Emergence of Manufacturing Related Services and Collaboration Between Korea and China Manufacturing Innovation Perspectives

Emergence of Manufacturing Related Services and Collaboration between Korea and China Manufacturing Innovation Perspectives

1. Background and Concept uating now is not what it once was. Interestingly, manufacturers do not only manufacture any more. (1) Background Instead, their activities increasingly involve services. According to a 2012 report from McKinsey, more The emergence of manufacturing related services than 34 percent of U.S. manufacturing employees (MRS) coincides with the revaluation of manufac- are involved in service areas, or service-like activi- ) turing. We observed that manufacturing-focused ties.1 These service-like-activities include research countries overcame the financial crisis which broke and development, engineering, design, marketing out in 2007 with less difficulty than their service-fo- and customer services which are sources of high cused counterparts. Manufacturing played a crucial value added and high quality jobs. In short, these role in navigating the economic problems such as changes allowed manufacturing to overcome finan- unemployment, polarization and stagnant growth cial crises and energize economies with trickle-down and so on. Moreover, this pattern of positive im- job creation, upgrades in the industrial value chain pacts from the manufacturing sector was observed and new demand for professional services. from European countries trying to boost their Those changes are attributed to a paradigm shift economy. Germany, a manufacturing-driven econ- in the manufacturing industry which is observed omy, showed continuous economic growth, while in various areas. First, new types of products have service-driven economies in Greece and Austria appeared in the market. These new products are experienced recession. Therefore, the importance described as smart, connected products (SCP) by ) of manufacturing was revaluated and commonly Michael Porter (2014).2 SCP are differentiated from shared. existing or previous products in that they consist of However, the manufacturing sector we are reval- different components and work in different ways.

1) McKinsey‌ Global Institute (2012), “Manufacturing the future: The next era of global growth and innovation”. 2) Porter & Heppelmann (2014) “How Smart, Connected Products Are Transforming Competition”.

4 KIET Industrial Economic Review Figure 1. The Advent of Smart Connected Products

5. System of systems

4. Product system WEATHER MAPS WEATHER FORECASTS RAIN, HUMIDITY, WEATHER DATA 3. Smart , connected product TEMPERATURE SENSORS APPLICATION WEATHER DATA 2. Smart product SYSTEM PLANTERS FARM PERFORMANCE 1. Product DATABASE

FARM COMBINE FARM FARM SEED EQUIPMENT SEED DATABASE HARVESTERS EQUIPMENT MANAGEMENT OPTIMIZATION TRACTORS SYSTEM SYSTEM SYSTEM SYSTEM

SEED OPTIMIZATION APPLICATION TILLERS

IRRIGATION SYSTEM FIELD IRRIGATION SENSORS APPLICATION

IRRIGATION NODES

Source: Porter & Heppelmann (2014).

As components, they are smart and connected to net- The second type of paradigm shift is found in the works, and must be embedded in operating systems value creation. Previously, production activity itself or user interfaces for optimal utilization. In addition, was the main source of value in manufacturing. SCP are connected through either wired or wireless However, the main source of value now comes from connections for auto-updating. SCP monitor, control services which are applied before and after produc- and optimize themselves autonomously. tion. To provide services as a source of value, manu- The emergence of these types of products re- facturing firms are now shifting production to smart quires manufacturers to cope with a new environ- products (in contrast to previously “dumb” products) ment with appropriate solutions. Manufacturers are through which services can be integrated. expected to form new technology infrastructure, In summation, products, competitiveness and value including product related hardware and software, creation are rapidly evolving in the manufacturing cloud servers for remote control of the product and sector. However, manufacturing firms are not able to security protocols. Moreover, these new products deal with this situation by sticking only to production are capital expenses, expected to result in relative- process. Convergence with various services is neces- ly higher fixed costs and lower variable costs for sary for the firms effectively respond to a changing manufacturers. Higher fixed costs result from the environment. This necessitates that manufacturers expenses induced in developing software, designing utilize MRS. interfaces and acquiring other technological capital. In the end, manufacturers are expected to become (2) Concept of Manufacturing Related Services providers of whole product systems and not sim- ply makers of individual products. Therefore, core MRS were defined when the so-called “smile curve” competencies of manufacturers will be determined was first plotted. Stan Shih, founder of Taiwanese by competitiveness at the system level. personal computer manufacturer Acer, first dubbed

December 2019 Special Issue Vol 24 No 7 5 Figure 2. Value Creation Pattern Changes in the VC

R&D & Brand & Services Technology

Fabrication & Added Value Supply Chain

Functions Product Concept Process Marketing Global Local Source: WEC (2014), The future of manufacturing: Driving capabilities, enabling investments p.9 rearranged.

Table 1. 12 Types of Manu-Services

Unit: % Design & Development System & Solution Maintenance & Support Retail & Distribution (22) (16) (12) (12)

Installation & Implementation Financial Services Property & Real Estate Consulting (5) (4) (4) (3)

Outsourcing & Operating Procurement Leasing Transportation (2) (1) (1) (1)

Source: Andrew Sissons (2011), “More than Making Things: a new future for manufacturing in a service economy”. Note: The number in the parentheses denote the proportion of manufacturing firms in England providing Manu-Services.

the curve the smile curve. He claimed that higher product value by creating higher value added. Ser- value added occurs in the stages of product plan- vices in this area are restricted to local competition. ning, design, branding and distribution — not in And now, services are also involved in the produc- production. Those are all services. tion stage, included services such as EMS, ODM ) Pre-production includes product planning, R&D, and MaaS.3 design, and engineering which are services that in In 2011, England categorized MRS into twelve the product conceptualization stage. These services fields. These twelve services are called Manu-Ser- face harsh global competition while creating higher vices, applicable to the manufacturing value chain value added. In post-production, services increase and contributing to manufacturing competitiveness.

3) ‌EMS and ODM stand for Electronic Manufacturing Services and Original Design Manufacturer, respectively. MaaS stands for Manufacturing as a Service, wherein manufacturing itself is prototyped as a service so that anybody can manufacture without factory.

6 KIET Industrial Economic Review 2. Main Issues and analysis of the four main production factors: Man, Machines, Materials and Methods (the 4M fac- There are two main issues with MRS. The first deals tors). This analysis is a type of engineering, conducted with improving a manufacturing firm’s innovation to minimize the probability of errors during the man- capability for higher value added. The other addresses ufacturing process. how to make such manufacturing innovation sus- MI is carried out during the whole product lifecycle tainable. To tackle the first issue firms must identify and has different goals depending on the manufactur- appropriate MRSs and promote them. To solve the ing preparation stage. In the initial product planning second problem firms must form a manufacturing and design phases and the process design and facility ecosystems where supply and demand of MRS work installation stages, MI is applied to develop new prod- together in an autonomous way to sustain innovation. ucts in a rapid way by shortening the product devel- From this point of view, we investigate recent trends opment cycle. At the next stage of product develop- in manufacturing innovation and identify necessary ment, MI is carried out to identify market niches and MRS. We conclude this study with suggestions to reduce time-to-market. In the last stage of launching promote collaboration between Korea and China in new products, MI helps firms dominate the market this matter. and increase market share through improvements to product quality and cost reductions. 3. Current‌ Trends in Manufacturing MRS applied to MIs at each stage are responsible Innovation for 90 percent of quality and 80 percent of original cost. New features of MI are defined as a non-linear (1) ‌Manufacturing Innovation and circular way of progress, whereas traditional MI is restricted to linear progress over product lifecycle. Manufacturing Innovation (MI) is related to manufac- Moreover, the recent applicability of digital capabili- turing activities aimed at securing quality of product. ties for MI makes it possible to sustain MI regardless In this study, these activities include pre-inspection of the positon in the product lifecycle. This is called

Figure 3. Manufacturing Innovation and its Purpose by Stages

< MFG Innovation > < Purpose >

Product/Process/Facility Reduction of Cycle Time

New Product Development Shortening of Time-to-Market New Product Launch Quality Up/Cost Down Market Share

December 2019 Special Issue Vol 24 No 7 7 the digital transformation in manufacturing. network perspective, we can identify two different approaches: IIOT, based in the U.S, and CIOT, (2) Global Trends in Manufacturing Innovation based in Germany. MI in the U.S is firm-driven and conducted across industry, with the ultimate aim of Global trends in MI are observed at individual creating smart cities. On the contrary, in Germany manufacturing firms in the utilization of networks. MI is government-driven and conducted for the Firstly, MI at the firm level is conducted to improve benefit of manufacturers, with the ultimate aim of products, processes and business models. As it is realizing smart manufacturing. Specifically, Germa- possible to secure connectivity through IoT, prod- ny is in pursuit of forming a smart manufacturing ucts generate values via data-based services. From a ecosystem, one that produces smart materials and

Figure 4. Manufacturing Innovation from a Network Perspective

INDUSTRIAL CONSUMER Internet of Things Internet of Things

SMART Grid Phone SMART

Transportation Wearable

City Plugs

Connectivity Data Exchange

Machine TV

Factory Appliances Health Home

Source: Fraunhofer FOKUS homepage. Note: Red circle is focus of MI in Germany.

Figure 5. Type of Manufacturing Innovation: Width vs Depth

Source: Industrial internet consortium homepage.

8 KIET Industrial Economic Review smart products at smart factories. over the product lifecycle to create value. Fourth, In the U.S. the focus of MI is on the horizontal I4.0 takes radical changes in the working environ- expansion of various industries through an Industri- ment into account by encouraging human-machine al Internet Consortium (IIC) utilizing Information collaboration. This differs from the previous three Technology (IT). Whereas Germany sticks to man- features in that it is related to processes. ufacturing specified vertical integration through Op- MRS in I4.0 can be analyzed by looking at how eration Technology (OT). MI of Germany is part those 4 features are realized. This realization process of its overarching Industry 4.0 policy (I4.0) where is projected in the RAMI 4.0 (Reference Architectur- MRS are easily identifiable. al Model of Industry 4.0). RAMI 4.0 is conceptual- ization of I4.0 over three dimensions: life cycle and (3) ‌Industry 4.0 and Manufacturing Related value stream, hierarchy levels and layers. The life cycle Services and value stream dimension is related to product services creating values across the product lifecycle. According to Platform Industry 4.0, the organi- Pre-production stage supporting services include zation responsible for I4.0, Germany is in pursuit development, computer simulation, prototyping and of ecosystem based MI. Industry 4.0 policies in software updates. Production stage supporting ser- Germany have four features reflecting the manu- vices are related to digitalization, facility management, facturing ecosystem. First, I4.0 promotes horizon- maintenance and recycling. The hierarchy levels tal integration. This is about creating digital value dimension is about production related services for networks between firms transcending geographical automation ranging from smart products and smart constraints. Second, I4.0 promotes intrafirm vertical factories to global connections. Lastly, the layers di- integration through digital connections that max- mension is concerned with informatization services imize efficiency. Third, I4.0 utilizes engineering all for the digitalization of physical things.

Figure 6. Four Main Features of Industry 4.0

Horizontal integration Vertical integration

End-to end engineering Humans orchestrate the value stream

Source: Implementation Strategy Industrie 4.0 (2016).

December 2019 Special Issue Vol 24 No 7 9 Figure 7. Manufacturing Services in RAMI 4.0

Source: Implementation Strategy Industrie 4.0 (2016).

(4) Global Expansion of Industry 4.0 lifecycles as integrated product lifecycles. Technol- ogy is associated with automation, connectivity Representative of MI responding to the Fourth and intelligence. SIRI analyzes readiness levels of Industrial Revolution (4IR), Industry 4.0 is a most technology in a more detailed way by subdividing complete system of smart manufacturing. Hence them into shopfloor technologies, enterprise tech- understanding the components of I4.0 and their nologies and facility technologies. Interestingly roles of I4.0 is a good way to grasp MI on the way enough, SIRI takes into account organization, a to smart manufacturing. From this aspect, the Smart non-technological aspect. In the process of smart Industry Readiness Index (SIRI) is very useful tool manufacturing, SIRI treats human resources, to understand the most recent trends in MI. SIRI leadership and governance as equally important was developed in Singapore with the help of Ger- factors as processes and technology. ) man experts who are directly associated with I4.0.4 In sum, global trends in manufacturing innovation SIRI deals with smart manufacturing in a com- aim at smart manufacturing. Moreover, the areas to prehensive way by taking into account multiple which manufacturing innovation applies have been aspects of process, technology and organization extended to non-technological factors, including at the same time. From processes to smart man- organization and human resources, and not just ufacturing, SITI measures smart-readiness de- processes and technology. In addition, all these MI pending on digitalization levels. Process includes activities should be handled within a manufacturing operation as a vertical integration within a firm, ecosystem since any one firm is not able to achieve supply chain as horizontal integration and product smart manufacturing by itself. Therefore, manufac-

4) ‌Singapore Economic Development Board (2017) “The Singapore Smart Industry Readiness Index, Catalysing the transformation of manufac- turing”.

10 KIET Industrial Economic Review Figure 8. Smart Industry Readiness Index in Singapore

Source: The Singapore Smart Readiness Index (2017). turing-related services should contribute to MI in var- searcher concentration and patent activity. Under this ious fields of manufacturing by improving their own rubric Korean has been recognized as possessing a capabilities. significant level of innovation capability. Yet Korea was ranked 25th in terms of 4IR responsiveness by 4. Current State in Korea the World Economic Forum. In addition, the country is suffering from recessions in production, exports (1) ‌Korean Paradox and manufacturing value added at the same time. In a word, Korea is in a paradoxical situation where in- Six years in a row, Korea was selected as the most novation capability does not create economic perfor- innovative country by the Bloomberg Innovation mance and outcomes. Index. The Bloomberg Index evaluates innovation Therefore, it is crucial for the Korean economy to capabilities of a country by considering seven aspects, find a way to make innovation capabilities generate such as R&D intensity, manufacturing value-added, economic performance as a tangible outcome. The productivity, hi-tech density, tertiary efficiency, re- main reason of the Korean Paradox could be found

Figure 9. Innovation Capability of Korea

Source: Bloomberg 2019 Innovation Index (2017).

December 2019 Special Issue Vol 24 No 7 11 in the economic outcome creation process. Ko- gration through IOS (Internet of Services). rea has been focusing on R&D under the simple As of 2018, there are 401 modelling and simu- assumption that R&D directly translates to eco- lation (M&S) firms in Korea. They provide engi- nomic outcomes. However, to generate economic neering software-based design and analysis services. outcomes, firms and industries must pass through Korean M&S service firms are showing outstand- the outcome creation stage consecutively. It is ing performance in the global market and highly manufacturing related services that bridge the gap recognized in their capabilities. The top 19 firms between innovations through R&D and economic domestically have global competitiveness dominant outcomes by improving the performance of firms the Asian market. In pursuit of MI in Korea, M&S and industries through manufacturing innovation. is expected to be the most influential MRS in the Therefore policy needs to focus on how to improve generation of economic outcomes. manufacturing innovation which creates economic outcomes at the firm and industry level. To this end, (3) ‌Current State of Manufacturing Innovation in MRS must be considered. Korea

(2) Smart Factory-Driven Manufacturing Innovation Compared to global leaders in manufacturing, the process of servitization in Korea is weak and prog- Manufacturing Innovation policy in Korea heavily ress is slow. When it comes to the production of promotes the diffusion of Smart Factories. In 2014 services induced by manufacturing, Korea has a co- the Korea Smart Factory Foundation was estab- efficient of 0.23, which is the smallest figure among lished and now functions as a control tower. The rival countries such as the U.S. (0.41), Germany (0.40) Korean government set a goal of building 30,000 and Japan (0.40). It is also beaten by China. More- smart factories by 2020 and is promoting the proj- over, post-production related services are mainly ect, now led by the private sector. Currently, the utilized so that the servitization in Korea is focused Smart Factory project is broadening its horizons to on developing business models related to marketing include smart factory suppliers to form a Korean and sales. smart factory ecosystem. Smart factories suppliers In the use of MRS at the pre-production stage, are responsible for continuous advancement typical firms have stuck to vertical collaboration. Thus the manufacturing related services covering vertical inte- outsourcing ratio of Korean manufacturers is lower

Table 2. Service Production Inducement by Manufacturing (2017)

KOR U.S. FRA GER JPN MEX CHN 0.23 0.41 0.52 0.40 0.40 0.29 0.25 Source: Korea Institute for Advancement of Technology (2017).

12 KIET Industrial Economic Review Table 3. Value Added Created by Business Services

Unit: % KOR U.S. FRA ENG GER ITA 7.3 11.7 12.7 11.9 10.5 9.2 Source: Korea R&D Association (2018). Note: Business Services include R&D, Design, Engineering, Planning, etc.

) than the average level among OECD countries.5 A long-term strategy for cooperation is required. Korea also ranks last in terms of value added creat- For collaboration at the pre-production stage, the ed by business services such as R&D, design, plan- two countries need to cooperate in the global mar- ning and engineering. ket. In the production and post-production stages, they need collaboration for their local markets. 5. ‌Directions for Promoting Collaboration Even if the benefits from cooperation are immea- surable, they should be distributed to both countries To promote collaboration between Korea and Chi- in a fair way. To this end, some practical pre-condi- na in the field of manufacturing related services, tions should be met. The differences resulting from the necessity of collaboration should be discussed free market principles of the Korean economy and first. Collaboration should contribute to promote the planned economy of China should be coor- manufacturing capabilities in both countries and be dinated. Moreover, specific actions for protecting complementary and beneficial to both countries by intellectual property rights in Chinese market should providing innovation momentum. To this end, col- be taken before the two countries launch a coopera- laboration needs to take a step-wise approach. tive effort. This type of institutional action provide a In the short run, Korea and China should identify firm ground for sustained collaboration by provid- opportunities for cooperation by comparing and an- ing incentives for inducing firms. alyzing strengths and weaknesses of two countries at the industry level. To avoid and minimize learning by trial and error, the two countries should strive to Lee SangHyun Associate Research Fellow understand institutional and cultural differences in Center for Service Industry [email protected] policies, markets, transaction practices and so on.

5) As‌ of 2016, the R&D outsourcing ratio in Korea and the OECD top 21 countries are 4.6 and 15 percent, respectively.

December 2019 Special Issue Vol 24 No 7 13