Smaller Companies Suffering From Low Tech Capability

○ Virtuous cycle broken

Before the Asian currency crisis in 1997, strong exports had a positive spillover effect on Korea’s industries overall.

Between 1970 and 1997, the correlation coefficient between exports and domestic demand was 0.98, according to Samsung Economic Research Institute. The closer the correlation is to one, the stronger the proportional relationship between domestic demand and exports.

Since the financial crisis, however, this correlation began to significantly weaken. From 1998 to 2005, exports grew at an annual average of 11.6 percent but domestic demand fell 0.02 percent. In this year’s second quarter, exports rose 9.1 percent from the first quarter, but domestic demand went up just 1.4 percent.

Exports are driven more by large companies since they require massive capital and facilities, while small and medium enterprises are generally domestic demand-oriented. Against this backdrop, the latter has been hit hard from the weakening of this “virtuous cycle.”

The weakened feedback loop is partially due to increasing overseas investment by large companies. Samsung Electronics produced 103 million mobiles phones in 2005, 77 million (75 percent) of which came from its plant in Gumi, North Gyeongsang Province.

Domestic production dropped to 52 percent in 2007 and to 22 percent in 2008, however, even as the number of units shot up to 161 million and 227 million units, respectively, over the same period.

Sluggish job creation is another factor. Domestic investment by large companies is mainly concentrated in automated facilities and information technology that require a smaller workforce, meaning employment is not proportionately rising with sales increases.

Bank of Korea data shows that the employment inducement coefficient of the IT manufacturing industry was 5.7 in 2007, lower than that of traditional manufacturers at 9.2. This means just six jobs were created for every billion won (850 million U.S. dollars) in investment in IT manufacturing, while the same investment in car production created 10 jobs.

○ Need to foster innovative smaller companies

No matter how much a large company invests, it will benefit small companies in advanced economies only if small Korean companies do not improve their technological capability.

Korean display companies will invest 8.2 trillion won (6.9 billion dollars) this year and must to import most of the core components from Japan, such as AMOLED equipment.

A source at a domestic electronics company said, “We have no other choice but to import components from Germany or Japan since theirs are of higher quality. For semiconductor parts, virtually all of them are imported.”

Though the portion of domestic components used reached 70.1 percent last year, those going into IT products such as mobile phones, electronics products and telecom equipment was just 43.6 percent, according to the Knowledge Economy Ministry.

Jeong Yu-hoon, senior researcher at Hyundai Research Institute, said “Small and mid-size companies must upgrade their technological capability so that exporters can buy components from them. Technological upgrade is also essential for smaller companies to shake off their image as simple contractors to equally compete with large companies.”

A survey conducted by the Korea Industrial Technology Association shows that among 835 small and medium companies that are 10 years old and have their own think tanks, seven or 0.8 percent eventually became large companies, a rate eight times that of typical small companies (0.1 percent).

The overall conditions for smaller companies remain inadequate, however. For starters, they are severely lacking in skilled talent who can develop technology. The CEO of an automotive parts maker based in Daejeon says, “We will advance overseas but it’s really difficult to hire people with both good English and marketing skills. In Korea, the social system and the people’s sentiment are hardened toward large companies.”

The lack of efforts by smaller companies to invest in R&D is also to blame. As of last month, 38.8 percent of large companies had R&D centers as opposed to 0.6 percent for smaller companies. The latter seems to prefer immediate profit over investing for the future.

○ Lessons from Japan

Until the mid-1980s, Japan had a pyramid-like business structure with large companies at the top and contractors right beneath in three layers. As the yen began to strengthen from the mid-1980s, however, large companies moved production abroad and imported components.

Under these circumstances, smaller companies lost their foothold and found themselves in a bind similar to that of their Korean counterparts now.

In response, Tokyo in 1999 revised laws to provide more support for smaller businesses advancing into new growth engines such as green technology. The revision offered drastic benefits for technological development by offering training expenses and tax cuts.

A private sector collaborative system also helps. Shonan Business Forum, comprised of businessmen in the city of Fujisawa, Kanagawa Prefecture, jointly fosters spatial experts with Shonan Institute of Technology and introduces them to smaller companies with spatial technological capability.

Hur Dae-sik, a business professor at Yonsei University in Seoul, says, “Small and medium enterprise policy should be shifted from one treating all small businesses the same to one in which the government and large companies foster smaller ones possessing innovative technological capability.”

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