Wanxiang Innovation Energy Fusion City Recommendations for Developing an Innovation Cluster

Rafiq Dossani, Marlon Graf, Eugeniu Han For more information on this publication, visit www.rand.org/t/RR2035

Library of Congress Cataloging-in-Publication Data is available for this publication. ISBN: 978-0-8330-9901-3

Cover: Artist rendering of future Wanxiang Innovation Energy Fusion City (via Wanxiang Group)

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www.rand.org Preface

The Wanxiang Group (the Group) has been awarded a contract by the City of Hangzhou to develop a new industrial park, named the Wanxiang Innovation Energy Fusion City (WIEFC), over the next seven years (2017–2024). The Group asked the RAND Corporation in 2016 to help achieve its vision of developing WIEFC into an innovative cluster built around smart and green automotive technologies. To achieve this vision, RAND was asked by the Group to develop a mission statement and recommend supporting policies. There are several hundred industrial technology parks around the world, and developing innovative clusters occupies a prominent place among the goals of their planners. As a result, innovative clusters have been widely studied. Much is known about what policies and structures have been adopted, although less is known about what has worked. Identifying policies and structures that will successfully spark an innovative cluster is, therefore, at the heart of the present study. For this purpose, we sought to draw lessons from global experience, while also understanding the local context within which WIEFC will operate. This report builds on earlier RAND work on technology policy and technology parks, both in China and elsewhere. In 2010, RAND evaluated the Qatar Science and Technol- ogy Park, and made recommendations on technology business incubation. In a 2012 report, RAND developed recommendations for a new innovation cluster known as the Sino-Singapore Guangzhou Knowledge City, located in Guangzhou, China. That report identified areas for policy action in finance, administration, intellectual property, talent development, and market access. In 2016, RAND examined the sources of innovation in the Los Angeles economy, with a focus on the digital technology and health care sectors. Finally, earlier this year RAND assessed the role played in patient care by the Oxford Biomedical Research Center, located in Oxford, England. This report undertakes the following tasks. First, in support of the Group’s vision for WIEFC, we recommend a mission that describes the aims of WIEFC. Second, this report identifies the contributing factors required to achieve that mission. Through an intensive, in- person study of two locations—the Stuttgart automotive cluster in Germany and the Aichi automotive cluster in Japan—supplemented by lessons from the academic literature on other clusters, we divided our findings into originating and sustaining factors. We then recommend policies for the implementation of these factors. Finally, we identify outcomes to measure the progress of the recommended policies. This report makes new contributions to the understanding of developing industrial technology parks in China through its recommendations on developing centers of excellence, talent development, and business development. Although our findings are primarily intended

iii iv Wanxiang Innovation Energy Fusion City: Recommendations for Developing an Innovation Cluster to benefit readers interested in industrial technology parks in China, they will also be useful for audiences interested in technology park development more generally.

RAND Infrastructure Resilience and Environmental Policy

The research reported here was conducted in the RAND Infrastructure Resilience and Envi- ronmental Policy program, which performs analyses on urbanization and other stresses. This includes research on infrastructure development; infrastructure financing; energy policy; urban planning and the role of public–private partnerships; transportation policy; climate response, mitigation, and adaptation; environmental sustainability; and water resource management and coastal protection. Program research is supported by government agencies, foundations, and the private sector. This program is part of RAND Justice, Infrastructure, and Environment, a division of the RAND Corporation dedicated to improving policy- and decisionmaking in a wide range of policy domains, including civil and criminal justice, infrastructure development and financing, environmental policy, transportation planning and technology, immigration and border protection, public and occupational safety, energy policy, science and innovation policy, space, and telecommunications. Questions or comments about this report should be sent to the project leader, Rafiq Dossani ([email protected]). For more information about RAND Infrastructure Resil- ience and Environmental Policy, see www.rand.org/jie/irep or contact the director at irep@ rand.org. Contents

Preface...... iii Figures and Tables...... vii Summary...... ix Acknowledgments...... xv Abbreviations...... xvii

CHAPTER ONE Introduction...... 1 Project Description...... 1 Background...... 2 Approach...... 5 Attributes of WIEFC...... 6 Summary and Looking Ahead...... 7

CHAPTER TWO Regional Case: The Stuttgart Automotive Cluster...... 9 The Stuttgart Region and the State of Baden-Württemberg...... 9 Historical Development of the Stuttgart Automotive Cluster...... 10 Supply Chains and Inter-Firm Networks...... 12 People and Workforce...... 14 Exploring Alternative Technologies...... 15 Summary of Stuttgart Case Study Findings...... 17

CHAPTER THREE Regional Case: The Aichi Automotive Cluster...... 21 Aichi Prefecture and the Aichi Automotive Cluster...... 21 Historical Development of the Aichi Automotive Cluster ...... 22 Supply Chains and Inter-Firm Networks...... 24 People and Workforce...... 26 Exploring Alternative Technologies...... 27 Summary of Aichi Case Study Findings ...... 28

CHAPTER FOUR Developing the Wanxiang Innovation Energy Fusion City Cluster...... 31 The Stuttgart Automotive Cluster...... 31 The Aichi Automotive Cluster...... 33

v vi Wanxiang Innovation Energy Fusion City: Recommendations for Developing an Innovation Cluster

The Taiwan Personal Computer Cluster...... 34 The Silicon Valley Model...... 35 Summary...... 37 Recommendations for WIEFC...... 38 Vision Statement...... 40 Mission Statement ...... 40 How to Start and Sustain the WIEFC Cluster: What to Do...... 41 What Not to Do...... 45 Outcomes...... 46 Policy Summary...... 47 Next Steps...... 48

APPENDIXES

A. Hangzhou and the Province of Zhejiang...... 51 B. Porter’s Regional Competitive Advantage Framework...... 59 C. List of Interviewees...... 61

References...... 63 Figures and Tables

Figures

1.1. Location of the Wanxiang Innovation Energy Fusion City...... 1 2.1. Baden-Württemberg Gross Regional Product...... 10 2.2. Geographical Location of the Stuttgart Region...... 11 2.3. Educational Attainment in the Stuttgart Region, by Sector...... 15 3.1. Geographical Location of Aichi Prefecture...... 21 3.2. Absolute Value of Shipments, Aichi Prefecture...... 22 3.3. Value of Shipments, Share of Aichi Prefecture in Japan...... 23 3.4. Value of Automotive Exports, Aichi Prefecture...... 25 3.5. Number of Employees, Aichi Prefecture...... 27 A.1. Zhejiang Province and the City of Hangzhou...... 51 A.2. Gross Regional Product of Zhejiang Province...... 52 A.3. Number Employed in the City of Hangzhou, by Sector...... 54 A.4. Percentage Employed in the City of Hangzhou, by Sector...... 54 A.5. Recent Graduates Employed in Hangzhou, by Degree...... 55 A.6. Recent Graduates Employed in Hangzhou, by Origin...... 55 A.7. Xiaoshan District in Hangzhou and the Location of WIEFC...... 57 B.1. Determinants of Regional Competitive Advantage...... 59

Tables

S.1. The Industrial Organization’s Access to Resources...... xiii S.2. The Industrial Organization’s Product Pricing...... xiii S.3. Recommended Policies to Implement the Sustaining Factors...... xiv 2.1. Employment in the Automotive Industry, by Largest Companies...... 12 2.2. Employees in the Automotive Industry...... 12 2.3. Employment in the Stuttgart Region, by Firm Size, 2006...... 13 2.4. Strengths and Weaknesses of the Stuttgart Automotive Cluster...... 18 2.5. Strengths, Weaknesses, and Uncertainties of the Stuttgart Automotive Cluster, with Regional Diamond Framework Applied...... 19 3.1. Strengths, Weaknesses, and Uncertainties of the Aichi Automotive Cluster, with Regional Diamond Framework Applied...... 28 4.1. Access to Talent, Technology, Clients, Standards, and Financing in Each of the Four Clusters...... 37 4.2. Value of Each Cluster to Large Firms and Small- and Medium-Sized Enterprises...... 38

vii viii Wanxiang Innovation Energy Fusion City: Recommendations for Developing an Innovation Cluster

4.3. Product Pricing for Both End User–Facing Firms and Firms Within the Supply Chain, by Each of the Four Clusters...... 38 4.4. The Industrial Organization’s Access to Resources...... 46 4.5. The Industrial Organization’s Product Pricing...... 47 4.6. Recommended Policies to Implement the Sustaining Factors...... 48 4.7. Access to Talent, Technology, Clients, Standards, and Financing in Each of the Five Clusters...... 48 4.8. Value of Each Cluster to Large Firms and Small- and Medium-Sized Enterprises...... 49 4.9. Product Pricing for Both End User–Facing Firms and Firms Within the Supply Chain, by Each of the Five Clusters...... 49 Summary

The Wanxiang Group (the Group) has been awarded a contract by the City of Hangzhou to develop a new industrial park, named the Wanxiang Innovation Energy Fusion City (WIEFC) over the next seven years (2017–2024). The area allotted for the project by the city spans 8.6 square kilometers (2,100 acres). WIEFC’s vision is to be an innovation-oriented cluster, whose ecosystem is built around the development and manufacturing of green products for the automotive sector.1 To achieve this vision, the RAND Corporation was asked to develop a mission statement and recommend supporting policies. For this project, RAND undertook the following tasks: (1) developed a mission statement; (2) identified contributing factors that will enable fulfillment of the mission and sequenced the factors into originating and sustaining factors; (3) recommended policies to implement the factors; and (4) identified outcomes to measure the progress of policies. These tasks were fulfilled through in-person interviews and analyses of two globally prominent automotive clusters, in Stuttgart Region, Germany; and Aichi Prefecture, Japan. We undertook additional analyses based on secondary sources of clusters in China and elsewhere, notably, the Taiwan personal computer industry and Silicon Valley.

Mission Statement

The WIEFC cluster consists of residential, commercial, and industrial areas that possess the following attributes:

• Its workforce, firms, and research centers are innovative and technically sophisticated. • Its workforce participates in career and business opportunities that are innovative, technically sophisticated, and diverse. • Its workforce participates in professional social networks that are dense and collaborative. • Its firms and research centers attract government and private support for research and development. • Its firms attract private risk capital. • Its support services, such as legal and financial services, are comprehensive.

1 An ecosystem is defined as a community or cluster of connected players that is sustainable. Sustainability means that the cluster is able to meet its goals (in this case, to be innovation-oriented around the development and manufacturing of green products for the automotive sector) on a long-term basis. Profitability is a requirement for sustainability, among other requirements. Sustainability does not, however, mean self-reliance in the sense that all the resources are generated internally. WIEFC is expected to interact actively with the world outside it.

ix x Wanxiang Innovation Energy Fusion City: Recommendations for Developing an Innovation Cluster

How to Start and Sustain the Wanxiang Innovation Energy Fusion City Cluster

What to Do We focus on identifying originating and sustaining factors that may be delivered through policy in support of the mission. The originating factors are those that should be in place, or that cluster planners ought to deliver at the beginning of the cluster. The sustaining factors should be implemented at later stages. The originating factors are

1. proximity to a large urban population 2. proximity to technologically sophisticated commercial and industrial firms 3. proximity to centers of advanced learning (research universities and institutions, and vocational training institutions) 4. sophisticated physical infrastructure 5. good living environment 6. affordable commercial and residential infrastructure.

WIEFC is located in a large, prosperous, and innovative urban center, Hangzhou. Hang- zhou is an important center for the automotive industry, and a center for the country’s digital technology businesses. Located within the city of Hangzhou is a world-class university, Zhe- jiang University (ZJU), and many smaller professional colleges and training institutions. To fulfill the first three originating factors, planners should ensure good connectivity, particularly in transport systems and bandwidth. Through good design and adequate financial commitment, the remaining three originating factors can be achieved. The sustaining factors are

1. Technology: access to cutting-edge technology 2. Talent: in-migration of high-quality talent 3. Supply chain: the higher value–added activities of the supply chain should increasingly be located over time within the firms at WIEFC 4. Clients: access to sophisticated clients domestically and globally 5. Standards: ability to set high standards for product development.

Policies to Implement the Sustaining Factors Policies are descriptions of principles of action that WIEFC should undertake. Policies are meant to be actionable once the accompanying detailed strategic plan is prepared. The strategic plan encompasses human and financial resources, tasks, and time lines. We describe suggested policies related to each sustaining factor below.

1. Access to cutting-edge technology a. WIEFC could establish centers of excellence (COEs), initially in collaboration with ZJU, to be located at WIEFC. Preliminary discussions with ZJU’s engineering faculty indicate a readiness to enter into such collaboration. Membership in the COEs should be open to all firms located at WIEFC. The COEs would undertake applied Summary xi

research to solve the engineering challenges faced by these firms, and thus help firms to develop technology leadership at WIEFC. b. WIEFC could establish a business development association (BDA). The BDA would be an open-membership, nonprofit association for all firms within the cluster. The goal of the BDA would be to undertake activities to further the businesses of its members. These activities might include facilitating the introduction of new technologies into the cluster through licensing, research programs, and other ways of accessing and developing intellectual property. The membership would commit a small percentage of their revenue to the association to enable the BDA to operate sustainably. 2. In-migration of high-quality talent a. Identify and develop talent for recruitment through the COE. The COE will be an important place for students and faculty to obtain experience in real-world engineering projects carried out at WIEFC. b. WIEFC could provide apprenticeships (one to two years) and internships (less than one year) to engineering students as part of a jobs program for fresh graduates working at the firms in WIEFC. This program would be managed and funded by the BDA. c. WIEFC could develop a jobs program that encourages employees at other firms in Hangzhou to work full-time at firms in WIEFC or start their own firms at WIEFC. This program would be managed and funded by the BDA. 3. Higher value–added activities of the supply chain: The BDA could help member firms identify gaps in their supply chains and bridge those gaps through building relationships with suitable partner firms. Note that such firms may be located within or outside WIEFC. If such firms are located outside WIEFC (possibly even outside the country), and undertake high value–added activities, BDA would work with those firms to ultimately open operations in WIEFC. 4. Access to sophisticated clients: The BDA could develop marketing expertise in support of its member firms. 5. Ability to set high standards for product development: WIEFC could establish an open-membership, nonprofit benchmarking institute (BI). The goal of the BI would be twofold: (1) to establish standards of capability for the business processes of firms at WIEFC (these standards would cover all operating standards, including environment and workforce standards); and (2) to help firms in WIEFC achieve consistently high standards through advisory support.

What Not to Do Policies to Attract Leading Firms Many successful clusters contain one or more global market leaders. Such firms, either by themselves or in combination with other firms in the cluster, play the role of providing technology and market leadership to the cluster. Such firms are often termedanchor firms. They serve multiple roles: They support firms lower down in the value chain and they attract other high- end firms to join the cluster. If a cluster contains anchor firms, the cluster’s chances of success improve dramatically. This may imply that it is desirable for WIEFC to try to attract such firms through special incentives or other policies to get a cluster started. However, new clusters typically find it dif- xii Wanxiang Innovation Energy Fusion City: Recommendations for Developing an Innovation Cluster

ficult to attract anchor firms. This is because anchor firms prefer to locate their high-end activities where they already have an industrial base (e.g., Mercedes in Stuttgart) or co-locate near other firms doing similar high-end work (e.g., social media firms in Silicon Valley). The experience of technology parks in China and elsewhere shows that such firms, should they even agree to set up operations at a new technology park, undertake low-end work, such as procurement or localization. Therefore, we do not recommend policies for inviting global leaders in the automotive industry to establish operations at WIEFC at the initial stages.

Policies to Attract Risk Capital WIEFC’s firms will need substantial external capital, both as loans and as equity, in order to grow. Therefore, many technology parks establish policies to attract global leaders in risk capital, particularly venture capital. The presence of such firms in successful clusters not only is important for access to capital, but also can play a significant role in technology access and talent acquisition. This may imply that it is desirable for WIEFC to try to attract venture capital through special incentives or other policies, but venture capital firms respond to business opportunities rather than create them. Therefore, new clusters may find it difficult to attract such firms. However, the marketplace is likely to work well quite quickly. We expect that venture capital firms and other financiers will be attracted by the presence of the technology and talent at WIEFC, once it develops, and will not need special policy attention. Accordingly, we do not propose policies to attract external capital.

Policies on Incubation Start-ups often need special support, such as technical support, opportunities to share ideas with other start-ups, and seed funding. To facilitate this, many industrial parks establish technology incubators. These are physical spaces for start-ups to locate their initial operations for a period of time at below-market costs until they are commercially viable. Incubators often contain support services, such as technical and legal services. This may suggest that WIEFC should establish policies for supporting incubation, including establishing an incubator for new firms. However, start-ups located in incubators often are unable to become commercially viable because they become reliant on subsidies to survive. Exposing start-ups to the full force of competition and financial discipline from the beginning is often a better way to achieve success. Most of today’s successful technology firms were not born in incubators. Accordingly, we do not propose policies on incubation.

Outcomes

Outcomes are results of initiatives that are attributable to policies and should be measurable. We describe six measurable outcomes below.

1. Talent: a large pool of global-quality talent in different fields of technology and business development. 2. Cluster environment: the presence of anchor firms, availability of risk capital for different-sized firms and activities, access to global markets, diverse business opportunities based on cutting-edge technologies, and the capacity to reinvent itself over time. Summary xiii

3. Government support provides funds for research and development to firms and institutions within the cluster. 4. Dense professional social networks that are collaborative and based on professional interaction. The networks should enable individuals and firms to work with each other, regardless of size or ownership; encourage risk-taking in product and services development; and tolerate experimentation and failures. 5. Professional services environment: the availability of comprehensive professional services, consisting of firms and individuals offering legal, financial, and other professional services. 6. Industrial organization. The industrial organization of WIEFC is a description of the activities of firms and other entities in WIEFC and their relationships to each other and to the marketplace; their ownership; and their access to human, financial, technological, and other resources. Tables S.1 and S.2 outline the industrial organization’s access to resources and product pricing, respectively.

Policy Summary

Table S.1 The Industrial Organization’s Access to Resources

Talent Technology Clients Standards Financing Access COEs and market- COEs, BDA, and BDA and market- BI Banks and venture based recruitment market-based based competition capital from universities competition and firms

Table S.2 The Industrial Organization’s Product Pricing

End User–Facing Firms Firms Within the Supply Chain Product pricing Market-based competition Competitive, off-market bidding for large firm contracts xiv Wanxiang Innovation Energy Fusion City: Recommendations for Developing an Innovation Cluster

the supply chain by identifying and building relationships with suitable partner firms within and outside WIEFC, identifying high value–added partner firms outside WIEFC and encour- aging them to open operations at WIEFC; and (4) develop marketing expertise in support of client access. The BI will establish standards of capability for the business processes of firms at WIEFC and help firms in WIEFC achieve consistently high standards. Table S.3 summarizes the recommended policies for WIEFC. The heading row lists the policies recommended and the first column lists the sustaining factors. The main body of the table indicates how each policy will support the sustaining factors.

Next Steps

To address each element in Table S.3, WIEFC could build a detailed strategic plan encompassing human and financial resources, tasks, and time lines. The plan could include recommendations on governance of WIEFC, including its constituent bodies, such as the BDA, and the delivery of public services. Such a plan might also include analyses of ways to benchmark progress of the desired industrial organization of WIEFC and to put in place monitoring and evaluation frameworks and mechanisms for course correction.

Table S.3 Recommended Policies to Implement the Sustaining Factors

COEs BDA BI Technology Applied research Licensing and research programs

Talent Practical experience On-the-job training

Supply chain Identify and induct high-value partner firms into WIEFC Clients Marketing expertise

Standards Process standards Acknowledgments

We would like to thank the interviewees at the various locations where data were gathered, including Stuttgart, Aichi, and Hangzhou, for their willingness to provide insights. We thank the reviewers, Richard Neu and K. C. Fung, for their comments. Finally, we thank the management of the Wanxiang Group for access to its management and for enabling regular interactions with the RAND team.

Abbreviations

BDA business development association BI benchmarking institute CARS Cluster Initiative Automotive Stuttgart COE center of excellence e-mobil BW electro-mobility initiative Baden-Württemberg IEEE Institute of Electrical and Electronics Engineers IT information technology ITRI Industrial Technology and Research Institute LEED Leadership in Energy and Environmental Design OEM original equipment manufacturing PTRs Public Testing and Research Center SME small- and medium-sized enterprise STTR Small Business Technology Transfer Program WIEFC Wanxiang Innovation Energy Fusion City ZJU Zhejiang University

xvii

CHAPTER ONE Introduction

Project Description

Th e Wanxiang Group (the Group) has been awarded a contract to develop a new industrial park, named the Wanxiang Innovation Energy Fusion City (WIEFC), over the next seven years (2017–2024). WIEFC is located within the city limits of Hangzhou, in an area abut- ting the Qiantang river on one side and surrounded by wetlands (see Figure 1.1). Th e site is near a number of small colleges and dense residential districts, and is well connected to the city’s transport system by light rail and road. Th e area allotted by the city for the project spans 8.6 square kilometers (2,100 acres) and consists of two large plots of land connected by a narrow strip of land. Th e Group plans to use one of the large plots to set up in-house industrial units for its own established and upcoming clean energy automotive products, such as batteries and electric

Figure 1.1 Location of the Wanxiang Innovation Energy Fusion City

Jianggan District Land Area Jianggan District Land Area Zone 2. Industry Innovation Qiantang River Area

Phase 2 Binjiang Provincial District Water Land Area Department Land Area Military Land Area Zone 3. Industry Demonstration Area

Phase 3 Xiaoshan District Land Zone 1. Industry Area Power Area Binjiang Xiaoshan District District Land Land Area Area Phase 1 Jianggan District Land Area Chuanhua Group Land Area

SOURCE: The Wanxiang Group. Used with permission. RAND RR2035-1.1

1 2 Wanxiang Innovation Energy Fusion City: Recommendations for Developing an Innovation Cluster vehicles. The other large plot of land is envisaged to be home to a cluster of firms undertaking innovative activities (an innovation cluster), that could be anchored by the Group’s activities in the first plot. The firms’ activities could include clean energy research labs and consulting services, and supply-chain extensions, such as ancillary manufacturers. The connecting strip of land is planned for residential use, including housing and community facilities, such as a school and a hospital, and is intended to house the professionals who will work in WIEFC. The three areas—Wanxiang Group activities, the innovation cluster of firms, and the living environment—are intended to be an ecosystem, i.e., an interconnected, dependent network of components that together compose a whole. This is a potentially transformative project for the Group, both because of the Group’s financial commitment, which is estimated at RMB 200 billion (the Group’s 2016 gross revenue is RMB 115 billion), and because it takes the Group into a new field of endeavor. Hitherto, the Group’s automotive activities have focused on original equipment manufacturing (OEM), i.e., the manufacture of components and assemblies for use by an upstream assembler or marketing firm. The Group’s OEM relies primarily on designs supplied by its upstream client. With its investment in WIEFC, the Group’s new activities will focus on the creation of supply chains built around innovation in the green automotive industry, the management of centers of excellence (COEs) in collaboration with universities, and industrial park development. The Group has identified three “pillars” (or foundational roles) that WIEFC should fulfill: an innovation platform, a smart city, and a zero-emissions environment. The Group has approached the RAND Corporation to help further develop this vision by creating a mission statement and recommending supporting policies. The city design will then be undertaken by other entities. Potential partners with whom WIEFC has proposals or agreements for second- stage work include Argonne National Labs (part of the University of Chicago) for designing a zero-emissions environment, and the City Planning Institute in Hangzhou for WIEFC’s design. Accordingly, this report develops further the vision laid out for WIEFC and provides guidance on the activities WIEFC should focus on to generate and foster an innovation cluster.

Background

There are several hundred industrial technology parks around the world, and developing innovative clusters occupies a prominent place among the goals of their planners. As a result, innovative clusters have been widely studied and much is known about what policies and structures have been adopted, although less is known about what has worked. What we know is that global experience with building centers of innovation through deliberate private, public, and shared initiatives has rarely been successful in recent times. For instance, there are about 160 technology parks in the United States, most of which were set up in the past 40 years (Link and Link, 2003; The United Nations Educational, Scientific and Cultural Organization, 2016). These vary in size and target a range of sectors, industries, and technologies. Some are large, such as Research Triangle Park in Raleigh-Durham, North Carolina, which occupies 7,000 acres. Others are much smaller, such as University Park at the Massachusetts Institute of Technology, which occupies 27 acres. Their activities range from a single sector or industry focus (such as health care), to digital technologies, to unspecified “cutting-edge” technologies across all industries. Many technology parks include community Introduction 3 living spaces. Yet, apart from Stanford Research Park in Palo Alto, California, and Research Triangle Park in Raleigh-Durham, North Carolina, few technology parks in the United States have succeeded in becoming centers of innovation (Macdonald and Deng, 2004; Tamasy, 2007; Wallsten, 2004). Outside the United States there are also few successes to report. In Europe, the successes comprise clusters that were not the outcomes of deliberate initiatives. Instead, they grew organically. They include clusters in the automotive, textile, and furnishing industries in Italy; the watch industry in Switzerland; and the automotive and chemical industries in Germany. In Asia, the successful innovative clusters include the automotive industry in Japan; and the computer, bicycle, and semiconductor industries in Taiwan. Of these, the Taiwan semiconductor industry is the only one that did not grow organically, but was, instead, delib- erately seeded (Chen and Choi, 2004). In 1973, the government of Taiwan established the Industrial Technology and Research Institute (ITRI) at Hsinchu to undertake research on semiconductors. It was modeled on Stanford University’s Stanford Research Institute. ITRI’s founders convinced several successful Taiwanese engineers working in Silicon Valley to return to Taiwan and work at ITRI. ITRI was successful in its research and created several spin-off firms. The government created the Hsinchu Science and Industrial Park in 1980 to accommo- date the first spin-off, United Microelectronics Corporation, which went on to become a very successful firm (June 2017 market capitalization is U.S. $5 billion). Another very successful spin-off from ITRI was Taiwan Semiconductor Manufacturing Corporation, established in 1987 (June 2017 market capitalization is U.S. $187 billion). The Stanford Research Institute and the Hsinchu Science and Industrial Park model have been widely copied in other countries. However, we are not aware of any successes, while there have been several failures (Chen and Choi, 2004). As a result, researchers have struggled to identify the common elements that constitute a successful innovative industrial cluster, whether within an industrial park or a larger city environment. The factors that have been regularly identified as associated with successful clusters include proximity to large urban locations and sophisticated physical and institutional infrastructure; the presence and participation of advanced universities, research institutions, vocational training institutions, and a mix of large and small firms in the core activities of the cluster; public-private partnerships; a good living environment; and access to global markets and financing (Bresnahan and Gambardella, 2004). Yet, academic research also shows that while these so-called “success factors” may be necessary to spur innovation, they may not be sufficient. There are locations that possess all of the aforementioned success factors but nevertheless failed to develop cutting-edge innovation (Feldman and Desrochers, 2003 and 2004). For instance, Los Angeles can claim to contain all of the success factors for cluster formation; yet, within California, Silicon Valley (in digital technologies), San Diego (in biotechnology), and San Francisco (in consumer technologies) contain more-successful clusters of innovation than Los Angeles does (Storper et al., 2015). It is difficult to pinpoint the real causes of success because these causes may change with time. For instance, in Silicon Valley, government support for research on network computing provided to both universities and private firms (including support for collaborative efforts between industry and academia) was critical for the development of the Internet for many years up to the 1990s (Dossani, 2007; Dossani and Kenney, 2007). Thereafter, it ceased to be critical. Since the mid-1990s, a large number of network technologies, such as social media, were developed through private initiatives and financing. Therefore, the success of a cluster 4 Wanxiang Innovation Energy Fusion City: Recommendations for Developing an Innovation Cluster might not depend on government support for private enterprise, and instead might be related to time and context. Another example of the importance of time concerns collaboration. Research has identified a collaborative culture as an important feature of a successful cluster (Walter, Auer, and Ritter, 2006; Martins, Bartolomeu Dias, and Khanna, 2016). This means that the professionals who work in the cluster are willing to collaborate to create new products and services. Collaboration may indeed be important in many cases. For instance, if certain products require sophisticated expertise of different types, successful product development may require collaboration among professionals who are specialized by discipline. However, the need for collaboration does not imply that it will happen. One of the reasons attributed to the failure of Boston (and the corresponding rise of Silicon Valley) as a center for the emerging computing industry in the 1980s was the absence of a collaborative culture (Saxenian, 1996). Yet, prior to the 1980s, Boston was the global leader in computing, led by firms such as IBM and DEC. As a success factor, a collaborative culture may have been more relevant to the computing industry from the 1980s onward than in prior periods. A further example is also time-related and concerns the affordability of physical infrastructure, such as real estate. This is often considered a key requirement. It has been attributed as a cause for why Silicon Valley was located away from San Francisco, even though the bankers who provided the capital were initially based in San Francisco (and who later followed their clients to Silicon Valley) (Kenney, 2000). This may have been true for the manufacturing start-ups of the 1980s and 1990s, but with the advent of the Internet, the need for large physical spaces has reduced (and may be behind the resurgence of San Francisco as a center of technology innovation). Understanding the limitations of policy is, thus, important. Policymaking should be restricted to arenas of action that policymakers can influence, which will depend on time and circumstance. Further, the tools of policymaking need to keep cause and effect in mind. We illustrate the importance of understanding cause and effect with the earlier example of developing a collaborative culture. Policies that seek to establish a collaborative culture need to be designed keeping the causal elements in mind. For instance, if collaboration among firms is important because of the need for interdisciplinary work, then—to the extent that firms are not collaborating—policymakers may design financial incentives to encourage such collaboration. However, it is also possible that firms may design incentive programs on their own for workers to conceptualize complex problems in teams. If this succeeds, then policy action by governments may not be needed. For instance, in Silicon Valley, the emergence of collaborative development of products from the 1980s onward appears to have been the result of firms’ actions rather than government support (Kenney, 2000). Among a large number of efforts to encourage collaboration, one of the few successful initiatives is the U.S. government–run Small Business Technology Transfer (STTR) program. This program aims to encourage private-sector firms to partner with nonprofit research institutions by providing financial support for partnerships aimed at the commercialization of research.1 It has experienced successes and has been widely copied, including in China, India, and other countries in Asia (Grindle, 2010; Ceulemans and Kolls, 2013).

1 For more information on STTR, see Small Business Administration, undated. Introduction 5

The reason that the STTR policy was effective was, in part, because there was a need for collaboration arising from the importance of interdisciplinary work. However, if the industry does not need interdisciplinary work, policies to promote collaboration would not succeed. The other important reason that the STTR policy was effective in the above example was that it created a direct commercial incentive for collaboration. Other types of interventions to promote collaboration found in many technology parks include educational interventions, such as organizing workshops on technical topics; or even pure “networking sessions,” i.e., mixers that bring people together without a particular topic to discuss. Such incentives have an indirect commercial benefit, and should carefully be related to the causes that need to be addressed, if they are to succeed. Despite the large number of such interventions, little is known about whether they are valuable after considering other factors, such as cost and the effect on firm incentives. If past experience is a guide, this will likely not stop government policymakers from continuing to find ways to support innovation and entrepreneurship, in part because of domestic political imperatives.

Approach

This report undertakes the following tasks. First, in support of the Group’s vision for WIEFC, it recommends a mission that describes WIEFC’s aims. Second, the report identifies the contributing factors required to achieve the mission. Through an intensive, in-person study of two locations—the Stuttgart automotive cluster in Germany and the Aichi automotive cluster in Japan—supplemented by learnings from the academic literature on other clusters, we divide our findings into originating and sustaining factors. We then recommend policies for the implementation of these factors. Subsequently, we identify outcomes to measure the progress of policies. We distinguish between (1) factors that policymakers can influence or implement at the outset of cluster formation which, together, will result in the emergence of an innovative cluster and (2) factors needed to sustain a cluster once it has formed. We call the first type of factors originating factors. These factors are dependent on time and place, and typically include the development of affordable and adequate physical and connectivity infrastructure. We call the second type of factors sustaining factors. These, too, are dependent on the circumstances of time and place, and typically include the development of pipelines for talent and technology and an environment for business development. We also recommend policies to influence or help implement these factors. Policies are descriptions of principles of action that WIEFC should undertake. Policies are meant to be actionable once the accompanying detailed strategic plan is prepared. The strategic plan encompasses human and financial resources, tasks, and time lines. In order to measure the progress of policies, we identify outcomes. Outcomes are results of initiatives that are clearly attributable to policies and should be measurable. The outcomes include an industrial organization structure for WIEFC that is expected to emerge with the adoption of the recommended policies. The industrial organization of an entity such as WIEFC is a description of the activities of firms and other entities within WIEFC; their relationship to each other and to the marketplace; their ownership; and their access to human, financial, technological, and other resources. 6 Wanxiang Innovation Energy Fusion City: Recommendations for Developing an Innovation Cluster

Attributes of WIEFC

We list below the desired attributes of WIEFC:

• Its workforce, firms, and research centers are innovative, experimental, and technically sophisticated. • Its workforce participates in career and business opportunities that are innovative, technically sophisticated, and diverse. • Its workforce participates in professional social networks that are dense and collaborative. • Its firms and research centers attract government and private support for research and development. • Its firms attract private risk capital. • Its support services, such as legal and financial services, are comprehensive.

The above list is intended to be a comprehensive list of attributes for WIEFC. Some of these attributes are more obvious than others, such as the innovativeness of its firms. We discuss some of the less-obvious attributes below.

Workforce Attributes An aspect of human talent that can be critical, although sometimes overlooked, is the fact that human capital often thrives in an environment that offers diverse business opportunities. Even science and innovation parks that focus on a narrow range of technologies or activities find that diversification is needed. For instance, Silicon Valley has built its success around digital technologies, initially consisting of manufacturing digital devices (Sturgeon, 2000). Over time, Silicon Valley not only pioneered semiconductor manufacturing but went on to pioneer software applications in a wide range of fields, such as e-commerce, health care, the Internet, medical devices, solar energy, electric cars, and autonomous vehicles (Lee, Miller, and Hancock, 2000). This was possible because Silicon Valley attracted a large pool of talent not just in manufacturing, but in design, marketing, finance, health care, education, and other fields from its beginning (Kenney, 2000). Diversification is also necessary for a practical reason: Although a firm employs individuals who come together to develop the firm’s goods and services, those individuals usually come with or build up families where the spouse needs a career, the children need education, and the family needs a community. The needs of the entire family, not just the employee, must be served appropriately if the park is to attract the world’s best talent. An important attribute of successful parks is that their firms and employees learn as much from failures as from successes. Because there is no magic formula for success at the cutting edge, success is likely to require experimentation. In other words, success is likely to require both taking risks and tolerating failures. Building a culture that accommodates such experimentation will be required (Castilla et al., 2000). This is more likely to happen when the costs of failure are low. For example, if the cluster is rich with job opportunities, those taking risks at the cutting edge might find it easier to find jobs in the event of failure. However, it is not clear if there are any simple lessons for policymakers, since the building of such a culture takes time and is hard to identify in its early days. However, policymakers should be aware of the importance of such a culture and be alert to opportunities or threats that policymakers might address. For example, laws to encourage mobility of jobs (such as portable pension schemes) Introduction 7

might be useful to consider, although such policies may be beyond the scope of WIEFC’s policymakers. Furthermore, workers in a successful industrial cluster should have the capacity to reinvent themselves over time (Kenney and von Burg, 1999). Technologies can change rapidly, as can industries. For example, in the automotive sector today, we are seeing the effect of digital technologies in the form of driverless vehicles (World Economic Forum, 2016b). If successful, they will revolutionize the industry. Yet even a decade ago, driverless cars were not viewed as technically feasible. Rapid technological change will have an impact on firm survival, since firms that are unable to adjust will go out of business. However, the cluster can thrive if the workers in the cluster are adaptable to new technologies, since new firms will replace the old.

Social Networks Much scholarly work has looked at how innovation is closely related to the existence of social networks, often termed networks of interaction, that form within a cluster. Social networks that are dense (i.e., have a high ratio of actual to potential connections), that are used for professional development, and that are characterized by openness to all participants offer the potential of being innovative (Castilla et al., 2000; Dossani and Kumar, 2011; Klyver, Hindle, and Meyer, 2008). It could be important for WIEFC to enable the development of dense, open, and professionally oriented social networks. Such dense social networks are found in populations that share common interests, such as participants who practice the same profession. When the participants in the social networks are well educated in relevant professions, the potential for innovation improves, as does the potential for retaining and attracting high-quality talent. Note that every successful industrial park displays above-average levels of human capital (Greve and Salaff, 2003). We do not mean to suggest that collaborative networks inhibit competition, but rather that they improve innovative outcomes while retaining the space for competition. For example, collaboration to create new standards of equipment often coexists with fierce competition to implement products that meet such standards (Chesbrough, Vanhaverbeke, and West, 2006). The importance of dense social networks built around highly educated persons challenges a long-held concept known as the death of distance, or the idea that digital technologies would enable high-quality remote working. As Silicon Valley evidently demonstrates, this has not happened, especially at the cutting edge of technology. Instead, what we see is distance decay, that is, the quality of interactions diminishing as the distance between actors increases, leading to the importance of what has been called nearness learning (i.e., face-to-face learning) or tacit knowledge transmission (i.e., knowledge that is difficult to transmit in writing or words) (Gertler, 2003; Lawson and Lorenz, 1999).

Summary and Looking Ahead

In this report, we develop a mission and recommend supporting policies that will help WIEFC fulfill its vision of creating an innovative cluster built around smart and green automotive technologies. To do so, we derive lessons from best practices globally and apply them to WIEFC. There are multiple clusters around the world in the automotive industry, and the most successful of them are increasingly focused on energy-efficient and high-technology vehicles. Exam- 8 Wanxiang Innovation Energy Fusion City: Recommendations for Developing an Innovation Cluster ples include Stuttgart, Germany’s automotive cluster, which houses Daimler, Porsche, and Bosch, and Aichi Prefecture in Japan, which includes Toyota and Denso. Furthermore, both are regional headquarter locations to several large multinational corporations—such as IBM in Stuttgart—that have set up activities to work with local manufacturing firms, as well as several high-tech small- and medium-sized enterprises (SMEs) undertaking automotive-related manufacturing and services. These clusters show a diversification of industrial activity and a strong emphasis on research activity. For example, the Stuttgart automotive cluster has, over time, developed viable businesses in information technology (IT), media, biotechnology, and electro-technologies, and the University of Stuttgart has developed advanced competencies in vehicle and engine technology, material sciences, electrical engineering, fuel cells, and industrial automation. There is close interaction and collaboration between Stuttgart-based research institutions and the private-sector firms—both SMEs and large firms. In Aichi, Toyota and its ancillary suppliers have developed competencies in IT and electro-technologies, leading up to its pioneering hybrid vehicle, the Prius. In later chapters, we present two in-depth case studies on the Stuttgart and Aichi automotive clusters in order to understand how they operate in terms of meeting their goals of developing innovative products under the existing ecosystem. Our findings are based on a combination of extensive literature reviews of academic, policy, and industry resources; site visits; and semi-structured interviews with local experts from academia, policymaking, think tanks, and industry. Further, through literature reviews, we compare and contrast our case study findings with two additional cluster models, the Taiwan high-technology cluster, which is focused on extensive collaboration and guided by coordinating institutions, and the Silicon Valley high- technology cluster, which presents a mix of innovative small and large firms. Silicon Valley was referenced on numerous occasions throughout our stakeholder interviews because of its recent impact on the automotive industry, due to the establishment of globally renowned enterprises such as Uber and Tesla and the automotive initiatives of Google and Apple. We derive originating and sustaining factors, policies, and outcomes from studies that are relevant to WIEFC. The originating factors, as noted earlier, are those that cluster planners ought to focus on at the beginning through deliberate policy initiatives. The sustaining factors become relevant later in the development of the cluster. The policies are intended to be a guide to actionably implementing and influencing the factors. We also specify outcomes against which to measure the progress of policy initiatives. The outcomes include an industrial organization structure for WIEFC that is expected to emerge with the adoption of the recommended policies. We end this report with suggestions for future work. CHAPTER TWO Regional Case: The Stuttgart Automotive Cluster

This chapter is based on interviews with industry stakeholders and analyses of secondary data. The interviews were conducted in Stuttgart, Germany, in November 2016. We list the interviewees in Appendix C of this report.

The Stuttgart Region and the State of Baden-Württemberg

The state of Baden-Württemberg is located in the southwest of Germany and is Germany’s third-largest state, with an area of 13,804 square miles and a population of 10.8 million people. It is one of the most prosperous regions in Europe. This is in part because it is home to the headquarters of large multinational corporations, such as Daimler and Porsche in the automotive industry; Bosch in the electronics and engineering industries; Carl Zeiss in the optics industry; and SAP SE in software and information and communications technology. The state has also historically been home to a large number of successful SMEs, mostly in manufacturing. These SMEs make up the Mittelstand and are considered the backbone of the state economy. They include many Hidden Champions, a term used for SMEs that are highly specialized and have attained global market leadership in their respective niches. Their innovativeness is cited as key to securing the state’s economic prosperity and in sustaining its technological leadership across a variety of industrial sectors (Venohr and Meyer, 2007). Figure 2.1 shows the gross regional product for Baden-Württemberg, which has grown steadily since the early 1990s, with a brief decline during the 2009 financial crisis, to over 400 billion euros in 2015. Manufacturing accounts for a substantial share of the local economy. Although the share of manufacturing in total output has decreased from roughly 40 percent in 1991 to 35 percent in 2015, it is still among the highest in the country. As in most industrialized economies, the role of design and other business service activities has become more important, and automation has decreased labor intensity in traditional activities. This has led firms to focus on integrating a larger number of more-sophisticated activities under common platforms—an initiative locally termed Industry 4.0 (Heng, 2014; Brettel et al., 2014; Kagermann, 2015; Davies, 2015). The state of Baden-Württemberg consists of two main regions: the Baden region in the north, and the Württemberg region in the south. Baden has typically been strong in technology and IT, and includes the SAP SE corporation. The economic base of Württemberg is in manufacturing and its large firms include Daimler, Porsche, and Bosch. The Stuttgart region in Württemberg was officially established as Germany’s first- con stituted region in 1994. It has a directly elected regional parliament with representatives from

9 10 Wanxiang Innovation Energy Fusion City: Recommendations for Developing an Innovation Cluster

Figure 2.1 Baden-Württemberg Gross Regional Product

450 Public administration, 400 health care, and education; private 350 household expenditures Financial, insurance, 300 enterprise services, and real estate 250 Trade, transportation logistics, tourism, and 200 information and

Billion euros communications 150 technology Construction 100 Industry and 50 manufacturing Agriculture and fisheries 0 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

Year SOURCE: RAND authors’ calculations based on data from Baden-Württemberg statistics of ce. RAND RR2035-2.1 all districts in and surrounding the city of Stuttgart. It exhibits a high degree of regional integration, supported by dedicated policy institutions. These institutions include the Stuttgart Region Economic Development Corporation (Wirtschaftsfoerderung Region Stuttgart, or WRS), which acts as a point of contact for companies, research and development centers, and investors. It is also tasked with establishing and curating innovation networks in the region. The Stuttgart regional association (Region Stuttgart), a trade association, works to enhance the visibility of the region and to connect various actors across the region to develop new, interdisciplinary sources of innovation. Figure 2.2 shows the geographical location of the Stuttgart region. Stuttgart is the capital of the state of Baden-Württemberg. Its metropolitan region is among Germany’s most densely populated and wealthiest regions. Its population numbers 2.7 million people and it occupies an area of 1,500 square miles. The gross regional product of the Stuttgart region was 120 billion euros in 2015, which corresponds to a gross regional product per capita of about 45,000 euros (Region Stuttgart, undated).

Historical Development of the Stuttgart Automotive Cluster

The historical development of the automotive cluster in Stuttgart has been well documented (Boch, 2001). The cluster emerged from the inventions of a group of automotive entrepreneurs in the late 19th century, including Gottlieb Daimler, Karl Benz, and Wilhelm Maybach. These entrepreneurs are credited with inventing the first four-wheeled cars in Europe, beginning production in 1900 under the brand name Mercedes. This initial automotive firm served as an anchor for the young Stuttgart automotive cluster and led to rapid expansion. Among the spin-off firms was Porsche, founded in 1947 by Ferdinand Porsche, a former engineer at Mer- Regional Case: The Stuttgart Automotive Cluster 11

Figure 2.2 Geographical Location of the Stuttgart Region

Stuttgart Region

SOURCE: Google Maps. RAND RR2035-2.2 cedes who founded the company to build race cars. Bosch was founded by Robert Bosch in 1886, and offered the first magnetos in 1906 for internal combustion engines to both Gottlieb Daimler and Karl Benz. The cluster experienced a substantial expansion in its productive capacity during the second World War, with the Nazi regime pushing for mass production of vehicles. After World War II, the cluster continued to expand and is currently considered to be one of the world’s preeminent automotive clusters. Today, the automotive cluster is still home to the global headquarters of Daimler, Porsche, and Bosch. It also hosts a vast number of small- and medium-sized supplier firms across a variety of technical disciplines. Thus, while the cluster hosts several large corporations, the role of SMEs is important, both in terms of securing the industry’s overall technology leadership and in terms of job creation for the region. Table 2.1 displays the number of employees in the automotive industry for the largest firms in the region, most of which operate as Tier 1 suppliers (i.e., direct suppliers) to the two large car manufacturers, Daimler and Porsche. In addition to those large suppliers, there are many small firms of up to 50 employees, acting as Tier 2 (suppliers to Tier 1 firms) and Tier 3 suppliers (suppliers to Tier 2 firms) further down the automotive supply chain. Tier 4 suppliers (raw material suppliers) are located outside the region. 12 Wanxiang Innovation Energy Fusion City: Recommendations for Developing an Innovation Cluster

Table 2.1 Employment in the Automotive Industry, by Largest Companies

Company 2001 2004 2009 2013 2014 Daimler AG 79,000 85,000 74,200 74,500 75,600 Robert Bosch GmbH 25,700 25,968 28,213 28,474 28,474 Porsche AG 7,800 8,554 9,478 10,820 14,500 Mahle GmbH 3,930 3,545 3,700 4,029 6,504 MBtech Group GmbH NA NA NA 2,190 2,156 Bertrandt AG NA NA NA 2,100 2,200 Acquired by Behr GmbH 2,020 4,500 4,300 2,040 Mahle TRW Automotive GmbH 2,000 1,850 1,800 1,900 1,900 Mann+Hummel GmbH 1,850 1,600 1,749 1,780 1,772 Eberspächer GmbH 1,300 1,250 1,185 1,428 1,459 Binder GmbH NA NA NA NA 1,430 DEKRA SE 960 1,140 1,300 1,360 1,400 Allgaier Werke GmbH 1,150 1,343 1,278 1,224 1,136 Valeo Wischersysteme GmbH 2,150 1,400 1,160 1,090 1,049 NOTE: AG = Aktiengesellschaft. This is a German term for a public limited company. GmbH = Gesellschaft mit beschränkter Haftung. This abbreviation denotes a German limited liability company. NA = not applicable. SE = Societas Europaea. This Latin term means European company and denotes a commercial company. SOURCE: Chamber of Commerce and Industry for the Stuttgart Region, 2015.

Supply Chains and Inter-Firm Networks

The Stuttgart region hosts a substantial share of national automotive sector employment. It is home to a supplier network that is both large and sophisticated enough to supply most of the need by large manufacturers for components and assemblies. Table 2.2 shows the share of the Stuttgart region in the overall German automotive sector and the employment breakdown for automobiles and automotive parts. One of the prominent features of the Stuttgart automotive cluster is its mix of large car manufacturers acting as anchoring firms, and smaller, specialized suppliers that operate in their respective product niches, delivering services, parts, and components either directly to

Table 2.2 Employees in the Automotive Industry

2007 2013 2014 Germany 800,311 848,402 872,700 State of Baden-Württemberg 194,618 202,361 206,922 Stuttgart region 105,155 106,515 109,180 Production of vehicles and engines 68,713 67,733 70,222 Production of parts and accessories for vehicles 35,348 37,728 38,120 Production of chassis, body parts, and trailers 640 476 216 Other vehicle-related production 454 578 622 SOURCE: Chamber of Commerce and Industry for the Stuttgart Region, 2015. Regional Case: The Stuttgart Automotive Cluster 13

Daimler and Porsche, or to their Tier 1 suppliers, such as Bosch and Mahle. According to several of our interviewees, these small, often family-owned firms have a history of driving innovation and frequently collaborate with local universities and trade schools to develop talent for the region. Table 2.3 shows that the region has many SMEs that together employ the majority of the workforce. Consistent with the trend in the automotive industry to outsource routine activities to lower-cost production locations, the Stuttgart region currently retains high-value, knowledge- intensive activities, while outsourcing the rest to regions such as Eastern Europe, Asia, and South America (Sturgeon and Van Biesebroeck, 2011). Typically, within large firms, research and development, vehicle design, high-technology parts, and quality assurance are handled in Stuttgart, while assembly and production of lower-technology parts are outsourced outside the region. SMEs within Stuttgart integrate closely with large firms through a focus on high- technology ancillary products. Large firms and SMEs interact closely in knowledge-intensive areas like development, design, and production. Stuttgart-based car manufacturers show a high degree of horizontal integration, and are reliant on local SMEs to contribute in the production process. This reliance on SMEs as suppliers of critical components has been studied extensively. Simon (1996a) refers to this phenomenon as one of Hidden Champions, pointing to a large number of small, relatively unknown firms all over Germany that manage to sustain market leadership in their respective, often highly technical and knowledge-intensive market segments. While several other economies across Europe are also reliant on small businesses, a notable feature of Germany’s Hidden Champions is that they are innovative and are key contributors to the technology leadership of their regions (Simon, 1996b; Simon, 2009; Venohr and Meyer, 2007; Schlepphorst, Schlömer-Laufen, and Holz, 2016). The region’s size, prosperity, and high level of education provide it with a demanding and sophisticated consumer test bed for new products. Large, integrated firms are the most direct beneficiaries of this local demand, while specialized SMEs benefit indirectly (Zhakiyanov et al., 2015). Several of our interviewees noted that while Stuttgart-based SMEs play a significant role in driving innovation in the area of combustion engines and traditional automotive technologies, they are dependent on the demands and strategies of the large car manufacturers. Generally, car manufacturers set incremental innovation objectives for local SMEs along the

Table 2.3 Employment in the Stuttgart Region, by Firm Size, 2006

Number of Firms for Different Employee Sizes Sector Total 0–9 10–249 More than 250 Manufacture of motor vehicles, trailers, and semi-trailers Number of firms 222 107 79 36 Number of employees 134,691 194 5,447 129,050 All private enterprise Number of firms 125,675 106,733 11,609 7,333 Number of employees 954,709 140,720 421,534 392,455

SOURCE: Tözün, 2009. 14 Wanxiang Innovation Energy Fusion City: Recommendations for Developing an Innovation Cluster supply chain and grant them considerable leeway in how to achieve those objectives. Outside of the freedom to achieve incremental innovation goals and to enhance supply-chain effective- ness, SMEs are rarely involved in decisionmaking procedures and strategy formulation when it comes to exploring new products and technologies. To bridge these knowledge gaps and to cope with ensuing uncertainties, policymakers and industry associations across the region have been working to organize SMEs and to provide a platform for discourse. In addition to WRS, noted earlier, publically funded organiza- tions and topic-oriented initiatives such as the Cluster Initiative Automotive Stuttgart (CARS) and the electro-mobility initiative Baden-Württemberg (e-mobil BW) link together large and small firms as well as government agencies and provide a platform for dialogue within the cluster and between different subclusters. Most importantly, these associations provide SMEs with a venue to learn about the strategic choices being considered by large car manufacturers. These platforms play an important role in ensuring the cluster’s competitiveness in forging new, interdisciplinary alliances and relationships by bringing together researchers, investors, and firms from different business sectors, such as automotive, IT, and electrical engineering.

People and Workforce

One of the distinguishing features of the workforce in the state of Baden-Württemberg is the mix between university graduates in science, technology, engineering, and mathematics fields and skilled, specialized workers on the shop floor. Many of these skilled workers are products of Germany’s dual education system, which provides students with both specialized vocational training and practical work experience (Bosch, 2010; Göhringer, 2002). The students receive theoretical lessons in the classroom, often at local trade schools or applied science colleges, and then apply their newly acquired skills and knowledge through working part-time for a firm in the region. Following graduation from their certificate or bachelor’s program, students often receive a job offer from the company that provided their on-the-job training. Consequently, labor mobility is low, as most students come from and remain in the region. This dual education framework ensures a steady supply of qualified workers and allows firms in the region to shape educational curricula to fulfill future workforce needs. Figure 2.3 shows educational attainment of employees in the Stuttgart region, broken down by business sector. There is a consistently high share of vocational certifications, including areas such as specialized mechatronics (a hybrid certificate between electrician and mechanic), in all industrial sectors, suggesting a strong reliance on specially trained workers. Unsurprisingly, the automotive, engineering, and manufacturing sectors show the highest shares of college-educated engineers, mainly in technical disciplines such as mechanical and electrical engineering. Par- ticularly in those sectors, 20–25 percent of the workforce holds an advanced degree, compared with only 6 percent in the construction sector, further emphasizing the knowledge-intensive nature of activities in the automotive cluster. Aside from its high-quality vocational training institutions and trade schools, the Stutt- gart region is home to a number of high-quality universities. These universities were established to meet the needs of the automotive industrial cluster and other industries in Stuttgart by training engineering and other technical talent. While the region’s primary university, the University of Stuttgart, started out as a training school for technical experts in engineering and engine construction, it now specializes in technical areas such as vehicle and engine technolo- Regional Case: The Stuttgart Automotive Cluster 15

Figure 2.3 Educational Attainment in the Stuttgart Region, by Sector

100

60 University degree Vocational certification 50 No vocational training 40 Not applicable

30 Percentage of workers

0 Automotive Engineering Manufacturing Construction Industrial production

SOURCE: Chamber of Commerce and Industry for the Stuttgart Region, 2015. RAND RR2035-2.3 gies, material sciences, electrical engineering, industrial automation, mechanical engineering, and physics. Aside from the University of Stuttgart, the region has many other applied-sciences colleges that supply engineers and technicians to the cluster, and further draw on the entire state of Baden-Württemberg as a talent pool. These include, notably, the Karlsruhe Institute of Technology in the northern part of the state, one of Germany’s top ranked universities in engineering and IT. However, given the demands of the region’s increasingly globally oriented corporations, recruitment activities for highly skilled, technical jobs are increasingly being sourced from the national and even international levels.

Exploring Alternative Technologies

In addition, as stated in our expert interviews, universities also contribute to the local research agenda to ensure the region’s human capital flow. They do so through blue-sky research as well as applied research, for which they may work closely with firms to explore new technologies. While many of the larger firms rely both on their internal research departments for critical innovations as well as on universities, SMEs rely on and regularly collaborate with universities and other research institutions to develop new ideas. Fostering university-industry cooperation has been an explicit objective of various statewide and regional policy actors, such as WRS. The Research Institute for Automotive Engineering and the Institute for Combustion Engines at the University of Stuttgart have been particularly active partners of the automotive industry in the region, seeding critical initiatives, such as the Auto Simulation Center Stuttgart and the Auto Electronics Innovation Alliance. Furthermore, there are several applied research institutes that contribute, including the Fraunhofer Institutes and Max Planck Institutes (Tözün, 2009). 16 Wanxiang Innovation Energy Fusion City: Recommendations for Developing an Innovation Cluster

One interviewee pointed to the critical role of university technology transfer and the impact that university-based research has had on the sustained technology leadership of the cluster. Specifically, the interviewee underlined the importance of opening up avenues for commercialization that enables university researchers to engage in applied research. Along those lines, the Steinbeis Foundation Network was established by the state of Baden-Württemberg to provide funding and commercialization avenues for researchers and to cultivate an innovation ecosystem for academic entrepreneurship by connecting researchers to local and regional SME partners to support and foster innovation (Strambach, 2002). As many interviewees noted, recent regulatory and market trends in the global automotive sector are leaning away from combustion engines and toward electric vehicles, fuel cell technologies, and hybrid models. In the Stuttgart region, a majority of production jobs to date depend on traditional technologies, and a move to alternative technologies will test the cluster’s ability to respond successfully. While large car manufacturers, such as Daimler and Porsche, and the largest automotive suppliers, such as Bosch, can afford to diversify their technological portfolio internally and shift resources to developing various technologies concurrently, a wait-and-see approach to dealing with this structural uncertainty may test the survivability of many of the small, highly specialized firms in the cluster. These small firms are usually reliant on existing technologies and do not have the financial or technical capacity to conduct mul- tifaceted research into new technologies. Given the cluster’s strong dependence on traditional combustion engine technologies and its high degree of specialization in related areas, connecting people across technological and industrial boundaries will be a critical task to ensure the region’s ongoing success as the industry enters a new phase. Particularly for SMEs that are far removed from the car manufacturers, servicing Tiers 2 and 3 of the supply chain, it is difficult to gain any insights into strategic directions and future product developments. Policymakers and industry associations have been instrumental in dealing with these information asymmetries, bundling together SMEs and representing their concerns in front of the large automotive corporations. Specialized initiatives, such as e-mobil BW in the area of electric vehicles; Cluster Brennstoffzelle BW in the area of fuel cell development; or the IT chapter of CARS, concerning the digitalization of the automotive sector, educate firms and entrepreneurs across the region about the challenges and opportunities from these new technological developments, and provide a platform for people from various sectors to get together and pursue interdisciplinary innovation. Aside from the convening and connecting role, these initiatives and others provide seed funds for collaboration across disciplinary boundaries and organize exchanges with other innovation clusters around the world. From our interviews and discussions with local experts, it appears that electric vehicles and the digital integration of the automotive sector are the most debated topics in the Stuttgart region today. As production processes become increasingly complex and interconnected, there is a need for enhanced interdisciplinary collaboration and pressure to cooperate across institutional boundaries. While car manufacturers in the Stuttgart region have traditionally relied on SME suppliers for technological and process innovation, they have been hesitant to collaborate with firms outside of the cluster and outside the automotive industry for high-end work, perhaps due to a lack of trust in intellectual property protection mechanisms (Kamp and Tözün, 2010). The authors take this to mean that the cluster is currently suffering from a “network failure” and that there is a need for policy intervention to overcome the cross-sectoral divide. The authors suggest that a combination of missing network nodes, inadequate coordination, and underdeveloped linkages between actors that are critical to future innovation is at the core Regional Case: The Stuttgart Automotive Cluster 17 of the network failure and that there is a need for policymakers to act as conveners and brokers, generating a marketplace of ideas and cultivating a flourishing innovation ecosystem. To some extent, the Stuttgart region’s most glaring need may not be to find new actors who can help it transition toward new technologies, but may be to find effective ways to coor- dinate and connect existing players. It already possesses all of the key ingredients for sustained innovation; they are just not yet connected properly. As an example, Kamp and Tözün (2010) point to several large IT corporations, such as Hewlett Packard and IBM, which have their German headquarters in Stuttgart but are not actively involved with the automotive sector. In addition, Germany’s largest software company, SAP, is located only two hours north of Stutt- gart and could become a critical partner in developing integrated automotive solutions and in moving the digitalization of the automotive industry forward. Our interviewees emphasized the role that newly emerging players in the automotive sector outside Stuttgart have had on people’s attitudes within the Stuttgart cluster and generally within traditional automotive firms. While Daimler and Porsche are operating as large, steady corporations and are concerned with long-term growth and stability, firms like Tesla, Uber, and others that have recently risen to prominence are shaking up the automotive landscape and are leaving a mark on the Stuttgart cluster as well. Due to pressure from these companies and increasingly complex production processes, the large firms in Stuttgart are being forced to rethink their recruiting and development strategies and are finding themselves in need of modernization in the face of disruptive changes. While firms in the cluster will have to adapt, the cluster is still very economically successful today, mainly fueled by the success of its large car manufacturers. In contrast to other automotive hubs across Europe—such as the Turin cluster in Italy, which houses the headquarters of Fiat, and the Ile-de-France cluster in France, composed mainly of Renault and Peugeot—the German car manufacturers are healthy. Financing change will not be a particularly difficult challenge for the Stuttgart automotive cluster. The bigger challenge will be in achieving change through the existing mechanisms of collaboration and the talent pools at hand. As such, the cluster offers valuable lessons for WIEFC, which we will consider in Chapter Four.

Summary of Stuttgart Case Study Findings

The Stuttgart region’s endowment of human capital resources and its closely networked, globally oriented large firms, SMEs, and research and teaching institutions are major driving forces behind its sustained success. Large firms focus on horizontal integration and rely on local SMEs to contribute technology-intensive critical components. SMEs tend to be independently owned. Government-supported regional banks are an important source of operating and long- term capital. The universities and other academic institutions work closely with large firms and SMEs to sustain Germany’s dual education system of specialized training combined with practical work experience. They also undertake joint research programs with firms, both large and small, for technology development. Government agencies and trade associations play an important role in connecting various actors across the cluster and in facilitating interdisciplinary collaborations. However, while the cluster is currently considered healthy, according to most interviewees, its specialization in traditional automotive technologies presents challenges for the future, as it transitions to a digital automotive environment and explores alternative technologies, 18 Wanxiang Innovation Energy Fusion City: Recommendations for Developing an Innovation Cluster such as fuel cell batteries and hybrid and electric vehicles. SMEs are becoming increasingly dependent on the strategies of the large car manufacturers. Given the conservative strategies of the region’s anchoring car manufacturers, Daimler and Porsche, and the high degree of niche specialization of many local small firms, the cluster might find it difficult to adapt in the short term. These and other key strengths and weaknesses of the Stuttgart automotive cluster are outlined in Table 2.4 below. To allow for a comparison across our study clusters, we use a “regional diamond” framework of competitive advantage, developed by Michael Porter in 1990 (see Porter, 1990, and Appendix B for more details).1 When applying Porter’s regional diamond framework to the Stuttgart automotive cluster in particular, we observe a number of strengths, weaknesses, and uncertainties, which we outline in Table 2.5.

Table 2.4 Strengths and Weaknesses of the Stuttgart Automotive Cluster

Strengths Weaknesses Four core pillars of the Baden-Württemberg regional • High cost of labor and land innovation system: • Limited physical connectivity • strong inter-firm collaboration • Traffic and congestion • blend of large corporations and SMEs • Dependence of the region on a single manufac- • institutional thickness and strong inter- turing cluster could pose a challenge to remain institutional networks innovative in the future, since the auto industry • educated and skilled workforce. is traditionally slow-moving, but is facing new Key strengths in automotive machinery, electronics, competitors from fast-moving industries, such and electrical engineering as technology and communications. • strong in exports • research-driven cluster –– active cluster in terms of patenting –– flourishing collaboration between industry and academia. SOURCE: Tözün, 2009; Schlossstein and Yun, 2008.

1 WIEFC will consist of an integrated cluster of firms that will draw on the Hangzhou region’s resources. These resources consist of factors of production and related or supporting industries. While local markets will be small as a share of sales, they provide relevant test-beds. The industrial organization of the cluster will be shaped by firms’ structure, strategy, and rivalry. Therefore, Porter’s regional diamond seems appropriate. Note that it has been applied to other clusters, such as Sili- con Valley. See, for example, Wonglimpiyarat, 2006, and Steinle and Schiele, 2002. Regional Case: The Stuttgart Automotive Cluster 19

Table 2.5 Strengths, Weaknesses, and Uncertainties of the Stuttgart Automotive Cluster, with Regional Diamond Framework Applied

Strengths Uncertainties Weaknesses Factor conditions • Strong talent base and • Limited import of education systems talent • Strong capital base avail- • Transportation net- able through large car work and physical manufacturers infrastructure some- • Frequent interaction what underdeveloped between research insti- • Limited IT base, lack tutions and firms to of connection to local secure technological IT firms leadership position • Dedicated policy initiatives Related and • Dedicated network of • Sophisticated • Strong dependence supporting suppliers, mainly SMEs tasks and ser- on a few large firms industries vices in-cluster, causes uncertainty routine tasks in the face of new outsourced technologies Firm structure, • Culture of coopera- strategy, and rivalry tion and competition between large automotive manufacturers and suppliers • Local and regional governments working closely to connect firms and institutions Demand conditions • Highly sophisticated • Regulation and • No strong customer customer base for tra- international base for alternative ditional automotive demand con- technologies, since technologies ditions slowly local customers still pushing to show strong prefer- expand product ence for traditional portfolios combustion engine vehicles

CHAPTER THREE Regional Case: The Aichi Automotive Cluster

Aichi Prefecture and the Aichi Automotive Cluster

Aichi Prefecture is located near the center of the main Japanese island of Honshu, with an area of 5,153 square kilometers and a population of 7.5 million people. Nagoya is the capital of Aichi Prefecture and is Japan’s fourth-largest city and third-largest port. It is located in the middle of the Tokyo-Hiroshima region. It is a prosperous, industrial city with a population of 2.2 million people. Aichi occupies 1.4 percent of the country’s land, hosts 5.8 percent of the population, and contributes 6.6 percent to the country’s gross domestic product.

Figure 3.1 Geographical Location of Aichi Prefecture

Honshu

Aichi Prefecture

SOURCE: Google Maps. RAND RR2035-3.1

21 22 Wanxiang Innovation Energy Fusion City: Recommendations for Developing an Innovation Cluster

Aichi Prefecture is one of Japan’s most developed and industrialized regions. It is the leading manufacturing center of Japan, accounting for $340 billion of production in 2015, with significant contributions from transport and transport machinery (48.4 percent), iron and steel (6.9 percent), and electrical machinery (4.5 percent). Aichi is a major hub for transportation and logistics, accounting for 40 percent of Japan’s total automotive shipment by value. Its main industry is the automotive industry. It hosts Toyota, the largest automotive manufacturer in the world, Denso (a large automotive component maker partly owned by Toyota), and a number of plants for other major car manufacturers, such as Mitsubishi, Suzuki, and the Volk- swagen Group. Figure 3.2 shows that, in recent years, Aichi has redefined itself as a center for development and production of automotive components, as Toyota and other large automakers opened large assembly facilities overseas. Nowadays, Aichi ships about half of all of the automotive components produced in Japan (Figure 3.3). In addition to automotives, Aichi is home to several major corporations, such as Mitsubi- shi Aircraft Corporation in aviation, Central Japan Railway Company and Nagoya Railroad in the railway industry, Sumitomo Riko in the rubber and plastic industries, and Brother Indus- tries in the electronics industry. Aichi Prefecture hosts an integrated automotive cluster that combines parts manufacturing and vehicle assembly. It hosts 14 automotive manufacturing plants, of which six plants are for assembly and eight plants are for parts and components production.

Historical Development of the Aichi Automotive Cluster

The Aichi automotive cluster is the present manifestation of a tradition in manufacturing in the region dating back several centuries. In medieval Japan, the Aichi region was known as a center of craftsmanship (Yamawaki, 2002). It became the major exporter of puppets, ceram-

Figure 3.2 Absolute Value of Shipments, Aichi Prefecture

25,000

Components total Motor vehicle assembly 20,000

15,000

Billion yen 10,000

5,000

Figure 3.3 Value of Shipments, Share of Aichi Prefecture in Japan

60 Motor vehicle assembly Components total Automotive total 50

30 Percentage 20

0 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 Year SOURCE: RAND authors’ calculations using data from “Aichi Prefectural Government Official Site,” undated. RAND RR2035-3.3 ics, music boxes, and textiles during the Meiji era. Another important factor in the region’s development was a high savings and investment rate. Historically, the Aichi region enjoyed large accumulations of capital and financial institutions that encouraged investment in local businesses (Okabe, 2003). The formation of the automotive cluster in Aichi is closely linked to the development of the Toyota Group of companies and their local suppliers. Aichi’s access to Nagoya port and to cheap agricultural land for industrialization facilitated large-scale operations. Once Toyota set up, supplier companies followed nearby. Their motives ranged from receiving the benefit of close interaction to reducing transportation and logistics expenditures (Toyota, 2014). The first Japanese automobile was built in Nagoya in 1936 by Toyota, and in ten years the region became a hub for the country’s automotive production, hosting Nissan Motors and Mitsubishi. Manufacturing clusters in aircraft production as well as agriculture and food- processing industries were also later established in Nagoya. Toyota started as a textile manufacturing company. In the 1880s, the textile industry dominated Japanese industry, accounting for 63 percent of all factories and employing 73 percent of the workforce (Toyota, 2014; Toyoda, 1987). Japan became a leading global textile exporter by the end of the 19th century. Sakichi Toyoda, who founded the Toyota Group in 1926, pioneered the industry’s backward integration into advanced textile manufacturing equipment. At first, Toyoda’s Loom Works Company produced imitations of machines made by Platt Brothers in the United Kingdom. In time, its engineers were able to achieve significant innovation by improving on Western designs. As important, perhaps, was the development of an advanced assembly line system known as the Toyota Production System that is considered to have played an important role in Toyota’s leadership in the automotive industry (Liker, 2004). 24 Wanxiang Innovation Energy Fusion City: Recommendations for Developing an Innovation Cluster

The cluster expanded in the 1930s and during World War II, initially with the support of Ford and General Motors factories and associated technology transfers. In the late 1930s the Japanese government forced out foreign competitors and subsidized domestic producers. The policy of excluding foreign competition continued even after rules restricting foreign direct investment liberalized after the war. These were replaced by high tariff and nontariff barriers on automotive products (Lawrence and Weinstein, 2001). After the war, the cluster developed a new generation of smaller automobiles and engines designed primarily for the domestic market while continuing to produce large cars for exports. The 1970s oil crisis allowed Japa- nese manufacturers to gain a foothold in the global auto industry by exporting from their established base of lighter and less powerful cars that had suddenly become attractive in the global marketplace due to increased gasoline prices. This new value proposition was possible because of the demand of sophisticated Japanese consumers for small, fuel-efficient cars, and it became the unique selling point of Japanese cars in the United States and elsewhere. Government played an important role in the development of the automotive industry. It restricted car imports and provided public loans to car manufacturers. It sought to ensure domestic competition through antimonopoly laws and incentives. As Japanese firms became more competitive worldwide, government gradually lifted the existing restrictions on car imports and promoted free trade. Today, the Aichi automotive cluster is home to the Toyota and Denso corporations, and a large number of suppliers integrated in hierarchical structures around them. For example, the Toyota Group consists of 16 companies (Toyota, undated) and has several hundred primary parts subcontractors and over 1,500 secondary subcontractors (Kito, 2014; Kito et al., 2014). These smaller companies employ a large workforce; however, they tend not to develop their own technologies. Instead, they rely on licensing arrangements with large firms for accessing advanced technologies and processes.

Supply Chains and Inter-Firm Networks

Aichi Prefecture accounts for 40 percent of total national shipments of transportation equipment and machinery. Large, horizontally integrated firms that act as anchor firms dominate the industry, providing technology and market leadership. Suppliers are hierarchically organized around the anchor firms and rely on the large firms for advanced technologies and innovation. They also rely on the large firms for working capital and long-term financing. Large firms monitor the quality and set the prices for their suppliers while maintaining an incentive mechanism that allows for profit and risk-sharing. Lower-level suppliers compete for the business of anchor firms and tend to be small, while higher-level suppliers tend to be larger. The latter establish long-term relationships with a single anchor firm through long-term production contracts, common shareholdings, and financial co-guarantees and subject themselves to comprehensive quality management by the anchor firm. These complex relationships between firms in the cluster have been a source of competitiveness due to efficient investment in assets (Dyer, 1996); reduced transaction costs (Argyres and Zenger, 2012); more-efficient product development (Takeishi, 2002); increased organizational learning (Ahmadjian and Lincoln, 2001); and even increased resilience in the face of disasters (Nishiguchi and Beaudet, 1998). On the other hand, earlier work suggests that it may lead to excluding outsiders (Cole and Yakushiji, Regional Case: The Aichi Automotive Cluster 25

1984) possibly leading to lower foreign direct investment inflows in the automotive parts sector (Bebenroth, 2015). The large parts suppliers tend to work with one anchor firm only. Eight of the top ten ranked car parts suppliers by sales in Japan in 2010 were exclusive suppliers to Toyota (He and Bai, 2012). Over time, this has led to a growing share of components in the value of automotive exports of the region (Figure 3.4). The World Economic Forum gives Japan the top spot in its rankings of local supplier quality, quantity, and intensity of local competition (World Eco- nomic Forum, 2016a). The strength of ancillary industries, such as chemicals and electronics provided additional benefits to the development of the automotive cluster. Anchor firms also drive research and development. Most research and development activities are performed within anchor firms. After developing the core technologies and standards, large firms provide production specifications to suppliers. This contrasts with the Stuttgart cluster, where research and development is spread across the entire value chain. Most local suppliers in Aichi are not particularly innovative and do not compete on a global basis (He and Bai, 2012). Globalization has affected Aichi’s production structure as it has Stuttgart’s. To meet domestic content requirements and to save costs, the large producers and several of their suppliers have built manufacturing plants around the world. As a result, offshore manufacturing has increased while domestic production has declined (Japan Automobile Manufacturers Associa- tion, 2016). Despite these trends, core activities, such as advanced engineering and evaluation, vehicle design, personnel training, and management are still concentrated in the Aichi region, and link with outsourced manufacturing locations through sophisticated IT infrastructures. To address the lack of innovation among smaller firms, the Japanese government created a number of Public Testing and Research Centers (PTRs) that could offer smaller suppliers the opportunity to innovate and become more independent from their main contractors (Cowling and Tomlinson, 2003). However, the actual work of these centers was seen as tightly

Figure 3.4 Value of Automotive Exports, Aichi Prefecture

10,000 70

9,000 Component (billion yen) Passenger cars (billion yen) 60 8,000 Ratio of components to cars (%) 7,000 50

6,000 40 5,000 30 Billion yen

4,000 Percentage

3,000 20 2,000 10 1,000

0 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 Year SOURCE: RAND authors’ calculations using data from “Aichi Prefectural Government Official Site,” undated. RAND RR2035-3.4 26 Wanxiang Innovation Energy Fusion City: Recommendations for Developing an Innovation Cluster

aligned with the agenda of anchor firms. For instance, earlier work suggests that the Aichi PTR, instead of helping small suppliers advance their own research, became a “tool to help subcontractors meet Toyota’s stiff demands” (Ruigrok and Tate, 1996). These scholars find that most activities at the center were focused on test inspections that scrutinize suppliers’ processes and components, arguing that Toyota has been able to direct the activities of the PTR to an extent that it became an integral part of the company’s domestic production system and a major instrument of control over its local supply chain. This finding suggests that in Aichi, large automotive firms traditionally exercised full control over strategic decisionmaking and conducted core research and development in-house, while local suppliers were “locked” into their main contractor’s supply chain and had a limited role in creating innovative products and processes. After Japan slipped into recession, there is evidence that the traditional Keiretsu system— characterized by long-term relationships between manufacturers and suppliers—may be changing as a result of a harsher economic environment. Recent research suggests that Toyota is moving toward more open, global, and cost-effective supplier relationships while preserving the collaboration and educational support that were key elements of the traditional system. In particular, instead of buying only from long-term suppliers at prices that are sometimes above the market price, Toyota started developing relationships with key international mega suppliers whose economies of scale allowed them to charge very low prices. While maintaining tight relationships with its long-term suppliers, Toyota also started setting prices for components based on comparison with multiple global companies and pushed its suppliers to provide more- integrated systems of components rather than individual parts. On the other hand, Toyota continues to help its suppliers achieve the necessary technological sophistication by increasingly involving them in product development and planning, as well as providing educational support (Aoki and Lennerfors, 2013).

People and Workforce

The automotive sector in Aichi Prefecture employs about 300,000 people. About two-thirds of the workforce is employed in parts production, and about one-third in motor vehicle assembly (see Figure 3.5). Historically, the motor vehicle assembly jobs were concentrated in the large firms and were relatively stable over time. Conversely, employment in the parts manufacturing industry was subject to greater volatility. The Aichi cluster benefits from a large and educated workforce consisting of engineering and natural science graduates, as well as skilled specialized workers. This is a product of a strong primary and vocational education combined with on-the-job training programs. As a rule, large firms attract top students from universities and vocational schools and provide them with in-house training. There is a widespread perception that university training is inadequate in terms of specific skills for manufacturing jobs, and firms often make significant investments in “re-education” of new graduates. Trained employees are expected to stay in the same firm for the duration of their careers. Japan’s advanced manufacturers’ labor productivity is 29 percent below that in the United States and 32 percent below Germany, possibly due to rigid labor markets and an inadequate competitive environment (McKinsey Global Institute, 2015). The Aichi region is home to a high number of vocational training institutions and several prominent universities. Nagoya University, the region’s primary university, has a strong reputa- Regional Case: The Aichi Automotive Cluster 27

Figure 3.5 Number of Employees, Aichi Prefecture

300,000

Components total 250,000 Motor vehicle assembly

200,000

150,000 People

100,000

50,000

0 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 Year SOURCE: RAND authors’ calculations using data from “Aichi Prefectural Government Official Site,” undated. RAND RR2035-3.5 tion for research in the sciences and accounts for almost one-third of Japan’s Nobel laureates in science (Times Higher Education World University Rankings, 2017). Local suppliers usually compete for talent produced within the region, while anchor firms, such as Toyota, attract tal- ented graduates from all over Japan. However, there is limited interaction between the universities’ research departments and firms in the cluster. This is partly compensated by a developed resident engineer program that allows professionals from supplier companies to work with Toyota designers for periods between six months and three years. This program contributes to better communication between automakers and suppliers and fosters learning and innovation through technology transfers (Pessôa and Trabasso, 2016). The IT revolution in the 1990s and the rise of new technologies led Toyota to reassess its “all on-site” strategy and develop large research and development centers in the United States, Germany, France, China, Thailand, and Australia (Toyota, undated). Toyota also lobbied the government for liberalizing the visa regime for engineers and IT specialists to transform Aichi into a global innovation hub. However, its efforts to attract top-notch foreign talent to the Aichi region have been largely unsuccessful. Most experts cite living conditions and cultural distance as the main reasons for failure to attract foreign talent. In particular, foreign specialists are less attracted to work in a culture that emphasizes lifelong commitment to one company and a system of equal compensation for similar positions across “brother” companies (McKinsey Global Institute, 2015).

Exploring Alternative Technologies

Automotive research and development in Japan has been historically concentrated inside large firms. Universities were largely focused on research rather than the exploration of new technologies. Toyota maintained close collaboration only with its suppliers, and almost no col- 28 Wanxiang Innovation Energy Fusion City: Recommendations for Developing an Innovation Cluster laboration with universities and outside research centers. High oil prices, the IT revolution, and rapid technological development forced Toyota to start experimenting with new technologies. Toyota made an early bet on hybrid vehicles and developed the highly successful Prius model, allowing it to capture a large market share both domestically and in the United States (Taylor, 2006; Cobb, 2016). To succeed, Toyota used the same strategy as it had earlier: It developed core research and development in-house and passed production specifications down to its supply chains. Innovation was pursued by improving management of the supply chains, building research and development centers abroad, and forging partnerships with leading universities and start-ups while remaining the leading innovation source for its supply chain.

Summary of Aichi Case Study Findings

The Aichi cluster’s rich historical tradition of manufacturing, skilled labor, globalized large firms, and networked SMEs are the major driving forces for the cluster’s success. Large firms are horizontally integrated and rely on sophisticated SMEs to contribute technology- intensive critical components. However, these SMEs rely on the large firms for access to technology, financing, product design, and quality assurance. They are closely linked to the large firms through long-term contracts, co-ownership, and financial co-guarantees. The local universities sustain a flow of high-quality talent to the cluster, but have limited roles in research and development. Government support for university-industry interaction and for SME development is limited and ineffective. When applying Porter’s regional diamond framework to the Aichi automotive cluster, we observe a number of strengths, weaknesses, and uncertainties, which we outline in Table 3.1.

Table 3.1 Strengths, Weaknesses, and Uncertainties of the Aichi Automotive Cluster, with Regional Diamond Framework Applied

Strengths Uncertainties Weaknesses Factor conditions • Well-developed • Low worker mobil- • Decreasing working infrastructure and ity due to lifetime population high-quality public employment culture • Low interaction services with universities • Large number of for research and skilled employees development • Proximate academic base for training Related and supporting • Strong base of local industries suppliers • Proximity to developed manufacturing clusters in electronics, aircraft manufacturing, robotics, and other advanced industries Regional Case: The Aichi Automotive Cluster 29

Table 3.1—Continued Strengths Uncertainties Weaknesses Firm structure, • Fierce competition • Long-term contract- • Low foreign direct strategy, and rivalry among large firms ing between large investment inflows for end customers firms and high-end and among small suppliers suppliers for busi- • Co-ownership ness with large firms between firms • High customer orientation • Supportive policy environment Demand conditions • Sophisticated • Shrinking domestic domestic customer market due to demo- base graphic trends • High-quality standards for safety and environmental protection • Government procurement of advanced technologies

CHAPTER FOUR Developing the Wanxiang Innovation Energy Fusion City Cluster

In this chapter, we summarize the lessons learned from the Stuttgart and Aichi cluster case studies and relevant additional secondary literature. We then derive recommendations for WIEFC. The method we use is to discuss the case studies, focusing on selected contributing factors and causes to draw lessons for a suitable mission statement and policies for WIEFC.

The Stuttgart Automotive Cluster

We first take up the case of the Stuttgart automotive cluster and detail the relevant contributing factors in the sections below.

Supply Chain Large firms tend to face the most-sophisticated users, i.e., end users or other large firms. Large firms are horizontally integrated, allowing them to face a diverse variety of end-users. SMEs are of two kinds. Those supplying low-end products compete for the business of several client firms. Those supplying high-end products specialize in a limited set of product lines for a single manufacturer. They compete with each other for the business of that manufacturer. The supply chain is less integrated as it moves downstream. The smaller the firm, the more likely it is to be specialized in a few types of outputs, while large firms are more likely to integrate products from smaller firms into their final product.

Price and Quality Large firms offer smaller firms a well-established yet competitive marketplace. They do so by sourcing products from suppliers both within and outside the cluster. As a general rule, knowledge-intensive components of the production process are handled by local firms, while routine tasks tend to be performed elsewhere. While sourcing products, large firms also specify standards of performance along with product specifications. This influences how quality assurance processes and performance standards are established for the cluster as a whole.

Ownership Large firms are likely to be owned by diversified shareholders and employee groups. SMEs are usually independently owned and managed, often as family businesses.

31 32 Wanxiang Innovation Energy Fusion City: Recommendations for Developing an Innovation Cluster

Resources Large firms typically access capital from capital markets and large commercial banks. SMEs rely on bank financing and internally generated funds. The regional government has established banks specializing in SME lending. These are a primary source of SME loans. Large firms and SMEs equally rely on fresh talent from the vocational and formal education system. However, large firms are more likely to have pipelines of identified talent due to research and training collaborations with the university and vocational training system; SMEs also identify talent by hosting vocational trainees as apprentices, an approach that is a unique feature of the German dual-education system. Firms partner with vocational institutions to provide ongoing professional development to employees.

Business Development and Technology Large firms obtain knowledge through their interactions with sophisticated clients. SMEs obtain knowledge through interaction with large firms and from a range of industry associations and initiatives, some of which are state-sponsored. Large and small firms also collaborate with universities to embed research into their products.

Discussion In the Stuttgart automotive cluster, large firms appear to be critical for employment in the cluster. While large firms face the most market risk—they deal with the most-sophisticated users, often by introducing new and untested products to clients—they can manage this risk by developing a pipeline of products through their experience of clients of different types and by being responsive to client needs. By contrast, SMEs work to order in a competitive marketplace and are reliant on a small pipeline of products. Therefore, they face more-volatile demand than large firms. This might reduce their attractiveness to employees. SMEs, however, due to their ownership structure, have historically valued long-term employees, thus offering the advantage of a long-term career. They have also historically offered a technologically sophisticated work- place that has made them attractive to employees. Recent trends, especially the rapid development of new technologies outside the cluster, have given the large firm a special place as the window through which technological change is understood and disseminated to the cluster. This has improved the attractiveness of large firms vis-à-vis SMEs in recent times. As a result, at the present time, from an employee’s perspective, the large firms offer not only a more technologically sophisticated environment than SMEs, but also more-stable employment prospects. This suggests that large firms would be seen as more attractive employers than SMEs would. Large firms appear to be critical for establishing standards of performance and new technology introduction. These are initially set or developed to meet client needs, and then cascade through the system. As noted, the responsibility for new technology introduction was earlier shared between SMEs and large firms, but has tended to shift toward large firms in recent years. For both large firms and SMEs, establishing a presence within the cluster seems to be critical for their progress, but for different reasons. For large firms, a cluster offers a way to interact with a large number of SMEs to ensure that the SMEs can meet the desired standards of output and performance. For SMEs, the cluster enables them to employ talent that has large- firm experience, interact with large firms to deliver competitive products, and network with Developing the Wanxiang Innovation Energy Fusion City Cluster 33 other SMEs and large firms (informally and through formal associations) to obtain knowledge about business development and technology trends.

The Aichi Automotive Cluster

We next take up the case of Japan, specifically, the case study of the Aichi automotive cluster. Below is a discussion of the relevant contributing factors of the industrial organization in Aichi Prefecture.

Supply Chain Aichi is both similar to and different from to Stuttgart regarding the supply chain. An important similarity is that large firms tend to face the most-sophisticated users, i.e., end users or other large firms. A second similarity is that large firms tend to be horizontally integrated. SMEs mostly deal with firms further down a supply chain that becomes less integrated as it moves downstream. The smaller the firm, the more likely it is to be specialized in a few types of outputs, while large firms are more likely to integrate products from smaller firms into their final products. A key difference lies in the relationship between large firms and SMEs. In Stuttgart, SMEs compete for the business of large firms, while in Aichi, the most critical SMEs are attached to large firms on a long-term basis; therefore, they do not compete with each other for business from the large firms. The long-term connection is contractual and supported by the ownership structure and financing provided by the large firms to the SMEs (see the ownership section for more details on this structure). This long-term connection has survived market volatility over several decades. While Toyota has moved to outsource some components since the 1990s as a way to discipline its long-term suppliers, it continues to give the privilege of long- term contracts and technology support to its traditional suppliers.

Price and Quality Large firms negotiate contracts with SMEs within their supply chain. As in Stuttgart, while sourcing products, these large firms also specify standards of performance along with overall product specifications. This influences how quality assurance and performance standards are established for the cluster as a whole.

Ownership Large firms are likely owned by diversified shareholders, just as in Stuttgart. However, in Aichi, SMEs are partly owned by their promoters or founders and partly owned by the large firms.

Resources While large firms can access capital from capital markets, SMEs rely on bank financing, internally generated funds, and, unlike Stuttgart, on project and working capital financing from their client, which is the large firm. Large firms and SMEs equally rely on fresh talent from the vocational and formal education system. However, as in Stuttgart, large firms are more likely to have pipelines of identified talents due to research and training collaborations with the university and the vocational training system; SMEs do not have this advantage. Unlike in Stuttgart, there is no formal appren- 34 Wanxiang Innovation Energy Fusion City: Recommendations for Developing an Innovation Cluster tice system whereby talent can be placed in large and small firms. After recruitment, employees receive in-house training from their employers.

Business Development and Technology In Aichi, large firms obtain knowledge through their interactions with sophisticated clients, as they do in Stuttgart. SMEs obtain knowledge through interaction within the supply chain established by their large-firm client. Instances of collaborative research with universities are rare, and universities are largely seen as a source of recruiting fresh employees.

Discussion In Aichi, as in Stuttgart, the role of large firms appears to be critical for employment in the cluster. While large firms similarly face the most market risk, they can manage this risk by developing a pipeline of products through their experience of clients of different types and by being responsive to client needs. Unlike in Stuttgart, SMEs work to order in a noncompetitive marketplace, although they are equally reliant on a small pipeline of products. This assures them of more-stable demand relative to SMEs in Stuttgart, and thus provides greater employment stability. From an employee’s perspective, this is attractive and enables SMEs to compete with large firms for such employees. However, since the SMEs rely on the large firms for technology and business development knowledge, they offer a less sophisticated work environment. For the more innovation-oriented employees, this suggests that in Aichi, large firms would be seen as more-attractive employers than SMEs. As in Stuttgart, large firms also appear to be critical for establishing standards of performance and new technology introduction. These are initially set or developed to meet client needs and then cascade through the system. For both large firms and SMEs, establishing a presence within the cluster seems to be critical for their progress, but for different reasons. This is similar to the Stuttgart case, but the causes diverge. For large firms, a cluster offers a way to interact with the entire supply chain efficiently to meet desired standards of output and performance. For SMEs, the cluster enables them to employ talent that has large-firm experience (this is similar to Stuttgart) and to efficiently interact within the supply chain. Both the Stuttgart and Aichi models of industrial organization offer insights into innovative automotive clusters. Because there may be lessons to be had from other industries, we consider two additional models.

The Taiwan Personal Computer Cluster

A third model of industrial organization considered is in use in many industries in Taiwan, such as the personal computer industry. Here, the industrial cluster is organized as a partner- ship between firms of different sizes and in different stages of the supply chain, most typically through an industry association or cooperative, which is jointly promoted by all members of the supply chain. The firms in the association are independently owned and enter the association on a voluntary basis. However, once they join, they are bound by long-term contracts to work with each other. The association takes the responsibility for business development on behalf of the entire supply chain, and for understanding and introducing new technologies and standards. Branding and other client-facing activities are the responsibility of the association. Developing the Wanxiang Innovation Energy Fusion City Cluster 35

The organization of the Taiwan personal computer cluster into associations originated from the dominance of local SMEs that initially produced simpler electronic consumer goods, such as hand-held calculators. Facing competition from larger, better-financed global rivals when they entered the personal computer business, the Taiwanese SMEs created industry associations that would help them to compete. These associations retained the ownership structure of the SMEs, while providing large firm–like business development capacities and access to financing (Sturgeon and Lee, 2001; Curry and Kenny, 1999; and Chen, 2002). Government did not play a significant role in the organizational form. The following are relevant features of the industrial organization of the Taiwan clusters.

Supply Chain The association, on behalf of its members, faces end-users for pricing, output, and quality standards. Each member tends to be specialized in a few items and there tend to be few large members.

Price and Quality The association plays a coordinating role and helps the individual members reach agreement on prices and quality standards within the supply chain.

Ownership Firms are independently owned and operated.

Resources Firms rely largely on bank financing and each firm within the supply chain sources its own talent. The association provides professional development support.

Business Development and Technology Business development is the responsibility of the association. The association typically receives a percentage of members’ revenue to support these activities on behalf of its members. Univer- sity collaborations are not significant as a source of knowledge or product development.

Discussion In Taiwan, there is no particular role for large firms for determining employment, business development, or technology trends. Market risk and technology development are shared among all firms in the cluster through the association, and employment prospects do not differ by firm size. For both large firms and SMEs, establishing a presence within the cluster seems to be critical for their progress, for largely similar reasons: The cluster offers a way to interact with the entire supply chain efficiently to meet desired standards of output and performance, jointly source talent, and share business knowledge (Kawakami, 1996; Kraemer and Dedrick, 1996).

The Silicon Valley Model

Finally, a fourth model is what may be called the Silicon Valley model (Lee, Miller, and Han- cock, 2000; Saxenian, 1991). In Silicon Valley, SMEs are the drivers of new technologies and 36 Wanxiang Innovation Energy Fusion City: Recommendations for Developing an Innovation Cluster industry standards are set by a variety of actors—including large and small firms—and professional associations, such as the Institute of Electrical and Electronics Engineers (IEEE). Talent is competitively sourced. Once recruited, individual employees take responsibility for their own professional development (Castilla et al., 2000). SMEs do not see it as their responsibility to support employees’ professional development through training. However, in some cases, larger firms may offer technology development training on their own platforms. An important, if somewhat informal, role is played by industry associations that provide their members with information on technology trends. The following are relevant features of the industrial organization of Silicon Valley.

Supply Chain Similar to both Stuttgart and Aichi, in Silicon Valley, large firms tend to face the most- sophisticated users, i.e., end users or other large firms, while SMEs mostly deal with firms further down a supply chain that is less integrated as it moves downstream. The smaller the firm, the more likely it is to be specialized in a few types of outputs, while large firms are more likely to integrate products from smaller firms into their final product.

Price and Quality As in Stuttgart, large firms offer smaller firms a ready, yet competitive marketplace. They do this by sourcing products from suppliers both within and outside the cluster. While sourcing products, they specify standards of performance along with product specifications. This influences how quality assurance and performance standards are established for the cluster as a whole. However, an important difference from Stuttgart is that SMEs in Silicon Valley offer new technologies for large firms as well as other SMEs. Thus, SMEs both supply their own technology to other firms at different stages of the supply chain and compete with other firms’ (including large firms’) in-house technology departments.

Ownership Large firms are likely to be owned by diversified shareholders. SMEs are independently operated, but tend to be owned jointly by the promoters and venture capitalists.

Resources Large firms rely largely on bank financing and capital markets, while SMEs rely on a combination of internal financing, venture financing, banks, and large-firm equipment or platform financing. Each firm within the supply chain sources its own talent, a task that is relatively easy given the abundance and mobility of human-capital resources in Silicon Valley (Fallick, Fleischmann, and Rebitzer, 2006). The advantage of an abundance of readily available local talent is not widely found elsewhere since it takes many years and an enabling environment of constant technological and economic growth to sustain. The local university system also offers highly educated talent for all levels of the workforce. San Jose State University and Santa Clara University and a number of local community colleges are large suppliers of fresh engineering talent at the undergraduate and associate levels, while Stanford University and University of California, Berkeley, are important suppliers of graduate- and doctoral-level talent. The community colleges play an important role in providing professional development services to local engineers. Developing the Wanxiang Innovation Energy Fusion City Cluster 37

Business Development and Technology As in Stuttgart, large firms obtain knowledge through their interactions with sophisticated clients. SMEs obtain knowledge through interaction with large firms and from a range of industry associations and initiatives, some of which are state-sponsored. In addition, venture capitalists are a source of knowledge for SMEs. The university system plays a significant role in knowledge generation, somewhat similarly to Stuttgart. All the major universities of the region—Stanford University; University of California, Berkeley; San Jose State University; and Santa Clara University, as well as several community colleges—host COEs and laboratories, funded jointly by the university and private industry for both basic and applied research.

Discussion In Silicon Valley, as in Taiwan, there is no particular role for large firms for determining employment, business development, or technology trends. Market risk and technology development are shared among all firms in the cluster through their business development activities. Employment prospects are often superior in SMEs due to their role in driving technological change (Bresnahan and Gambardella, 2004). For both large firms and SMEs, establishing a presence within the cluster seems to be critical for their progress, for largely similar reasons: The cluster offers a way to interact with the entire supply chain efficiently to meet desired standards of output and performance, source talent, and share business knowledge through the marketplace.

Summary

In Tables 4.1–4.3, we summarize the relevant features of the industrial organization of the four models.

Table 4.1 Access to Talent, Technology, Clients, Standards, and Financing in Each of the Four Clusters

Cluster Talent Technology Clients Standards SME Financing Stuttgart Competitive—recruited Large firm, Large firm Large firm Banks from universities and association, other firms university Aichi Recruited from Large firm Large firm Large firm Large firm, universities; SMEs also banks recruit from large firms Taiwan Competitive Association Association Association Banks Silicon Valley Competitive—recruited Competitive, Competitive Association, Banks, venture from universities and university all firms capital other firms and research institutions 38 Wanxiang Innovation Energy Fusion City: Recommendations for Developing an Innovation Cluster

Table 4.2 Value of Each Cluster to Large Firms and Small- and Medium-Sized Enterprises

Cluster Large Firms SMEs Stuttgart • Technology dissemination to SMEs • Market understanding • Market requirements dissemination to • Competitive supply-chain SMEs access • Supply-chain formation and • Talent acquisition management • Technology acquisition Aichi • Technology dissemination to SMEs • Assured supply-chain • Market requirements dissemination to participation SMEs • Talent acquisition • Supply-chain management • Technology acquisition Taiwan • Technology acquisition • Technology acquisition • Assured supply-chain participation • Assured supply-chain participation Silicon Valley • Supply-chain access • Competitive supply-chain • Talent acquisition access • Technology acquisition • Talent acquisition • Technology acquisition

Table 4.3 Product Pricing for Both End User–Facing Firms and Firms Within the Supply Chain, by Each of the Four Clusters

Cluster End User–Facing Firms Firms Within the Supply Chain Stuttgart Market-based competition Competitive, off-market bidding for large- firm contracts Aichi Market-based competition Off-market negotiated prices for large-firm contracts Taiwan Market-based competition Off-market negotiated prices for small- and large-firm contracts Silicon Valley Market-based competition Competitive, off-market bidding for large- firm contracts

Recommendations for WIEFC

WIEFC’s vision is to build an innovation-oriented ecosystem around manufacturing green products for the automotive sector. Since Wanxiang Automotive is a large player in this sector, we consider its potential role in WIEFC’s development. The insertion of China into the automotive supply chain occurred over the past three decades and was driven by the supply of affordable, high-quality labor and a supportive financial and physical environment for manufacturing. As a result of China’s entry, the global automotive industry has reorganized itself and sources a large number of intermediate products from China. Over time, the Chinese automotive components industry has delivered increasingly sophisticated products and continues to capture large components of upstream activities, such as design (though still largely on an original-design-manufacturer basis) and logistics. Wanxiang Automotive’s history mirrors this trend. It is a large OEM creator of automotive components and is the flagship company of the Group. It is an integrated firm that primarily sources raw materials, such as steel bars, and converts them to the finished product at its factories in China. Over time, it has moved up rapidly in both sophistication and product range. It has entered the field of electrical vehicle components and will be introducing an electric car under its own brand name in the near future. Developing the Wanxiang Innovation Energy Fusion City Cluster 39

Meanwhile, recent trends in the global automotive industry indicate a significant role for the IT industry and with it, Silicon Valley. The automotive industry experienced a potentially disruptive change with the recent arrival of firms such as Tesla, Inc. Located in Silicon Valley, Tesla’s production model derives from the earlier iterations of the business model of Apple, the renowned maker of smartphones and computers, among other products. Under the Tesla business model, activities related to marketing, design, and manufacturing are kept in-house (The Economist, 2016). Tesla outsources a large number of components to Toyota and other firms, both large and small, but its ultimate goal is to offer a product that is fully produced in-house. This is in the opposite direction of the typical Silicon Valley large firm, which outsources a large share of design and production both within Silicon Valley and elsewhere. For Tesla, the choice of Silicon Valley as its primary location appears to be driven mostly by the benefits of a large talent pool and the availability of venture capital. The arrival of Tesla and the role of digital technologies have challenged some, but not all, of the organizing principles of the automotive sector. One of the aspects that has not changed is that the sector is well-suited to deriving economies of scale. This has long been the case and is a key reason why the industry was historically organized around large firms, something that is still the dominant industry model in both the Stuttgart and Aichi clusters. To play an anchor role, a large firm in WIEFC should possess technological leadership and market leadership.

Technological Leadership This is usually only possible if the firm interacts directly with sophisticated users, such as end consumers. However, this condition can also be fulfilled indirectly if the firm can understand and implement technological change through interaction with those who are not final users, but have an interest in working closely with the firm because of its technology leadership. For example, Bosch, a firm in Stuttgart, is a technology leader which initially grew out of dependent relationships with large upstream firms such as Mercedes. Due to investment in Bosch’s own technologies, its dependence on upstream firms is now two-way, and Bosch also plays the role of disseminating technology to smaller firms in Stuttgart. Another exception is the typical Silicon Valley start-up, which may not face the end consumer, but instead delivers business products or services to upstream firms. Because of their endowment of skilled talent and easy access to venture capital and information from other firms in the cluster, start-ups are able to invest in new technologies and share innovative leadership with the cluster. Based on discussions with the leadership of Wanxiang Automotive and its history as a Tier 1 and 2 supplier, our assessment is that its present focus on OEM work has yet to develop to the stage where it can provide technological leadership at a global scale. However, due to its inbuilt strengths of financial support and early adoption skills and its recent investments in electric vehicle technologies, it could become a technological leader in the near to medium term.

Market Leadership As discussed in the Stuttgart and Aichi cases, one of the anchoring firm’s advantages in these clusters is its ability to contribute an understanding of market requirements to the cluster and to provide leadership in directing the activities of other firms in the cluster toward global market needs. Anchoring firms derive such understanding from their interactions with end users who are mostly located outside the cluster. Anchoring firms can also operate as bridg- 40 Wanxiang Innovation Energy Fusion City: Recommendations for Developing an Innovation Cluster ing institutions, facilitating access for outside companies into the local markets. Given its unique knowledge and experience of customer preferences, tastes, and responses in the Chinese market, Wanxiang could leverage its already existing customer base to foster cooperation with international technology leaders. Similar to the assessment of technology leadership, our assessment for Wanxiang Auto- motive is that it has yet to develop the relationships with end-users that will enable it to provide an understanding of markets to other firms. However, over time, as it moves closer to the end user, it will be able to provide such leadership as part of building its supply chains within WIEFC. Given the potential for Wanxiang Automotive to play a critical role in the future, it would not be advisable at this stage to invite a large automotive firm from overseas with established market and technological leadership to be an anchor firm in WIEFC. Such a firm’s activities would likely be a subsidiary to its primary location overseas. This is evident in a number of industrial parks in China, where large firms from overseas were invited to establish operations, but have not played the expected role in bringing the cluster to global leadership (Millward, 2012). The reasons for this are unclear, but could include a lack of sophistication of local markets and a factor cited earlier, the distance from the overseas firm’s headquarters. Wanxiang Automotive should instead aim to be a strong player among others established in WIEFC. Over time, it should aim to play a catalytic role in building supply chains within the cluster and attracting talent to the cluster. However, large and small foreign firms in WIEFC could play the role of anchor component. Foreign firms may be attracted to WIEFC if they feel that this would be a suitable gate- way to the Chinese domestic automotive market. While individual foreign firms would not be able to play an anchoring role, they may, together with key domestic firms, form an “anchoring cluster” of firms through the combined set of technologies and access to markets that they bring. As we discuss below, the appropriate model for WIEFC is likely to combine elements of each of the models discussed earlier, while not looking exactly like any one of them. We now present the appropriate mission statement and supporting policies for WIEFC.

Vision Statement

WIEFC’s vision is to be an innovation-oriented cluster, whose ecosystem is built around the development and manufacturing of green products for the automotive sector.1

Mission Statement

The WIEFC cluster consists of residential, commercial, and industrial areas that possess the following attributes:

1 An ecosystem is defined as a community or cluster of connected players that is sustainable. Sustainability means that the cluster is able to meet its goals (in this case, to be innovation-oriented around the development and manufacturing of green products for the automotive sector) on a long-term basis. Profitability is a requirement for sustainability, among other requirements. Sustainability does not, however, mean self-reliance, in the sense that all the resources are generated internally. WIEFC is expected to interact actively with the outside world. Developing the Wanxiang Innovation Energy Fusion City Cluster 41

How to Start and Sustain the WIEFC Cluster: What to Do

We focus on identifying originating and sustaining factors that may be delivered through policy in support of the mission. As noted earlier, the originating factors are those that should be in place, or that cluster planners ought to deliver at the beginning of the cluster. The sustaining factors should be implemented at later stages. Based on the literature reviewed and the case studies presented in this report, the lists of both originating and sustaining factors are discussed below. The originating factors are

1. proximity to a large urban population 2. proximity to technologically sophisticated commercial and industrial firms 3. proximity to centers of advanced learning (research universities and institutions, and vocational training institutions) 4. sophisticated physical and institutional infrastructure 5. good living environment 6. affordable commercial and residential infrastructure.

WIEFC is located in a large, prosperous, and innovative urban center, Hangzhou. Hang- zhou is an important center for the automotive industry, as well as a center for the country’s digital technology businesses (European Union SME Centre, 2015). High housing costs and the hukou system—a governmental system of residency per- mits—can often present significant barriers to accessing labor resources. WIEFC’s location in a densely populated city like Hangzhou should help address concerns about housing and the hukou system, since a large share of the workforce will be locally derived. Located within the city of Hangzhou is a world-class university, Zhejiang University, as well as many smaller professional colleges and training institutions. An important ingredient in the human capital mix is the living environment. A cluster should identify the best of the natural and built environments and preserve the best as a cultural asset to attract families on a long-term basis (Florida, 2014; Casper, 2009; Casper and Murray, 2005). In the case of WIEFC, given its location, this suggests that it will be important to preserve and make accessible the area’s wetlands and for WIEFC itself to be a low-emissions development. With regard to the built environment, making WIEFC an attractive place to live through good schools, health care facilities, good transportation, and community centers for cultural activities will also be important. 42 Wanxiang Innovation Energy Fusion City: Recommendations for Developing an Innovation Cluster

To fulfill the first three originating factors, planners should ensure good connectivity, particularly in transport systems and bandwidth. Through good design and adequate financial commitment, the remaining three originating factors can be achieved. The sustaining factors are

1. Technology: access to cutting-edge technology 2. Talent: in-migration of high-quality talent 3. Supply chain: the higher value–added activities of the supply chain should increasingly be located over time within the firms at WIEFC 4. Clients: access to sophisticated clients both domestically and globally 5. Standards: ability to set high standards for product development.

We propose policies for each of the sustaining factors in the sections below.

Policies for Technology Development

1. Develop technologies through joint research between research institutions and firms at the COEs. 2. Access new technologies through licensing, research programs, and other ways of developing and protecting intellectual property through the Business Development Associa- tion (BDA).

Policies for Talent Development

1. Attract research-oriented talent and build research capacity through the COEs. 2. Develop workforce capacity through the establishment of an internship and apprentice- ship program in collaboration with the leading technical training colleges and universities in the area. This program would be managed by the BDA. 3. Attract technical and innovative talent through the establishment of a jobs program to be managed by the BDA.

Policies for Client and Vendor Development

1. Build supply chains by linking firms within the cluster through the BDA. 2. Identify and bridge gaps in the supply chain within the cluster by inviting new firms to the cluster through the BDA. 3. Develop a client and vendor base outside the cluster by building relationships with clients and vendors through the activities of the BDA.

Policies for Standards Development

1. Develop and implement standards for firms’ manufacturing processes through the establishment of a benchmarking institute (BI) located at WIEFC. Membership in the BI would be open to all firms located in WIEFC. Developing the Wanxiang Innovation Energy Fusion City Cluster 43

Policy Details and Discussion Access to cutting-edge technology. WIEFC should establish COEs, initially in collaboration with Zhejiang University (ZJU), to be located at WIEFC. ZJU is one of the world’s leading universities in research and education. ZJU’s engineering faculty is ranked 14th in the world in the prestigious Academic Ranking of World Universities (2016) rankings, which measure research competence. Preliminary discussions with ZJU’s engineering faculty indicate a readiness to enter into such a collaboration. Membership in the COEs should be open to all firms located at WIEFC. The COEs would undertake applied research to solve the engineering challenges faced by these firms, and thus help firms to develop technology leadership at WIEFC.2 WIEFC should establish a BDA. The BDA would be an open-membership, nonprofit association for all firms within the cluster. The goal of the BDA is to undertake activities to further the businesses of its members. These include facilitating the introduction of new technologies into the cluster through licensing, research programs, and other ways of accessing and developing intellectual property. The membership would commit a small percentage of its revenue to the association to enable the BDA to operate sustainably. Access to talent. This aspect may be among the most critical to the success of WIEFC. Once a cluster is established, talent will be attracted by opportunities for work, within both SMEs and large firms. However, in the initial stages, there will be too few high-technology firms to attract talent. Selecting the right strategy at the start will be crucial to the creation of a viable cluster. Of the models studied, Silicon Valley and Stuttgart—which initially relied on the surrounding university and vocational training systems (though now they also attract talent from outside the cluster)—seem to offer the most useful approach. Identify and develop talent for recruitment through the COE. The COE will be an important place for students and faculty to obtain experience in real-world engineering projects carried out at WIEFC. While the main goal of a COE is to solve difficult applied engineering problems through collaborative research and development, a COE can be an excel- lent tool for recruiting advanced talent (Altbach, 2009; Kenney, 1988; Vallas and Kleinman, 2007; Bray and Lee, 2000). ZJU has established several COEs in engineering and other fields (Zhejiang University, undated). At these COEs, students and faculty will obtain on-the-job experience in real-world engineering projects carried out at WIEFC. We propose that WIEFC benefit from ZJU’s competencies in producing high-quality science and engineering graduates, as well as widen its attractiveness to talent outside the region. To this end, WIEFC should utilize the COEs proposed above not just for technology access but also as a way to access and acquire talent. WIEFC should provide apprenticeships (one to two years) and internships (less than one year) at the firms in WIEFC to engineering students as part of a jobs program for fresh graduates. This program should be managed and funded by the BDA. WIEFC should develop a jobs program that encourages employees at other firms in Hangzhou to work full-time at firms in WIEFC or start their own firms at WIEFC. This program should be managed and funded by the BDA. Supply chain. The BDA should help member firms identify gaps in their supply chain and bridge those gaps through identifying and building relationships with suitable partner

2 Shanghai Jiao Tong University, which ranks 16th in the world in engineering, might be a good partner in addition to ZJU due to the proximity of Hangzhou to Shanghai (Academic Ranking of World Universities, 2016). 44 Wanxiang Innovation Energy Fusion City: Recommendations for Developing an Innovation Cluster firms. Note that such firms may be located both within and outside WIEFC. If such firms are located outside WIEFC (possibly even outside the country), and undertake high value–added activities, the BDA should work with these firms to ultimately open operations in WIEFC. Outside firms are likely to be interested in working with the BDA because such firms will gain access to BDA’s activities in different aspects: technology access and development, supply- chain management, marketing, and other business development. By systematizing contracts on behalf of its member firms, the BDA can also better protect WIEFC firms from haphazard contract enforcement and corruption issues that often face smaller firms. Note that we are not making the case that in innovative clusters the entire supply chain must be located within the cluster. It is important that a cluster be open to new ideas that can come from working with firms outside the cluster. However, as a cluster becomes more successful, it increasingly contains certain activities that span the higher value–added activities of the supply chain (Christensen, 2013). Access to clients. The BDA should develop marketing expertise in support of its member firms. While firms in WIEFC should be free to conduct their own marketing activities, for most small firms, one of the advantages of a cluster is that it reduces the cost of accessing clients for business development. The establishment of the BDA offers a powerful tool to develop marketing expertise that firms would not otherwise be able to afford on their own, and should help to attract new firms to the cluster, including foreign firms. The BDA will also market WIEFC to the outside world as an attractive destination for high-quality firms and talent in the green automotive space. Setting standards for product development. The cluster’s impact on standards of performance of goods and services developed at WIEFC is one of the most significant opportunities for WIEFC to attract talent, technology, and firms, if done successfully. In most clusters, it is either the large firms or the marketplace that set performance standards. This is a suitable method if there are well-established, global-quality large firms within the cluster, or if the market consists of sophisticated users. Since neither of these conditions will be fulfilled at the origination of WIEFC, an alternative is needed. We therefore recommend that WIEFC establish an open-membership, nonprofit BI located at WIEFC. The goal of the BI would be twofold: (1) to establish standards of capability for the business processes of firms at WIEFC, and (2) to help firms in WIEFC achieve consistently high standards through advisory support. The process standards to be established will cover environmental standards, workforce standards, and other standards for operation to be met by firms located in the cluster. An example of an environmental standard is the popular Leadership in Energy and Environmental Design (LEED) standard, owned and managed by the U.S.-based Green Building Council. The proposed BI would work with firms at WIEFC to help them achieve desired LEED standards that should be consistent with WIEFC’s zero-emissions goal. Workforce standards would include standards of professional practice and professional development benchmarking. An example of a workforce standard is the continuing education component that is required in many professions, such as in engineering. The proposed BI at WIEFC would work with engineering standards institutions of global quality to advise firms to achieve desired workforce standards. Those members meeting the process standards established by the BI will receive due certification. WIEFC may need to collaborate with an outside institution to establish the BI. Such collaboration should include a research component to understand trends in standards and bring in an innovative component to developing new standards. Developing the Wanxiang Innovation Energy Fusion City Cluster 45

Note that we are recommending neither particular technology standards nor output standards for the BI. The evolution of technology standards is increasingly market-driven and driven by professional associations, such as the IEEE, rather than by industry associations. For instance, the technology standard for Wi-Fi (the 802.1x series) is managed by the IEEE. Output standards are also not driven by industry associations, but instead by the marketplace, firms, and professional associations.

What Not to Do

Policies to Attract Leading Firms (Anchor Firms) Many successful clusters contain one or more global market leaders. Such firms, either by themselves or in combination with other firms in the cluster, play the role of providing technology and market leadership to the cluster. Such anchor firms serve multiple roles. They support firms lower down in the value chain and they attract other high-end firms to join the cluster. If a cluster contains anchor firms, the cluster’s chances of success improve dramatically. This may imply that it is desirable for WIEFC to try to attract such firms through special incentives or other policies to get a cluster started. However, new clusters typically find it difficult to attract anchor firms. This is because anchor firms prefer to locate their high-end activities where they already have an industrial base (e.g., Mercedes in Stuttgart) or co-locate near other firms doing similar high-end work (e.g., social media firms in Silicon Valley). The experience of technology parks in China and elsewhere shows that such firms, should they even agree to set up operations at a new technology park, undertake low-end work, such as procurement or localization. Therefore, we do not recommend policies for inviting global leaders in the automotive industry to establish operations at WIEFC at the initial stages.

Policies to Attract Risk Capital WIEFC’s firms will need substantial external capital—both as loans and as equity—to grow. Therefore, many technology parks establish policies to attract global leaders in risk capital, particularly venture capital, to their parks. The presence of such firms in successful clusters not only is important for access to capital, but also can play a significant role in technology access and talent acquisition. This may imply that it is desirable for WIEFC to try to attract venture capital through special incentives or other policies. However, venture capital firms respond to business opportunities rather than create them. Therefore, new clusters find it difficult to attract such firms. However, the marketplace is likely to work well quite quickly. Since 2000, China has developed a substantial domestic venture capital industry that is closely networked with the global venture capital industry, and is the second-largest destination for venture capital after the United States (Soo, 2017). We expect that venture capital firms and other financiers will be attracted by the presence of the technology and talent at WIEFC, once it develops, and do not need special policy attention. Accordingly, we do not propose policies to attract external capital.

Policies on Incubation Start-ups often need special support, such as technical support, opportunities to share ideas with other start-ups, and seed funding. To facilitate this, many industrial parks establish tech- 46 Wanxiang Innovation Energy Fusion City: Recommendations for Developing an Innovation Cluster nology incubators. These are physical spaces for start-ups to locate their initial operations for a period of time at below-market costs until they are commercially viable. Incubators often also contain support services, such as technical and legal services. This may suggest that WIEFC should establish policies for supporting incubation, including establishing an incubator for new firms. However, start-ups located in incubators often are unable to become commercially viable because they become reliant on subsidies to survive. Exposing start-ups to the full force of competition and financial discipline from the beginning is often a better way to achieve success. Most of today’s successful technology firms were not born in incubators. Accordingly, we do not propose policies on incubation.

Outcomes

The following six measurable outcomes are intended to be useful for city planners, as they provide benchmarks against which to measure the progress of policy initiatives.

1. Professional environment for talent: a large pool of global-quality talent in different fields of technology and business development. 2. Cluster environment: the presence of anchor firms, availability of risk capital for different-sized firms and activities, access to global markets, diverse business opportunities based on cutting-edge technologies, and capacity to reinvent itself over time. 3. Government support that provides funds for research and development to firms and institutions within the cluster. 4. Dense professional social networks that are collaborative and based on professional interaction. The networks should enable individuals and firms to work with each other, regardless of size or ownership, encourage risk-taking in product and services development, and tolerate experimentation and failures. 5. Professional services environment: the availability of comprehensive professional service, consisting of firms and individuals offering legal, financial, and other professional services. 6. Industrial organization: a description of the activities of firms and other entities in WIEFC and their relationships to each other and to the marketplace; their ownership; and their access to human, financial, technological, and other resources. Tables 4.4 and 4.5 outline the industrial organization’s access to resources and product pricing, respectively.

Table 4.4 The Industrial Organization’s Access to Resources

Talent Technology Clients Standards Financing Access COEs and market- COEs, BDA, and BDA and market- BI Banks and based recruitment market-based based competition venture capital from universities and competition firms Developing the Wanxiang Innovation Energy Fusion City Cluster 47

Table 4.5 The Industrial Organization’s Product Pricing

End User–Facing Firms Firms Within the Supply Chain Product pricing Market-based competition Competitive, off-market bidding for large firm contracts

Policy Summary

To achieve the vision and mission of WIEFC, we identified five sustaining factors: technology, talent, supply chain, clients, and standards. To achieve these factors, we identified the following policies: establishment of COEs, a BDA, and a BI. The COEs will undertake applied research to solve the engineering challenges faced by these firms, thus helping firms to develop technology leadership at WIEFC. The COEs will also help identify and develop talent for recruitment by firms at WIEFC by providing them with practical experience. The BDA will undertake activities to further the businesses of its members. Specifically, the BDA will (1) facilitate the introduction of new technologies through licensing, research programs, and other ways of accessing and developing intellectual property; (2) develop talent through on-the-job training via apprenticeships, internships, and a job program; (3) develop the supply chain by identifying and building relationships with suitable partner firms both within and outside WIEFC and by identifying high value–added partner firms outside WIEFC and supporting them to open operations at WIEFC; and (4) develop marketing expertise in support of client access. We envisage the BDA’s management structure to be similar to that of a cooperative in which each member has an equal status (including vote share), regardless of size. This is important for the following reason: As the Aichi case demonstrates, long-term dependence on a single supplier can be a barrier to innovation and cost-reduction. This forced Toyota over the past two decades to shift from an exclusive vendor model to a hybrid model. In the proposed BDA, supply chains will be managed in a cooperative manner with long-term contracts and shared responsibility for innovation and cost-reductions among the firms in the BDA. There will be, by design, no lead firm in the BDA. This approach should prevent the firms at WIEFC from facing the incentive issues that Toyota’s suppliers faced prior to Toyota’s shift to the hybrid model, while retaining the advantages of long-term contracts for incentivizing technology access and cost reductions. Can the BDA help the COEs become locations for the development of new technologies with the potential to disrupt current technologies? At the very least, the COEs can become locations for cost-effectively adopting the latest technologies available elsewhere. For example, the use of smart robots and three-dimensional printing technologies can be tested on a shared- cost basis among the firms within the BDA through contracts with the COEs. Over time, more contracts may be possible. For example, individual firms with potentially disruptive technologies in mind can also individually contract with the COEs to develop these technologies. TheBI will establish standards of capability for the business processes of firms at WIEFC and help firms in WIEFC achieve consistently high standards. 48 Wanxiang Innovation Energy Fusion City: Recommendations for Developing an Innovation Cluster

Table 4.6 summarizes the recommended policies. The top row lists the policies recommended and the first column lists the sustaining factors. The cells indicate how each policy will support the sustaining factors. Tables 4.7–4.9 illustrate how access to different resources for WIEFC will look in comparison with the other clusters.

Table 4.6 Recommended Policies to Implement the Sustaining Factors

COEs BDA BI

Technology Applied research Licensing and research programs

Talent Practical experience On-the-job training

Supply chain Identify and induct high-value partner firms into WIEFC Clients Marketing expertise

Standards Process standards

Table 4.7 Access to Talent, Technology, Clients, Standards, and Financing in Each of the Five Clusters

Cluster Talent Technology Clients Standards SME Financing WIEFC COE and market- COE, BDA, and BDA and BI Banks and venture based recruitment market-based market-based capital from universities and competition competition firms Stuttgart Competitive— Large firm, Large firm Large firm Banks recruited from association, universities and other universities firms Aichi Recruited from Large firm Large firm Large firm Large firm, banks universities; SMEs also recruit from large firms Taiwan Competitive Association Association Association Banks Silicon Competitive— Competitive, Competitive Association, Banks and venture Valley recruited from universities all firms capital universities and other and research firms institutions

Next Steps

To address each element in Tables 4.7–4.9, WIEFC should create a detailed strategic plan encompassing human and financial resources, tasks, and time lines. The plan should include recommendations on the governance of WIEFC and its constituent bodies, such as the BDA discussed above, and the delivery of public services. Such a plan should also include analyses of ways to benchmark progress of the desired industrial organization of WIEFC and to put in place monitoring and evaluation frameworks and mechanisms for course correction. Developing the Wanxiang Innovation Energy Fusion City Cluster 49

Table 4.8 Value of Each Cluster to Large Firms and Small- and Medium-Sized Enterprises

Cluster Large Firms SMEs WIEFC Technology acquisition Technology acquisition Supply-chain access Competitive supply-chain access Stuttgart Technology dissemination to SMEs Market understanding Market requirements dissemination to SMEs Competitive supply-chain access Supply-chain formation and management Talent acquisition Technology acquisition Aichi Technology dissemination to SMEs Assured supply-chain participation Market requirements dissemination to SMEs Talent acquisition Supply-chain management Technology acquisition Taiwan Technology acquisition Technology acquisition Assured supply-chain participation Assured supply-chain participation Silicon Valley Supply-chain access Competitive supply-chain access Talent acquisition Talent acquisition Technology acquisition Technology acquisition

Table 4.9 Product Pricing for Both End User–Facing Firms and Firms Within the Supply Chain, by Each of the Five Clusters

Cluster End User–Facing Firms Firms Within the Supply Chain

WIEFC Market-based competition Competitive, off-market bidding for large firm contracts Stuttgart Market-based competition Competitive, off-market bidding for large firm contracts Aichi Market-based competition Off-market negotiated prices for large firm contracts Taiwan Market-based competition Off-market negotiated prices for small and large firm contracts Silicon Valley Market-based competition Competitive, off-market bidding for large firm contracts

APPENDIX A Hangzhou and the Province of Zhejiang

As shown in Figure A.1, Zhejiang province is located on the eastern coast of China and has an area of 101,800 square kilometers and a population of 55.6 million people. Hangzhou is the capital and most populous city of the Zhejiang province, with a population of 9.1 million people and an area of 16,596 square kilometers.

Figure A.1 Zhejiang Province and the City of Hangzhou

SOURCE: Google Maps. RAND RR2035-A.1

51 52 Wanxiang Innovation Energy Fusion City: Recommendations for Developing an Innovation Cluster

Despite the fact that Zhejiang has a smaller area than most other provinces, it ranks fifth among China’s administrative regions in terms of per-capita gross domestic product at $22,015; fourth in terms of overall gross domestic product at 1.2 trillion dollars, or 6.34 percent of the national output; and third in foreign trade, with 281.1 billion dollars’ worth of exports.1 Figure A.2 shows the gross regional product of Zhejiang province. It has a large manufacturing base in electric machinery (9.4 percent of provincial gross domestic product), textiles (9 percent), chemical industries (11.8 percent), and automobile manufacturing (5.5 percent). Figures A.3 and A.4 show employment in Hangzhou. The figures indicate that manufacturing remains significant for the economy of the city. The national government has, over the past few years, intensified efforts to transition from an economy driven by investment and lower-value exports to one based on consump- tion, services, and development of high-technology industries. These efforts are coordinated by “Made in China 2025”—a national-level policy aimed to upgrade the quality and level of Chi- na’s manufacturing sector. Similar to the concept of Industry 4.0, digitization of the production process is viewed as a key component of this upgrade. Ten key sectors are targeted for support: information and communications technology, robotics, agriculture, aerospace, marine, railway equipment, clean energy, new materials, biological medicine, and medical devices. The plan states the need to develop indigenous products in a number of fields, including electric vehicles. In addition, the “Internet Plus” initiative was launched in 2015 with the goal of digi- tizing major sectors of the economy and building a service-oriented interconnected intelligent industrial ecosystem by 2025. Both policies are being implemented nationally, and Zhejiang

Figure A.2 Gross Regional Product of Zhejiang Province

4,500

4,000 Tertiary sector Secondary sector 3,500 Primary sector

3,000

2,500

2,000

RMB (billions) 1,500

1,000

500

0 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 Year SOURCE: Zhejiang Statistical Yearbook, 2016. RAND RR2035-A.2

1 Zhejiang is China’s 25th–largest province by area. Gross domestic product is reported at purchasing power parity for 2015. Data from IMF WEO, 2016. Hangzhou and the Province of Zhejiang 53

province and the city of Hangzhou in particular are among the leading testing grounds for Made in China 2025.

Industry Development

Hangzhou is home to a sprawling automotive cluster. By the end of 2014, there were 197 enterprises in the automobile industry, including seven car manufacturers. The annual output value amounted to RMB 44.238 billion, up by 17.8 percent over the previous year. The sales output value was RMB 44.431 billion, up by 18.7 percent; the output value of new products was RMB 23.641 billion, up by 30.8 percent. The landscape is dominated by a few large automobile producers and numerous SMEs. The components industry has strong positions in power systems, transmission systems, braking systems, suspension systems, and steering systems. The IT industry in Hangzhou has been rapidly developing in recent years and may play a key role in the development of the automotive sector in the future. In 2014, the added value of the information economy industry in Hangzhou was RMB 168.864 billion, up 18.3 percent over the previous year and accounting for 18.1 percent of the city’s gross domestic product. Hang- zhou hosts numerous capital funds; big data firms; and hundreds of technology-linked companies, including Kuaidi Dache, part of China’s biggest taxi-hailing app, and Alibaba Group, China’s largest online retailer.

People and Workforce

Hangzhou’s transformation from a manufacturing base for household wares into a high- technology hub depends to a large extent on the skills available in local labor markets. In 2015, the total number of jobs posted on Hangzhou Talent Market and Hangzhou Talent Net amounted to 527,000, including 110,000 jobs that require higher education.2 Employment numbers by sector (Figures A.3 and A.4) suggest that primary and secondary sectors have been declining in recent years, while the tertiary sector has been growing both in terms of people employed and as a share of total employment (Hangzhou Talent Service Bureau, 2016). This transformation led to increased demand for more-educated workers relative to less- educated ones. In 2015, students graduating from institutions of higher education accounted for 62 percent of the total number of recent graduates employed in Hangzhou. At the same time, local firms are competing for talent from other cities. Data suggest that local higher education institutions provide for only about one-third of the demand. Another third is supplied by other cities in Zhejiang province, and the rest comes from all over the nation. In 2015, Hangzhou received 52,342 new graduates from other cities, or 68 percent of the total number employed (see Figures A.5 and A.6). The top 20 employers are dominated by firms engaged in e-commerce, internet of things technologies, mobile internet, cloud computing, and big data; consequently, students majoring in computer science, accounting, international trade, English, and e-commerce are in high demand. Continuous competition for talent both locally and at the national level is a defining feature of business development in Hangzhou.

2 See Zhang Yiyuan and Yu Kang, “Employment Situation of College Graduates,” Zhejiang Daily, Vol. 14, May 30, 2016. 54 Wanxiang Innovation Energy Fusion City: Recommendations for Developing an Innovation Cluster

Figure A.3 Number Employed in the City of Hangzhou, by Sector

7,000 Tertiary sector Secondary sector 6,000 Primary sector

5,000

4,000

3,000

Number employed 2,000

1,000

0 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 Year SOURCE: Hangzhou Statistical Yearbook, 2016. RAND RR2035-A.3

Figure A.4 Percentage Employed in the City of Hangzhou, by Sector

100

60 Tertiary sector 50 Secondary sector 40 Primary sector

20 Employment share (percentage) 10

0 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 Year SOURCE: Hangzhou Statistical Yearbook, 2016. RAND RR2035-A.4 Hangzhou and the Province of Zhejiang 55

Figure A.5 Recent Graduates Employed in Hangzhou, by Degree

Ph.D. Graduate 0.53% 2%

Undergraduate Other 18% 38%

Specialized college 42%

SOURCE: Hangzhou Talent Service Bureau, 2016. NOTE: Percentages do not total 100 due to rounding. RAND RR2035-A.5

Figure A.6 Recent Graduates Employed in Hangzhou, by Origin

From other From provinces Hangzhou 33% 32%

From Zhejiang province (excluding Hangzhou) 35%

SOURCE: Hangzhou Talent Service Bureau, 2016. RAND RR2035-A.6 56 Wanxiang Innovation Energy Fusion City: Recommendations for Developing an Innovation Cluster

Although Hangzhou is home to Zhejiang University, one of the world’s top schools for engineering,3 and a large number of colleges and vocational institutions of higher education, there is a rather-limited talent pool that is readily available. Skilled talent is becoming more and more expensive, the employee turnover rate is high, and many automobile manufacturers have to train their own technicians for their dealer network by working with universities (European Union SME Centre, 2015).

Wanxiang Group Information4

The predecessor of today’s Wanxiang Group was founded in 1969 as an agricultural machinery repair factory alongside the Qiantang River in Hangzhou. After the economic reforms in the early 1980s, this factory grew into a multinational enterprise with 2016 total revenue exceed- ing RMB 100 billion. Wanxiang’s main business is in automotive components manufacturing (OEM) and sales, where it is claimed to enjoy a 65-percent market share in China and a 12 percent share globally in the relevant industries. Internationally, Wanxiang Group owns over 30 overseas subsidiaries in ten countries and partners with large automotive manufacturers such as General Motors, Volkswagen, Ford, Chrysler, and others. Wanxiang Group invested in the clean energy industry in 1999 with investments in the battery, electric vehicle, natural gas–power generation, and wind-power generation industries. The lithium-ion production base has a 120 million ampere-hour capacity, and the planned long-term capacity is expected to reach 300 million ampere-hours. In terms of electric vehicles, Wanxiang has the capacity of producing 2,000 sets of electric powertrain and 1,000 electric buses annually. Wanxiang obtained the clean energy bus production qualification in 2015 and new passenger car production qualification in 2016. Electric powertrain products have been successfully used at the Shanghai World Expo, the Guangzhou Asian Games, and by the National Grid. In addition, Wanxiang has invested in a number of other traditional and renewable energy projects. The traditional energy projects are concentrated in coal-based electricity generation and chemical industry. Wanxiang launched the Wanxiang Xinjiang potassium nitrate and cogeneration project and it invested in the Giant Energy Limited company in the United States. In 2004, the Group set up the Amber Energy Company and built three natural gas power plants in Yuhang, Deqing, and Changxing, Zhejiang. Amber Energy was successfully listed on the Hong Kong Stock Exchange in 2009. The renewable energy projects of the Group are concentrated in wind- and solar-power generation. Wind-power projects are located in Ningbo, Zhoushan, Taizhou, and Inner Mon- golia. Wanxiang has successfully established a solar photovoltaic base in Illinois and carried out three national solar photovoltaic power generation projects in China. The research and development activities of the Group are concentrated in a number of centers, including a national-level technology center that has been recognized as a National Laboratory. It employs over two dozen postdoctoral fellows who conduct research on suspension-system integration, electric vehicles, solar energy, and other fields.

3 Zhejiang University is ranked fifth in engineering by U.S. News and World Report, 2016, and 14th in engineering by Academic Ranking of World Universities, 2016. 4 We have fully relied on the Wanxiang Group for the information presented in this section. Hangzhou and the Province of Zhejiang 57

This shift to clean technologies culminated in a plan to create WIEFC—an 8.6 square- kilometer area. Factories from the Group will focus their new investments in WIEFC in four industries: clean energy vehicle components, clean energy electric batteries, electric passenger buses, and clean energy passenger vehicles. The goal is to make this hub an automotive innovation cluster that is also a green, smart city.

Location and Structure of Wanxiang Innovation Energy Fusion City WIEFC is the flagship project of the Group. WIEFC will be built in the Xiaoshan district of Hangzhou (see Figure A.7), which also hosts the Alibaba and Huawei headquarters. The planned area is connected to an integrated transportation system including access to the Hang- zhou Xiaoshan International Airport, a high-speed railway, Qiantang river transportation, several highways, and the Hangzhou subway system. WIEFC will have three main areas: an industrial production area, an innovation area, and a cultural area. The industrial production area will host an array of facilities focused on the production of clean energy batteries, clean energy passenger cars and buses, and smart manufacturing. The innovation area will be home to research and development innovation platform focused on electric vehicles, block chain technology development, and smart city applications. The cultural area will feature ancillary services such as education, public offices, product promotion, financing, and other derivative functions. The goal is to create a high- technology low-carbon innovation cluster featuring interoperable infrastructure, smart transportation, and convenient life services while maintaining an ecological living environment and low carbon footprint. The research and development component of WIEFC will be hosted by two national engineering research centers or laboratories, one national innovation center, and several dozen international entrepreneurship teams attracting more than five thousand scientific and technical personnel. Wanxiang Group plans to invest over ten billion dollars to develop 20 billion Ah electric battery production capacity, enough to satisfy production of 300,000 electric cars and 10,000 electric buses by 2021.

Figure A.7 Xiaoshan District in Hangzhou and the Location of WIEFC

Wanxiang Innovative Energy Fusion City

Xiaoshan District

Location of Location of Hangzhou City in Wanxiang Zhejiang Province Innovative Location of Energy Fusion Xiaoshan District City in Xiaoshan in Hangzhou City District

SOURCE: Google Maps and Wanxiang Group. Used with permission. RAND RR2035-A.7 58 Wanxiang Innovation Energy Fusion City: Recommendations for Developing an Innovation Cluster

To attract top talent and technology, WIEFC is envisioned as an intelligent traffic demonstration and testing base. Energy flow will be regulated by a smart grid system that is expected to have a less-than-20-percent difference between peak and off-peak load combined with a large amount of energy storage equipment at household, factory, and power station levels. Data collection and processing will be facilitated by 5G network coverage throughout the city and ubiquitous cloud and data processing services. The design of WIEFC emphasizes a minimal carbon footprint. All buildings will use energy-saving designs. Clean energy will generate at least half of the total electricity demand, and over 80 percent of the buildings will have roofs covered with solar panels. It is expected that over 35 percent of WIEFC will be covered by green spaces to provide for an enjoyable and healthy living environment. APPENDIX B Porter’s Regional Competitive Advantage Framework

In his framework, Michael Porter (1990) suggests that the competitiveness of a region can be determined by its capacity in four separate areas, as depicted in Figure B.1. First, a region’s factor conditions describe its endowment with traditional economic resources, including labor; land; human, financial, and physical capital; and infrastructure. Porter further emphasizes that the match between a specific industry and the factor endowment in the region is a critical source of locational competitive advantage. While natural resources might be an asset in an industrial region, human capital is often the most critical component in knowledge-intensive economies. In essence, regional factor conditions are deciding factors in determining regional specialization. Second, a region’s demand conditions are crucial drivers of innovation. If local customers are highly sophisticated and demanding, they will push local firms to be more innovative. Local customers can act as test subjects for new products and services and can be useful in anticipating future market trends. Ultimately, highly competitive regions benefit significantly from an educated, forward-looking, and demanding customer base, as it continuously challenges their firms to be at the leading edge of technological development. Third, a region’s mix of firm strategy, structure, and rivalry describes the state of local collaboration and competition. If firms within a region are competing for customers, they are under pressure to constantly improve their products and services and to remain innovative in order to stay ahead of their competition. In addition, having many neighboring firms in related sectors generates a lot of potential for collaborative innovation. While firms in a region might

Figure B.1 Determinants of Regional Competitive Advantage

Firm strategy, structure, and rivalry

Factor conditions Demand conditions

Related and supporting industries

RAND RR2035-B.1

59 60 Wanxiang Innovation Energy Fusion City: Recommendations for Developing an Innovation Cluster

be rivals, they often still cooperate to ensure the innovation leadership of the region over other competing regions. If the region itself maintains a competitive role in an industry or sector, all local firms benefit. Lastly, a region’s related and supporting industries contribute to a region’s industrial or sectoral specialization. A strong local network of key suppliers allows firms to focus on customer interactions and complex design tasks rather than routine matters. By having a large endowment of supporting firms all along the supply chain of particular industries, regions can develop a highly specialized and skilled workforce and a competitive advantage on certain products or services. In addition, highly sophisticated suppliers, similar to highly sophisticated consumers, can participate in innovative processes and can be a driving force behind regional technology leadership. APPENDIX C List of Interviewees

Stuttgart

• Dr. Andreas Koch, Institute for Applied Economic Research • Dr. Simone Strambach, University of Marburg • Dr. Thomas Stahlecker, Fraunhofer Institute for Systems and Innovations Research • Dr. Jürgen Dispan, IMU Institute Stuttgart • Dr. Reha Tözün, BridgingIT GmbH • Anja Krätschmer, e-mobil BW

Aichi

• Professor Akifumi Kuchiki, Nihon University • Professor Masatsugu Tsuji, Kobe International University • Ms. Asumi Yamaguchi, head of the Industrial Promotion Department of Aichi Prefecture

Hangzhou

• Zeng Xiaopeng, director, International Cooperation Division, Zhejiang Provincial Sci- ence and Technology Department • Professor Yonghua Song, executive vice-president, Zhejiang University • Professor Min Li, director, Office of International Relations, Zhejiang University • Professor Yibing Wang, Institute of Transportation, Zhejiang University • Professor Daofei Li, director, Institute for Power Machinery and Vehicular Machinery, Zhejiang University • Wanxiang Group officials

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There are several hundred industrial technology parks around the world, and developing innovative clusters occupies a prominent place among the goals of their planners. As a result, innovative clusters have been widely studied. Much is known about what policies and structures have been adopted, but less is known about what has worked. Identifying policies and structures that will successfully spark an innovative cluster is, therefore, at the heart of the present study. For this purpose, we sought to draw lessons from global experience, while also understanding the local context within which the WIEFC will operate.

First, in support of the Group’s vision for the WIEFC, we recommend a mission that describes the aims of the WIEFC. Second, this report identiﬁes the contributing factors required to achieve that mission. Through an intensive, in-person study of two locations—the Stuttgart automotive cluster in Germany and the Aichi automotive cluster in Japan—supplemented by lessons from the academic literature on other clusters, these factors are sequenced into originating and sustaining factors. We then recommend policies for the implementation of these factors. Finally, we identify outcomes to measure the progress of the recommended policies.

www.rand.org $26.00

ISBN-10 0-8330-9901-9 ISBN-13 978-0-8330-9901-3 52600

9 780833 099013 RR-2035-WXG