Technology columnist Dennis Posadas says the Philippines can no longer compete on the basis of cheap labor. It must switch to a higher-value strategy
The Philippines, like many countries in Asia, relies significantly on electronics and semiconductors for job growth and export earnings. According to the Semiconductor & Electronics Industries of the Philippines, the local industry advocacy group, the sector currently earns around $31 billion annually in exports and employs around 460,000 people. The industry in the Philippines dates back to the 1970s and 1980s, the years of the first wave of manufacturing outsourcing to Asia by the electronics and semiconductor industry. Companies like Texas Instruments (TXN) and Intel (INTC) took advantage of cheaper wages to transfer labor-intensive assembly operations such as chip inspection, packaging, and eventually chip electrical testing.
The three-decade strategy of wooing foreign semiconductor/electronics multinationals to locate in the Philippines mainly through a cost carrot has worked well. But emerging signs indicate that a major strategy shift for the Philippines is long overdue. While TI has a new chip factory in Clark, a former U.S. Air Force base north of Manila that is now a free-trade zone, the country is becoming less attractive for some electronics manufacturers. Companies like Toshiba, for instance, have moved their laptop manufacturing operations from the Philippines to China; others are looking closely at Vietnam, where Intel has a new plant.
Unlike neighbors Malaysia, Singapore, and Taiwan, the Philippines has never pursued a serious higher-value strategy approach to electronics and semiconductors, preferring instead to rely on the country's status as a cheap manufacturing destination to attract investors. The key parts of this strategy are the export processing zones, tax- and duty-free areas designated by the government since the '70s to attract factories (and therefore jobs) in various places around the country. The idea was for a foreign multinational to import the sophisticated equipment and material that go into a chip, hire local labor, and export the products back to home while keeping costs down until a cheaper location came along.
Seasoned Engineers Are a Must
Aside from the typical concerns about political stability and business climate, cost considerations are extremely important in considering where to locate a major high-tech factory. But as high-tech manufacturing becomes more sophisticated and technical problems become harder to solve, one important consideration that these new semiconductor processes require is access to large pools of seasoned engineers and scientists with graduate degrees. Another consideration is access to suppliers of equipment and materials.
To shift to this new, higher-value-added strategy, the Philippines needs to make sure that industry works closely with key universities. This also means the Philippine government really needs to beef up its efforts in science and technology education. The Engineering Research & Development for Technology consortium, a group of seven universities led by the University of the Philippines to increase the number of master's and PhD degree holders in engineering and the sciences, is a right step in this direction. So if the Philippines really wants to show it can offer value to these big technology names, it should work on beefing up the numbers of engineers and scientists and have them work closely with industry.
One of the possible areas the Philippines can explore is chip and firmware design. Although the chip designer population is still small relative to its neighbors, big companies like Sanyo, Bit Micro, Numonyx, Rohm, and Canon (CAJ), and smaller startups like Symphony Consulting and Blue Chip, are designing chips and firmware using local talent. At the University of the Philippines, students and faculty members are designing chips and sending them for fabrication to TSMC (TSM) in Taiwan, courtesy of a grant by Intel.
Cost Savings in Local Suppliers
Another way to improve its value-added proposition is for the Philippines to try to localize some of the equipment and materials requirements of high-tech multinationals. Purchasing managers from these multinational companies are always on the lookout for better, faster, and cheaper suppliers for their needs. A year before Toshiba pulled its laptop assembly operations out of the Philippines, the company announced it was trying to localize some of its suppliers, presumably to save on costs. If it had succeeded in localizing enough of its suppliers, they could have acted as an additional buffer against Toshiba's eventual decision to pull out from the country. It would have also kept some jobs intact, even with the pullout, as supplier contracts (particularly for equipment and materials) do not necessarily terminate when a factory pulls out.
From my experience as a former chip industry engineer and analyst, a breakdown of the accounting costs of assembling and testing a microchip in Asia will reveal that most of the costs associated with chipmaking are really from the capital costs of the equipment and the direct materials (such as multilayer printed circuit boards and plastic molding compounds) that go into the chip, and not from electricity or even labor costs.
But to be able to come up with a local tech sector composed of these sophisticated, locally developed equipment and materials suppliers, the Philippines needs to develop and nurture the technology entrepreneurs who will eventually supply their products to the Intels, Toshibas, and TIs of the world. It requires a Silicon Valley-type innovation ecosystem where technology entrepreneurs are supported by universities, research laboratories, technology suppliers, patent laws, and angel and venture capital.
Moving Beyond Contract Manufacturing
Malaysia, Taiwan, China, Singapore, and Korea have done the same in the past and have executed it successfully. One Malaysian equipment supplier I worked with during my stint as an engineer at Intel started out as a machine shop, then slowly worked its way up to become a sophisticated equipment supplier to companies like Intel and Motorola (MOT). In the U.S., of course, Intel and Microsoft (MSFT) saw their fortunes change when they became suppliers for IBM (IBM) in the '80s. To some extent, some of the local electronics manufacturing companies like Integrated Microelectronics and Ionics are moving beyond contract manufacturing to become original device manufacturers and eventually original brand manufacturers like what HTC in Taiwan and Ningbo Bird in China are doing.
It is not easy, but companies like Intel and TI have been in the Philippines for three decades now, and yet their purchasing power for locally developed technology suppliers has barely been touched. No single country or company can dominate the whole spectrum and permutations of equipment and material needs for the sector. Therefore, companies and countries can simply pick the equipment and material niches they want to specialize and do business in.
For the Philippines to think it can still win the cost game using only the traditional metrics like labor and electricity against countries like Vietnam and China is simply sheer folly. To expand its electronics and semiconductor sector vis-à-vis the rest of Asia, it should seriously pursue a higher-value-added strategy premised on beefing up the number of MS/PhD degree holders, doing higher-value-added activities like chip design, and localizing equipment and materials to make itself more attractive to the tech giants.