Taiwan’s struggle to become an innovation leader

Taiwan became a manufacturing powerhouse and the center of the world's laptop production. However, it's a challenging place to launch successful start-ups. Can it rise to the challenge?

With a population half the size of Spain's, packed into a land area one-fiftieth the size of Mexico, Taiwan still manages to produce nine out of ten of the world's laptops. So, its economic prospects must be promising, right?

Profits are actually down in the island's tech sector, competition is increasing, and consumers are starting to prefer devices made elsewhere. Taiwan urgently needs to reinvent itself. However, with a tradition of making products to order for foreign companies and a hierarchical corporate culture, a new generation of start-up innovators is facing significant challenges.

"Innovation is crucial," says Huang Deray, former director of Hsinchu Science Park, which is home to 400 high-tech companies and a world leader in semiconductor manufacturing. "To continue succeeding, you must think about the next product that will help you earn money three to four years from now, even if you have a product that is currently selling well."

Taiwan first transformed itself from a labor-intensive economy to a high-tech powerhouse in the 1980s. You might not have heard of companies like Quanta Computer, Compal Electronics, Pegatron, Wistron, and Inventec, but together they produce more than 90% of the laptops sold worldwide, including those from top brands like Apple and Dell.

Making devices at low cost for others has become less profitable, and nearby manufacturing hubs like China and Vietnam are becoming more competitive. Profit margins for the five companies mentioned have halved compared to ten years ago. Revenues for Taiwan's hi-tech sector are mostly flat, unlike the double-digit growth seen a decade ago, according to Helen Chiang, a Taipei-based market researcher at tech consultancy IDC. "It's a real crisis situation," she says.

Worldwide PC shipments dropped from 363 million in 2011 to 352 million last year, with further declines in the first half of this year. Taiwanese PC makers have turned their focus to tablets, but they don't have the same dominance in this market as they do with laptops.

Small market

Meanwhile, smartphone sales are growing quickly. HTC, Taiwan's only manufacturer and most well-known brand, was once the second-largest vendor in the US. Now, it is struggling with decreasing market share and poor sales. Its phones lack the features to compete with brands like Apple and Samsung in advanced economies, and they aren't cheap enough to compete with popular low-cost Chinese brands like Huawei and Xiaomi.

There is a growing realization in Taiwan that the future success of its technology export-dependent economy will rely on its ability to innovate. However, some industry insiders are pessimistic about its prospects due to several significant challenges.

With a population of just over 23 million, the island has a relatively small domestic market, and its companies are generally small to medium-sized, unlike the government-backed giants in some neighboring countries. Even if products sell well locally, companies may not profit if they don't succeed internationally, leading to a reluctance to take risks.

As a result, Taiwan invests less in R&D and marketing than some of its competitors. Its R&D spending has steadily increased over the last decade to $26 billion (£16.3 billion) in 2011, but that's only about half of what South Korea spends, which also focuses on exporting tech products. Additionally, Taiwan's traditional emphasis on designing and manufacturing hardware means it lacks expertise in software development, which is becoming a larger part of tech industry revenues.

Some argue that a much bigger issue is Taiwan's lack of a consumer-focused culture, due to its long history of making products marketed under the brand names of companies based elsewhere. As a result, its businesses are not accustomed to understanding consumer preferences or testing products with them.

“They’re doing a lot of innovation, but they’re doing it for themselves, not for customers,” says Jamie Lin, founder of appWorks, an incubator for start-ups in Taipei. “They start with the technology and package it in a way they think the market might like. It’s different from Silicon Valley, where they focus more on starting with market needs.”

Cultural Constraints

But perhaps the problem runs even deeper. The culture of most companies, and many would say society as a whole, seems to work against innovation. Many parents pressure their children to seek stability after education, rather than exploring and pursuing their interests. The government’s largely hands-off approach means many companies are family-owned. These companies can often be hierarchical and led by older generations who tend to favor long hours over creativity.

“The management culture has been the same since the 1980s,” says Chiang. “It has depended largely on the mentality of the person at the top. And the top managers in the hi-tech sector have mainly been the same group of people.”

These cultural constraints make it even harder for those who want to do things differently to break out of the mold. One person who has succeeded in doing so is George Chao. Until 2009, he was earning about double the average wage of a tech engineer at a company that designs integrated circuits. But the long hours—14 a day nearly every day—were hurting his health and family life, so he quit.

"It's impossible to be innovative in that atmosphere," he says. "To be creative, people need to be relaxed. When you're tired, you can only follow instructions from above."

Turning 40 motivated Chao to "do something he could call his own." Being the one in his family responsible for cleaning the many windows in their four-story home inspired him to design a window-cleaning robot called the Hobot. He has sold 20,000 of these devices in various countries and now earns more than he did in his old job, while working fewer hours.

While societal and corporate pressures do hinder innovation, the situation isn't straightforward. Last year, Taiwan's companies and individuals obtained 11,628 patents from the US Patent and Trademark Office, compared to 14,196 for South Korea, despite Taiwan's much smaller population.

Chao says there is creativity, but often of a limited kind. "Taiwan should focus more on innovation," he says. "Right now, it's mainly doing research and development, like finding ways to make integrated circuits based on specifications from overseas companies. They're not really inventing something new."

Others complain that Taiwan doesn't make things easy for start-ups. The government taxes them based on the paper value of their company. This means investments from venture capitalists are taxed even if the companies haven't made a profit yet. Bureaucracy and protectionism also make it hard for tech companies to hire foreign talent, which they need to access markets in the US, China, and Southeast Asia.

Breaking Out

On the positive side, the island has a population eager to buy the latest products, making it a good testing ground for consumer acceptance of new gadgets like netbooks and phablets. E-commerce, mobile internet, including apps and games, and internet advertising are all growing quickly.

The decline of Taiwan’s traditional hi-tech companies might actually hold the key to a solution, as more people are starting their own businesses. Mr. Lin’s tech incubator, appWorks, provides office space for about 40 start-ups. He says the number of start-ups in Taiwan has at least doubled in the past three years to several thousand.

One of the companies based at appWorks is Chocolabs, which developed an app to help people search for and watch TV shows and music videos on their smartphones. It has gained more than two million downloads.

Another is the software start-up GoodLife. Its portal gathers information on daily discounts from local restaurants, convenience stores, and other businesses. Founded in 2010, it is now among the top 130 websites in Taiwan, and its fan page has over 500,000 members. “Running a software start-up in Taiwan is tough,” says co-founder Brenda Chen. “Making money is difficult. Why do it? It feels like a dream. I felt no one was doing this, but there was a need. I really liked comparing prices to see where I could get things cheaper. I used to go on Google, search company websites, and spend a lot of time doing that. Now, I can easily find discounts and coupons.”

This kind of energy leads people like Mr. Lin to believe Taiwan can transition to an innovation-based economy. “We have a lot going for us,” he says. He and others believe the island’s strong tech manufacturing background, large talent pool, and increasingly confident and energetic start-up sector will help it overcome the challenges and obstacles ahead.