[ Trade & Products > Market ] 

The Components Industry Meeting the Global Imperative

Korea's components and material industry is diffuse, typically small- or medium scaled and of a sub-contractor nature. To survive, the industry must adapt to a new era of global competition fueled by e-commerce

The National Agricultural Cooperative Federation in September of 1999 filed for an investigation on losses sustained by domestic garlic farmers as a result of cheap imports from China. The Ministry of Finance and Economy (MOFE) in November of that year tentatively raised the customs duties on frozen garlic from China from 30 percent to 315 percent. Korea later referred the matter to the World Trade Organization (WTO) and held working-level negotiations with China to receive compensation but both sides failed to narrow their differences. China, in response, suspended imports of Korean cellular phones and polyethylene products in May of 2000.

This action immediately threw Korean manufacturers of components used in cellular phones into serious financial difficulties. When the dispute was finally resolved, the component manufacturers gave a sigh of relief but are still uneasy about such an occurrence happening again. Had the Korean component manufacturers diversified their client base by cultivating overseas markets instead of being so heavily dependent on domestic purchasers, they would not have had such anxieties.

This incident exemplifies the very nature of the Korean component  and material industry. Manufacturers are typically small-scaled and rely on short-run orders of a broad range of products. They are also dependent on large, vertically integrated companies. Consequently, their ability to survive independently is weak, hampering their efforts to act internationally.

Furthermore, e-commerce is spurring the trend toward global components sourcing. Global competition has become fierce in the supply of components with the result  that large corporate buyers can no longer guarantee their small domestic suppliers any continuity of orders. In addition, in the wake of the recent wave of restructuring among large companies through sell-offs and mergers, many small-scaled manufacturers of components and materials are on the verge of going out of business. Korea's components and material manufacturers are thus at the point of having to rethink their strategy to survive in this new environment.

The Korean components and material industry can be characterized as follows.

First, the companies are very small in size. Small-sized companies with less than 50 employees account for the bulk of the industry. In the case of machinery components, 93.7 percent of the companies are small-scaled companies with less than  50 employees, 89.7 percent in the case of automobile parts and 78.9 percent in the case of electronic components. Since the companies are small and lacking in independent technological capability, most  concentrate on the production of mediocre, low-value added components for domestic use. The companies thus have difficulty in meeting global sourcing demands.

Secondly, a vertical business relationship exists between components and material suppliers and the manufacturers of completed products. As there are few manufacturers of completed products, the relationship is often monopolistic. In the automobile industry, for example, some 55 percent of suppliers face a monopolistic situation with their contracting company. As a result, the influence of the contractors is all pervading, not only in the settlement of bills but also such matters as the agreed unit costs. The component manufacturers, for their part, rely entirely on business from the contractor and feel no incentive to develop overseas markets. As a result, the industry is focused on domestic consumption rather than exports.

Third, the technological capabilities of the domestic component manufacturers, in general, lag far behind those in advanced nations. Some categories of electronic component suppliers do have world  level technology but this is not the case in the fields of automobiles and general machinery. For example, automobile assembly and processing technologies are almost 80 percent of the Japanese level but new product design and development is only 50 percent that of Japan. The situation is even more grave for the general machinery industry. The industry rates that its technology is 30 to 60 percent of the Japanese level.

The current status of the domestic component industry is best represented by the following point of view. In the summer of 1999, UCLA professor Kenichi Omae stirred controversy by stating that ".. the growth of the Korean economy will be limited by its heavy dependence on the buying power of the United States and Japanese markets."

One of the reasons for this gloomy prognosis cited by Professor Omae is the feebleness of the Korean components industry. He pointed out that Korean companies avoid the production of components that require considerable time and effort to develop and instead take the relatively easier route of producing semiconductors and cellular phones. Professor Omae noted that if such trends continue, Korean component manufacturers would no longer be able to survive in the face of foreign competition.

A look at the cellular phone industry, which has emerged as one of the two leading producers of exports along with that of semiconductors, points to the justification of Professor Omae's criticism. With the exception of some parts such  as memory and LCD, more than half of the components purchased in Korea for final assembly purposes, ranging from batteries to sound components are of foreign origin. More than half the 1,500 components used in highly functional personal computers, including CPUs, are foreign made, while the import dependency rate of DVD players and industrial robots ranks between  70 percent and 80 percent.

Also, the localization rate of components supplied to domestic client industries tends to be low. That for cellular phone components stands at 20 percent; that for mobile communications terminals, 47 percent; computers, 51 percent; and digital cameras, 45 percent. As a result, the higher exports go, the higher too go imports of associated components and materials. In other words, nearly half the components and materials required by exports have to be imported.

As most high value-added components are heavily dependent on imports for their manufacture, the trade deficit in the parts, material and machinery industries (excluding semiconductors) exceeded the entire trade deficit up to 1997. Since 1998 a surplus has been run in these areas of the current account, but is presumed to be largely due to reduced demand for imports and it remains to be seen whether this trend will continue.

Overall Trend in Trade: An Industry in Surplus but with Severe Sectoral Disparities

Korean component exports in 1999 reached $42.76 billion. Imports amounted to $32.58 billion producing a trade surplus of $10.18 billion. This surplus was vital in helping the Korean economy to overcome the financial crisis that forced the nation to turn to the International Monetary Fund for standby assistance in late 1997. Furthermore, total Korean exports grew by an annual average of 9.4 percent from 1992 throughout 1999 while the component industry grew rapidly by 15.6 percent annually. Component industry exports, which accounted for 20.2 percent of total overseas shipments in 1992, grew by a remarkable 29.8 percent in 1999.

Despite such growth, however, not all the component industry developed equally. In the case of the electrical and electronic industry, exports reached $38.8 million in 1999, accounting for some 91 percent of total component industry exports. It is no exaggeration to say that this sector has played a decisive role  in the trend of Korean component exports. Exports of auto parts and general machinery parts together totaled $2 billion, the two sectors undergoing two completely different stages of development. In the case of auto parts, exports grew on average by 22.4 percent annually, representing the most robust export trend among the three sectors while exports of machinery parts increased by 8.2 percent over the same period, a rate below that of Korean exports in general.

The three sectors are following completely different developmental paths even as they produce trade balances. Despite being among the nation's core industries, the surplus produced by the electrical and electronic parts sector has stagnated. Auto parts, meanwhile, has been in surplus since 1997 thanks to a boom in exports. However, as the shrinking and eventual elimination of the deficit are largely due to plummeting imports of machinery parts, there is some legitimate doubt as to whether the industry has truly overcome the conditions that led into chronic deficit.

Korea's largest trading partner in components during 1999 was the U.S. Components worth $10.89 million were exported to the U.S. in that year, accounting for one-fourth of all component exports. Imports amounted to $9.75 billion, for a trade surplus of $1.14 billion.

Although Japan is Korea's second-largest components customer, Japanese imports exceeded exports to that market. Exports to Japan in 1999 amounted  to $4.33 billion but imports were more than double that at $9.73 billion. In fact, the components trade deficit of $5.39 billion accounted for 64.5 percent of the total $8.29 billion trade deficit with Japan. Korea has a trade deficit with Japan in all of the three main component sectors. The electrical and electronic industry, Korea's prime export-generating business, also runs a deficit with Japan. Korean exports to Japan account for 10 percent of the nation's total component exports. Meanwhile, imports of Japanese components accounted for 30 percent of the total. In particular, the dependency of the auto industry on Japan is illustrated by the fact that 44 percent of auto part imports originated from that source.

The relative competitiveness of Korean products can be gauged by the Trade Specialization Index TSI, (see box below). The TSI measures the degree to which a country "specializes" in importing or exporting a particular product or whether its trade in balance.

The domestic component industry registered a TSI of 0.14 in 1999, indicating a state of balance in imports and exports. When considering that its TSI stood at 0.01 in 1992, it is apparent that a sustained improvement has been achieved.

The TSI for electrical and electronic parts rose slightly to 0.17 in 1999 from 0.14 in 1992. This improvement, however, is minimal compared with other products. This is the result of a rapid increase in imports prompted by an equally rapid increase in exports of communications devices such as cellular phones and computers. The continued decline in semiconductor prices also dampened the improvement in TSI.      

TSI analysis reveals that trade in automobile components is undergoing a dramatic switch from import to export predominance. Machinery parts, too, showed continued improvements in 1999 although the sector has failed to overcome conditions of import predominance. However, when considering that the economic crisis was not yet fully over in 1999, it is difficult to foresee that such improvement will continue.

Trends by Sector

Electronic and Electrical Parts:
The Key Industry in Korean External Trade

The electrical and electronic parts sector is the key element within the national industrial structure. The main Korean export item of semiconductors falls under this category as well as a range of other products with world-class competitive edge including TFT-LCDs.

Korea's electronic and electric parts industry in 1999 achieved $38.7 billion in exports and imported $27.6 billion worth of parts. The positive trade balance of $11.1 billion, exceeded the $10.8 billion surplus of the entire component industry. It also accounts for 45  percent of the entire 1999-trade  surplus of $24.5 billion. Meanwhile, the ratio of electronic and electrical parts in Korean exports grew to 26.9 percent in 1999 from 18.0 percent in 1992.

Korean exports of electrical and electronic parts originated from specific sectors in 1999. Electronic parts (excluding semiconductors), computer peripherals, and semiconductors accounted for 93.3 percent of electrical and electronic component exports. The trade surplus in electronic components and computer peripherals amounted to $11.65 billion, again exceeding the total trade surplus of US$11.14 billion in electronic and electrical parts. The surplus garnered in this field compensated for deficits in other sectors.

The boom in the production and exports of components for wireless and wire communications devices reflects the worldwide revolution in telecommunications, and accounts for the most rapid growth among the electrical and electronic component category. The trend has become even more marked recently.

In the case of components for wired communications devices, exports increased by 18.5 percent on average annually from 1992 to 1999, while imports grew by 24.9 percent. Imports and exports of components for wireless communications devices both grew by an annual average rate of 22 percent. One-fourth of all exports of this product group were destined for the U.S. In addition, exports to the major centers of cellular phone production such as Brazil and China have become extremely robust.

Imports of both wireless and wire communications devices, meanwhile, reached $1.26 billion in 1999. Some 70 percent of imports, amounting  to $890 million, originated from Japan and the U.S. In fact, the TSI in wireless communications device trade with Japan stood at -0.92 in 1999, an almost perfect state of import specialization.

Exports of peripheral devices  of computers have undergone a rapid increase thanks to bullish PC markets in the advanced economies. Exports in 1999 reached  $8.27 billion, an increase of 77  percent over the previous year. Meanwhile, imports of computer peripherals reached $2.87 billion. Within this group, cathode ray tubes terminals, which accounted for 90 percent of all computer peripheral exports, were off significantly from their peak of 1991. On the other hand, optical disk drive exports as well as other memory and display devices have risen rapidly.

CD-ROM drives account for the bulk of optical disk drive exports while DVD drives are emerging in importance. No exports of DVD drives were recorded until 1998 but in 1999 the total leapt to $120 million. CRTs, meanwhile, form the dominant item in data display exports.

Electronic parts exports amounted to $28 billion in 1999, and imports, $21.8 billion. Semiconductors ac-counted for half the total exports of electronic parts while exports of LCD devices showed a phenomenal rise. Semiconductors dominated trade in electronic parts. Semicon exports accounted for 64 percent of all exports of electronic parts while semiconductor imports accounted for 73 percent of all imports within this group.

As evidenced by the rising TSI for LCD devices and electronic tubes, their competitive edge is improving. Despite the trade surplus in semiconductors, though, the TSI for this group has recently faltered. This is because the price for DRAM semiconductors, the Korean semicon industry's key product continues to fall. At the same time the industry still relies on overseas markets for non-memory semiconductors. While accounting for the major portion of world semiconductor demand, it is an area in which Korea is not strongly competitive.             

Automobile Parts:
A Trade Surplus Industry Since 1997

As is the case with other component manufacturers, small and medium-sized companies constitute the bulk of the auto parts industry. The average number of companies specializing in a particular component is 4.1 on average compared to 2.3 in Japan. Evidently, there is much room for streamlining in the industry.

In particular, there is a high level of dependency through the industry on a single client, a situation characterized by the very often highly personal relationships between contracting companies and suppliers and which handicaps their ability and incentive to look overseas for alternate markets.

Korea's trade balance in auto parts was in a chronic state of deficit until 1996 when it shifted into the black  in 1997. Korean exports of auto parts reached $2.02 billion in 1999 and imports, $1.14 billion, marking a trade surplus of approximately $880 million. The large surplus is attributed to two factors: the decline in imports in the aftermath of the financial crisis and the sluggish domestic economy prompting the industry to increase exports.

In general, Korean auto parts exports are particularly robust in the fields of road wheels, braking devices, radiators, mufflers and exhaust pipes. Meanwhile, leading imports include gearboxes, air bags, driving wheels and safety devices.

Korea's major trading partners are Japan and the U.S. but exports are strong to Uzbekistan, Poland and Indonesia where the Korean auto industry has established plants to build completed cars. The industrialized economies are the main importers of Korean auto parts, but of rising importance are the nascent auto industries of Mexico and India.

It is predicted that the Korean auto parts industry will face ever-fiercer competition in the future. This is because auto industry consolidation and restructuring is not taking place solely in Korea but worldwide. As a result, the trend toward monopoly demand is expected to continue. Increased global sourcing by large-scaled auto parts purchasers such as Delphi and Visteon may help the Korean industry make gains but only through meeting the challenge of foreign competition. Major GM parts supplier Delphi has introduced a B2B auction system, which enables bidding by component makers scattered across the world to take place simultaneously. The impact of the auctioning process will undoubtedly act to lower sourcing costs.

Delphi's move comes as Ford, GM and Chrysler are set to launch a B2B site specializing in auto parts, indicating the role e-commerce is likely to take in the auto parts industry.

Machinery Components:
A Long Way to Go

In common with other areas of the industry, general machinery component manufacturers are mostly small- to medium-sized companies making parts to order for final assemblers. Manufacturers often lack the marketing ability to operate independently and although their manufacturing and processing technology has progressed markedly, their capability in design and pneumatics lags advanced nation-level

.

In a market where quality counts way more than price, the Korean industry faces severe handicaps in gaining overseas acceptance.

Machinery part exports amounted to $2.1 billion in 1999, with no sign of them matching their historic peak recorded in 1995. Imports dropped significantly during the economic crisis of 1998 to 1999. However, it is difficult to conclude that the industry has escaped the conditions that have held it chronic deficit even though the trade deficit for this product group has contracted recently.

The prime export items in the machinery components field in 1999 were components for construction and mining machinery ($260 million) and mechanical elements including valves and bearings ($600 million).

With the exception of components for refrigeration, construction and mining equipment, all trade in machinery components is in deficit. Trade in virtually all products with Japan is in a state of import specialization. By region, the U.S. and China are the largest Korean export markets for machinery components, while the most important sources of imports are Japan and the U.S. Following the abolition of the Import Diversification Program (IDP) in June of 1999, a virtual barrier to imports of a range of Japanese products including machining centers and numerically controlled horizontal racks, imports of machinery components are likely to increase even further.

As facility life cycles are expected to shrink with the introduction of progressively more advanced technology, the size of the world market is expected to expand from $1.6 trillion in 1997 to $2.4 trillion in 2008. In particular, the trend toward factory automation is projected to boost the mechatronics market from $93 billion in 1997 to $224 billion in 2008.

To make headway in the world market for machinery components, the domestic industry is thus obliged to focus on building capacity in mechatronics. Specific fields include CNC (Computerized Numerical Control) machinery, CAD/CAM (Computer Aided Design and Manufacture), PLC (Programmable Logic Controllers). After establishing a recognized competence in these areas, the industry will be positioned to advance into highly sophisticated production systems such as CIM (Computer Integrated Manufacturing) and IMS (Intelligent Manufacturing Systems).

To initiate this process the Korean government will select those companies with the greatest potential   to foster them to the position of leading companies to enable them to survive and compete in the   age of global parts sourcing. Concomitantly, government efforts to raise the technological standards within the industry will be strengthened. For example, plasma and  vacuum technology is now only 30 percent to 40 percent of advanced- economy level.

Bigger and Better:
The Key to Competitiveness

"In order to survive in the age of borderless competition, component manufacturers need, first of all, to change their way of thinking,?pointed out Sun-Wook Kim, president of the new venture enterprise, Ness Corp., an electronic part company which produces capacitors, batteries and displays. ?e must also develop products that can win recognition not only at home but also abroad and then aggressively market them."

Such changes in the industrial environment pose a both a challenge and an opportunity for domestic component and material manufacturers.  "In order for the world's leading final-assembly industries to maintain their competitive edge, they need the necessary products and this can only be achieved by globally outsourcing their components. It's this approach that will enable them to make inroads into new markets," notes Gapseong Noh, president of Paion Co., an ASIC company now competing internationally.

However, present conditions threaten the very existence of large sections of the component and materials industry.

For example, demand for digital and one-chip components are on the rise while product life cycles are becoming shorter. Companies that do not have the capacity to develop new products will thus be forced out of the market.

The global sourcing strategy of the final-assembly industries is based  on lowering input component prices. Suppliers that are not price-competitive will rapidly find their flow of new contracts drying up, no matter how long their business relationship with their contracting company might be. E-commerce has served to spur the process of globalization and foreign component manufacturers are now eyeing the Korean market. Perspectives among domestic component manufacturers, according to observers, remain calcified despite the rapid changes in the industry paradigm with the consequence many are content to simply sell on price.

Experts have pointed out that in order to improve the position of the domestic component industry, the industry itself, together with government and associated organizations must establish coping strategies and pursue them in a consistent manner.

In fact, legislation has been passed to provide the legal grounds for systematic industry support via taxation benefits and incentives to cultivate the necessary capital and human resources. The medium-term aim of such a program would be to address the trade deficit in capital goods through fostering the independent supply of materials within the next five years. Longer term, i.e., over the next ten years, the goal is to create within Korea a platform for the worldwide supply of highly sophisticated high value-added components. The government also plans to re-orient the vertical organization of the industry, which fosters dependency on the larger corporations by boosting the self-reliance of individual manufacturers.

"Component manufacturers without core technologies are always at risk, no matter how big their sales," notes Jong-Kook Kim, president of SYS Hightech. Mr. Kim's company is the only one in Korea to have developed the high voltage electrical discharge system (HVPS) core technology. A key element in copying machines and laser printers, the business machine industry was previously 100-percent dependent on Japan for HVPS technology. SYS Hightech achieved HVPS localization with just seven employees. At that time, the company had no credibility with the local OA industry, but a technical transfer arrangement with Mitsubishi of Japan enabled SYS Hightech to  jointly develop printer components

Mr. Kim, who experienced first-hand how the lack of core technology can handicap small-sized component makers, said that most Korean component manufacturers are merely the subsidiaries of major corporations. He added that no matter how many items a company may produce, once the person in charge of purchasing at the contracting company changes, "All bets are off."

Planning to Win Confidence

In order for the components and materials industry to survive in the era of global competition, the government believes that the component and material companies must become specialized and bigger. The government is considering financial and taxation measures to support merger and acquisition among industry players, and at the same time, provide financial assistance for industry wide standardization  projects. In this context, the government plans to select star component/material suppliers with large growth potential in the five key areas of automobiles, electronics, machinery, chemicals and metals. The  government will designate next-generation technologies to be developed by each company. Through financial assistance for technological development and tax benefits, it will aim to nurture them to the position of world leaders in their respective fields.

As it is vital to win the confidence of the market at an early stage when new products are developed, the government is considering establishing a credibility evaluation center and introducing an assurance system for products that have undergone evaluation.

Han-Suh Park, president of DnC Tech, the world's first company to develop MP3 encoder chips, remembers the cold response he encountered from domestic companies when the product was first developed. He recalls that the fortunes  of his company revived when Microsoft took notice of the product at the 1999 Fall Comdex. As a matter of course, potential purchasers reject newly developed venture products out of hand without even testing their market viability. It is therefore, of the utmost importance for the domestic final-assembly companies to be willing to assess new products.

In order for the domestic component and material industry to gain world-class competitiveness, it is also necessary to attract advanced-nation technology, capital and management techniques. In this regard, Korea's world-class and highly effective programs to lure foreign investors should come to the fore. They include complexes exclusively for the use of foreign companies, the designation of special-benefit Foreign Investment Zones (FIZs) at investors' requests and the provision of low-cost land. Assistance is also provided for funding and the cultivation of human resources.

Furthermore, in order to overcome the limits on Korean research and development resources and to fully capitalize on existing technology and human capability, it is vital to  conduct joint research in the international area and form strategic technological alliances. To this end, a cooperative system should be established among government-sponsored, corporate and foreign research institutes together with certification organizations to jointly develop advanced quality and certification procedures as well as highly sophisticated technology.

The Korean components and materials industry, despite its size must reorient itself to cope with the challenges posed by e-commerce and global sourcing. While the challenges may seem large the  government has the resources and the will to achieve the same success it has with other industries. Also, from a historic perspective, this is an industry that is essentially still in  its infancy.

Updated January 3rd 2001, By Byung-Kwon Kim
( byungkk@kotra.or.kr )