Essays on catch-up and innovation strategy of capital goods industry

Abstract

Development of the capital goods industry plays an important role in enlarging the wealth of a nation and technical progress. It is because localization of various and specialized capital goods contributes to high productivity and quality of the final goods production, and eventually it returns to high profitability of capital goods. In this perspective, we recognize that the Korean capital goods has achieved significant growth since the late 1980s and succeeded to develop virtuous circle between capital and final goods, so called “high-technology equilibrium”. More specifically, the Korean machinery and equipment industry has recorded strong growth that has been unprecedented globally, with the position of the unique country that achieved top 10 in global export share and a trade surplus at the same time in the industry. However, few studies have analyzed (1) what the primary sources of the remarkable growth are and (2) how firms in the industry can achieve sustained and successful catch-up. Furthermore, there is little understanding (3) what an innovation strategy can contribute to firm profitability in the industry after the catch-up periods. Regarding the first research question, this dissertation analyzes the total factor productivity growth (TFPG) of the industry and its 12 sub-sectors by utilizing stochastic frontier production approach. We found that the industry has achieved labor input and TP-driven productivity growth in its catch-up. More specifically, since the 1990s, the major contributor to productivity growth has been changed from scale effect (SE) to technical progress (TP). In contrast, among 12 sub-sectors, only six sub-sectors have achieved TFPG by accomplishing TP. In other six sub-sectors, we found that SE and allocation efficiency (AE) have been significant sources of achieving productivity growth. Likewise, the major contributor to productivity growth in the sub-sectors also has been changed as each sub-sector grows from initial catch-up stage to the present development. In order to explain the catch-up strategies of the firms in the industry (the second research question), this dissertation suggests two types of path-following catch-up strategies by identifying four important components of catch-up strategy: technology choice, product development procedure, knowledge exploitation, and market development. In case of independent small firm (ISF)’s catch-up strategy, it is found that ISF chose technology with modular architecture, allowing it to sequentially develop subsystems, which were developed from closed to open modular architecture. ISF thus could produce final goods by importing external subsystems, despite having low R&D capability at the early stage of catch-up. Furthermore, the ISF developed original market knowledge sharing and integration programs, based on “learning by servicing” and “learning by teaching,” to exploit market knowledge for product development as well as effectively manage diversified customer portfolio. This development of close relationships with numerous customers positively affects the internalization of customer ideas for product development. This tightly organized strategy enabled the ISF to achieve rapid path-following catch-up. On the other hands, affiliate of conglomerate (AoC) could acquire external technology with integral product architecture through the business relationships of affiliates. However, because integral architecture requires fine-tuning and optimization between subsystems to ensure performance as an integrated system, the AoC invested significantly in R&D focused on the simultaneous development of subsystems and thus achieved internalization of subsystems with affiliates. Meanwhile, because of the characteristics of integral architecture, the AoC implemented additional technology licensing from the same foreign firm to extend its product line. Moreover, the AoC utilized the assets of affiliates from co-development of components to development of both domestic and overseas markets to achieve rapid path-following catch-up. Lastly, this dissertation focused on the effect of service integration strategy on firms’ profitability in the industry (regarding the third research question) and found that service integration, measured as the service revenue ratio contribute to profitability, however, as the service integration go beyond a certain level, its effect on profitability diminishes, resulting in an inverted U-shape overall. We recognized that the diminishing effect of service integration often derives from internal conflicts (political cost) and reduction in manufacturing capabilities caused by allocation of limited resources to both manufacturing and service divisions. We also found that excessive customization cost (transaction cost) from broad product lines has aggravated the positive effect of service integration on firm profitability. It implies that managing political cost from internal conflicts and balanced management of product customization (reducing excessive customization cost) is important in achieving profitability from service integration. We also found that effect of service integration on profitability can vary across the different service offerings. Only those services that require high level of technical knowledge and thus customers’ willingness to pay are high, such as process operation outsourcing and technical consulting have a significant positive impact on profitability. The findings of this dissertation provided important theoretical contributions. First, our findings on TFPG of the industry differs significantly from previous studies that East Asia’s economic growth are mainly realized from the intensive input of factors such as capital accumulation. Our findings also provide a counter argument to the concerns about “low-technology equilibrium” of Korean economy. Furthermore, the heterogeneous patterns of TFPG across sub-sectors confirm the necessity of TFPG analysis to the disaggregated level and detailed policy design that consider industry-specific development patterns. Second, we extend the discussion on catch-up into path-following patterns and provide a new theoretical framework, which includes the four components - technology choice, knowledge exploitation, product development procedure, and market development - of catch-up strategy and emphasize strategic manipulation among them, to understand path-following catch-up phenomenon in various industries. The theoretical framework that we proposed also enables people to advance our understanding of catch-up from an intra-industry perspective and explain the success or failure of the catch-up strategies of firms. Our new suggestions that emphasize the importance of technology choice as an important antecedent for catch-up strategy as well as market knowledge exploitation as a way to overcome initial disadvantages in resources also relevant contributions of this dissertation. Lastly, we clarify that service integration strategy plays important role in enhancing firm profitability, even if the level of service integration is low. This is in contrast with previous studies that claim only above critical service revenue is significant for firm performance. Furthermore, we suggest that it is important to manage the harmful effect of political costs, a reduction in manufacturing capability, and excessive product customization cost (transaction cost) on profitability when service revenue reaches a certain level. At the end, identification of profitable services in terms of differentiated technical knowledge is another theoretical contribution of this dissertation.