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UCIrvineRecentWorkTitleCapturingValueinaGlobalInnovationNetwork:AComparisonofRadicalandIncrementalInnovationPermalinkhttps://escholarship.
org/uc/item/2qd206g1AuthorsDedrick,JasonKraemer,KennethLLinden,GregPublicationDate2007-09-01eScholarship.
orgPoweredbytheCaliforniaDigitalLibraryUniversityofCaliforniaThePersonalComputingIndustryCenterissupportedbygrantsfromtheAlfredP.
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Onlineathttp://pcic.
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edu.
Forinformation,contactJasonDedrick(949-824-2863)orKennethL.
Kraemer(949-824-5246).
CapturingValueinaGlobalInnovationNetwork:AComparisonofRadicalandIncrementalInnovationJasonDedrick,KennethL.
Kraemer,GregLinden*PersonalComputingIndustryCenter,UCIrvineSuite3200,BerkeleyPlaceNorthIrvine,California92697Draft:PleasedonotciteordistributeSeptember2007*Authorslistedalphabetically2Foradvancedindustrialnationsnolongerabletocompeteoncost,thecapacitytoinnovateisthemostcriticalelementinsustainingcompetitiveness.
CouncilonCompetitiveness,2003.
IntroductionInnovationisoftenidentifiedasakeytonationalcompetitivenessandprosperity,1andispromotedthroughvariouspolicyinitiativesinmanycountries.
Yetinnovationtodayisnolongercarriedoutwithinindividualcountries,butoftencrossesnationalbordersintheformofglobalinnovationnetworks.
Thesecancomprisetheglobalbranchesofmultinationalcorporations(MNCs)andlocalorregionalparticipantsfrommultiplecountries.
Wheninnovationisorganizedinsuchnetworks,itisnotclearhowtheeconomicgainsfrominnovationaredistributedamongthefirmsandcountriesinvolved.
Thesegainscanbemeasuredvariouswayssuchasfinancialvalue-added,jobsandwages,2andtradeflows,andatvariouslevelsofanalysisfromtheproducttothefirmtothecountry.
Thispaperreportsonastudythataddressesthequestionofwhobenefitsfinanciallyfrominnovationintheglobalnetworksforaspecificsetofproducts,includingthreemembersofApple'siPodfamilyandnotebookPCmodelsfromLenovoandHP.
Theseareallexamplesofgloballyinnovatedproducts,combiningtechnologiesfromtheU.
S.
,JapanandanumberofAsiancountries.
Aproduct-levelstudyallowsustobreakoutthefinancialvalueembeddedinaninnovativeproductandclarifyhowitisdistributedacrossthemanyparticipantsinthesupplychain.
Aggregatingthisfirm-leveldata,weareabletoestimatethedistributionofvaluebycountryaswell.
Theresultwillbeofinteresttomanagers,academics,andpolicymakersconcernedaboutthevaluecapturedbyinnovators.
Aproduct-levelfinancialfocusalsoservesasacounterweighttootherlensesusedtoviewglobalization.
Bilateralandmultilateraltradestatisticsareimportantmeasuresofoneeconomy'sinteractionwithothers,buttheycanalsobemisused.
Forexample,thebilateraltradedeficitoftheU.
S.
withChinahasreceivedconsiderableattention,butourstudymakesclearthatChinesefirmsandworkerscaptureasmallshareofthetradepriceofaniPodornotebookPCbecauseChina'sprimaryroleinthevaluechainisstillthatofalow-costassemblyplatform.
Thebilateraltradedataobscurehowthehigh-valueinputstotheiPodandnotebookscomefromJapan,Korea,andTaiwan,andeventhemultilateraltradedataarenotfine-grainedenoughtoclarifytheseflows.
ThechoiceofiPodsandnotebookPCsallowsustoexaminetwogeneraltypesofinnovation,radicalandincremental,whicharediscussedinthenextsection.
Thesecondsectiondescribeshowinnovationiscarriedoutinthecontextofglobalinnovationnetworks.
Thesubsequentsectionsdescribeandapplyaframeworkformeasuringand1SeeforexampleSolow(1956),Mokyr(1990),GrossmanandHelpman(1991)andPorter(1998).
2Thesealternatemeasureswillbeconsideredinourfutureresearch.
3mappingthefinancialvaluecreatedalongasupplychain(Lindenetal.
,2007a).
Finally,comparativeresultsforthefiveproductsareanalyzedatthefirmandnationallevels.
RadicalandincrementalinnovationRadicalproductinnovation(Utterback,1990)hasimportantdifferencesfromtheincrementalmodelofdevelopmentasillustratedinTable1.
Radicalinnovationeitherinvolvesintroductionofnewcoretechnologies,suchasdigitalcameras,orinvolvesanewwayofintegratingcoretechnologiestodevelopaproductwithdifferentcapabilities(thelatterisreferredtobyHendersonandClark,1990,asarchitecturalinnovation).
Bycontrast,incrementalinnovation,asthetermsuggests,involvessteadyevolutionaryimprovementsinproductswithoutfundamentalchangesintechnologyorarchitecture.
Table1.
FeaturesofIncrementalandRadicalInnovationRadicalinnovationIncrementalinnovationOpportunity-Newproductcategory-Newtechnologycreatesopportunitytoredefineaproductcategory-Earlyintroductionofnewtechnologiesprovidesshort-termmarketadvantage-MinordesignfeaturescanbeusedtodifferentiateproductswithinanestablishedcategoryStandards-Noexistingdominantdesignorstandard-Fewlimitsonhownewarchitectureisdefined,i.
e.
,howhardwareandsoftwarecomponentsworktogether-Dominantstandarddefinesandlimitsinnovationopportunities-Needtomaintaincompatibilitywithcomplementaryassetsandearliergenerations-Moremodular,openarchitectures,withproprietarycontrolofkeystandards-StandardsownerstrytomaintaincontrolovertechnologytrajectoryStrategy-Developcompleteplatformofhardware,software,content,services-Workwithkeypartnersforcoretechnologies-Controlkeystandardswithintheproductarchitecture-Createanecosystemofco-specializedassetprovidersaroundthestandard-Maybenecessarytocreatenewdistributionchannels-Innovatewithindominantdesign-Wherestandardsareinflux,influencedevelopmentthroughdesignchoices(e.
g.
,Blu-RayorHDDVD)-Controlproductplanning,brandimage,marketing,conceptdesign-LeverageexistingcomplementaryresourcesanddistributionValuecapture-Leadfirmcaptureseconomicrentsthroughhighmargins-Coretechnologysuppliersmayalsoenjoyhighmarginsbutcanbereplaced-Valuableuniqueintellectualpropertyisarequirementtocapturevalue-Competitiondrivesdownmargins-Consumerscapturemostvaluecreated-Firmscontrollingkeystandardsmayearnmonopolyprofits(e.
g.
,MSandIntel)-Lowcostsupplierscancapturevaluethrougheconomiesofscale4TheiPodprovidesanexampleofradicalinnovationcarriedoutinaglobalinnovationnetwork.
3Introducedin2001,theiPodwasnotthefirstintegratedportablemusicplayer,butitenteredafledglingmarketwithlimitedadoptionandnostrongincumbents.
Thenewindustrywasenabledbyacombinationofnewtechnologies(e.
g.
,audiocompressionsoftwaresuchasMP3),andadvancesinotherssuchasverysmallharddrivesandlowcostflashmemorywhichallowedstoringmusicinsidethedeviceratherthancarryingCDsortapes.
Thissituationcreatedanopportunityforsomeonetocreateanewproductwithnoneedtobecompatiblewithexistingproductsorcomplementaryassets(exceptthemillionsofdigitalmusictracksavailableforrippingfromCDsordownloadingfromNapsterorothersites).
Appletookadvantagebycombiningexistingtechnologiesinauniquewaythatcapturedconsumers'imaginationandbecameahitproduct(Lindenetal.
,2007a,2007b).
AppledesignedthesystemarchitecturethataffectedcriticalfeaturessuchassoundqualityandpowerconsumptionanddevelopedthedistinctiveindustrialdesignoftheiPod;itdevelopedmostoftheiPodandiTunessoftwarein-houseoradaptedothers'software.
Appletightlymanagedthewholeprocess,coordinatingcloselywithoutsidepartnerssothatitcoulddesigntheiPod,anditsmanufacturerandsupplierscouldconcurrentlypreparethetoolingandsupplychainforvolumemanufacturing,andbringittomarketineightmonths.
Whilemanystandardpartsandcomponentswereinvolved,Appleworkedcloselywithoutsidepartnerstodesignoradaptmanycustominputs,suchasintegratedcircuits,harddrives,andtheiPod'sdistinctiveplasticandmetalcasing,screenandcontrolwheel.
TheradicalinnovationoftheiPodwasnotadramatictechnologicaladvance,butratherauniqueintegrationofhardware,software,contentandservicesinawaythatwasmoreuser-friendlyandcomprehensivethanexistingmusicplayers.
AppledevelopedtheiTunessoftwareapplicationtocollectandmanagecontentonaPCorMacandeasilytransferthatcontenttotheiPod.
ItalsodevelopedtheonlineiTunesMusicStoreandtightlyintegratedthatwiththeiTunesapplication.
Applelicensedcontentfromallthemajormusiclabelsand,subsequently,fromtheaudiobook,movieandtelevisionindustries,andestablishedpricinganddigitalrightsmodelsthatwereattractivetoconsumers(Figure1).
3Usingarelatedterminology,theiPodanditsassociatedbusinessmodelalsoconstitutea"disruptiveinnovation"(ChristensenandRaynor,2003)thatprovidedasetoffunctionalityandinfrastructuretomainstreamuserswhowerenotattractedbythen-existingcombinationsofportablemusicplayersanddigitalmusicsources.
5Figure1.
iPodValueNetworkBycontrast,notebookPCstodayrepresentincrementalinnovation.
WhileaportablePCwasoriginallyaradicaldeparturefromdesktopPCs,requiringinnovationinbatteries,flat-paneldisplays,andminiaturization,today'snotebookPCsarebasicallyrefinementsandextensionsoftheoriginal"clamshell"laptopdesignsofthemid-1980s.
Thearchitecturehasnotchangedmuch,andthekeyboard,display,CPUetc.
areinthesameplace(bycontrast,considerthelayoutofatabletPC).
Themajorityoflaptops,includingthoseanalyzedhere,includeanoperatingsystemfromMicrosoftandanIntel(oratleastIntel-compatible)processor.
InthecaseofnotebookPCs,innovationisshapedbytheneedforcompatibilitywithavastarrayofcomplementaryassets,fromsoftwaretoperipheralstocomponents,andbytheneedforbackwardcompatibility(andperceivedfuturecompatibility)withothersystems.
ThekeyarchitecturaldecisionsaredrivenbyMicrosoftandIntel,alongwithafewkeyplayersinothercomponents(e.
g.
,Nvidia,AMD/ATI,creativeingraphicsandsound;TIandBroadcomincommunicationsandAdobeinsoftware).
PCmakersatbestcaninfluencethetechnologydirectionsbytheirowndesignchoices,suchaswhatsetofwirelessinterfacesornext-generationDVDstandardstoincorporate.
ButthisinfluenceislimitedbythefactthatnoPCmakerhaseven20percentoftheglobalmarket.
ThematurePCindustryconsistsofthousandsoffirms,producingmostlyinterchangeableinputsandcomplementaryassets,aswellasindustry-standardsystems.
Barrierstoentryarelowinmanysegmentssuchasdesktopsystems,commoditypartsandsoftware.
Theindustryishighlyglobal,withmanufacturers,assemblersanddevelopersaroundtheworld,althoughthereisastrongconcentrationintheU.
S.
andtheAsia-Pacificregion.
Thenotebookindustry,discussedbelow,isdominatedbyasmallnumberofPCvendors(HP,Dell,Acer,Lenovo,Toshibaandafewothers)whorelyonasimilarnumberofTaiwanesemanufacturerstoproduceabout80percentoftheirproducts.
PCvendorsconcentrateondesign,branding,marketinganddistribution,leveragingtheinnovationofotherstoenhancetheirproduct(DedrickandKraemer,2007).
PCwithiTunesiTMSiPodInternetPCwithiTunesiTMSiPodInternetNetworkofIPagreements6Competitioninalmosteverysegmentoftheindustrydrivespricesdownsteadily,sothatmuchofthevalueofinnovationispassedontoconsumersintheformofcheaperandmorepowerfulcomputers.
TheexceptionsareMicrosoftandIntel,whoenjoynetmarginsofabout30percentand20percentrespectively,thankstotheircontroloverkeystandardsandlackofcompetition.
Othercomponentmakersmustconstantlyinnovatetokeepup,andyetmustalsocontrolcoststosurviveinhighlycompetitivemarkets.
GlobalizationofinnovationInthepast,largeelectronicscompaniesdesignedanddevelopedtheirownproducts,oftenusinginternally-producedcomponents.
Suchhighlyintegratedcompaniescreatedandcapturedalargeshareofthevalueofinnovation,mostlyintheirhomecountries.
Sincethen,supplychainsintheglobalelectronicsindustryhavesteadilydisaggregatedacrosscorporateandnationalboundaries(Sturgeon,2002;DedrickandKraemer,1998).
Companiesthatformerlymanufacturedmostproductsin-house,suchasIBMandHP,aswellasstart-upsthatneverhadmanufacturingcapabilities,haveoutsourcedproductionandevenproductdevelopmenttoglobalnetworksofcontractmanufacturers(CMs)andoriginaldesignmanufacturers(ODMs).
EvenverticallyintegratedJapaneseandKoreancompaniesrelyonoutsidesuppliersforkeyparts,equipmentandsomefinalassembly.
Today,thecreationofasuccessfulproductintheglobalelectronicsindustryspreadswealthfarbeyondtheleadfirm,i.
e.
thecompanywhosebrandappearsontheproduct,andwhobearsprimaryresponsibilityforconceiving,coordinating,andmarketingnewproducts.
Whiletheleadfirmanditsshareholdersarethemainintendedbeneficiariesofthefirm'sstrategicplanning,otherbeneficiariesincludepartnersinthefirm'ssupplychain.
Firmsthatoffercomplementaryproductsorservicesmayalsobenefit.
Thedependencyrelationshipsinthesenetworksrunbothways.
Whileinnovationinnotebookcomputersisincremental,manufacturersofchips,displays,harddrivesandothercomponentsmustoftenachievefundamentalscientificadvancestoadvancetoensuinggenerationsoftechnology.
PCmakersmustworkcloselywiththosesupplierstointegrateadvancedtechnologiesinhighlysophisticateddesigns.
Theseglobalnetworksareflexible.
Leadfirmsandtheirsuppliersareindependentorganizationsthatcompete,cooperate,shift,andrecombinenetworksfromoneproductgenerationtothenext.
MeasuringValueCreationandCaptureinGlobalNetworksWithinasupplychain,eachproducerpurchasesinputsandthenaddsvalue,whichthenbecomespartofthecostofthenextstageofproduction.
Thesumofthevalueaddedbyeveryoneinthechainequalsthefinalproductprice.
Thenaturalstartingpointforestimatingthesevaluesisamapofasupplychainshowingtheactivities(R&D,manufacturing,designandbranding,anddistribution,salesandservice)involvedinpassingfromcomponentsupplierstofinalcustomers(Figure2).
7Figure2:GenericElectronicsSupplyChainMovingfromlefttorightinthefigure,mostR&Disdonebyafewkeycomponentsuppliers,althougheachproductincorporatesalargenumberofcomponents(inthecaseofanotebookcomputer,hundreds).
Somecomponentsarelow-value,suchascapacitorsandresistorsthatcostlessthanapennyeach.
Althoughthesuppliersofthesecomponentsearnprofits,theyaccountforasmallshareofthetotalvalueaddedalongthesupplychain,andcontributerelativelylittleinnovation.
Weexpectsuppliersofthesegenericinputstoearnthinprofitmarginsbecausetheycompetewithclosesubstitutes.
Mostelectronicsproductsalsocontainafewhigh-valuecomponents,suchasavisualdisplay,harddriveorkeyintegratedcircuits.
Thesecomponents,whicharethemselvescomplicatedsystems,arethemostlikelytoembodyproprietaryknowledgethathelpstodifferentiatethefinalproductandtocommandacommensuratelyhighmargin.
Byvirtueoftheirhighcost,thesefewinputswillusuallyaccountforarelativelylargeshareoftotalvalueadded.
Innovationisrapidinthesecomponents,andaccountsformuchofthesteadytechnologicalimprovementinfinalproductssuchastheiPodornotebookPCs.
Thesecomplexcomponentsmayhavetheirownmultinationalsupplychains.
Forexample,anintegratedcircuitmightbesoldbyaU.
S.
companybutfabricatedbyacontractorinTaiwanandencasedinitsfinalpackageinKoreabeforebeingshippedtoaproductassemblyplant.
Themanufactureofthesecomponentsintothefinalproductisdonebyanumberoflargemultinationalcontractmanufacturers(CMs)ororiginaldesignmanufacturers(ODMs)suchasFlextronics,Solectron,Foxconn,Quanta,andCompalwhoprovideassemblyservices.
Theseassemblerscompetefiercelyforhigh-volumeopportunities,limitingtheirmargins.
EvenlargeverticallyintegratedmanufacturerssuchasSonyandToshibanowoutsourcepartoftheirproductiontotheseCMsandODMs.
Productdesign,brandingandmarketingisdonebybrand-namevendors.
Theseleadfirmscontributemarketknowledge,intellectualproperty,systemintegrationandcostmanagementskills,andabrandnamewhosevaluereflectsitsreputationforquality,innovation,andcustomerservice.
Leadfirmscancreatevaluebytransformingtheinnovationsofothersintoproductsthatconsumersfindusefulandusable.
DistributionisdonebyafewglobalwholesalerssuchasArrow,TechDataandIngramMicro.
SalesarebylargeretailchainssuchasBestBuy,CircuitCity,Fry's,CompUSAandMicroCenter.
Theyoperateonafixedmarginfromthevendorandseekscaleandreach,butpricecompetitionpluscapitalandoperatingcostskeepmarginslow.
CM/ODMRetailersDistributorsCustomersR&DManufacturingDistribution,sales,customerserviceBrandnamevendorsIP,design,marketingComponentsuppliers8SalesarealsodoneincreasinglybythebrandedvendorsdirectlyonlineandincasessuchasAppleandSony,throughtheirownstores.
Thelowercostofdirectsalescontributestotheleadfirm'smarginsandownstoresalesmaycontributetocross-sellingaswell.
ThefiguresbelowexpandthisgenericvaluechainfortheiPodandnotebookPC.
Figure3.
ValueChainforaniPod.
Figure4.
ValueChainforNotebookPCiTunesstoreComponentsuppliersCM/ODMContentproviders3rdpartyaccessoryprovidersApplestores,webOtherretailersDistributorsCustomeriPodsAccessoriesSoftwareandcontentR&DIP,designsoftwaremarketingManufacturingSales,distributionCM/ODMRetailersDistributorsCustomersR&DManufacturingDistribution,sales,customerserviceBrandnamevendorsIP,design,marketingComponentsuppliersSoftwarepublishers3rdpartyperipheralsmanufacturersPCsPeripheralsSoftwareDirectsalesIndirectchannel9Usingthesemapsasaguide,wecalculatethevalueaddedatvariousstagesofthesupplychainbyestimatingthesellingpriceofthatstage'soutputandsubtractingthecostofallpurchasedinputs.
Thedataandmethodaredescribedfullyinanotherreport(Lindenetal.
,2007a)andbrieflydescribednext.
DatasourcesandanalyticalapproachProduct-leveldataareextremelyhardtoobtaindirectlyfromelectronicsindustryfirms,whojealouslyprotectinformationaboutthepricingdealstheyhavenegotiated,andoftenrequirethesilenceoftheirsuppliersandcontractorsthroughnon-disclosureagreements.
Formanyelectronicproducts,listsofcomponentsandtheirfactorypricesareavailablefromindustryanalysts.
These"teardown"reportscapturethecompositionoftheproductataspecificpointintime.
Ateardownreportcanbeusedtoestimateaproduct'svalueaddedbysubtractingtheinputpricesfromthewholesaleprice.
Firm-levelinformationaboutpurevalueaddedisn'treadilyavailablebecausepublicly-listedcompaniesdonotgenerallyrevealtheamountoftheirwagesfor"directlabor"(workerswhoareinvolvedinconvertinginputstoasalableproduct).
Instead,thewagebillishiddenwithin"costofgoodssold"or"costofsales.
"Therefore,thenumberwewillusetoestimatethevaluecapturedbysuppliersis"grossprofit,"alsocalled"grossmargin,"thedifferencebetween"netsales"and"costofgoodssold.
"Grossprofitdataarereadilyavailablefromannualreportsinthecaseofpubliccompanies.
Figure5showsthedifferencebetweenvalueaddedandgrossprofit.
Theredareaincludesthecomponentsofvalueaddedandtheblueareaincludesthecomponentsofgrossprofit,orvaluecapturedbythefirm.
Figure5.
ComponentsofValueAddedandGrossProfit-purchasedinputs-directlabor-costofgoodssoldSales-SG&A-SG&Aprice-R&D-R&D-Depreciation-Depreciation-Netprofit-NetprofitGrossprofitdoesnotequalthefullvalueadded,sinceitexcludesdirectlabor.
Instead,itmeasuresthevaluethecompany(excludingitsdirectworkers)capturesfromitsroleinthevaluechain,whichitthencanusetorewardshareholders(dividends),investinfuturegrowth(R&D),coverthecostofcapitaldepreciation,andpayitsoverheadexpenses(marketingandadministration).
IncasessuchastheiPodorHewlett-Packard(HP)notebook,wheretheleadcompanyoutsourcesallofitsmanufacturing,thevalueaddedcalculatedfromtheteardownreportwillbemoreorlessidenticaltothegrossprofit.
Sincegrossprofitexcludeswagesfordirectlabor,itavoidsthegeographicalambiguityaboutwhereaproductwasassembledversuswherethecompanyisheadquartered.
TheValueaddedGrossprofit(valuecapture)10offshoreassemblyaspectofvaluedistributionneedstobecapturedinotherways,suchasananalysisofthelocation,quantity,andsalaryofjobs.
InsidePortableElectronicsApple'siPodisessentiallyaportablecomputerdedicatedtomediaprocessing.
Assuch,itsharesgeneralfeatureswitharangeofrelatedproducts,includingnotebookcomputers,cellphones,andPDAs.
Thesefeaturesincludeadisplay,astoragemedium,microprocessors,systemmemory,aninputinterface,abattery,printedcircuitboards(PCBs),aphysicalenclosure,andsoftware.
Theyallalsorequireassemblyservices,whicharetodaymostlyoutsourced.
UsingPortelligentteardownreports,wecomparedthekeypartsinonemodelofApple'siPod(30GBVideoiPodfrom2005)andaHewlett-Packardnotebookcomputer(nc6230,alsofrom2005).
Table2showshowthetwosystemscompareintermsofeachoftheirfeaturesasapercentageoffactorycost(thecostoftheinputsplusassemblyservices).
Table2.
ComparisonofInputsasPercentageofFactoryCost:30GBVideoiPodandHPnc6230notebookVideoiPodHPnc6230SoftwareNotApplicable11%Storage50%12%Display16%16%Processors9%27%Assembly5%5%Battery2%5%Memory2%4%PCBs2%2%Enclosure2%1%InputDevice(s)41%2%Subtotalforkeycomponents11%15%Hundredsofothercomponents89%85%TOTAL100%100%TotalParts4512,196Note:iPodsoftwarewasdevelopedin-housebyApplesothereisnosoftwarelicensefeeinthebillofmaterials.
Source:Authors'calculationsOnemajordifferenceisthatsoftwaredoesnotfigureinApple'sbillofmaterials.
TheiPod'ssoftwarewasdevelopedin-house,whichsparesApplefrompayinglicenseorroyaltyfeesoneachunitsold.
Incontrast,softwarelicensesfortheoperatingsystemandapplicationsareamajorpart(11percentforthenc6230)ofthebillofmaterialsfor4"InputDevice(s)"varybyproduct.
Foranotebookcomputer,itisthekeyboardandtrackpad(orotherpointingdevice).
FortheiPod,itisthescrollwheel.
11notebooks,whichmeansthatthisportionofthevalueiscapturedbyanotherfirm(i.
e.
,Microsoft).
AnotherkeydifferenceisthattheiPod'slimited-purposemicroprocessorsarerelativelyinexpensiveasashareofcosts(9percent)comparedtothenotebook'sgeneral-purposeprocessorchipset(27percent).
Bycontrast,theiPod'sstoragesystem,ahard-diskdrive,accountsforhalfofthefactorycostcomparedtojust12percentinthenotebookforboththeharddiskandDVDdrives.
Interestingly,thedisplaymoduleineachsystemworkedoutto16percent,andtheassemblyservices(includingcomponentinsertion,boardtest,andfinalassembly)to5percentofthetotal.
5Thecircuitboard,enclosures,andmeansofinputaccountforarelativelysmallshareineachcase.
Thehundredsofcomponentsthatoccupysupportingrolesinthetwodevicesonlyamountto11to15percentofthetotalinputcost.
Thedetailsfortheseandthreesimilarproducts(anearlier-modeliPod,aniPodNano,andaLenovoThinkPad)arepresentedinfivetablesintheAppendix.
Thesetablesshowspecificpartsdetailfortheharddriveandotherstoragedevices,thedisplayassembly,theprocessorchips,thebattery,andshort-termmemorychips.
ThetablesomitdetailsforthePCBs,case,andinputdevices,aswellasahostofsmallerparts.
Functionally,thesepartsmightbeveryimportantforaparticularproduct,6buttheircostisrelativelylow.
Theirinclusionwouldnotmateriallyaffecttheresultswereportbelow.
Cross-modelcomparisonsTobetterunderstandthecompositionoftheiPod,wecomparedthreedifferentmodelsforwhichinformationwasavailable:thethird-generationharddrive-basediPod,whichwentonsaleinearly2003at$399;thefifth-generationharddrivebasedVideoiPod,whichwentonsaleinOctober2005at$299;andtheinitialmodeloftheflash-basediPodNano,introducedinSeptember2005at$249.
TheharddrivebaseunitsusedinthePortelligentteardownsbothhaveastoragecapacityof30gigabytes(GB),andtheNanoacapacityof4GB.
Differentcapacitymodelswerealsoavailableforsalebutwerenotanalyzed.
Theshareofthemaininputsinthefactorycostisroughlysimilar,evenbetweentheharddriveandflash-basedmodels.
Table3comparestherelativecostofthesemainfunctionalpartsforeachmodel.
5Seep.
15foradiscussionofhowtheassemblytotalwasestimatedfromPortelligentdata.
6Forexample,theiPod'scaseentailsdesignfinesse,requiresgreatprecisioninitsmanufacture,andisakeypartoftheApplebrandimage,butit'sasmallproportion(2%)ofthebillofmaterials.
12Table3.
CostofPartsandServicesforiPodModels30GBiPod,200330GBVideoiPod,20054GBNano,2005PriceofkeyfunctionalpartsaspercentageoffactorycostStorage61%50%67%Display3%16%9%Chips*6%12%7%Battery2%2%1%AssemblyServices5%5%4%Estimatedfactorycost$184.
92$148.
10$156.
28Totalnumberofparts424451359*Includesprocessorsandmemorychips;somechipsnotincludedhere.
Note:Softwarenotshownbecausedevelopedin-housebyApplesothereisnosoftwarelicensefeeinthebillofmaterials.
Source:seeAppendixtablesA-1toA-3.
AppendixtablesA-1toA-3provideadetailedbreakdownofthesekeyinputs,whichaccountforabout77and88percentofthecostofpartsforthemodelsstudied.
Thebalanceisaccountedforbyhundredsofparts,mostlysmallinvalue,includingdozensofresistorsandcapacitorsworthlessthanapennyeach.
ThecostliestinputineachofthethreeiPodmodelsisstorage(harddriveorflashmemory).
Inthe2003iPod,the30GBharddrivefromJapan'sToshibahasanestimatedcostof$112,whichaloneamountstomorethan60percentoftotalinputcost.
ThesameistrueintheVideoiPod,althoughby2005,Portelligent'scostestimatefortheToshibadrivehasdroppedto$73(50percentoftotalinputcost),whichreflectsthetypicalpricereductions(inthiscaseapproximately20percentperyear)ofelectronicscomponentsovertime.
Inthe2005Nano,thecostliestinputisthe4GBofflashmemoryfromKorea'sSamsung.
Inthe4GBmodelanalyzedhere,thissolid-statestorageaccountsfor67percentoftheinputcosts,althoughthiswouldhavebeenapproximately51percentifwehadlookedatthe2GBmodelthatwasavailableatthesametime.
Table3showsthat,unliketheharddrive,thedisplaybecomesalargerpartofthebillofmaterialsbetween2003and2005astheiPodevolvesfromamusictoamultimediaplayer.
Theincreasedcomplexityalsoraisesthecostshareofthemicrochips,withavideoprocessorfromU.
S.
-basedBroadcomaddedtothemaincontrollerfromPortalPlayer,aU.
S.
start-upcompany.
PortalPlayer'schipbyitselfin2005hadfallento$4.
94fromthe$6.
18estimatedcostoftheanalogouschipinthe2003model,adeclineofabout10percentperyear.
Table4showsasimilarcostbreakdownfortwo2005notebookmodels,includingtheHewlett-Packardnc6230fromTable1.
DetailsareinAppendixtablesA-4andA-5.
13Table4.
CostofKeyPartsandServicesforTwoNotebookPCModelsHewlett-Packardnc6230LenovoThinkPadT43PriceofkeyfunctionalpartsaspercentageoffactorycostStorage12%12%Display16%15%Chips*27%27%Battery5%5%Software11%11%AssemblyServices5%5%EstimatedFactoryCost$877.
83$898.
27Totalnumberofparts2,1962,477*Includesprocessorsandmemorychips;somechipsnotincludedhere.
Source:seeAppendixtablesA-4toA-5.
Thebreakdownisverysimilaracrossthetwomakes.
Thebillofmaterialsisdominatedbytheprocessors,particularlythecentralprocessor,whichinbothcasesisanIntelPentiumM,estimatedbyPortelligentat$127.
7Followingthatisthedisplayineachunit,whichinbothcasescamefromaJapanesejointventurecompany,Toshiba-MatsushitaDisplay,thathasalsosuppliedsomeoftheiPod'sdisplays.
Nextinmagnitudearethestoragedevices(harddrivesfromHitachiandFujitsuandDVD-ROMdrivesfromHitachi-LG,aJapan-Koreajointventure,orMatsushita)andtheoperatingsystem(WindowsXPPro).
ValueCapturealongtheSupplyChainAsthecomponentbreakdownsabovemakeclear,manycompaniescontributetoeveryiPodandnotebookpersonalcomputer(PC).
However,thepriceofthecomponentacompanyprovidesdoesnotcorresponddirectlytothevaluethatitcapturesfromthesale.
ThebillofmaterialsWeusethepartslistsinAppendixtablesA-1toA-5toestimatefirm-specificvaluecapturefortheiPodsandnotebooks.
Theseestimatesareshownintheright-handcolumnoftheAppendixtables.
Ourbasicprocedureforderivingthesevaluesusesthegrossprofitrateofthecompanythatsuppliesthepartfortheyeartheproductwasmanufactured.
Forafewsmallerparts,wehavehadtomakeaneducatedguessaboutthelocationofthefirmthatsuppliedthepartandarepresentativegrossprofitrate(markedwithasterisksinthetables).
Theseestimates,limitedtothebatteriesinthreeoftheproductsandthemonochromedisplayin7Volumediscountsforcomponentsarenotdisclosedbythecompaniesinvolved,andPortelligentnotesthatitsestimatefortheprocessorchips"shouldbescrutinizedcarefully"(Portelligent,2005c).
Whilethisandothernumbersmaynotbeperfectlyaccurate,theyarecloseenoughforthepurposesofthisanalysis.
14the2003iPod,donotmateriallyaffectthepatternsofvaluecapturediscussedbelowbecauseoftherelativelysmallamountsinvolved.
TheseinputswereassignedtoJapanbecauseofthedominanceofJapanesecompaniesinthesetechnologies.
WeillustratethisapproachtoestimatingvaluecaptureusingtheVideoiPod.
StorageWebeginwiththeharddrive,suppliedbyToshiba.
Theuseofcompany-widegrossprofitmaybeinaccurateforacompanylikeToshibathatmakesawiderangeofproducts,frommemorychipstopower-generatingfacilities,butitcansufficeforafirstapproximation.
AccordingtoToshiba'sincomestatements,itsgrossmarginforthefiscalyearendedMarch2006,whichwas26.
5percentofnetsales.
8Aspointsofcomparison,thegrossmarginsfor2005ofthetwotopfirmswhoproduceonlyharddrives,SeagateandWesternDigital,were23.
2percentand19.
1percent,respectively.
9UsingToshiba'soverallgrossmargin,recognizingthatitisonthehighsidefortheharddriveindustry,thevaluecapturedbyToshibaandassignedtoJapanfortheVideoiPodisabout$20.
DisplayThedisplayusedintheVideoiPodwassuppliedbyToshiba-MatsushitaDisplay,ajointventure.
Theestimatedfactorypricewas$23.
27,andtheaveragegrossmarginforToshibaandMatsushitawas28.
7percent,whichwouldtranslateintoanadditional$6.
68capturedbyJapan.
10ProcessorsNextaretwomicrochipsfromU.
S.
companies,BroadcomandPortalPlayer,thatcontrolvideoplaybackandmanagetheiPod'sfunctions,respectively.
Theirgrossmarginsin2005were52.
5percentand44.
8percent,respectively,leadingtoanestimateof$6.
60invaluecapturedassignedtotheU.
S.
11BatteryInthecaseoflithium-ionbatteries,Portelligentwasnotabletoidentifythesupplier,norwereweabletodosothroughourownresearch.
Themarketforlithium-ionbatteriesisdominatedbythreeJapanesecompanies,Sanyo,Sony,andMatsushita,whocollectively8Grossprofitratecalculatedfromdataathttp://www.
toshiba.
co.
jp/about/ir/en/finance/pl.
htm.
9CalculatedfromEdgarOnlinedataaccessedathttp://finance.
yahoo.
com.
10Matsushitamarginof31%forfiscalyearendedMarch2006calculatedfromdataat:http://finance.
yahoo.
com/q/iss=mc&annual.
Toshibamarginwasalreadydiscussedintheharddriveanalysis.
11Grossmarginsfromhttp://finance.
yahoo.
com/q/iss=BRCM&annualandPortalPlayer's10-KfortheyearendingDecember31,2005.
15accountformorethanhalfthemarket.
12TheirrespectivegrossmarginsinthefiscalyearendingMarch2006were18percent,31percent,and31percent.
13BecauseSanyo'slowmarginappearstobeduetoproblemsinitsnon-batterylinesofbusiness,14weassignedagrossmarginof30percenttotheVideoiPodbattery.
MemoryAsimilaranalysiswasperformedforthethreechipsservingasmemoryfromSamsung(mainsystemmemory),Spansion(non-volatileflashmemoryforretainingsettingsbetweenuses),andElpida(memorysupportforthevideoprocessor).
15AssemblyOurestimateofthevaluecapturedbytheplacingofcomponentsoncircuitboards,boardtesting,andfinalproductassembly,requiredadifferentapproach.
Afairamountofcomponentinsertionandfinalproductassemblyofelectronicsgoodsisoutsourcedtospecialistsuppliersofmanufacturingservices,especiallybyU.
S.
companies.
Sinceitisnotclearfromateardownwhetheraproductwasassembledin-houseorbyasupplier,Portelligent'sreportsincludeonlyanestimateofthedirectcostofcomponentinsertion,test,andfinalproductassembly,asopposedtothetotalcostofmanufacturingservicesifsuppliedbyacontractmanufacturer.
Asbestwecandetermine,allmanufacturingexceptthefinalassemblyoftheLenovonotebookPCwasoutsourcedtoTaiwanesecompanieswithfactoriesinmainlandChina.
Apple'sinitialmanufacturingpartnerfortheiPodwasTaiwan'sInventec.
16WhileInventecreportedlycontinuestoassemblethehard-drivebasediPods,anotherTaiwanesecompany,HonHai(alsoknownunderthebrandnameFoxconn)washiredtoassembletheNano.
17IntheLenovoThinkPad,themainPCB(whichaccountsfor93percentofinsertionandtestcost)wasassembledbyUniversalScientificIndustrial.
AlthoughwedonotknowthespecificcompanythatassembledtheHewlett-PackardPC,H-Pusesseveral122002marketdatafromInstituteofInformationTechnology,Japan,reportedinNIST(2006).
Subsequentmentionsinthepress(e.
g.
TimCulpan,"SonyBatteryRecalltoCauseShortageUntilJune,MakersSay,"Bloomberg.
com,October12,2006)suggestthatthisisstillthecase.
13Calculatedfromdataathttp://www.
hoovers.
com/sanyo/--ID__41882,target__financial_information--/free-co-samples-index.
xhtml,http://finance.
yahoo.
com/q/iss=SNE&annual,andhttp://finance.
yahoo.
com/q/iss=mc&annual.
14BasedonareviewofbusinesssegmentdatainSanyoFinancialStatements:http://www.
sanyo.
co.
jp/ir/e/library/pdf/financialstatements/fs-2006.
pdf152005grossmarginsfrom:http://samsung.
com/AboutSAMSUNG/ELECTRONICSGLOBAL/InvestorRelations/FinancialInformation/AnnualFinancialSummary/Income.
htm,http://finance.
yahoo.
com/q/iss=SPSN&annual(Spansion),andhttp://investing.
businessweek.
com/businessweek/research/stocks/financials/financials.
aspsymbol=6665.
T&dataset=incomeStatement&period=A¤cy=US%20Dollar(Elpida).
16Levy(2006),Chapter"Origin.
"17DanielShen,"Sources:InventecAppliancesmakingvideoiPodforApple,"DigiTimes.
com,October14,2005.
16contractmanufacturersinTaiwan,includingArima,Compal,HonHai,Inventec,Quanta,andWistron.
18Wehaveapproximatedthemarketpriceoftheseassemblyandtestservicesbyassuminga100percentmark-upoverPortelligent'slabor-onlycostestimate.
Thisapproachwaschosenasareasonableapproximationafterassessingtheincomestatementsoftypicalcontractmanufacturers.
Thereportedgrossmarginsofcontractmanufacturerstendtobesmall,butthisismisleadingbecausetheyoftencarrysomeoralloftheunassembledcomponentsintheirCostofGoodsSold.
The$1.
22in-houselaborcostforLenovo'sfinalassemblywasincludedin"OtherParts"alongwithinputcosts.
UpstreamvaluecaptureForthecomplex,high-valuecomponents,wearealsoresearchingupstreamvaluecapturedbythesupplier'ssuppliers,especiallywherethesehavecross-borderimplications.
Thiscaninvolveextensiveresearch,andthevaluesinvolvedareinherentlysmall.
WewillusePortalPlayer'scontrollerchipasanexample.
AccordingtoPortalPlayer'slast10-KfilingbeforeitwasacquiredbyNvidiain2006,PortalPlayer'smanufacturingwasoutsourcedtoTaiwanSemiconductorManufacturingCorp.
(TSMC)orLSILogic,aU.
S.
company.
Chipfabricationtypicallyaccountsforaboutathirdofthefactorypriceofachip,soapproximately$1.
63ofPortalPlayer'scostofgoodssoldcanbeattributedtoTaiwan.
TSMC'sgrossmarginfor2005was44percentandLSILogic'swas43percent,soabout$0.
70wascapturedinthisway.
However,giventhatwedonotknowwhetherTSMCorLSILogicdidthechipfabrication,itisunclearwhetherthisvaluecaptureshouldbeattributedtotheU.
S.
orTaiwan,sowehaveomitteditfromthegeographicbreakdown,below.
PortalPlayer'schipalsorequiresalicenseforoneofitsmainelements,theprocessorcore,fromaBritishcompanynamedARM.
ARMchargesanywherefrom$0.
35to$2.
00perchipinroyalties,whichisalmostpuregrossprofitandshouldbeassignedtoGreatBritain.
19ThisamountwillnotbediscussedfurthersincesolittlevalueintheseproductsiscapturedbyEuropeanfirms.
AsimilarupstreamanalysiscouldbeconductedfortheVideoiPod'sharddrive,whichcontainsanumberofexternalinputs,includingchips,disks,motor,andheadassembly,andforthedisplaymodule,whichincludesadisplaypanelandanembeddedchip.
18CeliaLinandJessieShen,"HPtostrengthenTaiwanR&Dfacilityandpartnershipswithnotebookmakers,"DigiTimes.
com,September26,2005.
19RoyaltyrateestimatefromJimTurley,"EmbeddedProcessors,PartOne,"January11,2002,http://www.
extremetech.
com/print_article/0,3998,a=21014,00.
asp17Beyondthebillofmaterials:distributionandretailOncetheproductismanufactured,thereisstillagreatdealofvaluetobecaptured.
Theretailpriceofthe30GBVideoiPodatthetimeofPortelligent'sanalysiswas$299.
Basedonourresearch,weestimatea25percentwholesalediscountforeachunit,with10percentfordistributionand15percentforretail.
20TheseamountswereappliedtoeachiPodandnotebookPCinourstudy,althoughwecontinuetoresearchthereasonablenessofthisassumption.
Applyingalltheseestimatestotheretailprice,wewereabletoarriveatanestimateofApple'sgrossmarginoneach30GBVideoiPodsold.
AppleistheleadfirmintheiPodvaluechain,incurringcostsforR&D,marketing,coordinationoftheentirevaluechain,andotheroverheadcostssuchaswarranty.
21Itistheresidualclaimantforvaluecapture,asdetailedinTable5.
Table5.
DerivationofApple'sGrossMarginon30GBVideoiPodRetailPrice$299DistributorDiscount(10%)($30)RetailerDiscount(15%)($45)Sub-Total(estimatedwholesaleprice)$224FactoryCost($148)RemainingBalance(estimatedApplegrossmargin)$76Source:Authors'calculations;seetext.
Apple'sestimatedgrossprofitontheseunitswouldbe$76,whichworksoutto34percentofthe$224estimatedwholesalepriceforthismodel.
ThisisnotfarfromApple'soverallcorporategrossmarginof29percentfortheyearendingSeptember30,2006.
22Apple'sestimated$76profitisgreaterthanthepriceofanysingleinput,soitisdefinitelygreaterthanthevaluecapturedbyanyofitspartners.
AndforsalesthroughApple'sownweborstoreoutlets,italsocapturestheretailerdiscountof$45.
20Agrossprofitmarginof"lessthan15percent"fornon-ApplesalesisclaimedinDamonDarlin,"TheiPodEcosystem,"NewYorkTimes,February3,2006,soApple'swholesalediscountwouldneedtobeatleastthislarge.
Thedistributionestimateisfromanindustryinterview.
21WeexaminedwhetherwarrantyexpenseswerehigherforApplethanforthenotebookcomputercompaniesbecauseoftheiPod'sfullexposuretotheconsumermarket(asopposedtothenotebookindustry'smixofenterpriseandconsumercustomers).
Basedonpublisheddata(http://www.
warrantyweek.
com/archive/ww20070508.
html),Apple'soverallwarrantyexpenseasashareofsalesislowerthanthatforthemajorcomputermanufacturersfortheperiod2003-2006.
WealsointerviewedaformerAppleemployee(February2007),whoindicatedthat,althoughwarrantycostswereconsideredtoohighintheiPod'searlyyears,returnratesweregraduallybroughttoanacceptablelevelevenassalesvolumerosesubstantially.
22Calculatedfromdataathttp://finance.
yahoo.
com/q/iss=AAPL&annual.
Grossmarginfortheprecedingyearwasalso29%.
18Similarestimatesofvaluecaptureweremadeforalltheproductsinourstudy.
TheresultsareshowninTable6.
Table6.
LeadFirmEstimatedGrossMarginsforFiveProducts23ProductRetailPriceEstimatedWholesalePriceEstimatedGrossProfitGrossProfitasPercentageofWholesalePrice30GB3rd-GenerationiPod,2003$399$299$11438%30GBVideoiPod,2005$299$224$7634%4GBiPodNano,2005$249$187$3016%LenovoThinkPadT43,2005$1,479$1,109$21219%Hewlett-Packardnc6230,2005$1,399$1,049$17116%Source:Author'scalculations;seetext.
Apple'siPodgrossmarginsaregenerallyhigherthanthoseforthetwonotebookmodels.
ThelowerNanomarginmaybeduepartlytoitsbeingtargetedatthemassmarket,ratherthanApple'susualpremiumniche,butitmayalsorepresentanoverestimationofthepricethatAppleactuallypaidfortheflashstoragethataccountsfortwo-thirdsoftheNano'sfactorycost(seeAppendixTableA-3).
ApplereportedlynegotiateddeepdiscountsfromflashsuppliersinexchangeforhighvolumeatthetimeoftheNano'sintroduction.
24Apple'shighergrossmarginispartlydissipatedbyitsextraoverheadcosts.
25Asmentionedabove,Apple'sin-housesoftwarewascriticaltotheiPod'ssuccess,butabsentfromthebillofmaterials.
Apple'sinternalelectricalandmechanicalengineeringcapability,whichdetermineimportantdetailslikethequalityofanaudiocircuit,theabilitytopackcomponentsinalimitedspace,andthematerialschosenforthecase,addvaluetotherawcomponentsthatmakeaniPod.
Otherleadfirmsvaryinthelevelofinternalengineeringcapabilitytheymaintain.
Forexample,HPreliesmoreonODMsfordevelopmentengineering(mechanicalandelectricalengineering,PCBlayout,andsoftwareengineering),whereasLenovoreliesmoreontheinternalcapabilityacquiredwiththeIBMPCdivision(althoughLenovoalsooutsourcestoODMs).
Bothhavetheirowndesignengineeringcapabilitiesforthecriticaltaskofestablishinginitialspecificationsthatbalancemarketdemandsandtechnologytrends.
ForthemakersofIntel-basedcomputers,itishardtogetaroundthefundamentaleconomicsthatsiphonoffalargeshareofindustryprofitstoMicrosoftandIntel,whose23Theproduct-specificgrossmarginsinTable5arecalculatedasdescribedinthetext.
TheyaredifferentfromthegrossmarginsforinputslistedintheAppendixtables,becausethosearecompany-widevaluesfrompublishedcorporatereports.
24DavidLammers,"iPodupsetsNANDflashApplecart,"EETimes,August19,2005.
25Forthecompanyasawhole,a29%grossmarginforfiscalyear2006fallsto10%netmarginafterallexpenses.
19ownershipandmaintenanceofvaluablestandards(operatingsystemandprocessorarchitecture,respectively)allowthemtochargeaconsiderablepremiumfortheircomponents.
Networkeffectsthatfavortheseinputsmakeithardforcomputercompaniestofindalternatesuppliers.
IntheHPnc6230,forexample,weestimateHP'sgrossprofitasapercentageofwholesalepricetobe16percent.
IntelandMicrosoftcombinedhaveagrossmarginofabout66percentoncomponentswhosevalueequalsabout30percentofthewholesaleprice,whichmeanstheircombinedgrossprofitworksoutto20percentofthewholesaleprice.
Inotherwords,theIntel-Microsoftgrossprofitis125percentoftheHPgrossprofit.
Asnotedearlier,theiPodisnotjustahardwareinnovation,butanintegratedsystemcomprisedoftheiPodproductfamilyandcloselyintegratedwithitsiTunessoftwareandiTunesMusicStore.
ApplebuiltupitsiPodecosysteminstages,asacceptanceoftheproductjustifiedadditionaleffort.
TheinitialiPod,introducedinFall2001,wasintegratedwithiTunesonlyonApple'sownMacintoshplatform.
Twoyearslater,AppleaddedsupportfortheWindowsplatform,greatlyexpandingtheavailablemarket.
NoneofthetechnologiesbehindtheiPodoriTuneswerecontrolledexclusivelybyApple.
ThischangedinApril2003withtheintroductionofiTunesMusicStore(iTMS)withcooperationfromallthemajormusiclabels.
TheiTMSusesanexclusivesystemofdigitalrightsmanagementcalledFairPlay,whichlimitsthenumberofcomputersonwhichthepurchasedtrackscanbeplayed.
Moreimportantly,FairPlay-encodedtrackswillnotplaybackonanyportableplayersotherthantheiPodorApple-licensedplayerssuchasMotorola'sROKRphone,sinceApplehaschosennottolicensethesystemtoitsrivals.
ThecombinationofApple'sradicalinnovation,thefirstlegalmusicdownloadingservicewithalargelibrary,anditscontroloftheunderlyingdigitalrightsmanagementsystemproducedanetworkeffectthathelpedkeeptheiPodaheadofitsmanycompetitors.
Totakeadvantageofthisopportunity,Applereportedlyspent$200milliononadvertisingintheiPod'sfirstfouryears,whichwasfarmorethantheadvertisingofitsmusic-playerrivals.
26TheiPodcasemakesclearhowasuccessfulradicalinnovationcreatesthepotentialforafirmtoretainasignificantshareofprofitsevenwhenrelyingonaglobalnetwork.
Applemaintainscontroloveritssupplychainbycontrollingessentialelementssuchascoresoftware,aproprietarystandard,orcomplementaryinfrastructure.
27Table7showshowApple'stotalgrossprofitcomparestothatofotherfirmsinthevaluechainforsalesinsideandoutsidetheU.
S.
AccordingtoInternationalDataCorporation(IDC),about40percentofitshard-drive-basediPodsalesareoverseas.
28Inthetable,thegrossmarginfor"Retail"hasbeensubdividedtoreflectourestimateoftheshareofApplesalesthataremadethroughitswebsiteoritsgrowingchainofAppleStores.
26Levy(2006),Chapter,"Cool.
"27Forrelatedanalyses,seeChesbroughandTeece(1996)andJacobides,etal.
(2006).
28Estimatedfromdatafor2006in"WorldwideandU.
S.
PortableMediaPlayer2007-2011ForecastandAnalysis.
"IDCReport#206016,March2007.
20Table7.
TheDistributionof$190ofCapturedValueinaSingle30GBVideoiPodSalesintheU.
S.
SalesoutsideU.
S.
ValueChainSegmentAppleAllotherfirmsAppleAllotherfirmsAppleGrossMargin(development,software,marketing)$76$76PartsSuppliers(keyinputsonly,TableA-2)$35$35Manufacturing(assembly,test)$4$4Distribution$30$30Retail*$23$22$11$34TOTALVALUECAPTURE$99$91$87$103*"Retail"issplitbetweenAppleandotherfirmsbasedonourestimatethatone-halfofallretailsalesintheU.
S.
andone-quarterofallretailsalesoutsidetheU.
S.
arebyApplethroughitsstoresandonlinewebsite.
Source:Authors'calculations;seetext.
Table7showsthatApple,theleadfirmintheiPodvaluechain,faressignificantlybetterthananyofitspartners.
Applecaptures52percentofthemeasuredvaluefromU.
S.
salesand46percentfromsalesoutsidetheU.
S.
–wellbeyondthe18percentcapturedbyallsuppliersofkeypartsorthesharesfordistributionandnon-Appleretail.
Thisunderscorestheimportanceofinnovationbyaleadfirm.
TheGeographyofValueCaptureOuranalysiscanalsobeusedtostudythedistributionofvaluecapturebycountry.
Table8showsthisfortheVideoiPod.
Table8.
TheGeographyof$190ofCapturedValueina30GBVideoiPodforaUnitSoldintheU.
S.
U.
S.
JapanKoreaTaiwanTotalAppleGrossMargin(development,software,marketing)$76$76PartsSuppliers(keyinputsonly,TableA-2)$7$27$1$35Manufacturing(assembly,test)$4$4Distribution$30$30Retail$45$45TOTALVALUECAPTURE$158$27$1$4$190Note:ForthistableitisassumedthattheunitissoldintheU.
S.
Source:Authors'calculations.
21Asnotedabove,hundredsoflow-valueinputswithatotalestimatedpriceof$24havenotbeenincluded,butthedominanceoftheU.
S.
shareisrobusttoanypossibledistributionofsuppliergeographyoftheseinputs.
Eveniftheas-yet-unanalyzedinputshaveagrossmarginashighas40percentandwereallfromasinglecountry,whichisunlikely,themostthiswouldaddtothatcountryis$9.
12.
Inthecaseofretailunitssoldinothercountries,asignificantportionoftheU.
S.
sharewouldshiftelsewhere.
ForaunitsoldinJapanthroughanon-Appleretailer,thetotalvaluecapturedbyJapanesecompaniesmightevenbelargerthantheU.
S.
share,asshowninTable9.
Table9.
TheGeographyof$190ofCapturedValueina30GBVideoiPodforaUnitSoldinJapan(TotalsOnly)U.
S.
JapanKoreaTaiwanTotalTOTALVALUECAPTURE$83$102$1$4$190Note:ForthistableitisassumedthattheunitissoldinJapanthroughanon-Appleretailer.
Source:Authors'calculations.
ApplyingthismethodologytoallfiveproductsinourstudyyieldstheresultsshowninTable10.
Table10.
TheGeographyofValueCaptureforFiveProductsRetailPriceDistrib.
RetailLeadFirmGrossMarginU.
S.
InputsJapanInputsKoreaInputsTaiwanInputsTotal30GBiPod,2003$399$40$60$114$4$32$2$5$25730GBVideoiPod$299$30$45$76$7$27$1$4$1904GBiPodNano,2005$249$25$37$30$3$4$32$3$134HPnc6230,2005$1,399$140$210$171$216$81$11$23$852LenovoT43,2005$1,479$148$222$212$214$81$15$22$914Source:Authors'calculationsTofacilitatecross-productcompatibility,Table11restatesthegeographicbreakdownsintermsofpercentages.
22Table11.
TheGeographyofValueCaptureforFiveProducts(percentagesrelativetototalmeasuredvaluecaptureasdescribedintext)TotalValueCaptureDistrib.
Retail*LeadFIrmGrossMarginU.
S.
InputsJapanInputsKoreaInputsTaiwanInputs30GBiPod,2003$25716%23%44%2%12%1%2%100%30GBiPod,2005$19016%24%40%4%14%1%2%100%4GBiPodNano,2005$13419%28%22%2%3%24%2%100%HPnc6230,2005$85216%25%20%25%10%1%3%100%LenovoT43,2005$91416%24%23%23%9%2%2%100%*RetailvaluecaptureearnedbyAppleforunitssoldthroughAppleStoreoutlets.
NOTE:AppleandHewlett-PackardareU.
S.
-basedfirms.
Lenovois,intermsofownershipatthetimeofthePortelligentreports,25percentU.
S.
and75percentChinese(seefootnote29).
Source:Authors'calculations.
ThetotalU.
S.
shareisdeterminedbyacombinationofthecountrywheretheunitissoldandtheidentityoftheleadfirm.
ThisisshowninTable12,inwhichtheretailanddistributionsharesforthetwonotebooksareassignedbasedonwheretheunitissold.
ThehighmarginsofIntelandMicrosoft(AppendixTablesA-4andA-5)securealargeshareofvaluefortheU.
S.
However,thebulkofvaluefromnon-U.
S.
salesstillgoesoverseas,andtheeffectisincreasedwhenthebrandbelongstotheSino-AmericanfirmLenovoratherthantheU.
S.
-basedHewlett-Packard.
29Table12.
ValueCapturebyLocationofSaleHPnc6230LenovoT43IfsoldintheU.
S.
IfsoldelsewhereIfsoldintheU.
S.
IfsoldelsewhereU.
S.
ValueCapture$737$387$637$267OtherValueCapture$115$465$277$647U.
S.
ShareofValueCapture87%45%70%29%Source:Authors'calculations.
Asnotedabove,thereareadditionalpartsthathavenotbeenanalyzed.
Asarobustnesscheck,weassumedarelativelyhigh40percentall-non-USmarginontheseextrainputs(whichworkouttojustover$70inbothcases)andtheresults(notshown)arequalitativelythesame.
29In2005,LenovoacquiredIBM'sPCbusiness.
IBMacceptedsharesequaltoabout15%inpartialpayment.
Atthesametime,Lenovoreceivedanequityinfusionequalto10%fromthreeU.
S.
basedinvestmentfirms.
WeassignLenovo'sprofitsheretotheU.
S.
andChinausinga25-75split.
23Table12makesclearhowimportanttheheadquarterslocationofafirmcanpotentiallybefortheheadquarterscountry.
OurestimateoftheU.
S.
shareofvaluecapturefromtheHPnotebookis87percentofthetotalwhenthesaleisintheU.
S.
,andthisfallstosomewhatlessthanhalfwhenthesaleiselsewhere.
Bycontrast,theU.
S.
sharewhentheLenovonotebookissoldintheU.
S.
is70percentandfallsto29percentwhenthesaleiselsewhere.
ThecomparisonwouldbeevenmoreextremeifwecomparedtheresultsfortheiPodinTables8and9withahypotheticalcaseinwhicheverythingwasthesameexceptthattheleadfirmwasJapan'sSony.
Althoughdistributionandretailloomlargeintermsofvaluecapture,headquarterslocationoftheleadfirmisthemostrelevantvariableforpolicy.
Apolicythatreducedoverseassaleswouldobviouslybecounter-productive,whereaspoliciestostimulatethecreation,growth,andretentionofinnovativefirmsarewellwithinthereachofgovernments.
Thegrossprofitthatwearecalling"valuecapture"isofparamountimportanceforcountries.
Someofitgoestoshareholders,butmostlyitgoestohigh-payingjobsinproductdevelopment,marketing,andmiddlemanagementthatcoordinatetheleadfirm'sdevelopmentandmanufacturingpartners.
Althoughsomeofthisworkwillbedoneoffshore,mostofthesecorejobsarestilllocatednearcompanyheadquarters(DedrickandKraemer,2006).
Geography,valuecapture,andinnovationAtthecountrylevel,thegreatestvalueiniPodsandnotebookPCsiscapturedbytheU.
S.
andJapan.
Koreaalsohasasignificantrolethankstoitsstrengthsinafewcoretechnologies,whileEurope,Taiwan,andChinaarelessvisible.
Wenowlookbrieflyatthegeneralizabilityoftheseresults.
Thevalue-captureresultsreflecttheglobaldistributionofcompanies.
TheU.
S.
andJapanarehometomostoftheworld'smajorbrand-nameelectronicscompanies,andalsotothemostadvancedsuppliersofmostcoretechnologiessuchassemiconductors,storage,displaysandsoftware.
Europe,wheresignificantinnovationstilloccurs,hasseenagradualretreatofitsleadelectronicsfirms,withThomson(RCAbrand),Siemens,andPhilipsallconsolidatingordiversifyingtheiractivities.
Koreaalsohastwomajorglobalbrand-namemanufacturers:Samsung,whichisastrongcompetitorinotherproductcategoriessuchasmobilephonesandTVsets,andLGElectronics,itssmallerrival.
Taiwanhasproducedonesignificantleadfirm,Acer,andseveralmajorproducersofcomponents,suchasTSMC(logicchips)andAUO(flat-paneldisplays),butTaiwanesefirmshavegenerallyadoptedfast-followerortrailing-edgestrategiesthatmaybedenyingthemtheopportunitytocapturevaluefrominnovationandbrandleveraging.
24Aswehaveseen,China,wheremostoftheworld'snotebookPCsandallofApple'siPodsareassembled,capturesverylittlevaluefromeither.
InspiteofthesuccessofafewChinesebrands(e.
g.
LenovoandHuawei),Chinahasyettomovemuchbeyonditsroleasprovideroflowcostlabortosupportthefirmswhocapturemostofthevalueofinnovation.
Thediscussionsofarhasfocusedprimarilyonbrand-namecapital,butitisalsosupportedbydataoninnovation.
Table13summarizesthetop50granteesofU.
S.
inventionpatentsfor2005.
30Thegranteecompanies(notshown)areprimarilyelectronicscompanies,withautomotivecompaniesalsorepresented.
31Table13.
Top50U.
S.
PatentGranteesbyCountry,2005CountryorRegionNumberofGranteesNumberofPatentsUnitedStates2518,310Japan1614,710Europe53,359Korea32,490Taiwan1441Source:Calculatedfromdatain"IFIIssuesListof2005'sTopPatentCompanies,"IFIPatentIntelligencePressRelease,January102006.
Althoughthequantityofpatentsdoesnotaddressthewidely-varyingvalueoftheunderlyinginventions,thedataaresuggestiveandgenerallysupportthequalitativediscussionabove.
TheUnitedStatesandJapanhavethemostcompaniesandpatents.
EuropeandKoreaformasecondtier.
TaiwanisrepresentedonlybyTSMC,andChinaisabsent.
TaiwanesefirmsaregenerallysmallerthantheconglomeratesofKoreaandJapan,sowealsolookedatabroaderselectionofTaiwanesefirms.
Thetop10TaiwanesegranteesofU.
S.
inventionpatentsreceivedatotalof1,571patentsin2005,stillwellbelowKorea'stopthree(Samsung,LGElectronics,andHynixSemiconductor).
32Therefore,bothcasualobservationandpatentdataindicatethatthegeographicdistributionofvaluecapturethatwenotedinourstudyisfirmlyrootedintheinnovativeactivitiesofthecompaniesineachregion.
30AllgranteesareprivatecompaniesexceptfortheRegentsoftheUniversityofCalifornia,whoweregranted410patentsin2005.
31BecausesomeoftheJapaneseconglomerates,suchasToshibaandHitachi,alsoproduceheavyindustrialgoods,itwasnotpossibletomakeanelectronics-onlysub-list.
32DataforTaiwan'stop10patentgranteesfromYen-tingChenandAdamHwang,"TSMCtopsTaiwancompaniesinUSpatentsin2005,"DigiTimes.
com,September22,2006.
25ConclusionsAswehaveshown,thedistributionofvaluecapturedintheiPodandnotebookPCmodelsisquitedifferentbetweenfirms,yetrelativelyconsistentatthenationallevel.
Therefore,ourstudyhasdifferentimplicationsformanagersandpolicymakers.
ThefirmlevelThefirmleveliswherethedifferencebetweenradicalandincrementalinnovationcanbeseen.
ThegreatestvalueforthemoreradicaliPodinnovationiscapturedbythebrand-namesystemintegrator,Apple,whichcontrolstheproductarchitectureandwassuccessfulinfindingtherightcombinationofhardware,softwareandcontentdistributiontohaveawinningproduct.
FornotebookPCs,amatureproductcategory,thegreatestvalueiscapturedbyMicrosoftandIntel,whowereabletousurpcontrolofthearchitecturefromthesystemvendors(namelyIBM)andnowlargelycontrolthetrajectoryofsoftwareandhardwareevolution.
Thisdominanceovervaluecaptureisgenerallyassertedintheformativeyearsofanewtechnology,whenthetechnologydirectionisnotyetdefined,andthentendstohardeninplaceoncetheincrementalstageisreached.
InPCs,Microsofthasnorealcompetitors,andIntelfacesonlylimitedcompetitionfromAMD.
Inportablemusicplayers,thereseemtobefewer"iPodkillers"overtime,andthosewhopredictedApplewouldsuccumbtoMicrosoftasitdidinPCshavebecomequitesilentasMicrosoftgaveuponitsopenarchitectureapproach("PlaysforSure")andhashadlittlesuccesswithitsproprietaryZune.
Ofcoursethebattleisnotover,butitseemstobeshiftingtootherfrontssuchasmobilephonesandthedigitalhome.
Theimplicationformanagersisthatstrategyshouldbeconceivedintermsnotofproducts,butofecosystems.
WhatbundlesofmarketrequirementsarenotyetbeingmetWhatcomplementaryproductswouldraisethevalueofwhatyourfirmcanofferOpportunitiestodefineanddominateanewproductcategorythroughradicalorarchitecturalinnovationarerare,butcanoccuratanytimeandcanbepioneeredbyanycompany.
EarlierexamplesincludeSeagateinharddrives,Nokiainmobilephones,andNintendoinvideogames.
33ThenationallevelOurresultsshowthat,onaverage,countriestendtooccupywell-definedspacesinglobalsupplychains.
Theinnovativecountriesinnovate,whiletheothercountriesnipattheirheelsandcaptureasmallshareofthevaluecreated.
Theserelationshipsarenotwritteninstone,butareslowtochange.
33Seeforexample,Mitchell(1991)andRosenbloomandChristensen(1994)fordiscussionsofhownewcomersandindustryincumbentsfarefollowingtheintroductionofinnovations.
26Forpolicymakers,thismeansthatsupportpoliciesshouldbegearedtowardimprovingormaintainingacountry'sposition.
LeadcountriessuchastheU.
S.
andJapanhavebeenwellservedbypoliciessupportingR&Dandinnovation.
Policymakersalsoshouldembracethefactthatnosinglecompanyorcountryisthesourceofallinnovation,andallcompaniesneedtoworkwithinternationalpartners.
Thisissimplyafactoftheelectronicsindustryinthe21stcentury,andpolicymakersshoulddowhattheycan,intermsoftradeandotherpolicies,tofacilitatetheparticipationoflocalcompaniesinthesenetworks.
Developingcountriesbenefitfromtheirrolesaslow-costmanufacturersandoffshoreproductdevelopmentcenters,creatingjobsandexportearnings,butdonotcapturemuchofthevaluecreatedthroughinnovation.
Policymakersindevelopingcountriesneedtolookforwaystoleveragelocalknowledgeintocommercialsuccess.
ExamplessuchasKorea'sSamsung,Taiwan'sAcerandTSMC,China'sLenovoandHuawei,andIndia'sWiproandInfosysshowthatcompaniesfromdevelopingnationscancompeteontheglobalstage.
AsinthecaseofSamsung,theycan,onoccasion,evenhumblethestrongestU.
S.
orJapanesecompetitors.
Chinaprovidesanexampleofacountrywithanactiveindustrialpolicythatisnotlimitedtoitscurrentplaceinglobalvaluechains.
ThegovernmentofChinaisnotsatisfiedwithChina'sroleasasourceofcheaplaborandispromotingthedevelopmentofglobalbrand-namecompanies.
Withitshugedomesticmarkettoprovideastronghomebase,itislikelythatatleastsomeofthesenationalchampionswillsucceed.
ThegovernmentisalsosupportingeffortstodevelopChina-onlyproductstandardsthatcouldpotentiallybecomeglobalstandards,althoughforthetimebeingitsreachexceedsitsgrasp(Linden,2004).
AslongastheU.
S.
marketremainsdynamic,withinnovativefirmsandrisk-takingentrepreneurs,globalinnovation,bothradicalandincremental,shouldcontinuetocreatevalueforAmericaninvestorsandwell-paidjobsforknowledgeworkers.
Butifthosecompaniesgetcomplacentorlosefocus,thereareplentyofforeigncompetitorsreadytotaketheirplaces.
Ifthishappens,thebenefitsfromtheglobalinnovationsystemcouldquicklyshiftawayfromtheU.
S.
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30AppendixTableA-1.
KeyInputsinthe30GB3rd-GenerationiPod,2003TypeInputSupplierSupplierHQCountryEstimatedInputPricePriceas%ofFactoryCostSupplierGrossProfitRateEstd.
ValueCaptureStorageHarddriveToshibaJapan$112.
0061%26.
9%$30.
18ProcessorControllerchipPortalPlayerUS$6.
183%41.
4%$2.
56DisplayMonochromedisplayassemblyUnknownJapan*$5.
813%20.
0%*$1.
16MemorySDRAM-32MBSamsungKorea$5.
233%32.
3%$1.
69BatteryBatterypackUnknownJapan*$3.
462%30.
0%*$1.
04Sub-Total$132.
6872%OtherParts$42.
6423%Estimatedassemblyandtest$9.
605%$4.
80Estimatedfactorycost$184.
92100%$41.
43*-suppositionSource:Portelligent,Inc.
,2003andauthors'calculations.
31TableA-2.
KeyInputsinthe30GB5th-GenerationiPod(VideoiPod),2005TypeInputSupplierSupplierHQCountryEstimatedInputPricePriceas%ofFactoryCostSupplierGrossProfitRateEst'd.
ValueCaptureStorageHardDriveToshibaJapan$73.
3950%26.
50%$19.
45DisplayDisplayAssemblyToshiba-MatsushitaJapan$23.
2716%28.
70%$6.
68ProcessorsVideo/MultimediaProcessorBroadcomUS$8.
366%52.
5%$4.
39ProcessorsControllerchipPortalPlayerUS$4.
943%44.
8%$2.
21BatteryBatteryPackUnknownJapan*$2.
892%30.
0%*$0.
87MemoryMobileSDRAMMemory-32MBSamsungKorea$2.
372%28.
2%$0.
67MemoryMobileRAM-8MBytesElpidaJapan$1.
851%24.
0%$0.
46MemoryNORFlashMemory-1MBSpansionUS$0.
841%10.
0%$0.
08Sub-Total$117.
9180%Otherparts$22.
7915%Estimatedassemblyandtest$7.
405%$3.
70Estimatedfactorycost$148.
10100%$38.
50*-suppositionSource:Portelligent,Inc.
,2006andauthors'calculations.
32TableA-3.
TheMostExpensiveInputsinthe4GBiPodNano,2005TypeInputSupplierSupplierHQCountryEstimatedInputPricePriceas%ofFactoryCostSupplierGrossProfitRateEstd.
ValueCaptureStorageNANDFlash–4GBSamsungKorea$105.
2067%30.
0%$31.
56DisplayDisplayModuleOptrexorSharporToshiba-MatsushitaJapan$13.
849%23.
0%$3.
18ProcessorsMainprocessorPortalPlayerUS$5.
113%44.
8%$2.
29ProcessorsATAFlashDiskControllerSSTUS$1.
621%18.
0%$0.
29MemoryMobileSDRAM-32MBSamsungKorea$2.
622%30.
0%$0.
79MemoryFlash-512KBSSTUS$0.
801%18.
0%$0.
14BatteryBatteryPackAmperex(acq.
TDK2005)Japan$2.
061%26%$0.
54Sub-Total$131.
2584%Otherparts$18.
7912%Estimatedassemblyandtest$6.
244%$3.
12Estimatedfactorycost$156.
28100%$41.
91Source:Portelligent,Inc.
,2005aandauthors'calculations.
33TableA-4.
TheMostExpensiveInputsintheHewlett-Packardnc6230NotebookPC,2005TypeInputSupplierSupplierHQCountryEstimatedInputPricePriceas%ofFactoryCostSupplierGrossProfitRateEst'd.
ValueCaptureProcessorsMainchipset+Wi-FiIntelUS$205.
4323.
4%59%$121.
20ProcessorsGraphicsProcessorATITechnologiesUS$20.
502.
3%28%$5.
74ProcessorsEthernetcontrollerBroadcomUS$2.
010.
2%53%$1.
07ProcessorsCardbusControllerTexasInstrumentsUS$3.
280.
4%48%$1.
57ProcessorsI/OControllerStandardMicro-systems(SMSC)US$1.
420.
2%46%$0.
65ProcessorsBatteryChargeControllerTexasInstrumentsUS$1.
220.
1%48%$0.
59DisplayDisplayAssemblyToshiba-Matsu-shitaDisplayJapan$137.
1415.
6%28%$38.
40SoftwareWindowsXPProOEMlicenseMicrosoftUS$100.
0011.
4%85%$85.
00Storage60GBHardDriveFujitsuJapan$68.
007.
7%26%$17.
68StorageDVD-ROM/CD-RWDriveMatsushitaJapan$40.
004.
6%31%$12.
40BatteryBatteryPackUnknownJapan*$40.
524.
6%30%*$12.
16MemoryMemoryModule(512MB)SamsungKorea$29.
653.
4%30%$8.
90MemoryDDRSDRAMMemory2x32MBHynixSemiconductorKorea$5.
680.
6%41%$2.
33Sub-Total$654.
8575%Otherparts$177.
7220%Estimatedassemblyandtest$45.
265%$22.
63Estimatedfactorycost$877.
83100%$330.
31*-suppositionSource:Portelligent,Inc.
,2005candauthors'calculations.
34TableA-5.
TheMostExpensiveInputsintheLenovoThinkPadT43NotebookPC,2005TypeComponentSupplierSupplierHQCountryEstimatedFactoryPricePriceas%ofFactoryCostSupplierGrossProfitRateEstd.
ValueCaptureProcessorsMainchipset+Wi-FiIntelUS$205.
3422.
9%59%$121.
15ProcessorsGraphicsprocessorATITechnologiesUS$21.
702.
4%28%$6.
08ProcessorsMicrocontrollerRenesasJapan$2.
830.
3%24%$0.
68ProcessorsPowerSupplyControllerToshibaJapan$2.
110.
2%26%$0.
55ProcessorsSingleChipLANControllerBroadcomUS$2.
010.
2%53%$1.
07ProcessorsPCCardControllerRicohJapan$1.
810.
2%42%$0.
76ProcessorsPowermanagementASICIBMUS$1.
420.
2%40%$0.
57ProcessorsMicrocontrollerPhilipsEurope$1.
160.
1%32%$0.
37DisplayDisplayModuleToshiba-MatsushitaDisplayJapan$138.
3215.
4%28%$38.
73SoftwareWindowsXPProMicrosoftUS$100.
0011.
1%85%$85.
00Storage60GBHardDriveHitachiJapan$68.
007.
6%23%$15.
64StorageCD/DVDDriveHitachi-LGDataStorageJapan$40.
004.
5%25%$9.
80BatteryLi-IonBatteryPackSonyJapan$41.
064.
6%37%$15.
19MemoryMemoryModule(512MB)HynixKorea$29.
683.
3%41%$12.
17Memory32MBDDRSDRAMHynixKorea$5.
680.
6%41%$2.
33Sub-Total$661.
1273.
7%Otherparts$192.
2121.
4%Estimatedassemblyandtest$43.
724.
9%$21.
86Estimatedfactorycost$897.
05100.
0%$331.
94Source:Portelligent,Inc.
,2005bandauthors'calculations.