3.4. The Distribution of Manufacturing Joint Venture Investments into Sub- Sectors
The distribution of joint venture investments into manufacturing sub-sectors, such as building materials, textile & clothing, chemicals, electronics, automobiles, and pharmaceutical is shown in the following table. Accordingly, investments into the electronics and pharmaceutical sub sectors are negligible. Investments in the Automobile and Chemical sub sectors are not significant as well. Joint Venture investments in the Textile & Clothing sector are somewhat considerable and 33% of the JV companies are engaged in this sector. Building material manufacturing sector represents 15% of the enterprises. However, majority of industries engage in
042 • 2014/15 Knowledge Sharing Program with Sri Lanka other sectors including rubber based, plastics, polythene, mineral, paper, steel, and packaging material industries.
Distribution of Manufacturing JVs into Sub-Sectors Others 46% Textile & Clothing 33% Building Materials 15% Chemicals 3% Electronics 0% Automobiles 2% Pharmaceutical 1%
Source: Board of Investment of Sri Lanka, internal document
3.5. Composition of Countries of Origin of JV Companies
Joint Venture investments have come from India, the UK, the US, Malaysia, Singapore, Dubai, China, Japan, Pakistan, Comoros, France, the Netherlands, Canada, the UAE, Hong Kong, Germany, Australia, Oman, Taiwan, Israel, and South Korea. The number of joint ventures could not exactly be allocated to each country due to the information restriction applied on databases by some of the investors including restriction on their addresses from which the country has to be identified. However, from the available information, there are references to the above mentioned countries.
3.6. Additional Benefits Given to JV Companies
Foreign direct investments and joint venture investments are considered under the same incentive schemes at present. No additional incentives are granted specifically for joint venture investments. However, there are incentives for FDI. Tax incentives are given to FDI. Corporate tax incentives (full tax holiday) will be offered for large scale enterprises based on the criteria of minimum investment, number of employment opportunities created, and the location. For export oriented projects (90% exports of annual production), all import duties and levies are exempted on capital goods and raw materials for export oriented projects. For non-export oriented projects, only customs duty is exempted on capital goods during the project implementation period.
Chapter 1 _ Framework of Joint Venture Partnership with Global Companies and Local Partners • 043 Any dividends paid to a shareholder of a small, medium, or large scale company, are exempted from dividend tax (during the tax holiday period). However, a resident construction project will be eligible for an additional one year exemption from dividend tax. Exemption on exchange control is granted for export oriented projects approved under Section 17 of the BOI Law, or selected large scale projects as determined by the Board. Exempted companies are entitled to open and operate a Foreign Currency Banking Unit (FCBU) in any commercial bank in Sri Lanka. This facility is applicable for the income generated from the approved business activity only.
3.7. Criteria to Select Some Industries as “Challenged Areas” and “Opportunity Areas”
Some of the industries, such as textile and clothing, rubber based, building materials, light engineering, ship building etc., which have been in existence for over 2 decades and having backward integrated supporting industries could be classified as opportunity areas for joint venture investments to improve the capacity and production volumes. The risk of investment in the above areas is low due to the availability of a skilled workforce and due recognition by the international community.
However, the other heavy industries involving extensive levels of chemicals, radio- active material, and entirely new industries without supporting industries and a skilled work force are considered as challenging areas for joint venture investments.
4. The Experiences of Other Countries 4.1. The Case of Korea
Korea preferred foreign loans than FDI in the initial stage of its economic development because of its colonial experience and hesitation to be economically dependent on any other country. Korea opened and started liberalizing its FDI related regime (Ministry of Justice and Korean Association of Civil Law 2012) from the mid-1980’s. However, the Korean government promoted JVs to obtain advanced technology. Even in the 70’s, the Korean government allowed foreign direct investment in JVs. The standards for the permission of the FDI were as follows: i) projects that have spill-over effects on the improvement of the trade balance, the increase of employment, production growth, and the development of the related industries ii) in principle, FDI was allowed in the form of JVs when some of the products were sold in the domestic market, but wholly foreign owned enterprise was allowed only when all the products were exported. At that time, the ownership of
044 • 2014/15 Knowledge Sharing Program with Sri Lanka foreign investors could not exceed 50%. However, in 1980, the Korean government changed the rule on the ownership restrictions. Foreign ownership over 50% was allowed in the case of FDI with advanced technology and management know- how, investments that could change the origin of the FDI, investments by overseas Koreans, and in the industrial park and free export zones. In 1984, the restriction on the foreign investors’ ownership was eliminated and the negative system on the possible sectors of FDI was introduced.
After the revision of Foreign Investment Promotion Act, Enforcement Decree of Foreign Investment Promotion Act and Enforcement Rule of Foreign Investment Promotion Act, the Korean government made an effort to increase FDI. Thereafter, Korea has introduced many incentives for the FDI.
The foreigners' investment eligible for the abatement or exemption of the corporate tax, income tax, acquisition tax and property tax shall be the cases in which factory facilities are established or operated in order to carry on a business falling under any of the following categories:
A. Industry-supporting service business; B. Business accompanying high technology 1) Technology that has a great economic or technical diffusive effect on the national economy, and that is essential to enhance the industrial structure and strengthen the industrial competitiveness; 2) Technology for which three years have not elapsed since the date of its initial introduction into Korea from a foreign country or for which 3 years have elapsed, and that has an economic effect or technological capacity much excellent than the already introduced technologies; 3) Technology for which the process requiring it is carried out mainly in the country.
The foreigners’ investment eligible for the abatement or exemption of the corporate tax, income tax, acquisition tax and property tax shall be the case where the facilities are newly installed within the foreign investment zone that falls under any of the following subparagraphs: A. Where the amount of foreigners’ investment is 30 million U.S. dollars or more, and a new factory facility is installed in order to carry on a manufacturing business; B. Where the amount of foreigners' investment is 20 million U.S. dollars or more, and the facilities are newly installed in order to carry on the business falling under any of the following items: 1) Tourist hotel business, floating tourist hotel business and Korean traditional hotel business;
Chapter 1 _ Framework of Joint Venture Partnership with Global Companies and Local Partners • 045 2) Specialized recreation business and universal recreation business; 3) International convention facilities; 4) Resort condominium business; 5) Youth training.2)
Korean government regarded investments related to advanced technology as the essential element to enhance the competitiveness of Korean industries to promote exports. Therefore, in the area of advanced technology investment, incentives were given to attract more investment in these categories.
Foreign investors can claim an exemption from corporate and income taxes in proportion to their equity ratio in the investing company (usually a joint venture company) for the first seven years of such investment and can thereafter claim a 50 per cent exemption from the corporate tax in proportion to their equity ratio for the next three years.
The Foreign Investment Promotion Act includes the guarantee that dividends accruing from stocks or quotas acquired by a foreign investor; the proceeds from the sale of such stocks or quotas, and payments of principal, interest and fees to be paid under loan agreements can be fully repatriated as long as such accrued amounts conform with the content of the report initially required in connection with the underlying agreement.
Provincial and metropolitan governments can designate certain areas as foreign investment zones after obtaining prior approval from the Foreign Investment Committee established by the Ministry of Finance and Economy. If such approval is granted, investors in the foreign investment zone can become eligible for tax benefits and in some cases receive infrastructure support in the zone from national and local governments.
The Foreign Investment Support Center is a unit established under the auspices of the Korea Trade-Investment Promotion Agency. It has been set up to provide one- stop service in assisting foreign investors with various government approvals and reports required in connection with foreign investment activities in Korea.
The acquisition of land by foreigners was one of the most closely regulated areas of business in Korea. The approval from the Minister of Construction and Transportation is required for the foreigners to acquire or lease land or buildings or to obtain other real estate rights. However, many restrictions have been eliminated in an effort to attract foreign investment by the promulgation of a new law called
2) Enforcement Decree of the Restriction of Special Taxation Act, Article 116-2, Retrieved from Statues of the Republic of Korea, http://elaw.klri.re.kr/eng_service/jomunPrint.do?hseq=12218&cseq=440384
046 • 2014/15 Knowledge Sharing Program with Sri Lanka the Alien Land Act in 1998. This Act enabled foreigners to invest in new areas including the acquisition of land, commercial leasing of buildings and land, and land development and marketing. However, foreign investment in the area of real estate investment trusts is still not allowed.
4.2. The Case of the People’s Republic of China
The Law of the People’s Republic of China on Joint Ventures Using Chinese and Foreign Investment (Joint Venture Law) was promulgated by the National People’s Congress on July 1, 1979 as part of the Chinese modernization program. The purpose of the Joint Venture Law is to attract foreign technology and expertise in the production of goods to promote Chinese economy. To implement this law, the PRC has had to pass a number of additional laws, including labor, tax, and banking regulations - all of which are designed to attract additional foreign investment.
Moreover, to do business with the new foreign participants, the Chinese have had to establish a number of agencies to authorize and oversee the operations of joint ventures in the People’s Republic. Equity joint ventures (EJV) have been a popular choice for foreign investors entering China during the early stage of market opening in China because the Chinese government believed that forming JVs with MNCs could promote capital inflow and expertise exchange.
In the early 1980s, JVs were preferred by the Chinese government because it could bring a number of benefits. It provided a chance to obtain modern managerial know-how, marketing skills and technological transfer, a means for job creation, and access to export markets. These were particularly attractive given the time- consuming nature of developing the above on its own and China’s deficiency of foreign exchange. Therefore, significant incentives including tax holidays and import duty exemptions for essential production equipment and materials were granted to JVs.
However, the Chinese government adopted a protectionist attitude towards particular strategic sectors and only JVs were allowed for foreign investment. Therefore, JVs were the only possible way to invest in China for the foreign investors.
There are four main steps to establishing a joint venture in China. These are: (1) obtaining the assistance of the China International Trust and Investment Corporation; (2) negotiating the legal framework of the joint venture; (3) obtaining the authorization of the Foreign Investment Commission of the People’s Republic; and (4) registering with China’s General Administration for Industry and Commerce.
The China International Trust and Investment Corporation is responsible for
Chapter 1 _ Framework of Joint Venture Partnership with Global Companies and Local Partners • 047 working with foreign investors in finding business opportunities in China and assisting them in negotiating the terms of the joint venture. The broad scope of the Joint Venture Law leaves many of the legal and business issues of the venture unresolved, with the expectation that the parties will address them in the negotiated agreement. The foreign partner is expected to contribute at least twenty five percent of the venture’s registered capital although there are a number of different forms of permissible capital contributions.
The Joint Venture Law offers a significant degree of flexibility in determining the composition of the venture’s board of directors and in delimiting its authority over the operations of the venture. The recently enacted Labor Management Regulations must also be consulted by the parties since these regulations provide guidance on some of the more essential issues involved in management and labor relations.
The venture is required to open a bank account with the Bank of China or a bank approved by the Bank of China and to register with the local tax bureau for the payment of taxes. Tax provisions for the joint venture corporation and the individuals employed by it are found in the Joint Venture Income Tax Law and the Individual Income Tax Law, respectively.
These laws address various aspects of Chinese taxation, including taxable income, tax rates, tax credits, tax incentives and tax payment. The Joint Venture Law permits the remission of profits abroad through the Bank of China, pursuant to foreign exchange regulations in the currency provided for in the venture contract.
Two of the broader provisions in the Joint Venture Law deal with technology transfer and the marketing of joint venture products. The parties to the venture must consider what technology is appropriate to China's needs and what marketing practices are compatible with the legal and economic regulations, not only of China, but also of potential third country recipients.
Joint venture operations may be terminated by mutual agreement of the venture parties. The Joint Venture Law provides for consultation, conciliation, arbitration, and judicial procedure (in that order of preference) for the resolution of disputes arising during the life of the venture. The foreign participant, in negotiating the terms of dispute settlement provisions, must keep in mind that the Chinese eschew adversarial techniques common in Western litigation practices. Once the terms of the venture contract are agreed upon, the venture must seek the approval of China's Foreign Investment Commission and register with the General Administration for Industry and Commerce.
The Joint Venture Law is an ambitious undertaking, but many of its provisions
048 • 2014/15 Knowledge Sharing Program with Sri Lanka are ambiguous and somewhat obscure - this has caused concern and even reluctance on the part of the foreign venture partner to invest in China. Moreover, foreign participants have expressed displeasure with China's management expertise, the lack of attention paid to consumer satisfaction in the PRC, the level of factory pollution, and the inadequacies of the PRC’s factory infrastructures.
The concerns voiced by foreign venture partners are offset somewhat by the Chinese commitment to joint ventures and their desire to attract foreign technology. Despite the inadequacies and inexperience of its legal environment, the PRC's political environment is sufficiently stable so as to permit the Chinese to recognize the shortcomings of the Joint Venture Law and account for them in the negotiated joint venture contract. The basis of a workable and profitable venture agreement is the mutual consultation that precedes it. Both sides can negate the problems and shortcomings encountered in the law by careful and amicable negotiation. Knowledge of local governmental issues, culture and market, is critical to both parties of a JV in China, although they have different emphasizes for different areas. The red-tape of the Chinese government can make it difficult to do business in China as well. However, many MNCs could not afford to sacrifice the first-mover advantage because of competition or rivalry pressure. On the contrary, JVs could help MNCs overcome economic and political difficulties, and provide more favorable conditions for the improvement of a sales environment than wholly-owned enterprises. Therefore, many MNCs favored JV establishment in China.
5. Policy Recommendations
In the course of the economic reform, JVs cannot solve every problem that foreign investors may encounter in developing countries. The performance of JVs can depend on many factors. Individual personalities, organizational cultures, administrative style, and management philosophy are the factors that can bring difficulties in the development of JV that the foreign partners want. Local partners’ substandard performance, local partners’ leverage that is restricted to their own provinces can be the problems to bring about low performance of a JV. The veto-power of the local partner can be a stumbling block for the foreign partners in strategic decision- making. All these made foreign investors put more emphasis on gaining control of their investment in the host country, especially after they gradually get confidence in doing business in that country.
There are some policies on JVs in China from which we can get some suggestions for Sri Lanka.
Share holdings in a joint venture are usually non-negotiable and cannot be
Chapter 1 _ Framework of Joint Venture Partnership with Global Companies and Local Partners • 049 transferred without approval from the Chinese government. In China, investors are not allowed to withdraw registered capital during the period the joint venture contract is maintained. There may be specific requirements for the management structure of a joint venture but either party can hold the position as chairman of the board of directors. A minimum of 25% of the capital must be contributed by the foreign partner(s). There is no minimum investment for the Chinese partner(s).
The permissible debt to equity ratio of a joint venture in China is regulated depending on the size of the joint venture. When the sum of debt and equity is less than US$ 3 million, equity must constitute 70% of the total investment. In the case of a joint venture where the sum of the debt and equity is more than US$ 3 million but less than US$ 10 million, equity must constitute at least half of the total investment. In cases where the sum of the debt and equity is more than US$ 10 million but less than US$ 30 million, 40% of the total investment must be in the form of equity. When the total investment exceeds US$ 30 million, at least a third of the sum of the debt and equity must be equity.
There are restrictions on contribution by a party. The technology contributed as registered capital by a party generally should not exceed 20% of the total registered capital (but this can be increased with approval for certain encouraged projects) or 50% of an individual investor's capital contribution.3)
5.1. Challenges to Sri Lanka’s Joint Venture FDIs
Sri Lanka’s manufacturing and export trade faces severe competition due to the emergence of other markets, shifting sourcing strategies, and increases in the cost of production within Sri Lanka. When it comes to shifting sourcing strategies, there are current trends in global sourcing which are dynamic and growing still. The cost is still the key driver of global sourcing, but not the key focus. As companies look to the future, increase of product quality is trapped as their highest differentiator. Specifically, following are the challenges that Sri Lanka is confronted with when trying to promote joint-venture FDIs in the manufacturing sector of Sri Lanka;
5.1.1. Lack of Brand Awareness Internationally
Due to the limitations in resources, technology, and research & developments, Sri Lanka has not been much successful in developing their own brand names and in particular, making them internationally known. This seems to be a major hindrance in promoting international joint ventures.
3) http://www.pathtochina.com/reg_jv.htm
050 • 2014/15 Knowledge Sharing Program with Sri Lanka 5.1.2. Small Production Volumes (But High Quality)
Except products manufactured in the garment, tea, and rubber industries to a certain degree, the volume of other products manufactured within the country has no significant influence in the international market. However, as the products manufactured are of high quality, taking them to the international market with the support of overseas investors would be a somewhat easier task.
5.1.3. Lack of Raw Materials in Large Volumes
Due to the geographical limitations, there are no major raw material deposits within the country. Petroleum deposits in the south western region are being investigated and commercial deposits are yet to be found. However, mineral deposits such as limestone, quartz, phosphate etc. are available for medium scale production processes. The quality of the deposits is high and the cost of purification is low.
5.1.4. Cost of Energy & Production
The country is fully dependent on imported fossil fuel and therefore, the cost of energy is relatively high compared with other developing countries. The government has taken measures to replace costly diesel generators with low cost coal generation in order to reduce the energy cost. However, the coal price too is gradually going up in the international market negating the efforts made.
5.1.5. Small Domestic Market
The population size of the country is just 20 million people, which is not a big market to sustain major industries with large production volumes. Further, the purchasing power of the consumers is alsolow. Therefore, the investors are compelled to look in to markets beyond local boundaries.
5.1.6. Lack of Knowledge
Due to the lack of international business exposure, manufactures producing goods for the local market have no knowledge on international joint ventures and their advantages. Most of the businesses are run by a board of directors comprising members of the same family and therefore, partnerships and joint ventures are seen as a threat to their comfort zones. It is not difficult to safeguard interests of different parties by properly documented agreements. However, it is not so easy to convince local entrepreneurs of the above position.
Chapter 1 _ Framework of Joint Venture Partnership with Global Companies and Local Partners • 051 5.2. Opportunities in Sri Lanka for Joint Venture FDIs
There are both huge potentials and tremendous opportunities to invest jointly in the manufacturing sector in Sri Lanka, which is a free and open economy with several attractive incentives including tax holidays for strategic investments to create a business-friendly environment for foreign investors.
Since the end of the civil war, the government has been steadily rebuilding, with the infrastructure development across the island from expressways to road and rail networks and deep-sea port expansion. The country’s economy has been able to maintain an impressive growth rate of around 7.5%, while expanding the GDP by 61%, from US$ 42 billion in 2009 to US$ 67.2 billion at present. The GDP per capita has risen from US$ 2,057 to US$ 3,280 during the same period. The government aims to achieve a per-capita income of US$ 4,000 by 2016.
The following industries have a huge potential and offer tremendous opportunities for joint investments in the manufacturing sector of the country.
5.2.1. Apparel Industry
Sri Lankan companies are spotting opportunities to set up joint ventures with overseas companies having vast manufacturing capability and the equally strong purchasing power to gain access for them to penetrate into the new markets such as Japan, China, and the Middle East by producing internationally branded products for overseas markets.
The USA and the United Kingdom have been the major buyers of Sri Lankan apparel throughout the decades. The US and British companies continue to maintain their long-lasting partnerships. As a result, exports to the USA continue to be over US$ 1 billion, and the contracts coming from the EU member states are more than US$ 1.5 billion and increasing continuously.
Sri Lanka’s apparel export industry is the most significant and dynamic contributor for its economy. The industry has experienced high growth levels over the past four decades. It is Sri Lanka’s primary foreign exchange earner accounting for 40% of the total exports and 52% of manufacturing exports. This industry, entirely privately owned, has penetrated into the international market and has made a name for itself. Well-known global brands such as Victoria’s Secret, GAP, Liz Claiborne, Next, Jones New York, Nike, Tommy Hilfiger, Pink, Triumph, Ann Taylor, Speedo, Abercrombie & Fitch, Land’s End, and Marks & Spencer are currently produced in Sri Lanka.
The following are the positive characteristics that enhance the attractiveness of
052 • 2014/15 Knowledge Sharing Program with Sri Lanka the industry for international joint venture formation:
- The industry is well geared to meet global market demand for fast, high quality fashion products. - Three decades of experience. - Environmental friendly factories – world’s first LEED certified Platinum rated production facility. - Ethical practices–known to the world as a producer of “Garments without Guilt” under the principles of Ethical working conditions, free of child labor, free of forced labor, free of discrimination on any grounds, free of sweatshop practices. - International reputation as a reliable and a quality manufacturer with a highly competent, skilled and literate workforce. - Innovation focused factories which offer superior product development and design resources. - Strategic shipping advantage.
Sri Lanka has targeted to double the output of the industry by 2016 and therefore, it is essential to bring further investments into the apparel sector by way of joint investments due to the prevailing capacity limitation with the local manufacturers.
5.2.2. Manufacturing of Fabric
The fabric required for the garment manufacturing industry in Sri Lanka is not available within the country. As such, 70% of the fabric required is imported to the country. Over US$ 1.5 billion worth of fabric is imported to the country annually for the manufacture of garments for the export market. Therefore, a huge opportunity is available for the manufacture of fabric within the country. The leaders in the garment manufacturing industry are eyeing the situation to take part with overseas experienced investors to start fabric manufacturing plants in Sri Lanka.
5.2.3. Rubber Industry
Sri Lanka prides itself in the manufacturing of a number of rubber products by processing raw rubber. They range from extrusion products like rubber bands, beadings, latex products such as medical, industrial and household gloves, industrial products like hoses, auto parts, compounds, tires, tubes, and general rubber products like floor mats, carpets, sports goods, footwear etc. Rubber products consist of around 8.6% of the annual export from Sri Lanka amounting to about US$ 900 million. The rubber and rubber product exports are expected to reach US$ 3 billion in 2020. The major markets for manufactured rubber products are the USA, Germany,
Chapter 1 _ Framework of Joint Venture Partnership with Global Companies and Local Partners • 053 Italy, Belgium, and the UK. The manufacturing facilities vary from small scale to large international joint ventures. Most of the export oriented rubber manufacturers are large and medium scale and located mainly in the Western Province.
Rubber products exported by Sri Lanka are currently dominated by solid tires, which is 23% of the global market demand. Other products consist of pneumatic tires, latex gloves, rubber flooring, mats, auto components, sealing rings, rubber bands, straps, hoses etc.
About 175,000 MT of natural rubber is produced per annum and available in the form of Smoked sheets, latex crape, sole crape, and centrifuged latex. Premium quality natural rubber type known as Lanakprene, which is odor free, to a certain degree light colored, clean, rubber that is ideally suited for medical equipment and up market value added products.
The industry provides direct and indirect employment to about 300,000 persons. In the rubber sector, the mix of investment models consists of purely local investments, foreign direct investments, and joint ventures. There are about 50 large and medium scale enterprises registered under the Board of Investment of Sri Lanka.
The demand for rubber products is ever increasing and the local manufacturers are not in a position to increase the capacity without further investments coming from overseas. So the rubber manufacturing industry, as well, offers opportunities for joint venture investments.
5.2.4. Ceramic Industry
Sri Lanka is endowed with raw materials used in the ceramic industry such as kaolin, ball clay, feldspar, silica quartz, and dolomite. The excellent quality and purity of these materials, which is available in abundance, contribute to the high standards of the products. Domestic value addition has become an essential factor when exporting products utilizing duty advantages offered under trading arrangements. Being over 60% value addition, the ceramic industry ranks high amongst the locally manufactured export products.
As a result of the perfect combination of advanced technology and the traditional indigenous craftsmanship, Sri Lankan products can be found in top department stores such as Macy’s, Crate & barrel , Marks & Spencer, Hallmark and Pottery Barn in USA, El Corte Ingles in Spain, Debenhams, Susie Watson Designs, John Lewis, and House of Frazer in UK, Sanrio and Isetan in Japan. Also, Sri Lanka manufactures products for reputed licensors such as Walt Disney, Universal Studios, Lucas Arts and Warner Brothers to name just a few. All Sri Lankan tableware products conform
054 • 2014/15 Knowledge Sharing Program with Sri Lanka to Food and Drug Administration (FDA) norms and ASTM Standards. Main export markets of Tableware & kitchenware are the UK and the USA. This industry has some significant operational strength, including a highly skilled workforce, competitive labor costs, and excellent management at factory levels, state-of-the-art technology, research and development facilities, high ethical standards, and confidentiality of design integrity, in contrast to its Asian competitors.
Further, Sri Lanka is proud of exporting under their own brands: Dankotuwa, Elan, Royal Fernwood, and under the back stamp of Noritake to the USA, Japan, the UAE, Italy, and India. Main export markets for tiles are Australia, the USA, Canada, the Netherlands, and the Maldives.
The Sri Lankan ceramic industry supplies ceramic products to the international market under four major categories. They are porcelain tableware, ornamental and utility ware, tiles including wall tiles and floor tiles, and sanitary and bath ware.
The sector needs an infusion of capital and technology to enhance its production capacities and quality. As such, an immense opportunity is available in the ceramic industry for joint venture FDI investments.
5.2.5. Boat and Ship Building
Sri Lanka has one of the best natural harbors in the South Asian region. Its commercial port in Colombo is one of the most economical and efficient, which offers complete service to shippers.
With the dawn of peace in Sri Lanka, an expanding tourism industry is opening up a new frontier of leisure and pleasure crafts. Also, the increased interest of the local community in boating activities has created additional market opportunities. The country’s leisure sector records growth where whale watching and other leisure activities contributed by the surge in the tourism industry have a positive impact on the boat building industry.
Further, considering the high marine diversity in the country and the influx of fairly high spending tourists, the country has a massive potential for marine (natural) tourism which too will create more market opportunities.
There are about 20 to 25 active boat yards around the country producing various types of boats, as described above, providing employment to around 2000 directly and around another 10,000 indirectly. The export value of the industry is about US$ 60mln, while meeting the domestic market demand too.
Chapter 1 _ Framework of Joint Venture Partnership with Global Companies and Local Partners • 055 With the increasing demand in fisheries, tourism, and defense, the boat building sector in Sri Lanka, as a high quality product manufacturer, has a potential for further expansion. The industry has an untapped potential for further development with the support of international investments in technology and capacity enhancement through joint venture partnerships.
5.2.6. Cement Manufacturing
Sri Lanka’s cement consumption is about 3.5mn metric tons per annum and it is estimated that the market is growing at the rate of 10% per annum. Sri Lanka imports more than 70% of its cement requirement, both in bulk and bags, from Pakistan and India. The value of cement import is in the range of US$ 400 million per annum, despite the fact that Sri Lanka is abundant in high quality limestone. The government of Sri Lanka has an ambitious plan for the development and upgrading of infrastructure in the entire country. So, the demand for cement as a main construction material will continue to increase. Only one company, at present, engages in the total manufacturing process of cement in Sri Lanka. All the other companies engage in grinding operation, packing, and distribution. Cement manufacturing comes under the strategic import replacement concession scheme and eligible for tax exemption for a period depending on the value of investment and a concessionary tax rate after the tax holiday period. So, there is an immense opportunity for new players to enter in to the market establishing complete production plants jointly with existing operators.
5.2.7. Petro Chemical Products Manufacturing
Sri Lanka is well positioned in the Indian Ocean adjoining the East–West shipping route. Therefore, there is no doubt that the petro chemical processing and manufacturing industries will become highly profitable and feasible ventures. At present, few companies engage in the petro chemical industry and the sector has a promising future. The annual crude oil consumption in Sri Lanka is about 40 million barrels, and it is estimated that the demand is growing at 7% annually.
There are four major players in the oil and gas sectors in the Country. The Petroleum Corporation, the Indian Oil Company, the Littro Gas Company, and Laugfs Gas Company are the four players and they envisage to expand their operations.
With the opening of the new Hambantota port facilities, an immense opportunity has been created for major investments in oil refineries and the manufacturing of petro chemical products for the local as well as for export markets. Hambantota port has become the most attractive location along the middle east-west shipping route in respect to the proximity and connectivity for such kind of industries. Further, the
056 • 2014/15 Knowledge Sharing Program with Sri Lanka Hambantota & Colombo Ports are operating as free ports under the provisions of the Commercial Hub Regulation No.01 of 2013 and therefore, it would be highly efficient and convenient to import crude oil and export products out of the country from Hambantota as well as from Colombo harbors.
5.2.8. Manufacturing of Pharmaceutical Products
The pharmaceutical industry has a promising future due to the growing demand of over 8% per annum. Over 70% of medical and pharmaceutical products are imported to the country. The annual average import of medical and pharmaceutical products is over US$ 350 million. There are about five manufacturers that are engaged in the pharmaceutical industry with limited capabilities. Therefore, the opportunities are promptly available for the enhancement of capacity, range of products, and volumes. The pharmaceutical industry falls under the strategic import substitution investment scheme too and therefore qualifies for attractive incentives. The sector has a hidden potential for major joint venture investments.
5.2.9. Manufacturing of Milk Powder and other Dairy Products
The Milk powder manufacturing industry also has a promising future due to the ever increasing demand for the product in the domestic market. Sri Lanka spends about US$ 400 million annually to import milk powder and dairy products. As such, the government has identified this sector as one of the key areas for investment promotion. This sector too qualifies for concessions under the strategic import substitution investment scheme under the large category of investments. The sector offers immense opportunities for joint venture investments.
The above sectors or fields are the identified areas under this study as potential areas for joint venture investments in the manufacturing sector of the country, but, there exist opportunities virtually in all sectors for joint investments.
5.3. Supportive Regulations
Even though, there is no comprehensive framework inclusive of direct regulations for the promotion and enhancement of joint venture formations in Sri Lanka, the following international agreements and regulations encourage indirectly the formation of joint ventures.
5.3.1. The India–Sri Lanka FTA and the Pakistan–Sri Lanka FTA
The rules of origin as spelled out below encourage 35% minimum value addition within Sri Lanka to enjoy duty free access to both markets. Indirectly, both
Chapter 1 _ Framework of Joint Venture Partnership with Global Companies and Local Partners • 057 agreements encourage international joint investments in Sri Lanka to make new products or to set up value added processes in order to qualify for concessions under the FTAs.
5.3.2. Rules of Origin
In order to receive benefits assigned under the agreements, the merchandise export between India/Pakistan and Sri Lanka should comply with the following Rules of Origin criteria.
5.3.3. Wholly Obtained Products
All wholly obtained products will be able to enjoy duty free benefits in each other’s markets without difficulty, provided they are eligible for duty concessions.
5.3.4. Products Not Wholly Produced or Obtained
These include the products manufactured using imported raw materials. In order to enjoy ISFTA/PSPTA benefits, the products should comply with the following criteria. The Domestic Value Addition (DVA) in the exporting country should not be less than 35% of the FOB value of the finished product and Harmonized SystemHS Codes of the imported raw materials and the finished products should be different at 4-digit level (Change of Tariff Heading criteria).
5.3.5. Cumulative Rules of Origin
The Cumulative Rules of Origin encourage the contracting states to source raw materials needed for their exports from each other. Accordingly, an exporter has to show only a minimum DVA of 25% of the FOB value of the finished product, provided the raw materials imported from the other contracting state accounts for not less than 10% of the FOB value of the particular product. In other words, the aggregate value addition should not be less than 35% of the FOB value of the finished product, while the DVA in the exporting country should be minimum 25% of the FOB value.
The progress made by the Sri Lankan side under the above agreements is not so satisfactory up to date due mainly to the non-availability of qualifying products in bulk form with 35% value addition within Sri Lanka. So, there is an opportunity to start assembly lines with components imported from a third country. This could be easily done within designated free ports or bonded areas as specified under the Commercial Hub Regulation No.01 of 2013.
058 • 2014/15 Knowledge Sharing Program with Sri Lanka 5.3.6. Strategic Development Projects Act, No.14 of 2008
The strategic development project means a project which is in the national interest and which is likely to bring economic and social benefits to the country inclusive of substantial inflow of foreign exchange to the country. For example, major investments in oil refineries, cement manufacturing, vehicle manufacturing etc. could be considered under this act, and the Cabinet of Ministers grants concessions subject to the approval of the Parliament. The investments made jointly with local partners or companies too are eligible for consideration under the above act.
The qualifying projects under the above act too could be located within the free ports or bonded areas as specified under the Commercial Hub Regulation No.01 of 2013.
5.3.7. Finance Act- Commercial Hub Regulation No. 1 of 2013
The Colombo and Hambantota ports have been declared as free ports while the Katunayaka Export Processing Zone, the Koggala Export Processing Zone, the Mirijjavila Export Processing Zone, and the Mattala Airport have been declared as bonded areas for the purposes of the above regulation.
Any enterprise which is established or incorporated in Sri Lanka and engaged in entrepot trade involving an import, minor processing, and re-export, where at least sixty five percent (65%) of its total investment has been from foreign sources, including and transfers from a Foreign Currency banking unit of a licensed commercial Bank operating in Sri Lanka, and of which the total turnover is from export of goods and or services, shall be exempted from the application of the Provisions of Customs Ordinance (Chapter 235), the Exchange Control Act (Chapter 423) and the Imports and Exports (Control) Act, No 1 of 1969.
The above act also encourages the formation of joint ventures within those commercial hubs as the foreign investment component requirement is only 65% of the total investment.
5.4. Policy Actions Needed for Fostering Joint Venture FDIs in Sri Lanka
As we can see in the following figures, the current situation of doing business in Sri Lanka is better than in its neighboring countries (World Bank, 2014). Therefore, if the Sri Lankan government provides a good business environment for the joint ventures, another boost in FDI attraction activities can be expected.
Chapter 1 _ Framework of Joint Venture Partnership with Global Companies and Local Partners • 059 [Figure 1-3] Current Business Situation of Sri Lanka
SRI LANKA
Ease of… Resolving insolvency 0 Starting business
Enforcing contracts 100 Dealing with…
200 Trading… Getting electricitiy
Paying… Registering property Protecting minority… Getting…
Source: World Bank (2014).
[Figure 1-4] Current Business Situation of Pakistan
PAKISTAN
Ease of… Resolving insolvency 0 Starting business
Enforcing contracts 100 Dealing with…
200 Trading… Getting electricitiy
Paying… Registering property Protecting minority… Getting…
Source: World Bank (2014).
[Figure 1-5] Current Business Situation of Bangladesh
BANGLADESH
Ease of… Resolving insolvency 0 Starting business
Enforcing contracts 100 Dealing with…
200 Trading… Getting electricitiy
Paying… Registering property Protecting minority… Getting…
Source: World Bank (2014).
060 • 2014/15 Knowledge Sharing Program with Sri Lanka [Figure 1-6] Current Business Situation of India
INDIA
Ease of… Resolving insolvency 0 Starting business
Enforcing contracts 100 Dealing with… 200 Trading… Getting electricitiy
Paying… Registering property Protecting minority… Getting…
Source: World Bank (2014).
5.4.1. The Enactment of the Foreign Direct Investment Promotion Act
The Board of Investment Act is currently applied to FDI in Sri Lanka. However, there are many ministries and laws which deal with FDI and JV. Therefore, many foreign investors experience difficulties as to which ministry and law they should consult and follow. The Sri Lankan government is well advised to introduce and enact a comprehensive FDI promotion law, which is expected to increase the effectiveness of policy implementation.
As documented by the best practices of Korea and China, many successful countries have introduced and enacted their own FDI promotion acts, which reflect their inherent situation to make a more FDI friendly environment. It also can reduce the transactions costs incurring to foreign investors substantially, by making the FDI policies of the government more transparent. Therefore, it is recommended to establish the Foreign Direct Investment Promotion Act which can cover all the aspects of FDI matters.
5.4.2. The Introduction of the Model Joint Venture Agreement
From the perspective of foreign investors interested in joint ventures with Sri Lankan local companies, it is crucial to secure a favorable business environment by agreeing upon the terms and conditions of such business cooperation. As we can find in many successful cases of JV, the formal agreement was one of the reasons partners can establish credibility with each other. The legal and business-related certainties are two of the most significant factors that the foreign investors would like to ensure when engaging in joint ventures with companies in other countries.
However, there is no model agreement for JVs in Sri Lanka. Model JV agree-
Chapter 1 _ Framework of Joint Venture Partnership with Global Companies and Local Partners • 061 ments can also provide material assistances to Sri Lanka’s local companies seeking opportunities of engaging with multinational corporations. Therefore, the introduction of the Model Joint Venture Agreement can enhance the possibilities of business contracts between MNCs and Sri Lankan companies, especially by increasing the accessibility of legal documents at a low cost. A sample JV agreement shown in the appendix can serve as a reference even though there should be some modifications made to reflect Sri Lanka’s particular situation.
5.4.3. Special Incentives for the Joint Venture
There is no special incentive for joint ventures in Sri Lanka. However, there are many advantages for joint ventures in developing countries, and other competing countries have introduced incentives for JVs. Therefore, to have more favorable conditions for JVs in Sri Lanka, the introduction of special incentives for JVs should be considered because JVs can contribute to Sri Lanka more than 100% foreign owned FDI can.
5.4.4. Restructuring of the Board of Investment
The Board of Investment of Sri Lanka was established in 1992 and structured to function as a central facilitation point for investors. The BOI is committed towards continuously improving the country’s investment climate. However, their performance is not fully appreciated by its customers. Therefore, to be a one-stop service center for FDI promotion, the restructuring of the BOI should be considered including the introduction of The Foreign Investment Support Center.
062 • 2014/15 Knowledge Sharing Program with Sri Lanka Appendix
S A M P L E JOINT VENTURE AGREEMENT by UNIDO4)
The Joint Venture Company
This agreement is made and entered into on [day] of [month, year] by and between: [name of the foreign company], a company organized under the laws of [country of the foreign company] having its principal office at [address of the foreign company], hereinafter referred to as FOREIGN; and [name of the local company], a company organized under the laws of [host country] having its principal office at [address of the local company], hereinafter referred to as LOCAL.
Recitals
WHEREAS the government of [host country] passed a Joint Venture Law on [date] permitting the establishment in [host country] of private companies with participation from developed and developing countries;
WHEREAS LOCAL has performed, at its own expense, market and pre-feasibility studies of a joint venture for the establishment of a production facility for [product 1] and their sales initially in [host country] and eventually abroad and for the expansion of already existing production facilities for [product 2] in [host country] for sales abroad.
WHEREAS LOCAL and FOREIGN entered into a Letter of Intent on [date] under which LOCAL and FOREIGN undertook to conduct jointly a feasibility study to analyze and evaluate the potential for such a joint venture between LOCAL and FOREIGN;
WHEREAS the feasibility study carried out by the consulting firm [name of consulting firm] pursuant to the above mentioned Letter of Intent demonstrated the viability of establishing such a joint venture and has indicated the likelihood of a 60 per cent increase in sales of [product 2] to FOREIGN and a feasible sales volume for [product 1] of 25,200 units per annum at full capacity;
WHEREAS LOCAL has applied for and been granted permission from the Board of Investments of [host country] to form a joint venture with FOREIGN for the purposes outlined below;
WHEREAS LOCAL and FOREIGN now wish to enter into a joint venture for the
4) UNIDO (2008), pp.193-203
Chapter 1 _ Framework of Joint Venture Partnership with Global Companies and Local Partners • 063 production of [product 1] and [product 2] in [host country].
NOW THEREFORE, in consideration of the mutual representations, warranties, covenants, and agreements herein contained, LOCAL and FOREIGN agree as follows:
1. Formation of the Joint Venture Company
On or before the [day] of [month, year], the parties hereto shall cause the formation of a private joint venture company under the laws of [host country] as follows:
1.1. The joint venture company shall be called [name given to the joint venture company] hereinafter referred to as JOINT COMPANY.
1.2. JOINT COMPANY shall be limited by shares and have an authorized share capital of US$20.0 million [host country] currency units (hereinafter referred to as “CU”) divided into 10,000 class A common shares having a par value of CU 1000 each and having voter’s rights at all shareholder’s meetings; and 14 class B ordinary shares having no par value but bearing rights to membership on the Board of Directors, and 10,000 cumulative preferred shares having a par value of CU 1000 each and having rights to priority in the receipt of dividends and participation from assets in case of dissolution.
1.3. JOINT COMPANY’s initial issued share capital shall be 8,000 class A common shares, 14 class B ordinary shares, and 8,000 (cumulative) preferred shares and shall be subscribed by the parties in the following proportions to their respective equity ownership: LOCAL: Common shares, class A: 4,080 Common shares, class B: 6 Cumulative preferred shares: 4,080 FOREIGN: Common shares, class A: 3,920 Common shares, class B: 8 Cumulative preferred shares: 3,920
1.4. JOINT COMPANY shall have its registered and principal offices at [address of JOINT COMPANY].
1.5. JOINT COMPANY’s by-laws and articles of association shall be as set out in appendix A which is attached hereto and made a part hereof.
064 • 2014/15 Knowledge Sharing Program with Sri Lanka 2. Objectives of the JOINT COMPANY
The objectives of the JOINT COMPANY are:
2.1. General objectives
To develop modern [product 1] production and marketing in [host country]; expand and upgrade existing [product 2] production and sales facilities for export.
2.2. [Product 2] Production:
• To obtain foreign currency through the sale abroad of locally made • [Product 2]; • To provide employment for the local labor force; • To establish a new market for locally manufactured [product 2]; • To safeguard the already existing market for furniture in [country of FOREIGN] by obtaining a product produced at lower cost in [host country]; • To secure advanced [product 1] manufacturing know-how and design and modernize The already existing local [product 1] industry; • To utilize an abundant natural resource; • To safeguard the raw material supply required for the [country of FOREIGN] [product 2] market.
2.3. [Product 1] Production:
• To secure advanced electronic know-how; • To develop low cost [product 1] for [host country] home market through local production and to upgrade thereby the local level of computer sophistication; • To obtain management know-how for a [product 1] production plant; • To obtain cost and other advantages through [host country]’s low labor and raw materials costs, tax and other incentives; • To establish a new market in [host country] and possibly abroad for [product 1] and related parts; • To obtain foreign currency in the event that [product 1] and related parts are sold abroad.
3. Expansion and Future Growth of Operations
Each party shall take such action as may be necessary to ensure that JOINT COMPANY shall progressively develop and expand the joint [product 1] production and [product 2]
Chapter 1 _ Framework of Joint Venture Partnership with Global Companies and Local Partners • 065 production to the maximum extent consistent with sound commercial practice.
4. JOINT COMPANY’s Future Share and Loan Capital Requirements
4.1. Should JOINT COMPANY decide to export outside the territory of [host country] the [product 1] which it produces under this contract, LOCAL and FOREIGN will jointly undertake during the period of three years starting on the first day of [date] to make additional contributions to JOINT COMPANY at its request up to an aggregate of CU 10.0 million.
4.2. Each such contribution shall be divided between the parties in proportion to their respective equity ownership. Not more than 50 per cent of such contributions shall be requested before [date] and not more than 75 per cent total of such contributions before [date].
4.3. Any further equity may be issued by the JOINT COMPANY in excess of the above equity contribution requirements, provided, however, that shares representing such equity shall be offered for subscription in the first instance to the parties in proportion to their respective equity ownership and that any such further equity shares shall be issued for subscription at a price per share equal to the book value per share of the company as of the end of its immediately preceding fiscal year.
4.4. The parties agree that no additional equity contributions will be required to be made to JOINT COMPANY during the six year period following the formation thereof beyond the initial equity contribution provided under section 1 of this Agreement.
4.5. The parties agree that any additional financial requirements of JOINT COMPANY shall be met through borrowing. To the extent that any such borrowing should not be available to JOINT COMPANY without the assistance of guarantees by either party, the parties shall supply such guarantees provided that at no time shall LOCAL’s exposure for such guarantees be in currency other than CU or exceed the amount of CU 7.5 million and that FOREIGN’s exposure for such guarantees shall not exceed the amount of CU 6.0 or the equivalent thereof.
4.6. The exchange rate for any operation under this contract shall be the average of the exchange rates of buying and selling published by the National Foreign Exchange Bureau of [host country] on the date that the said operation takes place.
066 • 2014/15 Knowledge Sharing Program with Sri Lanka 5. Parties’ Contributions to and Contractual Relations with JOINT COMPANY
5.1. LOCAL shall contribute to JOINT COMPANY in total fulfillment of its contribution to the initial share capital of JOINT COMPANY in accordance with the preceding section 1 of this Agreement the facilities and other assets listed in appendices B and F.
5.2. FOREIGN shall contribute to JOINT COMPANY in total fulfillment of its contribution to the initial share capital of JOINT COMPANY in accordance with the preceding section 1 of the Agreement the facilities and other assets listed in appendix C.
5.3. The parties agree to accept the evaluation of said facilities and other assets found in the feasibility study.
[ALTERNATIVE WORDING: In the event that both parties agree that, because of time lapse since the feasibility study, the evaluation found in the feasibility study no longer represents the true value of the facilities and/or assets described therein, they will use their best efforts to arrive at an evaluation satisfactory to both parties. If, however, despite their best efforts, they should fail to reach such conclusive agreement with respect to any such item prior to [date], the final evaluation shall be conclusively determined by (independent chartered accountant or other third party agreeable to both sides) at fair market value in the country and city where located. The valuation determined by said third party shall be final and binding for the parties who shall bear the costs of his/her services in equal shares.]
5.4. All contractual and other commercial dealings, including supplies of all kinds, between either party or its respective affiliates and JOINT COMPANY shall be negotiated on a commercial arm’s length basis. Upon its request, each party shall have the right to be informed by JOINT COMPANY annually of the prices applied with respect to dealings contemplated in this provision in order that it may review compliance with the principles set out herein.
5.5. Prices of material or equipment supplied by either party or its respective affiliates to JOINT COMPANY shall be negotiated having regard to prices of similar products and services sold or supplied by independent suppliers to their most preferred customer. Where similar products are not available from independent suppliers, prices shall be negotiated on the basis of bearable cost plus a mark-up.
6. Incentives
6.1. This agreement is made subject to JOINT COMPANY’s continuing to be admitted to
Chapter 1 _ Framework of Joint Venture Partnership with Global Companies and Local Partners • 067 the benefits of the following incentives under the Joint Venture Law of [date], other pertinent legislation and regulations of [host country], and the [host country]/[country of FOREIGN] double taxation treaty.
6.1.1. Tariffs and Other Forms of Protection:
• Seven year import tariff of 100 per cent on purchase price of competing goods from other countries;
6.1.2. Import-Duty concessions:
• Import restrictions for three years thereafter and limiting permitted imports to a one quarter of the number produced in the preceding year by JOINT COMPANY;
6.1.3. Tax incentives:
• Tax rate on salaries of individual expatriate employees reduced to the same tax rate as in [country of FOREIGN]; • Exemption from the 20 per cent export tax on profits (in accordance with the [host country]/ [country of FOREIGN] double taxation treaty; • Reduction of the tax on profits from 38 per cent to 33 per cent.
6.2. [host country] Shall immediately upon signing this agreement duly file any further applications necessary for the above incentives to the competent authorities and shall comply with any requirement prescribed in connection therewith.
7. Marketing
7.1. Marketing of the [product 2] of JOINT COMPANY shall be conducted by FOREIGN in accordance with the terms set forth in the marketing agreement annexed hereto in appendix D.
7.2. Marketing of the [product 1] in [host country] under this Agreement shall be conducted by LOCAL in [host country] and by FOREIGN abroad in accordance with the terms set forth in the marketing agreement annexed hereto in appendix E.
8. Board of Directors
8.1. JOINT COMPANY shall be directed by a Board of Directors which shall consist of a total of seven members of whom four shall be nominees of FOREIGN and three shall
068 • 2014/15 Knowledge Sharing Program with Sri Lanka be nominees of LOCAL for so long as the proportion of ownership in the Company is 49 per cent by FOREIGN and 51 per cent by LOCAL. If the proportion of ownership is altered by any means whatsoever, this alteration shall be reflected in the proportion of the members of the Board of Directors nominated by each party at the meeting of the shareholders at which the said alteration of proportion of ownership is approved.
[ALTERNATIVE WORDING: FOREIGN shall be the owner of 8 class B shares and shall be entitled to make binding nominations for the appointment of four of the directors, and LOCAL shall be the owner of 6 class B shares and shall be entitled to make binding nominations for the appointment of three directors. Both parties agree to take all steps necessary to secure the appointment of the said nominees in accordance with the law of [host country].]
8.2. Should one of the positions on the Board of Directors become vacant for any reason whatsoever, the partner who originally nominated the holder of the position now vacant shall have the right to appoint another director to fill out the remainder of the term of the vacant position.
8.3. Each party shall exercise its voting rights in JOINT COMPANY and take such other steps as lie within its power:
8.3.1. To Procure that the persons nominated in accordance with the preceding paragraph shall be directors of JOINT COMPANY; and
8.3.2. To Prevent the passing of any resolution for the removal of any director nominated by the other party, except at the request, or with the consent of, that other party.
8.4. LOCAL will use its best efforts to remove obstacles to temporary visas for FOREIGN board members attending board meetings in [host country].
8.5. The Board of Directors shall hold at least one regular meeting annually. A special meeting shall be held upon the recommendation of at least three of the directors.
8.6. The meetings of the Board of Directors shall be normally held at the headquarters of JOINT COMPANY. Upon approval of all directors, it may be held at other locations.
8.7. The Chairperson shall send each director a written notice indicating the agenda, time and place of any meeting 30 days prior to the said meeting.
8.8. If a Director is unable to attend any meeting, he may designate in writing another
Chapter 1 _ Framework of Joint Venture Partnership with Global Companies and Local Partners • 069 person as a proxy to attend the meeting.
8.9. A quorum for a meeting of the Board of Directors shall consist of at least six Directors.
8.10. The written minutes of each meeting of the Board of Directors shall be signed by all Directors attending. The minutes will be in [host country language] and English and will be filed in JOINT COMPANY’s headquarters.
8.11. Unanimous approval of the Board of Directors is required for the following issues:
8.11.1. Approval of reports submitted by the general management, such as production plans, annual business operation reports, loan statements;
8.11.2. Approval of the annual financial statements, including profit and loss accounts;
8.11.3. Approval of major corporate regulations and rules;
8.11.4. Approval for amendments of JOINT COMPANY’s articles of association;
8.11.5. Approval of any bankruptcy petition for JOINT COMPANY;
8.11.6. Approval of extension of the term of JOINT COMPANY;
8.12. Approval of five or more directors is required for the following issues:
8.12.1. Approval of managing director’s normal operation plan;
8.12.2. Approval of corporate working regulations and rules including the policies concerning bonuses;
8.12.3. Approval of decisions made by the general manager and the deputy general managers concerning the day-to-day operation of JOINT COMPANY.
9. Management of JOINT COMPANY
9.1. LOCAL shall appoint a general manager who will be responsible for all nontechnical questions in the day-to-day management of JOINT COMPANY under the direction and control of the Board of Directors.
9.2. FOREIGN shall appoint two deputy general managers for the first five years of JOINT
070 • 2014/15 Knowledge Sharing Program with Sri Lanka COMPANY’s operation. One deputy general manager will be responsible under the direction and control of the Board of Directors for the setting up of the [product 1] production operation with sales in [host country] and will be responsible for recommending to the Board of Directors if and when sales should begin outside [host country]. The other deputy general manager will be responsible for the [product 2] production operation and will be responsible under the direction and control of the Board of Directors for modernizing and upgrading the standards of wood furniture production and for overseeing the adherence to specifications provided by FOREIGN, including the installation of new equipment and the quality control of the final product.
9.3. After the first five years of JOINT COMPANY’s operation, the Board of Directors shall decide whether to market [product 1] produced in [host country] in other countries. If such decision is taken, FOREIGN will have the right to appoint a third deputy general manager and an assistant deputy general manager who will have responsibilities for sales outside [country of FOREIGN] during the next five-year period. In such case, FOREIGN will also provide JOINT COMPANY at cost, without any charge for creative work, all advertising and marketing aids which it then has or will acquire during the term of this Agreement and which relate to [product 1] sold by JOINT COMPANY outside [host country]. More specifically, but without limiting the generality of the foregoing, such advertising and marketing aids shall include brochures, pamphlets, catalogue sheets, labels, boxes, cartons, packaging, diagrams, manuals, designs, pictures, descriptions, instructions, films, scripts, recordings, color schemes and other data designed to explain, assist or promote the sale, distribution, use and servicing of the said computers.
9.4. The [product 1] division will have four additional managers for the first five years of JOINT COMPANY’s operations: a technical director and a financial director appointed by FOREIGN and a marketing director and a personnel director appointed by LOCAL 9.5 The [product 2] division will have four additional managers: a technical director and a marketing director appointed by FOREIGN and a financial director and a personnel director appointed by LOCAL.
9.5. LOCAL will use its best efforts to remove obstacles to employment permits for foreign management in [host country].
10. Shareholders’ rights
10.1. As long as either party holds at least 45 per cent of the equity securities of JOINT COMPANY, none of the following actions shall be taken without the consent of both
Chapter 1 _ Framework of Joint Venture Partnership with Global Companies and Local Partners • 071 parties:
10.1.1. Amendment of the by-laws or articles of incorporation;
10.1.2. Increase of capital;
10.1.3. Distribution of dividends;
10.1.4. Merger or consolidation with another company or companies;
10.1.5. Appointment or removal of the independent auditor of JOINT COMPANY;
10.1.6. Dissolution, transfer of any substantial part of the assets, or institution of any fundamental change in the nature of the business.
10.2. The parties shall cause JOINT COMPANY at the close of each fiscal year to have an audit conducted by an independent firm of chartered accountants acceptable to both parties, and to present to its shareholders an annual report covering such year, including financial statements certified by such accountants as having been prepared in accordance with the standards established in [host country] for state-owned enterprises.
10.3. As early as practicable after the formation of JOINT COMPANY, the parties shall cause the JOINT COMPANY to provide both parties with at least quarterly financial and operating reports, business plans and forecasts, prepared on principles consistent with those set out for JOINT COMPANY’s annual reports.
10.4. The parties are requesting that JOINT COMPANY be exempted from the [host country] Joint Venture Law requirement that joint venture auditing be carried out by an [host country] auditing organization operating on a self-supporting basis and that joint venture not submit any accounting or business information to the state or other authorities of foreign countries as [country of FOREIGN] requires FOREIGN to submit tax and other information about its subsidiaries in its accounting documents which must be prepared in line with generally accepted accounting standards. If such authorization is granted, JOINT COMPANY will employ [name of auditing firm] to prepare its accounts.
11. Transfer of Shares
Neither party shall, without the previous written consent of the other party, sell,
072 • 2014/15 Knowledge Sharing Program with Sri Lanka transfer, pledge, encumber, dispose of, or otherwise part with the beneficial ownership of, any of its shares of the capital of JOINT COMPANY.
12. Profit Policy
LOCAL and FOREIGN recognize that their own and the best interests of JOINT COMPANY will be best served by taking all reasonable steps to ensure the expansion of the production facilities of the joint company as rapidly as market conditions permit and, to this end, agree to retain sufficient earnings in JOINT COMPANY before distributing profits to the shareholders, as shall be reasonably required in the circumstances to provide for such expansion and for the other requirements of conducting the affairs of JOINT COMPANY according to sound business practices.
13. Patent Rights
FOREIGN is the owner of certain patents outlined in the Foreign Patent License Agreement in appendix F and has the right of disposal of the said patents. FOREIGN agrees to license LOCAL which undertakes to assign said license to JOINT COMPANY to permit JOINT COMPANY to use these patents and the manufacturing secrets and experience (know-how) concerning the manufacture of the [product 1] to be assembled by JOINT COMPANY and the [product 2] to be produced by JOINT COMPANY for a period of time not to exceed the present term of JOINT COMPANY, i.e. not longer than fifteen years from the date JOINT COMPANY comes into existence as a legal entity.
14. Duration of Agreement
14.1. This Agreement shall enter into effect on the date of its registration in accordance with the laws of [host country] and shall remain in effect for a period of fifteen years therefrom and shall be subject to renegotiation at the end of the period.
14.2. Should the parties fail to agree within a period of three months following the end of the fifteen year period on the renegotiation of the Agreement or on termination of the Agreement under section 15 of this Agreement, LOCAL shall have the option to acquire the shares in the Company then held by FOREIGN at a valuation to be calculated by the auditor of JOINT COMPANY on the basis of the net tangible assets of JOINT COMPANY as disclosed in the latest audited accounts.
15. Termination of the Agreement
15.1. Either party may terminate this Agreement in the event that the other party shall:
Chapter 1 _ Framework of Joint Venture Partnership with Global Companies and Local Partners • 073 15.1.1. Breach in any material manner any provision of this Agreement and fail to remedy such breach within 60 days after the injured party has given written notice requiring that the breach be remedied or such longer period as the injured party may specify as reasonable in the circumstances;
15.1.2. Commit any act of bankruptcy, become insolvent, enter into any agreement with its creditors, take advantage of any law for the benefit of debtors, go into liquidation, whether compulsory or voluntary, or have a dissolution order made in respect of it.
15.2. The effective date of termination of this Agreement shall be the date on which the injured party gives written notice to that effect in accordance with this clause.
15.3. Any termination pursuant to this clause shall be without prejudice to any rights and remedies which the injured party may seek against JOINT COMPANY or the other party for breach of contract or otherwise and shall not operate to prejudice the rights and obligations provided for in the [host country] Joint Venture Law or this Agreement concerning the disposition of shares and assets of JOINT COMPANY.
16. Distribution of Assets on Dissolution
In the event of the dissolution of the Company, the assets of the Company shall be disposed of in accordance with the following rules:
16.1. LOCAL shall be given a first option for a period of ninety (90) days to purchase all or any of such assets at their depreciated book value;
16.2. After the expiration of the first option, FOREIGN shall be given an option for a further period of ninety (90) days to purchase at their depreciated book value all or any assets not purchased under the first option;
16.3. Any remaining assets shall be disposed of in accordance with the directions of the liquidator of the Company.
17. Arbitration
Any dispute between the parties that cannot be settled by mutual agreement and that relates to the interpretation, carrying out of obligations, breach or enforcement of this Agreement, or of any document or instrument referred to herein, shall be finally settled under the Rules of Conciliation and Arbitration of the International Chamber of Commerce by one or more arbitrators appointed in accordance with the Rules. The arbitrator or
074 • 2014/15 Knowledge Sharing Program with Sri Lanka arbitrators shall sit in Vienna, Austria.
18. General
18.1. This Agreement shall be construed in accordance with and governed by the laws of [host country].
18.2. This Agreement represents the entire understanding and agreement between the parties and supersedes any and all previous oral or written understandings or agreements between the parties with respect to the matters set forth herein. Appendices annexed hereto are for all purposes an integral part of this Agreement.
18.3. No modification or amendment to this Agreement or any schedule or exhibit thereto and no waiver of any of the terms or conditions hereof or thereof shall be valid or binding unless made in writing duly signed.
18.4. Any notice or other communications to a party required or permitted hereunder hall be made in writing and shall be sent by cable or telex and confirmed by registered air mail addressed to the address of such party set forth below or to such other address as such party shall have communicated to the other party.
Notices or communications to LOCAL shall be sent to:
[Name of LOCAL, address, contact coordinates, contact person]
Notices or communications to FOREIGN shall be sent to:
[Name of LOCAL, address, contact coordinates, contact person]
18.5. Each party shall use its best efforts to secure any authorization by public authorities necessary for the execution and performance of this Agreement in accordance with its terms.
18.6. Each party represents and warrants that, except for any authorization specified under the preceding paragraph 18.5, it has full power and authority to execute and to fulfill all of its obligations set forth in this Agreement and that this Agreement constitutes a valid and binding agreement of such party in accordance with its terms.
18.7. The parties shall cause JOINT COMPANY, upon its registration, to become a party to this Agreement, whereupon JOINT COMPANY shall be entitled to the rights and
Chapter 1 _ Framework of Joint Venture Partnership with Global Companies and Local Partners • 075 bound by the obligations provided for the company herein. JOINT COMPANY shall deliver to each of the parties an appropriate document evidencing its agreement to such affect.
IN WITNESS WHEREOF, the parties have caused this Agreement to be executed by their duly authorized representatives on the day and year first above written.
By ------
(LOCAL)
By ------
(FOREIGN)
076 • 2014/15 Knowledge Sharing Program with Sri Lanka References
Board of Investment of Sri Lanka, Investment Guide, 2014. Helplinelaw, Introducing Joint Venture in India, 2014. International Trade Center, Model Contracts for Small Firms: LEGAL GUIDANCE FOR DOING INTERNATIONAL BUSINESS, 2010. Investment Guide, 2004 KPMG, Joint Ventures: A tool for growth during an Economic Downturn, 2009. Lee, Chol and Paul W. Beamish, “The Characteristics and Performance of Korean Joint Ventures in LDCS, Journal of International Business,” Vol. 26, No. 3, 1995, pp. 637-654. Miller. Robert R., Jack D. Glen, Frederick Z. Jaspersen and Yannis Karmokolias., “International Joint Ventures in Developing Countries: Happy Manages?,” Discussion paper 29 , 1996. Salem, David I., “The Joint Venture Law of the Peoples’ Republic of China: Business and Legal Perspectives,” 7 Maryland Journal of International Law 7(1), 1981. Tong, Tony W and Jeffrey J. Reuer., “Competitive consequences of interfirm collaboration: How joint ventures shape industry profitability,” Journal of International Business Studies 41, 2010. UNIDO, Patterns of Internationalization for Developing Countries Enterprises, 2008. ‘WHOLLY FOREIGN OWNED ENTERPRISES’ IN THE PEOPLE’S REPUBLIC OF CHINA, Judge Institute of Management Studies Working Paper 11, University of Cambridge, 2011. World Bank, Doing Business 2015, 2014. Yan, Daniel and Malcolm Warner., ‘SINO-FOREIGN JOINT VENTURES’ VERSUS
Chapter 1 _ Framework of Joint Venture Partnership with Global Companies and Local Partners • 077
2014/15 Knowledge Sharing Program with Sri Lanka: Upgrading Technology to Improve Export Competitiveness in Sri Lanka Chapter 2
Development of the Automobile Components Manufacturing Industry of Sri Lanka through the Creation of Forward Linkages with Global Value Chains
1. Introduction 2. The Automobile Components Manufacturing Industry of Sri Lanka 3. Integrating the ACMI of Sri Lanka into Global Value Chains (GVC); As a Strategy for Developing the Industry 4. Procurement Strategy and Conditions of the Global Automakers 5. Strategies for the Sri Lankan Automobile Component Industry’s Participation in Global Value Chain (GVC): Lessons from Korea ■ Chapter 02
Development of the Automobile Components Manufacturing Industry of Sri Lanka through the Creation of Forward Linkages with Global Value Chains
In Soo Kang (Center for International Economic Studies, Sookmyung Women’s University) Hee Sik Jeong (Korea Automotive Research Institute) Sejun Mo (Korea Automotive Research Institute) Inoka de Alwis (Ministry of Industry and Commerce, Sri Lanka)
Summary
At present, the automobile components manufacturing industry (ACMI) of Sri Lanka is mainly engaged in supplying ‘generic’ components to the spare parts/ after markets, both domestic and international. It is important to graduate the country from a producer of ‘generic/modular’ components to a ‘specific’ component manufacturer, supplying to branded automobile manufacturers/OEMs. In order to achieve the above, Sri Lankan auto parts manufacturers should contrive to integrate and to move up in Global Value Chains(GVC) through value addition, product diversification, and innovation. Policy recommendations as to how the auto parts industry of Sri Lanka should be developed to meet the standards required by world renowned automobile manufacturers are needed. For this purpose component procurement strategies and conditions of the global automakers are very carefully reviewed. We compare those of the big 3 global automakers.
VW discovers new competitive component suppliers through the Regional Sourcing Offices (RSO). RSO enrolls these new candidate suppliers to the procurement system. Request for Quotation (RFQ) is sent to parts suppliers and a capacity assessment of the relevant suppliers is conducted. Local component suppliers also directly enroll themselves to VW’s procurement system and get a chance for evaluation. The enrolled component suppliers have to pass the multi-dimensional evaluation in order to participate in the bidding. Global sourcing of VW has 6 stages. The 1st stage is ‘Request for Quotation’ (RFQ). The 2nd stage is ‘Registration of
080 • 2014/15 Knowledge Sharing Program with Sri Lanka Quotation’. The 3rd stage is ‘Engineering Review’. The 4th stage is a comprehensive evaluation stage. The 5th stage is ‘price negotiation.’ The last stage is ‘final selection’.
Asian automakers (such as Toyota) are promoting the procurement of parts and components based on vertical integration and long-term partnerships with auto parts producers. They are procuring key components through affiliated parts suppliers, and long-term partners procure the remaining components. Therefore, discovering new parts suppliers is relatively passive in comparison with European automakers. In discovering new suppliers, the purchasing organization of local plants directly makes evaluations and recommendations. In fact, Asian automakers are accompanied with their affiliates when they advance into a new market, which makes it hard for a local supplier to become a primary supplier. However, Japanese automakers are recently promoting a procurement policy without making any distinction between affiliates and non-affiliates in order to expand the publication of parts and components. The non-affiliates can make new deals with automakers if they meet the criteria of cost reduction and new technology.
GM has been very active in finding new component suppliers since 2004. GM developed India as a basecamp for small cars to compete with Toyota in the Asia market. GM finds new component suppliers through① procurement announcement meetings, ② a network of local strongholds, such as Opel (Europe), Holden (Australia), Korea GM or ③ direct self-enrollment of new component suppliers in GM’s system (GM Supply Power). GM evaluates the enrolled suppliers by quality, service, technology, and price. At the first stage of the procurement process GM holds Sourcing Committee (SC) in which staffs from finance, R&D, and quality divisions participate. SC prepares a Request for Quotation (RFQ) and a Statement of Requirement (SOR). The SOR is a document which specifies the responsibilities of suppliers and requirements of GM in R&D, design, and testing. The next stage is the Technical Review for the selected suppliers. The R&D division and purchase division lead the technical review. The key evaluation items are the technology capacity of the development team and the level of the environment management system of the supplier. The most important thing that the suppliers should prepare is the SOR. New suppliers should check the SOR very carefully because it contains technology related arguments and regulations as well as contracts. The technical review is based on the SOR and the final selection is determined by the result of the technical review and bidding price.
In addition to this it is necessary to evaluate the automobile component manufacturing industry of Sri Lanka and review the current policies on integrating the Sri Lankan ACMI into GVC. Based on these analyses we provide policy recommendations by applying the experiences of Korea.
Chapter 2 _ Development of the Automobile Components Manufacturing Industry of Sri Lanka through the Creation of Forward Linkages with Global Value Chains • 081 Since there is hardly any car manufacturer in Sri Lanka, it needs a strategy different from that of Korea to foster its auto parts industry. The central and local governments will be responsible for the roles that were once played by the Korean car manufacturers. In the short term, the government needs to focus on improving the product quality of Sri Lankan parts makers, while assisting them to secure access to foreign markets. The first step is to build up the ACMI database through the investigation of the current ACMI status, such as, technology levels, types of products, companies, etc. It is necessary to build up an information sharing system among the government and private sector. Especially, it is necessary to make an auto parts producers’ association in order to share information among companies and to strengthen communications between the government and the private sector. In the mid- to long-run, the government needs to continue improving the technology of parts makers by establishing a government-affiliated organization, such as the ‘Automotive Technology Institute’. It is also necessary to maintain consistency among policies, especially in the tariff structure. For this purpose it is necessary to evaluate the current tariff structure and its effectiveness. Also, Sri Lanka should be prepared for motorization and examine relevant ways to foster the automobile industry in order to bring about its sustainable growth. Major policy recommendations are as follows.
□ Improving the Quality of Auto Parts
The Sri Lankan government needs to develop their strategy to first select potential parts makers and to improve their product quality. To this end, parts makers should secure skilled laborers. Sri Lanka should conduct in-house training to improve the skills of its workforce. In addition, it needs to adopt a system to check any defects on components in the design and production process. In the meantime, the government should acquire high-quality inspection equipment, such as non-destructive testing equipment, for common use. The government should encourage parts makers to set up the target for error rate and to develop specific plans to achieve it. Particularly, it is important to introduce a training program at the national level. The government should identify best practices of quality improvement and provide corresponding firms with preferential treatment. Due to the limited resources of the government, auto parts makers should form an association in order to effectively promote the movement for quality improvement. Meanwhile, the government should examine plans of the association and evaluate their feasibility while helping them overcome possible obstacles.
□ Fund/Tax support
The Sri Lankan government should provide both direct and indirect funds to parts makers so that they can expand and build a basis for exportation. It is necessary to
082 • 2014/15 Knowledge Sharing Program with Sri Lanka build an industrial complex for auto parts near export ports through cooperation with the local government. In particular, parts makers should be provided with a factory site at free or low rent. At the same time, parts makers that moved into the industrial complex should be provided with a tax reduction for a certain period. Policy funds should be provided for investment in plant/equipment and R&D. The government should encourage joint ventures and technical cooperation, while at the same time exempting taxes on importing raw materials.
□ Enhancing Marketing Capabilities of Parts Exporters
The Sri Lankan government should set up specific goals for parts exports and foster specialized parts exporters. First, the government needs to select potential exporters and provide concentrated support. Second, in order to increase exports, a ‘one-stop service for export’ should be established. Third, its marketing capabilities should be strengthened.
□ Establishment of Automotive Technology Institute
The Sri Lankan government needs to establish a government-affiliated automotive technology institute to take technology to new heights. At present, the Sri Lankan parts makers are using excessive labor and monetary resources to attain technology demanded by the global market. Particularly, the automotive technology institute needs to realize the priority for technology development based on global demands. Then, it can provide education for workers on technology, and at the same time, it should acquire high-quality testing equipment for parts makers to use upon developing newer technology. It is also necessary to induce the private sector to participate in the establishment of a technology center jointly with the public sector.
□ Promotion of Cooperation Between Industry and Education
One of the biggest challenges in fostering parts makers is the lack of high-skilled labor. Therefore, the central and local government of Sri Lanka should open an automobile technology department in local universities to sustainably provide high- skilled labor.
□ Promotion of Joint Venture with Global Parts Producers
As the price and quality competition are intensifying and modularization is accelerating among car manufacturers, the role of global parts producers is becoming more and more important. Hyundai Motors determine corresponding part makers based on public competitive tendering through an established system called the VAATZ (Value Advanced Automotive Trade Zone). Through VAATZ, Hyundai
Chapter 2 _ Development of the Automobile Components Manufacturing Industry of Sri Lanka through the Creation of Forward Linkages with Global Value Chains • 083 Motors have a standardized global procurement process for auto parts and share relevant information through a network it has built.
1. Introduction
The automobile industry, including component manufacturing, has been identified by the government of Sri Lanka as a potential industry for development. Even though the current automobile demand of Sri Lanka is only about 50,000 per year, it will increase as the economy grows. At present, the automobile components manufacturing industry (ACMI) of the country is mainly engaged in supplying ‘generic’ components to the spare parts/after markets, both domestic and international.
Currently, Sri Lanka produces tires (for motor cars, buses, lorries, motor cycles, agricultural & forestry vehicles, three wheelers etc.), different types of hoses, cables, mounts, bushes, hooks, and batteries, hybrid precision parts such as plastic housing for circuits, carpets, door upholstery, parts of silencer, buffers, wheel house, different types of brackets, mud flap, radiator, leaf springs, seats, roof rail, body panels, oil filters, air filters, wiper blades, brake shoes, brake pads, spark plugs, bulbs, bearings, fan belts, etc. Sri Lanka exports several types of automobile parts, especially rubber components such as tires as well as electrical components. Further, in efforts to make Sri Lanka a knowledge economy, the objective of the government is to create knowledge & technology based industrial sectors.
In view of the above, it is important to graduate the country from a producer of ‘generic/modular’ components to a ‘specific’ component manufacturer, supplying to branded automobile manufacturers/OEMs. In order to achieve the above, Sri Lankan auto parts manufacturers should contrive to integrate and to move up in Global Value Chains (GVC) through value addition, product diversification and innovation. It is with this objective that a proposal was made to the Republic of Korea under its Knowledge Sharing Program (KSP) to make policy recommendations as to how the auto parts industry of Sri Lanka should be developed to meet the standards required by world renowned automobile manufacturers.
For this purpose the component procurement strategies and conditions of the global automakers need to be precisely reviewed. Chapter 2 explains the vision and the key objectives for the development of the ACMI in Sri Lanka and investigates the current status and the competitiveness of Sri Lankan auto parts industry through a SWOT analysis. Based on this analysis, several auto parts are selected as promising candidates. Chapter 3 examines Sri Lanka’s policies to promote the integration of the ACMI into GVC and policies to upgrade domestic industries from resource based industries towards technology/knowledge based industries. Chapter 4 explores
084 • 2014/15 Knowledge Sharing Program with Sri Lanka how to integrate the ACMI of Sri Lanka into global value chains. We compare the component procurement strategies and conditions of the big 3 global automakers, Volkswagen (VW), General Motors (GM), and Toyota. Quality, technology, delivery, and cost are key conditions of global automakers. Chapter 5 provides policy recommendations by applying the experiences of Korea.
2. The Automobile Components Manufacturing Industry of Sri Lanka
Today, the automobile components manufacturing industry has become a lucrative industry. The industry is chiefly divided into two; the first, are the producers of components for manufacturers/assemblers of vehicles, which are Own Equipment/ Brands Manufacturers (OEMs/OBMs) (Owned Brands Manufacturer) and the second, are the manufacturers of components for after (sales) markets.
Originally, or traditionally, the entire process of manufacturing a vehicle was done by a single entity (for example, General Motors). In other words, the design and the manufacture of each and every component required for a vehicle, as well as the final assembly, were carried out in house, by the same company. After long use of a vehicle, certain components needed replacement due to decay & damage, and as a result, a secondary market for the automobile components emerged, which is better known as the after (sales) market.
At the same time, the method of producing the entire vehicle under one roof, proved to be a costly one, due to its slow, inefficient and less productive process and as such, the practice of fragmentation and outsourcing of the production process emerged, under which the different components of a vehicle are manufactured and supplied by separate organizations according to the requirements of the final manufacturer. With the development of international trade, the outsourcing of fragmented production processes has spread across the globe, especially, with the view to benefit from low cost of production in certain countries achieved mainly through low cost labor. Accordingly, many multinational OEMs/OBMs have established links with components manufacturing industries all over the world, which produce and supply different parts of the vehicle, made according to the specifications of the OEM.
Today, the ACMI consists of different tiers or stages in the process of sophistication, which are linked vertically. The lower tiers/levels of production comprise of those producing raw materials or intermediate/semi processed components to the tier above. The final component manufacturers would be at the next few levels while those supplying basic raw materials such as metals, rubber, types of oil and lubricants
Chapter 2 _ Development of the Automobile Components Manufacturing Industry of Sri Lanka through the Creation of Forward Linkages with Global Value Chains • 085 etc. are at the lowest tier.
Thus, the current trend and the nature of the ACMI, provides opportunities to expand a country’s production process as well as the trade of raw materials, intermediate inputs and components, through linking with the different tiers in a supply chain (both local and global) or with the OEM itself, which would require the modification or improvement of the components, to suit the requirements of the buyers.
2.1. Government’s Vision and the Key Objectives for the Development of the ACMI in Sri Lanka
2.1.1. The Change of Government Policies over the Years and their Effects on the ACMI of Sri Lanka – A Brief Overview
Sri Lanka gained independence from 150 years of British rule in 1948 but continued to depend on the plantation economy established by the British government, i.e., the export of plantation crops such as, tea, coconut, and rubber, while the majority of the country’s needs were supplied through imports. However, during these times, massive steps were taken to re-develop the agricultural sector to ensure food security in the country.
Thereafter, during the late 1950s, 1960s, and 1970s, an era of industrialization emerged, where several government owned manufacturing industries such as National Paper Corporation, Ceylon Ceramics Corporation, Ceylon Plywood Corporation, Marketing Department Fruit Cannery, Sri Lanka Sugar Corporation, State Fertilizer Manufacturing Corporation, National Textile Corporation, State Rubber Manufacturing and Exporting Corporation, Ceylon Fisheries Corporation etc. were established, or private industries were vested in the government.
Some of these were related to the ACMI such as the Sri Lanka Tire Corporation. Similarly, United Motors Ltd., a private company, was established in 1947 as the agent to certain international automobile manufacturers such as Mitsubishi, Mahindra. Also, Automobile Assembly and Manufacture Ltd. was incorporated in 1967 to assemble motor vehicles and to distribute imported automobile components for the after sales market. These were also vested in the government in 1972. The above could be considered as the first policy measures taken by the government of Sri Lanka to develop the automobile sector locally.
Out of the three establishments mentioned above, only the Tire Corporation was directly engaged in manufacturing and the main items produced were rubber tires and tubes, air bags and flaps, and allied products. The tires manufactured by the Corporation included pneumatic tires for trucks, agricultural vehicles, jeeps, cars,
086 • 2014/15 Knowledge Sharing Program with Sri Lanka and scooters, as well as solid tires. The Tire Corporation was privatized later and was renamed as Kelani Tires Pvt. Ltd., which merged with CEAT India in 2010, to form the joint venture CEAT – Kelani Tires (Pvt.) Ltd., which is operating successfully to date.
With the liberalization of the Sri Lankan economy in 1977, the import of vehicles increased and with that, the demand for automobile components for after markets was also marked with rapid growth. As a result, more automobile parts manufacturers emerged in the private sector who at first, supplied the requirements of the domestic market and thereafter, captured overseas markets by adding value and through quality improvement.
The National Development Policy Framework of the government continues with the open market policy. It states “The current industrial policy advocates an approach where domestic enterprises can be supported while encouraging foreign investments. It integrates the positive attributes of liberal market economy with domestic aspirations. The industrial policy envisages more effective industrial harmony, higher value added and productivity driven industrialization. It stands on ‘knowledge based’ and ‘technology intensive’ development. The proposed paradigm is a shift from the ‘import based’ industries to higher value added industries with backward linkages.”5)
Several policy documents of the government have identified the ACMI as an industry with a potential for development, viz.: Mahinda Chinthana National Development Policy, including the Mahinda Chinthana Industrial Policy, has selected a set of industry sub sectors for development through tariff, tax and financial incentives, support for R&D activities, and the easing of regulatory controls. The selection of these thrust areas was based on the resource availability in the country, potential for inward technology transfer, and development.6)
Accordingly, the rubber industry has been identified as a potential sector in the Mahinda Chinthana, which reads as; “It has been proposed that by manufacturing higher value added products, the rubber industry of Sri Lanka should lead the process of industrialization of the country.” One of the strategies that have been proposed to improve the competitiveness of the rubber based industry is to promote Foreign Direct Investment (FDI in the rubber industry and to develop tire manufacturers.7)
Further, one of the strategies of the Board of Investment (BOI) to attract FDI is to ‘Develop and utilize Sri Lanka’s capacity to enter into the growing Indian market on selected sectors (for example, automobile parts)’8)
5) Ten Year Horizon Development Framework 2006 - 2016, p.51. 6) Ibid pp. 55- 56. 7) Ibid p. 56. 8) Ibid p. 61.
Chapter 2 _ Development of the Automobile Components Manufacturing Industry of Sri Lanka through the Creation of Forward Linkages with Global Value Chains • 087 2.1.1.1. Mahinda Chinthana Vision for the Future (MCVF) – National Development Policy Framework for 2010 - 2016
MCVF sets out the policies for the development of the country for the period of 2010–2016 and the document carries forward the Mahinda Chinthana Development Policy of 2005.
Amongst a few other industries such as the rubber based industries, apparel, value added tea, IT/BPO, electrical and electronics, gem and jewellery, pharmaceuticals, and minerals, the MCVF has identified the automobile assembly industry as a sector which has the potential for development. The document states that the, “Automobile assembling industry is relatively a new industry developed in the country. The manufacturers will be encouraged to use locally produced spares and accessories. Setting up of automobile assembly plants will be promoted, especially in the investment promotion areas.”9)
2.1.1.2. Unstoppable Sri Lanka; The Public Investment Strategy for 2014–2016
This document contains the investment strategy of the government for 2014 – 2016 with the view to develop the sectors identified in the policy documents, MC and MCVF. Accordingly, the automobile sector has been identified as a sector with a potential for investment in this document as well.10) Further, the automobile accessories manufacturing industry has been specifically identified as an industry for development, which also has an investment potential.
2.1.2. The Objectives of the Government to Develop the ACMI in Sri Lanka
The objectives of promoting the ACMI by the government are to achieve the following:
• The government has identified the automobile sector as an industry for development. In other words, to develop the country’s own automobile industry, the government has emphasized the importance of export market. Hence, the government expects world renowned automobile companies to set up plants in Sri Lanka, with the view to exploit the overseas markets, especially the countries with which Sri Lanka has entered into Free/Preferential Trade Agreements that offer duty free/preferential access to their markets.
9) Mahinda Chinthana Vision for the Future p. 74. 10) Unstoppable Sri Lanka p. 272.
088 • 2014/15 Knowledge Sharing Program with Sri Lanka • To export automobile components of high quality to the automobile manufacturing/assembly industries overseas, especially India and Pakistan, since the two countries are engaged in the assembly of some of the world renowned automobile brands. As such, at present, Sri Lanka exports components to both countries, even though the majority of which are supplied to after markets. It must be noted that India and Pakistan offer duty free access to many automobile components, through the Free Trade Agreements with Sri Lanka.
2.2. The Current Status of the ACMI of Sri Lanka
The majority of Sri Lanka’s ACMI fall under the small and medium industry category in the Sri Lankan context. Most of these manufacturers produce for after markets, both local and abroad, while a few supply to OEMs.
2.2.1. Production of Automobile Components in Sri Lanka
According to the latest version of the Annual Survey of Industries published by the Department of Census and Statistics, the production of the ACMI of Sri Lanka is indicated in Table 2-1. However, it must be noted that the data for the industries with less than 25 persons engaged have not been reported.
Value of ACMI OutputValue of output in ISIC code Industry sub sector No. of firms Employment Rs. (LKR) in 2011 2511 Rubber tires and tubes 25 11,858 44,190,853,601 Manufacture of bodies for 3420 motor vehicles, trailers and 6 411 303,175,508 semi-trailers Manufacture of spare parts and 3430 n.a. n.a. 964,167,807 accessories for motor vehicles
Note: Only the establishments with 25 or more persons engaged in Sri Lanka (2011) are reported. Source: Annual Survey of Industries - 2012 (Tables 1 & 9).
The types of automobile components which are currently manufactured in Sri Lanka could be categorized as follows:
• Rubber Components - Tires • Pneumatic: tires for passenger vehicles such as cars, motor cycles, vans etc. • Solid tires: tractor & lorry tires - Bushes
Chapter 2 _ Development of the Automobile Components Manufacturing Industry of Sri Lanka through the Creation of Forward Linkages with Global Value Chains • 089 - Hoses - Mounts - Cables - Mud flaps - Carpets - Fan belts • Metal and Related Components - Mufflers, leaf springs, mounts, bushes, brackets, wiper blades, brake liners, brake shoes and brake pads, pedals, and other casted components - Body panels - Oil, fuel and air filters - Spark plugs - Bearings • Seats and Upholstery • Electrical and Electronic - Radio, Air conditioning, cables, wires/harness, switches, sensors, PCBs, electrical connectors, and distributors • Mirrors/glass items such as wind screens and bulbs • Plastic - Housings and casings, especially for electrical/electronic components such as circuits/PCBs and sensors, and seals • Fibre Glass - Buffers • Radiators • Batteries
In view of the above, it is evident that Sri Lanka’s ACMI is dominated by rubber components, followed by metal parts. It must be noted that due to their nature, automobile components fall under different product categories as aforementioned: rubber based, metal, electrical, leather based, fibre glass based, mechanical etc., and as such, the production and trade data of the industry are not reported under a single/few categorie(s) as other industries such as apparel, textile, chemical, processed food etc.
Further, the reporting of the production data in the ISIC classification and trade data in the HS classification has made them incompatible/incomparable and as such, prevented the reporting of data in a single group/category.
below indicates the annual value addition of the industrial sector during the period of 2009 to 2013. The automobile components are categorized under rubber and plastic based and the basic metal products, which are represented by the items 5, 7 and 8 in , respectively. It is to be noted that these sectors have recorded a continuous growth during the period under review.090 • 2014/15 Knowledge Sharing Program with Sri Lanka
Industrial Production of Sri Lanka(Unit: million Rs., 2002 constant prices) Category 2009 2010 2011 2012 2013 Food, beverages and tobacco 1 185,142 197,731 211,848 222,722 239,519 products Textile, wearing apparel and 2 87,762 92,293 102,263 107,242 116,828 leather products 3 Wood and wood products 1,125 1,193 1,246 1,286 1,349 Paper products, publishing and 4 1,635 1,742 1,835 2,051 2,308 printing Chemical, petroleum, coal, 5 59,706 66,990 73,203 77,455 83,306 rubber, and plastic products 6 Non-metallic mineral products 14,794 16,328 17,670 18,826 19,873 7 Basic metal products 965 1,028 1,090 1,105 1,140 Fabricated metal products, 8 machinery and transport 32,794 35,482 37,733 39,663 43,135 equipment Other manufactured products 9 2,004 2,138 2,290 2,371 2,474 (not elsewhere specified) Total 385,927 414,925 449,177 472,721 509,932
Source: Annual Report of the Central Bank of Sri Lanka – 2013.11)
According to the data published by the Sri Lanka Export Development Board (EDB), the export income of the two subsectors that mainly contain automobile components are as follows: 11)
• Transport equipment & parts – USD 50.13mln. • Pneumatic and retreaded rubber tires & tubes – USD 554.6mln.
It must be noted that pneumatic and retreaded/solid tires have contributed to 5% of Sri Lanka’s total exports in 2013.
2.2.2. Human Resources Available at the Graduate and Technical Levels in the Automotive Sector
Some universities and the majority of the vocational training institutions conduct degree or diploma level courses on automobile engineering. In addition, there are skilled and semi-skilled workers attached to industries who have acquired a
11) Table 22, Statistical Appendix
Chapter 2 _ Development of the Automobile Components Manufacturing Industry of Sri Lanka through the Creation of Forward Linkages with Global Value Chains • 091 considerable level of knowledge through their experiences.
indicates the number of graduates in automobile engineering degree programmes or the same as a major subject area. The Number of Graduates in Automobile Engineering Who Graduate Annually from State Universities The number of automobile engineering graduates / University engineering graduates with automotive engineering as a major subject areaUniversity of Moratuwa 100 University of Ruhuna 40 University of Peradeniya 40 Open University of Sri Lanka 30 Total 210
Source: The respective Universities.
It must be noted that around 1500 engineering graduates graduate annually from the above universities as well as from the University of Jaffna and the South Eastern University of Sri Lanka, specializing in different fields including automotive, as well as civil, mechanical, electronic, electrical, software etc.12)
Similarly, the nine main public vocational training institutes have the capacity to train around 4,500 trainees annually, in automotive and motor mechanism, who are all well recognized as skilled automobile technicians. The breakdown of each institution is given in
below. The Existing Capacity of Public Vocational Training Institutions (Selected full time courses)Skill VTA TCs NAITA NYSC COTs NIBM CGTTI NIFNE UNIVOTEC Total Category Centres Automobile & Motor 2,220 455 792 395 455 - 130 - - 4,447 Mechanics
Note: VTA – Vocational Training Authority COT – College of Technology TC – Technical College NIBM – National Institute of Business Management NAITA – National Apprentice & Industrial CGTTI – Ceylon German Technical Training Training Authority Institute NYSC – National Youth Service Council UNIVOTEC – University of Vocational Technology NIFNE – National Institute of Fisheries & Nautical Engineering Source: Mahinda Chinthana Vision for the Future, p. 135.
12) University Grants Commission, p. 28.
092 • 2014/15 Knowledge Sharing Program with Sri Lanka At the same time, the automobile industry‘s annual demand for skilled technicians have increased over recent years, indicating an expansion of the automotive sector. The annual demand for training/skills development in automobile technology and related areas is indicated in
below. Demand Side - The Estimated Annual Training NeedsDemand side 2011 2012 2013 (2011–13 ) Automobile and motor mechanic technicians 10,200 10,430 10,666 31,296 Metal and light engineering – managerial 3,580 3,660 3,743 10,983 and technical grades Metal and light engineering – craft related 13,166 13,587 14,025 40,778 grades Rubber and plastic industry – related skills 576 584 592 1,752
Source: Mahinda Chinthana Vision for the Future, p. 133.
2.3. A SWOT Analysis of the ACMI of Sri Lanka
The Sri Lankan government is currently promoting industry development policies around the auto parts industry, in which forward and backward linkage effects are huge. The auto parts industry in Sri Lanka is less developed in comparison to that of neighboring countries, such as India and Thailand. However, it can develop significantly by utilizing government support, a low-cost workforce, and advanced rubber processing technology. Based on these, it can exploit the adjacent markets where high growth is expected. In this chapter, SWOT analysis is used to indicate areas that need to be fostered urgently, which will contribute to the overall development of the auto parts industry in Sri Lanka.
2.3.1. Competitiveness of the Sri Lankan Auto Parts Industry
2.3.1.1. Strength
Sri Lanka’s is manufacturing sector relatively lagging behind its competitors, but it has secured international competitiveness in rubber products. In 2013, the manufacturing sector accounted for as low as 17.1% of the total industry. However, the textiles and rubber products sectors are highly competitive because of low-cost labor and natural resources. In particular, Sri Lanka is rich in natural rubber, and the rubber-related processing industry is relatively well developed. Auto parts companies require numerous rubber-based products, including tires, gaskets, shock-absorbing bushings, and hoses that deliver a variety of oil and hydraulic pressure. In order to
Chapter 2 _ Development of the Automobile Components Manufacturing Industry of Sri Lanka through the Creation of Forward Linkages with Global Value Chains • 093 produce these types of products, formulation technology, coating technology, design technique, and molding technique are required.
In addition, Sri Lanka’s wages are low compared to neighboring countries but the level of labor skills is relatively high. According to the JETRO, the average wage of factory workers in Sri Lanka is $118, which is the lowest except for that of Bangladesh. In comparison to neighboring competitors such as Chennai, India ($324), Bangkok, Thailand ($345) and Beijing, China ($466), Sri Lanka’s average wage is less than half. Though labor costs are low, Sri Lanka shows a high level of education with the illiteracy rate of less than 10%. Also, the British colonial era contributed to the rise of fluid communication in English. The labor productivity is lower than those of China and Vietnam; however, in comparison to South Asian countries that show a similar level of wages, Sri Lanka’s productivity is assessed to be high. For instance, the second largest global airbag producer, Takata, has recently established its operation center in Sri Lanka in order to exploit the high-skilled and low-cost labor force.
[Figure 2-1] Comparison of Monthly Wages of Asian Cities (Unit: $)
5,000 4,615
4,500
4,000 3,306
3,500 3,009 2,725 3,000
2,500 1,734 2,000 1,619 1,230 1,500 1,143
1,000 466 449 404 398 395 118 345 344 329 326 324 315 308 301 281 276 239 218 188 177 500 173 148 145 132 74 0
Naha Seoul Cebu Sydney Taipei Beijing Dalian Manila Jakarta Batam Hanoi Dhaka Bangkok Chennai Wuhan Qingdao Mumbai Karachi Auckland Singapore Shanghai Bangalore Shenzhen Shenyang New Delhi VientianeColombo Yokohama Hong Kong Ulan Bator Guangzhou Kuala Lumpur Ho Chi Minh
Source: JETRO (2013).
Compared to its neighbors, Sri Lanka shows a national character of diligence, and thus labor is easily managed. This is partly because of a deeply rooted Buddhist culture, which has led to 70% of the population being Buddhist. On the other hand, global carmakers encounter challenges of frequent strikes in India. For instance, GM suffered a setback when a labor strike occurred there last January. Moreover, in 2012, riots occurred at the local Suzuki factory from which one person was killed and 100 more were injured. The factory was forced to close for a month, resulting in a total loss of $250 million.
094 • 2014/15 Knowledge Sharing Program with Sri Lanka 2.3.1.2. Weakness
Sri Lanka lacks infrastructures, such as steel, petrochemical and metal processing etc., which are necessary for the development of an auto parts industry. The overall industry output value has shown an average annual growth of 15.2% since the civil war ended. However, the share of food and tobacco accounted for 50%. On the other hand, steel, petrochemical and metal processing sectors make up less than 30% of the total industrial output value. Petrochemical, coal, rubber, and plastic appear to occupy a large share, but most of them are rubber products. Thus, the technical level of producing petrochemicals is assessed to be low.
The heavy and chemical industry of Sri Lanka is also weak, and opportunities for existing auto parts firms to enter the global markets are limited to areas associated with rubber-based products. For example, in order to produce high value-added components such as bearings, high-quality steel materials and precision processing technology are required. However, there is no industrial base or firms to produce and supply these materials or technology.
Furthermore, Sri Lanka’s low level of petrochemical technology will act as a barrier in achieving competitiveness as a parts supplier. Although Sri Lanka is an exporter of natural rubber, they are importing synthetic rubbers for use as a raw material in hose and bush due to a lack of chemical technology. Sri Lanka lacks not only the technical infrastructure for the procurement of raw materials, but also shows a low level of technology needed for developing higher value-added products. In order to improve the performance of rubber parts, research manpower, and necessary facilities need to be in place. However, only a small number of large companies, such as CEAT Kelani Holdings and Elastomeric Engineering, are equipped with their own research facilities. Many other suppliers are small-scale enterprises that cannot pursue large-scale investment in research and development. Today, most Sri Lankan parts producers are not able to make notable advancements because they develop technology in conjunction with local universities and research institutes.
Another weakness of the Sri Lankan auto parts industry is the lack of experience in delivering products to global automotive manufacturers. Due to a small domestic market, the Sri Lankan parts producers should exploit foreign markets in order to develop their industry. However, global carmakers are strengthening quality management in the procurement process because of recent massive recalls caused by GM’s defective ignition switch and Takata’s airbag defects. Accordingly, inexperienced parts suppliers of Sri Lanka will find it more difficult to target the foreign markets in the future.
Lastly, funding for large-scale investment is difficult because of Sri Lanka’s
Chapter 2 _ Development of the Automobile Components Manufacturing Industry of Sri Lanka through the Creation of Forward Linkages with Global Value Chains • 095 chronic budget deficits and a low national credit rating. Since 2010, the Sri Lankan government has implemented a fiscal policy that aims to recover post-war infrastructure and strengthen national refugee welfare. The chronic budget deficit increases macroeconomic uncertainty, which in turn leads to an interest rate increase. In addition, the international credit rating agencies categorize Sri Lanka as junk status, which further increases funding costs in the global market. Thus, chronic budget deficit and high interest rates inhibit active investments that are necessary for strengthening the constitution of the Sri Lankan producers.
2.3.1.3. Opportunity
Sri Lanka is geographically adjacent to countries that show steep growth, such as India, Thailand, and Indonesia. The auto parts producers can utilize these countries as export and production bases. The automobile industry of these neighboring countries is expected to grow rapidly with an annual growth rate of over 3.5% during the period of 2014-2020. In particular, the automobile market of India, which is the nearest in terms of location, is expected to become the third largest market in the world with an annual average growth rate of 9.9%, and the number of vehicles is expected to increase from 3 million in 2014 to 5.2 million in 2020.
[Figure 2-2] Projection of Automobiles in Neighboring Countries
CAGR (’14~’20)
India Indonesia Thailand (Million Units) 5.2 9.9% 4.5 3.7 3
5.2% 1.7 1.4 1.5 1.2 8.3%
1.2 1.4 1.4 0.9
2014 2016 2018 2020
Source: HIS Automotive.
Growth of the Indian market is expected to provide new revenue opportunities for parts producers in Sri Lanka. With the FTA signed by the two parties, they can enjoy duty-free benefits when they export their products to India. In addition, Sri Lankan parts producers will have more opportunities to supply Indian automakers because the car manufacturers in India, such as Tata and Mahindra, are increasingly
096 • 2014/15 Knowledge Sharing Program with Sri Lanka operating their assembly plants in close-by emerging markets. Dealing with the Indian manufacturers can improve the reliability and quality of Sri Lankan parts suppliers, which can facilitate their market access in other foreign countries. Moreover, demand for replacement parts is especially high because the Sri Lankan automotive market is formed around used cars, which are mostly imported from Japan. Though the local CDK companies are launching the assembly production models, their market share is less than 1% with weak durability. Accordingly, Sri Lanka has a well-developed aftermarket. Due to the high price sensitivity of replacement parts, cheaper parts produced by local companies have a competitive advantage over imported goods that are more expensive. The Sri Lankan parts producers will sell their products in the aftermarket because of the initial difficulties in delivering products to auto manufacturers. This will in turn generate cash flows necessary for product development and business maintenance.
2.3.1.4. Threat
Sri Lanka’s infrastructure facilities are falling behind due to the long-term civil war. The railroad is worn out because it has not been properly maintained since its construction during the British colonial era. Since it cannot exceed a maximum speed of 30~40km, it is not suitable for freight. In fact, the railway is responsible for only 0.7% of the total freight. Also, roads are too narrow and congested, which increases the time and money loss in the carriage of goods. Except for Colombo, other areas do not have ports and aviation facilities, but recently, port facilities and a second international airport are being constructed in Hambantota.
The biggest problem is the power supply. Since the civil war, power demand during the period of 2009-2013 has increased at an average annual growth rate of 5.9% because of industrial development and tourism invigoration; however, the annual growth rate of power supply is only about 4.7%. In 2013, electricity demand in Sri Lanka was 10,389 GWh, but the production was recorded at 11,801 GWh. In other words, Sri Lanka had only 12% of reserve power. The current status of power generation is even worse. In comparison to other countries, Sri Lanka’s share of hydroelectric power is as high as 49% based on the generation capacity. One problem related to the generation of hydroelectric power is unreliable power generation and supply due to unstable rainfall. In fact, KITA noted that one of the business obstacles in Sri Lanka is unsafe voltage and frequent power outage.
Chapter 2 _ Development of the Automobile Components Manufacturing Industry of Sri Lanka through the Creation of Forward Linkages with Global Value Chains • 097 [Figure 2-3] Trend of Electricity Production and Consumption in Sri Lanka
14 11.8 10.7 9.8 9.9 9.9 10.4 9.3 9 8.3 8.4 8.4
4
-1 2009 2010 2011 2012 2013
consumption production
Source: CIA World Factbook, Korea Trade Association.
In addition, Sri Lanka’s rigid labor laws have dropped their investment attractiveness despite the government’s aggressive investment policy. Foreign investment activation and protection of investing enterprises are specified in the Constitution (157), which is a clear indication of the government’s active promotion of foreign investment. To this end, an allowance of 100% independent foreign investment, import duty exemption for equipment and raw materials, tax exemption for a certain period of time, and free remittance of corporate profits are provided as incentives. However, inflexible labor laws, such as the Termination of Employment of Workers Act of 1971 (TEWA), are decreasing investment attractiveness despite diverse incentives and low-cost labor resources. According to TEWA, no employer can involuntarily dismiss workers employed for more than six months. In order for dismissal, employers have to pay the extremely high compensation stipulated in the TEWA. In addition, employers cannot effectively manage their personnel because administrative procedures for dismissal are opaque and arbitrary.
Another risk factor in fostering Sri Lanka’s auto parts industry is the expansion of the global parts suppliers’ production in emerging markets. In order for Sri Lanka to overcome the limitations of a small domestic market, advancing into neighboring emerging markets is essential. However, global parts suppliers have recently enhanced cost competitiveness through offshoring production of high quality products. For example, Korea’s rubber parts manufacturer, the HS R&A, has built four operation bases in China, India, and Vietnam in order to develop emerging markets. Thus, Sri Lanka needs to strengthen its product competitiveness through developing high value-added products.
098 • 2014/15 Knowledge Sharing Program with Sri Lanka 2.3.2. SWOT Analysis and Promising Auto Parts
The above analyses are summarized in Table 2-6. The strategic location of Sri Lanka in the Indian Ocean along the major sea routes linking the East and the West is strength. However, the lack of awareness/knowledge amongst the automobile components manufacturers/automobile assemblers, the government officials, and other stakeholders on the components manufactured in Sri Lanka and the capacities of the industries, is highly disadvantageous for the ACMI, when policies are formulated regarding the industry. Due to these reasons the communication between industries is not up to the expected level, which has adversely affected the development of supply chains within the country, between different levels/ tiers.
SWOT Analysis of Sri Lanka’s Auto Part IndustryStrength Weakness
• Good processing technology • Weak upstream industry of rubber products (Steel, Petro-chemistry) • Low labor costs • High import dependency of • High labor productivity synthetic rubber • English-speaking workforce • Lack of experience in • Strategic location developing/supplying value-added products
Opportunity Threat
• Fast growth of neighboring • Undeveloped infrastructure automotive market • Instability of power supply system • Expanding Indian automakers’ • Difficulty in flexible workforce investments in EM(Emerging Market) • Expanding global suppliers’ • Big A/S market investments in EM
It is very important to find promising auto parts in order to develop the ACMI. Even though there are several companies which export certain items to aftermarkets/ OEMs overseas, most of the auto parts exports are rubber based products. Both demand condition and supply condition should be considered to select promising items. However, Sri Lanka needs to give more weight to the supply side including natural resources and technologies.
Sri Lanka should develop its auto parts industry by focusing on enhancing
Chapter 2 _ Development of the Automobile Components Manufacturing Industry of Sri Lanka through the Creation of Forward Linkages with Global Value Chains • 099 the competitiveness of its rubber products. Rubber processing technology is one of the few sectors in which Sri Lanka has secured international competitiveness. Accordingly, Sri Lanka is expected to gain product competitiveness in both domestic and emerging markets when auto parts suppliers develop low-cost components for the aftermarket through utilizing cheap labor and rubber processing technology. These products include hoses, gaskets, bush and mat, as well as strip.
[Figure 2-4] Candidates of Auto Parts in Sri Lanka
Parts Suppliers
» Flexible hollow • Jafferjee Brothers Exports tube to carry fludis • Imperial Rubber Industries • Hoses
» Seal between the engine block • Imperial Rubber Industries and cylinder head • Gasket
» Elastic bearing used as a type of • Bopitaya Auto Enterprises vibration isolator • Bushing
» Piece of fabric • Imperial Rubber Industries or rubber placed on the car floor • Samson International • Mat
Soon after Sri Lankan parts suppliers advance into emerging markets based on cost competitiveness, they need to promote the development of higher value- added rubber products and the diversification of a product portfolio. In order for parts producers to supply the automobile manufacturers, not only is price important, but also the need to fulfill a basic quality level. Especially in recent years, the level of quality demanded by automakers is increasing. Though the Sri Lankan parts producers have the rubber processing technology, they cannot produce products with strong durability due to a lack of formulation technologies. Therefore, they cannot supply sensitive components such as power steering pressure hoses, brake
100 • 2014/15 Knowledge Sharing Program with Sri Lanka vacuum hoses, and other driving-related parts. To counteract this, Sri Lanka needs to strengthen its basic chemical technology, which will in turn lead to the development of higher value-added products. In addition, they need to utilize chemical technology and India’s advanced electrical/electronic technology. This will create a diversified product portfolio through the production of other components such as switches and expand the market base, which will be necessary for industrial growth.
In order to successfully strengthen its chemical technology capacity , which is necessary for higher value-added and portfolio diversification, the active support of the Sri Lankan government is needed. Except for a small number of parts suppliers, many are small-scale enterprises that are not able to make massive investment on research and development. In addition, it is difficult to raise funds in Sri Lanka’s financial market because of high interest costs. Therefore, the Sri Lankan government should consider ways to reduce the financing burden of parts producers.
3. Integrating the ACMI of Sri Lanka into Global Value Chains (GVC); As a Strategy for Developing the Industry
The world is moving away from the traditional practice of the trading of final goods, towards trading of parts and components. Many factors such as location, cost of labor, resource availability, efficiency of production etc., have contributed to this phenomenon. This trend is more significant in industries where the production process could easily be fragmented into different stages. These industries have been able to outsource certain or all activities of the manufacturing process to others in the same market or overseas. Electronics, electrical, machinery, automobile, apparel, are some examples for industries which are largely dispersed when it comes to the sourcing of components. In other words, the majority, if not all, the components of these industries are being manufactured by different industries in different locations, which are finally put together, by the final assembler/manufacturer/OEM.
The fragmentation and outsourcing of production processes have opened up many opportunities for developing countries, which at present, do not have the capacity to manufacture the final product itself, but are in a position to produce parts and components with the available technology, skills and capital. Often, it is through joint ventures or contract manufacturing agreements with OEMs that parts and components manufacturing is carried out by developing countries.
It must be noted that about 60% of global trade, which today amounts to more than USD 20 trillion, consists of trade in intermediate goods and services that are
Chapter 2 _ Development of the Automobile Components Manufacturing Industry of Sri Lanka through the Creation of Forward Linkages with Global Value Chains • 101 incorporated at various stages in the production process of goods and services for final consumption.13) The world network trade has increased from USD 12,803 billion in 1990-91 to USD 59,070 billion in 2010-11, while the share of developing countries in world network exports has grown from 11.9% to 45.1%. Similarly, the share of network products in total manufacturing exports from developing countries has increased from 41.4% to 60.1%.14) It must be noted that moving up/upgrading along GVCs by climbing up the technological ladder is equally or more important when compared to integrating/plugging into GVCs.
3.1. GVCs as a Strategy for Developing the ACMI of Sri Lanka
The best example of Sri Lanka’s success in plugging into GVCs is its apparel industry, which operates through joint ventures and contract manufacturing with international brand owners such as Marks and Spencer, GAP, Victoria’s Secret, Nike etc. Initially, the design, fabrics, apparel accessories and machinery were sourced from abroad, while the domestic contribution was almost limited to the labor component of cutting, stitching, finishing packing etc. However, Sri Lanka was able to gradually move up the apparel value chain by enhancing the domestic value addition through backward integration. Hence, at present, some of the designs, fabrics, and accessories are sourced locally, which has contributed to increase the domestic value addition of the industry to over 50%. It must be noted that all the international quality and other standards required by the brand owner are duly complied with, by the Sri Lankan apparel industries.
In addition, the ACMI and electronics sectors could be identified as industries which have the potential to link with GVCs through appropriate strategies, since Sri Lanka already has some of the necessary resources and well established domestic industry, while these sectors are largely linked to GVCs at the global level as well.
Sri Lanka manufactures several types of automobile components at present. However, most of them are basic components made of rubber and metal, while a few hybrid precision components are also manufactured. As stated earlier, the majority of the components are manufactured for the domestic market, while a considerable amount is exported. However, almost all these parts are supplied to after markets with only a few companies supplying directly to OEMs. An example for a direct supplier of automobile parts to OEMs is Lanka Harness Ltd., which supplies automobile air bag sensors switches, seatbelt switches, wire harness, and sun visors to several leading automobile manufacturers such as Toyota, Nissan, Honda, Mitsubishi, and Mazda of Japan, Ford, GM, and Chrysler of the USA, Volvo, SAAB, BMW, Aston
13) World Investment Report 2013, p. xxi. 14) Athukorala (2014)
102 • 2014/15 Knowledge Sharing Program with Sri Lanka Martin, Opel, and Renault of Europe. Another example is Boehm Leckner Multi Moulds (Pvt.) Ltd., a Sri Lankan owned company which supplies to several European automobile brands such as Audi, Volkswagen, Benz, etc.
In view of the above, it is evident, that, in order to develop the ACMI further to an international level as envisioned by the government policy of Sri Lanka, the quality (durability, strength and outlook), differentiation, value addition, efficiency, and resource utilization etc., of the industry should undergo a rapid transformation process from a generic component manufacturer to a producer of specific and more sophisticated components. In order to achieve the aforesaid goal, massive investments in terms of technology and skills development have to be made by the industry, for which, the assurance of a stable demand/market for their products is an essential pre-requisite.
Therefore, the initial step in graduating the automobile parts industry of Sri Lanka to the international level is to find suitable markets/buyers for the products. However, it must be noted that a demand/market is not created by itself and on the other hand, there is a high risk involved in investing in product development without a ready market/buyer at hand.
The local automobile assembly industry would have been a suitable market for the parts manufacturers, if not for it being almost insignificant in supplying vehicles to the domestic market with a share less than 1% out of the total vehicle population of Sri Lanka, which was 5,065,746 at the end of July, 2013.15) Thus, an investment made to manufacture parts and components, targeting the domestic automobile manufacturing industry at present, would not be viable. However, industries could expand their domestic aftermarket base by investing in import substitution activities.
When focusing on the overseas markets, the meeting of quality and safety standards is essential, whether supplying to OEMs or to aftermarkets. In order to comply with international quality standards, proper guidance is required from the prospective buyers and the best strategy to obtain the same is through joint ventures or contract manufacturing and in other words, by linking with GVCs. Therefore, the conclusion is that, the strategy for developing the automobile components industry of Sri Lanka should be through the creation of forward linkages with international OEMs in the automobile industry or with component manufacturers on higher tiers.
15) Source: Department of Motor Traffic, http://www.motortraffic.gov.lk/web/index.php?option=com_con tent&view=article&id=84&Itemid=115&lang=en
Chapter 2 _ Development of the Automobile Components Manufacturing Industry of Sri Lanka through the Creation of Forward Linkages with Global Value Chains • 103 The above discussion could be summarized as follows:
Objectives:
Integrating the automobile components manufacturing industry (ACMI) of Sri Lanka into global value chains (GVCs) to develop its quality & the brand image and thereby, enhance the export income. 16)
Rationale:
At present, Sri Lanka does not have an automobile manufacturing industry, except a locally value added assembly industry, with an insignificant market share. Therefore, in order to develop the auto parts industry to the level of suppliers to OEMs/OBMs, the industry should be plugged into GVCs.
Strategy:
• To integrate and to move up in GVCs through value addition, product diversification and innovation • And thereby, to graduate the country from a manufacturer of generic/modular components, which produces to domestic and international after markets to a ‘specific’ component manufacturer which produces to branded automobile manufacturers/original equipment manufacturers (OEMs)
The Automobile Assembly / Manufacturing industry of Sri Lanka
The assembly of automobiles in Sri Lanka began as a government venture, by the Automobile Assembly and Manufacture Ltd, a State Owned Enterprise. Thereafter the ‘Upali Fiat 128 Car’ and ‘UMC Mazda’ were two models assembled in the 1970s by Upali Motor Company and in 1999, ‘Micro Privilege Car’ was introduced by Micro Cars Ltd.16) as the first car to be manufactured in Sri Lanka, and not simply assembled. However, even though the aforementioned car brands sold well in the domestic market, the production and the demand was not sufficient for the companies to gain economies of scale. As a result, the production of these vehicles was not continued. However, at present, Micro Cars Ltd. and Unimo Enterprises Ltd. assemble automobiles (including cars, vans & SUVs) with a considerable local value addition. From time to time, a few other companies such as Universal Auto Assembly Pvt. Ltd. (Universal Rino Double Cab), GFS Frontier Ltd. (Land Rover Defender Jeeps), David Peiris Motor Company (Chery QQ Car) etc. have been engaged in the assembly of motor vehicles with local value addition. Apart from the cost of direct labor involved in assembly, these companies add value through the sourcing of locally manufactured components such as tire, battery, radiator, buffers, seats, many types of bushes, mounts, hoses and cables, body panels, silencer etc., which are used in these vehicles.
16) http://symc.microcars.lk/privilage.html
104 • 2014/15 Knowledge Sharing Program with Sri Lanka continued
In addition, SUVs, three wheelers, motor cycles, tractors, buses, lorries, bicycles and three – wheeled goods carriers etc. are assembled without a substantial local value addition except the cost of direct labor. The automobile assembly industry with local value addition came into being with the introduction of the scheme of exemption from excise duty for locally assembled motor vehicles with at least 30% local value addition, which was introduced in 2004. As mentioned above, Micro Cars Ltd. and Unimo Enterprises Ltd. continue to assemble vehicles with local value addition, to benefit through this scheme. Micro Cars Ltd. ventured into this scheme by assembling certain vehicle models of Ssangyong of Korea (now managed by Mahindra and Mahindra Ltd. of India, with an ownership of 70%) such as Kyron, Rexton, Actyon and Korando. However at present, the majority of the vehicles assembled are of the Geely Automobile Holdings Ltd. of China, such as Panda Car, Panda Cross Car, Mx7 (Mark II) Car, MPV Van etc. Unimo Enterprises Ltd. also assembles vehicles sourced from China such as Zotye Extreme SUV, DFSK V 27 Mini Vans and the Jonway Compact SUV.17) At present, Micro Cars Ltd. assembles 15 models of vehicles with local value addition, while Unimo Enterprises Ltd. assembles 3 models. Around 20% of the ex-factory cost of these vehicles, come from the locally manufactured components, while the 30% local value addition is achieved when the direct labor cost etc. are added. In addition, certain parts used in Micro Cars Ltd. are manufactured by the company itself, exclusively for their vehicles, such as buffers, seat covers, parts of silencer/muffler etc. Other than the parts added locally, all the other components are imported/sourced from the original manufacturer. It must be noted that the original design of the vehicle is not changed, except in a few models where the conversion of the dash board takes place to suit the requirements of Sri Lanka. These vehicles are registered in Sri Lanka as locally manufactured vehicles, while the names of the assembling companies and that of the original manufacturer are displayed on most of the models. (Eg. Micro - Ssangyong, Micro - Geely). A few locally assembled vehicles have been exported by Micro Cars Ltd. to Nepal and Bangladesh.
Source: Summary by author.
17) 3.2. Policies Favorable for the Development of the ACMI of Sri Lanka through GVCs
3.2.1. Industrial Policy
The industrial policy of Sri Lanka envisages more effective industrial harmony, higher value added, and productivity driven industrialization. It stands on ‘knowledge based’ and ‘technology intensive’ development, which is a paradigm shift from the ‘import based industries’ to higher value added industries with backward linkages.
17) The models of vehicles assembled by Micro Cars Ltd. and Unimo Enterprises Ltd. could be viewed on the websites of the companies; www.microcars.lk and www.unitedmotors.lk/unimo-enterprises-limited
Chapter 2 _ Development of the Automobile Components Manufacturing Industry of Sri Lanka through the Creation of Forward Linkages with Global Value Chains • 105 In brief, the aspirations of the government for the development of the industrial sector of Sri Lanka could be highlighted by the following;
• Facilitation of domestic industries as well as foreign investments • Supply chain development • Higher value addition and productivity improvement • The creation of a knowledge and technology intensive industrial sector • A shift from the ‘import based’ industries to higher value added industries with backward linkages
Thus, the policies implemented by the government for the manufacturing sector is based on the above.
3.2.2. Trade Policy
Sri Lanka has a liberal trade policy, favorable for trading activities. Accordingly, around 50% of the total tariff lines in the HS 6 digit level, have not been imposed a customs duty, i.e., they could be imported duty free to Sri Lanka. The majority of machinery and equipment in the HS chapters 84 and 85 are duty free, while a major portion of the intermediate inputs and raw materials could be imported either duty free or at the lowest import duty rate of 7.5% applicable in Sri Lanka. 18)
The four-band tariff structure of Sri Lanka is given below:
Tariff Structure of Sri LankaType of Item Customs Duty No. of tariff lines Essential inputs, not manufactured locally 0% 3,376
Raw materials and semi raw materials 7.5% 184 Intermediate goods 15% 1,605 End user products 25% 1,412
Source: Department of Sri Lanka Customs.18)
The above tariff structure is highly favorable for the various activities related to linking with GVCs, such as, establishing new industries, product and process development, technology transfer and development, etc., since it facilitates the importation of capital goods and other inputs required in the process at a low or zero duty rates. However, it must be noted that certain automobile parts are placed at a higher tariff range, (even though they fall under the intermediate inputs
18) Budget Speech 2014, (Technical Notes), p. 39.
106 • 2014/15 Knowledge Sharing Program with Sri Lanka category), in order to safeguard the interests of the domestic industry. eg: rubber tires and tubes.
Further, an investor entering into a joint venture with a Sri Lankan industry could utilize the FTAs of which, Sri Lanka is a party, as a gateway to enter the markets of the partner countries at free/preferential duty rates.19) For instance, automobile components could be exported duty free under the FTAs to OEMs/higher tiers, operating in India or Pakistan, where the automobile assembly/manufacturing takes place in large scale, with the presence of many international brand operating such as Mercedes, General Motors, Volkswagen, Benz, Land Rover, Jaguar, Ford, Toyota, Nissan, Hyundai, Mitsubishi, Renault, Suzuki, Daihatsu, Mahindra & Mahindra, TATA Motors etc.
Similarly, inputs required for the manufacture of automobile components could be imported to Sri Lanka duty free, from partner countries of these FTAs (for example, tools & machinery and steel from India). 20)21)
Free / Preferential Agreements of Which Sri Lanka is a Party
• Indo - Sri Lanka Bilateral Free Trade Agreement (With India) • Pakistan - Sri Lanka Bilateral Free Trade Agreement • South Asia Free Trade (Regional) Agreement (with SAARC countries; Afghanistan, Bangladesh, Bhutan, India, Maldives, Nepal & Pakistan) • Asia Pacific Preferential Trade Agreement (with Bangladesh, China, India, Laos & South Korea) • GSP schemes of EU, USA, Australia, Japan etc. which offer preferential tariff rates for selected exports from Sri Lanka.20) The Free/Preferential Trade Agreements of which, Sri Lanka is a party, both bilaterally and at regional level, provide opportunities to import inputs and capital goods for domestic industries, duty free/at a preferential duty rate (as well as for services and the agricultural sector), and gives an opportunity for Sri Lankans as well as for foreign investors in Sri Lanka to exploit the markets of the partner countries. In other words, export goods at a zero/preferential duty rate to the partner country and thereby gain a price advantage.21) Trade facilitation activities such as the introduction of the ASYCUDA World and other online trading services are provided by the Department of Customs.
19) Abeyratne (2013); a study on the possibilities of integrating into Indian supply chains 20) More information on FTAs could be obtained from the web site of the Department of Commerce of Sri Lanka at www.doc.gov.lk (Information > Trade Agreements) 21) A document containing the concessions available for exports of various automobile components under FTAs / PTAs is annexed hetero, as Annexure III
Chapter 2 _ Development of the Automobile Components Manufacturing Industry of Sri Lanka through the Creation of Forward Linkages with Global Value Chains • 107 3.2.3. Investment Policy
Sri Lanka has a liberal investment regime and has institutions, policies and regulations to facilitate FDIs. The Ministry of Investment Promotion and the Board of Investment of Sri Lanka, which is a one-stop-shop for investment related activities, are the key government institutions established for investment promotion.22) The BOI offers many facilities for investment including land with infrastructure in its many export processing zones (EPZs) and industrial parks located around the country, in addition to the exemption from income tax and import duties for a number of years, which depend on the size of the investment made.23) Apart from the land available in EPZs, an establishment located in a private land could also receive the incentives given by the BOI, if the requirements for eligibility are met.24)
Under Section 17 of the BOI Act, corporate tax concessions, duty free facilities for the import of capital goods and raw materials, and an exemption from the Exchange Control Act, are given for both local and foreign investments, if the eligibility criteria set out by the BOI are complied with. The period of time during which these concessions are available, is based on the minimum investment level stipulated by the BOI.
Further, the exemption from import duties and exchange control regulations are granted only to the companies, which export more than 90% of the goods and services that they produce.
It must be noted that, the eligibility criteria under Section 17 are more stringent than those of Section 16. The minimum investment level differs according to the scale of the investment (small/medium/large scale) as well as the category, i.e., manufacturing, agriculture, and services. Further, foreign investment into certain sectors are either prevented (in other words, totally reserved for Sri Lanka), receives conditional approval, or regulated according to their sensitivity.
Certain incentives are given for the expansion of existing enterprises which meet the minimum investment level stipulated and for the strategic import replacement enterprises such as fabrics, pharmaceuticals, milk powder, and cement. As per the
22) The Board of Investment Act No 4 of 1978 lays down the laws related to the investment policy of Sri Lanka and sets out the government’s objectives with regard to the investment regime of the country, which is also supported by the Customs Ordinance No 17 of 1869 (with amendments), Exchange Control Act No 24 of 1953 and Inland Revenue Act No 10 of 2006, Strategic Development Projects Act No 14 of 2008. 23) Guide to Invest in Sri Lanka http://www.investsrilanka.com/pdf/INVESTMENT-GUIDE.pdf 24) The incentives thus given, differ according to the system under which an investment is registered. Accordingly, under Section 16 of the BoI Act, foreign investments are allowed to operate under the general laws of Sri Lanka, meaning that they are subject to the provisions of the Customs law, Inland Revenue law and Exchange Control law.
108 • 2014/15 Knowledge Sharing Program with Sri Lanka provisions of the Strategic Development Projects Act No. 14 of 2008, projects which are of national interest to Sri Lanka, which could contribute to the economic and social benefit of the country, are exempted from corporate tax, customs duty, value added tax, port and aviation levy, excised duty, nation building tax etc. for up to 25 years.
In addition, the government has set out certain priority sectors for which investments are highly encouraged.25) Accordingly, under the manufacturing sector, investments to the tire and tube and the motor spare parts industry, are encouraged, in addition to the manufacture of boats, pharmaceuticals, furniture, ceramics, glassware, mineral based products, cosmetics, processed food, and construction materials. Similarly, under the Strategic Development Act, investment into the sub sectors of transport equipment amongst several others, namely, rubber, minerals, metal, gem and jewellery, electrical and electronic, chemicals, boat building etc. are encouraged.26)
By the Finance Act - Commercial Hub Regulation No. 1 of 2013, the harbours of Colombo & Hambantota were declared as free ports, while the EPZs at Katunayake, Koggala, and Mirijjawila as well as Mattala Rajapaksa International Airport have been declared as bonded areas, with the latter two dedicated for entrepot trade. Any new enterprise established or incorporated in Sri Lanka for these activities with at least 65% of its total investments from foreign sources and total turnover from the export of goods and services are eligible for exemptions from Customs duties, value added tax (12%), Nation Building Tax (2%), Special Commodity Levy, and Port and Aviation Levy (5%).27)
The establishment of free ports as aforesaid is highly favourable for manufacturing industries using imported inputs, ideally, automobile manufacturing as well as for high tech components manufacturing. Manufacturing bonded areas are given special facilities under sections 84A and 84B of the Customs Ordinance No 17 of 1869 and its amendments.28) Micro Cars Ltd. has already established an assembly plant at the Mirijjawila Industrial Park, which has been declared as a bonded area, while certain international OEMs of the automobile industry have expressed interest in investing in the same.
25) Doing Business in Sri Lanka; Handbook for Indian Business, p. 82. 26) Doing Business in Sri Lanka; Handbook for Indian Business, p. 83. 27) Annual Report of the Central Bank of Sri Lanka – 2013, pp. 57~58. 28) Available under Part XI at http://www.customs.gov.lk/cusordinance.html
Chapter 2 _ Development of the Automobile Components Manufacturing Industry of Sri Lanka through the Creation of Forward Linkages with Global Value Chains • 109 The Investment Climate of Sri Lanka
• A liberal investment policy • All sectors are open to foreign investment (with a few exceptions*) • Foreign equity up to 100% allowed (with a few exceptions) • Attractive incentive regime: (full tax holidays of 3 -5 years, - thereafter, concessionary tax rates - duty free import of capital goods & raw materials, exemption from exchange control, repatriation of capital, dividends/ royalties) • Equal treatment to both local and foreign investors • Legal protection to investments • Remittance of capital, profits and royalty allowed • A network of industrial zones all over the country • The Board of Investment (BOI) of Sri Lanka, a one stop shop for facilitating investments * Exceptions: areas totally reserved for Sri Lankans and areas regulated (with a foreign ownership up to 40% and areas regulated by line authorities)
Source: Board of Investment of Sri Lanka.
3.2.4. The Government Policy to Upgrade Domestic Industries from ‘Resource Based Industries’ Towards Technology / Knowledge Based Industries29)
At present, many of Sri Lanka’s industries fall under the low technology category of the OECD classification for high tech industries.30) Due to the limitedness of Sri Lanka’s market, with a population of 20.5 million, the country depends heavily on the income generated through exports. However, the export income earned through low tech products is low and inadequate to meet the country’s needs. At present, only around 1~1.5% of Sri Lanka’s exports fall under the high tech category. Thus, it is the objective of the government to increase the share of high tech exports from 1.5% to 10% by 2015,31) in order to enhance the country’s export income. However, the country has not been able to progress much towards this goal. Hence, at a time when the global market for high technology goods is growing at a faster rate than for other manufactured goods,32) Sri Lanka must invest more in high tech industries, in order to keep pace with world trends.
Automobile components are categorized as high and medium technology items under the OECD classification, and as such, in Sri Lanka’s march towards increasing the share of high tech exports, developing more sophisticated automobile components, and supplying the same to OEMs or higher tiers of the supply chains via
29) Mahinda Chinthana Vision for the Future, p. 70. 30) OECD (1997) According to this classification developed by Thomas Hatzichronoglou, the level of technology used in an industry is measured by the R&D intensity (i.e., R&D expenditure/output) of that industry. 31) Science, Technology & Innovation Strategy for Sri Lanka (2013), p. 24. 32) Science, Technology & Innovation Strategy for Sri Lanka (2013), p. 23.
110 • 2014/15 Knowledge Sharing Program with Sri Lanka GVCs, would contribute to the economy in a favourable manner.
The government has taken several steps towards creating a knowledge economy in Sri Lanka such as: the 5-year R&D Investment Plan formulated by the Ministry of Technology & Research, the establishment of institutions such as, the Coordinating Secretariat for Science, Technology and Innovation – COSTI (to integrate all the research institutions towards a common goal, share knowledge and to minimise duplication of work), Sri Lanka Institute of Nano Technology (SLINTEC), Nano Technology Park, etc., strengthening of universities and research institutions, the introduction of the University Township programme to benefit through the interchange of human and physical resources, the introduction of the technology stream to the secondary and tertiary levels of the education system, the triple tax deduction on R&D expenditure, the establishment of Technology Innovation Support Centre (TISCs) by the National Intellectual Property Office at relevant institutions and at provincial level to identify and develop the innovations with a commercial potential, are some examples.
In addition, the following factors are also favourable for Sri Lanka in integrating into GVCs.
- The strategic location in the Indian ocean with close proximity to major maritime routes - The availability of natural resources used in industries, eg: rubber of the highest quality with a growing global demand. - Availability of a skilled workforce at a comparatively low cost. The universities and technical colleges as well as the industries produce persons specialized in automobile engineering and related fields. - The availability of industrial parks under government institutions such as the Ministry of Industry & Commerce, Board of Investment, Industrial Development Board, Urban Development Authority, which provide land with the necessary infrastructure facilities for investments at a very low rate. In addition, the connectivity within the country has developed rapidly with new high ways and improved road and railway networks as well as sea & air ports. - Electricity supply has improved with new hydro and coal power plants, in addition to the renewable energy plants at a minor scale. Further, a lower electricity tariff rate applies to manufacturing industries.
• A Special Policy for the ACMI - The Scheme of Concessionary Rate of Excise Duty for Locally Value Added Automobiles - Locally assembled motor vehicles are granted a concessionary payment of only 15% of the excise duty payable, if a local value addition of at least 30% is achieved, as per the Extraordinary Gazette Extraordinary No. 1885/42 dated
Chapter 2 _ Development of the Automobile Components Manufacturing Industry of Sri Lanka through the Creation of Forward Linkages with Global Value Chains • 111 24.10.2014.33) The preceding regulations to this offered a complete exemption of the excised duty. - Under this scheme, the cost of locally manufactured components, direct labor and a depreciation of machinery & equipment directly used in the assembly process and a limited profit margin are considered as locally added value. - One of the main objectives of this scheme is to develop the local ACMI through backward integration. Seven companies have assembled vehicles under this scheme including Micro Cars Ltd. and Unimo Enterprises Ltd. which continue operations, as mentioned earlier in this study.
4. Procurement Strategy and Conditions of the Global Automakers
At the beginning of the 21st century, global automakers have increased the global sourcing of automobile components in order to increase price competitiveness by reducing costs. At the early stage of global sourcing global automakers purchased most of their automobile components from global parts companies. However, as the share of automobile production of emerging markets increases, the sourcing from the local automobile component companies kept increasing. Global automakers are trying to find qualified local automobile component companies.
Since most of the global automakers are increasing their production in India, the procurement of components from local companies is also expected to increase. There is a chance for Sri Lankan companies to increase sales of their automobile components to global automakers in this region as 2nd or 3rd tier suppliers. To become a supplier to global automakers, it is important to figure out the procurement process of global automakers. This section explains the procurement processes of the top 3 automakers.
4.1. Volkswagen (VW)
4.1.1. Finding New Automobile Component Suppliers
Volkswagen (VW) reduces the costs of components by inducing the competition among the automobile component suppliers. VW expands the scope of component supplies which can participate in the bidding over the world in order to enhance the competition. VW has two different ways of finding new automobile component suppliers.
33) www.documents.gov.lk/Extgzt/2014/PDF/Oct/1885_42/1885_42%20E.pdf
112 • 2014/15 Knowledge Sharing Program with Sri Lanka First, VW discovers new competitive component suppliers through the Regional Sourcing Offices (RSO). RSO enroll these new candidate suppliers to the procurement system. RSO are located in 15 countries throughout different regions including Europe, Asia and Latin America. Not only are RSO responsible for discovering local parts suppliers, but they also investigate market environments and technology trends. Along with the recent increase of automobile production in Asia and Latin America, the RSO are actively engaged in discovering local parts suppliers. It is encouraging newly found parts suppliers in the local to register onto VWs global component manufacturer’s information system. VWs purchasing department then evaluates a registered parts supplier and lists it as a candidate for a potentially new parts supplier. Then, Request for Quotation (RFQ) is sent to parts suppliers and a capacity assessment of the relevant suppliers is conducted. Once parts suppliers pass quality and technology assessment, the price negotiation begins. If the price is successfully negotiated, VWs procurement decision-making body admits to procure components from the parts suppliers. The opportunity for Asian parts suppliers to produce parts for VW is expected to increase as it plans to increase the production share of Asia from 20% in 2012 to 38% in 2018.
[Figure 2-5] Regional Sourcing Offices (RSO) of VW
Source: Author made this chart based on the interview results with VW.
Chapter 2 _ Development of the Automobile Components Manufacturing Industry of Sri Lanka through the Creation of Forward Linkages with Global Value Chains • 113 [Figure 2-6] New Automobile Component Partner Selection Process of VW
RSO’s recommendation for Head office DB search auto parts companies for auto parts companies
Selection of candidate for new auto parts company
Sending RFQ to auto parts company
Capacity evaluations of auto Parts Company
Price negotiation
Purchasing Director(brand/local)’s evaluation
Final purchasing decision
Source: Author made this chart based on the interview results with VW.
Second, local component suppliers directly enroll themselves to VWs procurement system and get a chance for evaluation. By operating the open enrollment system, VW can reduce the searching costs and widen the database (DB) of global component suppliers. The enrolled component suppliers have to pass the multi-dimensional evaluation in order to participate in the bidding. The multi-dimensional evaluation of new suppliers are implemented by the VW headquarter team or the China branch team. The evaluation team is composed of the purchasing division, quality control division, production division, and R&D division. This team visits the factories of new suppliers and evaluates quality control, production technology and development capacity. In addition to these, transaction experiences with global automakers, global production capacity and communication capability are considered as important factors.
The evaluation results are categorized into three groups. The grade ‘A’ group can participate in the bidding without any constraint. However, the grade ‘B’ group should submit a proposal of capacity improvement and commit the implementation of the proposal within one year. With these conditions ‘B’ group suppliers can
114 • 2014/15 Knowledge Sharing Program with Sri Lanka participate in the bidding. Thegrade ‘C’ group cannot participate in the bidding because they have to pass re-evaluation. The company codes are given to the new suppliers which acquired the bidding participation right. After they get the company identification code, they can participate in the bidding and receive the bidding information from VW.
[Figure 2-7] VW’s Multi-dimensional Evaluation of New Suppliers
Evaluation result Evaluation Division Main contents of Evaluation (Signal light system)
• Cost competitiveness of product goods Quality Purchase prod • Product performance, Delivery • Bidding available uct durability and innovation A Available without restriction • Satisfaction of ISO standard
• Past experience in large • Bidding available Research Production Produc quantities Delivery Delivery under the conditions tion • Own quality management B under the (submit improved pro capability condition suggestion and cess • Status of equipment implementation • Joint assessment of each sector installation within one year) • Product quality and production process capability evaluation Devel • Size and capabilities of C focused on-the-spot inspection op Delivery • Delivery Disabled and ment professional researchers Disabled need to re-evaluation cap • Language skill of ability development part’s staff
Source: Author made this chart based on the interview results with VW.
In order to expand the participation of new suppliers, VW operates Volkswagen Coaching GmbH which supports the education of component suppliers. It holds seminars and workshops on cost reduction, quality improvement, technology innovation and share new ideas and know-how with the component suppliers. It also opens the success cases and failure cases on its portal site to minimize the trials and errors of component suppliers.
4.1.2. Procurement Process and Strategy of VW
VW has two procurement processes. One is forward sourcing and the other is global sourcing. The former is related with the procurement of new components. Since high technologies are required for these components, these processes are mainly contracted with the large component suppliers who have a long term relation with VW. The latter is a searching process to maintain the quality and reduce costs. Unlike the forwarding sourcing it is open to suppliers who have price competitiveness along with quality. Since Sri Lankan suppliers have chances in global sourcing, it is carefully investigated.
Chapter 2 _ Development of the Automobile Components Manufacturing Industry of Sri Lanka through the Creation of Forward Linkages with Global Value Chains • 115 Global sourcing of VW has 6 stages. The 1st stage is ‘Request for Quotation’ (RFQ). VW sends the outlines of the necessary components to the registered component suppliers and asks them the quotation in this stage.34) The 2nd stage is ‘Registration of Quotation’. VW accepts the quotation only through online methods and the registration period is strictly applied. The 3rd stage is ‘Engineering Review.’ VW selects 5-7 candidates by reviewing the registered quotations. Then VW asks for additional information (such as, 3 dimensional blueprints) from these suppliers. The suppliers submit a detailed plan which reflects the request of VW. The R&D division of VW evaluates the plan and adjusts the contents of the plan. This stage is mainly focused on the evaluation of the technology related capacity of component suppliers. The 4th stage is a comprehensive evaluation stage. R&D, quality control, purchase, and production divisions of VW jointly evaluate the supply, quality control, and development capacities of the screened candidates. The evaluation results are categorized into 3 groups (A, B, C). At least grade B is required for the next stage.
[Figure 2-8] Global Sourcing Process of VW
1. Request for Quotation 2. Registration of Estimate 3. Engineering Review
• Parts company • Registration of • Technical skills receives request through estimate only through evaluation by VW the system technology team the VW’s B2B system • After the registration • Adjustment of period, system is Estimate according to blocked technical requirements
6. Selection of Company 5. Price Negotiation 4. Final Internal Aaudit
• Final decision of VW • Choice of online • The final evaluation of parts CSC bidding or offline companies by department negotiations of quality, R&D, Purchase • Notification of and Production selection result on • Price negotiation of last • Classified as A,B,C classes the system 3 to 5 companies by competition round way • Class B or higher can be selected
Source: Author made this chart based on the interview results with VW.
The 5th stage is ‘price negotiation.’ Price negotiations are implemented through both online and offline methods. Online biddings are mainly for the components in which price is important but not so much the technological differences among the suppliers. However, offline negotiations are used when other additional
34) VW is relatively open system in the sense that all registered component suppliers can see the requested quotation. Most of the other major automakers have screening process before they send RFQ.
116 • 2014/15 Knowledge Sharing Program with Sri Lanka conditions are necessary. 3-5 candidates negotiate with the purchasing division of VW. VW can have bargaining power through this type of negotiation as well as comprehensiveness. The last stage is ‘final selection.’ Corporate sourcing committee selects the final component suppliers by considering the VW’s long-term purchasing strategy and notices the results to the suppliers.
[Figure 2-9] Offline Negotiation Method of VW
Offline competition round(Hotel room meeting) way negotiation process
1 • Selection of 3 to 5 times shortlist companies VW Meeting Purchase • Not reveal the information about team Preparation attending companies • Setting order for meeting
2 • In order one on one meeting Meeting • Propose VW's purchase conditions progress • In case of unsatisfying the conditions, progress negotiation with other company
Hotel Hotel Hotel Room 1 Room 2 Room 3 3 • In case the company satisfies purchase company A company B company C conditions, discontinuing the negotiation Meeting • Set up terms and conditions of business complete except price Repetition of meeting till reach a agreement • Not reveal the details of negotiation
Source: Author made this chart based on the interview results with VW.
4.2. Toyota
4.2.1. Finding New Automobile Component Suppliers
Asian automakers are promoting the procurement of parts and components based on vertical integration and long-term partnerships with auto parts producers. They are procuring key components through affiliated parts suppliers, and long- term partners procure the remaining components. Therefore, discovering new parts suppliers is relatively passive in comparison with European automakers. In discovering new suppliers, the purchasing organization of the local plants directly makes evaluations and recommendations. In fact, Asian automakers are accompanied by their affiliates when they advance into a new market, which makes it hard for a local supplier to become a primary supplier. However, Japanese automakers are recently promoting a procurement policy without making any distinction between affiliates and non-affiliates in order to expand the publication of parts and components. The
Chapter 2 _ Development of the Automobile Components Manufacturing Industry of Sri Lanka through the Creation of Forward Linkages with Global Value Chains • 117 non-affiliates can make new deals with automakers if they meet the criteria of cost reduction and new technology.
[Figure 2-10] Vertical Systematization of Auto Parts Sourcing: Toyota Case
Category Internal Production Subsidiary Suppliers Eco Parts Hybrid Powertrain System Toyota Engine Toyota Industries Power Train Transmission, Drive Shaft Aisin Seiki Suspension Aisin Seiki Chassis Steering JTEKT Brake Aisin Seiki Bumper/ Press Hood Door Toyota Autobody Exterior Door Door Frame Aisin Seiki Seat Toyota Boshoku Interior Plastic Molding Rubber/ Plastic Toyota Gosei Control/ Safety HVAC Denso Automotive Motor Denso Electronics Electronic Parts Semi-conductor, ECU Denso AVN Denso
Source: IRC (2012), Case of Toyota Group.
Toyota has a relatively closed structure of component sourcing. Toyota has more than 26 affiliated component manufacturing companies, such as Denso and JTEKT, which are well known global component suppliers. More than 60% of the major 200 components are sourced from the affiliated companies. Toyota has established long term transactions and cooperative relations with the component suppliers even though they are not directly affiliated with Toyota. In 1943 Toyota made the cooperative association which is the Toyota-cooperative automobile component suppliers’ association has more than 220 member companies. Toyota has kept very close relations with these companies through the transfer of production technologies. Due to these solid relations Toyota is relatively passive in discovering new suppliers in comparison with other automakers and it is very hard for a new component supplier to make a link with Toyota.
However, with the rising competition in the global market Toyota has to increase the portion of its global sourcing. Toyota is actively searching new component suppliers by holding automobile exhibitions for new cars, investigating local markets, and analyzing supply chains. Not only the headquarters but also overseas strongholds hold the exhibitions for new cars every two months. More than 50
118 • 2014/15 Knowledge Sharing Program with Sri Lanka component suppliers are invited to each exhibition. Information on local component suppliers are gathered through these exhibitions and shared with the headquarters. Management, quality, cost, and technology are the major evaluation elements. Sustainability of transaction is also considered as a key element of a prospective foreign component supplier since Toyota needs a flexible and long-term relation with partners to maintain the Toyota production system (TPS). Depending on the locations of the component suppliers, the leading divisions of evaluation are changing.
The most prominent characteristics of Toyota’s evaluation process is that Toyota gives more weights to the evaluations of field investigation, rather than the official certificates of quality such as a QS or ISO. This reflects Toyota’s business culture, which emphasizes the field and internal concurrence rather than external evaluation.
[Figure 2-11] Toyota’s Leading Division of Evaluation and Evaluation Items
Supply factory Evaluation Department Evaluation Items
• Management, quality, Japan headquarters’ Factory in japan prime cost, purchase department production, New technology overseas company • In case of new Local purchase overseas company, Factory in overseas department emphasis on sustainable business
Source: Author made this chart based on the interview results with Toyota.
Toyota operates a program to build up the evaluation capacities of local purchase departments. Toyota invites the managing directors of overseas local factories and provides a systematic training about evaluations. The 1st tier partners are directly controlled by Toyota. However, 2nd and 3rd tier partners have direct cooperative relations with 1st tier partners. For the 2nd and 3rd tier partners, a SIG (Supplier Improvement Group) is formed and Toyota’s management style is propagated. For example, Denso operates a training academy in Thailand in which personnel of local Denso and 2nd tier partners are trained.
4.2.2. Procurement Process and Strategy of Toyota
The procurement process of Toyota starts from the sending of a RFQ (Request for Quotation) to the selected component suppliers. Unlike VW, Toyota sends a RFQ only to the selected suppliers. Since the consultations for partner selection are mainly made with the R&D division, technology level is the primary concern. Hence, it is
Chapter 2 _ Development of the Automobile Components Manufacturing Industry of Sri Lanka through the Creation of Forward Linkages with Global Value Chains • 119 necessary to get recognition from the R&D division for a new company to become a partner of Toyota.
After receiving a RFQ, the supplier has to submit a blueprint which covers plans for product development, quality control, and delivery. After the presentation of the supplier Toyota performs a field investigation. The suppliers who pass the presentation and field investigation have to submit samples and quotation for mass production. Only after they pass these multi-step evaluations, can they become partners of Toyota.
[Figure 2-12] Component Procurement Process of Toyota
Planning Making Proto Prepareing Production
Basic Confirm Confirm Check New Design Design Function Tech Car Production/ Issue R & D Making Issue Development Proto Evaluation Process Department Concept Design Structure Confirm Cost Design Check Design Structure Targeting Cost Approving Parts Mass Documents Design Production Supplier Select Supplier Purchasing First Ordering Request Survey/ Select Department Check Proto Estimate RFQ Ordering Mold Purchasing Proto Contracting Process Contract First Making Send Make & Evaluate Supplier Presentation Meeting Proto Estimate First Sample
Source: Toyota (2011), Guideline of Components Procurement.
Toyota can ask for a sample of mass production during the procurement process. This is possible because Toyota has a long relation with the suppliers and staff of a purchase division, and they are trained for multi-functions (such as, product development, quality evaluation, blueprint design, etc.) so that they can interpret the blueprint.
Depending on the importance of the components, the leading divisions are changing. The procurements of the most important components, such as the engine, transmission, and brake (grade ‘A’ components) are solely determined by the headquarters’ purchase division. The procurements of grade ‘B’ components are determined by the joint decisions of R&D, quality, and purchase divisions of HQ, however, they reflect the opinions of overseas strongholds. The procurements of grade ‘C’ components, which are used for general purposes, are determined by the purchase division of overseas strongholds.
120 • 2014/15 Knowledge Sharing Program with Sri Lanka 4.3. General Motors (GM)
4.3.1. Finding New Automobile Component Suppliers
GM has been very active in finding new component suppliers since 2004. GM turned a loss in 2004 and Delphi which was the main component supplier of GM went bankrupt in 2005. GM began to search for new overseas component suppliers in order to reduce costs and enhance the stability of its sourcing. China is the key place for GM’s global sourcing. More than 200 staff member of GM have been dispatched to China since 2005. They found local suppliers and transferred the necessary technologies. As a result the portion of component sourcing from China increased from 5.3% in 2006 to 17% in 2012.
It is expected that the component sourcing from Korea and India will increase. Quality improvement of Korean products and the FTA between Korea and the US accelerated GM’s sourcing from Korea. Also, GM developed India as a basecamp for small cars to compete with Toyota in the Asian market. On the other hand, component sourcing from North America and Europe is likely to decrease.
[Figure 2-13] Changes in Global Component Sourcing of GM
2006 2012
Others Korea/ 11.5% Others Japan 7.1% 17.2% Korea/ China 5.3% North America Japan 8.7% North America 39.7% 54.3% EU 21.8% China 17.0% EU 17.4%
Source: Author made this chart based on the interview results with GM.
GM finds new component suppliers through ① procurement announcement meeting, ② network of local strongholds, such as Opel (Europe), Holden (Australia), Korea GM or ③ direct self-enrollment of new component suppliers in GM’s system (GM Supply Power). GM evaluates the enrolled suppliers by quality, service, technology, and price.
Chapter 2 _ Development of the Automobile Components Manufacturing Industry of Sri Lanka through the Creation of Forward Linkages with Global Value Chains • 121 4.3.2. Procurement Process and Strategy of GM
The procurement process of GM is similar to VW because Jose Ignacio Lopez, who established the procurement system of GM, moved to VW as a vice president and completed the procurement system of VW. However, there are two differences between GM and VW. One is that GM selects the candidates before sending a RFQ, and the other is that GM has no more evaluation processes after technology evaluation.
At the first stage of procurement process GM holds a Sourcing Committee (SC) in which staff from finance, R&D, and quality divisions participate. The SC prepares Request for Quotation (RFQ) and Statement of Requirement (SOR). A SOR is a document which specifies the responsibilities of suppliers and the requirements of GM in R&D, design, and test. The purchase division sends a SOR and a RFQ to the enrolled suppliers and selects the candidates after collection.
The next stage is a Technical Review for the selected suppliers. The R&D division and purchase division lead the technical review. The key evaluation items are the technology capacity of development team and the level of the environment management system of the supplier.
The most important thing that the suppliers should prepare is a SOR. The volume of a SOR is more than 1,000 pages and the key contents are contract, R&D, and material. Contract part contains the contents of a RFQ, basic elements of the product, quantity, and packaging. The R&D part contains design, test items, and responsibilities. The material part is composed of regulations and duties. New suppliers should check the SOR very carefully because it contains technology related arguments and regulations, as well as contracts. The technical review is based on the SOR and the final selection is determined by the result of the technical review and bidding price.
The Global Creative Team (GCT) superintends the procurement in GM. The GCT belongs to the department of global purchasing and supply chain and 120 teams over 10 countries are in operation. Before the GCT is made, there are inefficiencies in procurement because the same components were sourced from different suppliers. However, the efficiency of global sourcing/procurement will improve after the GCT superintends the procurement.
As explained above, there are similarities in finding new automobile component suppliers and procurement processes from among the global automakers. However, there are differences in their procurement strategies. VW has a relatively open procurement system. However, technology level and global supply capacity are
122 • 2014/15 Knowledge Sharing Program with Sri Lanka carefully evaluated during the procurement process. Toyota has a rather closed procurement system. In addition to quality and cost, Toyota asks for production technologies, which can comply with the Toyota production system. GM emphasizes low costs in global sourcing.
Sri Lankan component manufacturers have cost advantage, even though global supply capacities and production technologies are not strong yet. Hence, the 1st target for GVC needs to be GM rather than the European automaker VW or the Japanese automaker Toyota.
4.4. Conditions of Global Automakers for Components Sourcing
4.4.1. Basic Condition
The global auto manufacturers first identify basic skills and quality levels when selecting new parts suppliers. They send out a Request for Information (RFI) in order to test basic ability. The questionnaire includes questions related to employment, availability of quality certification, and share of auto parts business. In particular, suppliers can receive preferential treatment if they have experiences in dealing with the auto manufacturers. They should employ more than 100 workers, and a quality management system such as ISO9000 and TS16949 are required. Though questionnaire forms differ among automakers, this step is very important as it assesses whether or not new parts suppliers are eligible to be registered on the database.
Example of a RFI
1. Please notice your company information and contact person. 2. How many employees are working in your company? 3. Is your company certified? ISO 9000 Yes ( ) , No ( ) (if yes, please send copy of the certificate) TS 16949 Yes ( ) , No ( ) (if yes, please send copy of the certificate) ISO 14001 Yes ( ) , No ( ) (if yes, please send copy of the certificate) Who examined your company? 4. What’s the ratio of automotive products in your company? 5. Do you have international references? Please notice some of your automotive customers.(OEM or Tier 1) 6. Do you have contracted product liability insurance?
Source: Cho (2011).
Chapter 2 _ Development of the Automobile Components Manufacturing Industry of Sri Lanka through the Creation of Forward Linkages with Global Value Chains • 123 4.4.2. Quality
Global automakers are consider parts quality as the most important evaluation factor, because a single defect in 20,000 components used in vehicles can take away the life of a consumer. Also, a large recall caused by poor components can massively damage the sales of automakers. In fact, Toyota conducted a recall of over 10 million units in 2010 due to faulty accelerator pedals supplied by the CTS, a North American parts producer. This significantly reduced Toyota’s sales and profits. Recently, a recall of 13 million units has occurred due to GM’s defective ignition switches, which resulted in more than $10 billion loss.
As the primary indicator of parts suppliers’ quality level, a level of labor skill, quality improvement methods, and quality inspection equipment are assessed. First, it is very important to secure a skilled workforce in order to improve the quality level. During the production process, the trained personnel can check the quality failure in advance, which in turn reduces the cost of quality inspection. Availability of training programs for employees is also investigated. Second, whether or not quality management is in place from automotive design to production is assessed. Third, quality inspection equipment should be constructed in the automobiles production process.
The quality management team of global automakers visits parts suppliers to assess whether or not they meet the quality standards. In the case of VW, production experts evaluate diverse aspects of parts suppliers’ production process and grade them in three categories, A, B and C. If suppliers do not obtain a minimum grade of B, they are dropped out from the list of candidates. Also, VW assesses quality management capacity through a quality review process and certification of outside agencies. In the case of the purchase sector, quality responsibility is located in advance at the component design stage and is specified in the contract.
124 • 2014/15 Knowledge Sharing Program with Sri Lanka [Figure 2-14] Components Quality Control Program of VW
Quality Management Program
Evaluation of basic Process examination of Prior agreement for management capacity auto parts companies design responsibility
ISO Quality Certificate Actual inspection of Factory Division of design domain
Source: VW, HIS Automotive.
4.4.3. Technology
The global automakers utilize the technology level as an important evaluation criterion because they can enhance their future competitiveness through dealing with parts suppliers that hold a high level of technology. First, they investigate whether or not the parts suppliers operates a R&D department, in particular, a self- managed R&D, which they value highly. Also, the parts suppliers can be highly rated if they operate a R&D sector in their other plants as well. Second, automakers assess the reserved R&D equipment. The parts suppliers can get a high score when they have equipment that is highly compatible with those of automakers. Third, the level of trained personnel’s ability to use design software is assessed. In this case, automakers perform a detailed evaluation based on the level of R&D personnel training, in-company training programs, and design data. Lastly, automakers assess whether or not parts suppliers have adopted a long-term R&D strategy. Detailed evaluation factors include R&D roadmaps, R&D staffing plan, and a R&D investment plan. In particular, a detailed technology development plan is the most important. In recent years, the global automakers are increasingly demanding small-scale parts suppliers to independently design parts and components.
4.4.4. Delivery
The global automakers select new parts suppliers partly based on their logistics capabilities and methods. In particular, they evaluate JIT (Just in Time) delivery capability. Parts delivery is very important because excess supply leads to increase in costs and parts delivery in a non-timely fashion leads to plant shutdowns. Therefore,
Chapter 2 _ Development of the Automobile Components Manufacturing Industry of Sri Lanka through the Creation of Forward Linkages with Global Value Chains • 125 parts suppliers that cannot deliver parts and components just in time are not selected. Most parts suppliers thus locate their operation plants near the automakers. Others operate warehouses near automakers’ operation bases. However, in recent years, the maintenance of parts delivery has become convenient with the development of technology that enables them to remotely monitor production schedule and real- time inventory levels.
Nevertheless, management of a parts supply chain is becoming increasingly important. Toyota for instance experienced production suspension when their supply chain collapsed due to an earthquake. Since then, Toyota directly controls all three segments of its supply chain risk management.
[Figure 2-15] Risk Management of Auto Parts Supply Chain: Toyota Case
Purchasing Department Before Earthquake
1st Auto parts companies
After 2nd Auto parts companies Earthquake
3rd Auto parts companies
Source: Author made this chart based on the interview results with Toyota.
4.4.5. Cost
The global automakers begin price negotiations with parts suppliers who have passed quality, technology, and delivery capabilities tests. The primary purpose of building a global parts’ supply chain lies within the production of high quality products with lower costs. Automakers focus on evaluating the ability of parts suppliers to sustainably reduce costs through productivity improvement and management innovation. In the past, a low price of parts supply was the most important. Recently, automakers primarily consider a reasonable price based on a comprehensive analysis of the sustainability of cost reduction, reliability, quality, and after services (A/S).
126 • 2014/15 Knowledge Sharing Program with Sri Lanka 4.4.6. Others
Other evaluation factors include the management vision of the CEO, labor- management relations, and experiences of dealing with global automakers. First, global automakers evaluate a CEO’s business objectives and long-term investment plans to achieve them. At the same time, they investigate activities related to business innovation campaigns and employees’ training plans. In particular, they focus on parts suppliers’ campaigns on quality innovation and cost reduction. Second, they evaluate whether or not relationships between labor and managers are amicable. In analyzing labor-management relations, they use variables such as employees’ average years of service and turnover rate. They also conduct a direct interview with the employees to derive a more accurate analysis. Third, they examine the business relationship with other global automakers. The parts suppliers receive the highest grade if they have a track record of supplying products to the top 8 auto manufacturers, including Toyota, VW, and GM.
5. Strategies for the Sri Lankan Automobile Component Industry’s Participation in Global Value Chain (GVC): Lessons from Korea
Since there is hardly any car manufacturer in Sri Lanka, it needs a strategy different from that of Korea to foster its auto parts industry. The central and local governments will be responsible for the roles that were once played by the Korean car manufacturers. In the short term, the government needs to focus on improving the product quality of the Sri Lankan parts makers, while assisting them to secure access to the foreign markets. The first step is to build up the ACMI database through an investigation of the current status of the ACMI, such as, technology level, types of products, companies, etc. It is necessary to build up an information sharing system between the government and private sector. It is especially necessary to make an auto parts producers’ association in order to share information among companies and to strengthen communications between the government and private sector. In the mid- to long-run, the government needs to continue improving the technology of parts makers by establishing a government-affiliated organization, such as an ‘Automotive Technology Institute’. It is also necessary to keep policies consist, especially in the tariff structure. For this purpose it is necessary to evaluate the current tariff structure and its effectiveness. Also, Sri Lanka should be prepared for motorization and examine relevant ways to foster its automobile industry in order to bring about its sustainable growth. Major policy recommendations are as follows.
Chapter 2 _ Development of the Automobile Components Manufacturing Industry of Sri Lanka through the Creation of Forward Linkages with Global Value Chains • 127
Development Strategies of Sri Lankan Auto Components IndustryProvincial Central government Auto parts companies government • Supporting quality improvement • Attract auto parts • Reduce defect rate - Select promising parts companies for companies - Promoting quality intensive support - Construct auto parts improvement - Establish government organization for industry cluster • Certify global quality quality management • Supporting building site standards • Quality Education and tax system - ISO 9000, TS 16949, etc. - Invite international quality experts for - Provide building site as • Market expansion for India Short training low rental fee and southeast Asia term • Supporting fund and tax - Reduction and - Building capacity for - Support equipment fund and give exemption of local tax the overseas marketing customs benefit for a certain period of professionals • Supporting auto parts export time - Establish one-stop export supporting center - Co-marketing for international market • Establishment of research center for • Economic vitalization • Improve technology Auto parts and job creation development for auto parts - Core technology development based upon auto parts - Establish technology institute Mid/ - Technology transfer to auto parts industry - Increase number of long companies - Expending investment researchers term • Build the University-industry incentives for auto-parts • Joint investment with cooperation system companies Global Auto parts - Joint development of technologies companies among universities and companies - Learn advanced technologies
Source: Summary by author.
5.1. Short-term Strategy
5.1.1. Improving the Quality of Auto Parts
In order for the Sri Lankan parts makers to supply their components, it is crucially important to improve their quality. In fact, global auto manufacturers consider product quality as the priority in selecting new corresponding parts makers. Thus, the Sri Lankan government needs to develop their strategy to first select potential parts makers and to improve their product quality. To this end, parts makers should secure skilled labors. At present, they depend on inspection personnel for product inspection as a means to decrease the error rate. Sri Lanka should conduct in-house training to improve the skills of the workforce. In addition, it needs to adopt a system to check any defects on components in the design and production process. In the meantime, the government should acquire high-quality inspection equipment, such as non-destructive testing equipment, for common use.
128 • 2014/15 Knowledge Sharing Program with Sri Lanka As for the criteria in selecting potential parts makers, quality, product development capabilities, and management skills can be considered. International quality certification, skills of the workforce, and documentation capabilities are some of the factors considered to assess quality. In assessing product development capabilities, the availability of a R&D task force, holdings of testing equipment, and design skills are generally considered. Lastly, management skills are assessed based on a CEO’s vision and personnel management. Based on these criteria, Sri Lankan parts makers can be evaluated and given a score out of 100. Those scoring over 80, 70~80, 65~70 are respectively designated as the first, second, and third grade. Those scoring 65 or below are dropped out.
Selection Criteria for Potential Parts Makers (Example)Category Check Contents Operator skill control, Quality document update, First sample Process inspection etc. Quality International certification, Final inspection procedure, Quality control Incoming part inspection etc.
Basic R&D Organization, Reliable test equipment, Development competence document control etc. Development Present ability R&D employee ability, Proto development capability etc. Future ability Development long term strategy Management CEO Career, Management Vision, Labor management etc.
Source: Summary by author.
In 1978, the Korean government announced the selection criteria for parts makers who were going to be subject to major governmental support. From all the participating makers, the government evaluated and selected a total of 62 makers. Then, these firms were asked to submit documents related to information on plant and finance, quality management systems and technical personnel. Since then, they designated a total of 59 product items and 228 parts makers as auto parts specialists. These selected firms were provided with a facilities fund with a low interest rate and foreign borrowing funds on a preferential basis. In addition, the government undertook a variety of technical assistance projects.
In 1984, the Korean government introduced the rating system for auto components, in which products were classified into three grades. With consideration to post-management, first, second, and third grades underwent quality inspection a year, half a year, and four months after the prior inspection, respectively.
Chapter 2 _ Development of the Automobile Components Manufacturing Industry of Sri Lanka through the Creation of Forward Linkages with Global Value Chains • 129
Korea’s Development Policies on Auto Parts1. Establishment of quality management system - Obligated installation of quality management organization - Installation of facilities for quality inspection - Implementation of the quality rating system 2. Implementation of standardized system - Induction of mass production through standardization 3. Funding - Facilities fund(30 million US$), Management fund(15 million US$) - Means of funding : divided payments in three years 4. Improvement of taxation : Tax exemption for induction of foreign facilities
Source: Cheol Cho (1997).
In order to bolster quality improvement for the Sri Lankan auto parts, parts makers should set a target for quality level while at the same time promoting the movement towards quality innovation. The government should encourage parts makers to set up the target for error rate and to develop specific plans to achieve it. Particularly, it is important to introduce training program at the national level so that all personnel from the CEO to field workers can receive training. Furthermore, the government should identify best practices of quality improvement and provide corresponding firms with preferential treatment. Due to the limited resources of the government, auto parts makers should form an association in order to effectively promote the movement for quality improvement. Meanwhile, the government should examine plans of the association and evaluate their feasibility while helping them overcome possible obstacles. In 1994, the Korean government introduced the XC-5 project to develop its auto parts industry. Through this project, the Korean government set the operational error rate at 100PPM (Parts per Million) and the delivery failure rate at 10PPM. The Korea Automobile Manufacturers Association internally assigned a Quality Management Team as the main body managing quality improvement. First, it encouraged parts makers to actively promote factory automation and plant innovation, and required them to attain ISO9000 certification.
130 • 2014/15 Knowledge Sharing Program with Sri Lanka
Korea’s Policy on Strengthening Quality Competitiveness for Auto Parts Makers1. Goals - Achieving the operational error rate at 100PPM and delivery failure rate at 10PPM by 2000 - Establishing Quality Management Team within the Korea Automobile Manufacturers Association 2. Basic approach - Sequential links and responsibilities for quality improvement - Providing incentives to the firms with outstanding performances 3. Quality Innovation 1) Factory Innovation - Target: increasing the number of firms with ISO 9000 certification up to 200 - Training for managers and practitioners provided by the SBC - Training provided by the car manufacturers and self-training of parts suppliers - Inviting international quality experts for training (government-funded) 2) Quality Evaluation - Parts suppliers hold conference on quality innovation on a daily, weekly, and monthly basis. Evaluating track record on quality improvement. - Government and car manufacturers select 10 parts producers with outstanding performances. 3) Reward - Firms of outstanding performance are granted benefits including funds, tax credits, tax exemption etc. 4) Outcomes - SBC’s promotion of best practices - Assigning working-level personnel of outstanding firms as a professional trainer. Training provided for parts suppliers
Source: XC-5 Project of Korean Government (1994).
Moreover, with the funds provided by the Korean government, international quality experts were invited to train the parts makers. Second, the Quality Management Team periodically evaluated parts producers on their quality innovation. Firms of outstanding performance were provided with the incentives including overseas field trips, funds, and tax benefits. Third, significant efforts were made for quality improvement. The best practices of the relevant firms’ success were publicly promoted though diverse promotional materials. Also, quality managers of other firms visited and examined the products of outstanding firms.
5.1.2. Fund/Tax support
The Sri Lankan government should provide both direct and indirect funds to parts makers so that they can expand and build a basis for exportation. It is necessary to build an industrial complex for auto parts near export ports through cooperation with the local government. In particular, parts makers should be provided with a factory site at free or low rent. At the same time, parts makers that moved into the industrial complex should be provided with a tax reduction for a certain period. Policy funds should be provided for investment in plant/equipment and R&D. The
Chapter 2 _ Development of the Automobile Components Manufacturing Industry of Sri Lanka through the Creation of Forward Linkages with Global Value Chains • 131 government should encourage joint ventures and technical cooperation, while at the same time exempting taxes on importing raw materials.
In 1974, the Korean government fostered its auto parts industry through the ‘Long-term Development Plan for Automobile Industry’. Under this plan, the industrial complex was assigned. In 1978, a total of 230 outstanding firms were provided with 10 billion won for facility building and 50 billion won for management. Through the ‘Measures for Enhancing Productivity of Auto Parts Industry’ in 1981, potential firms were selected to be provided with a facility and management funds. In 1994, plans to raise government funds for a facility and technology investment were included in the ‘XC-5 Project’.
Korea’s Policy on Financial/Tax Support for Auto Parts Producers1. Financial Support - Facility/management fund (Since 1978, a total of 15 billion won was provided within three years) - Technical assistance - Small and Medium Industry Bank, Trust guarantee fund’s investment on auto parts makers - Since 1994, attracting internal investment through IPO 2. Tax Support - Import duty exemption on raw materials for localization of parts - Introduction of duty-free system for production facilities
Source: Cheol Cho (1997).
5.1.3. Enhancing Marketing Capabilities of Parts Exporters
The Sri Lankan government should set up specific goals for parts exports and foster specialized parts exporters. First, the government needs to select potential exporters and provide concentrated support. In addition to funds for product development, a facility and management fund should be provided. Because it takes about 2~3 years at minimum to enter a foreign market, continuous support is needed. Second, in order to increase exports, a ‘one-stop service for export’ should be established. With trade experts assigned at the one-stop service, trade activities can be facilitated by overcoming any difficulties. Also, it is important to provide market information, tariff status, and rules of origin of importing countries. Third, marketing capabilities should be strengthened. To this end, potential foreign markets need to be selected, and market research should be periodically conducted. Moreover, export logistics should be improved in order to reduce the time and improve service., As an island country, Sri Lanka experiences long delivery time, thus improving logistics is of utmost importance.
During the 1970s, the Korean government promoted plans to export parts and
132 • 2014/15 Knowledge Sharing Program with Sri Lanka components but it did not bear fruit. Thus in 1981, they set up specific goals and plans to promote the export industrialization of the auto parts. Particularly, with the goal of increasing parts exports up to a billion dollars by 1986, the government started fostering the parts industry.
Since 1994, market research teams were sent to major exporting markets on a periodic basis. At the same time, the ‘Support Group for Global Parts Supply’ was formed by KITA, the Association of Auto Parts Manufacturers, and car manufacturers, with the objective of resolving bottlenecks arising during the process of exportation. Due to the decrease in yen/dollar exchange rate at the time, Korea’s parts producers were able to enhance their price competitiveness. Since then, parts producers started exporting their products to Japanese auto firms, reaching 140 million dollars of exports in 1996 from only 11 million dollars in 1977.
Korea’s Policy on Enhancing Auto Parts Exports1. Setting Up of a Goal of Achieving a Billion Dollars of Exports (1981) - Selecting firms with potentially high growth - Providing facility and management fund 2. Accessing Foreign Markets (1994) - Dispatching market research team every year - Expanding exports with basis on price competitiveness after Yen appreciation - Establishing support group for global parts supply 3. Improving Global Competitiveness of Parts Producers (2011) - Establishing ‘Auto-parts Park’ in the US, the EU and China, and supporting overseas management of parts producers - Establishing joint logistics center in New Delhi, India - Transforming existing logistics system into direct delivery service (China, Japan)
Source: Cheol Cho and Gyeongyu Kim (2012).
In 2011, the ‘Auto-parts Park’ was established in Chicago (US) and Frankfurt (EU) in order to support the overseas activities of parts producers. Also, a joint logistics center was established in New Delhi, India. With these supporting policies, Korea’s exports of parts and components have reached 26 billion dollars in 2013 from 10.2 billion dollars in 2006, which is about a threefold increase. Of a total export amount in 2013, 16 billion dollars of exports account for the supply to Hyundai’s overseas production factory, and 10 billion dollars account for sales to GM, Volkswagen, Ford, Nissan, Chrysler etc.
Sri Lanka is recommended to focus on promoting its market access to the automobile industry of India and ASEAN. In addition to geographical proximity, their industries are expanding at a rapid rate. Based on the 2014 figures, India and ASEAN’s automobile market have increased at annual sales of 3.44 million and 3 million vehicles, respectively. In the foreseeable future, due to motorization, the
Chapter 2 _ Development of the Automobile Components Manufacturing Industry of Sri Lanka through the Creation of Forward Linkages with Global Value Chains • 133 demand for cars will further increase, thereby increasing demand for auto parts.
In India, US car manufacturers, such as GM and Ford, are expanding their production capacity, which can be deemed as an opportunity for Sri Lankan parts makers. With the objective of reducing production costs, US car manufacturers set up a goal of expanding outsourcing. Lately, Daimler has announced its plans to develop India as a commercial hub for emerging export markets with the core objective of expanding their sales in them. As Sri Lankan parts makers have competitiveness in components used in commercial vehicles, such as leaf spring and rear crossbar, they can bring about an increase in exports. In the case of the ASEAN market, Sri Lankan parts makers can target a niche market by supplying already-entered Japanese car manufacturers.
[Figure 2-16] Estimates of Indian Automobile Market
Comercial vehicle (10 thousands) Sedan (10 thousands) 32.9 Sedan’s year-on-year (%) 16.9 7.8 5.5 9.2 2.7 -7.3
94 72 226 73 86 82 69 53 231 243 266 246 253 272 174
2009 2010 2011 2012 2013 2014 (F) 2015 (F)
Source: www.kaica.or.kr.
134 • 2014/15 Knowledge Sharing Program with Sri Lanka [Figure 2-17] Estimates of the ASEAN Automobile Market
Sales volume (10 thousands) year-on-year (%)
34.7 36.0
3.8 8.6 2.3 -8.5
-7.9 322 330 302 328 228 237 170
2009 2010 2011 2012 2013 2014 (F) 2015 (F)
Source: www.kaica.or.kr.
To this end, Sri Lankan parts makers should secure their marketing capabilities. First, in addition to linguistic abilities, they need to foster marketing experts who have in-depth understanding of technology. Since it is difficult to employ an outside specialist, they need to conduct foreign language courses for the internal workforce. Also, collecting market information on parts and components is highly recommended. The government, trade association, and government agencies should work in cooperation to support the parts makers. Moreover, the Sri Lankan government should hold a trade exhibition in India and ASEAN, and parts makers should participate in a motor show and the International Auto Parts Fair as a means to promote their products.
5.2. Mid- to Long-term Strategy
5.2.1. Establishment of Automotive Technology Institute
In order for the Sri Lankan parts makers to improve their long-term competitiveness, technology development is of utmost importance. Recently, global car manufacturers are considering both quality and technology as a criterion for selecting corresponding parts makers. In other words, producers with up-to-date technology have a better chance of supplying global car manufacturers. Therefore, the Sri Lankan government needs to establish a government-affiliated automotive technology institute to take technology to new heights. At present, the Sri Lankan parts makers are spending excessive labor and monetary resources to attain technology demanded by the global market. The Sri Lankan government needs to
Chapter 2 _ Development of the Automobile Components Manufacturing Industry of Sri Lanka through the Creation of Forward Linkages with Global Value Chains • 135 invest in technology innovation. Particularly, the automotive technology institute needs to realize the need prioritize technology development based on global demands. Then, it can provide education for its workers on technology, and at the same time, it should acquire high-quality testing equipment for parts makers to use for developing newer technology. It is also necessary to induce the private sector to participate in the establishment of technology center jointly with the public sector.
During the 1980s, the Korean government tried to promote a technical partnership with foreign firms but their efforts did not bear fruit. In 1994, the five- year plan was included in the XC-5 Project with the aim of developing technology comparable to that of advanced countries. Above all things, the establishment of an automotive technology institute is considered as the most effective means. It focused on developing technology, an evaluation mechanism, and a technical certification model. In particular, a technical training school was internally established to foster high-skilled labor. For four years until 1999, 30 billion won were invested to foster a total of 560 technical personnel.
[Figure 2-18] Function and Role of Korea Automotive Technology Institute
Role of automotive technology institute
Strategic Core Technology National Auto Parts Reliability evaluation and Specialized Technology Development Industry Planning Technology Education development
Research & development/ Reliability certification/ Component testing/ Provide research test Technical guidance Failure analysis Technology Education/ and Facility Manpower training
Source: www.katech.re.kr.
In addition, as a first step towards technological innovation, the Korean government focused on developing design and production technology until 1997. Next, they had brought about modularization of auto parts by 2000.
5.2.2. Promotion of Cooperation between Industry and Education
In order to develop technology and foster a skilled workforce, cooperation between industry and education is needed. One of the biggest challenges in fostering parts makers is the lack of high-skilled labor. Thus, parts makers should
136 • 2014/15 Knowledge Sharing Program with Sri Lanka establish a technology institute in order to sustainably develop high-skilled labor in the long term. However, attaining a desirable technology capacity is limited due to a lack of monetary and labor resources. Therefore, the central and local governments of Sri Lanka should open an automobile technology department in local universities to sustainably provide high-skilled labor. In particular, local universities should conduct research on relevant technology, of which parts producers have not been able to do so due to scarce resources. Once the local government provides a skilled workforce through education in local universities, it can induce a vitalization of the local economy.
In 1981, the Korean government established a university industry cooperation committee in order to localize auto parts. The Auto Parts Industry Association was designated as the committee representative, while professors of mechanical engineering at five universities were appointed as the advisory committee. In 1994, the number of automobile departments increased until 2000, and industrial high schools and vocational training centers had expanded the capacity of the total number of trainees related to the automobile industry.
Korea’s University Industry Cooperation Policy1. Establishment of University Industry Cooperation Committee (1981) - Opening of automobile departments in universities - University Industry Cooperation Projects 2. Implementation of plans to supply technical labor (1994) - Expansion of automobile departments at universities: around 4 (1994) → 6 (2000) - Expansion of automobile departments at colleges: around 15 (1994) → 30 (2000) - Expansion of capacity for the number of students at technical high school: 3,000 (1994) → 5,000 (2000) - Increase in the number of certified technician at vocational training center: 9,000 (1994)→ 15,000 (2000)
Source: Ministry of Education, Science and Technology (2011).
5.2.3. Promotion of Joint Ventures with Global Parts Producers
In order for the Sri Lankan parts makers to supply global car manufacturers, they need to actively attract investment from global parts producers. As price and quality competition are intensifying, and modularization is accelerating among car manufacturers, the role of global parts producers is becoming more and more important. The car manufacturers’ dependence on parts producers is deepening due to the strengthening focus on the development of a green car, autonomous vehicle etc. Once the Sri Lankan parts producers enter into a technical partnership or joint venture with global parts makers, they will have a better chance of supplying global car manufacturers. In the 2000s, sales growth of parts makers in Germany and Japan
Chapter 2 _ Development of the Automobile Components Manufacturing Industry of Sri Lanka through the Creation of Forward Linkages with Global Value Chains • 137 increased at annual average rate of 10%. Therefore, through cooperation with these global parts producers, the Sri Lankan firms can absorb advanced quality control processes and technology.
[Figure 2-19] FDI of Global Automobile Component Firms into Korea
Amount of inverstment (millions$) Number of global suppliers 95 93 93
1,395 1,266
903
~1990 1995~2000 2001~Present
Source: www.kaica.or.kr.
In 1974, the Korean government designated those firms who successfully entered into a technical partnership or attracted a joint venture as specialist firms. During the 1980s, the Korean government provided tax incentives in order to increase exports of auto parts. By 1990, Korea attracted a total of 93 foreign parts producers, and total investments had increased up to 900 million dollars.
Sri Lankan part makers have strong incentives to make connections with Hyundai Motors. Hyundai Motors support 1st tier and 2nd tier partners through technology transfer and quality control. Unlike Japanese companies, Hyundai Motors do not restrict the sales of partner firms to other global companies even though the products are based on the assistance of Hyundai Motors. In 2013 Hyundai-Kia Motor’s 1st and 2nd tier partners (about 300 firms) sold $9.5 billion to global auto makers, such as GM, Ford, Nissan, etc. Hyundai Motors maintains an open position towards part suppliers because it regards the competitiveness of part suppliers as a key factor. In this sense Sri Lanka parts makers need to pay attention to the 1st tier and 2nd tier partners of Hyundai Motors.
138 • 2014/15 Knowledge Sharing Program with Sri Lanka [Figure 2-20] Sales of Hyundai-Kia Motor’s 1st and 2nd Tier Partners to Overseas Global Auto Makers
Amount of Revenue (million$) 9,500
8,600
5,200
2011 2012 2013
Source: www.kaica.or.kr.
Hyundai Motors built a factory in Beijing, China in 2004 and in Alabama, US in 2005. It has also completed the construction of local plants in the Czech Republic, Slovakia, Russia, and Brazil. Thereafter, Hyundai Motors have reached an offshore production capacity of over 400 million vehicles by 2013.
[Figure 2-21] Overseas Investment of Korean Automobile Component Companies
Russia 11 U.S.A 45 st st 1 supplier 30 1 supplier 11 nd Europe 33 2 supplier 15 1st supplier 19 2nd supplier 14
China 417 1st supplier 121 Turkey 11 2nd supplier 296 1st supplier 8 2nd supplier 3 India 71 Brazil 11 1st supplier 42 1st supplier 8 2nd supplier 29 2nd supplier 3
Source: www.kaica.or.kr.
Chapter 2 _ Development of the Automobile Components Manufacturing Industry of Sri Lanka through the Creation of Forward Linkages with Global Value Chains • 139 Hyundai Motors determine corresponding part makers based on public competitive tendering through an established system called VAATZ (Value Advanced Automotive Trade Zone). Since its inception in November 2011, it manages transaction with over 3,500 parts producers. Through VAATZ, Hyundai Motors have standardized a global procurement process for auto parts and shared relevant information through the network it has built. Hyundai Motors has a factory in Chennai, Sri Lanka. Even though it is not easy for Sri Lankan component manufacturers to become 2nd or 3rd tier partners in a short time, there is a possibility to have transactions with Hyundai’s Chennai factory.
140 • 2014/15 Knowledge Sharing Program with Sri Lanka References
Abeyratne, S, Integrating Sri Lankan Industry into the Indian Supply Chains, Pathfinder Foundation, 2013. Agrawal, M. K., From Bharata to India, Chrysee the Golden Press, Volume 1, 2012. Athukorala, Premachandra, Crafting Policies for effective Participation in Global Production Networks, the workshop on ‘Plugging into Global Value Chains; Role of the Trade and Investment Policy’, Malaysia, June 2014. Banga, R., Measuring Value Chains in Global Value Chains, UNCTAD, 2013. Central Bank of Sri Lanka, Annual Report, 2013. Central Intelligence Agency, The World Factbook, 2014. Cho, Byeonghwi, Export to Global Automobile Company, 2011. Cho, Cheol, Hanggu, Lee, and Gyeongyu, Kim, Environmental Change of industry and Development Strategy on Automobile parts industry, KIET Policy Data 2005-19, 2005. Confederation of Indian Industry (CII), Doing Business in Sri Lanka: Handbook for Indian Business, 2012. Coordinating Secretariat for Science, Technology & Innovation, Science, Technology & Innovation Strategy for Sri Lanka; National Coordinating and Monitoring Framework – 2013 - 2015, 2013. Department of Census and Statistics, Annual Survey of Industries, 2012. Department of Commerce, 2015. www.doc.gov.lk Department of National Planning, Ministry of Finance of Sri Lanka, Mahinda Chinthana Vision for the Future (MCVF): National Development Policy Framework for 2010 – 2016, 2010. Department of National Planning, Ministry of Finance of Sri Lanka, Mahinda Chinthana; Vision for a New Sri Lanka; A Ten Year Perspective, Development Framework 2006 – 2016, 2005. Department of National Planning, Ministry of Finance of Sri Lanka, Unstoppable Sri Lanka; the Public Investment Strategy for 2014 – 2016, 2013. Export Development Board of Sri Lanka, Industry Capability Report-Sri Lanka Rubber Products Sector, 2012. Export Development Board, Export Performance Indicators 2004 – 2013, 2014. Hatzichronoglou, T., “Revision of the High Technology Sector and Product Classification,” OECD Science, Technology and Industry Working Papers, 1997. IHS Automotive, Supplying VW Group International Trade Centre (ITC), 2015. www.trademap.org
Chapter 2 _ Development of the Automobile Components Manufacturing Industry of Sri Lanka through the Creation of Forward Linkages with Global Value Chains • 141 IRC, Production and Distribution Survey of 200 auto parts items, 2010. IRC, Status of Toyota automobile group, 2012. Japan External Trade Organization, Survey on the Needs and Strategies for Japan – Sri Lanka Business, 2013. Japan External Trade Organization, The 23rd Survey of Investment Related Costs in Asia and Oceania, 2013. Kim, Suwook, “Korea Automobile Industry’s product innovation history and aftermarket,” Business History Series of Research 22, 2009. KITA, Country information of trade center, Colombo, Sri Lanka, 2014. Korea International Labor Foundation, “Labor Management Guide for Korean company in Sri Lanka,” 2003. Kotra, Auto parts supply guide for German automobile, 2006. Kotra, GM’s Auto parts procurement plan in China, 2005. Kotra, Roadmap for auto parts supply of German Volkswagen group, 2009. Kotra, Trends of US Auto Parts Industry, 2014. Kotra, Why are USA, GM active in sourcing of Korean auto parts?, 2011. Ministry of Finance, Sri Lanka, Budget Speech 2014, 2014. Ministry of Finance, Sri Lanka, Budget Speech 2015, 2015. N. M, Murry and Dowell, P, Examining Gaps and Surpluses in the Automotive Cluster in Tennessee, University of Tennessee Press, 1999. Seo, Hongseok, “Technology Trends for Automobile’s polymeric materials,” KISTI, 2003. Siriweera, W. I., Ship Building in Ancient Sri Lanka, Daily News, Press release November 3, 2011 (in English). Sri Lanka Customs, 2015. www.customs.gov.lk UNCTAD, “Global Value Chains; Investment and Trade for Development,” World Investment Report, 2013. UNESCAP, “Enabling Environment for the Successful Integration of Small and Medium Sized Enterprises in Global Value Chains: Country Studies of Bangladesh, Nepal and Sri Lanka,” Studies in Trade and Investment 70, 2011. University Grants Commission, Admission to undergraduate courses of the Universities in Sri Lanka, 2012 – 2013, 2013. Volkswagen(VW), Sustainability in Supplier Relations at VW, 2010.
142 • 2014/15 Knowledge Sharing Program with Sri Lanka 2014/15 Knowledge Sharing Program with Sri Lanka: Upgrading Technology to Improve Export Competitiveness in Sri Lanka Chapter 3
Technology Business Incubators in Support of Technology-Based Industries in Sri Lanka: Preparatory Study for the Establishment and Operation of the TBI in the Science Park
1. Introduction 2. Field Survey for a TBI in Sri Lanka 3. Benchmarking of Other Countries’ Experiences 4. Core Issues of Feasibility and Business Plan for a TBI in Sri Lanka 5. Policy Recommendations on Planning and Operation of the TBI ■ Chapter 03
Technology Business Incubators in Support of Technology-Based Industries in Sri Lanka: Preparatory Study for the Establishment and Operation of the TBI in the Science Park
Hosaeng Rhee (Center for International Economic Studies, Myongji University) Woosung Lee (Science & Technology Policy Institute) Shehan de Silva (SLINTEC, Sri Lanka) Himali Athaudage (MoTR, Sri Lanka)35)
“Incubators encourage firms to become innovative and competitive. Such a mission can be pursued only if incubators themselves become competitive, business- oriented, and innovative.” (Akçomak 2009)
“In many developing countries, a growth-potential group will have to be ‘pre-incubated’ before entering the incubator, in order to revive and guide entrepreneurial aptitudes.” (Lalkaka 2006) 35)
Summary
What and Why Technology Business Incubator (TBI)?
• TBI: Small management staff that provides the physical space, shared facilities, counseling, training, and information specific to selected technology ventures, with access to university research, financial resources, and technical support services, in one integrated and affordable package → Caring and sharing can facilitate technology startups by reducing initial costs and delays at the early stage.
35) Shehan de Silva is a Senior Scientist and Manager - Strategic Planning of the Sri Lankan Institute of Nanotechnology and Himali Athaudage is the director of the Sri Lankan Ministry of Technology and Research. They are the local consultants for the KSP Sri Lanka 2014 and coauthors of this study in charge of the section 2.
144 • 2014/15 Knowledge Sharing Program with Sri Lanka • The main features of a TBI - Careful selection of prospective entrepreneur-clients - Assistance in accessing seed capital - Training, mentoring, managerial/marketing/technological consulting, networking etc. - Graduation of successful businesses after a reasonable incubation period
The Sri Lankan government is looking for ways and means to make the first TBI a success. This report is to examine the feasibility and business plan for the TBI, and thereby, suggest policy recommendations that can contribute to the successful establishment and management of the TBI in Sri Lanka.
Field Survey for a TBI in Sri Lanka
As a first step, a field survey was carried out to provide basic information for analysis of TBI’s feasibility. The survey identified favorable environment for establishment of a TBI in Sri Lanka, which includes the following.
• Various activities and programs provided to foster entrepreneurship culture and spirit for youth at the primary and secondary level • Quite a few exhibitions and competitions allowing active interaction among inventors, universities, research institutes, industries etc • Existence of PRIs in the S&T area with researchers willing to try startups under the TBI’s support • Innovations taking place in the ICT and apparel industries in particular • Government’s high willingness to support the TBI including construction • Preferable tax treatment on the expenditure spent on the R&D activities • The Hosting Institution (SLINTEC)’s excellent capacity in manufacturing R&Ds and close relationship with large local companies • Preferential access to near-by big markets such as India and Pakistan through FTAs (FTA with China under way) and the South Asian Free Trade Area
Unfavorable environment was also revealed by the survey.
• Reluctance to try technology startups remains large. Graduates with science degrees often leave the science field because of poor salary and research culture. • In the S&T universities, lecturers tend to focus on teaching, and their researches are not market driven. • Despite the large tax incentives on R&D activities, companies tend to concentrate on short-term plans, rather than R&D based growth. • Several governmental support programs for R&Ds (grants and concessional
Chapter 3 _ Technology Business Incubators in Support of Technology-Based Industries in Sri Lanka: Preparatory Study for the Establishment and Operation of the TBI in the Science Park • 145 loans) have been in place, but too small in scale, so, not effective. • Entrepreneurs encounter a number of barriers in attempting to access seed funding from banks. There exist just a small group of angel investors and venture capitals. • Entrepreneurs lack know-how to access markets, especially foreign market. • The TBI building under construction is far from the business center in the city, S&T universities and research institutes.
Benchmarking of Other Countries’ Experiences
Other countries’ experiences can be benchmarked for the planning and operation of Sri Lanka’s TBI. Implications were drawn for Sri Lanka’s TBI from the experiences of Korea, China, and India.
• At the early stage, the government’s support and sponsorship play a critical role in the successful launch and promotion of TBIs. But, as TBIs are on track, the private sector needs to be encouraged to participate in the TBI’s operation for financial sustainability. • Most developing countries suffer from a reluctance to pursue risky technology startups, lack of information, and education for techno-entrepreneurship etc. The TBIs played an important role in promoting a techno-entrepreneurship culture and education. Some successful startup cases nurtured by the TBI can work as role models that young potential technology startups are motivated to emulate. • Networking with knowledge organizations such as S&T universities, PRIs etc, greatly help in identifying/securing promising TBI clients. Researchers in the organizations can be encouraged to start technology-intensive businesses if they are allowed to be on leave for technology startups. • The TBI cannot succeed without competent managers who understand and network businesses or research communities. The role of excellent managers cannot be overemphasized in achieving the TBI’s competitiveness. • As TBIs get on track, they put more emphasis on value-added services, such as consulting, mentoring, technology advisory, IP-related, marketing, and business plan writing assistance services etc.
TBI’s Feasibility and Business Plan
Examination of the TBI’s feasibility derived the following findings:
• The feasibility study showed several strengths and weakness of Sri Lanka’s TBI potential. - From the perspective of current performances, Sri Lanka’s R&D investment
146 • 2014/15 Knowledge Sharing Program with Sri Lanka ratio was absolutely low and their output performance in terms of patents and high-tech exports, which indicates commercial potentials of research, was minimal up to now. - However, Sri Lanka has good potential from the perspective of the government’s policy dedication, good engineering and S&T universities with high-quality HRST (Human Resources for Science and Technology),36) and most importantly recent private sectors’ venture movements.
• The Sri Lankan government's national strategy and high-level interview showed the policy willingness and dedication to establishing a TBI and to technology- commercialization promotion through startups. - Even from the private sector, the incubation activities and the inventors’ competition, high-tech startups are already in motion during the last 2-3 years. - When considering the high potentials of engineering human resources, especially chemical, agricultural, and most importantly software development engineers, Sri Lanka has a good background in the startups movement and TBI establishment.
• The intensive interviews and survey also revealed that there already exist good candidates for high-tech and medium-tech startups from inventors’ competition, PRIs’, and universities’ contract research with industry, and from private sectors’ incubators. - Technology/industry areas suitable for TBI include ICT, nanotechnology, agriculture, apparel and textile, (mineral-based) chemical products, and rubber products. - It was pointed out that best example Sri Lankan startups can contribute to promoting high-tech startups, and the TBI may play a role in developing these best examples.
Core elements of business plan include the following:
• TBI Vision - National wealth creation and startup-economy creation through a dynamic technology entrepreneurship promotion. - In reference with “Develop a dynamic technology transfer platform for wealth creation through the Techno entrepreneurship Initiative” (Sri Lanka National STI Strategy 2011-2015).
36) In fact, Sri Lanka does not have a unified method of monetizing university led research. The ease of which university IP can be brought in to a commercial landscape is suspect. Also, the 300% tax benefit does not affect BOI based exporters.
Chapter 3 _ Technology Business Incubators in Support of Technology-Based Industries in Sri Lanka: Preparatory Study for the Establishment and Operation of the TBI in the Science Park • 147 • TBI Mission - Build up a national platform for technology entrepreneurship - Promotion of national startup activities ensuring national venture eco- system birth and growth - Creating national technology entrepreneurship network in Sri Lanka linking all technology-entrepreneurship-related stakeholders, such as large industrial groups, investors, universities, PRIs, and ministries.
• Target Technologies / Industries - ICT technology (Software / Mobile Apps development) - Nano-technology sector (Materials and Applications to agro-processing, rubber, textiles and etc.) - Agro-processing (Natural Products, Health Products, Nutrient Products) and Cosmetics - Rubber/Chemical Products - Technology-based new Apparel/Garment Industry
• TBI Governance - TBI Board of Directors: The roles and responsibilities of the BOD are the directing and monitoring of the TBI in a strategic manner. A TBI's strategic and major financial decision maker, - TBI Advisory Board: It consists of technology, management, finance, and legal experts from various stakeholders such as universities, PRIs, inventors' associations, SMEs associations, and professional service associations.
Policy Recommendations
Based on the previous analysis (field survey, benchmarking, examination of feasibility, and business plan), policy recommendations are laid out for the successful establishment and operation of the TBI.
1. The Center for Innovation & Entrepreneurship Promotion (CIEP) as the Pre- Incubation Program of the TBI in the Colombo City Area
Start-up education and training (SET program), competition events etc. can cultivate an entrepreneurial culture. • The CIEP will be the hub for the cultivation of a technology entrepreneurial culture, climate, and ecosystem. The CIEP, as a liaison office in the city area, can increase potential clients’ accessibility to the TBI. • Symbolic Role of Success Startup Cases: Star startups have to be incubated as early as possible. They can help form advocacy for the TBI, and provide role models for the young techno-entrepreneurial minds.
148 • 2014/15 Knowledge Sharing Program with Sri Lanka 2. Target Industries and Technologies
As Sri Lanka’s first TBI, it needs to broaden its target industries and technologies as far as they are high-value-added. • Exclusion of the ICT from the first TBI’s target areas would negatively affect the TBI’s early performance and settlement. • As soon as the SLINTEC-led TBI in the Science Park gets on track, more TBIs that focus on specific industries/technologies need to be introduced.
3. Governance for PPP
• Participation of the private sector, especially already established large companies, in the TBI is very important for the TBI’s long-term financial sustainability with the phase out of government subsidies in the early stage. • Tax incentives and the procurement-guaranteed R&D program may give some incentive for the companies’ participation.
4. Recruiting a Capable Manager
• The right manager has to be recruited at the planning stage, so that the manager may play a crucial role in networking with stakeholders and sponsors, preparing for the CIEP, as well as in detailing a business plan. • The manager has to be equipped with a business and R&D-related mind and experiences, as well as capabilities to network with both communities.
5. Networking of Stakeholders and Sponsors
• Stakeholders and sponsors have to be identified and networked at the outset. (central and local government, S&T-related universities, research institutes, large corporations, and industry associations) • Stakeholders’ supports are a necessary condition for the TBI’s success in that they can help form favorable atmosphere and provide supportive services for the TBI.
6. Securing Deal Flow (On-Going Critical Mass of Quality Clients)
• The CIEP: Pre-incubation programs such as the CIEP can identify and provide a pool of potential quality clients with growth potential for the TBI. • Allowing Leave of Absence for Start-Up Researchers: The most promising pool of potential technology start-ups comes from the existing researchers at the S&T universities and research institutes. Allowing leave of absence can give them incentives to pursue technology start-ups.
Chapter 3 _ Technology Business Incubators in Support of Technology-Based Industries in Sri Lanka: Preparatory Study for the Establishment and Operation of the TBI in the Science Park • 149 7. Financial Sustainability of the TBI
• Government Support at the Early Stage: The government needs to provide financial support at the early stage. The financial support will have to be gradually withdrawn, so that the TBI can become self-sustainable. • Full Support for a Techno-entrepreneurial Culture Promotion: The CIEP’s function should remain subsidized since it has a great deal of positive externalities on innovation and entrepreneurship promotion. • Extension of the Triple Tax Deduction: The Sri Lankan government needs to consider extending the “Triple tax deduction” for charity funds, private (large) companies, and individuals as long as they are making contributions to S&T- focused and R&D-related institutions including the PRIs, the TBI etc.
8. Financing for the Clients
• Significant Increase of Existing Funds for Start-ups: The existing mechanisms have to be fully utilized with a significant increase of fund for the mechanism. • Procurement-Backed R&D Assistance Program: The purchase guarantee by public organizations or private large companies can facilitate start-ups and SMEs’ R&D by sharing R&D costs and resolving marketing problems at the initial stage. • Extension of Tax Incentives: The government needs to consider offering tax incentives for individuals who invest in the venture capital fund.
9. Monitoring and Evaluation
• The M&E is required to draw evidence and consensus on the effective spending of public money. Clearly articulated criteria and indicators need to be prepared as the TBI starts its operation. • After 2 or 3 years of the TBI’s operation, all subsidies should be conditional on the rigorous M&E results so that the TBI should be induced to become perfor- mance-oriented as if it were under the market pressure.
150 • 2014/15 Knowledge Sharing Program with Sri Lanka 1. Introduction
Innovations are prerequisite for economic competitiveness, so, developing as well as developed countries have tried to promote innovations. Innovations exert a great deal of positive externalities, which gives the government every reason to intervene and employ policy measures that can support innovation37) (World Bank, 2010).
Sri Lanka has been pursuing a transformation into a knowledge-intensive economy. As one of its objectives in this regard, the Sri Lankan government aims to foster technology entrepreneurship and increase technology-intensive exports, which are considered to be essential for the high-value-added structure of the Sri Lankan economy. In this vein, the government is trying to find out how to nurture technology entrepreneurship and start-ups.
It is well known that technology startups usually face various difficulties at the early stage.38) Most of the governments in developing and developed countries have devised and applied promotion measures, which include entrepreneurship education, infrastructure supports, funding, mentoring, and consulting services etc. The table 1 shows the classification and examples of such measures.
Classification of Measures to Promote Technology StartupsConstraints Support measures Entrepreneurship • Startup academy for pre-startups, potential startups etc. Education • Entrepreneurship and startup education at schools • Start-up grants and loans • Public venture capital Financial Aid • Technology guarantee • Tax exemptions Infrastructure and • Low-cost spaces, facilities, equipment etc. (TBIs) Consulting • Consulting assistance on technological, managerial, legal difficulties • Building role models: Awards for successful startups, Startup business plan Promotion and competition, activities to raise public awareness of entrepreneurship etc. Marketing • Trade fairs, support for entry into foreign markets etc. • Certification with government’s priority purchases
Source: Modified from GIZ (2012).
37) In addition to the positive externalities (network effects, knowledge spillovers, learning effects), asymmetric information between technology start-ups and funding agents can cause market failure. (giz, 2012) 38) The valley of death refers to “the high probability that a startup firm will die off before a steady stream of revenues is established. After a firm receives its first round of financing, it incurs a lot of initial costs. Offices are usually built, staff is hired and operating costs are incurred; meanwhile, the firm is not earning significant income. Unless a firm can effectively manage itself through the valley of death, it will fall victim to negative cash flows.” (Investopedia, 2014)
Chapter 3 _ Technology Business Incubators in Support of Technology-Based Industries in Sri Lanka: Preparatory Study for the Establishment and Operation of the TBI in the Science Park • 151 The KSP Sri Lanka 2013 looked into policies and measures to promote technology startups in Sri Lanka by analyzing Sri Lanka’s current status of R&D capacities and technology startups. The policy recommendations in the KSP 2013 included the promotion of technology entrepreneurship education and the establishment of 2 or 3 pilot TBIs, which turned out to be in line with the Sri Lankan government’s intention to introduce a technology entrepreneurship promotion mechanism in the Science Park.
The Sri Lankan government opened the science park in 2013 with plans for further expansion. The Sri Lanka Institute of Nanotechnolgy (SLINTEC) entered the park first, and the other institutions will follow. The government has tried to promote S&T and value addition in manufacturing sectors, and thereby, increase its technology intensive exports. As the figures below show, Sri Lanka has been experiencing unsatisfactory performances in the manufacturing sector, gaps in trade balance, and technology-intensive exports.
[Figure 3-1] Manufacturing, Value Added (% of GDP)
35
30 Korea, Rep.
Malaysia 25 Upper middle income
20 Sri Lanka Lower middle income 15
10 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012
Source: World DataBank.39)
39)
39) The World Bank classifies countries into income groups as follows. The low income group: less than $1,045, the lower middle income group: $1,045~$4,125, the upper middle income group: $4,125~$12,746, the high income group: more than 12,746. So, Sri Lanka with income of $3,170 belongs to the lower middle group. The average income of the lower-middle income countries is $2,067.
152 • 2014/15 Knowledge Sharing Program with Sri Lanka [Figure 3-2] Export & Import Value Index (2000 = 100)
350
300
250 Export value index 200 (2000=100)
150 Import value index (2000=100) 100
50
0 2000 2002 2004 2006 2008 2010 2012
Note: Sri Lanka’s major export items consist of industrial products (textiles and garments, rubber products, germs/ diamonds/jewelry, petroleum products), agricultural products, (tea, rubber, coconut, spices), mineral resources. Source: World DataBank.
[Figure 3-3] High-Technology Exports (% of Manufactured Exports)
40
35 Sri Lanka 30 India 25 Korea, Rep. 20 Lower middle income 15 Upper middle 10 income
5
0 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010
Note: High-technology exports are products with high R&D intensity, such as in aerospace, computers, pharmaceuticals, scientific instruments, and electrical machinery. Source: World DataBank.
Chapter 3 _ Technology Business Incubators in Support of Technology-Based Industries in Sri Lanka: Preparatory Study for the Establishment and Operation of the TBI in the Science Park • 153 Upon the completion of the KSP 2013, the Sri Lankan government decided to build the first TBI in the Science Park. The brick-and-mortar building is already under construction in the Science Park, and expected to be done by the end of the first half of this year.40) The first TBI’s successful performance will provide momentum for the establishment of more TBIs across Sri Lanka. The Sri Lankan government is looking for ways and means to make the first TBI a success, and the KSP 2014 seeks to provide ideas to meet the needs of the Sri Lankan government. The main focus of this report is to examine its feasibility and provide core contents of a business plan for the TBI in Sri Lanka, and thereby, suggest policy recommendations that can contribute to improving the feasibility and successful management of the TBI.
Technology Business Incubator: What and Why?
What is a TBI?
• Small management staff that provides the physical space, shared facilities, counseling, training, and information specific to selected technology ventures, with access to university research, financial resources and technical support services, in one integrated and affordable package → enterprise creation focused on technology-based ventures: ‘caring and sharing’ shown to facilitate business startups by reducing initial costs and delays at the startup stage. • The main features of a TBI - Careful selection of prospective entrepreneur-clients - Assistance in accessing seed capital - Training, mentoring, (managerial, marketing, technological) consulting, networking etc. - Graduation of successful businesses after a reasonable incubation period
Target Entry Exit Incubation Graduates Market Criteria Criteria
Pre- Business Financial Technology After Training Incubation Advice Support Support Care
Physical Space
Networks
40) The Coordinating Secretariat for Science, Technology and Innovation (COSTI) had submitted proposals to the Government to construct a National Science Centre in 2010. In the 2014 Budget, funds were allocated to facilitate this proposal. The Ministry immediately started planning for a Science Centre and an Incubation Centre both to be constructed in the Nano Science Park situated in Homagama. Initially Rs. Mn. 300 was allocated to the Urban Development Authority (UDA). The MOTR started the project with UDA and SLINTEC. The foundation stone was laid in December 2014, and their construction is under way. For the year 2015, the funds are allocated to the Ministry of Higher Education where the funds of technology and research are allocated. Their construction is expected to be completed this year. Although the model for operation is yet undecided, many entrepreneurs have set their sights for a slot in the TIC when it is completed.
154 • 2014/15 Knowledge Sharing Program with Sri Lanka continued
Why TBI?
Benefits of Well-Managed Incubators • Clients: TBI enhances the chances of success, raises credibility, helps improve skills, creates synergy among client-firms, and facilitates access to mentors, information, and seed capital. • Research institutes and universities: The TBI helps strengthen interactions among U-I-R, promotes R&D commercialization, and gives opportunities for faculty/graduate students to better utilize their capabilities. • Businesses: TBI can develop opportunities for acquiring innovations, supply chain management and spin-offs, and helps them meet their social responsibilities. • Investors: TBI provides risk capitals a promising pool of startup companies for investment. • Local community: TBI creates entrepreneurial culture, promotes regional development, generates jobs, incomes and taxes, and becomes a demonstration of the government’s political commitment to small businesses.
Concerns regarding Incubators • Calls for good business infrastructure in a good location. • May be dependent on government support in policy, infrastructure, and initial funding, including external subsidy for some years before it can become self-sustainable. • May be expensive as it provides focused assistance and work-spaces to only a selected group of potential winners. • May be duplicative as it may undermine existing markets for business development services. • Requires experienced management teams. • Creates dependency by sheltering entrepreneurs from the harsh realities of the market.
Source: quoted from infoDev (2010), Lalkaka (2006)
This study starts with the analysis of demands for the TBI services in Sri Lanka. Securing market demands is essential for the TBI’s feasibility so, a field survey was carried out to identify the market demands. Then, implications are drawn from the experiences and best practices of the other countries including Korea, China, and India. Building on these analyses, this study goes over the core elements of the feasibility and business plan of the first TBI to ensure its successful establishment and management. Lastly, policy recommendations are drawn for the successful operation of the TBI.
Chapter 3 _ Technology Business Incubators in Support of Technology-Based Industries in Sri Lanka: Preparatory Study for the Establishment and Operation of the TBI in the Science Park • 155 [Figure 3-4] Structure of the Report
Field study Benchmarking on TBI-related of TBI experiences environment in SL esp. in DCs
• Analysis of TBI’s feasibility • Core elements of business plan
Policy recommendations for feasibility improvement and successful operation of the TBI
2. Field Survey for a TBI in Sri Lanka
The purpose of the field survey is to identify the market demand for a TBI in Sri Lanka. The survey seeks to examine the current technology venture status and trends, workforce availability, funding and financial networks, potential markets, the regulatory frameworks and infrastructure, the state of intellectual property, and support mechanisms within the country. In addition, the survey also carries out case studies of current (primitive form of) incubators functioning within the entrepreneurship ecosystem in Sri Lanka. Market demand seeks to uncover what factors suggest an incubator can be successful. Establishing market demand for an incubator is imperative since, without it, other success criteria become moot.
156 • 2014/15 Knowledge Sharing Program with Sri Lanka Methodology of the Field Survey
Primary and secondary data were collected. A desk review was carried out to obtain country level data and supplement the research findings. Primary data was collected in the form of face-to-face interviews with key informants and stakeholders. The key informants and stakeholders were identified both by the SLINTEC and a snowball sampling method where existing study subjects recommended future subjects from among their acquaintances. All interviews were carried out between the period of 22 Sept ~ 14 November, 2014. Each interview lasted approximately 1hr 30mins. 10 entrepreneurs and inventors, 1 investor, 7 universities and public research institutes and 5 incubators were enrolled into this interview. Different survey tools were specifically designed for each group to gather the necessary information. Follow-up phone calls were made as needed to seek clarification or new information. Basic information concerning the entrepreneurs and inventors recruited into the survey is shown in the appendix.
Source: SLINTEC (2014).
6 of the 10 entrepreneurs and inventors interviewed said they would have been willing to locate within an incubator given the hypothetical subsidies of 50% for 1~6months, 33% for 7~21 months, and 17% for 13~18 months at the outset of their business. Of the 10 entrepreneurs and inventors interviewed, 6 reported requiring an office or lab space for their businesses. The space requirement varied from 150 to 6000ft2.
2.1. Potential Demands for Entry into the TBI
Sri Lanka has one of the highest literacy rates among developing nations at 91%. Overall unemployment remains low at 4% but youth unemployment is high compared to other countries in the region: 15.5% male youth unemployment and 24.1% female youth unemployment. Young people are currently suffering from a wave of “corporate fatigue” and are looking for alternate job options. While parental pressure to follow conventional jobs remains large and cannot in any way be ignored, entrepreneurship is gaining increasing social legitimacy among this younger generation.
Many of those that graduate with science degrees often leave the due to poor salaries and the prevailing research culture in the country. Having recognized the importance of fostering a research and innovation driven economy some small steps have been taken to change the existing situation. Extracts from the innovator survey highlight some of the initiatives being taken at the primary, secondary, and university levels.
Chapter 3 _ Technology Business Incubators in Support of Technology-Based Industries in Sri Lanka: Preparatory Study for the Establishment and Operation of the TBI in the Science Park • 157 2.1.1. Priming of a Workforce: Primary and Secondary Level
There are several activities and programs that intend to foster an entrepreneurial culture and spirit for youth at the primary and secondary level.
2.1.1.1. School Young Inventors Club41)
The objective of the young inventors club is to promote and encourage creativeness among school children, stimulate interest in science and technology and help them participate in competitions and exhibitions. Each club is officially registered with the Sri Lanka Inventors Commission (SLIC). This is the official point of interaction between the school inventors and the SLIC. There are a 115 school young inventors clubs registered with SLIC currently.
Television Young Inventors Club Program
This is the first reality TV program done on local television for school inventors. Young inventors from the school inventors clubs are given a problem that needs a technological solution. Within a limited time period, children are expected to conceptualize a solution and present it to an eminent panel of inventors and academics who then pose tough questions on the viability of the solution. The TV program was co-sponsored by the SLIC, the Ministry of Education, Sampath Bank, and the Independent Television Network. The Toast Masters club of Sampath Bank ran special workshops in presentation skills for all school participants. Having first aired in 2013, 48 schools took part from all over the island for 30weeks. The winning designs were from Mawanella and Trincomalee.
Source: SLINTEC (2014).
2.1.1.2. Young Entrepreneurs Sri Lanka (YESL)
YESL was established in 1998 and is a member nation franchise holder of Junior Achievement Worldwide.42) The three core areas of training are financial literacy, work force readiness, and entrepreneurship. Key informant interviews revealed that different programs were run for elementary (grades 1 -7), middle School (grades 7~9), and high School students (Ordinary and Advanced level).43) Middle school
41) The circular No 23 of 2006 issued by the Ministry of Education made setting up of Young Inventors Clubs in each 1AB, 1C and Type 2 schools compulsory (Sri Lanka Inventors Commission, 2014). Other schools that do not fall into this category but are interested in starting clubs are encouraged and given the necessary help to do so. 42) Junior Achievement Worldwide working in 125 countries provides “a variety of practical business economics and entrepreneur education programs” focused on young people aged 5~25. 43) Elementary students are taught about economic concepts through stories, types of jobs, the interdependent role of workers in a community, how businesses operate in various countries and the complexities of international trade. Middle school level programs examine the U.S. Economic System.
158 • 2014/15 Knowledge Sharing Program with Sri Lanka students are helped to discover what it takes to start and run a business. Students in high schools are trained to improve their interpersonal effectiveness, encouraged to form mini corporations under the guidance of volunteer business advisors. YESL has reached over 460 schools and 42,500 children living in both rural and urban areas since its inception.
2.1.2. Priming of a Workforce: University Level
Stakeholder discussions revealed that Sri Lankan universities produce approximately 20,000 final year research projects, of which about 5000 are Science and Tech related.44) While none of these projects have proceeded to hit the market, it highlights the potential that lies within these universities. The top three universities for research are Moratuwa University, Colombo University, and Peradeniya University. Key innovation and entrepreneurial initiatives that have been made by these universities are discussed below.
2.1.2.1. Moratuwa University
Moratuwa University is leading the way with industry-university research labs.45) It currently houses six labs where applied research, wholly funded by the industry, is carried out. Top graduates are snapped up by these research cells that offer them paid employment.
The university set up ‘UNI Consultancies’ in 2001, an association registered as a company with the objective of leveraging the vast expertise, knowledge, and experience of the academic staff of Moratuwa to meet industry needs. Their long terms goals are to “provide opportunities for technology transfer to industry”, advisory services, and “be a catalyst for product development in Sri Lankan industries” (UNI Consultancies, 2005).
Moratuwa University has also introduced a Minor in Entrepreneurship offered together with the Major in Engineering.46) The survey did reveal, however, that this initiative has had limited success. Students often drop out of the entrepreneurship modules due to the heavy workload of their major. Academics, as opposed to
High school students undertake computer simulated programs (initiated by the Citi Group) which allow student to assume the role of bankers and make banking decisions. 44) There are 15 universities under the purview of the University Grants Commission, 2 under the Ministry of Education, 1 under the Ministry of Defense and 1 under the Ministry of Vocational and Technical Training. 45) Main areas of research here include Engineering, Information Technology and Architecture. The university has published 178 journal articles and registered 84 patents. It has also collaborated with 80 institutions thus far: 18 from North America, 23 from Europe and 48 from the Asia Pacific region (Coordinating Secretariat for Science, Technology and Innovation, 2014). 46) The Minor is optional and offered as a set of 12 modules arranged over a 4year period.
Chapter 3 _ Technology Business Incubators in Support of Technology-Based Industries in Sri Lanka: Preparatory Study for the Establishment and Operation of the TBI in the Science Park • 159 entrepreneurs, teaching the entrepreneurship degree and visiting industry experts and merely sharing their experiences, rather than teaching subject content, were key reasons for discontent with the running of the Minor program.
Another key initiative is the Electronic and Electrical Technology Incubator that was established within the Engineering Design Centre. The incubator was set up in September 2011 as a joint initiative between the university, the electrical and electronic industry, and the Ministry of Industry and Commerce.47) Also of note is that the incubator does not have a separate physical space but rather exists at a more conceptual level.48) The survey revealed that the incubator was virtually defunct due to a lack of financing, prioritization, and insufficient knowledge on how to run the incubator.
2.1.2.2. University of Colombo
A key initiative of the university has been the establishment of the Colombo Science and Technology Cell in 2009.49) The Cell was registered as a Company (Limited by Guarantee) and was a joint venture operated by seven university departments. Among their portfolio of activities, the Cell aims to have cooperative research projects on request by industry, provide technical assistance for SMEs, and facilitate university-industry exchange programs.
2.1.2.3. University of Peradeniya
A key initiative of the university has been the establishment of the Engineering Design Centre in 1993.50) This was established as a Science and Technology project of the Asian Development Bank and is now an entirely self-supporting organization. It is governed by an executive committee consisting of five faculty members and one industry expert. Table 3-2 below shows the number of jobs handled by the Engineering Centre as of 2010 and some of their clients.
47) Only six of the twelve originally selected have stayed on in the incubator. The follow-up fund allocation of Rs 6million promised by The Ministry has yet not been received. In October 2011, The Ministry provided Rs 10million for setting of the incubator. Twelve student incubatees were enrolled in May 2012. 48) Two academic staff members and one office assistant were available for running of the incubator. None of them were employed for the incubator full-time. 49) The University of Colombo has collaborated with 525 institutions (148 in North America, 25 in South America, 161 in Europe, 16 in the Middle East, 20 in Africa and a 155 in the Asia Pacific region) and co- authored 636 publications (Coordinating Secretariat for Science, Technology and Innovation, 2014). 50) The University of Peradeniya has collaborated with 641 institutions (178 in North America, 18 in South America, 170 in Europe, 21 in the Middle East, 28 in Africa, 226 in the Asia Pacific region) and co- authored 757 publications (Coordinating Secretariat for Science, Technology and Innovation, 2014).
160 • 2014/15 Knowledge Sharing Program with Sri Lanka
Portfolio of the Engineering Design Centre, University of PeradeniyaJob Value Number of jobs Clients < 0.1 million 383 - 0.1 ~ 0.5 million 94 - Sri Lanka Railways, Sri Lanka Red Cross Society, Trax Rail Pvt Ltd, Colombo Dockyard Pvt Ltd, Department of Industrial Development of Enterprise Promotion, 0.5 ~ 1.0 million 19 Ministry of Science and Technology, Ceylon Electricity Board, Colour Products Pvt Ltd, Urban Development Authority, Ceylon Fishery Harbours Corporation Road Development Authority, China Harbour Engineering Company, Keangnam Enterprise > 1 million 15 Devlopment, Tea Shakthi Fund, Ceylon Petroleum Corporation, Disaster Management Centre
Source: Engineering Design Centre, University of Peradeniya, 2009.
Common problems at all universities, as discovered by stakeholder interviews, included insufficient funding for equipment and laboratories, research not being market-driven, and lecturers tending to concentrate on teaching rather than research due to their immense workload.51) The ineffective asset management at universities (research labs closing at 4pm and universities not being allowed to rent out physical space as per the University Act) were highlighted as factors impeding research, development, and innovation within the university space.
2.1.3. Technology Entrepreneurship Status and Trends
Most innovators and entrepreneurs shared the opinion that inventions in Sri Lanka tended to stay as inventions rather than graduate through the process of becoming innovations, thus, tech start-ups were described as being in a “naïve or underdeveloped state”. Also highlighted were that, most innovations in the country tended to be low-tech ones.
Government institutes, inventors, entrepreneurs, and investors were asked whether innovations in Sri Lanka tended to concentrate in a particular industry/ sector. Mixed responses were received to this question. While the energy and electrical sectors were mentioned, the ICT and apparel industries were highlighted in particular.
Concentration of innovations in the ICT sector was justified by the availability
51) It was also highlighted that the education system was churning out students that were highly qualified academically but lacked creative thinking capacity.
Chapter 3 _ Technology Business Incubators in Support of Technology-Based Industries in Sri Lanka: Preparatory Study for the Establishment and Operation of the TBI in the Science Park • 161 of human resources, the comparatively small initial investment required, the quick financial return on investments, and the bias of investors towards this sector. Innovations in the apparel industry were justified by the globally advanced and competitive level at which the Sri Lankan apparel sector currently lies.52)
Investors highlighted that recent years have seen startups in Sri Lanka capitalizing on some of the major global trends. As a result, what is seen is a replication of existing knowledge rather than the creation of new knowledge. Lanka Angel Networks and Blue Ocean Ventures were highlighted as some of the active champions of tech ventures in Sri Lanka. As the apparel and ICT industries were highlighted by the key informants and stakeholders, they are briefly discussed in further detail below.
Apparel Industry: The country “aims to be one of the top 10 apparel exporters in the world by 2020.”53) (Abeysinghe, 2014) As Sri Lanka no longer enjoys a low competitive cost labor comparative advantage, it cannot compete with countries such as Bangladesh and India in the low-value, high-volume markets. Instead, it aims to reach high-value, low-volume markets. “Sri Lanka is seeking duty free access to potential future markets for apparel in the region such as China through FTAs.” (Abeysinghe, 2014)
ICT Industry: “Sri Lanka acts as an offshore development center for [the] USA, Ireland, [the] UK, Australia, and as a joint venture development center for Sweden, Norway, [the] USA, and Japan. Several transnational ICT companies have invested in Sri Lanka, some of which run their R&D departments here. Sri Lankan software companies are presently doing outsource contacts for USA, Europe and Japanese markets.”54) (Ministry of Technology & Research, 2010)
2.2. Service Needs by the Potential Clients (tenants)
Entrepreneurs and inventors were asked to rate the importance of various potential service offerings of an incubator program on a scale of 1 to 5 with 1 being very important and 5 being of little importance. 80% of entrepreneurs and inventors gave access to capital a rating of 1 (i.e. very important). All entrepreneurs
52) Others, however, expressed the view that innovations tended to be spread out evenly across the board. 53) “Sri Lankan apparel exports worth US$4.5billion accounting for 1% of the apparel exports worldwide - ranks it at the 20th place in the global apparel export league tables.” (Abeysinghe, 2014) 54) In 2010, there were about 75 software development companies in operation. “In 2012, 24.6% of total service exports were ICT service exports. Estimated exports of software and related services in the year 2003 were valued at US$ 70 million.” “Sri Lankan software runs in some of the stock markets, such as Boston-USA and Croatia. Airlines such as Emirates, UAE, Burton-Scandinavia also use Sri Lankan software. Sri Lankan software also has its name in HRM and Telecom billing.” (Ministry of Technology & Research, 2010)
162 • 2014/15 Knowledge Sharing Program with Sri Lanka and inventors gave ‘strategic partnering’ a rating of 1-3 (very important ~ somewhat important). Assistance with ‘product development’, ‘business plan development’, ‘basic office services’, and ‘marketing’ came a close second with 90% of entrepreneurs and inventors giving it a rating of 1 to 3. Also important to potential services of the incubator program were ‘law services’, ‘accounting and financial reporting’, and ‘assistance with product costing/ pricing’ with 80% of entrepreneurs and inventors giving it a rating of 1 to 3. The following table provides further information on this topic.
Demand for Potential Services by an Incubation Program% of entrepreneurs & % of entrepreneurs & Services inventors with a rating of 1 inventors with a rating of 1-3 High speed internet 60 70 Business plan development 60 90 Marketing 50 90 Website development 40 70 Market research 10 60 Law services 40 80 Basic office services 30 90 Accounting/ financial reporting 20 80 Access to capital/financing 80 100 E-commerce/technology 40 60 Strategic partnering 40 100 Product costing/pricing 50 80 Product development 50 90 Human resources 50 60
Note: The rating 1 means ‘very important’, 3 ‘somewhat important’. Source: Primary data – SLINTEC, 2014.
Five of the ten entrepreneurs reported having accessed external capital when starting their businesses as shown in the Table 3-3. Five of the ten entrepreneurs also reported having accessed law services. Three of the ten entrepreneurs had accessed marketing assistance while two reported having accessed assistance for the development of their business plans. Virtually all forms of assistance were from personal contacts and friends. One entrepreneur reported obtaining a variety of services from an incubator while another reported having obtained assistance from various government offices. Other services that had been obtained included secretarial work, product testing, technical knowledge and know-how, auditing,
Chapter 3 _ Technology Business Incubators in Support of Technology-Based Industries in Sri Lanka: Preparatory Study for the Establishment and Operation of the TBI in the Science Park • 163 telecom services, and mentorship for learning to speak to investors.
2.2.1. Funding and Finances
Access to funding was highlighted as the single biggest factor for a gap between research and commercialization of innovations. 8 out of 10 entrepreneurs surveyed gave “access to capital / financing” a rating of “1” i.e. of extreme importance when considering the various potential service offerings of an incubator. The amount of seed funding used to start businesses amongst this group varied from 1 ~ 500,000 US dollars. 5 out of the 10 entrepreneurs surveyed started their businesses using their own personal funding. Table 3-4 below shows the amount of seed funding, source of seed funding, and the current financial status of each entrepreneur surveyed.
Seed Funding and Current Financial Status of the Ten EntrepreneursAmount of Current financial status seed funding Source of seed funding (Profits made in the past year - Rs) (Rs) Unsure of total revenue generated but 20,000,000 Co-founder of business/ friend reported having earned US$200,000 – 300,000 from India alone 10,000 Personal funding 0 – Has not sold any products as yet Personal funding. Could not provide numerical value but 200,000 Mortgaged personal belongings described profits as low 45,000 Personal funding 0 – No sales last year US$ 31,500 Lanka Angel Network 0 – Made sales but yet to make profits 65* Personal funding 0 – Sold business Lanka Angel Network, Blue Ocean 6,000,000 0 – Made sales but yet to make profits Ventures and Family/ Friend 1000 Personal funding 0 – Has not sold any products as yet Indian Angel Network, 500 US$ 500,000 startups (venture capital firm out US$ > 5 million of the US) and Family/Friends US$ 15,000 – Incubator 0 – Has not sold any products as yet 50,000
Note: * Rs65 was invested in 1970 at the inception of the business. Follow up funding of Rs. 200,000 was invested subsequently in 1971 by an individual. Source: Primary data – SLINTEC, 2014.
164 • 2014/15 Knowledge Sharing Program with Sri Lanka 2.2.1.1. Government’s Financial Supports
The Sri Lankan government has introduced several financial support measures even if they are not very broad. Below is the summary of key measures.
1) Tax Concessions
In 2011 the Government has introduced a significant tax deduction system where the expenditure incurred on R&D expenditure of an entity where a PRI is involved is considered as eligible for the system. The deductible tax is twice the amount spent on the R&D activity. In 2012, the deductible amount was increased to three time of the expended amount. The concession was extended to R&D activities in the private sector as well. In 2014, women entrepreneurs were made eligible for interest free loans.
Profits of research companies and income earned by researchers are taxed at lower rates. The VAT is exempted for supply of R&D services. Many equipment and reagents needed for R&D are also exempted from VAT and customs duty.
2) Technology Startup Grants
The National Science Foundation (NSF) and the Sri Lanka Inventors Commission (SLIC) have schemes to provide grants for technology startups. The SLIC developed a comprehensive and transparent methodology to provide financial grants to appropriate inventors, but the amount granted is minimal. The SLIC has also prepared a proposal to provide angel funding to promote startups of innovation, which is submitted to the Treasury. The approval of the proposal is pending.
On the other hand, the NSF has provided technology grants such as the “Support for Technology Development” and the “Support for Startup Businesses Based on Novel Technologies.” At the initial stage of the grants, the NSF received a low number of applications with poor quality. The Technology Division of the NSF conducted awareness programs on two grant schemes and workshops on effective proposal writing. As a result, applications increased in 2012. Still, the NSF received a limited number of applications under the “Support for Startup businesses based on new technologies,” where the majority of which fell out of the scope of the grant scheme. Furthermore, the amount of the grants is too small to be effective.
3) Techno-Entrepreneurship Development Program
The former Ministry of Technology and Research (now a Division (TRD) under the Ministry of Highways, Higher Education and Investment Promotion) is allocated
Chapter 3 _ Technology Business Incubators in Support of Technology-Based Industries in Sri Lanka: Preparatory Study for the Establishment and Operation of the TBI in the Science Park • 165 funding for a program called “Techno-Entrepreneurship development”. The objective of this program is to provide funding for inventors or entrepreneurs, new or already in business, to start or add a technology intensive business in the production of, a new or improve the existing product, a process or an organization.
The TRD will call for proposals from entrepreneurs and inventors to submit their proposals for funding in the first part of the year. A team comprising of subject specialists and other renowned entrepreneurs and inventors will evaluate the proposals and submit their conclusion to the TRD. The TRD through the Treasury will fund the entity to follow the proposal they have submitted. The TRD will be monitoring the progress of the project through the action plan that will be developed by consultation with the proposer.
In the meantime, the TRD will be requesting all universities to submit research papers/theses submitted by students and lecturers on technology related subjects to find the potential of each research to be commercialized. A competent team will evaluate and recommend the possibility of commercialization. If a positive outcome is shown, with the consent of the author of the research and with consultation of the relevant RPI, funding can be provided to start pilot projects.
2.2.1.2. Venture Funds
Entrepreneur surveys revealed that there was a very small angel and venture capital network in Sri Lanka but, it was growing. The two companies highlighted were the Lanka Angel Network (LAN) and Blue Ocean Ventures (BOV).
1) Lanka Angel Network
LAN is Sri Lanka’s first alliance of angel investors consisting of about 60 investors. 16 companies have been funded thus far and approximately Rs250 ~ 300million has been invested in start-ups to date.55) Table 3-5 below shows the names and types of companies that have been funded by LAN thus far.
55) LAN partners include the Indian Angel Network, Sri Lanka Inventors Commission, The Ceylon Chamber of Commerce, PWC, Blue Ocean Ventures, Sri Lanka Institute of Nanotechnology, Orion City, Venture Engine, Idea Mart, Academy of Design, Yarl IT Hub and LinkLK.
166 • 2014/15 Knowledge Sharing Program with Sri Lanka
Companies That Have Been Funded by LAN to DateName of company Type of company Lanka BPO Academy Training and Capability Building for the BPO Industry in Sri Lanka 24/7 Techies Virtual CIO for US SMBs Nithya Designer Fashion with Traditional Handlooms Lonali Environmentally Friendly and Innovative Designs Takas.lk Electronic Ecommerce in Sri Lanka Trekurious Unique and Exclusive Experiences and Activities in Sri Lanka Mywish wedding pages Social Wedding Pages and Invitations for the Special Event of Your Life Wild Trails Eco Friendly and Outdoor Focused Hotels Saraii Eco-tourism Resort in the South of Sri Lanka for Travelers Push Skateboards Push Skateboards is the 1st Skateboard Brand in Sri Lanka. Glitteray Unique Jewelry Designed, Crafted and Delivered Globally Ridgecrest Services to the Financial Services Community Founded by 2 Wall Street Veterans Healthy Living Helping Individuals in Sri Lanka to Lead a Healthy Life. Extrogene Builds Products for the Mobile Internet Zigzag.lk Commerce Platform for Fashion Designers Locally and Globally
Source: Lanka Angel Network, 2014.
2) Blue Ocean Ventures
BOV is a Sri Lankan based BOI-approved venture capital firm created to bridge the gap in risk capital funding for startups. They usually look to invest between Rs2 ~ 20million per company. Their engagement model is on a ‘as need’ basis within which they help develop and refine business plans, build customer bases, link with networks, and aid with the improvement of products.
2.2.1.3. Banks
Discussion with investors and entrepreneurs revealed, however, that entrepreneurs encounter a number of barriers when attempting to access seed funding from banks. Banks almost always require some form of collateral. First class collateral includes but is not limited to property, fixed deposits, and government securities. Although not considered first class collateral, registered shares, machinery, and other removable items are also considered. For this reason, banks tend to show a preference to fund start-ups that have some physical infrastructure that they can leverage as collateral. Most start-ups are unable to meet this requirement of collateral. Banks also require highly robust business plans, business models, cash flow
Chapter 3 _ Technology Business Incubators in Support of Technology-Based Industries in Sri Lanka: Preparatory Study for the Establishment and Operation of the TBI in the Science Park • 167 projections, financial forecasts, and guarantees. It was highlighted that there was no real understanding amongst banks on how start-ups function and that this acted as a significant bottleneck in accessing funding.
The general consensus from stakeholder discussions were that access as opposed to availability remained the problem. Investors are hesitant to invest in start-ups as the awareness around start-ups remains low. The need for a “tremendously successful startup” to showcase the potential of startups and propel investment in startups was reiterated.
2.2.2. Potential Markets for the Startups’ Products
Of the entrepreneurs surveyed, 4 reported having accessed the local market only, 1 reported having accessed foreign markets only, 2 reported having accessed both foreign and local markets while 3 reported not having accessed any markets at all. Foreign markets accessed included the US, Canada, Australia, India, Portugal, Japan, and the United Kingdom. A lack in the ‘know-how’ to access markets was highlighted as a barrier to commercialization of inventions in key informant interviews.56)
Sri Lanka is situated in proximity to two large foreign markets, India and Pakistan, with whom they have free trade agreements. The Indo-Lanka Free Trade Agreement, established in 2000, allows duty free entry to goods produced in Sri Lanka with at least a 35% value addition57) (Bureau of Economic and Business Affairs, 2014). The Sri Lanka-Pakistan Free Trade Agreement was established in 2005, and provides duty free access to all Sri Lankan products except those specifically identified on the negative list. Sri Lanka also belongs to the South Asian Association for Regional Cooperation (SAARC), which established a South Asian Free Trade Area in 2006 (Bureau of Economic and Business Affairs, 2014). Discussions are currently underway to establish a Free Trade Agreement with China (Bureau of Economic and Business Affairs, 2014).
56) Of the three government research institutes that reported having research and development activity, the NERD center and ITI commercialized 11 innovations each while the Arthur C Clarke Institute commercialized 5 innovations. ITI was the only one of the three that reported having accessed foreign markets with 4 of their products (Virgin Coconut Oil, Isotonic – Lime Blast, Bottle/ Can Coconut Milk, Coconut Cream). 57) If raw materials for production are imported from India, a 25% value addition is sufficient to qualify for duty free entry into the India market (Bureau of Economic and Business Affairs, 2014).
168 • 2014/15 Knowledge Sharing Program with Sri Lanka 2.3. Sponsors and Stakeholder Supports
2.3.1. Platforms for Engagement
Discussions between inventors, universities, research institutes, and industry takes place albeit in a haphazard fashion. Aside from the university-industry collaborations mentioned above, exhibitions, and competitions were highlighted as the next main mediums within which these interactions take place. The exhibitions and competition that surfaced through stakeholder discussions are listed in the table below.
Research-Industry Platforms for EngagementExhibition/ Description Competition • Initiated by the Institution of Engineers in 1985 • Target group: children aged 9-12 from all school in Sri Lanka Junior Inventor • “The top ten inventions at this competition together with the ten finalists of the Year (JIY) of the Science Research Competition then compete at the Sri Lanka Science Competition and Engineering Fair (SLSEF)” (The Institution of Engineers Sri Lanka, 2013). Winners at SLEF then proceed to the Intel International Science and Engineering Fair International • Most important exhibition worldwide dedicated to inventions held each year. Exhibition of • In 2013, a Sri Lankan inventor secured a Gold award for air purifying CFL Inventions in lamp and a Silver award for a nano visible light photocatalysis based hospital Geneva infection control system Ray • Administered and presented by the Ray Wijewardene Charitable Trust (RWCT) Wijeywardene in partnership with the Sri Lanka Inventors Commission and Commercial Bank Awards • Aids winning inventors to commercialize his/her inventions • Organized by the Sri Lanka Inventors Commission Presidential • Annual cash prizes and medals provided to patented inventions in Sri Lanka Award in a number of fields which include but are not limited to medicine, physics, chemistry and agriculture • The goal of MIT- GSL is to identify, develop and commercialize successful tech enterprises MIT-Global • Targeted at 2nd year and above students or graduates from any discipline Startup Labs • Selected participants gain entrepreneurship training by MIT-GSL instructors and mentorship and networking opportunities through Brandix and SLASSCOM • Business Plan Contest organized by the British Council in partnership with HSBC. HSBC Youth • Taget group: 16 – 26 year old students affiliated with a university, private Enterprise higher education institution, technical and vocational institution or professional Awards training body • Cash prizes for winning team (LKR 500,000) and others to help kick start their businesses
Chapter 3 _ Technology Business Incubators in Support of Technology-Based Industries in Sri Lanka: Preparatory Study for the Establishment and Operation of the TBI in the Science Park • 169
continuedExhibition/ Description Competition • Organized by Blue Ocean Ventures and the Indian Angel Network • Applicants are required to submit a business plan, market research, equity report, projected growth rate and presentation statements • Shortlisted applicants are given the opportunity to work one-on-one with Venture Engine mentors which include local and international businessmen and venture capitalists for development of their business plan (Venture Engine, 2014) • Top three business plans selected and awarded cash prizes (Venture Engine, 2014) • Organized by Disrupt Unlimited, Brandix • Selected applicants are given key insight into problems within the apparel Disruptathon industry by industry experts • Winning entrepreneurs are given the opportunity to commercialize their ideas through Disrupt Unlimited’s 4month seed accelerator • Sri Lanka has seen an increase in the number of Hackathons in recent years which include the Virtusa Hackathon, WS02 Hackathon, Women’s Hackathon and Colombo Hackathon Various • Women’s Hackathon organized by SLASSCOM together with Microsoft and the hackathons US Embassy in Sri Lanka and the Maldives is open to current female students in state universities, higher education institutes and private education institutes • The Colombo Hackthon is a non-profit volunteer event organized by the SLASSCOM entrepreneurship forum
Source: SLINTEC (2014).
2.3.2. Government Institutes
Secondary research highlighted some of the key institutions in the S&T arena operating under the government’s authority. They are listed below as follows:
• Arthur C Clarke Institute of Modern Technology • Atomic Energy Authority • Industrial Technology Institute (ITI) • National Engineering Research and Development Centre (NERD) • National Science and Technology Commission • National Science Foundation • Planetarium • Polipto (Lanka) Pvt Ltd • Sri Lanka Accreditation Board for Conformity Assessment • Sri Lanka Institute of Nanotechnology • Sri Lanka Standards Institute
170 • 2014/15 Knowledge Sharing Program with Sri Lanka Primary data was collected from the Arthur C Clarke Institute of Modern Technology, Industrial Technology Institute, the National Engineering Research and Development Centre, the National Science and Technology Commission, the Ministry of Technology and Research, the Sri Lanka Inventors Commission, and the Coordinating Secretariat for Science, Technology and Innovation. Of the seven institutes interviewed three (ITI, NERD, and Arthur C Clarke Institute) had research and development activities. These three institutes are discussed briefly in further detail below.
Industrial Technology Institute: Of the three institutes, the ITI was the only institute that reported having student researchers completing their postgraduate studies at the time of interview.58) The ITI reported having commercialized 11 innovations of which 4 have accessed foreign markets. (Primary data – SLINTEC, 2014) The institute has five Research and Development divisions (food technology, herbal technology, materials technology, environmental technology, engineering services), and four technical services divisions (chemical and microbiology laboratory, materials laboratory, industrial metrology laboratory, and electro technology laboratory).
National Engineering Research and Development Centre59): The Centre has commercialized 11 innovations – all of which have accessed the local market but have not penetrated any foreign markets (Primary data – SLINTEC, 2014).
Arthur C Clarke Institute of Modern Technology60): The institute has commercialized 5 innovations all of which have accessed the local market albeit with limited success (Primary data – SLINTEC, 2014).
Other institutions that support the innovation system include the Coordination Secretariat for Science, Technology and Innovation (COSTI), the Sri Lanka Inventors Commission (SLIC), the Youth Business Sri Lanka (YBSL), and the Chamber of Commerce.
58) The ITI has around 396 research and technical personnel, thereby making it one of the larger R&D public research institutes. In 2012, 17% of the staff had PhDs and 39% had a Master’s degree. (Industrial Technology Institute, 2012) It reported a budget of Rs 45.3 million for R&D in the year 2013: Rs 13.6 million – capital expenditure, Rs 31.7million – recurrent expenditure. 67% of the funding was from foreign sources, 27% from the Government of Sri Lanka and 6% from other local sources. (Primary data – SLINTEC, 2014) 59) The NERD Centre has 46 research staff including top-level management. They reported a budget of about Rs240million for R&D in the year 2013 of which around Rs 200Mn was provided by the state and Rs 40Mn raised through income generating activities and commercialization of inventions (Primary data – SLINTEC, 2014). 60) Research and technical staff at this institute numbered around 38 including technical management and technical services personnel (Primary data – SLINTEC, 2014).
Chapter 3 _ Technology Business Incubators in Support of Technology-Based Industries in Sri Lanka: Preparatory Study for the Establishment and Operation of the TBI in the Science Park • 171
Other Institutions Supporting the Innovation System of Sri LankaInstitutions Description • Has plans to launch an ‘Innovation Dashboard’ in December 2014. Database being created to “capture information pertaining to institutions, institutional research and personnel of all institutions that exist in Sri Lanka on Science, Technology and COSTI Innovation” (Coordinating Secretariat for Science, 2014) • In the process of developing the ‘Sri Lanka Innovation Index’ in parallel with the Global Innovation Index for the availability of reliable data an internal responsibility • Has a number of important functions that include providing technical assistance to inventors and financial aid to further develop their inventions • Encourages Sri Lankan inventors by annually giving sizeable cash rewards and prestigious awards referred to as the ‘Presidential Awards’ for Inventions • Responsible for organizing the only national exhibition in the country ‘Sahasak SLIC Nimavum’ • Has taken the lead in encouraging invention and entrepreneurship at the school level with the Young Inventors Club and the Television Young Inventors Club Programme • Has the unique website containing an ‘Inventors Directory’ allowing industry to access and reach out to inventors to solve industry problems • Has created a platform referred to as the Industry-Inventor Introduction Process • Set up within the Ceylon Chamber of Commerce in 2007 to help young people start their own businesses by providing access to mentors and credit61) YBSL • Young Leaders within the Ceylon Chamber of Commerce are currently in the process of securing funding from international funding institutions and local companies to invest in startup companies The National • Established in 1948 to create a forum for the business community Chamber of • Works across virtually all industry sectors and plays a leading role in trade and Commerce investment promotion
Source: SLINTEC (2014).
2.3.3. State of the Intellectual Property System in Sri Lanka 61) The National Intellectual Property Office of Sri Lanka (NIPO) is responsible for the administration of the intellectual property system.62) NIPO has 2~3 personnel to aid patent applications. The process of application was considered relatively straightforward by the inventors interviewed although it was said that completion of the registration process takes about 2years. Of the 10 inventors and entrepreneurs interviewed 6 had patented their products (2 were still awaiting approval). Of the
61) “YBSL provided credit support for more than 83 young entrepreneurs in the districts of Trincomalee, Jaffna, Kandy, Kegalle and Badulla. These loans which were granted for a period of 6 to 12 months have already recorded a payback ratio of 90%.” In 2011, YBSL together with the European Union’s Delegation to Sri Lanka and Maldives began a program to reduce the economic and social disparity in the North and East through the promotion of youth entrepreneurship. (The Ceylon Chamber of Commerce, 2014) 62) Intellectual property is protected as per the Intellectual Property Act No. 36 of 2003. The law is fairly refined and deals with aspects of trade and service marks, patents, industrial designs, copyright and related rights.
172 • 2014/15 Knowledge Sharing Program with Sri Lanka six, four had written their patents without any external assistance while the other two had consulted local or international lawyers. Inventors tended to opt for local patents, as the cost of international patents was considered very high: Rs 3000 vs. Rs 200,000. Stakeholder discussions worryingly highlighted the issue of patent leakage and thus demonstrated a lack of trust in the intellectual property system. Table 3-8 below shows the number of patents registered by residents and non-residents in the past five years.
Patent Application & Registration from 2010-2014Applications Registrations Year Resident Non-resident Total Resident Non-resident Total 2010 225 235 460 220 284 504 2011 194 235 429 45 227 272 2012 242 297 539 37 89 126 2013 328 188 516 71 165 236 Upto 226 180 406 28 150 178 30.09.2014
Source: National Intellectual Property Office Sri Lanka, 2014.
2.3.4. Investment Incentives
The tax incentive repeatedly highlighted by interviewees was the tax concession of the “Triple tax benefit”. A 300% tax deduction rate on research and development expenditure was made applicable for any research contracted to universities or government research institutes as of 1 April 2014. Despite such a large incentive, it was highlighted that very few companies had actually taken advantage of this. Reasons cited included that larger multinational companies often have their own R&D arms, and that companies did not prioritize research and development based growth and tended to concentrate more on alternate short-term growth plans.
Also brought out from one of the interviewees was the salary bonus of 35% (as per the 2014 Budget) offered as an incentive to researchers. Traditionally university researchers have concentrated on the teaching component of their job and have neglected research due to their immense workload. This monetary incentive was provided in the hope that it would increase research output by university and public research institute personnel.63)
63) Researchers are expected to submit a research proposal to the Ministry of Technology and Research. Following the undertaking of the research, findings have to be published in an internationally recognized journal, patented, and presented at a symposium to be eligible for this salary bonus.
Chapter 3 _ Technology Business Incubators in Support of Technology-Based Industries in Sri Lanka: Preparatory Study for the Establishment and Operation of the TBI in the Science Park • 173 Projects defined as being in “the national interest, likely to bring economic and social benefits to the country and change the landscape of the country through the provision of goods and services, substantial inflow of foreign currency, generation of employment and income, and transfer of technology” are identified as Strategic Development Projects (Bureau of Economic and Business Affairs, 2014). The Strategic Development Project Act of 2008 provides such projects with a variety of tax exemptions for up to 25 years. The BOI also provides the following tax incentive schedules:
BOI Tax Holiday Schedule (Bureau of Economic and Business Affairs, 2014)Size of Minimum Duration of tax Type of business enterprise investment (US$) holiday(years)
Information technology, agriculture, Small-scale animal husbandry, fisheries, creative 219,000 4 - 5 work including art work
IT/BPO, manufacturing, healthcare, education, agriculture, agro processing, Medium- animal husbandry, fisheries, fish 192,000 – 4-6 scale processing, cold rooms/ storages, 1.5million tourism, sports, fitness centers and creative work
Knowledge cities, manufacturing or processing of non-traditional goods for exports, services provided to a person or partnership outside Sri Lanka, renewable energy, agriculture, dairy or 300million – Large-scale forestry, tourism, infrastructure projects, 6 - 12 2.5billion industrial estates, urban housing, town centers, waste management systems, water services, hospitals, software development, light or heavy engineering industry, education services
Import 5, followed by Cement, steel, pharmaceuticals, fabric Minimum level Replacement a concessionary and milk powder apply Industries tax rate of 12%
Source: SLINTEC (2014).
Entrepreneurs also highlighted some of the strategic and policy-level changes that they thought would help foster the innovation and entrepreneurship ecosystem within the country: match funding incentives such as in Malaysia or Israel to encourage investments, special visa categories to encourage startups to locate within the country, and exit strategies for investors were among the key suggestions made.
174 • 2014/15 Knowledge Sharing Program with Sri Lanka 2.4. Competing Facilities or Institutions
2.4.1. Disrupt Unlimited
The Brandix Group is the largest exporter of apparel in Sri Lanka. In Feb 2014, The Group invested US$1 million setting up Disrupt Unlimited, a seed accelerator. The Brandix Group currently owns shares in this new venture.
The Accelerator is currently run by three employees. The Brandix Group provided the physical space for the Accelerator in exchange for monthly rental. The Incubates, however, are not located within this physical space but are stationed within the Strategic Business Units (SBU’s) of the Brandix Group. Incubates do not pay rental for locating within the SBUs. SBUs in turn have the ‘first point of refusal’ for products developed by the incubate companies. Every effort is made to match the problems faced by the SBU and the solutions offered by the incubate companies.
Disrupt Unlimited: Selection Process
Innovators and creative minds were encouraged to apply for enrolment into the accelerator via social media, universities and personal contacts. 20 applicants from different domains were shortlisted from all the applications received. Only two of those that were shortlisted had a background in apparel/textiles. The applicants were then invited to a ‘Disruptathon’ (term coined from hackathon) where Brandix mentors presented nine industry problems. The decision to present industry problems was made as previous conversations with entrepreneurs showed a lack of knowledge on what there really was to innovate within the apparel industry. Contestants were given three weeks to come up with a solution to one of the problems highlighted or innovate something of their own. They worked closely with mentors and factory personnel to further their understanding of the industry problems. Contestants were given the opportunity to team up among the 20 applicants or find external personnel who would complement their skills should they wish to. Of the twenty, 11 teams developed solutions. Of this group, 3 companies were shortlisted by an expert panel purely based on their idea. Enrolment into the incubator required a minimum of two people in the company as per the mandate of the incubator. Hence, individuals were provided with an opportunity to select their own partner/team. The accelerator also initiated ‘Founder Dating’ for individuals who had trouble selecting a suitable partner.
Source: SLINTEC (2014).
The Brandix Group is leveraged for mentorship, technical consultancy and access to equipment. The Accelerator also provides legal assistance in registering the company prior to incubation, help with financial and accounting management and access to capital. US$ 15,000~50,000 is provided as seed funding with the exact amount being determined by the development of the project.
Chapter 3 _ Technology Business Incubators in Support of Technology-Based Industries in Sri Lanka: Preparatory Study for the Establishment and Operation of the TBI in the Science Park • 175 Incubates are also expected to attend a weekly meeting where they share progress made and ideas. Each meeting has a theme and is often frequented by an industry expert who offers knowledge and experience. Incubates are also paid a monthly stipend of Rs 50,000 for the four month period. This was mainly done to counteract the pressure from family to follow a traditional/ conventional career. The entrepreneurs may be offered a job with the Brandix Group, should they be determined as “successful failures” after the four month period.
In exchange for enrolling in the program, the Accelerator obtains 20% equity in the incubate company. The focus lies on helping the startup put out a minimum viable product within the incubation period64). Disrupt Unlimited has signed an MOU with Lanka Angel Networks, who will be among the investors invited to the Demo Day.
As the Disrupt Unlimited does not receive a monthly rental fee from the Incubates, their success is determined solely by how successfully the Incubates exit their incubator. It is anticipated that Disrupt Unlimited will be an entirely self- supporting organization within three years.
2.4.2. SIL-UOM Rubber Products and Process Development Incubator65)
The incubator leverages Samson Compound Pvt Ltd for materials and chemicals. The University provided the physical space for the incubator, and is leveraged for technical consultancy with expert university researchers being paid about 1/3 that which would have been paid to an external consultant.66) Lab trials are followed by pilot trials in the factories. Intellectual property is shared between the industry partners and the university. Profits are shared in a similar fashion67).
64) The Accelerator has limited itself to its domain expertise in apparel, textiles and accessories, thereby distinguishing itself from its competition. The Brandix Group provides a unique test bed for the novel products designed by the incubated companies. While some incubators, such as Y-Combinator are run on a model of ‘probability of success’, the Disrupt Unlimited focuses its energy and resources on a small number of companies to ensure their success. 65) The SIL-UOM rubber products and process development incubator was established in February 2011 as an initiative between the University of Moratuwa, Samson International PLC and Samson Compound Pvt Ltd – subsidiary companies of the DSI Group. THE DSI Group of companies are leading rubber product exporters in Sri Lanka. UNI Consultancies acted as the administrative body in this alliance. Three industry personnel, two university personnel and one UNI Consultancies personnel make up the board of directors. The incubator is managed by two personnel (a Director Incubator and Director Projects) and employs 3 engineers and 1 chemistry graduate. 66) Sri Jayawardenepura University has also provided technical consultancy to this incubator. Samson International PLC has a designated group within the industry for purpose of providing business, managerial and marketing assistance to the incubator. 67) The University Council has used the profits made by the incubator thus far to further develop other undergraduate laboratories. The incubator has also applied for a Public-Private Partnership NRC Grant for the purpose of recruiting a full-time PhD student in the future.
176 • 2014/15 Knowledge Sharing Program with Sri Lanka A budget of Rs 28million was allocated last year for the incubator. Research direction is determined by industry partners. 41 projects have been completed thus far with 8 products being commercialized in foreign markets (mainly European markets). Projects include those focused on cost reduction, quality improvements, enhanced productivity, and effective utilization of energy/resources.
Graduates are recruited on a contract basis primarily based on their academic qualifications and tutor recommendations.68) The incubator entices graduates into the program by offering them the opportunity to complete further postgraduate study on a part-time basis at the university.69)
2.4.3. Orion’s Nest70)
Orion’s Nest, an incubation facility for startups was set up within Orion City. This facility houses small business enterprises usually requiring only about 2~3 seats. Seats are made available at Rs 10,000 per month. This cost also includes, space, utilities, and internet coverage. The facility aspires to work towards a ‘plug and play’ concept.
2.4.4. Conceptnursery.com71)
Conceptnursery.com has graduated about 35 companies thus far of which around 12 have become somewhat successful (i.e. grown or acquired). Companies are required to complete an application form and attend an interview before they are accepted into the incubator. The application form covers all aspects of business plans. Incubates are accepted for 5% equity in their companies. Incubates are required to find their own seed funding and pay a small sum of Rs 15,000 per month to locate within the incubator where they have access to infrastructure, mentors, and technical consultants. The SLIIT university staffs are leveraged for their technical expertise. Two full-time personnel, one of which acts as a manager, oversee the running of the incubator. The incubatees are initially enrolled for a period of 1 year with the potential for staying on for 2 years. Should the incubatees do sufficiently well within the incubator, they might secure a second round of funding from the Peoples
68) Graduates who have completed 4 year degrees are paid about Rs 40,000 per month while those with 3 year degrees are initially paid Rs 35,000 a month for the first six months. 69) This is made possible as most postgraduate classes take place on the weekends. The incubator has also provided three groups of undergraduates with the opportunity to completed research projects within the past year. 70) Orion City, a premier IT-Park housing global companies, was established in 2008. It is set on 16 acres of land in Colombo 09 and has a projected investment of US$ 500 million over a 5-10 year period. 71) This was established in 2001, as a joint venture between the Sri Lanka Institute of Information Technology, Media Solutions, Peoples Venture Investment Company and Prudential Holdings with the aim of growing the ICT industry and sustaining competitiveness through R&D. USAID provided a vast amount of exposure and guidance when setting up the incubator. The incubator is located alongside the SLIIT University in Malabe.
Chapter 3 _ Technology Business Incubators in Support of Technology-Based Industries in Sri Lanka: Preparatory Study for the Establishment and Operation of the TBI in the Science Park • 177 Venture Investment Company.
This model however has had limited success: managing such large numbers of small equities became problematic. Companies also often became lifestyle companies, focused on day-to-day activities rather than focusing on their single original idea/product. As of recent years, however, to improve output, students with truly innovative ideas/products from the Business, IT, and Engineering faculties of the SLIIT campus have been invited to locate within the incubator for a 1year period. While here, they maintain close contact with their undergraduate supervisor and receive mentorship and technical consultancy from SLIIT technical advisors. Students are paid a salary for the 1year period to counteract pressures to make ends meet and parental pressures to follow conventional careers. During this period, they are also introduced and linked with angel investors. While the incubator remains very much open to external companies locating in the incubator, the presence of student companies appears to be an astute decision.`
2.5. Summary and Implications
The field survey dealt with various issues on the TBI to be established. Table 3-10 below contains summary of especially favorable and unfavorable environment for the TBI under construction.
Environment for the Establishment and Operation of the TBI in Sri LankaFavorable environment Unfavorable environment
• Various activities and programs provided to • Parental pressure to follow conventional jobs foster entrepreneurship culture and spirit for rather than startups remains large. youth at the primary and secondary level • Owing to poor salaries and research culture • Quite a few exhibitions and competitions in Sri Lanka, the graduate with Science allowing active interaction among inventors, degrees often leaves the science field. universities, research institutes, industries • In the S&T universities, lack of funding for etc. equipment and laboratories, research not • Sri Lankan universities carrying out quite a market driven, lecturers’ tendency to focus few S&T related research projects(5,000 last on teaching instead of research. year) • Despite the large tax incentives on R&D • Existence of PRIs in the S&T area with activities, companies tend to concentrate researchers willing to try startups under the on short-term plans, rather than R&D based TBI’s support growth. • Innovations taking place in the ICT and • There are several governmental funding apparel industries in particular support programs (grants and concessional • Government’s high willingness to support loans) for R&Ds, but too small in scale, so, the TBI including construction of the TBI not effective building
178 • 2014/15 Knowledge Sharing Program with Sri Lanka
continuedFavorable environment Unfavorable environment
• Preferable tax treatment on the expenditure • The intellectual property system has lack of spent on the R&D activities trust with low efficiency. • The Hosting Institution (SLINTEC)’s excellent • Attempting to access seed funding from capacity in manufacturing R&Ds and close banks, entrepreneurs encounter a number of relationship with large local companies barriers, such as high requirements and lack • Preferential access to near-by big markets of awareness on startups. such as India and Pakistan through FTAs (FTA • There exist just a small group of angel with China under way) and the South Asian investors and venture capitals in Sri Lanka, Free Trade Area but, still growing. • Entrepreneurs’ lack of know-how to access markets, especially foreign market • As a result, technology startups are not active up to now, and most innovations tend to be low-tech ones. • The TBI building under construction is far from the business center in the city, well- known S&T universities, S&T research institutes etc.
Source: summary by the author.
Stable access to long term funding is a key requirement for creating wealth through next generation technology. Such activities are in line with government objectives and capabilities. It is recommended that a funding model similar to the BOI framework be used, and adapted towards addressing the needs of startups requiring technology business incubation,
• Primary funding of the incubator is recommended to be a through a multi-year government budget allocation, the duration of which should be aligned to the incubation period given to the startups. • Operationally, it is recommended that the incubator be a private limited company operating under a public-private partnership model • The Board of Directors to be mainly working directors giving leadership within the technology business incubator.
Potential startup candidates need to be selected through a relevant and rigorous entry process, and once selected, full and complete effort has to be targeted at making these companies successful. Similar to the well-researched models used at the SLIIT-USAID and Brandix Incubators. Specifically,
• No cost and open access to the technical, market, and legal resources available through the facility. • An incubation period of 4 years to achieve profitability
Chapter 3 _ Technology Business Incubators in Support of Technology-Based Industries in Sri Lanka: Preparatory Study for the Establishment and Operation of the TBI in the Science Park • 179 • Given government funding for national wealth and job creation, which will be recovered through corporate tax of a successful venture, the incubator should seek no more than a maximum ownership of 5% of the startup.
Primary requirements from a manufacturing based technology incubator are providing access to capital, markets, equipment, and human resources. The Nanotechnology and Science Park contains within it, equipment and human resources for high technology research. Thus it is critical that these resources be made available to the incubator and its tenants as part of its national mission. This would differentiate, fortify, and give stability to the long term role of the incubator to position its tenants as the premier next-generation technology businesses of the country.
3. Benchmarking of Other Countries’ Experiences 3.1. Korea’s Experiences
3.1.1. Overview of TBI in Korea
Korean government’s support for TBI has existed since 1991 when Ministry of Trade, Industry & Energy (MTIE) provided financial supports for new technology startups by researchers outsourcing offshore production technology. The first private incubator, the “Yongdong Startup Incubator Center” was founded in 1993, and the government supported incubators began in 1994 with the startup support programs by MTIE, SMBC (Small & Medium Business Corporation), and the MOST (Ministry of Science and Technology). Since 1994, diverse Ministries, including the MOIC (Ministry of Information and Communication), the SMBA (Small and Medium Business Administration), the MOCT (Ministry of Culture and Tourism), the MOE (Ministry of Environment), the MOND (Ministry of National Defense), and also provincial governments have provided financial and real estate support for incubation centers in universities, public research institutes, and public agencies throughout the late 1990s and 2000s. In 2005, in order to enhance efficiency and efficacy of Korean TBIs, the Korean government enacted the “Efficiency Improvement Plan for Startup Incubator”.70) According to 2013 Startup Survey by the KISED (Korea Institute of Startup & Entrepreneurship Development), Korean TBIs numbered 290 in 2012, among which university TBIs accounted for 218 and research centers 27. Korean TBIs numbered 30 in 1998, and rapidly increased to 240 in 2000, and afterwards stabilized at 290 in 2012.
In 2005, in order to enhance efficiency and efficacy of Korean TBIs, the Korean
180 • 2014/15 Knowledge Sharing Program with Sri Lanka government enacted the “Efficiency Improvement Plan for Startup Incubator”.72) According to 2013 Startup Survey by the KISED (Korea Institute of Startup & Entrepreneurship Development), Korean TBIs numbered 290 in 2012, among which university TBIs accounted for 218 and research centers 27. Korean TBIs numbered 30 in 1998, and rapidly increased to 240 in 2000, and afterwards stabilized at 290 in 2012. 73)
Brief History of Growth of TBIs in KoreaYear Startup Incubator Business (Center) Project Supported New Technology Startups by Ministry of Trade, Industry & Energy(MTIE) 1991 (in the form of offshore outsourcing production technology researchers) Founded Yongdong Startup Incubator Center for Jungbu Industry Consulting, the first 1993 private incubator center Startup support project for MTIE Small & Medium Business Corporation and Ministry of 1994 Science & Technology • Startup support projects for the Ministry of Information and Communication 1996 • Startup support projects for local governments (Seoul, Chungcheongnam-do) 1998 Extended Startup support project for the Small and Medium Business Administration 2000 Startup support project for Cultural Industry Support Center, Ministry of Culture & Tourism Startup support project for Environmental New Technology Startup Incubator Center, 2001 Ministry of Environment 2003 Startup support project for Defense Venture Center, Ministry of National Defense Operating 365 Startup Incubator Centers, including 7 central departments and 9 startup 2005 support projects Enacted Efficiency Improvement Plan for Startup Incubator Business at the Economic Policy 2005 Forum Operating 279 Startup Incubator Centers, including 226 universities, 7 small & medium 2010 business centers, 22 research centers and 11 local government, designated by Small & Medium Business Corporation and 50 undesignated startup support institutions
Source: SMBC, Korea Institute of Startup & Entrepreneurship Development (2014).
TBI Institutional Types73)Total Universities Research Centers Local Government SBC Others 290 218 27 12 7 26
Source: SMBC, Korea Institute of Startup & Entrepreneurship Development (2014).
72) Refer the 2013 KSP report (pp. 229~234) for various policies and measures that the Korean government has employed to support technology startups. 73) In Korea, the business incubators, in almost all cases, attract technology entrepreneurs. So, even though they are called business incubators, they can be considered as TBIs in Korea.
Chapter 3 _ Technology Business Incubators in Support of Technology-Based Industries in Sri Lanka: Preparatory Study for the Establishment and Operation of the TBI in the Science Park • 181
TBI Trends in Government Financial Support Amounts and Numbers (Unit: hundred million won/ea) Year Budget # of TBIs 1998 63 30 2000 468 240 2002 271 293 2004 269 292 2006 168 265 2008 175 281 2010 324 286 2012 267 290 Total 3,873 -Source: SMBC, Korea Institute of Startup & Entrepreneurship Development (2014).
The survival rates of Korean startups are 59.8% after one year, 46.3% in two years, 38.0%, 33.4%, 30.9%, in 3, 4, 5 years respectively in the base year of 2012 according to Statistics Korea Agency (Statistics Korea 2014).74) The industry-level survival rates of Korean startups after 5 years are the highest, real estate industry, 46.3%, health and social welfare 42.9%, and manufacturing 39.6%, with the lowest, hotel and restaurants industry 17.7% and arts, sports and leisure industry, 14.7%.
3.1.1.1. General Performances of TBIs in Korea
The direct effects of TBIs can be measured as: 1) number of incubated enterprises, 2) total amounts of sales of those incubated enterprises, and 3) total employees. The SMBA (2012) study showed that, in 2011, in total, 4,764 enterprises were incubated and the sales of those enterprises amounted 2,005.5 billion won with total employees being 18,078 persons.75) Thus in 2011, the average number of incubated enterprises per an incubating center was 17.0 and the average amount of total sales per center was 71.6 billion won with 64.6 employees in total. This in turn means that an incubated firm has 4.2 billion won sales and 3.8 employees in average.
These are not quite satisfactory. Intensive interviews with TBI managers and experts suggested that the minimal number of TBI incubated tenants should be more than 30-50 in order to have efficient and effective diverse incubation services, but the actual average of the Korean TBI was 17.0 in 2012, which means that many of Korean TBIs are small-scale, and not large enough to be sustainable, and to have economy of scale for incubation services. And also the average size of the incubated
74) Statistics Korea (2014) “Korean Firms’ birth and Closure Statistics 2013” 75) SMBA (2012), “BI Management Evaluation Model Development and Supporting Measures”
182 • 2014/15 Knowledge Sharing Program with Sri Lanka enterprises, 4.2 billion won and 3.8 employees are also very small-scale and not enough to provide financial sustainability in the long-term without governmental support. The small-scale problem was also reflected in the average number of professional managers and general managers, who are the cores of professional incubation services for successful technology commercialization. In the study conducted by Yang Hyun-Mo (2012), the average number of professional managers and general managers per incubation center were 1.64 and 0.63 persons, which means 1 or 2 managers operate in an average incubating center for all professional services.
Direct Effects of Incubation CentersYear 2009 2010 2011 Incubated Enterprise (ea.) 4,770 4,818 4,764 Sales (100 million won) 25,382 24,807 20,055 Employees 22,017 21,113 18,078
Source: SMBA (2012) “BI Management Evaluation Model Development and Supporting Measures”.
Average Number of Professional and General Managers Per CenterProfessional Manager General Manager
Number 435 persons (72.26%) 167 persons (27.74%)
Mean Number Per Center 1.64 0.63
Source: SMBA (2012) “BI Management Evaluation Model Development and Supporting Measures”.
3.1.1.2. Reasons of TBI entry and TBI Screening Factors in Korea
The most important factor that induces Korean startups to enter incubation centers is the relatively low rental fees, unlike the ones offered by professional mediation services. Among 1,101 incubated enterprises 414 answered that the relatively low rent was the most important factor for entry, which was followed by “opportunities for consulting services and Joint-research” 19.7%, “easier access to governmental funding and loans” 16.0%. The human network, research equipment access, and information access, which can be categorized as basic infrastructure services, all scored relatively lower as important factors. These survey results showed that what tenants of incubators expect or demand from TBIs are mostly financial support and consulting services rather than infrastructure services such as network, equipment, and information.
Chapter 3 _ Technology Business Incubators in Support of Technology-Based Industries in Sri Lanka: Preparatory Study for the Establishment and Operation of the TBI in the Science Park • 183
Reasons for TBI Entry in KoreaReasons for entry Frequency (Cases) Rate (%) Relatively low rent 414 37.6 Opportunities for Consulting Service and Joined Research 217 19.7 Easier Access to Governmental Funding and Loans 176 16.0 Easier Outsourcing of Human/Material Network 113 10.3 Facilities and Research Equipment 108 9.8 Better Corporate Image or Brand Recognition 64 5.8 Easier Access to Market/New Product Information 9 0.8 Total 1,101 100.0
Source: SMBA (2012) “BI Management Evaluation Model Development and Supporting Measures”.
Another important aspect of a TBI’s establishment is what a TBI expects or demands from new entrant startups for the success of a TBI. The 2013 Startup Survey showed that the most important factor to screen startup applicants was the marketability of their products (38.7%). This indicates that incubator managers assess whether the startups’ new items have a large enough market and potential to penetrate a sizable portion of it, are the most important factors for new applicants. Other important factors are industry feasibility (21.4%) and manager credibility (18.5%). Thus market prospects and industry prospects are the most important factors, with the credibility of managers following. Unlike the general expectations, management ability (10.5%), technology level (5.4%), and financing ability (3.3%) are all relatively low in the incubators' perspectives of the potential for success of new applicants.
[Figure 3-5] Most Important Factors to Screen Startup Support Program Applicants (Unit: %)
38.7
18.5 21.4 10.5 5.4 2.3 3.3
Manager... Marketability Management... Industrialization... Financing Ability Technology Level Commercializatio...
Source: SMBC, Korea Institute of Startup & Entrepreneurship Development (2014).
184 • 2014/15 Knowledge Sharing Program with Sri Lanka 3.1.1.3. The KAIST TBI Case
KAIST TBI is one of the top performing TBIs in Korea, along with the Hoseo University TBI and Hanyang university’s EUREKA campus TBI. The KAIST TBI was established in 1994 as a Technology Innovation Center (TIC) and Technology Business Incubation (TBI), which was expanded to a High-Tech Venture Center (HTVC) in 1997. The KAIST TBI was selected as a Technology Transfer & Exchange Center by the Ministry of Science and Technology in 2002. It was designated as a Technology Licensing Office (TLO), which are financially supported by the Ministry of Education and Human Resources, and the Ministry of Commerce, Industry and Energy in 2006. The KAIST Business Incubation Center was selected as the best business incubation center in Asia by the Asia Association of Business Incubation (AABI) in 2007. The KAIST TBI and student startup support programs were commended as the Best Startup Incubation Center by the prime minister in 2013.
Brief History of the KAIST TBI1994 Founded KAIST TBI/TIC
1997 Expanded a New Tech Startup Support
1999 Selected as a Project Management Agency (MST)
2001 Built Alumni Startup Building
Selected as Technology Transfer & Exchange Center(MST), Built New Tech Startup 2002 Building
2005 Selected as KAIST Technology Incubation Center (SBC)
2006 Renamed Industry-Academic Organization, Opened KAIST Technology Clinic
2007 Selected as the Best Center by the AABI
2010 Expanded Incubation Center with the integration of KAIST and the ICU
Total Sales (Resident & Graduate) $2,312 million, New Business Contest Award from 2012 Small Business Administrator
Claiming Startup KAIST (student startup support), Commended as the Best Startup 2013 Incubation Center by the prime minister
Source: KAIST TBI annual report (2014).
The KAIST TBI has progressed very drastically in terms of technology developments, commercialization, and startup incubations. Domestic and overseas patent registrations were 894 and 91 in 2013, which has increased from 406 and 76 in 2007. Technology transfer and the according licensing fee income amounted to 2,790 million won in 2013.
Chapter 3 _ Technology Business Incubators in Support of Technology-Based Industries in Sri Lanka: Preparatory Study for the Establishment and Operation of the TBI in the Science Park • 185 [Figure 3-6] Domestic and Overseas Patent Applications and Registrations
1,381 (Unit: case) As of Jul, 2014 1,233 1,259 1,174 1,183 985 945
1,005 242 212 223
878 114
244 790 91 95 172 533 44
251 482 374
337 83 76 47 75 627 833 1,010 1,047 1,059 1,139 939 406 327 262 450 476 850 894
2007 2008 2009 2010 2011 2012 2013 2007 2008 2009 2010 2011 2012 2013 Domestic Applications Overseas Applications TOTAL Domestic Registrations Overseas Registrations TOTAL
Overseas Domestic Overseas Domestic Applications Applications Registrations Registrations 1,644 7,122 592 4,302
Patent(Applications) TOTAL Patent(Registrations) TOTAL 8,766 4,894
Source: KAIST TBI annual report (2014).
[Figure 3-7] Licensing Fees for Tech Transfer Cases
3,857 3,056 2,790
2,121
1,454
1,069 973
2007 2008 2009 2010 2011 2012 2013
Licensing Fee
Source: KAIST TBI annual report (2014).
For venture incubation, about 80-100 startup companies were incubated during 2009-2013, while new tenants and graduation tenants were mostly the same, 20- 30 in number. This means that the KAIST incubation center operates with about 90 tenants with 20 new entrants and 20 graduating, which can manage an economy of scale, and an economy of scope with diversity and on scale large enough for professional services. As of 2013, the KAIST recorded that there exists 804 KAIST alumni startups, among which 39 companies are listed on the KOSPI or KOSDAQ.
186 • 2014/15 Knowledge Sharing Program with Sri Lanka These companies’ total asset amounts to 13,855 million dollars with total annual sales of 9,133 million dollars, and total employees at 23,511 persons.
[Figure 3-8] Annual Number of Venture Incubations 85 27 41 88 20 17 96 25 19 89 22 29 89 22 22
2009 2010 2011 2012 2013
Current tenant New tenant Graduation
Source: KAIST TBI annual report (2014).
The KAIST has diverse strengths for a technology startup incubation. KAIST has its origin from its beginning as a more engineering-oriented and industrial technology- oriented university. Especially their ICT-related advanced cutting-edge technology expertise is highly regarded in globally. Moreover it has one of the top MBA programs in Korea that combines cutting-edge technology with business planning and education in inter-disciplinary research. Moreover, the KAIST TBI is working with technology transfer offices, which are closely related to existing industries and global companies in Korea. Its tenants can benefit from learning more about the recent industrial trends and up-to-date technology development information from industrial companies. Overall, the KAIST research and commercialization environment could contribute to the success of the KAIST venture incubations.
KAIST TBI has its own vision, goal, and strategies. The vision states their mission more specifically as a, “One-stop service for business incubation management and technology transfer commercialization”. The goal is to become a “Global Venture Innovation Platform of Startups”. In order to become a global innovation platform for startups, KAIST TBI formed their four core services and strategies, which are 1) Education Service: Entrepreneurship Culture creation, 2) Technology Service: KAIST Startup programs, 3) Management Service: Creating Company programs, 4) Funding and Marketing Service: Global Partnership program.
The KAIST incubation programs are more-or-less similar to average standard incubation services such as professional services (legal and consulting service), general
Chapter 3 _ Technology Business Incubators in Support of Technology-Based Industries in Sri Lanka: Preparatory Study for the Establishment and Operation of the TBI in the Science Park • 187 services (incubating space provision and office equipment provision), and networking services (funding connection, industrial linkages, and marketing connection).
However, the KAIST incubating services have their own uniqueness based on their individual strengths. With the global capacity for technology research and business administration, KAIST can provide entrepreneurship and business education as intensive courses for tenant startups. These high-quality capacity development programs can contribute substantially to raising the long-term competitiveness of startups, which cannot be achieved by just providing on-and-off business consulting services like other incubation services.
Related to this, the KAIST also provides intensive technology services to tenant startups. With technology-field-wise and highly diverse KAIST faculties, the KAIST TBI can provide consistent technology mentoring and technology professional services on technology transfer, technology evaluation and testing, and certification.The business and technology aspect supports, in a consistent manner with largescale diversity, can provide tenant startups with more opportunities for experimenting with various marketability and technology paths for new ideas. Moreover, since there already is a large KAIST TBI alumni, among which many startups are highly successful and listed in Korean stock markets, they have a vast network in the Korean venture ecosystem. These networks can provide new opportunities for recent markets and new technology uptrends, and also for funding, which cannot be easily provided by other Korean incubation centers.
[Figure 3-9] KAIST TBI Vision, Goal and Strategy
OUIC Vision Increase the value of KAIST for the world and for the humanities Mission : One-Stop Service for Business Incubation Management and Technology Transfer Commercialization
TBIC Goal Global Venture. Innovation Platform of Startups
Entrepreneurship Startup Creating Global Strategy Culture KAIST Company Partnership
• Entrepreneurial • E5-KAIST & Velocity • Creative Corporate • U.S. Silicon Valley Mindest • Startup Clubs Ecosystem • Europe Business • Business Contest • Researcher-Specific • CEO Community Clubs Network Action Plan • Idea Community Club Startups • Industry-Academic • Southeast Asia • Industry-Academic • Customized Startups Fundraising • Domestic/Global Cooperation • Startup Space • HR Marketplace Research Centers • Technology Support and Commercialization
Core Service Education Tech Service Management Fund & Marketing
Source: KAIST TBI homepage.
188 • 2014/15 Knowledge Sharing Program with Sri Lanka For its vision and goals, the KAIST’s organization has two basic centers, one for a technology business incubation center (TBIC) and the other for a technology commercialization center (TCC). These two core centers can produce synergetic effects through close industry relations, IP management, marketing, and branding for better and efficient technology incubation services.
[Figure 3-10] KAIST TBI Organization
KAIST President
Vice President of Research
Dean of University - Industry Cooperation
Technology Technology Business Commercialization Incubation Team Center
Technology Commercialization Center TBIC (Technology Business Incubation Center) • General management (1 person) • General management (1 person) • Industrial property management -Domestic (1 person) • Project planning and management (1 person) • Leader of ip strategy team, patent agent (1 person) • Supporting business for customized incubation (1 person) • Patent Attorney (1 person) • Bi operation (3 persons) • Industrial property management -Overseas (1 person) • Int'l bi operation (1 person) • Industrial property management -Invention report (1 person) • Industrial property management -Annual fee (1 person) • Patent evaluation (1 person) • Leader of technology transfer team (1 person) • Technology transfer (2 persons) • Technology transfer marketing (1 person) • Planning / Technology transfer (1 person) • Research on university-industry (1 person) • Brand / Industrial liaison program staff manager (1 person) • Dean's secretary (1 person)
Source: KAIST TBI homepage.
3.1.1.4. Implications
The KAIST’s success factors can be summarized into: 1) world-class engineering- oriented and industrial technology capability, especially in ICT cutting-edge technology expertise, 2) top MBA programs for inter-disciplinary research and entrepreneurship education, 3) team-ups with technology transfer offices, which are closely related to existing industries and global companies in Korea, 4) intensive
Chapter 3 _ Technology Business Incubators in Support of Technology-Based Industries in Sri Lanka: Preparatory Study for the Establishment and Operation of the TBI in the Science Park • 189 technology mentoring services to tenant startups through the highly diverse KAIST faculties, and 5) a huge alumni from the KAIST TBI and vast networks in the Korean venture ecosystem.
3.2. Experiences of China and India
3.2.1. China’s experiences
China utilized TBIs as a means to foster entrepreneurship in the high-technology sector, and implemented various support policy measures to create favorable environments for high-technology start-up activities.76) The Torch Program of the Ministry of Science and Technology was introduced in 1988 to promote R&D and commercialization. A series of the Medium to Long-term Plans and the National High-Technology R&D Program (863 Plan) have consistently supported establishment and operation of TBIs. Following the first TBI built in Wuhan with the government’s funding in 1987, TBIs spread out across the country.
Growth of TBIs in China occurred in two stages. In phase one (1987~1997), the Chinese government concentrated on providing basic physical infrastructure and services, such as land and buildings. Incubators were mostly sponsored by government funds on a non-profit basis. Incubators were not specialized in certain technologies or industries. Entry and exit criteria were not clearly articulated.
In the phase two (1997~present), more specialized and industry-specific TBIs have been developed, and value-added services (consulting, training, networking etc.) began to be provided. This phase can be characterized by the diversification of funding sources, localization of incubators, and the appearance of private incubators funded by venture capital.77)
76) The China’s experience is looked into here because China is one of the countries that successfully utilized TBIs as a means to foster technology entrepreneurship on a very large scale with the government’s comprehensive support and intervention. 77) Profit-oriented incubation were introduced in Shenzhen and Guangzhou
190 • 2014/15 Knowledge Sharing Program with Sri Lanka
The Development and Performance of TBIs in China (2003-2010)2003 2004 2005 2006 2007 2008 2009 2010 Number of TBIs 431 464 534 548 614 670 772 896 Number of tenants 27,285 33,213 39,491 41,434 44,750 44,346 50,511 56,382 Number of Tenants per TBI 63.30 71.57 73.95 75.60 72.88 66.18 65.42 62.92 Incubation space for tenants 1,359 1,515 1,970 2,008 2,270 2,316 2,901 3,044 (10,000 m2) Total income of tenants (bil. $) NA NA 163 193 262 187 179 118 Number of graduated tenants 8,981 11,718 15,815 19,896 23,394 31,764 47,286 53,198 Number of employees (10,000 48 55 72 79 93 93 101 118 persons)
Source: Business Incubator: A Cradle for SMEs and Innovation, Liming Wang, 2012.
The government has been a key supporter and promoter of TBIs under the Torch Center Program. It has provided financial supports, implemented preferential policies, set the strategic focus, and imposed a selection criteria, and management structure for the incubators. However, the government’s involvement negatively impacted the incubators’ market orientation as well as the nature of their services.78)
The organizational structure of the TBIs varied with sponsorship. In the first phase, the government-run TBI managers were mostly prior government officers or SOE managers with little market experience. In the second phase, the TBIs were run by a mixed group of sponsors, and the managers were more likely to bebeen enterprise- oriented.79)
The TBIs in phase one primarily served as bridges helping incubators’ access government grants (seed funds), banks, angel investors, and venture capitalists. Most of the fund was provided by the government as grants or soft loans. In phase two, the services were more sophisticated with a refined evaluation system. Beyond the financial supports from the TBI, government fund for technology-based small firms (Inno-fund) were also set up in 1999 to encourage innovation and commercialize academic research (Ming Feng Tang et al 2014).
In the first phase, the client selection criteria was laid out in principle, but not consistently applied due to political considerations intervening in the actual implementation. In the second phase, the entry criteria seem to be based on a strict, clear, market-oriented criteria such as the innovativeness of idea, type of technology,
78) More than 70% of business incubators in China are under state ownership and control. They make an attempt to diversify their revenue sources in order to reduce dependence on a single revenue stream from the government. 79) The Shenzhen incubator had instituted performance-based pay incentives for his incubator staff.
Chapter 3 _ Technology Business Incubators in Support of Technology-Based Industries in Sri Lanka: Preparatory Study for the Establishment and Operation of the TBI in the Science Park • 191 market potential, short and long-term financing plan, growth potential, the quality of management team etc.
The first generation incubators emphasize physical infrastructure services with poor value-added services because of a lack of managerial capability with less experience in a market environment. In the second phase, the service appears to be focusing more on higher value-added services such as consulting, networking, pre and post incubation service etc.80)
Chinese incubators can be classified as follows in terms of focus on target sectors and adaptation to local needs (OECD 2007, Ming Feng Tang et al 2014).
• General high-technology business incubator: The largest share of TBIs in China. Open to all types of technology start-ups. Provides basic services, preferential government policies, tax incentives, access to financing etc. • Specialized high technology business incubator: More focused on a specific technology sector. Provide specialized guidance and training through universities or R&D institutes as well as more sophisticated financial services. • University-based Business Incubator (UBI): Strategically offers hospitable environments for the academic entrepreneurships to transfer and commercialize the technologies from university. • Returned Scholar Business Incubator: Evolved in response to the need to transform a brain drain into a brain circulation. With the beginning of setting up the recruiting programs, such as ‘100 Talents’ and ‘Yangtze River Scholar’, the ‘1000 talents’ initiated in 2008 to boost China’s scientific and innovative capability. Since 2000, the government also has provided incentives, such as special permits for entering and leaving the country, tax reduction or exemptions, spaces near universities, and funding for start-ups.81) (OECD 2007) • International Business Incubator (IBI): Assist Chinese SMEs’ penetration into international markets and international firms’ entry to the complex Chinese market. Expect cross-fertilization of technology and market oppor-tunities. • State-owned enterprise (SOE) incubator: Help absorb redundant labor from the SOE privatization in the process of restructuring traditional industries
The Chinese TBI industry witnessed explosive growth in the number of incu-bators within a short period of time. Chinese incubators have focused on high-technology start-ups, have relied primarily on government funding, and have developed localized incubators. However, many of them were run as non-profit TBIs, and suffered from attaining self-sustainability.
80) For example, an incubator from southern China outsources basic, low value services while focusing on two tiers of high value services: 1) general services aimed at a broad client base, and 2) specific services targeted to the needs of client firms in specific high-technology sectors. 81) For example, the Tsinghua BI in Beijing is running a business incubator for returned scholars.
192 • 2014/15 Knowledge Sharing Program with Sri Lanka 3.2.2. India’s Experiences
The Indian government pursued innovation-driven growth policies since the 1980s, but it was not until the 2000s that the intensive promotion of TBI programs were introduced and supported by the government.82) Up to the 1990s, STI promotion policies centered on establishing Science and Technology Entrepreneurs Parks (STEPs) that focused on linkages among academia, industries, and research institutes to foster entrepreneurship culture. India’s TBI program was launched during the early 2000s by the National Science and Technology Entrepreneurship Development Board (NSTEDB) as a main mechanism to encourage innovative entrepreneurship.83) The TBIs’ objectives included nurturing technology start-ups, creating value added employment opportunities, promoting technology transfers and R&D commercialization, promoting entrepreneurship culture etc.
The TBIs focused on entrepreneurship in the high-tech areas such as ICT, biotechnology, new materials, manufacturing and engineering, health and Pharmaceutical, energy and environment etc. (Tang et al 2011, NSTEDB 2014) Figure 11 below shows the thrust areas of the TBIs in India.
[Figure 3-11] Thrust Areas of the TBIs in India
16% 13% 13% 12% 11% 9% 8% 7% 6% 6%
Source: NSTEDB (2014).
The TBIs in India are usually located at or near research centers and academic institutions, so that they may make use of existing expertise and facilities for technology development and its commercialization. (Suresh Kumar 2012)84)
82) India is the Sri Lanka’s neighboring country with many cultural backgrounds in common. Regarding the experiences on TBIs, also, it is quite natural for Sri Lanka to learn from India, so, major features of the India’s case are reviewed here for Sri Lanka’s reference. 83) The Council of Scientific and Industrial Research set up a Patent Cell, and all the IITs established Industrial Research and Consultancy Offices that aimed to facilitate institute-industry interaction. (Deloitte Touche and Tohmatsu India Private Limited, 2014) 84) “By the end of 2009, there were approximately 120 TBIs in India. NSTEDB promoted 53 TBIs in collaboration with premier academic and research institutions Of these, 14 are in Science and Technology Entrepreneur’s Parks (STEPs)” (NSTEDB 2009)
Chapter 3 _ Technology Business Incubators in Support of Technology-Based Industries in Sri Lanka: Preparatory Study for the Establishment and Operation of the TBI in the Science Park • 193 3-19> below summarizes the typical profile of a TBI in India.
Typical Profile of a TBI in IndiaBiotech & Electronics & Mechanical & Agriculture ICT Domain Manufacturing Domain Total Floor Area 8500 -10000 ft2 10000 to 20000 ft2 15000 to 25000 ft2 Number of Companies 15-20 8-12 10-15 Floor area for Each Company 100-300 ft2 225-750 ft2 350-500 ft2 Number of Employees at Start-up 1 to 5 3 to 10 3 to 10 Incubation Period 1 to 2 years 2 to 3 years 3 to 5 years
Source: NSTEDB (2009).
More than two thirds of TBIs are established by the government and the rest by private companies or financial institutions. The TBIs supported by the government are based in host institutions (HIs), which are academic institutions (mostly universities), technology parks, R&D institutes, industrial associations, and PPPs. Over 75% of HIs are academic institutions.85)
The HI plays a main role in establishing and operating the TBI. It has to provide land, building, and utilities (electricity, water etc.) for the TBI, which usually are part of its existing facilities. In most cases, the TBIs in India are governed by a board that draws a strategic plan that contains the TBI’s objectives and management system. (Tang et al, 2011)
[Figure 3-12] Type of Host Institution
7% 6% 4% University/ Academic Institution 6% Technology Park PPP Industrial Association/ Consultancy 77% R&D Institution/ Laboratory
Source: NSTEDB (2014).
85) Spinoffs from academic institutions are still not so active in India. (Basant and Chandra, 2007)
194 • 2014/15 Knowledge Sharing Program with Sri Lanka The NSTEDB supports capital expenditure on equipment, software, and facilities. Support for recurrent operating costs is also provided for five years. The HI is responsible for the building and basic infrastructure cost. The TBI is supposed to be self-sustainable without government support within five years of operation. After the initial funding from the NSTEDB, financial reporting is required for subsequent funding.
Promising potential start-ups are identified through business meets, referrals, and start-up competitions. They are provided with pre-incubation supports of counseling, business plan development, and networking. A committee is set up by the TBI for selection of entrant start-ups with growth potential.86) (Tang et al, 2011) The TBIs in India typically provide their clients with services such as basic infrastructure support (office spaces, conference rooms, power back up etc.), laboratories and testing facilities, mentoring support, and funding support. (NSTEDB 2009)87)
Start-ups in the TBIs can obtain funds from several sources. Seed funding is offered by the government (NSTEDB, Technology Development Board) as well as the angel network and venture capital.88) The DSIR’s Technopreneur Promotion Program provides grant-in-aid. However, in most cases, start-ups have to get funding by themselves or from friends/family because of the limited availability of public and private funding supports, although investors are more willing to fund start-ups than before.89) (Tang et al, 2011)
Table 3-20 below compares the main characteristics of TBIs in China and India to describe the merits and demerits of TBIs in each country.
86) The committee is usually composed of representatives from the HI, financial institutes, and technical experts. 87) Even with the Indian government’s efforts, the incentive structure and risk-averse culture discouraged start-up activities. Mostly, the researchers from government-funded academic institutions tend to focus on publications, and hardly involved in industry cooperation. (Robert H. Meyer, 2012) 88) The Technology Development Board introduced the ‘Seed Support System for Startups in Incubators’, which provides a maximum amount of Rs 25 lakhs. The NSTEDB has also provided a similar seed fund with the amount of Rs 50 lakhs. (ISBA 2010) 89) According to the 2008 National Knowledge Commission Study, 63% of the start-ups had been self- financed. (NKC, 2008)
Chapter 3 _ Technology Business Incubators in Support of Technology-Based Industries in Sri Lanka: Preparatory Study for the Establishment and Operation of the TBI in the Science Park • 195
Comparison of Characteristics of TBIs in China and IndiaSimilar objectives: creation of technology based new enterprises, facilitating technology Objective transfer, creating jobs and regional economic development • China: non-profit organizations, mostly government-sponsored Nature of • India: about 2/3 promoted by government, around 1/3 by banks and private companies. Host ownership institutions that provide spaces for the TBIs play a key role in planning and managing the TBIs. Establishment of TBIs has been driven by the central government’s top-down approach. • China: Local government is directly involved in implementation and central government in Governance monitoring. • India: Central government plays a promoting role and has loose control over TBIs. TBIs are governed by the Governing/Advisory Board and the Management Team. • China: intellectual property with market potential, a qualified entrepreneurial team (MOST’s requirements: maximum registration capital, foundation year, registration place, incubation surface, property of high-tech and environment friendly products, professional entrepreneurs) Client • India: different selection policy across TBIs according to their missions and objectives (Usually, selection entry criteria include sound idea and business plan, commitment and integrity, potential for growth, willingness to follow mentoring/advice, capacity to meet targets, willingness to pay for facilities and services.) Duration China: 3-5 years , India: 2-3 years • China: criteria by MOST and TBI Graduation • India: criteria by the TBI (benchmarks provided by NSTEDB/DST) • China: local government (free land and initial fund), other sponsors including universities, Funding for SOEs and investors TBIs • India: central government, host institutions, financial institutions, private sector companies Start-ups mobilize high proportion of the initial capital by themselves. Venture capital system is weak especially for early start-ups. Public funding is provided as seed to attract other funds. Funding for • China: Innovation fund for start-ups through R&D project competitions. Local government incubatees agencies pool and channel funds into new ventures. • India: TBI facilitates funding for start-ups, provide seed capital in some cases. Physical resources, business support, access to capital, mentoring, coaching, consulting, legal advice, bookkeeping, networking services (links with customers, universities, investors etc.) Services • China: Emphasis on building and administrative services. Networking not well developed. to client Mentoring service has started. Focus on few services on competitive advantages. companies • India: Emphasis on basic infrastructure service. Significant value-added services include mentoring and networking. Matured TBI provide specialist services such as Seed and Patenting. The central government identified high tech sectors for growth and applied supportive measures. • China: policies to support growth of high-tech sectors in all 5-year plan since 1980s and a series of STI promotion programs (Spark Program, Torch Program, Key Technologies R&D National Program, National High- tech R&D Program (863 Program), National Science and Technology STI policy Infrastructure Program etc.) initiatives • India: measures to support growth of the identified high-tech sectors since 1980s (STPs, STEPs, Special Innovation Zones etc.), various Innovation and entrepreneurship promotion programs (Technology Development and Innovation Program, Technopreneur Promotion Program etc.)
Source: Tang, Baskaran, Pancholi and Muchie (2011), Tang, Baskaran, Pancholi and Lu (2013).
196 • 2014/15 Knowledge Sharing Program with Sri Lanka 3.2.3. Implications
• The experiences of China and India show that, at the early stage, the government’s support and sponsorship played a critical role in the successful launch and promotion of the TBIs. But, as the TBIs are on track, the private sector including large companies and investors need to be involved in the financing and investment for the TBIs, which will ultimately contribute to the TBIs’ financial sustainability. For that purpose, they are attracted to participate in the TBI’s operation, for example, on the board or the client selection body.
• Identifying and securing promising clients is the first step for the TBI’s successful operation and performance. The two countries’ experiences say that organizations such as universities with S&T majors, S&T-related public research institutes, and the inventors’ association are the potential pool of promising TBI clients. So, networking with those organizations will help the TBI acquire promising technology startups that can enter the TBI. At the same time, as in Korea’s experiences, governmental policy measures can stimulate technology startups out of those organizations. The researchers in the above mentioned organizations that can be encouraged to try to start technology-intensive businesses if they are allowed to be on leave for some period when they attempt to launch technology startups.
• As in most developing countries, China and India suffered from reluctance to engage in risky technology startups, lack of information, and education for techno-entrepreneurship etc. In this environment, the TBIs played an important role in promoting techno-entrepreneurship culture and education. Some star or successful startup cases nurtured by the TBI can work as role models that young potential technology startups can be motivated to follow.
• China’s experience at the early stage proves that the TBI cannot succeed without competent managers who understand and network business and research communities. In order for the TBI to incubate competitive startups that can survive in the market, the TBI, itself, must be competitive in its incubating capability. The role of excellent managers cannot be overemphasized in achieving the TBIs competitiveness. Furthermore, regular monitoring and evaluation of the TBIs performance is imperative to keep improving the TBI’s competitiveness.
• As TBIs got on track, China and India have gradually put more emphasis on the TBIs value-added services. Tangible services such as low-rent spaces and internet connection are basic. More important are the intangible value-added services that include consulting, mentoring, technology advisory, IP-related,
Chapter 3 _ Technology Business Incubators in Support of Technology-Based Industries in Sri Lanka: Preparatory Study for the Establishment and Operation of the TBI in the Science Park • 197 marketing and business plan writing assistance services etc. Especially, without demands for developed technology and product, startups cannot survive in the market. So, it is very important to help start-ups carry out market-oriented and demand-driven technology/product development from the outset.
3.3. Good Practices in Business Incubation
Various researchers and organizations working on business incubation suggested good practices to be followed by developing countries that try to establish and run the business incubators. Some of them derived good practices for the overall business incubators including the TBIs. Here, we look at previous literature on good practices that focused on TBIs. (Appendix 7 provides a detailed summary.) Good practices and success factors for TBIs that the previous research noted in common can be categorized as follows.
□ Clear Mission and Objectives
• The mission and objectives are to be set to achieve broader policy goals. The other components of the TBI need to be aligned to the mission and objectives.90) • The incubator’s type, target sector(s), and clients are to be determined to attain its objectives most effectively.
□ Stakeholders and Sponsors’ Supports with Consensus on the Objectives.
• The incubator needs the community’s supports for success. It has to identify stakeholders and sponsors and draw their supports to enhance its chance of success. • Stakeholders can help market the TBI and identify promising clients. They can benefit from outsourcing of technologies and products, investment opportunities etc.
□ Financial Sustainability with the Private Sector’s Participation (PPP)
• Government’s support for construction and operation is needed at the early stage. • Incentive measures for large corporations’ contribution can help the incubator’s financial sustainability. • Government’s support has to come with a strict performance check for the efficient use of public money.
90) The Malaysian government supports 100% of the incubator’s costs. (infoDev 2010 p 29)
198 • 2014/15 Knowledge Sharing Program with Sri Lanka • R&D competition grants and loans from government can help the TBI and clients secure R&D and seed money.
□ Importance of Pre-Incubation
• Especially in developing countries, pre-incubation can play an important role in promoting entrepreneurship climate and culture. • Pre-incubation can help potential start-ups ready to enter the incubator, and secure promising clients for the incubator.
□ Enough and Decent Deal Flow with Strict and Transparent Entry/Exit Criteria in Line with the TBI’s Objectives
• The incubator’s objectives cannot be achieved without enough deal flow of promising clients. • Cooperation with technical universities, research institutes, industry associations etc., can help recruit clients with technological capabilities and growth potential. • Strict and objective entry/exit policies are needed to select excellent clients with good potential, which critically affect the TBIs performance.
□ Competent Management Team
• A competent manager with a business and technology mind is pre-requisite for efficient operation of the incubator, so, the right manager should be recruited with comparable pay. • The manager has to be in charge of all processes of the TBI’s operation including pre-incubation. The manager’s participation at the early stage including preparation of the business plan can help the manager acquire detailed information and ownership on the TBIs operation.
□ Quality Value-Added Services
• Clients can benefit very much from quality professional services such as consulting, mentoring, legal assistance etc. • The clients’ needs for various services should be identified and met by the management team on a regular basis.
□ Monitoring and Evaluation
• M&E is important not only for the incubator’s self-performance check but also for the funder’s willingness to maintain supports.
Chapter 3 _ Technology Business Incubators in Support of Technology-Based Industries in Sri Lanka: Preparatory Study for the Establishment and Operation of the TBI in the Science Park • 199 • Lessons from the M&E and best practices of the other incubators have to be allowed for the overall improvement of performances.
4. Core Issues of Feasibility and Business Plan for a TBI in Sri Lanka 4.1. Feasibility of Sri Lanka TBI
The feasibility study on Sri Lanka’s TBI establishment consists of three components, which are 1) policy-relevance of Sri Lanka’s TBI, whether the TBI is one of the Sri Lankan government's priorities and is aligned with the general directions of the Science, Technology and Innovation (STI) basic plans and policies, 2) technological feasibility of the Sri Lankan TBI, whether Sri Lanka's technological capability is enough to create startups and have the potential to boost up entrepreneurship in technological areas, 3) economic feasibility, whether there exists enough demand for a Sri Lankan TBI center, and which industrial areas are best suitable for a Sri Lankan TBI, and whether there exists willingness to pay for investers in Sri Lanka’s TBI.
4.1.1. Policy Relevance of a Sri Lankan TBI
Sri Lanka government’s STI basic plan is called “The Science, Technology and Innovation Strategy 2011 – 2015”, which is the first of its kind and was developed based on the National Science and Technology policy adopted by the Cabinet of Ministers in 2009.
Among the four overarching goals and fourteen sub-objectives, the plan stressed the importance of STI and technological entrepreneurship in Sri Lanka’s overall economic development. Goal 1 states that “an efficient system to actively harness innovations and technologies to generate and improve products and services to contribute towards doubling the per capita GDP in an equitable manner by increasing the high tech value added exports and the production for the domestic market”. The three sub-objectives of Goal 1, states “Develop a dynamic technology transfer platform for wealth creation through the Techno entrepreneurship Initiative”, which exactly indicates the importance of techno-entrepreneurship and the role of a dynamic technology transfer platform to promote techno- entrepreneurship in Sri Lanka. The plan indicates that the development of “Minipolis to support techno-entrepreneurial capabilities at grassroots level (through Vidatha Centers) and the convergence of all government and other support organizations on one physical location”.
The Coordinating Secretariat for Science, Technology and Innovation (COSTI) is
200 • 2014/15 Knowledge Sharing Program with Sri Lanka an important institute supporting the innovation system in Sri Lanka. This institute was established in February 2013 and is set to remain viable for a 3 year period. Their main objectives include 1) Establishment of an Inter-Ministerial Steering Committee for Science Technology and Innovation to coordinate all activities in Science, Technology and Innovation, 2) Establishment of a Secretariat to centralize, institutionalize and support the Coordination and Monitoring activities related to Science, Technology and Innovation and 3) a flexible comprehensive National ICT platform for coordination and monitoring of all activities related to Science, Technology and Innovation across more than 25 ministries and more than 70 institutions.
The interviews with COSTI chairman, Prof. Ajith de Alwis, showed the importance of a Sri Lanka TBI and the background of TBI establishment plans. He mentioned that, in order to develop a new high-tech industry and the modernization of the manufacturing industry in Sri Lanka, the country needs a high-tech venture success story. The exemplary cases and quick-win strategy may enlighten Sri Lankan energetic youth people to pursue entrepreneurship in high-tech industries for long- term development of Sri Lanka. He suggested that Sri Lanka has huge technological potentials in terms of ICT, Chemical engineering, and Nano-technology but technology transfers and entrepreneur activities are not enough to commercialize these potentials into industrial success. These situations led Sri Lanka’s government to introduce diverse policy measures to boost technology transfers from PRIs to industries in order to solve the industrial technology problems of universities and PRIs, and to promote startups and techno-entrepreneurship, including a TBI establishment. He remarked that the Sri Lankan government has two-fold purposes for a TBI solving the technological problems of industrial sectors through technology transfers, technology commercialization, and boosting up startups in high-tech sectors through market research, consulting, technological co-research, and business planning.
“The Science, Technology and Innovation Strategy 2011 – 2015” and a high-level interview with the COSTI chairman clearly showed that the Sri Lankan government has a consistent intention and strategy with a high priority for promoting high-tech or more advanced technological industry sectors through not only R&D promotion but also technology commercialization, startups, and techno-entrepreneurship, which clearly indicates that a TBI is one of the core platforms for these interfaces of technology and industry.
4.1.2. Technological Feasibility of a Sri Lankan TBI
From the point of a technological capability assessment, we may use various aspects of the Sri Lanka National Innovation System (NIS). It consists of 1) STI inputs
Chapter 3 _ Technology Business Incubators in Support of Technology-Based Industries in Sri Lanka: Preparatory Study for the Establishment and Operation of the TBI in the Science Park • 201 such as the size of R&D investments, research personnel, 2) STI outputs such as scientific journal publications, patents, technological sector’s export amounts, and industry proportion, and 3) technological capabilities of universities, PRIs, and private sectors.
4.1.2.1. STI Inputs and Outputs
Concerning the STI inputs of Sri Lanka, its R&D investment is estimated as low as 0.16% of GDP (World Bank Science and Technology Data, 2010). The world average was 2.13% in 2011, while South Asia, in which Sri Lanka belongs to, recorded 0.76% in 2011. India' R&D expenditures recorded 0.81% of GDP in 2011. In terms of HRST, the number of researchers in R&D is a good indicator, which was estimated as 103.09 per million peoples in 2010, which is quite comparable to India’s, 159.93 per million peoples, but far lower than China’s, 890.44 and Korea’s 5,450.91. The numbers of researchers in R&D per million people in Sri Lanka was higher in the 1990s, which was 188 (1996), but 136 (2004). Technicians in R&D are also in a similar situation. Sri Lanka’s technicians per million peoples are estimated as 89.17, while it is quite comparable to India’s 103.01, but is far lower than Korea’s 981.48. These imply that Sri Lanka has very low R&D investment money, which is quite comparable to Sub- Saharan African Countries, but their R&D manpower is quite comparable to India's capability in terms of average number. In other words, R&D money is short but HRST is quite available.
STI outputs are already quite nicely assessed by the 2013 Sri Lanka KSP R&D chapter, which states that “even in comparison with the lower middle income group, Sri Lanka shows worse performance in R&D outputs in terms of royalty and license fee receipts, S&E journal articles, patents, high-tech exports etc” but also suggests the bright side of STI in Sri Lanka’ private sectors, which states that “Sri Lanka’s potential for R&D looks promising since Sri Lanka possesses better platform for R&D than does the average upper middle income country with regard to private sector spending on R&D, intellectual property protection, university-company research collaboration, firm-level technology absorption, availability of venture capital”.
As suggested by the previous KSP, Sri Lanka does not show any good performance in R&D output in terms of scientific publication, technology development (which can be measured as patent results), and innovation (which can be measured as royalty and license fee receipts, high-tech exports), even comparing to a lower income country group. These things indicate that even though they have quite good HRST researchers they do not invest in R&D, and as a result all facets of STI showed no sign of a good performance. This again implies that the current economy of Sri Lanka is not conducive for a STI-based knowledge economy.
202 • 2014/15 Knowledge Sharing Program with Sri Lanka [Figure 3-13] R&D Inputs & Outputs - World Bank’s KAM Indicators
Manuf. Trade as % of GDP, 2009 High-Tech Exports as % of Manuf. 10 Intellectual Property Protection (1-7), Exports, 2009 8 2010 Patents Granted by USPTO / Mil. 6 University-Company Research People, avg 2005-2009 Collaboration (1-7), 2010 4 S&E Journal Articles / Mil. People, 2 Private Sector Spending on R&D (1-7), 2007 0 2010
Royalty and License Fees Receipts Firm-Level Technology Absorption (US$/pop.), 2009 (1-7), 2010
Royalty and License Fees Payments Availability of Venture Capital (1-7), (US$/pop.), 2009 2010 Capital goods gross exports (% of Capital goods gross imports (% of GDP), 2005-09 GDP), avg 2005-09
Sri Lanka Lower Middle Income Upper Middle Income
Source: the 2013 Sri Lanka KSP R&D chapter. Original Source: World Bank KAM Database.
But there exist some very good new signs for Sri Lanka’s innovation-based economic growth. As was indicated by the 2013 KSP R&D, between 2008 and 2010, the business enterprises’ R&D expenditure had increased more than 3.5 times in only 2 years. Government R&D expenditure also increased more than 30% during these 2 years. Since we do not have the current national survey on R&D expenditure, we cannot say any definite trend has been observed for the business’ innovation appetite uptake. But as indicated by the above KAM database indicators, private sector’s R&D spending, firm-level technology absorption, and university-company research collaboration recorded even higher than an upper middle income country group’s performance.
This may indicate that, after the internal war of Sri Lanka ended in 2009, the private sectors’ innovation investment has restarted with their capacity for absorption and good collaboration with university research. In 2010, business R&D expenditure already reached the proportion of 40.93% of total R&D expenditure. In Korea, in 1970, business R&D expenditure proportion was 23.7% of total R&D, but increased to 35.2% in 1976, 48.8% in 1980, 80.5% in 1985, and stabilized more-or-less afterwards. Most of the high-tech manufacturing based economy's business R&D proportion is quite comparable to 70-80% of total R&D expenditures in their economies. During 1975-1985, the Korean business sector's R&D spending increased drastically due to the realization of large business enterprises of the importance of R&D and the needs to transform their manufacturing structure from low-tech assembly lines to advanced
Chapter 3 _ Technology Business Incubators in Support of Technology-Based Industries in Sri Lanka: Preparatory Study for the Establishment and Operation of the TBI in the Science Park • 203 high-value-added tech product developments with the support of huge R&D tax incentives by Korean government.
Sri Lanka’s GERD with Funding Sources in 2006-2010 (Unit: Rs. Million) Source 2006 2008 2010 3,338 3,624 4,907 10,000 Government 65.2% 71.8% 55.90% 8,000Business 975 1,004 3,592 6,000 enterprise 19.10% 19.90% 40.93% 4,000 246 215 239 Foreign 2,000 4.8% 4.3% 2.72% 0 559 203 39 2006 2008 2010 Other* Other* Foreign Business Government 10.9% 4.0% 0.45% enterprise Total 5,119 5,047 8,778
Note: * Funds generated by the institution itself by providing services etc. Source: the 2013 Sri Lanka KSP R&D chapter. Original Source: National R&D Survey, Sri Lanka, 2010.
After achieving internal stabilization, Sri Lanka’s business sector may be experiencing a similar transformation of its manufacturing sector for more high- value-added product development. In this process of transformation, business enterprises may be greatly increasing their spending on R&D for the innovation of industry with good collaboration with universities. These are being highly supported by Sri Lanka’s government with the initiative of the Triple-tax haven for business R&D expenditures and with good IP protection, and also with a good institutional environment for venture capital investment in Sri Lanka. These can be all possible due to the good resources of S&T personnel in Sri Lanka. Since they already had a good potential for R&D and innovation from the perspective of HRST, the R&D money inputs by business enterprises would possibly lead to innovation and technology advancement in Sri Lanka in the coming years. Since the innovation outputs and impacts of R&D investment take quite some years to develop, the STI performance might not be captured in the 2010 KMA World Bank STI indicators.
Among STI output indicators are scientific journal publications, patent registrations, and technological sector exports. First, the SCOPUS Science Journal Database system shows that the number of Sri Lanka’s scientific papers increased almost 5 folds in recent years from 245 in 2000 to 1149 in 2013, which added up to a total of 9,917 papers as of January 2015.
204 • 2014/15 Knowledge Sharing Program with Sri Lanka [Figure 3-14] The Number of Scientific Publications Since 2000-2015 (As of January 2015)
1400
1200
1000
800
Documents 600
400
200
0 2000 2005 2010 2015
Source: SCOPUS DB.
The major innovators in scientific publications are 1) the University of Peradeniya, which has 2,206 publications during the period of 2000-Jan. 2015, 2) the University of Colombo, which has 1,202 publications during the same period, and 3) the University of Moratuwa, which had 804 publications.
[Figure 3-15] The Number of Publications according to Affiliation
Compare the document counts for up to 15 affiliations
University of Peradeniya
University of Colombo
University of Moratuwa
University of Colombo Faculty of Medicine
University of Kelaniya
International Water Management Institute IWMI Colombo
University of Ruhuna
Institute of Fundamental Studies Kandy
University of Sri Jayewardenepura
National Hospital of Sri Lanka 0 250 500 750 1000 1250 1500 1750 2000 2250 2500 Documents
Source: SCOPUS DB.
The major subject area of publications, which produced more than 1,000 papers, are 1) Medicine (2,823 publications), 2) Agricultural and Biological Sciences (1,868), 3) Engineering (1,220), 4) Environmental Science (1,216), and 5) Computer Science (1,120). This means that medicine and environmental science, which are all related to the basic social problems in Sri Lanka, are quite advanced and has the capability
Chapter 3 _ Technology Business Incubators in Support of Technology-Based Industries in Sri Lanka: Preparatory Study for the Establishment and Operation of the TBI in the Science Park • 205 for scientific research, comparing to other scientific research areas. But from the industrial perspective, agriculture, mechanical engineering, and computer science also have a strong capability to conduct scientific research. This scientific background and research capabilities, when comparing other scientific disciplines, can contribute to industrial research and technological capability for new-tech development (such as ICT) and/or for the agricultural and manufacturing sectors’ development.
[Figure 3-16] The Number of Publications according to Subject Area
Medicine (28.5%)
Other (43.8%)
Agricultural an... (18.8%)
Undefined(1.0%) Physics and Ast..(5.2%) Engineering Chemistry(5.4%) (12.3%) Biochemistry, G... (7.9%) Social Sciences... Environmental S... (8.9%) Computer Scienc... (12.3%) (11.3%)
Source: SCOPUS DB.
Patents are the direct outcome of industrial technology development activities and can be a good indicator for new-technology capabilities. But for catch-up economies and for technology-wise mature industries, rather than patent activities, firms’ knowhow and firm specific industrial secrets are more important, which cannot be easily accounted as indicators. According to a local consultants’ survey, Sri Lanka has “328 resident patents and 128 non-resident patents were registered with the National Intellectual Property Office in 2013”. But as we research through the FOCUST patent database system, Sri Lankan affiliated US patents are not found, which means Sri Lankan nationals never had a US patent registration during the entire period in question.
The high-tech sectors’ export performances are often used to compare the technological commercialization capability of an industry. According to a local consultants’ survey, “in 2010, high technology exports as a percentage of manufactured exports was only 1% in Sri Lanka, compared with 75% in Korea, 27% in Thailand, and over 50% in Singapore and Malaysia”.
206 • 2014/15 Knowledge Sharing Program with Sri Lanka 4.1.2.2. Technological Capabilities of Universities, PRIs and the Private Sectors
Research capabilities and technology development capability lies in the universities and PRIs in developing countries. Private sectors and companies mostly show a very low capability of R&D in most developing countries. Until the early 1980s, when Korean global companies saw the opportunities and benefits of private R&D investment for new industry development in the sectors of electronics and automobiles, Korean R&D capabilities and technology leadership mostly lied in the hands of PRIs, such as the Korea Institute of Science and Technology (KIST).
4.1.2.3. Technological Capabilities of Sri Lanka Universities
Moratuwa University can be considered as the top university in terms of scientific research and engineering capabilities, especially in the areas of chemical engineering, software development, and ICT. Their efforts for industry-funded contractual research through the above incubators are highly successful in terms of rubber production and in the ICT sector. Through industry-academy co-research, the university can have commercialization and technology transfer capability understanding in industrial technological problems and demands.91)
Moratuwa University operates the SIL-UOM Incubator, which is a contract university-industry collaborative research center, rather than just one that incubates startup companies. SIL-UOM, which is owned 50% by industry and 50% by the DSI business group (Polymer and Rubber industrial group), research on the subject of new chemical polymer product development, and the hazardous effects of toxic elements to food and human health. These research is a sort of contract collaborative research in which the DSI group provides research funds, equipment and raw materials while the university provides human resources and infrastructure, along with testing facilities. Research results are directly reported to the DSI group and utilized for industrial applications.92)
The university operates 5 other collaborative research centers such as the Dialog- UoM Mobile Communication Research Laboratory, the High Performance Computing Laboratory, the UoM research laboratory for biomedical technologies, the UoM- Cargills Food Process Development Incubator, and the Zone24x7-UoM Electronic
91) Upon interviewing with rubber production incubator, the incubator director (who has long experiences of R&D and product development in rubber industry private sector) and his co-research team have capabilities of chemical research and a deep understanding of industrial technological demands and industrial process for rubber production. These industrial research experts and outstanding engineering students from the university can make their contribution to industry technology development and market success. 92) Currently, SIL-UOM consists of the center director, a Ph.D. and highly experienced in industrial polymer research, and 6 researchers with master degrees in chemical engineering.
Chapter 3 _ Technology Business Incubators in Support of Technology-Based Industries in Sri Lanka: Preparatory Study for the Establishment and Operation of the TBI in the Science Park • 207 Systems Research Laboratory. Thus, chemical engineering and ICT technology, which is mostly computer science research related, i.e. software development, have quite a competitive advantage for industrial purposes.
The University of Moratuwa certainly has an engineering and computer science research orientation. With research on SCOPUS DB, the DB shows that engineering and computer sciences ranked first and second with 509 and 378 scientific publications respectively during the years of 2000-2015. Following these areas, business, management, and accounting (81), the social sciences (79), environmental science (76), energy (63), and material science (43) recorded far behind that number of publications during the same period.
[Figure 3-17] The Scientific Publications of The University of Moratuwa
Ratio of Scientific Publications Number of Scientific Publications according according to their disciplines to their disciplines
10.3% 1.8% Engineering 509 2.2% Computer Science 378 2.8% 34.3% 2.9% Business, Management and Accou... 81 4.3% Social Sciences 79
5.1% Environmental Science 76 Energy 63 5.3% Materials Science 43 5.5% Earth and Planetary Sciences 41 25.5% Decision Sciences 32 Agricultural and Biological Sciences 27 Engineering Mathematics 27 Computer Science Business, Management and Accounting Chemical Engineering 20 Social Sciences Environmental Science Multidisciplinary 20 Energy Materials Science Medicine 18 Earth and Planetary Sciences Decision Sciences Chemistry 13 Agricultural and Biological Sciences Arts and Humanities 12 Other
Source: SCOPUS DB.
Even though the University of Colombo is the largest one in Sri Lanka, it is more- or-less medicine-research and social-sciences oriented, and not much suitable for high-tech development in engineering, and also not for technology transfers and the commercialization of high-tech. The key initiative of the university, which was the Colombo Science and Technology Cell in 2009, has completed four projects thus far, which are mostly biotech and chemical engineering related, but not highly sophisticated enough for high-tech development.
The University of Colombo has its research capabilities mostly in medicine being followed by agricultural and biological sciences, biochemistry, and computer sciences.
208 • 2014/15 Knowledge Sharing Program with Sri Lanka With research on SCOPUS DB, the DB shows that medicine ranked first, 651 scientific publications during the period 2000-2015. Following medicine research, agricultural research (273), biochemistry (260), computer science (211), and the social sciences (174) recorded the far behind that number of publications during the same period. The University of Colombo Faculty of Medicine also recorded the highest publications on medicine; 1014 in number.
[Figure 3-18] The Scientific Publications of The University of Colombo
Ratio of Scientific Publications Number of Scientific Publications according according to their disciplines to their disciplines
Medicine 651 21.4% Agricultural and Biological Sciences 273 23.3% Biochemistry, Genetics and Molecu... 260 3.4% Computer Science 211
3.7% 9.8% Social Sciences 174 4.4% Pharmacology, Toxicology and Pha... 161 5.3% Chemistry 149 9.3% 5.8% Engineering 124 6.2% 7.5% Environmental Science 103 Multidisciplinary 96 Medicine Immunology and Microbiology 89 Agricultural and Biological Sciences Biochemistry, Genetics and Molecular Biology Physics and Astronomy 85 Computer Science Social Sciences Business, Management and Accou... 59 Pharmacology, Toxicology and Pharmaceutics Chemistry Earth and Planetary Sciences 52 Engineering Environmental Science Mathematics 52 Multidisciplinary Materials Science 44 Other University of Colombo Faculty of Medicine
10.3% 1.8% Medicine 1014 2.2% Immunology and Microbiology 185 2.8% 34.3% 2.9% Biochemistry, Genetics and Molecu... 128 4.3% Social Sciences 75
5.1% Pharmacology, Toxicology and Pha... 70 Nursing 54 5.3% Agricultural and Biological Sciences 53 5.5% Psychology 23 25.5% Neuroscience 22 Environmental Science 20 Engineering Health Professions 14 Computer Science Business, Management and Accounting Multidisciplinary 12 Social Sciences Environmental Science Veterinary 12 Energy Materials Science Chemistry 7 Earth and Planetary Sciences Decision Sciences Engineering 7 Agricultural and Biological Sciences Decision Sciences 4 Other
Source: SCOPUS DB.
Chapter 3 _ Technology Business Incubators in Support of Technology-Based Industries in Sri Lanka: Preparatory Study for the Establishment and Operation of the TBI in the Science Park • 209 The University of Peradeniya has the highest publications of scientific journals, but the university’s main focus and capability is on agriculture research and medicine, which most of Sri Lanka scientists’ interviewees pointed out. Their scientific publication on engineering and computer science are also a quite good number, comparable to the University of Moratuwa, but their location is quite far from the capital city Sri Lanka and the center of manufacturing activities in Colombo, Sri Lanka.
The University of Peradeniya has its research capabilities mostly on agricultural and biological sciences and medicine, then being followed by biochemistry, engineering and chemistry, environmental science, and computer science. From research on the SCOPUS DB, the DB shows that agricultural and biological sciences and medicine ranked first and second in scientific publications with almost the same number of publications, which are 853 and 832 from 2000-2015 respectively. Following those areas, biochemistry, engineering, chemistry, and environmental science all recorded around 350-400 publications during the same period.
[Figure 3-19] The Scientific Publications of The University of Peradeniya
Ratio of Scientific Publications Number of Scientific Publications according according to their disciplines to their disciplines
15.4% Agricultural and Biological Sciences 853 25.6% Medicine 832 Biochemistry, Genetics and Molecu... 404
15.0% Engineering 400 3.9% Chemistry 367
4.0% Environmental Science 346 4.0% 7.3% Computer Science 262 4.7% 7.2% Pharmacology, Toxicology and Pha... 223 6.2% 6.6% Multidisciplinary 221 Earth and Planetary Sciences 218 Agricultural and Biological Sciences Immunology and Microbiology 217 Medicine Biochemistry, Genetics and Molecular Biology Materials Science 177 Engineering Chemistry Social Sciences 168 Environmental Science Computer Science Physics and Astronomy 163 Pharmacology, Toxicology and Pharmaceutics Multidisciplinary Dentistry 135 Earth and Planetary Sciences Veterinary 93 Other
Source: SCOPUS DB.
Comparing these three top universities in Sri Lanka in terms of scientific publications according to their disciplines, the University of Moratuwa has the highest number of publications (509), the University of Peradeniya (400) is second, and the University of Colombo (124) is the third in engineering research. In the areas of computer sciences, the University of Moratuwa ranked the first, 378, the second,
210 • 2014/15 Knowledge Sharing Program with Sri Lanka the University of Peradeniya, 262, and the third, the University of Colombo, 211. In terms of agricultural research, the University of Peradeniya ranked first, 853, and the second, the University of Colombo, 273, with the third being, the University of Moratuwa, 27. Thus in terms of engineering and computer sciences research, the University of Moratuwa has the highest capabilities and in terms of agricultural research, and the University of Peradeniya has the highest research capabilities.
4.1.2.4. Technological and Commercialization Capabilities of Sri Lanka PRIs
There exist four PRIs, which perform R&D functions and commercialization activities: Arthur C Clarke Institute of Modern Technology (ACCIMT), the Industrial Technology Institute (ITI), the National Engineering Research and Development Centre (NERD), and the Sri Lanka Institute of Nanotechnology (SLINTEC). However, the technological capabilities and commercialization activities of PRIs mostly lie in agricultural the research capability of the ITI (Industrial Technology Institute), and in material engineering research the SLINTEC (Sri Lanka Institute of Nanotechnology). Even though the NERD (National Engineering Research and Development Centre) has mechanical engineering research capabilities and the Arthur C Clarke Institute of Modern Technology has electronic engineering research capabilities, the commercialization and market success of these technologies are not mature enough to have an impact on industrial development and modernization.
As the local survey (SLINTEC, 2014) revealed, the NERD and the ACCIMT commercialized 11 and 5 innovations respectively, but that commercialization only reached local markets with limited success. However, the ITI had 11 commercialized innovations, among which 4 have penetrated into foreign market competition. And the 2014/15 KSP R&D part also reported that the only PRI, which filed a US and a PCT patent application filing, was the SLINTEC. The number of SLINTEC’s US patent applications was 5 and PCT filing, 2. Even though those are only patent applications, which are still not accepted or registered, those are the only US and PCT application filings to ever happen in Sri Lanka.
Interviewing with the A.C. Institute of Modern Technology’s director, Shiran Welikala and J.K. Jayawardena (Principal Research Engineer), the institutes’ research areas are largely focused on the electric industry, information and communication, and IT industry. It is running internal projects and also contract-based external projects. Internal research projects include radio frequency guarding, monitoring system development, and imbedded system development, and it also runs pilot test services using equipment. There are 15 researchers and engineers and none of them holds doctor’s degree as most of them are master’s degree holders. Each department is running 1 or 2 projects a year and about 6 engineers are working at each department. Technology business start-ups and business launching are driven by
Chapter 3 _ Technology Business Incubators in Support of Technology-Based Industries in Sri Lanka: Preparatory Study for the Establishment and Operation of the TBI in the Science Park • 211 external organizations and most of the activities of the research institute are focused on internalized system development and supply for each industry. There are no spin- off companies from the institute.
Interviewing the Industrial Technology Institute’s (ITI) Dr. Muditha Liyanagedara (Director General), and Dr. Radhika Samarasekara (Additional Director R&D), the research areas are found to be agriculture, pharmaceutical industry, and cosmetics. It is especially specialized at agricultural product development research and is running projects on chemical-based and bio-based research, such as research on natural ingredients like herbs and food. The two key research areas are 1) food and 2) natural herbal ingredients. However, out of the total financial structure, income from technology transfer makes up only a minor portion and most of the income comes from testing and approval fees for agricultural products. Currently, approximately 400 staff members are working at the institute and it includes approximately 100 researchers and 150 technology support staff. The local consultant survey (SLINTEC 2014) showed that the ITI are reported to have the largest R&D staff in Sri Lanka, 396 research and technical personnel in 2012, among which 17% of the staff had PhDs and 39% had a Master’s degree.
The Sri Lanka Nanotechnology Institute, which was established as the first public- private partnership, with five leading private sector companies, has its research focus on nanotechnology R&Ds targeting not local markets, but more on the competitive global market. Most of its R&D personnel hold a PhD and Master degree from the UK, and their testing and R&D equipment and facilities are the best front technology and the only in Sri Lanka. With these R&D facilities and S&T human resources, the SLINTEC has the potential to do research in advanced nano-technology areas. Interviewing with the SLINTEC’s researchers, the SLINTEC’s strategic research areas are said to be apparel, agriculture, water purification, and mineral resources, and most of its R&D activities are industry-funded contract research. But visiting the SLINTEC’s research labs, many of the industrial application research areas using nano- technology are still in the progress of setting-up labs.
Judging from these interviews and evidences, it can be assessed that the competitive R&D capability and successful commercialization possibilities lie in the ITI and the SLINTEC.
4.1.2.5. Technological Capabilities of Sri Lankan Industries
1) Agriculture Sector
Interviewing the ITI’s, Dr.Muditha Liyanagedara (Director General) and Dr. Radhika Samarasekara (Additional Director R&D), the agriculture and cosmetic industry's
212 • 2014/15 Knowledge Sharing Program with Sri Lanka technological capabilities and industrial situations are said to be overall weak, but in some other sectors are promising. The largest enterprise in the agricultural sector in Sri Lanka is the CIC, and in the cosmetics industry, there are 4-6 domestic companies including Nature Secret and Janet. But mostly these sectors’ companies focused on low value-added products but about 10% of the SMEs in the sector are dealing with high value-added products requiring high tech capabilities. Concerning the industry- academia cooperation status in the agriculture and cosmetic industry sector, joint research with companies are implemented in the forms of joint R&D projects or contract-based projects. ITI provides technological solutions for production process improvement, technology consulting for QC (Quality Control), ISO certification, and/or ITI’s technology transfer with license fees or royalties. Most of the products with viable business potentials are agro-processing products, cosmetics, or natural ingredients products. The ITIs royalty from technology transfer accounts for 3-5% of total revenue. In the interview with the CEO and inventor(of Hybrid Technologies), Mr. Manju Gunawardene, also a part time consultant to SLINTEC, he mentioned that high value added application R&D is also widely conducted in food processing (e.g. cinnamon, tea, etc.) and indigenous medicine. He mentioned that a wide temperature gap among regions of Sri Lanka is in favor of agriculture research in the nation.
Mrs. Sunanda Weerasinghe, Sri Lanka Food Processing Association (SLFPA) explained that agriculture sector’s innovations tend to concentrate around “traditional foods” that haven’t been commercialized previously or “natural foods” (where the process doesn’t have additives or preservatives). Health related foods are also among the innovations. Most of these are domestic/home-level industries. While there are a couple of private companies that do testing, most of these people get their food tested through the ITI. However, getting food tested is a costly exercise. Each test at the ITI costs around Rs 11,000. One obviously also needs more than one test and have to repeat tests at various stages of the development cycle. At the Sri Lanka Standards Institute they encouraged the micros to get themselves certified.
2) Electrical Manufacturing Industry
In terms of electrical manufacturing industry, interviews with, the AC Institute of Modern Technology Center, Shiran Welikala (Director) and J.K. Jayawardena (Principal Research Engineer), revealed that most of the companies are working on small-scale assembly manufacturing only, and there is no domestic or foreign large-scale electric manufacturing company in Sri Lanka. Most electric products are imported rather than manufactured in Sri Lanka. Because the electrical manufacturing industry’s innovation system requires large-scale production capabilities supported by high technology development and process technological capabilities, Sri Lanka’s electrical manufacturing industry has difficulties in promoting high-tech venture start-ups
Chapter 3 _ Technology Business Incubators in Support of Technology-Based Industries in Sri Lanka: Preparatory Study for the Establishment and Operation of the TBI in the Science Park • 213 in the industry area. The director mentioned that in terms of research contracts with private companies, there exist 1-2 research projects commissioned by private companies but as the project is not aimed for commercialization, most of them do not make it to the market.
3) Rubber and Polymer Industry
The interview with Dr. Shantha Egodage (SIL-UOM Director, University of Moratuwa) showed the industry has a long history in polymer and rubber industry manufacturing and it has a good potential for high value-added products and technological development. In terms of the status of the polymer plastic and rubber industry, there are 4,600 SMEs in total, and every year about 50 new players enter the market with 20% of them expected to be start-ups with new products with high tech capabilities. Most of the SMEs stay at the level of the household family business. Major technology products, which are mostly rubber tire and gasket products are developed by sub-contractors for big enterprises like the DSI Group. Major research institutes in the sector include the Plastic and Rubber Institute, the ITI, and the Sri Lanka Standard Research Center, which are the leading research institutes in the chemical sector. Industrial development in rubber products has been huge. In the mid 1970’s natural rubber products accounted for 95% of rubber exports of the nation but currently it imports natural rubber and around 80% of the production is for domestic manufacturing consumption. 15 years ago, rubber product exports amounted to USD 15,000 million but it has grown to over USD 1 billion in Sri Lanka. The director mentioned that key factors for the industrial development are education and training at universities and colleges. Since an education facility was built by Russia in the initial stage in the mid-1970s for rubber production, education and training in the chemical sector has been well implemented at Sri Lankan universities and colleges, among which the University of Moratuwa is the most talented. Also, stable electricity supply and industrial water is another key factor to facilitate industrial development.93)
The director explained that there hasn’t been much product innovation in the rubber industry as far as the export industry is concerned. Multinational companies have their own R&D arms and they are making progress with inventions in that manner. Innovation must be happening in-house for the big companies with much of this innovation happening abroad. Sri Lankan companies also have some R&D activity
93) Director, Lalan Rubbers Pvt Ltd, SLAMERP, explained the rubber industry structure and innovation activities. There are about 8-10 leading multinational companies here within the rubber sphere. In the dry rubber sphere these are Loadstar, Eurotech, CEAT Kelani Holdings, and AMW. Sri Lankan companies in the dry rubber sector include: Global Rubber and Laugfs gas. In the glove rubber sphere, Ansel and Industrial Clothing are the main multinationals. Sri Lankan companies within the glove sector include Hayleys and the Lalan Group. Between these companies we are talking about 80% of exports approximating to US$900 Million. Other companies include: DSI Rubber, Richard Pieris etc.
214 • 2014/15 Knowledge Sharing Program with Sri Lanka but this isn’t concentrated very much on inventions. There is a tendency among Sri Lankan companies to adapt things that have been developed by multinational companies. Process developments are however happening continuously in big companies. Improvements on existing products are also taking place.
The director discussed the collaboration with the S&T sectors in Sri Lanka. He said the companies feel there is a limitation on our local scientists to work. PRIs have insufficient raw materials and scientists are paid low salaries. The DSI is the only group that is working with the University of Moratuwa, but even they have some concerns as to whether the outcomes are up to standard. The Industrial Development Rubber Centre has virtually closed down. Their main function was to service the SME sector. There are no platforms for engagement between industry and researchers. The SLINTEC is viewed differently by industry as it is run as a private sector organization.
The director also mentioned that the lack of testing facilities has also proved to be big challenge in Sri Lanka. There are insufficient government institutes supporting the rubber sector. The CISR and the Rubber Research Institute have virtually becoming testing beds. Unfortunately their testing standards are not recognized by European markets. So large companies are also not making use of these institutes, and most of the testing is done abroad. The ITI doesn’t even have a rubber department. They are focusing on food and various other areas. Rubber companies are using the laboratories in Europe and Malaysia. The multinationals have laboratories that are accredited.
4) Textile Industry
The CEO, Mr. Ayman Firouze, who is one inventor in the Disrupt Unlimited incubator, explained the current textile industry's innovation activities. He said that big textile enterprises in Sri Lanka such as Brandix and MAS Holdings mostly signed research contracts with external innovators for product and technology development, rather than conducing internal R&D. Brandix and MAS Holdings jointly founded the Technical College to nurture talents for technology development in the textile sector. The big enterprises mostly have outside innovators to recommend solutions to technology issues or product development needs at hand and support the projects of the innovators when the projects seem relevant and helpful for productivity enhancement and new product development.
A well-known case of R&D in textiles is where researchers in Sri Lanka are performing R&D on functional textile under a R&D contract with big enterprises like Nike and MAS Holdings to meet their demand (e.g. high functional swim suits). IP rights for the findings of application R&D in these fields belong to the big enterprises
Chapter 3 _ Technology Business Incubators in Support of Technology-Based Industries in Sri Lanka: Preparatory Study for the Establishment and Operation of the TBI in the Science Park • 215 as it is bound by contract with the companies but the research capabilities are held by researcher in Sri Lanka so it leaves much potential to launch businesses with new technologies.
5) ICT and Software Industry
It was pointed out that, in the ICT and software sectors, there are several companies in Sri Lanka that completed SW development projects with commission from the stock exchanges of major countries, so it is expected that the nation already secured a certain level of technology capabilities in this field. The University of Moratuwa and University of Peradeniya are known to have an extensive level of development capabilities in the fields of engineering and agro-processing, making significant contribution to the development of the SW industry.
The SLASSCOM (2014) showed that the revenue of the IT/BPM industry in Sri Lanka is estimated to be 720 million USD in 2013. The sector has grown by 238% since 2007 in terms of total revenue. Their export markets are mostly Europe (UK and Ireland), the US, and South Asia. The National ICT workforce survey 2013 in Sri Lanka showed that the total ICT workforce is estimated to be 75,107 in 2013, and projected to be 82,854 in 2014. Among them 40.8% are working in ICT companies while 47.1% are working in non-ICT private sector users. The annual supply of ICT graduates was 6,611 in 2013, and is projected to be 7,010 in 2014. Among them 63% held graduate or post-graduate level qualification.
[Figure 3-20] Growth in Revenue and Workforce in the ICT Industry of Sri Lanka
Growth in Revenue (in USD Mn) Growth in Workforce 1000 100,000
850 82,854 800 80,000 75,107 720 66,518 600 605 60,000 56,526 484 50,159 42,821 400 40,000 39,107 310 33,702 258 213 200 209 20,000
2007 2008 2009 2010 2011 2012 2013E 2014P 2007 2008 2009 2010 2011 2012 2013E 2014P Source: SSASSCOM (2014). Source: National ICT Workforce Survey 2013.
216 • 2014/15 Knowledge Sharing Program with Sri Lanka According to SSASCOM, Sri Lanka’s IT/BPM industry targeted an achievement of USD 5 billion in exports by 2022, with 200,000 jobs created and 1,000 start-ups. While explaining Sri Lanka’s government support for entrepreneurship, the SSASSCOM assessed that “with expanding opportunities, initiatives such as empowerment and funding programs and entities focusing on providing guidance and capital for entrepreneurs starting up their ventures have been making an impact over the past few years”. And it also assessed that “growth in angel and venture capital investments are helping to develop the base for a sound start-up eco system essential for future growth”. The SLASSCOM also started an incubator program, Global Startup Labs, in partnership with the MIT Startup Labs in the University of Moratuwa for entrepreneurship instructor capacity with five-years’ funding from Brandix.
[Figure 3-21] National Target for 2022
162 1,920 $720Mn $5Bn
558 3,080
IT 2013 BPM 2022
Source: SSASSCOM (2014).
6) Material Industry
Pointed out that Sri Lanka’s graphite materials and application research capabilities has good potential for the nano-material markets and nano-material application markets. Application R&D for high-purity graphite and crystal for which the nation has a vast reserve is also extensively conducted so these fields can be a promising candidate for new technology-based business start-ups. (High purity graphite is exported to Germany and Australia, and crystal to Korea and Japan as materials for silica wafer in low added value status.) Recently, the Sri Lankan government introduced new regulations to allow export of the resources only when the added value the resource is higher than 30% and this is expected to open ways for joint venture investments with foreign companies.
Chapter 3 _ Technology Business Incubators in Support of Technology-Based Industries in Sri Lanka: Preparatory Study for the Establishment and Operation of the TBI in the Science Park • 217 4.1.3. Economic Feasibility of Sri Lanka TBI
Economic feasibility assessment of Sri Lanka TBI consists of 1) growth potentials of startup venture companies, whether there exists a significant amount of inventors or technological experts who would venture into a startup business, and 2) their demands for TBIs, whether they have enough incentives for entering a TBI, which areas of technological fields are most needed, and what kind of services are mostly required from TBIs.
4.1.3.1. Growth Potentials of Startup Companies in Sri Lanka
1) Industrial Research and Startup Possibilities
As most of Sri Lanka’s researchers, including those at universities, government research institutes, and general inventors, are focused on basic and theoretic R&D rather than developing products or technologies driven by market demand, it is rare to make it to business development due to the difficulty in securing stable demand. Currently, the application of R&D is estimated to be below 10%. Thus, the government of Sri Lanka took the policy approach to increase the percentage of application R&D at colleges above 40%. Application R&D that is directly applicable to industries is being performed by a small number of researchers at colleges, corporations or affiliated organizations, or government research institutes.
However, currently, in an attempt to increase the added value of mineral materials including graphite, crystal, and ilmenite, R&D at laboratories or pilot plants are being performed (SLINTEC is working on these research.) One of the examples is R&D to develop and produce products with high added value graphene extracted from high-purity graphite or sugar (e.g.: water purifying filter, paint coating, metal, etc.) and it is expected to have high potentials for technology business start-ups.
The government-sponsored research institute, ITI, is also producing mid-tech products like medicinal products, consumables (nutraceuticals, cosmetics, etc.) based on R&D contracts to meet the industrial demand. It is also likely to see technology start-up potentials from the institution. In argo-processing, the SL Food Processors Association and the SL Institute for Food S&T and Spice Council are working to develop technologies, explore export markets, and support certificate acquisition and business start-ups springing up in the field.
2) Inventors’ Activities and Startup Possibilities
According to Mr. Dinesh Sattrukalsinghe (CEO of Sri Lanka Inventors Commission (SLIC)), the overview of activities at the Venture Entrepreneur Committee Fair is
218 • 2014/15 Knowledge Sharing Program with Sri Lanka as follows: invention fairs are held every year, and organized by the technology research departments and with cooperation of the Ministry of Education. About 400 participants compete in the local round and the top 3-5 participants are invited to the national round. Every year it attracts around 4,000 participants. Other than the competition for students, there are open and commercial category for open competition for companies, institutions, college students, and professors. In general, around 150 institutions apply for the open category while 40-50 institutions apply for the commercial category. The business opportunity is evaluated for potentials of invention, startups, and future markets.
More close to startup activities, there exists the “Business Promotion Workshop and Inventor Awards”, which is also held by the SLIC. The Business Promotion Workshop is held in partnership with the Sri Lanka Angel Network and 20 participants out of 80 in total are selected, and then one winner inventor is selected to earn a USD 100,000 prize. Additional projects are being planned to provide additional support of business know-how and funding connection with angel investors. Currently, only the space for education and workshops are secured, and the space is not utilized for venture incubation programs while exports are being made for cooperation with other partners. Starting from last year, the demands for follow- up programs are growing after the invention fair. Therefore, there are more efforts being made for invention exhibitions, funding support, and market entry. Since 2013, a project has been implemented to link inventors and investors like Brandix Group or an angel network. Examples of these efforts include building partnerships to help inventors from the Academy of Design to improve their product design, linking them with big enterprises to run businesses or providing administrative help to register their businesses.
Concerning the SLICs network and partnership of institutions, the SLIC has currently has 400-500 inventors listed as members. However, the CEO mentioned that most of the venture entrepreneurs are in the low technology sector rather than being highly skilled science and technology experts, while only 10-20% is in the high tech sector. Five or six partnerships are in place with big enterprises to address industrial issues. Expert service are also provided through partnership: support of financial service, science and technology service, business service, and licensing service is provided in partnership with expert institutes in the form of voluntary services.
3) Current Startups and Incubating Situations
The SLIC CEO explained the backgrounds and history of venture start-ups and incubation activities in Sri Lanka. In sync with the remarkable development of the software industry since the 1990s, an incubation center for venture start-ups in IT software industries, like Concept Nursery, was established. Additionally, the ITI
Chapter 3 _ Technology Business Incubators in Support of Technology-Based Industries in Sri Lanka: Preparatory Study for the Establishment and Operation of the TBI in the Science Park • 219 (Industrial Technology Institute) was opened as a government–run research institute to develop business opportunities out of technology research outcomes of public institutions. It was aimed to make technologies and equipmentequipment of public research institutes available and build connections among venture entrepreneurs to facilitate venture start-ups. Most recently private groups began to establish private venture incubation centers like Disrupted Limited, which is operated by Brandix.
An interview with Mr. Suren Karunakaran, director of Disrupt Unlimited, which is the first private incubation center in Sri Lanka, showed that Sri Lanka has innovation- promotion trends in the private sector, and inventors are trying to utilize the opportunities of technology startups created by this private sector trend. However, risk-averse minds are still dominant among Sri Lankan professionals. Disrupted Limited was spun off from the Brandix Group, the largest apparel group in Sri Lanka. The group recently drew upon then innovative ideas and solutions obtained from inventors or innovators for business processes or new products. The apparel industry is going through dramatic changes in its business environments and this is posing a great threat to the industry in Sri Lanka. With uncertainties evolving from the mobile communication environments and a new internet trend, it calls for an innovative reform of the industry. In an effort to respond to the changing needs, the Brandix Group built the Open Innovation Platform to better respond to the changing environments. Concerning the real benefits for Branix Group, the mother group is aimed to unleash entrepreneurship to initiate innovative reform of the apparel industry in Sri Lanka.
The director of Disrupted explained the current startups in the incubation center. Among the 22 venture start-ups participating, 6 companies were selected in the first round and it was narrowed down to 3 in the 2nd round, and the 2 companies selected in the final round are still running. Most of the participants are those with engineering, IT, or electric backgrounds. Only a small number of them have business management backgrounds, and students are also in small number. Currently 2 venture start-ups are running and a venture start-up incubation program will be running for 4 months, and continuous coaching will be provided until it is commercialized in the market. It takes 3-6 months from design development to market launch in the apparel industry in Sri Lanka but the venture ideas they are working on is expected to reduce the period down to 2 weeks.
He also explained the operational aspect of the incubator: Concerning business programs of the incubator, he said that efforts are being made to identify business opportunities and provide solutions with business start-up ideas mostly for outside venture entrepreneurs or innovators, but programs for internal employees especially those with extensive experiences of 15-16 years, are also being prepared. For individuals in the founder group, part of their living expense is supported.
220 • 2014/15 Knowledge Sharing Program with Sri Lanka Concerning the company ownership structure, 80% will be owned by individual founders while the remaining 20% will be owned by the company. The company will be provided with support from the mother group for 3 years and is planning to become financially independent afterwards. Currently, in the market, the success rate of venture start-ups is estimated to be around 5%, and every year 8 venture firms are founded to have 24 venture star-ups in 3 years, and it is an aim to increase the success rate up to 25%. The goal is to secure returns from 20% of the investment in the start-ups when these start-ups attain success in commercialization.
The ITI Director General discussed the ITI's incubation plan and support of venture start-up activities in Sri Lanka. Concerning the current support for venture startup activities, the ITI is providing in-house technology support services for SMEs, and makes sure small-sized companies receive technology consultation for at least a month with various technology support schemes. Current activities are part of the technology transfer to SMEs, and in-house incubation is provided. However, there has been no spin-off company from the institute, and as no leave is allowed for staff at public research institutes to establish a spin-off start-up, it is expected that there will be no business start-up activities as of yet. The ITI has an incubation center establishment plan: it is to build an incubation center after securing a proper site and provide services for technology venture start-ups and a pilot plant construction. Also, a new product exhibition and technology support centers will be opened at the exhibition facility. It will utilize PPP methods, just as SLINTEC does, and it will establish a technology venture start-up incubation center for food technology and natural ingredient sectors, and is also reviewing a plan to run the center independently.
4.1.3.2. Demands for TBI in Sri Lanka
1) General Demands for TBI
Dinesh Sattrukalsinghe (SLIC CEO) mentioned that, concerning the likelihood of success with the TBI, there will be enough demand for a TBI as there are more than 10 invention competitions in Sri Lanka, and all of them are crowded with enthusiastic participants.
Mr. Ayman Firouze, who is the CEO of the startup in Disrupted Unlimited incubation center, also mentioned that they will have enough demand for a TBI entry in Sri Lanka. He pointed out that, as seen in the fact that more than 100 candidates participated in the competition held by Brandix to select an innovator to work for Disrupt Unlimited Incubator, there seems to be a large pool of innovators for technology ventures in the textile sector. They are willing to enter a TBI for the benefits of space and various professional services, and it is suggested that they need government funding for at least the first 2 years. When they enter the TBI, they are
Chapter 3 _ Technology Business Incubators in Support of Technology-Based Industries in Sri Lanka: Preparatory Study for the Establishment and Operation of the TBI in the Science Park • 221 willing to pay USD 30~40 for monthly rent.
Suren Karunakaran (Director of Disrupt Unlimited) was also confident there will be enough demands for a TBI and technology entrepreneurship in Sri Lanka. Given the enthusiasm for venture start-ups and the strong interest of passionate inventors, innovators, and students, it is clear that they have strong commitment to engage in business start-ups, but it is not easy to attract enough venture start-ups to stay at a TBI without robust investment.
Prof. Ajith de Alwis (COSTI Chairman) also sees that there will be enough enthusiasm in Sri Lanka for a TBI. He specifically mentioned the ICT sector in a Sri Lankan TBI, “for existing industries, it can facilitate problem solving and promote venture start-ups in ICT industry”. From the governmental side, he said, support can be provided for a market survey, technology research, and business planning with the establishment of a technology venture start-up incubation center. Mr. Shiran Welikala (Director of A.C. Institute of Modern Technology) also spoke about topics concerning venture start-up activities in Sri Lanka, pointing out that there are several venture start-ups in the IT and software industry but almost none of them are in the electric manufacturing industry.
2) Demand of Potential Services and Functions
Mr. Ayman Firouze, who is the CEO of a startup in the Disrupted Unlimited incubation center under Brandix, is provided with working space, seed money for pilot product development, a stipend, and opportunities for networking with in- house mentors and high profile figures outside of the group. They expect the service of high speed internet, business plan assistance, marketing assistance, access to equipment, and legal service from the TBI. An entrepreneurship education course is open at several local colleges in Sri Lanka but it is not practical or effective. If the courses of practical entrepreneurship programs are to be provided, it is expected to strengthen preferences for venture startups. If the newly established TBI offers an entrepreneurship education/seminar, active participation is expected from students and graduates, who are interested in technology ventures, even if the TBI is located far from Colombo, like SLINTEC (It takes more than an hour and a half from the city of Colombo to travel there).
The CEO further pointed out the benefits of the SLINTEC and the nano-science park. As the SLINTEC and the nano-science park have cutting-edge equipment and competent scientists, and as it is near a business management college, it has favorable environments to catch the attention of venture entrepreneur candidates. There is a space allocated for technology companies run by the government, so it is possible to use part of the space to provide a venture start-up education organized
222 • 2014/15 Knowledge Sharing Program with Sri Lanka by a TBI. The CEO mentioned that one of the reasons behind sluggish venture activities seems to be the lack of a role model or success case for potential technology venture entrepreneurs at colleges. Also, to promote technology venture start- ups, support from the government with funds, technology training, and support is required as a key component. Space and equipment for pilot product development is required for technology venture incubation facilities but it can be an option to assign a production qualification test of pilot products to relevant companies.
The SLIC CEO mentions the needs of inventors as follows: inventors need business projects to scale up their inventions. For inventors professional business start- up service is important but what is more crucial is building personal connections, support, and, especially, funding opportunities.
Suren Karunakaran (Director of Disrupt Unlimited) explained the merit of working with a large business group and the demands for a TBI operation. As they, entrepreneurs, are provided with space free of charge from Branidx Group, and USD 1 million investment in the initial stage of the business initiation, the group supports and nurtures venture start-ups with the fund for 3 years. Especially, as they are asked to provide ideas to tackle the problems at hand for the group, and solutions to the issues at manufacturing process and product development, the biggest merit is that it is more likely for their final solution to actually lead to a business start-up, as the group already has the capability to purchase the ideas and solutions as long as they are viable. For the TBI to be opened, it would be desirable to include sectors with robust demands from big enterprises, with strong purchasing capabilities, thus connecting the incubation program to R&D initiatives and solution development initiatives with strong purchasing potentials. This would increase the chance of success for the technology incubation center.
Prof. Ajith de Alwis (COSTI Chairman) also mentioned a similar rationale for large group involvement in startup companies. The DSI Group manufactures rubber products and they have success cases in resolving technology issues, technology transfer, and business launches in partnership with colleges. Support and technology transfer with colleges were quite successful in these groups but were not scaled up or disseminated to other sectors. Especially, the success in this case was dependent on funding by the group. Also, as technology transfer has public components in its nature, some of the issues have to be addressed through a private-public partnership between the government and private sector. It is required to implement a PPP in the framework where colleges and public research institutes collaborate. Thus, for the operation of a technology venture start-up incubation center, it is necessary to tackle the issue of funding separately for public support from technology transfer and troubleshooting by the private sector, as well as from the financial profits from investment in venture start-ups.
Chapter 3 _ Technology Business Incubators in Support of Technology-Based Industries in Sri Lanka: Preparatory Study for the Establishment and Operation of the TBI in the Science Park • 223 We have conducted the demand survey for a TBI through local consultants on what kinds of TBI services and functions are most needed, with a group of researchers from the University of Moratuwa and public research institutes including the ITI, Arthur Clarke, and the SLINTEC, and also with a group of inventors and startup companies. The number of total respondents is 79. The percentage was calculated for the 1st and 2nd priorities response incidents among total responses.
The highest demands for TBI potential services are 1) high-speed internet infrastructure, 2) technological assistance for product development, and 3) human resources development, which are respectively 13%, 13%, and 12%, which compose almost 40% of total demands. Following ICT infrastructure, technology, and HRD demands, mostly management-type services are ranked high, such as business plan development (9%), market research (9%), marketing (8%), and product costing/ pricing (7%), which total 33%. Access to capital financing was 8% of the responses in 1st and 2nd priorities. Other than these, professional services such as legal and accounting services made up a very small percentage of importance.
[Figure 3-22] Potential Service Offering in the TBI
High speed Human resources internet High speed internet 12% 13% Bisiness plan development Marketing Bisiness plan Website development Product development development Market Research 13% 9% Law services Basic office services Marketing Accouting / financial reporting 8% Product costing / pricing Access to capital / financing 7% E-commerce / technology Website development Strategic partneting Market Research 3% Strategic partnering Product costing / pricing 9% 5% Access to Product development capital / financing Human resources E-commerce / technology 8% Law services 4% 3% Basic office services Accounting / financial reporting 3% 3%
Source: Survey result.
224 • 2014/15 Knowledge Sharing Program with Sri Lanka 3) Demands of Technology/Industry Areas
Combining the interview results and the technological capability feasibility assessment, technology/industry areas that could be suitable for a TBI include ICT, nano-technology, agriculture, apparel and textile, (mineral-based) chemical products, and rubber products. For the areas where Sri Lanka is technologically competent, natural science, agriculture (such as organic spice) agro-processing, nano-technology, and medical science (natural product medicine) are suggested.
The survey for researchers and entrepreneurs also contained questions regarding what are the most suitable technology or business areas for a TBI in Sri Lanka, along with what are the most competent S&T areas in Sri Lanka. The most competitive S&T areas in Sri Lanka were more-or-less equally 1) natural science research (18%), 2) ICT (19%), 3) agricultural research (17%), and 4) agro-processing (16%). Although the engineering technology, mechanical engineering (5%), electrical engineering (7%), chemical engineering (4%) and nano-technology (6%) are mentioned, all have below 10% response rates. This means that ICT technology and agro-processing technology are most competitive when compared to chemical, electrical, and mechanical engineering technology.
[Figure 3-23] Most Competitive Technology in Sri Lanka
Other Nano-technology 1% 6%
Natural Science Research Natural Science Research 18% Medical Science Research Agriculure Research Information and Mechanical Engineering Communication Technology Chemical Engineering 19% Medical Science Research Electrical Engineering 7% Agro-processing Information and Communication Technology Agro-processing Nano-technology 16% Agriculure Research 17% Other
Electrical Engineering 7%
Chemical Engineering Mechanical Engineering 4% 5%
Source: Survey result.
Chapter 3 _ Technology Business Incubators in Support of Technology-Based Industries in Sri Lanka: Preparatory Study for the Establishment and Operation of the TBI in the Science Park • 225 The most appropriate business for the TBI were recommended to be the agro- processing industry (28%) and the apparel and textile industry (20%). Following these, ICT (10%), electrical industry (10%), and nano-technology sector (11%) were recommended for TBI business. But the rubber and chemical industry (6%) and equipment manufacturing (7%) industry recorded a somewhat lower percentage.
[Figure 3-24] The Most Appropriate Business for the TBI
Other 2% Internet marketing Mobile 4% Equipment software Manufacturing / IT 7% 10% Mobile software / IT Nano-technology 11% Electrical and Internet marketing electronics Electrical and electronics Rubber and Chemical 10% Business services or BPO offshore Industry Bisiness services or 6% BPO offshore Agro-processing business 2% Apparel / Garmentand Twxtile industry Rubber and Chemical Industry Apparel / Garment and Twxtile Nano-technology Agro-processing business industry Equipment Manufacturing 20% 28% 20% Other
Source: Survey result.
226 • 2014/15 Knowledge Sharing Program with Sri Lanka
Summary of the Feasibility AnalysisFeasibility components Summary • “The Science, Technology and Innovation Strategy 2011 – 2015” and the high-level interview with the COSTI chairman clearly showed that the Sri Lankan government has a consistent intention and strategy with high priority for promoting high-tech or Policy Relevance more advanced technological industry sectors through not only R&D promotion but also technology commercialization, startups, and techno-entrepreneurship • These policy statements clearly indicate that a TBI is one of the core platforms for these interfaces of technology and industry. • Concerning the STI inputs of Sri Lanka, its R&D investment is estimated as being quite low at 0.16% of GDP (World Bank Science and Technology Data, 2010). • R&D manpower is quite comparable to India's capability in terms of average number • The business enterprises' R&D expenditure had increased more than 3.5 times only in STI inputs 2 years. and outputs • Sri Lanka does not show any good performance in R&D output in terms of scientific publication, technology development (which can be measured as patent results), and innovation (which can be measured as royalty and license fee receipts, high-tech exports), even when comparing with a lower income country group. • The University of Moratuwa can be considered as the top university in terms of scientific research and engineering capabilities, especially in the areas of chemical engineering, software development, and Information and Communication Technological Technology (ICT). Industry-funded contractual research through the incubators are Feasibility highly successful in rubber engineering and in the ICT sector. • The technological capabilities and commercialization activities of PRIs mostly lie in the agricultural research capability of the ITI (Industrial Technology Institute) and on the Universities, material engineering research of the SLINTEC. PRIs and • Polymer and rubber manufacturing has a long history in Sri Lanka and has a good private potential for high value-added products and technological development. sector • Big textile enterprises in Sri Lanka, such as Brandix and MAS Holdings, mostly signed research contracts with external innovators for product and technology development, rather than conducing internal R&D. • Sri Lanka already secured a certain level of technology capabilities in the IT/BPM industry. The revenue of the IT/BPM industry in Sri Lanka is estimated to be 720 million USD in 2013. • Sri Lanka's graphite materials and application research capabilities has good potential for the nano-material markets and nano-material application markets • Most of Sri Lankan research with universities, government research institutes, and general inventors are focused on basic and theoretic R&D rather than developing products or technologies driven by market demand. • Currently, in an attempt to increase added value of mineral materials including graphite, crystal, and ilmenite, R&D in laboratories or pilot plants are being performed Growth with a good potential for startup companies. potential • ITI is producing mid-tech products like medicinal products, consumables of startups (nutraceuticals, cosmetics, etc.) based on R&D contracts to meet the industrial demand with good potential for startups. • The Venture Entrepreneur Committee Fair, Business Promotion Workshop and Inventor Awards have promoted startups’ activities in Sri Lanka in recent years but are still in an early stage.
Chapter 3 _ Technology Business Incubators in Support of Technology-Based Industries in Sri Lanka: Preparatory Study for the Establishment and Operation of the TBI in the Science Park • 227
continuedFeasibility components Summary • In sync with the remarkable development of the software industry since the 1990s, Growth an incubation center for venture start-up in IT software industries like Concept potential Nursery was established of startups • Most recently private groups began to establish private venture incubation centers like Disrupted Limited, ran by Brandix. • Dinesh Sattrukalsinghe (SLIC CEO) mentioned that, concerning the likelihood of success with TBI, there will be enough demand for a TBI as there are more than 10 invention competitions in Sri Lanka and all of them are crowded with enthusiastic participants. • Mr. Ayman Firouze, who is a CEO of a startup in the Disrupted Unlimited incubation center, also mentioned that they will have enough demand for TBI entry in Sri Lanka. He pointed out that, as seen in the fact that more than 100 candidates participated in the competition held by Brandix to select an innovator to work for Disrupt Unlimited Incubator, there seem to be a large pool of innovators for technology ventures in the textile sector. • Prof. Ajith de Alwis (COSTI Chairman), also sees there will be enough enthusiasm in Economic Sri Lanka for a TBI. He specifically mentioned the ICT sector in a Sri Lankan TBI, “for Feasibility existing industries, it can facilitate problem solving and promote venture start-ups in ICT industry” Demands • According to the survey of this study, the highest demands for TBI potential services for TBI are 1) high-speed internet infrastructure, 2) technological assistance for product development, and 3) human resources development, which are respectively 13%, 13%, and 12%, and total almost 40% of total demands. • Combining the interview results and the technological capability feasibility assessment, technology/industry areas could be suitable for a TBI include ICT, nano- technology, agriculture, apparel and textile, (mineral-based) chemical products, and rubber products. • The most competitive S&T areas in Sri Lanka were more-or-less equally the 1) natural science research (18%), 2) ICT (19%), 3) agricultural research (17%), and 4) agro- processing (16%). • The most appropriate businesses for the TBI were recommended for agro-processing industry (28%) and the apparel and textile industry (20%). Following these, ICT (10%), electrical industry (10%) and nano-technology sector (11%) were recommended for TBI business.
Source: Summary by the author.
4.1.3.3. Remarks on the Feasibility Analysis
The feasibility study showed several strengths and weakness of Sri Lanka’s TBI potentials. From the perspective of current performances, Sri Lanka's R&D investment ratio was absolutely low and their output performance in terms of patents and high- tech exports, which indicates commercial potentials of research, was minimal with no US patent registration up to now. However, Sri Lanka has a good potential from the perspective of the government's policy dedication, a good engineering university with high-quality HRST, and most importantly the private sectors' recent venture
228 • 2014/15 Knowledge Sharing Program with Sri Lanka movements.
The Sri Lankan government’s national strategy and high-level interview showed the policy willingness and dedication to establishing a TBI and technology- commercialization promotion through startups. Especially from the private sector, the incubation activities, and the inventors’ competition, high-tech startups have are already been in motion during the last 2-3 years. Even though it is a very new phenomenon, when considering the high potentials of engineering human resources, especially chemical, agricultural, and most importantly software development engineers, Sri Lanka has a good background for a startup movement and a TBI establishment.
The intensive interviews and survey also revealed that there already exist some good candidates for high-tech and medium-tech startups from inventors’ competition, PRIs’, universities’ contract research with industry, and from private sectors’ incubators. Combining interview results and the technological capability feasibility assessment, technology/industry areas that could be suitable for a TBI include ICT, nanotechnology, agriculture, apparel and textile, (mineral-based) chemical products, and rubber products. However, they also pointed out these are in a very tentative stage and, in order to promote high-tech startups in Sri Lanka, it needs an indigenous best example startup as a quick winner and role model. A Sri Lankan TBI may play a role in developing these best examples.
4.2. Business Plan of a Sri Lankan TBI94)
4.2.1. Vision, Mission, Goal, and Target Areas
□ Vision
• National wealth Creation and startup-economy creation through a dynamic technology entrepreneurship promotion • In reference with “Develop a dynamic technology transfer platform for wealth creation through the Techno entrepreneurship Initiative” (Sri Lanka National STI Strategy 2011-2015)
□ Mission
• Build up a national platform for technology entrepreneurship • Promotion of national startup activities ensuring national venture eco-system birth and growth
94) The interview with the SLINTEC CEO, which is included in the Appendix 8, was helpful in sorting out the core issues of the business plan.
Chapter 3 _ Technology Business Incubators in Support of Technology-Based Industries in Sri Lanka: Preparatory Study for the Establishment and Operation of the TBI in the Science Park • 229 • Creating a national technology entrepreneurship network in Sri Lanka linking all technology-entrepreneurship-related stakeholders, such as large industrial groups, investors, universities, PRIs, and ministries.
□ Goals
• Build up physically one or two Technology Business Incubator by early 2016 • More than 30-40 TBI tenants on average in operation since 2016 • More than 20% of graduates of TBI annually after 2018 • More than 10% of successful TBI graduates after 2018 • Up to 2020 in 1st phase, in total, 25 new startups with 500 job creations and 50 million USD revenue creation
□ Target and Focused Technology/Business Areas
• ICT technology (Software/Mobile Apps development) • Nano-technology sector (Materials and Applications to agro-processing, rubber, textiles and etc.) • Agro-processing (Natural Products, Health Products, Nutrient Products) and Cosmetics • Rubber/Chemical Products • Technology-based new Apparel/Garment Industry
4.2.2. TBI Governance and Organization
□ Governance
• TBI Board of Directors: Roles and Responsibility of the BOD is the directing and monitoring of the TBI in a strategic manner. The TBIs strategic and major financial decision maker, the TBI CEO’s appointment and removal will be determined in annual and/or quarterly BOD meetings. The BOD consists of the Ministry of S&T, Investors’ Groups and Industrials’ Group, and a TBI hosting institution, who invests in the TBI with finance or equipment/facility/real estates. • TBI Independence: A TBI is independent from a TBI hosting institution in CEO appointment and removal, major financial and strategic decisions. The TBI belongs to an independent TBI BOD. • TBI Advisory Board: it consists of technology, management, finance, and legal experts from various stakeholders such as universities, PRIs, inventors’ associations, SMEs associations, and professional services associations. The board members is appointed by the TBI BOD. • Collaboration with the TBI technology transfer center: the requirement of a
230 • 2014/15 Knowledge Sharing Program with Sri Lanka TBI hosting institution is to establish a technology transfer department in the institution for the purpose of streamlining the institutions’ role for facilitating new technologies’ successful commercialization. These activities can create synergetic effects with the TBI for creating an ecosystem for a startup economy.
[Figure 3-25] Governance Structure of the TBI
Ministry of Science and Investors’ Group Technology Industrials’ Group
TBI Hosting Institution Board of Directors
Advisory Board
Technology Transfer Center TBI Universities Professional Servicess Inventors PRIs Association SMEs
Source: Summary by the author.
□ Organizational Structure and Functions
• One CEO: a professional manager of technology incubation and technology commercialization, who has at least 20 years of experiences in relevant fields, and at least more than 10 years of experiences in a private industry. • Three professional incubating managers: One in the ICT sector, and one in Nano/material/chemical engineering sector, and one in the agro-processing sector, who has at least 10 years of experiences in relevant fields, at least more than 5 years of experiences in private industry. The R&R of managers are 1) recruiting new tenants, 2) technology development and management mentoring of tenants, 3) external network formation of tenants including funding opportunities, HRD/entrepreneurship education program and 4) evaluation and monitoring of tenants. • Administrative team: One team leader with roles in strategy, and project development, one in accounting and HR, one in external relationships, and one in general operation and management of the TBI.
Chapter 3 _ Technology Business Incubators in Support of Technology-Based Industries in Sri Lanka: Preparatory Study for the Establishment and Operation of the TBI in the Science Park • 231 • Outsourcing of professional services such as legal advices, patent management, and marketing activities and etc.
[Figure 3-26] Organizational Structure of the TBI
TBI CEO
Administrative Sectoral Managers Outsourcing Team
Strategy/ Project ICT Professional Management Services
Extemal/ Nano/Materials Design/ Financing /Chemical Marketing
Accounitng/HR Agro-biz, Bio, Patent /IT Operations Cosmetics Management
Source: Summary by the author.
5. Policy Recommendations on Planning and Operation of the TBI
The field survey revealed an unfavorable environment for the establishment of a TBI in Sri Lanka, which includes the following.
• Reluctance to try technology startups remains large. Graduates with science degrees often leave the science field because of the poor salary and research culture. • In the S&T universities, lecturers tend to focus on teaching, and research is not market driven. • Despite the large tax incentives on R&D activities, companies tend to concentrate on short-term plans, rather than R&D based growth. • There are several governmental funding support programs (grants and concessional loans) for R&Ds, but too small in scale, so, not effective.
232 • 2014/15 Knowledge Sharing Program with Sri Lanka • Entrepreneurs encounter a number of barriers in attempting to access seed funding from banks. There exist just a small group of angel investors and venture capitals. • Entrepreneurs lack know-how to access markets, especially foreign markets. • The TBI building under construction is far from the business center in the city, S&T universities, and research institutes.
Some of the lessons drawn from other countries’ experiences and good practices are as follows.
• At the early stage, the government’s support and sponsorship play a critical role in the successful launch and promotion of TBIs. But, as TBIs get on track, the private sector needs to be encouraged to participate in the TBI’s operation for financial sustainability. • Most developed countries suffer from reluctance in risky technology startups, lack of information and education for techno-entrepreneurship etc. The TBIs played an important role in promoting a techno-entrepreneurship culture and education. Some star or successful startup cases nurtured by the TBI can work as role models that young potential technology startups are motivated to follow. • Networking with knowledge organizations such as S&T universities, PRIs etc., greatly help in identifying/securing promising TBI clients. Researchers in the organizations can be encouraged to start technology-intensive businesses if they are allowed to be on leave for technology startups. • The TBI cannot succeed without competent managers who understand and network business and research communities. The role of excellent managers cannot be overemphasized in achieving the TBI’s competitiveness. • As TBIs get on track, they put more emphasis on value-added services, such as consulting, mentoring, technology advisory, IP-related, marketing, and business plan writing assistance services etc.
Furthermore, the analysis on the TBI’s feasibility derived the following findings.
• The feasibility study showed several strengths and weakness of Sri Lanka’s TBI potentials. - From the perspective of current performances, Sri Lanka’s R&D investment ratio was absolutely low and their output performance in terms of patents and high-tech exports, which indicates commercial potentials of research have been minimal up to now. - However, Sri Lanka has good potential from the perspective of the government's policy dedication, good engineering and S&T universities with high-quality HRST, and most importantly the private sectors’ recent venture movements.
Chapter 3 _ Technology Business Incubators in Support of Technology-Based Industries in Sri Lanka: Preparatory Study for the Establishment and Operation of the TBI in the Science Park • 233 • The Sri Lankan government’s national strategy and high-level interviews showed the policy willingness and dedication to establishing a TBI and technology-commercialization promotion through startups. - Even from the private sector, the incubation activities and the inventors’ competition, high-tech startups are already in motion during the last 2-3 years. - When considering high potentials of engineering human resources, especially chemical, agricultural, and most importantly software development engineers, Sri Lanka has a good background for startups movement and a TBI establishment. • The intensive interviews and survey also revealed that there already exist quite good candidates for high-tech and medium-tech startups from inventors’ competition, PRIs, and universities’ contract research with industry, and from private sectors’ incubators. - Technology/industry areas suitable for TBI include ICT, nanotechnology, agriculture, apparel and textile, (mineral-based) chemical products, and rubber products. - It was pointed out that best example Sri Lankan startups can contribute to promoting high-tech startups, and the TBI may play a role in developing these best examples.
Based on the previous analysis (field survey, benchmarking, feasibility and business plan), policy recommendations are drawn for feasibility improvement and successful operation of the TBI.
□ The Center for Innovation & Entrepreneurship Promotion (CIEP) as a Pre- Incubation Program
• It takes time and effort for technology entrepreneurship to germinate and grow. Fertile soil and enough water will help and speed up germination. Start- up education and training (SET program), competition events etc. can cultivate entrepreneurship culture. • The CIEP is to be affiliated to the TBI, located in the Colombo city area. The CIEP will be the focal point or the hub for cultivation of techno-entrepreneurship culture, climate, and ecosystem.95) • The TBI will be located in the Nano science park out of the Colombo business area. The CIEP, as a liaison office in the city area, can increase potential clients’ accessibility to the TBI.96)
95) “In NBIA’s 2012 SOI survey, creating jobs in the local community and fostering the community’s entrepreneurial climate ranked highly as program goals across incubator types.” (NBIA 2012, p 28) Usually, the technology entrepreneurship culture and climate are worse than those in the US, which means the TBI in Sri Lanka should play a systematic role in fostering a entrepreneurship culture. 96) “A thorough feasibility study will help avoid the two classic errors of incubator formation: accepting
234 • 2014/15 Knowledge Sharing Program with Sri Lanka • The CIEP can benefit from economies of scale in information and experience sharing (exhibition of recent trends and cases of star start-up technologies and products world-wide, workshops, and seminar), start-up education, and training on technology entrepreneurship. • Pre-incubation services in the CIEP such as mentoring and assistance in idea development and business plan writing etc. can help the TBI identify and nurture good deal flow for the TBI. • Provision of hot desk and fab lab services will make the CIEP the popular gathering place for tech-youngsters and potential technology start-ups.97)
□ Symbolic Role of Success Cases: Star start-ups need to be incubated as early as ossible. They can help form advocacy for the TBI, and provide role models for the young techno-entrepreneurial minds.
□ Target Industries and Technologies
• Not only high-tech but also medium-high tech, not only startups but also SMEs at the early stage with growth potential need to be considered for the client candidate for decent and enough deal flow. • As Sri Lanka’s first TBI, it needs to broaden its target industries and technologies as far as they are high-value-added. As the first TBI gets on track and consensus on more TBIs emerge, the next TBIs can focus on specific industries and technologies. • Recently, the ICT is one of the most promising areas for technology entrepreneurship. In Sri Lanka, there are a few ICT-focused TBIs, but, they are at the primitive stage in terms of accessibility or value-added services.98) Exclusion of the ICT from the first TBI’s target areas would negatively affect the TBI’s performance and early settlement since the ICT is the area where it is most likely that incubation can come up with short-term success cases. Some of the next TBIs following the first one could specialize in the ICT in cooperation with the existing incubation facilities.
□ Governance for PPP
• Participation of the private sector, especially already established large
the worst building in town and thinking that the management assistance program will somehow take care of itself” (Meeder 1993) 97) A fab lab (fabrication laboratory) is a small-scale workshop offering (personal) digital fabrication. A fab lab is generally equipped with an array of flexible computer controlled tools that cover several different length scales and various materials, with the aim to make almost anything. This includes technology-enabled products generally perceived as limited to mass production. (Troxler 2011) 98) The Conceptnursery.com and Orion’s Nest focus on the ICT start-ups. However, the former is only accessible to the SLIIT’s students, and the latter is a kind of hot-desk for potential start-ups.
Chapter 3 _ Technology Business Incubators in Support of Technology-Based Industries in Sri Lanka: Preparatory Study for the Establishment and Operation of the TBI in the Science Park • 235 companies, in the TBI is very important for the TBI’s long-term financial sustainability with a phase out of the government subsidies at the early stage. Also, the large companies can help start-ups with providing information on market potential and discipline. • The board of directors should be composed of public/private stakeholders who practically contribute to the successful operation of the TBI. Local leading companies have to be encouraged to take part in the board as important stakeholders. Tax incentives and the procurement-guaranteed R&D program may give some incentive for the companies’ participation.
□ Networking of Stakeholders and Sponsors99)
• Stakeholders’ supports are a necessary condition for the TBI’s success in that they can help form a favorable atmosphere and provide supportive services such as marketing of the TBI, enough deal flow of decent clients, value-added services for clients such as mentoring and consulting, financing etc. for the TBI. • Stakeholders and sponsors include central and local government, S&T-related universities, research institutes, large corporations, and industry associations. Stakeholders and sponsors have to be identified and networked at the outset.
□ Recruiting a Capable Manager
• The TBI cannot do without a capable manager for its successful settlement and operation.100) The right manager has to be recruited at the planning stage, so that the manager may play a crucial role in the networking of stakeholders and sponsors, preparing for the CIEP, as well as the creation of a detailed business plan. • The manager’s mission is to help technology start-ups and early-stage enterprises successfully grow into the market. So, the manager has to be equipped with a business and R&D-related mind and experiences as well as capabilities to network with both communities.
□ Securing Deal Flow (On-Going Critical Mass of Quality Clients)
• CIEP: Pre-incubation programs such as the CIEP suggested above can identify and provide a pool of candidate clients with growth potential for the TBI. • Stakeholders: Stakeholders (esp. research institutions such as technical universities, PRIs, large companies’ research arms etc.) can help identify
99) A stakeholder is “any group or individual who can affect or is affected by the achievement of the organization’s objectives” (Freeman, R. E. 1984. Strategic management: A stakeholder approach. Boston: Pitman. p. 46) 100) This lesson was clearly proven right from the early-stage Chinese experience where most of the TBI managers were government officers or former SOE managers.
236 • 2014/15 Knowledge Sharing Program with Sri Lanka promising potential start-ups • Allowing Leave of Absence for Start-Up Researchers: The most promising pool of potential technology start-ups comes from the existing researchers at the S&T universities and research institutes. They are mostly reluctant to quit their jobs to start a business even though they have ideas and technologies of great commercial potential. Allowing leave of absence can give them incentives to go for technology start-ups. Korea has introduced this incentive measure, which turned out to be effective in encouraging technology start-ups by researchers. (Refer to the box below.)
Incentives for Researchers to Start a Venture Business in Korea
The Korean government began to make a five-year plan for revitalizing venture start-ups and placed the highest priority on venture policies among the economic policies of 1997, followed by the enactment of the ‘Act on Special Measures for the Promotion of Venture Businesses’ in August of 1997. The law was the pivotal legal infrastructure for various government policies, including public investments and deregulations. Based on the ‘Act on Special Measures for the Promotion of Venture Business’, dual position of professors and researchers is allowed as long as the companies are certified as ventures. It has been changed as followings; • In 1998, the ‘Act on Special Measures for the Promotion of Venture Business is amended, with introducing stock options to venture businesses, allowing high-quality human resources such as professors and researchers to hold executive positions in ventures, and allowing lab factories on campuses • In 2007, the subjects and period for leave of absence for professors and researchers is extended (venture businesses → start-up business, 3 years → 6 years). • In 2009, the ‘Act on Special Measures for the Promotion of Venture Business’ is amended for permission for leave of absence during pre-start-up periods and alleviation of regulations on start-up specialized companies • In 2011, leave of absence for entrepreneurial professors and researchers was extended.
Source: Quoted for KDI (2013).
□ Financial Sustainability of the TBI
• Government support at the early stage: The TBI is not-for-profit and fills the gap in techno-entrepreneurship due to market failures. So, the government may provide financial supports at the early stage (for example, at least for 5 years) until it gets on track in terms of deal flow, graduation, survival, and good performance in the market. We can hardly find exceptions in other countries that adopted the TBI approach. Government’s supports include construction and equipment cost, and part of the operating cost. What the government should be concerned with is how broad and how long the subsidy has to be provided. • Gradual Reduction of the Government’s Support: After the period of full
Chapter 3 _ Technology Business Incubators in Support of Technology-Based Industries in Sri Lanka: Preparatory Study for the Establishment and Operation of the TBI in the Science Park • 237 support, the government may gradually withdraw its financial support, and the TBI should try to find other revenue sources and become self-sustainable. • Full Support for Techno-Entrepreneurship Culture Promotion: While the subsidies on incubation are to be reduced in the med/long term, the CIEP’s function should remain subsidized since it has a great deal of positive externalities on innovation and entrepreneurship promotion. • Extension of the “Triple tax deduction”: It is recommended that the Sri Lankan government extend the “Triple tax deduction” for charity funds, private (large) companies, and individuals as long as they are making donations and contributions to S&T-focused and R&D-related institutions including the PRIs, the TBI etc. This extension will help the TBI attain its financial sustainability
□ Financing for the Clients
• Technology start-ups in Sri Lanka have suffered from difficulties in acquiring seed money and R&D supports from banks, angel, and venture capital investors. The difficulties are expected to prevail for the time being. • Technology start-ups hardly benefit from the triple tax deduction since they usually do not earn enough revenue. The technology start-up grant schemes have been offered since the mid-2000s, but, the grant amount has not been significant. The tech-entrepreneurship development program has just been introduced, so, need some time to be in full shape ad effect. • Significant Increase of Existing Funds for Start-Ups: It is imperative that, at the early stage of technology start-ups, the government provide some R&D and seed money for them through competition. At first, the existing mechanisms mentioned such as the technology start-up grants, tech-entrepreneurship development program etc., have been fully utilized with a significant increase and allocation of funds for the mechanism. • Procurement-Backed R&D Assistance Program: Brandix Disrupted has been supporting start-ups with a pre-specified demand and purchase guarantee. Korea has been applying the “procurement-guaranteed R&D program” in a similar vein. The pre-specified purchase guarantee by public organizations or private large companies can facilitate start-ups and SMEs’ R&D by sharing R&D costs and resolving marketing problem at the initial stage. The measure can be utilized as a mechanism for large-small companies’ win-win cooperation. (Refer to the Box below.)
238 • 2014/15 Knowledge Sharing Program with Sri Lanka Public Procurement as a Tool to Foster Demand for Innovation
Innovative startups often have trouble in attracting investors to finance their R&D projects, especially at the seed stage. Pre-commercial procurement of R&D occurs when the public sector directly procures R&D to support some policy goals of public authorities. It intends to help fill gaps in risk financing for early-stage startups. In some cases, procurement is designed to lessen biases against SMEs, as in Korea, where it is guaranteed that SMEs’ innovations will be purchased by government. From the government perspective, public procurement can stimulate technological innovation, develop a market for a new technology, and provide government agencies with new cost-effective solutions. By creating a signaling effect as a lead user, the government can promote diffusion of innovations. (OECD 2011)
Korea - Procurement-Guaranteed R&D Program for Start-ups and SMEs Marketing of new products is one of the big concerns of innovative entrepreneurs. The purchase-guaranteed R&D support program has been implemented to help them secure demands and R&D money since the early 2000s in Korea. Demands for new products or technologies are pre-specified by public entities or private large companies. The SMEs, including start-ups, are selected by competition to carry out the project for technology and product development. The selected enterprises are provided with R&D supports and purchases guarantees. The government or large companies support part of technology and product development costs as follows: • Public organizations’ demands: 75% of the cost borne by the government, 25% by the SME • Private large companies’ demands: 50% of the cost borne by the government, 25% by the private company, 25% by the SME • Usually 1~2 years for project execution with maximum 1/2 mil. US dollars support by the government • The SMEs, if successful, pay back 10~20% of the financial support. During 2002~2007, the successful projects acquired, on the average, 990 million Korean won in revenues (with average funding of 150 million Korean won). The selected SMEs turned out to improve their technology levels and independence.
Source: Lee (2011), OECD (2011).
• Extension of Tax Incentives: The government needs to consider offering tax incentives for individuals who invest in venture capital fund. This incentive measure has been implemented effectively in Korea to induce private investment in venture capital. • Hybrid Funding, Fund of Funds (VCFs): The government needs to play a role in providing seed funding. It is recommended that, in the medium and long term, the government consider introducing the hybrid (equity + loan) funding mechanism. Also, a public fund that invests in private venture capital funds (so called “fund of funds”) can facilitate the formation of venture capital funds. (Refer to Appendix 10.)
.
Chapter 3 _ Technology Business Incubators in Support of Technology-Based Industries in Sri Lanka: Preparatory Study for the Establishment and Operation of the TBI in the Science Park • 239 □ Monitoring and Evaluation
• The M&E is required to draw evidence and consensus on effective spending of public money. The clearly articulated criteria and indicators need to be prepared as the TBI starts its operation. • After 2 or 3 years of the TBI’s operation, all subsidies should be conditional on the rigorous M&E results so that the TBI should be induced to be performance- oriented as if it were under the market pressure.
□ Industry-Specific TBIs Following the First General TBI in the Science Park
• The first TBI alone cannot attain the TBI’s goals of increasing technology- intensive exports and creating more employment. As soon as the SLINTEC-led TBI in the Science Park gets on track and starts to show successful performances, more TBIs that focus on specific industries and technologies need to be introduced. • The next TBIs could be attached to the universities or the PRIs that have specialties in specific industries and technologies.
240 • 2014/15 Knowledge Sharing Program with Sri Lanka Appendix
1. Basic Information Pertaining to the Entrepreneurs and Inventors Enrolled into the Field Survey
Entrepreneurs and Inventors Enrolled in the Field SurveyAge or stage Financial performance Type of business or invention Human resources of business in the past year 55 employees in total, 3 IT enabled services and tech support R&D personnel – Highest to small business consumers in the > 5 years > US$ 5million qualification Master’s US, Canada and Australia degree 1 employee in total, 1 Prototype R&D personnel – Highest Has not sold any products Energy saving electric iron development qualification Master’s as yet degree 1 employee in total, 1 R&D New technology for mixing and Scaling up personnel. Daily laborers No sales last year storage of organic matter hired as necessary Has made sales but did Third party for booking premium 8 employees, 0 R&D 2-3 years not make any profits in the tourist experiences personnel past year Has made sales but did 15 employees, 0 R&D E-commerce website 2-3 years not make any profits in the personnel past year New technology for accelerating 2 employees, 1 R&D the lead time in the sample Has not sold any products < 6months personnel – Highest approval process for the apparel as yet qualification BSc industry Yoghurt production using wholly 6 employees (friends and > 5 years Profits described as low local ingredients family), 0 R&D personnel Electronic jacket for the expulsion 1 employee in total, 1 Prototype Has not sold any products of fever from young children and R&D personnel – Highest development as yet electronic incense burner qualification A/L Unsure of total revenue Innovative product development in 7 employees in total, 7 R&D generated but reported the field of energy, agriculture, life personnel. 39 university having earned US$200,000 and medical sciences. Air-purifying > 5 years professors attached to – 300,000 from India alone light bulbs produced for consumers company for branding in the past year from the in India, UK, Portugal and the local purposes sale of the air-purifying market (albeit very limited) light bulbs Branded furniture with rubber wood for consumers in the US, > 5 years, sold Not applicable Not applicable European, Japanese and local company markets
Source: SLINTEC (2014).
Chapter 3 _ Technology Business Incubators in Support of Technology-Based Industries in Sri Lanka: Preparatory Study for the Establishment and Operation of the TBI in the Science Park • 241 2. Technology Entrepreneurship and the Role of a TBI
Technology entrepreneurship is “investment in a project that assembles and deploys specialized individuals and heterogeneous assets that are intricately related to advances in scientific and technological knowledge for the purpose of creating and capturing value for a firm” (Bailetti T., 2012). Siyanbola et al (2011) define Tech entrepreneurship as “the setting up of new enterprises by individuals or corporations to exploit technological innovation”, “the commercialisation of emerging technological discoveries or innovation” and as a “style of leadership that involves identifying high-potential, technology-intensive commercial opportunities, gathering resources such as talent and capital, and managing rapid growth and significant risk using principled decision-making skills” (Siyanbola W., Aderemi H., Egbetokun A and Sanni M 2011). New firms create jobs, increase productivity, alter the dynamics of competition and generate national wealth. Tech entrepreneurship is important to maintain national competitiveness in a globally competitive marketplace. (Bhide, 2000; Acs and Audretsch, 1990; Zahra and Bogner, 2000)
Technology Business Incubators (TBI’s) unlike some other incubators are usually initiatives of universities, public research institutes or local governments to accelerate the successful development of innovative, mostly new technology driven or knowledge intensive-service sector startups (National Science & Technology Entrepreneurship Development, 2002). Incubators associated with universities and research institutes often leverage them for advanced technology laboratories, equipment, and resources such as their staff (National Science & Technology Entrepreneurship Development, 2002). Also critical to the incubator concept and process is the provision of space, assistance in obtaining finances necessary for company growth, technical assistance for resolving difficulties in R&D and consultancy on finances, management, and marketing. Incubators vary in their organizational structure, delivery of services and clients they serve. Studies have shown that TBIs not only encourage the development of knowledge and technology driven startups but that they improve the survival rate of startups from 30% to over 70% (National Science & Technology Entrepreneurship Development, 2002).
3. Sri Lanka Country Profile and Economic Outlook
The tropical island officially referred to as the Democratic Socialist Republic of Sri Lanka is a South Asian Island home to approximately 20.48 million people. The island sits on several major maritime trading routes between Asia, the Middle East, Europe, Africa, and Australia (Central Bank of Sri Lanka, 2014). It is currently ranked by the World Bank as a lower middle-income country, with a GNI per capita of US $3,170 and GDP of US$67.18 billion. The island suffered from a brutal civil war that lasted three decades until its bitter end in May 2009. Despite the conflict annual GDP growth remained at ~5% through 2000
242 • 2014/15 Knowledge Sharing Program with Sri Lanka – 2008, while post conflict growth has averaged around 7.5% (Bureau of Economic and Business Affairs, U.S Department of State, 2014).
In the 1960s, the Sri Lankan economy began changing from that dominated by the agricultural sector to one that is dominated by the service sector: by the end of 2013, percentage contribution to GDP by the agriculture, manufacturing, and services sectors were 10.6%, 32.4%, and 57% respectively (Index Mundi, 2014). The country does however suffer from a large current account deficit with its annual imports valued at US$ 18billion and exports at US$ 10 billion. Approximately US$ 6 billion of the deficit is plugged by the export of low skilled labor.
“Compared to other South Asian countries, Sri Lanka is relatively open to foreign investment. It offers a fairly open financial system, moderately stable monetary policy, improving infrastructure and world class local companies” (Department of Commerce, U.S Commercial Service, 2014). The country has identified five economic hubs for development: ports, aviation, commerce, knowledge, and energy (Board of Investment, 2014). Sri Lanka is expected to continue this momentum in growth largely favored by improvements in infrastructure and macroeconomic conditions (Central Bank of Sri Lanka, 2014).
4. Current Research and Development Status of Sri Lanka
Research and development in Sri Lanka has been hampered by a lack of prioritization and investment. Although absolute amounts invested in R&D have shown an increase over the years, expenditure on R&D as a percentage of GDP has declined (Table A-2). Sri Lanka’s Gross Expenditure on R&D as a percentage of GDP is much lower in comparison to those of competing countries: 1.07% Malaysia, 1.16% Brazil, 0.80% India, 1.76% China, and 3.74% Korea (2010) (World Bank Data, 2010). In 2008, 40% of GERD was spent on applied research, 31% on basic research and just 29% on experimental research (National Science Foundation, 2008).
Gross Expenditure on R&DYear GERD (Rs) GERD as a % of GDP 1996 1,410.0 0.18 2000 1,810.0 0.14 2004 3,807.5 0.21 2006 5,119.19 0.17 2008 5,047.73 0.11
Source: Weerasinghe, M., (2013) R&D Country Profile Sri Lanka.
Chapter 3 _ Technology Business Incubators in Support of Technology-Based Industries in Sri Lanka: Preparatory Study for the Establishment and Operation of the TBI in the Science Park • 243 Sri Lanka also performs poorly in comparison to other lower income countries in the number of scientists in R&D per million people and scientific journal articles published: 103 researchers per million people (2010) and 130 scientific journal articles (2011). It is reported that Sri Lanka currently has approximately “4600 researchers working in research related jobs at the 31 state institutions, 16 universities and few private sector industries” (Rhee et al 2014). Worryingly, the number of researchers in R&D per million people in Sri Lanka has shown a decline over the years: 188 (1996), 136 (2004), and 103 (2010) (World Bank Data, 2014). The table below highlights the poor performance of Sri Lanka in this indicator in comparison to competing countries:
Researchers in R&D (Per Million People) from 2004/2005 to 2010Researchers in R&D (per million people) Country 2004/2005 2010 Sri Lanka 136 103 India 137 160 Brazil 545 710 Malaysia 499 1459 China 707 890
Source: World Bank Data (2014).
328 resident patents and 128 non-resident patents were registered with the National Intellectual Property Office in 2013. In 2010, high technology exports as percentage of manufactured exports was only 1% in Sri Lanka, compared with 75% in Korea, 27% in Thailand, and over 50% in Singapore and Malaysia (Ministry of Technology & Research, 2010). On a promising note, the share of private sector investment into R&D has increased from 19.19% in 2006 to 40.93% in 2010. Also encouragingly, an intended budget of Rs 50 billion for R&D has been planned over the next 5 years reflecting the intentions of the government to build a knowledge hub in the South Asian space.
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Innovation and Entrepreneurship IndicatorsIndicator performance Sri Lanka is ranked 99 overall but is at the top of the South Asia countries. Economies are ranked on their ease of doing business, from 1–189. “A high Ease of Doing ease of doing business-ranking means the regulatory environment is more Business Rank conducive to the starting and operation of a local firm” (World Bank Group, 2014) • The number of new businesses registered per 1000 people aged 15-64. A good measure of entrepreneurial activity. In Sri Lanka, it is clearly growing. New Business Density • 0.21 (2007), 0.32 (2008), 0.30 (2009), 0.44 (2010), 0.55 (2011), 0.51 (2012) • Number of new businesses registered 2873 (2007) and 6975 (2012) • “The Global Entrepreneurship Index is an annual index that measures the health of the entrepreneurship ecosystems. The GEDI methodology collects data on the entrepreneurial attitudes, abilities and aspirations of the local Global population and then weighs these against the prevailing social and economic Entrepreneurship ‘infrastructure’ – this includes aspects such as broadband connectivity and Index transport links to external markets” (The Global Entrepreneurship and Development Institute, 2014) • Ranked 71 out of 130 countries and 11th in the Asia Pacific Region • SL ranked 98 among 142 countries worldwide in 2013. GII 2013 looks at 142 economies around the world, using 84 indicators including the quality of Global Innovation top universities, research spending, and the availability of microfinance and Index venture capital deals. It gauges both innovation capabilities and measurable results, and also places them in a broader socio-political context. • Sri Lanka is among the top 3 performers in Central and South Asia. Sri Lanka Innovation Being developed by COSTI in line with international practices to ensure that Index (SLIINDEX) reliable data is available
Source: SLINTEC (2014).
5. Policy Objectives on S&TI and Entrepreneurship Promotion
Encouragingly, the Sri Lankan government has provided strategic policy-level guidance for the development of Science, Technology and Innovation. The policy documents surfaced by the interviews with government institutes are discussed in further detail below.
Mahinda Chintana: “Sri Lanka, The Emerging Wonder of Asia, Mahinda Chintana – Vision for the Future 2010” highlights the objective “to transform Sri Lanka into a strategically important economic centre of the world.” The document refers to developing Sri Lanka as a “Naval, Aviation, Commercial, Energy and Knowledge Hub, serving as a key link between the East and the West.” The document also calls for restructuring of
Chapter 3 _ Technology Business Incubators in Support of Technology-Based Industries in Sri Lanka: Preparatory Study for the Establishment and Operation of the TBI in the Science Park • 245 “the education and knowledge systems suitably, so that Sri Lanka becomes a key hub for knowledge and learning in the world.” “Over the next six years, I will dedicate myself to increase our per capita income to well above US$ 4000, thereby placing out country in the ranks of middle income nations” (Department of National Planning and the Ministry of Finance and Planning, 2010).
Science, Technology and Innovation Strategy 2011~2015: The Science, Technology and Innovation Strategy 2011 – 2015 is the first of its kind and was developed based on the National Science and Technology policy adopted by the Cabinet of Ministers in 2009. The strategy was developed by the Ministry of Science and Technology with a team of 24 personnel from diverse institutes and bodies working within the Science and Technology arena. The strategy was officially adopted by the Cabinet in October 2010 and is the guiding document for all relevant government ministries and institutions. The document contains four overarching goals and several sub-objectives. (National Science Foundation, 2010)
Goals and Sub-Objectives of the S&TI Strategy 2011~2015Goal 1 An efficient system to actively harness innovations and technologies to generate and improve products and services to contribute towards doubling the per capita GDP in an equitable manner by increasing the high tech value added exports and the production for the domestic market • Increase the high tech value added exports from 1.5% to 10% by the year 2015 through the Advanced Technology Initiative • Achieve a marked increase of import replacement by strategic production and social activities in a competitive milieu through enhanced and focused research and development. • Develop a dynamic technology transfer platform for wealth creation through the Techno Entrepreneurship Initiative. Goal 2 Well established, dynamic and resourced world class National Research and Innovation Eco-System • Establish a system for efficient and coordinated S&T Governance. • Attract, build and retain strategic Human Capital needed to make Sri Lanka a leading knowledge and innovation hub in Asia. • Create a comprehensive, world-class research and innovation system through a well-planned S&T infrastructure and services modernization initiative. • Ensure rationalized, increased Investment in R&D supported by facilitated utilization. • Facilitate International Partnerships in promoting high end technology and research. Goal 3 An effective framework to prepare the people of Sri Lanka for knowledge society • Implementation of the ‘Science for All’ Initiative • Attract students at all levels to science • Create awareness of the potential of Technology, R&D, and innovation in industry and businesses.
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continuedGoal 4 Sustainability principles entrenched in all spheres of scientific activities • Ensure strategic competitive advantage and differentiation to achieve economic sustainability in all scientific activities. • Ensure Environmental Sustainability in all areas of work • Ensure Social Sustainability in all activities.
Source: SLINTEC (2014).
The Investment Framework for Research and Development 2015 - 2020: The Investment Framework was an initiative spearheaded by the Ministry of Technology and Research together with the National Science and Technology Commission. It identifies ten areas of national priority and ten intervention methodologies and is hence referred to as the ’10X10 Investment Framework’ (Ministry of Technology and Research, 2011).
10X10 Investment FrameworkTen Focus Areas Ten interventions Water Policy Studies Food, nutrition, agriculture Pure and applied research Health Innovations Shelter Information Communication Technology Energy Nanotechnology Textile Industry Biotechnology Indigenous knowledge and Intellectual Property Environment Rights Mineral resources Testing and Standardization Information Communication Technology and Capacity Building Knowledge Services Basic Sciences, Emerging Technologies and Popularization Indigenous Knowledge
Source: Ministry of Technology and Research (2011).
Chapter 3 _ Technology Business Incubators in Support of Technology-Based Industries in Sri Lanka: Preparatory Study for the Establishment and Operation of the TBI in the Science Park • 247 6. Entrepreneurship Education in the Tertiary level
The University of Sri Jayawardenapura has started a four year degree course on Entrepreneurship three years ago. Under the faculty of Management Studies and Commerce, a separate Department of Entrepreneurship was established.
The student book states the objective of this degree program is “To develop an entrepreneur with appropriate entrepreneurial spirit, characteristics and behaviors who would readily start and run successfully a business venture at the maximum efficiency and effectiveness”
The faculty had identified that the progress and the advances made on the entrepreneurial business front is very vital for the development of the country. The importance of the education system in producing entrepreneurs of high intellectual and professional caliber has been emphasized and acknowledges by governments worldwide. Accepting the global trend, the government of Sri Lanka has also taken various initiatives to encourage and foster entrepreneurial business development in the country.
They forecast that a degree holder will be able to:
1) Have a rigorous theoretical understanding of the approaches to micro and macro aspects of entrepreneurship, recognize their strengths and limitations, and apply those theories with necessary modifications for the betterment of their business venture and society at large; 2) Recognize environmental opportunities and creatively exploit them to produce new products, processes or organizations that would lead to the betterment of the society; 3) Evaluate business projects and produce business plans for their ventures; 4) Comprehend the different stages of an entrepreneurial ventures and manage their requirements at maximum efficiency and effectiveness to ensure the smooth growth of the venture; 5) Organize the resources of the business displaying maximum level of expertise for making optimal use of them; 6) Demonstrate the belief in the use of local resources, technology, and science, and establish a truly indigenous business with maximum value addition; 7) Possess good moral and intellectual values with exemplary personal traits and lead the rest.
The special degree program will start from the second year and is completed in the fourth year. The students selected for this course will only be awarded the degree if they
248 • 2014/15 Knowledge Sharing Program with Sri Lanka have started a business on their own by the fourth year. Some of the subjects included in the curriculum are as follows;
• Marketing management and HRD • Macroeconomics and financial management • New venture creation and managing creativity and innovations • Commercial law and corporate law • Business plan development • Professional skills development • Managing entrepreneurial growth and information systems • Research methods and study in entrepreneurship • Strategic management etc.
The undergraduates of this course are facilitated with internships in industry and research institutes. This differs from a conventional degree program as it avail the students to learn not only the theory but also other social skills needed to build a good business venture such as developing their social skills. The program has special reference to the development of SMEs.
In addition to the degree program the Department of Entrepreneurship had conducted a program named the ‘Development of Entrepreneurial Skills among Undergraduates’ with the aim of equipping undergraduates with appropriate entrepreneurial spirit, characteristics, and behaviors. The program had designed in a way which undergraduates are able to challenge the status-quo and to readily come up with innovative solutions to improve their social systems and thereby ensure the social wellbeing.
The program covered following areas;
• Creative Thinking for Managing Innovation • Willingness to Take Risk. • Leadership and Team Work • Professional Skills Development (Presentation Skills, Ethics and Etiquette for Executives, Assertiveness etc.) • Business Plan Development and Venture Creation • Career Management
The program was enriched with an Outward Bound Training (OBT) for the best 100 participants in order to improve leadership, team work, communication, self-confidence, commitment, initiative, courage, determination, creativity, and risk taking.
Chapter 3 _ Technology Business Incubators in Support of Technology-Based Industries in Sri Lanka: Preparatory Study for the Establishment and Operation of the TBI in the Science Park • 249 In the University of Ruhuna, in the Faculty of Management and Finance, Department of Management and Entrepreneurship, a four year degree course is offered for entrepreneurship. A student enrolled will be awarded a Bachelor of Business Administration (BBA) specializing in entrepreneurship. They study the common subjects in the first two and half years with a view to give them an opportunity to make a better-informed choice of the specialization area for the last three semesters of the degree program. With the BBA Degree specialized in entrepreneurship, the department aims to develop students with sound entrepreneurial attributes who could immensely contribute to the Sri Lankan economy by starting and running a venture.
In addition, the University of Moratuwa and University of Wayamba have entrepreneurship development as one subject but not as a comprehensive module.
7. Best Practices and Success Factors for Technology Business Incubators
Summary of Best Practices and Success Factors for TBIsLalkaka 2006 (UNESCO) In the Planning Stage • Establish realistic goals and identify strong partners at the outset. • Develop linkages to knowledge bases such as research, learning and professional communities. • Leverage state policy and legislative support for competitiveness strategies, human resources development, regulatory and legal systems, financial and property systems. • Select a location with good business infrastructure: While it should be connected to knowledge bases (technical universities, research laboratories etc.), it should also give some indications of entrepreneurial energy. • Plan the physical facility to stimulate interaction and creativity. • Undertake rigorous feasibility and business planning exercises. • Mobilize information and communications technologies. • Secure ‘patient money’ for TBI operations. During the Implementation • Select and train a dynamic management team. • Select and prepare entrepreneur groups. • Organize to provide quality value-adding services. During the Operations • Enhance TBI performance and raise income. • Monitor the performance, assess effectiveness and expand impacts. • Create an outward-looking incubation system for the future. Khalil & Loafsen 2009 (The Innovation for Development Report 2009~2010) Operational and Strategic Challenges • Financial sustainability: Partnerships are essential to sustainability as well as effectiveness. • Competent management teams: It is well-known that the effectiveness of TBIs critically hinges on the right mind and skills of the management teams.
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continued• Deal flow: The objectives of TBIs cannot be pursued without enough deal flow. Success Factors That Help Overcome the Challenges • A careful feasibility study is needed for successful planning of a TBI. • The TBI should be tailored to local market conditions. • TBI managers should have the right skills and mentality, and be given sufficient incentive to stay. • TBIs must be run in a business-minded way, even if they are owned by academic institutions or government agencies. • The selection criteria for clients are in line with the core objectives of the TBI and with local market needs. • A certain size is required for effective incubation in order to maximize the likelihood that the incubator will achieve financial sustainability.* • The greater investor and private sector involvement is critical for successful performances. Akçomak 2009 (UNU) Requirements for Successful Incubation • The purpose and the mission of the incubator should be clear. • Incubators should set clear selection, entry, and exit criteria. • Incubator managers should be qualified, preferably with a business experience. • Monitoring firms is essential for success. • Services that are provided by the incubator should be strategically selected. • Intangible services are much more important than tangible services (space, infrastructure, labs etc.). • Networking adds value only if it is a deliberate strategy. • The incubator should be able to self-sustain its operations. infoDev 2010 (World Bank)
Recommendations for the Design and Implementation of an Incubation Program • Consistency between objectives and the broader strategic framework: Incubators are designed and implemented to pursue defined objectives as part of a broader strategic framework or of particular policies (job creation, social policies, competitiveness etc.). • Consistency between objectives pursued and suitable service mix: The actual service mix should reflect an analysis of the needs of clients for the specific objectives of the incubator. • Stakeholder support: The involvement and support of stakeholders and incubator management are vital for incubator success. There should be consensus among stakeholders on a mission that defines the incubator‘s role. • Investing in Pre-incubation: A pre-incubation program to assist potential start-ups to develop their ideas and learn basic business skills is critical to ensuring that the incubator takes on clients close to business launch. • Addressing gaps in Business Environment: Incubators need to analyze the local business environment and propose solutions to any problem faced by their clients. • Commercial approach: The policy framework needs to encourage a business mindset and discipline for a public benefit in line with the set objectives and assess the performance of incubators in those terms, which an impact on the funding policy. • Ensuring elements of competition and merit in grants assignments: The efficient use of Public support funds can be achieved by organizing open competitive rounds for grant funds and keeping funded incubators accountable for their performance.
Chapter 3 _ Technology Business Incubators in Support of Technology-Based Industries in Sri Lanka: Preparatory Study for the Establishment and Operation of the TBI in the Science Park • 251
continued• Financial sustainability: To achieve sustainability, incubators need to develop a range of alternative funding sources, both public and private. • Networking and PPP: Partner networks can share experiences, and help expanding market opportunities for clients. PPP models should be promoted either in the ownership or in the governance of incubators. • Incubator Manager: Failure to employ a suitably skilled and motivated manager is one of the key reasons for the failure of an incubator. • Monitoring and Appraisal: The design of a monitoring and appraisal system is critical to identifying unexpected problems, further improvements and best practices. Lewis et al 2011 (NBIA) Business Incubation Best Practices
Management of the Program • Conduct a feasibility study before starting a program. • Develop a consensus-driven mission statement. • Establish client entry & exit criteria. • Collect outcome data. • Provide networking opportunities between client firms. • Establish effective tools to deliver support services. • Build networks with area business services providers. • Market incubators beyond the entrepreneurial community. Key Entrepreneurial Support Services** • Business plan writing and business basics • Legal assistance (general legal services, intellectual property protection, incorporation or other legal business structure, import/export requirements etc.) • Access to capital • Marketing assistance • Access to broadband high-speed Internet • Mentoring boards for clients with area business service providers • Close ties with higher education institutions (where possible) • Accounting and financial management services • Networking with other entrepreneurs, particularly other clients • Networking with area business community • Assistance in developing presentation skills • Assistance in developing business etiquette Additional Key Services for Technology Business Incubation Programs • Technology commercialization assistance • Access to specialized equipment and laboratories at reduced rates • Intellectual property management assistance
* The infoDev suggests 20 to 30 clients and a space of at least 2,000m2 for effective management of the TBI in most cases, but this may depend on specific circumstances of the TBI. ** The management practices and entrepreneurial support services are not listed in hierarchical order. Source: quoted from Lalkaka (2006), Khalil & Loafsen (2009), Akçomak (2009), infoDev (2010), Lewis et al (2011).
252 • 2014/15 Knowledge Sharing Program with Sri Lanka 8. Interview Results with the SLINTEC CEO, Mr. Harin De Silva Wijeyeratne about TBI Establishment Plan
(1) TBI Purpose
The TIC (Technology Incubation Center, the government of Sri Lanka prefers the term TIC to TBI as it wants to put focus on high-end technology) to be established will be focused on venture start-ups based on high-end science and technology. The government of the nation is planning to attract high-end manufacturing start-ups at TIC. For IT business start-ups, it already provides support for space and funding so it will be excluded from candidate TIC residents. Unlike IT start-ups, manufacturing start-ups in Sri Lanka did not have sufficient infrastructure support for business start, growth, and production expansion. TIC will provide technology venture start-ups in manufacturing sector but funding for these start-ups shall come from separate investors.
(2) TBI Progress Plan
The TIC is scheduled to open around August ~ September, this year so the plan needs be defined by April. In the coming 6 months, 5~6 promising start-ups to stay at the TIC will be selected from colleges and the SLIC.
(3) TBI Governance
Lessons from experiences of Korea will be applied. SLINTEC’s Board will supervise TIC’s activities as a committee of the TIC and it is possible to have an advisory group to evaluate/assess resident companies. No specifics have been fixed yet and it will be decided in accordance with the nature and needs of the TIC. In SLINTEC, 50% of the shares at the board is owned by the government. Likewise, for the TIC, the government’s involvement is essential and natural. However, in SLINTEC the private sector takes the lead regardless of the government’s 50% share and it is expected to be effective for the TIC, too.
(4) Funding and Incentives for a TBI Establishment and Operation
Funding for a TBI Establishment and Operation: For the establishment and operation of a TIC, early stage infrastructure is required, and additional operation cost is required. Stakeholders around the TIC will participate in funding the TIC in various ways including leasing, donation, and investment but to ensure the TIC provides services for resident companies at nominal cost, support from the government for operation is essential. As it is expected to have 10-year TIC settlement period, the government’s support is required for the period. As environments, conditions and culture for venture start-ups in Sri Lanka are
Chapter 3 _ Technology Business Incubators in Support of Technology-Based Industries in Sri Lanka: Preparatory Study for the Establishment and Operation of the TBI in the Science Park • 253 not so favorable, a 10-year period was set to improve the environments and build a basis for a technology start-ups promotion. When the project enters the 2nd phase after the 10- year period, the time required for start-ups to stand independent can be reduced. There is no budget plan for the first 1~2 years of the TIC operation. With the contribution of the KSP, we expect to see a substantial business plan and an associated financial plan.
Incentives for the TBI: To operate the TIC, part of the tax shall be directly used for the TIC, excluding the infrastructure building, so accountability shall be defined for the spending and the government’s involvement in the TIC operation in any format is required.
(5) TBI Operational Plan
TIC Manager: It is not decided yet whether a full-time manager will be necessary for the first 2 years. To reduce cost burden, management team formation and governance will be decided depending on how it unfolds at the TIC. What is clearly decided is that the manager of the SLINTEC will not be allowed to take the role of TIC manager at the same time. It is not easy to find a manager with appropriate experiences, commitment, and patience to facilitate technology start-ups based on an extensive understanding of business environments in Sri Lanka.
Selection of Resident Companies: Leveraging all the mechanisms to identify inventors and innovators in Sri Lanka, the most promising high-end manufacturing start-ups will be attracted. Based on cooperation with colleges and research institutes, start-ups with the highest potentials will be invited. The TIC to be established will be the focal incubation facility for all promising technology venture start-ups at all colleges across the nation. If it is limited to technology start-ups that are within the original intention, it is likely to have difficulties in attracting residents so it would be wise to expand the spectrum to include promising SMEs seeking further growth along with start-ups in the infant stage. For the growth of the TIC and to attract promising candidates, all parties including colleges, research institutes as well as private sectors will join hands.
Venture Capital Funding for Tenant: The angel investor group, LAN, might provide funding but it is desirable to have bigger investors than LAN, like investment banks. SMEs that started with promising products or technologies but are now facing funding issues for production scale-up will be allowed to move into the TIC to march into the next level of growth with extensive support including funding. LAN, an angel investment group recently established, is investing in approximately 10 venture start-ups but it is not limited to technology venture start-ups. Rather it reaches across various industries. It invests US$ 100,000 in average for business start-up seed money. Angel investment groups will also explore opportunities to invest in venture start-ups staying at the TIC. Recently, there is a
254 • 2014/15 Knowledge Sharing Program with Sri Lanka movement to establish a small-scale venture capital fund led by banks in Sri Lanka. The VC (Venture Capital) fund is expected to be the source of investment for the TIC during the 2nd phase.
Research Funding and Others for Tenants: The needs-based research funding program running in Korea (government or big enterprises announce their technology needs and decide the institute to win a R&D fund through competitive bidding) can be applied in securing a fund for the TIC resident companies so review over the measures to apply the program to Sri Lanka is required. Just as Disrupt Unlimited, it is possible for big enterprises to present their technology needs and TIC works to meet their needs, and in this case of companies incubated at Disrupt Unlimited, they can move to the TIC and get support to expand their basic ideas and technologies further to the level of production.
Services Provided by TBI: It will prioritize and provide services resident companies want. With an aim for smooth service provision, it is planning to leverage support from the government and private sector from the initial phase. For professional service of the TIC, and to minimize cost burden, it will be outsourcing with consideration of an on-line service option and they will work as a part-timer (one day per week).
Entrepreneurship Education: TIC will also take the role of disseminating business start-up education and culture and to this end the TIC will continue to provide education, training, seminars, and workshops. It is essential to secure funds for these activities.
(6) Physical Space Plan of TBI
Maximum Capacity of TIC: The TIC building occupies 16,000 ft2 but some of the space will be used for a pilot plant led by the SLINTEC (It is planning to build around 2 pilot plants), and the remaining space will be used for venture start-up incubation. The space, with the exception of the section for pilot plants for SLINTEC’s internal projects, will be available. As the needs for space will vary among companies to enter the facility, it is too early to estimate how many start-ups it can accommodate in advance. As of now, having 15 resident companies in the first 2 years seems desirable.
Space Plan with Layouts: Currently, all the space at the TIC buildings have a high roof structure to build a pilot plant. After identifying specific demands for a pilot plant and start-ups incubation, depending on the portion, the space will be divided into an incubation section including office, lab, and a pilot product fabrication and a pilot plant section for production. In the space allocated for start-up incubation in high roof buildings, work rooms and facilities will be placed in accordance with their needs. The thing is that for start-up incubation, they need office-type space and it doesn’t have to be high-roof.
Chapter 3 _ Technology Business Incubators in Support of Technology-Based Industries in Sri Lanka: Preparatory Study for the Establishment and Operation of the TBI in the Science Park • 255 The TIC building layout was decided based on the assumption that the entire space will be used for a pilot plant and incubation space and facilities will be placed under the current lay out. For manufacturing start-ups, they will spend much of the time outside the office and in this case, the office can be shared for other purposes. After a 2-year operation, the space plan will be specified for the 2nd phase. It is planning to build 12 offices now but it is not decided whether all of the 12 offices will be used for individual offices for start-ups. (Offices might be used as administration room, common space, board room, and office for a pilot plant). If additional offices are needed for start-up incubation, it might be worth considering expansion of the TIC buildings.
(7) Triple Tax Deduction Discussion and Implication to the TBI
The program has been implemented for about 2 years but no tangible outcomes have been seen yet. For investors to have a clear understanding of and take full advantage of the program it will take time but it is expected to be more widely used. Tax deduction in Sri Lanka is not applied to seed capital to acquire shares at venture start-ups. It is required to see what type of tax incentives are there in Korea for venture start-ups and for venture capital to acquire shares at business start-ups and see how it can be applied to cases in Sri Lanka. In this case, it should be based on clear standards and a strict application to see whether the case is applied to venture capital investment to acquire shares as it might cause abuse or misuse of the system otherwise. Possibility of abuse or misuse can be reduced or prevented by limiting tax incentives to venture capital investments meeting a certain level. No significant issue is expected for a tax deduction on the venture capital fund (It is required to check whether the incentive is already applied in Sri Lanka.)
For the endowment fund raised by donation from the rich for science and technology promotion, it will be a great boost to fund raising if the donation will be allowed to enjoy a tax incentive. Recently about US$ 250,000 was donated. If it becomes easier to get an approved charity status for the endowment fund, it will boost the donation for science and technology promotion fund. As the maximum ceiling for corporate tax is 28%, the tax deduction rate for R&D expenses of companies is about 84%. This means you can conduct US$ 100 worth of R&D activities with only US$ 16. Thus, it is required to see whether there is any incentive for big companies to donate or provide funds for the TIC. If big enterprises provide funds in the form of an equity investment to the TIC, it will be impossible to offer tax incentives but if it is for the operation of the TIC or expenses of resident companies (without obtaining equity shares), it is possible to provide tax incentives.
9. Young Start-up Academy of Korea
This program intends to provide one-stop assistance to young people hoping to start
256 • 2014/15 Knowledge Sharing Program with Sri Lanka technology-based businesses through the entire stages including selection, business preparation, and commercialization. This program supports 70% of the entire business expense within 100 million won.
Services and Achievement of Young Start-up Academy of KoreaCategories Description Performance • Holding IR including Pitch & • Hosting investment: 11 companies, 6 bil Mentoring won Investment • Investment promotion education - 2nd graduation: 8 companies, 3.3 bil • Individual investment consultation won • Using policy funds (Start-up business • Financing: 119 companies, 12.2 bil won funds for the youth) - 1st graduation: 12 companies, 1.6 bil • Introducing and teaching SME policy won Finance funds - 2nd graduation : 63 companies, 6.8 bil won - 3rd graduation : 44 companies, 3.8 bil won • Operate exhibit booths in Happy • 34 companies and items department store - The Hive signed 200 thousand dollar Marketing • Participating in overseas and domestic contract exhibits (11 exhibits, 191 companies) - DMLITE exports products to 30 • Export BI (LA) residence countries • Three-tier follow-up service system • Follow-up management (Self- Management • Development history management management 3, commission 1) system • The average rate of survival: 94.8%
Overall Achievement
The number of jobs created Rate of Survival 98.6 100 1212 95 679 91 90 85 2012 2013 First Year Second Year
Source: Small & Medium Business Corporation of Korea Homepage, http://home.sbc.or.kr.
Chapter 3 _ Technology Business Incubators in Support of Technology-Based Industries in Sri Lanka: Preparatory Study for the Establishment and Operation of the TBI in the Science Park • 257 10. Hybrid Funding, Fund of Funds
Hybrid Funding
The investment and loan hybrid financial project supports SMEs that have valuable technologies and great growth potential by offering a low interest rate credit loan featuring advantages of both investment and financing. It consists of two forms; The Income Sharing Loan which started in 2011, and the Growth Sharing Loan in 2008.
• Income Sharing Loan: After financing, the government receives income-related interest (fixed interest plus income-related interest) based on the company’s sales performance. The term of this loan is 5 years with 2,000 million won a year. • Growth Sharing Loan: The Small and Medium Business Corporation acquires equity linked corporate bonds as CBs (Convertible Bond), which have been issued by SMEs. The term of this loan is 5 years with 4,500 million won a year.
Financing Performance (Unit: Company, 1 million won) June, Total 2008 2009 2010 2011 2012 2013 2014Total Amount 575,804 15,479 37,077 33,859 98,006 150,000 170,000 71,383
# companies 274 33 55 40 39 45 52 10 Growth Sharing Amount 217,101 15,479 37,077 33,859 37,563 42,646 42,177 8,300
# companies 1,689 - - - 297 517 572 303 Income Sharing Amount 358,703 - - - 60,433 107,354 127,823 63,083
Source: Small & Medium Business Corporation of Korea Homepage, http://home.sbc.or.kr.
Fund of Funds
After the burst of the venture bubble in the early 2000s, the venture capital market contracted rapidly, so much so that the amount of venture capital invested in 2004 was less than 30% of that in 2000. In order to enhance the investment capability of and to provide incentives for private venture capital companies, the government decided to establish the Fund of Funds (called “Mother Fund”), worth 1 trillion won until 2009. The Fund, different from other general funds, acts as seed money by investing in private drop-down funds rather than direct investment, and was established in June 2005 based on the ‘Act
258 • 2014/15 Knowledge Sharing Program with Sri Lanka on Special Measures for the Promotion of Venture Business’. The fund of funds distributes investment sources to raise drop-down funds according to the establishment purpose of the contributing institutions, and the created venture capital funds must invest more than 60% of the funds to SMEs in main investment areas for every fund type.
The Korea Venture Investment Corporation, the agency specializing in managing the fund of funds, under the supervision of the Small and Medium Business Administration, invests in start-up investment funds, new technology industry investment funds, and private equity funds. The fund is raised according to the management plan through scheduled distribution two to three times a year and non-scheduled distribution.
As of June 2012, the fund of funds distributed 1.66 trillion won to 233 drop-down venture funds since its establishment in 2005 through scheduled and non-scheduled distribution plans, and through the following fund-raising processes, the total amount of drop-down funds is worth more than 6.52 trillion won. Through the drop-down funds, 4.303 trillion won has been invested to 3,269 SMEs in early to growth stages in not only general manufacturing industries, but also various areas such as IT, bio/environmental/energy, and culture industries such as movies and music.
The fund has also made a macroeconomic contribution, such as job creation and increase in sales, of businesses invested by fund-of-funds contributed venture funds (June 2008, Korea Fixed Income Research Institute). From 2005 to the first half of 2007, 229.2 billion won was invested in 158 businesses and created 4,504 jobs and increased their sales by 1.13 trillion won (For every hundred million won, two jobs and increase of sales by five hundred million won). In addition, venture businesses that received venture investment experienced a 132.9% increase in sales and 57.5% increase in employment.
11. Australia – The Victoria State Government Smart SMEs Market Validation Program
SMEs Market Validation Program (MVP) was introduced in 2008 to help SMEs commercialize new intellectual property and develop globally competitive technologies, products and services. The MVP seeks to yield R&D proposals that deliver a solution to a public-sector technology requirement. MVP features are as following;
• Using a three-stage approach: specification of technology requirements by agencies, feasibility studies, and proof of concept. • Engaging two stakeholder groups: public sector entities and SMEs. • Broadly modelled on the US SBIR program: a tendering and contractual scheme based on solicitations using a description of the problem rather than pre-determined
Chapter 3 _ Technology Business Incubators in Support of Technology-Based Industries in Sri Lanka: Preparatory Study for the Establishment and Operation of the TBI in the Science Park • 259 solution specifications. One important difference between the SBIR and the MVP is that the MVP aims to encourage participation by public-sector entities by providing funding through a central and independent agency (DIIRD). • Following a milestone funding model, along venture capital lines, which allows for “fast fail” decisions and systematic evaluation. SMEs own the intellectual property developed under the program.
260 • 2014/15 Knowledge Sharing Program with Sri Lanka References
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2014/15 Knowledge Sharing Program with Sri Lanka
.go.kr www. ksp ity 30149, Korea Center for International Development, KDI cid.kdi.re.kr Knowledge Sharing Program www.ksp.go.kr korea.ac.kr (set) www.cies.or.kr www. www.mosf.go.kr www.kdi.re.kr 3 7 SBN 978-89-8063-953- SBN 978-89-8063-827- I I Korea University 145 Anam-ro, Seongbuk-gu, Seoul 02841, Korea Tel. 82-2-3290-1152 Tel. 82-44-550-4114 Center for Iternational Economic Studies 1st Floor, Insung Bldg., 7-14 Eonnam 11-gil, Seocho-gu, Seoul 06776, Korea Tel. 82-2-2058-2303 Korea Development Institute c 263 Namsejong-ro, Sejong Special Self-Governing Ministry of Strategy and Finance Sejong Special Self-Governing City 30109, Korea Government Complex-Sejong, 477, Galmae-ro, Tel. 82-44-215-7762
