Bill Zhang

Tuesday, October 04, 2005

Nokia’s China Ambition


Dr. Dan Steinbock, an expert on dynamic strategy, marketing, and globalization, offers an interesting account on Nokia's activities in China in the Beijing Review, vol. 28, September 29.

Steinbock is a Visiting Virtual Professor at the Department of Management and Organization, and Department of Marketing at the Helsinki School of Economics and Business Administration (HSEBA).

In February, Nokia marked its 20-year presence in China. The Finnish company’s China unit has grown from five employees in 1985 to more than 4,700 employees, focusing on global manufacturing and R&D. This represents more than 8 percent of Nokia’s workforce worldwide.

Finland is a country of 5.2 million inhabitants, and in the recent past, Chinese mobile operators have created as many subscribers on a monthly basis. Last year, Nokia’s net sales in Finland amounted to 351 million euros ($ 431.37 million), which is only about 13 percent of its sales in China.

“In 2004, Nokia not only retained, but clearly extended, its position as the No.1 player in the Chinese mobile device market,” said Jorma Ollila, Nokia Chairman and CEO. “It was also an excellent year for exports. We were again ranked the largest telecom exporter in China, a position held since 2000, with our export sales growing 56 percent year on year in 2004 to reach a record $3.3 billion.”

Last year, Nokia’s net sales in China amounted to almost 2.7 billion euros ($3.32 billion), with assets at 880 million euros ($1.1 billion).

Arduous Journey

When Nokia’s mobile operation began business in China around 1985, it faced a difficult market. As the veteran Nokian, Topi Honkavaara, arrived in Beijing to head the office, aggregate sales were less than $180,000; when he left China in the early 1990s, revenues are said to have amounted to $460 million.

Since China’s reform and opening-up began in the late 1970s, Western technology leaders have traded new technology for market access in China. Until the early 1990s, U.S. players dominated China’s mobile market. After 1989, the Americans reduced their presence or disinvested, providing a strategic opportunity for Nordic players—Nokia and Ericsson.

At about the same time, Nokia embraced its global focus strategy. As a new generation of Nokians arrived in China, the subsidiary began to expand very rapidly.

“In 1995, our annual revenues amounted to $200 million,” said Matti Vesala, chief of Nokia Networks’ production in China in 2000. “In the course of the next three years, these revenues tripled.” Despite Asia’s financial crisis, Nokia increased its investments in China.

“We Finns have always looked for free trade opportunities and tried to secure our access to our main markets,” said Martti Ahtisaari, a highly regarded international diplomat who recently mediated the peace talks between Indonesia and the Aceh rebels. As Finland’s president in 1994-2000, he facilitated the internationalization of Nokia and other Finnish firms by traveling with Finnish industry leaders to new markets. “I figured that if I didn’t help Finnish industrialists, I could not help the workers either,” he added. In China, Ahtisaari introduced Nokia’s chief Jorma Ollila to Chinese leaders.

In October 1998, Ollila visited Beijing to open Nokia’s new R&D center. In the long term, he said, China might well become Nokia’s leading geographic segment.

By then, Nokia had already manufactured half of its Chinese products in China. In Beijing, it was participating in the third generation test network. With access to the Chinese market, its Finnish suppliers, partners and other software firms soon followed suit.

Overseas Growth

In the past few years, Nokia, like other major Finnish multinationals, has grown primarily abroad, triggering some criticism in Finland. In the past, the company was “too Finnish.” In the course of its overseas expansion, it has become locally responsive. That is vital for worldwide success.

Owing to its long-term commitment, Nokia has worked to maximize growth and global competitiveness for all firms in the value chain, which it says has so far contributed to the creation of an estimated 25,000 jobs among its cooperation partners and local sub-contractors and suppliers.

Nokia credits its success in China to its strong brand, leading technology and quality products, and to enhancing the efficiency and reach of the distribution system, particularly in more rural areas.

With ever intensifying competition, Nokia has had to defend its dominance. In 2001, Chinese equipment manufacturers had less than 10 percent of the market; in 2003, this share grew to more than 50 percent! Led by Ningbo Bird and TCL, these challengers exploited the weaknesses of Western leaders, particularly in pricing and distribution.

Although known for its ability to “listen to the market,” particularly in Europe, Nokia fell behind rivals with clamshell phones in China. But it has hired more Chinese employees and learned more about the Chinese market. Last December, it also launched its 3128 clamshell models in China. By 2004, the incumbents—Nokia, Motorola, and Ericsson—reestablished their dominance, basically with their great resources and by mimicking the strategies of Chinese rivals.

Strategically, China is vital for Nokia. As a logistics hub, it plays a major part in Nokia’s global manufacturing base. Of the 15 manufacturing centers, only Finland and China have four each. Nokia deploys Beijing and Dongguan in Guangdong Province for mobile devices. The base station production in China was transferred from Beijing to Suzhou in Jiangsu Province in 2004, while the company continues to manufacture network elements for core and radio networks products in Beijing. Consolidation of base station manufacturing in China enables increased economies of scale, bringing improved operational efficiency and cost benefits.

This year, to meet growing market demand, Nokia plans to add further capacity to its manufacturing facilities in China. As far as Nokia is concerned, there is still much room for expansion in China, where mobile subscriber growth is expected to almost double over the next five years. It is driven by a strong replacement market in urban areas and more and more users in rural China gaining access to mobile communications.

Defining Moment

On August 1, Nokia moved forward with its management succession plan, electrifying the global mobile industry. Nokia’s top leadership will change, but the succession may have little impact on the company’s China strategy. Expect more of the same—and ever-increasing competition.

Ollila will continue as chairman and CEO until June 2006. Many expected Pekka Ala-Pietilä to be Ollila’s successor, but he will resign in February 2006. Olli-Pekka Kallasvuo will be appointed president and COO of Nokia as of October 1 and president and CEO effective June 2006.

As I have written in The Nokia Revolution (2001), Nokia’s mobile success was defined by the difficult strategic decisions following the boardroom shakeup in 1992. It was then that Ollila, as CEO, and Kallasvuo, as CFO, envisioned a new course for the company. They crafted the winning strategy. “We had unhappy Finnish shareholders, unhappy international shareholders. The only thing you could do is to start building a base for very meaningful stock performance,” recalled Ollila.

Ollila and Kallasvuo bet the future of the company on the mobile business while disinvesting everything else. It was a magnificent gamble.

At Nokia, China is seen as a complex operating environment, which is characterized by government influence, the emergence of local standards, regional cooperation with South Korea and Japan, and operators gaining more control of the value chain.

“The opportunities in China comprise robust market growth, 3G in horizon, availability of local talent and resources, and declining trade barriers,” explained David Ho, President of Nokia China. These opportunities are balanced by challenges, such as “domestic competition, stronger multinational competitors and government influence.”

Nokia estimates the total global mobile subscriber base, which hit 1.7 billion at the end of last year, will reach 3 billion by 2010. Of these new subscriptions, nearly one quarter are expected to be in China.

“This represents a tremendous opportunity for Nokia,” said Ollila. “Our aim is to maintain our leading position in China and to continue to grow as the most preferred partner within the Chinese mobile communications industry.”

Chinese Innovation

“We’re moving away from the business of ears to the business of eyes,” said Anssi Vanjoki, Nokia’s multimedia chief as early as in 1998. During the past decades, mobility has been synonymous with voice. Things began to change with “texting” (SMS) in the 1990s. Today, mobility means data communication—new mobile services, including rich voice and data, mobile Internet and intranets/extranets, messaging, personalized content (ultimately, mobile phone television).

In the future, Chinese innovation will play an increasingly important role in the global mobile rivalry. China is no longer important only as a market, but also as an emerging environment for innovation.

In addition to serving as a logistics hub for Nokia, China plays an increasingly important role in the company’s global R&D network. Located in Finland, Nokia Research Center (NRC) is the heart of the company’s R&D operation. It engages in open innovation, through international R&D cooperation and with universities and research institutes worldwide. NRC has two units in Finland (Helsinki and Tampere). These cooperate with four in the United States (Mountain View, San Diego, Dallas and Boston), two in Europe (Bochum and Budapest) and two in Asia-Pacific (Beijing and Tokyo).

At the end of August, Nokia opened a mobile infrastructure R&D center in Chengdu, capital city of Sichuan Province in west China. It is the company’s sixth R&D unit and the second 3G R&D center in China. It will develop mobile applications based on 3G and IP Multimedia Subsystem for both Chinese and global markets.

“Nokia is delighted to establish a new R&D center in this part of China,” said President Ho of Nokia China. “This marks another important step forward for Nokia in implementing its localization strategy.”

Nokia is committed to long-term development in China. Along with its rivals, it is also preparing for the Beijing Summer Olympics in 2008.

”Until the 1970s, Nokia was a Finnish company, in the 1980s Nokia was a Nordic company and in the beginning of the 1990s a European company,” said Ollila. ”Now, we are a global company.”

“During the next three years, I would not be surprised to see China become Nokia’s largest market in net sales terms,” Ollila announced last spring.

China, clearly, is critical to Nokia.

Sunday, October 02, 2005

Outsourcing Innovation

First came manufacturing. Now companies are farming out R&D to cut costs and get new products to market faster. Are they going too far?

As the Mediterranean sun bathed the festive cafés and shops of the Côte d'Azur town of Cannes, banners with the logos of Motorola (MOT ), Royal Philips Electronics (PHG ), palmOne (PLMO ), and Samsung fluttered from the masts of plush yachts moored in the harbor. On board, top execs hosted nonstop sales meetings during the day and champagne dinners at night to push their latest wireless gadgets. Outside the city's convention hall, carnival barkers, clowns on stilts, and vivacious models with bright red wigs lured passersby into flashy exhibits. For anyone in the telecom industry wanting to shout their achievements to the world, there was no more glamorous spot than the sprawling 3GSM World Congress in Southern France in February. Advertisement

Yet many of the most intriguing product launches in Cannes took place far from the limelight. HTC Corp., a red-hot developer of multimedia handsets, didn't even have its own booth. Instead, the Taiwanese company showed off its latest wireless devices alongside partners that sell HTC's models under their own brand names. Flextronics Corp. demonstrated several concept phones exclusively behind closed doors. And Cellon International rented a discrete three-room apartment across from the convention center to unveil its new devices to a steady stream of telecom executives. The new offerings included the C8000, featuring eye-popping software. Cradle the device to your ear and it goes into telephone mode. Peer through the viewfinder and it automatically shifts into camera mode. Hold the end of the device to your eye and it morphs into a videocam.

HTC? Flextronics? Cellon? There's a good reason these are hardly household names. The multimedia devices produced from their prototypes will end up on retail shelves under the brands of companies that don't want you to know who designs their products. Yet these and other little-known companies, with names such as Quanta Computer, Premier Imaging, Wipro Technologies (WIT ), and Compal Electronics, are fast emerging as hidden powers of the technology industry.

They are the vanguard of the next step in outsourcing -- of innovation itself. When Western corporations began selling their factories and farming out manufacturing in the '80s and '90s to boost efficiency and focus their energies, most insisted all the important research and development would remain in-house.

But that pledge is now passé. Today, the likes of Dell (DELL ), Motorola, (MOT ) and Philips are buying complete designs of some digital devices from Asian developers, tweaking them to their own specifications, and slapping on their own brand names. It's not just cell phones. Asian contract manufacturers and independent design houses have become forces in nearly every tech device, from laptops and high-definition TVs to MP3 music players and digital cameras. "Customers used to participate in design two or three years back," says Jack Hsieh, vice-president for finance at Taiwan's Premier Imaging Technology Corp., a major supplier of digital cameras to leading U.S. and Japanese brands. "But starting last year, many just take our product. Because of price competition, they have to."

While the electronics sector is furthest down this road, the search for offshore help with innovation is spreading to nearly every corner of the economy. On Feb. 8, Boeing Co. (BA ) said it is working with India's HCL Technologies to co-develop software for everything from the navigation systems and landing gear to the cockpit controls for its upcoming 7E7 Dreamliner jet. Pharmaceutical giants such as GlaxoSmithKline (GSK ) and Eli Lilly (LLY )are teaming up with Asian biotech research companies in a bid to cut the average $500 million cost of bringing a new drug to market. And Procter & Gamble Co. (PG ) says it wants half of its new product ideas to be generated from outside by 2010, compared with 20% now.

Competitive Dangers
Underlying this trend is a growing consensus that more innovation is vital -- but that current R&D spending isn't yielding enough bang for the buck. After spending years squeezing costs out of the factory floor, back office, and warehouse, CEOs are asking tough questions about their once-cloistered R&D operations: Why are so few hit products making it out of the labs into the market? How many of those pricey engineers are really creating game-changing products or technology breakthroughs? "R&D is the biggest single remaining controllable expense to work on," says Allen J. Delattre, head of Accenture Ltd.'s (ACN ) high-tech consulting practice. "Companies either will have to cut costs or increase R&D productivity."

The result is a rethinking of the structure of the modern corporation. What, specifically, has to be done in-house anymore? At a minimum, most leading Western companies are turning toward a new model of innovation, one that employs global networks of partners. These can include U.S. chipmakers, Taiwanese engineers, Indian software developers, and Chinese factories. IBM (IBM ) is even offering the smarts of its famed research labs and a new global team of 1,200 engineers to help customers develop future products using next-generation technologies. When the whole chain works in sync, there can be a dramatic leap in the speed and efficiency of product development.

The downside of getting the balance wrong, however, can be steep. Start with the danger of fostering new competitors. Motorola hired Taiwan's BenQ Corp. to design and manufacture millions of mobile phones. But then BenQ began selling phones last year in the prized China market under its own brand. That prompted Motorola to pull its contract. Another risk is that brand-name companies will lose the incentive to keep investing in new technology. "It is a slippery slope," says Boston Consulting Group Senior Vice-President Jim Andrew. "If the innovation starts residing in the suppliers, you could incrementalize yourself to the point where there isn't much left."

Such perceptions are a big reason even companies that outsource heavily refuse to discuss what hardware designs they buy from whom and impose strict confidentiality on suppliers. "It is still taboo to talk openly about outsourced design," says Forrester Research Inc. (FORR ) consultant Navi Radjou, an expert on corporate innovation.

The concerns also explain why different companies are adopting widely varying approaches to this new paradigm. Dell, for example, does little of its own design for notebook PCs, digital TVs, or other products. Hewlett-Packard Co. (HPQ ) says it contributes key technology and at least some design input to all its products but relies on outside partners to co-develop everything from servers to printers. Motorola buys complete designs for its cheapest phones but controls all of the development of high-end handsets like its hot-selling Razr. The key, execs say, is to guard some sustainable competitive advantage, whether it's control over the latest technologies, the look and feel of new products, or the customer relationship. "You have to draw a line," says Motorola CEO Edward J. Zander. At Motorola, "core intellectual property is above it, and commodity technology is below."

Wherever companies draw the line, there's no question that the demarcation between mission-critical R&D and commodity work is sliding year by year. The implications for the global economy are immense. Countries such as India and China, where wages remain low and new engineering graduates are abundant, likely will continue to be the biggest gainers in tech employment and become increasingly important suppliers of intellectual property. Some analysts even see a new global division of labor emerging: The rich West will focus on the highest levels of product creation, and all the jobs of turning concepts into actual products or services can be shipped out. Consultant Daniel H. Pink, author of the new book A Whole New Mind, argues that the "left brain" intellectual tasks that "are routine, computer-like, and can be boiled down to a spec sheet are migrating to where it is cheaper, thanks to Asia's rising economies and the miracle of cyberspace." The U.S. will remain strong in "right brain" work that entails "artistry, creativity, and empathy with the customer that requires being physically close to the market."

You can see this great divide already taking shape in global electronics. The process started in the 1990s when Taiwan emerged as the capital of PC design, largely because the critical technology was standardized, on Microsoft Corp.'s (MSFT ) operating system software and Intel Corp.'s (INTC ) microprocessor. Today, Taiwanese "original-design manufacturers" (ODMS), so named because they both design and assemble products for others, supply some 65% of the world's notebook PCs. Quanta Computer Inc. alone expects to churn out 16 million notebook PCs this year in 50 different models for buyers that include Dell, Apple Computer (AAPL ), and Sony (SNE ).

Now, Taiwanese ODMs and other outside designers are forces in nearly every digital device on the market. Of the 700 million mobile phones expected to be sold worldwide this year, up to 20% will be the work of ODMs, estimates senior analyst Adam Pick of the El Segundo (Calif.) market research firm iSuppli Corp. About 30% of digital cameras are produced by ODMs, 65% of MP3 players, and roughly 70% of personal digital assistants (PDAs). Building on their experience with PCs, they're increasingly creating recipes for their own gizmos, blending the latest advances in custom chips, specialized software, and state-of-the-art digital components. "There is a lot of great capability that has grown in Asia to develop complete products," says Doug Rasor, worldwide strategic marketing manager at chipmaker Texas Instruments Inc. TI often supplies core chips, along with rudimentary designs, and the ODMs take it from there. "They can do the system integration, the plastics, the industrial design, and the low-cost manufacturing, and they are happy to put Dell's name on it. That is a megatrend in the industry," says Rasor.

Taiwan's ODMs clearly don't regard themselves as mere job shops. Just ask the top brass at HTC, which creates and manufactures smart phones for such wireless service providers as Vodafone and Cingular as well as equipment makers it doesn't identify. "We know this kind of product category a lot better than our customers do," says HTC President Peter Chou. "We have the capability to integrate all the latest technologies. We do everything except the Microsoft operating system."

Or stop in to Quanta's headquarters in the Huaya Technology Park outside Taipei. Workers are finishing a dazzling structure the size of several football fields, with a series of wide steps leading past white columns supporting a towering Teflon-and-glass canopy. It will serve as Quanta's R&D headquarters, with thousands of engineers working on next-generation displays, digital home networking appliances, and multimedia players. This year, Quanta is doubling its engineering staff, to 7,000, and its R&D spending, to $200 million.

Why? To improve its shrinking profit margins -- and because foreign clients are demanding it. "What has changed is that more customers need us to design the whole product," says Chairman Barry Lam. For future products, in fact, "it's now difficult to get good ideas from our customers. We have to innovate ourselves."

Sweeping Overhaul
India is emerging as a heavyweight in design, too. The top players in making the country world-class in software development, including HCL and Wipro, are expected to help India boost its contract R&D revenues from $1 billion a year now to $8 billion in three years. One of Wipro's many labs is in a modest office off dusty, congested Hosur Road in Bangalore. There, 1,000 young engineers partitioned into brightly lit pods jammed with circuit boards, chips, and steel housings hunch over 26 development projects. Among them is a hands-free telephone system that attaches to the visor of a European sports car. At another pod, designers tinker with a full dashboard embedded with a satellite navigation system. Inside other Wipro labs in Bangalore, engineers are designing prototypes for everything from high-definition TVs to satellite set-top boxes.

Perhaps the most ambitious new entrant in design is Flextronics. The manufacturing behemoth already builds networking gear, printers, game consoles, and other hardware for the likes of Nortel Networks (NT ), Xerox (XRX ), HP, Motorola, and Casio Computer. But three years ago, it started losing big cell-phone and PDA orders to Taiwanese ODMs. Since then, CEO Michael E. Marks has shelled out more than $800 million on acquisitions to build a 7,000-engineer force of software, chip, telecom, and mechanical designers scattered from India and Singapore to France and Ukraine. Marks's splashiest move was to pay an estimated $30 million for frog design Inc., the pioneering Sunnyvale (Calif.) firm that helped design such Information Age icons as Apple Computer Inc.'s original Mac in 1984. So far, Flextronics has developed its own basic platforms for cell phones, routers, digital cameras, and imaging devices. His goal is to make Flextronics a low-cost, soup-to-nuts developer of consumer-electronics and tech gear.

Marks has an especially radical take on where all this is headed: He believes Western tech conglomerates are on the cusp of a sweeping overhaul of R&D that will rival the offshore shift of manufacturing. In the 1990s, companies like Flextronics "completely restructured the world's electronics manufacturing," says Marks. "Now we will completely restructure design." When you get down to it, he argues, some 80% of engineers in product development do tasks that can easily be outsourced -- like translating prototypes into workable designs, upgrading mature products, testing quality, writing user manuals, and qualifying parts vendors. What's more, most of the core technologies in today's digital gadgets are available to anyone. And circuit boards for everything from cameras to network switches are becoming simpler because more functions are embedded on semiconductors. The "really hard technology work" is migrating to chipmakers such as Texas Instruments, Qualcomm (QCOM ), Philips, Intel, and Broadcom (BRCM ), Marks says. "All electronics are on the same trajectory of becoming silicon surrounded by plastic."

Why then, Marks asks, should Nokia (NOK ), Motorola, Sony-Ericsson, Alcatel (ALA ), Siemens (SI ), Samsung, and other brand-name companies all largely duplicate one another's efforts? Why should each spend $30 million to develop a new smartphone or $200 million on a cellular base station when they can just buy the hardware designs? The ultimate result, he says: Some electronics giants will shrink their R&D forces from several thousand to a few hundred, concentrating on proprietary architecture, setting key specifications, and managing global R&D teams. "There is no doubt the product companies are going to have fewer people design stuff," Marks predicts. "It's going to get ugly."

Granted, Marks's vision is more than a tad extreme. True, despite the tech recovery, many corporate R&D budgets have been tightening. HP's R&D spending long hovered around 6% of sales, but it's down to 4.4% now. Cisco Systems' (CSCO ) R&D budget has dropped from its old average of 17% to 14.5%. The numbers also are falling at Motorola, Lucent Technologies (LU ), and Ericsson. In November, Nokia Corp. said it aims to trim R&D spending from 12.8% of sales in 2004 to under 10% by the end of 2006.

Close to the Heart
Still, most companies insist they will continue to do most of the critical design work -- and have no plans to take a meat ax to R&D. A Motorola spokesman says it plans to keep R&D spending at around 10% for the long term. Lucent says its R&D staff should remain at about 9,000, after several years of deep cuts. And while many Western companies are downsizing at home, they are boosting hiring at their own labs in India, China, and Eastern Europe. "Companies realize if they want a sustainable competitive advantage, they will not get it from outsourcing," says President Frank M. Armbrecht of the Industrial Research Institute, which tracks corporate R&D spending.

Companies also worry about the message they send investors. Outsourcing manufacturing, tech support, and back-office work makes clear financial sense. But ownership of design strikes close to the heart of a corporation's intrinsic value. If a company depends on outsiders for design, investors might ask, how much intellectual property does it really own, and how much of the profit from a hit product flows back into its own coffers, rather than being paid out in licensing fees? That's one reason Apple Computer lets the world know it develops its hit products in-house, to the point of etching "Designed by Apple in California" on the back of each iPod.

Yet some outsourcing holdouts are changing their tune. Nokia long prided itself on developing almost everything itself -- to the point of designing its own chips. No longer. Given the complexities of today's technologies and supply chains, "nobody can master it all," says Chief Technology Officer Pertti Korhonen. "You have to figure out what is core and what is context." Lucent says outsourcing some development makes sense so that its engineers can concentrate on next-generation technologies. "This frees up talent to work on new product lines," says Dave Ayers, vice-president for platforms and engineering. "Outsourcing isn't about moving jobs. It's about the flexibility to put resources in the right places at the right time."

It's also about brutal economics and the relentless demands of consumers. To get shelf space at a Best Buy (BBY ) or Circuit City often means brand-name companies need a full range of models, from a $100 point-and-shoot digital camera with 2 megapixels, say, to a $700 8-megapixel model that doubles as a videocam and is equipped with a powerful zoom lens. On top of this, superheated competition can reduce hit products to cheap commodities within months. So they must get out the door fast to earn a decent margin. "Consumer electronics have become almost like produce," says Michael E. Fawkes, senior vice-president of HP's Imaging Products Div. "They always have to be fresh."

Such pressures explain outsourcing's growing allure. Take cell phones, which are becoming akin to fashion items. Using a predesigned platform can shave 70% of development costs off a new model, estimates William S. Wong, a senior vice-president for marketing at Cellon. That can be a huge savings. As a rule of thumb, it takes around $10 million and up to 150 engineers to develop a new cell phone from scratch. If Motorola or Nokia guess wrong about the market trends a year into the future, they can lose big. So they must develop several versions.

With most of its 800 engineers in China and France, Cellon creates several basic designs each year and spreads the costs among many buyers. It also has the technical expertise to morph that basic phone into a bewildering array of models. Want a 2-megapixel camera module instead of 1-megapixel? Want to include a music player, or change the style from a gray clamshell to a flaming-red candy-bar shape? No problem: Cellon engineers can whip up a prototype, run all the tests, and get it into mass production in a Chinese factory in months.

Moving Up the Food Chain
Companies are still figuring out exactly what to outsource. PalmOne Inc.'s collaboration with Taiwan's HTC on its popular Treo 650 smart phone illustrates one approach. Palm has long hired contractors to assemble hardware from its own industrial designs. But in 2001, it decided to focus on software and shifted hardware production to Taiwanese ODMs. PalmOne designers still determine the look and feel of the product, pick key components like the display and core chips, and specify performance requirements. But HTC does much of the mechanical and electrical design. "Without a doubt, they've become a part of the innovation process," says Angel L. Mendez, senior global operations vice-president at palmOne. "It's less about outsourcing and more about the collaborative way in which design comes together." The result: PalmOne has cut months off of development times, reduced defects by 50%, and boosted gross margins by around 20%.

Hewlett-Packard, a company with such a proud history of innovation that its advertising tag line is simply "invent," also works with design partners on all the hardware it outsources. "Our strategy is now to work with global networks to leverage the best technologies on the planet," says Dick Conrad, HP's senior vice-president for global operations. According to iSuppli, HP is getting design help from Taiwan's Quanta and Hon Hai Precision for PCs, Lite-On for printers, Inventec for servers and MP3 players, and Altek for digital cameras. HP won't identify specific suppliers, but it says the strategy has brought benefits. Conrad says it now takes 60% less time to get a new concept to market. Plus, the company can "redeploy our assets and resources to higher value-added products" such as advanced printer inks and sophisticated corporate software, he says.

How far can outsourced design go? When does it get to the point where ODMs start driving truly breakthrough concepts and core technologies? It's not here yet. Distance is one barrier. "To be a successful product company requires intimacy with the customer," says Azim H. Premji, chairman of India's Wipro. "That is very hard to offshore in fast-changing markets." Another hurdle is that R&D spending by ODMs remains relatively low. Even though Premier develops most of its own cameras and video projectors, "the really core technology," such as the digital signal processors, is invented in the U.S., says vice-president Hsieh. Premier's latest wallet-size video projector, for example, was based on a rough design by Texas Instruments, developer of the core chip. With margins shrinking fast in the ODM business, however, Premier and other Taiwanese companies know they need to move up the innovation food chain to reap higher profits.

That's where Flextronics and its design acquisitions could get interesting. Inside frog's hip Sunnyvale office, designers are working to create a radically new multimedia device, for an unnamed corporate client, that won't hit the market until 2007. The plan, says Patricia Roller, frog's co-CEO, is to use Flextronics software engineers in Ukraine or India to develop innovative applications, and for Flextronics engineers to design the working prototype. Flextronics then would mass-produce the gadgets, probably in China.

Who will ultimately profit most from the outsourcing of innovation isn't clear. The early evidence suggests that today's Western titans can remain leaders by orchestrating global innovation networks. Yet if they lose their technology edge and their touch with customers, they could be tomorrow's great shrinking conglomerates. Contractors like Quanta and Flextronics that are moving up the innovation ladder, meanwhile, have a shot at joining the world's leading industrial players. What is clear is that an army of in-house engineers no longer means a company can control its fate. Instead, the winners will be those most adept at marshaling the creativity and skills of workers around the world.