetition and is very difficult to make profit. Even if the firms could afford to develop the key
parts by themselves, it would also definitely increase the overhead and would lose competitiveness.
Above all, if the Chinese/Taiwanese firms do not acquire the integral technology of the key parts, thelate coming catch-up countries would take over their market position by means of much smaller
overhead.
As the cost of total business operation is only a factor to win the business of the modular productsin the given market, the role of the overhead rises up out of the depth of business operation. This isbecause most of the modular products are built from almost the same key parts and/or solution-kits
which are in wide use in the market and because not only Chinese/Taiwanese firms but also Japanesefirms and Korean firms manufacture the product at factories in China. This means that the12Architecture-based Advantage of Firms and Nations

manufacturing/assemble direct costs turn out to be the same for all firms of any country.
The overhead defined here includes the patent royalty fee, long term investment for basic R&D,
key parts development, product development, market development, international standardization,
manufacturing factory/equipment, SCM, tax, and so on. As is schematically shown in Figure 11,among the overhead in the DVD business, patent royalty accounts for the most significant portion of
the product competitiveness for the catch-up countries’ firms (see Note 6), because the royalty of the
DVD is much higher than that of CD’s.
A Japanese firm called Funai Electric, a typical catch-up type firm in Japan, has started DVD
player and recorder business and has quickly joined the top runner group in the world-wide DVD
market. Funai’s products are manufactured at factories in China and directly shipped to the US
market. Its overhead is much smaller than Korean firms and even smaller than major Taiwanese
DVD manufacturers. Funai is the toughest competitor to Chinese firms (See Note 7).
The competitive advantage and the vulnerability of the Chinese firms described above are thetypical international trade conflict between catch-up countries and developed countries which we cansee many examples in our history, such as between India and England in the late 1600s and the early
1700s (Kawakatsu, 1991 and Note 8), Germany/France and England in the mid-1800s, USA andEurope in the early 1900s, and Japan and USA in the 1970s and 1980s (Shintaku, 1994). These
conflicts will always come to the surface as firms of catch-up countries become conspicuous bycompetitive products in the worldwide market and/or as the products of front running counties areforced to be banished from the market.

7. Proposal of New Global Alliance between Japan and Catch-up Countries
As has been described above, the product architecture has been gradually changed from the integral
to the modular mode and the modular mode has provided new business opportunity for the catch-up
firms to join the market. The catch-up countries’ firms has been and could be very competitive in themodular product if the overhead would be kept very small as it has been, while Japanese firms havebeen and will be competitive in the integral product because it restricts many of the technologies,
integral properties, and know-how within the products.

13

Ogawa, Shintaku, Yoshimoto

Figure 11. Product-cost and Overhead Comparisonof DVD Drive between Chinese Firm and Japanese Firm
CompetitivenessLaborCost+R&D+Transport
Cost+PublicityCost+Tax,etc

Chinese Firm

Material/Parts/Solution-Kit

Vulnerability

Royalty
Overhead

Wide Use
Available in market
CompetitivenessJapanese Firm

Royalty

Material/Parts/Solution-Kit
Overhead

Assemble Cost

Vulnerability
Basic R&D,
Standardization,
Product Development,
Market Development
Labor Cost,
Tax, SCM, Publicity
etc

at Factories in China(Almost the Same Cost)

Understanding (1) the difference of the product architecture position (see Figure 7), (2) that thepatent royalty claimed from Japanese firms accounts for the most significant portion of the overhead
for the catch-up countries’ firms (see Figure 11), (3) that most of the Japanese firms have been andwould be forced to withdraw from the market saddling with heavy deflects (see Figure 4 and Figure12), and (4) that each nation has its own strong point, authors propose that Japan and the catch-up
countries promote the architecture-based global alliance for symbiotic co-prosperity. As has been
mentioned in Section 5 of this paper, we can see a successful example of the alliance between LG of
Korea and Hitachi of Japan, in which the power of integral architecture and of modular architecture
are combined into one joint venture company called HLDS. Funai Electric, the typical catch-up typefirm in Japan, had started a joint venture company called Digitek with Mitsubishi Electric in 1999
before Funai started DVD player and recorder businesses.
It is very important for the industry of the catch-up countries to understand the reason why thepercentage of Hitachi’s investment to HLDS is 51%, and why Mitsubishi’s investment to Digitek is51%. The 51% from Hitachi means that HLDS is consolidated subsidiary company of Hitachi andthus all the patent royalty issues are automatically handled by Hitachi. It is said that the actual royalty
fee of the DVD business has been significantly decreased because Hitachi has established patentclaim to rank with other patent holders, and moreover Hitachi has many cross-licensed partner firms
in the world.

14

Architecture-based Advantage of Firms and Nations

Figure 12. Overhead-position of China/Taiwan, Korea, Japanand Direction of Profitable Business Operation

Gross Margin

o
rati
Op e

Pr o

b
fita

（D）

(C)
K or e(B)
rginaChin oss Ma
r
mG
imu
n
i
M

5%

profit

ess
usin
B
le
ＨＬＤＳ

(A)

Modular

n

for

a

r
Ope

n
atio

Jap

Integralan
Heavy deficit

Price Competition

10%

20%

30%

40%

Overhead of DVD firm

Most of the optical storage products were first developed by Japanese firms who have competitive
advantages in the integral product. However the position of the top player has been quickly replacedby catch-up firms in the process of market development and/or volume production. A very serious
problem for the Japanese firms is that the period of profitable business operation has become shorter
year by year, because speed of the architecture change from the integral to the modular mode has
become faster and faster. In these digital business environments where product architecture shift
occurs rapidly, Japanese firms need to find business partners who have strong competitiveness in themodular products, while catch-up countries’ firms need to build up closer cooperation with a partner
who has strong competitiveness in the integral products and has many essential intellectual propertiesof the product. Without moving on to a global alliance, the catch-up countries’ firms could notcontinue the business even in the modular products under the WTO environment.
We must emphasize that positive technology transfer does not mean technology leakage. From a
position of Japanese firms, the global joint venture company shown in Figure 8 means that it haschanged the business direction of Japanese firms alongside arrow (D) in Figure 12. Since 2003, only
three years after the joint venture company has started, HLDS has turned into one of the mostprofitable subsidiary companies of Hitachi group. It has been said that without moving on to thealliance, Hitachi would have been forced to withdraw from the optical storage industry. The joint
venture company between Mitsubishi Electric and Funai Electric also shows similar success story
15

Ogawa, Shintaku, Yoshimotothat Funai is exceptionally a profitable firm among the DVD suppliers in Japan because Mitsubishi
Electric is the majority (51%) among the investors and is one of the major license holders in the
DVD Forum.
According to our investigation, similar relation of symbiotic co-prosperity has been observed in
the business relation between JVC and Lite-On (2002), Philips and BenQ (2003), and Toshiba andSamsung (2004) aiming at the same success story. From a stand position of the firms of the latecoming catch-up countries like China, to start the global joint venture company with Japanese firms
will change the business direction of the firms along arrow (A) in Figure 12. Without moving on to
the architecture-based global joint venture company, most of the catch-up countries’ firms would goin the direction of arrow (B), in the same way as many of traditional Japanese, US, and European
companies have experienced. If they would pay all of the claimed royalty, the overhead cost ofalmost all the firms of the catch-up countries would become very large and will push the businessdirection alongside arrow (B) in Figure 12 (see Note 9). On the other hand, without moving on to thearchitecture-based global joint venture company, many of the Japanese firms except for the firms like
Funai (see Note 10) would be forced to withdraw from the market saddling with heavy deflects.
The concept of the symbiotic global joint venture company in the digital business environmentof the Asian-Pacific arena is inevitably required as the dynamic change of the product architecture tomodular mode occurs and as the total business overhead, in which the royalty accounts for the mostimportant portion, becomes the key factor of the competitive advantages. The authors propose thatboth Japan and the catch-up countries promote this new type of architecture-based global alliance.
These alliances will definitely contribute not only to prevent Japanese firms from withdrawing fromthe market but also to produce the cash-flow for the Japanese firms to develop new integral
technologies. Furthermore, the alliance will contribute not only to the economic growth of eachcountry but also to solve trade conflicts between Japan and the catch-up countries.

16

Architecture-based Advantage of Firms and Nations

Note 1
PCST Report (2005) by Giga-Stream referring the American CEA report which analyses the DVD
player and the DVD recorder market in USA.
Note 2Loader unit defined here includes optical pickup, disk rotation motor, traverse mechanics, andloader mechanics.
Note 3Chinese firms cannot join the writable DVD market so far, because technology of the chipset andoptical pickup is much more advanced than those of the read only DVD player, and because
Taiwanese chipset suppliers cannot provide even a single chipset nor further modularized
solution-kit to Chinese firms. Japanese chipset suppliers have learned much about the businessstrategy in the modular product business environments in the past 15 years.
Note 4The overhead of Chinese firms noted here does not include the royalty which has been claimed
from front runner countries. The percentage is estimated by the authors based on the interview
with the industry analysts and to direct interview with major DVD manufactures of Japan, Taiwan,
and Korea.
Note 5The percentage noted here is estimated based on the authors’ interview to the analysts who havebeen deeply involved in Taiwanese optical storage industry.
Note 6More than 80% of the essential patents in DVD are covered by Japanese firms (DVD Forum
http://www.dvdforum.org/forum.shtml), but not many licensers have opened the royalty fee.
According to industry analysts, total sum of the royalty claimed against Chinese firms is estimatedto be well over 10 dollars per a DVD player even though the retail price of the player in US market
has dropped to 30-50 dollars in 3Q/2005, while royalty claimed against Japanese firms is estimatedto be 2-4 dollars because the firms are major license holders in the DVD forum. Further more, thestreet price of Japanese brand DVD player is 50-80 dollars, which is 50% higher than that ofChinese brand products.
Note 7On top of the low overhead, Japanese firms like Funai Electric has a high potential to reduce the
manufacturing cost of the DVD player, that is, much lower than that of Chinese firms, because
17Ogawa, Shintaku, Yoshimoto

Funai has powerful vertical integration manufacturing system based on technologies andsophisticated production system FPS (Funai Production System) like Toyota’s, which Chinese
firms do not possess. By taking many of the added-values inside of the vertical integration, Funai
can reduce the cost in each process of the manufacturing system at the factories in China,
nonetheless.
Note 8The fur textile industry of England was forced to withdraw from the market by the mass export ofcalico (cotton) from India in the late 1600s and the early 1700s. But the withdrawal had created thetechnology-enabled industry revolution in England, where they manufactured copied calico by
newly invented spinning machine (Kawakatsu, 1991).
Note 9
According to the DVD industry people, the number for the DVD players formally reported by
Chinese firms to the licensers is much smaller than the actual shipment. Bad firms have driven out
good firms in China.
Note 10
If Japanese industry policy could encourage and bring up powerful manufacturing firms such as
Funai Electric, Orion Electric, Nidec, Minebea, Mitsumi Electric, Teac, and so on, the integral type
Japanese

firms

would

choosethese

Japanesemanufacturing

firms

as

partnersforarchitecture-based alliance. In such an alliance, Japan could control the technology diffusion morestrategically than today even while the product architecture changes to the modular mode. And if
the Japanese firms could strictly control the patent royalty, the architecture-based alliance among
the Japanese firms would take over the world-wide DVD market. According to DVD industry
people, Japanese firms have gradually become profitable even from the low price DVD player
business in US market, nonetheless, where the royalty is attached a great importance to the DVD
business. The authors believe that not only the innovation of the vertical manufacturing integration
but also strategic control of the patent royalty which have been created through the long term R&D
investment, will be the fount/source of the comparative/competitive advantage of Japan/Japanesefirms. The authors will report in another paper the new direction of Japanese manufacturing
management system of the modular product by combining the importance of the vertical
integration and of the strategic control of the patent royalty.

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Architecture-based Advantage of Firms and Nations

Reference
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Kawakatsu, H. (1991). Nihon bunmei to kindai seiyou [Japanese culture and the modern Westerns].
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Ogawa, K. (2003). The vicissitude of business architecture in optical storage industry. Akamon
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Ogawa, K. (2005). Rise and business development of optical storage industry. (MMRC Discussion
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Shintaku, J. (1994). Nihon kigyo no kyousou senryaku [Competitive strategy of Japanese Firms].
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TSR (2004). 2005 nen ban hikari disc sijo no maketingu bunseki [Marketing analysis on optical discmarket in 2005]. Tokyo: Techno Systems Research Co., Ltd. http://www.t-s-r.co.jp/e/index.htm (InJapanese)

Yoshimoto, T., Shintaku, J., & Ogawa, K. (2005). Architecture-based analysis of technology
transfer. (MMRC Discussion Paper No. 37). University of Tokyo.
http://www.ut-mmrc.jp/DP/PDF/MMRC37_2005.pdf (In Japanese)19