China Boots Up

Berglund Authority Level 4

by Jeffrey Barlow <barlowj@pacificu.edu>
Director, Berglund Center

Introduction

The announcement that a Chinese company, Lenovo, has acquired the Personal Computing Division of the I.B.M. Corporation should be regarded as extremely important, even epochal, in any terms.  But it is of particular significance as a milestone in the rise of the People’s Republic of China to global importance since its founding in 1949.  At that time, Mao Zedong, then the leader of a poverty stricken radical Communist regime, which was shunned by virtually the entire Western world, proclaimed that China had “stood up.”  In computer-related terms, appropriate to the IBM-Lenovo deal, we may say that with this purchase, China has “booted up.”[1] This purchase not only creates the world’s third largest PC business but also puts IBM in partnership with the Chinese government itself. The consequences, while currently unforeseeable, are bound to be very far reaching.

The Lenovo Group

Lenovo (The Lenovo Group, Ltd.) is, by world standards, a well-established company, dating back to 1983, when it was founded as Legend Computer, one of the first entrepreneurial activities of the Chinese state organ, the Academy of Sciences.[2]  Legend began in part by adapting IBM operating systems to the Chinese market by producing useful programs that “localized” elements of the system, particularly the critical operation necessary to permit the input of Chinese characters. Legend’s engineers also reverse engineered basic IBM machines to produce their own sturdy low-end computers for the Chinese market.  Legend essentially created the Chinese market for home PC’s in 1990. By 2000, Legend had a 30% share of what soon became the world’s fastest growing domestic computer market.  In April of 2003, Legend Computer became Lenovo, to “lay the groundwork for its expansion in the overseas market.”[3]

Legend was founded by Liu Chuanzhi, the current chairman of the Lenovo Group.  It is then, like Microsoft, one of the few major hi-tech corporations in the world still under the control of its founder.  Liu was quick to study Western business practices, saw the importance of establishing a presence in the Hong Kong market, where much was to be learned about both capitalism and technology, and adapted the technology park model used so successfully in Taiwan to China.[4] By 1994 Hong Kong Legend was trading on the Hong Kong stock exchange and ensconced in a new highly advanced technology park in Guangdong province of south China, adjoining Hong Kong.

Legend soon began acquiring significant market share in Asia outside of Japan, where Japanese trade practices keep most foreign firms safely at bay. By 2003 this amounted to a 12+% share.

Lenovo and IBM

While the transaction is an acquisition, its terms bring the two corporations into close partnership.  IBM acquires 18.9% ownership of the Lenovo group, becoming in the process a partner with an organ of the Chinese state, the Academy of Sciences, which also still has a large share of Lenovo.  IBM and Lenovo together accounted for 8% of world market share of PC units in 2003.

Lenovo is clearly interested in IBM’s management expertise and its current international marketing chain.  Steven M. Ward, jr, currently a senior VP of IBM will become the CEO of Lenovo in the Spring of 2005. The current CEO of Lenovo will become its Chairman at the same time, replacing Liu Chuanzhi.  Some have read this transaction as amounting to IBM’s withdrawal from the PC market to concentrate upon higher-end operations aimed at enterprises rather than consumers.  There is an element of truth in this, of course, but the agreement also gives IBM a strong position in what is arguably the world’s most successful producer of personal computers.

Lenovo, in addition to being sponsored into the American market, also acquires IBM’s international sales network in 160 countries, instant global brand recognition, and such intangibles as having IBM function as its preferred services and customer-financing provider.

Conclusion: Long-term Consequences?

The long-term consequences of this agreement are incalculable.  For example, one can only imagine the impact for such American brands as Dell and others which produce a good deal less than they sell.  It is possible that a whole new line of personal computers labeled Lenovo- IBM will soon enter the market at price points in which IBM has not competed for decades.  And unlike the current providers of parts for Dell and others, Lenovo, aided by IBM’s research and development labs, will be capable of rapid technological breakthroughs, which will quickly differentiate them from others.

There are also other than financial or economic consequences to this transaction.  Even international relations may well be affected. From the Chinese point of view, entering the American market for technology directly is a highly desirable outcome.  At present, Chinese firms and Chinese firms supplying Taiwanese manufacturers certainly have the lion’s share of the American market, but the brands on those computers are American ones, and the largest part of the profits go to those American firms. Other than perhaps Tsingtao Beer, it is difficult to name a truly Chinese brand succeeding in the American market.

At the same time, Americans are painfully aware of the gigantic trade imbalance with China, and Chinese trade practices are often said to be the root cause of that imbalance.[5] If the purchase does indeed facilitate Lenovo’s access to American markets, the question of unfair trade practices will be minimized, as Lenovo will, correctly, point that it is in fact an international company with significant American ownership, guided in part by IBM management, backed by IBM research and development.

There is a certain irony to the acquisition of IBM’s Personal Computer Division by a Chinese mainland corporation.  The Asian computing boom began not in China, but in Taiwan.[6] The Korean War persuaded Harry Truman, earlier dubious of the viability of Taiwan, of the importance of an American guarantee of Taiwan’s independence, under the painfully thin pretext that Taiwan was, in fact, the government of all of China and merely in temporary retreat before Mao’s regime. Then in the late 1950’s and 1960’s the issue facing the United States was how to shore up Taiwan economically as an anti-communist bastion in the face of Mao’s China, which had not only stood up but also seemed to threaten to expand rapidly.

One strategy was to encourage Taiwan to develop a technology industry.  Taiwan had proved adept at pirating American technology, but to openly support piracy was too much even for the most fervent anti-communist.  So, as I heard in Taiwan at the time, IBM sent engineers to Taiwan to, paradoxically, assist the Taiwanese in reverse engineering IBM personal computers, but without infringing the critical patents protecting the BIOS, the communication heart of the PC.

With this advantage, the Taiwanese industry took off.  By the 1990s the Taiwanese would be the largest manufacturers of a considerable portion of the elements necessary to the high-tech boom of that era.  Then, as production costs began to mount, Taiwanese began to outsource stages of their production processes to factories in China.

While this process quickly became a very controversial one in Taiwan, and one inextricably intertwined with the heart of Taiwanese partisan politics, it was unstoppable.  Taiwanese told themselves that they could safely keep control over the higher value-added end of the industry by assiduous state-encouraged efforts at research and development.

The acquisition of IBM by Lenovo shows this Taiwanese hope to be what it always was, a short-term strategy that was bound to fail as mainland entrepreneurs simply followed the path already laid out by Taiwanese entrepreneurs before them: take advantage of low labor costs and a highly educated technically savvy group of college graduates to exploit a rapidly developing domestic market, then move swiftly to enter export markets, finally, continually upgrade research and development, often with foreign partners to create new products to keep the expansion moving.

Another way of examining the implications of the IBM-Lenovo agreement is to consider what other alternatives were open to IBM.  The first company that comes to mind is Acer of Taiwan.[7] Acer is long known to have been contemplating entering the American market under its own name.  It has a minor brand presence in the U.S., but is known primarily as a supplier to better-established American brands such as Dell.  As of 1998, Acer produced one third of the world’s personal computers, well ahead of Lenovo. Acer, led by the dynamic Stan Hsieh, is highly regarded as an innovative, reliable, and extremely competitive firm. Acer has had a record year in terms of income, and expects to do better in 2005.[8]  It certainly has the capital base to have been a competitor for the IBM division.

But what Acer does not have is the China market, or the political ties that Lenovo does.  The actual purchase price for the IBM division was startlingly low, 1.75 billion. What IBM got was less cash value than future influence and a stake in the booming Chinese high-tech economy.  The telecasts of the upcoming Beijing Olympics will establish Lenovo as an international brand just as surely as did the 1964 Tokyo Olympics establish Seiko.[9]

So if Dell looks upon this transaction as a potentially threatening one, it is impossible to imagine the despair that must grip many Taiwanese, hi-tech entrepreneurs and political leaders alike. The political issues affecting Taiwan are doubtless going to continue to be periodically controversial ones.

But Taiwan grows less and less important as an economic entity, worth less to China, and to America, less worth disrupting trade with China. This may, in the long run, actually be good for all concerned as the status of Taiwan is less likely to be the focal point of major international conflicts.

Another possible impact of the sale will be an incalculable cultural one.  At present, as we have repeatedly argued in our editorials in Interface, Americans are in a sort of love-hate relationship with China.  Once the smiling computer engineers of Lenovo are familiar figures at American board meetings, we wonder if they can continue to be viewed as politically threatening.  Certainly Lenovo is banking upon this result.

Notes

[1] See Lohr, Steve.  “Sale of I.B.M. PC Unit Is a Bridge Between Cultures.”  12/08/04, The New York Times, http://www.nytimes.com/2004/12/08/technology/08computer.html?oref=login  See also the announcements on the WWW site of Lenovo, found at: http://www.lenovo.com/us/en/

[2] For a great deal of useful information on not only the Legend Corp, but also the Chinese computer industry in general, see Sheff, David. China Dawn. The Story of A Technology and Business Revolution. New York: Harper Business, 2002. A review of the book in Interface is found at: http://bcis.pacificu.edu/journal/2002/10/sheff.php

[3] Lenovo, “History” found at: http://www.pc.ibm.com/us/lenovo/about/history.html

[4] See review of Jussawalla, Meheroo, and Richard D. Taylor. Information Technology Parks of the Asia Pacific. M. E. Sharpe, 2003., found at: http://bcis.pacificu.edu/journal/2003/06/jussawalla.php

[5] “In 2003, the United States ran a record-breaking $124 billion trade deficit with communist China, importing $152 billion worth of goods while exporting only $28 billion, a five-to-one ratio of imports to exports.” AFL-CIO Executive Council, “Taking Action to Challenge Communist China’s Unfair Trade Practices” at http://www.aflcio.org/aboutaflcio/ecouncil/ec03112004m.cfm

[6] For a fuller treatment of computing in Asian, with particular regard to the triangular relationship between China, Taiwan, and the United States see: “The Internet, R&D, and U.S. policy in the Taiwan Straits. PART I OF II” in Interface, found at: http://bcis.pacificu.edu/journal/2003/01/edit.php#.03 and “The Internet, R&D, and U.S. policy in the Taiwan Straits. Conclusion” found at: http://bcis.pacificu.edu/journal/2003/02/edit.php#.03

[7] See http://www.brandingasia.com/cases/case1.htm for a basic treatment of Acer’s success story.

[8]  See Steve Shen, “Acer November revenues hit record high for third straight month” Digitimes, Taipei. http://www.digitimes.com/news/a20041208B1046.html Acer revenue for 2003 is said to be USD 4.9 billion.

[9] Lenovo states in its web pages that it was the first Chinese enterprise to join the Olympic Partner Programme with the IOC. This makes Lenovo the computer supplier to both the Milan Winter Games and the Beijing Summer Games.  See Wang Dan, “China's Lenovo heads to the Olympics” CNETASIA News, 3/26/04 found at: http://www.asia.cnet.com/news/systems/0,39037054,39173295,00.htm