Abstract A challenge facing local firms in China is the selection of effectivetechnology strategies to compete against MNEs in the era of globalization. Theexisting literature suggests two alternatives, developing strong manufacturingcapabilities or developing innovation capabilities, but provides no clear answer tothe question of how to select one strategy or the other. This paper explores this issueby introducing two concepts: ‘‘barriers to appropriability’’ and ‘‘opportunities forimprovement.’’ We develop four propositions to specify the boundary conditions forlocal firms to choose their technology strategies and analyze two local firms’ tech-nology strategies to illustrate two of the propositions. We find that development ofstrong manufacturing capabilities will not necessarily be an effective strategy forlocal firms competing against MNEs. If there are opportunities for improvement, itmight be possible for local firms to compete against MNEs by developing innovationcapabilities and core technologies.

Keywords Catch up Æ Globalization Æ Innovation capability Æ Manufacturingcapability Æ Technology strategy

JEL Classification M10

X. Gao (&)School of Economics and Management, Tsinghua University,Beijing 100084, Chinae-mail: gaoxudong@em.tsinghua.edu.cn

P. ZhangHisense Group, 17 Donghai Xilu, Qingdao 266071, Chinae-mail: zhangping@hisense.com

X. LiuNational Research Center for Science, Technology, and Development,Ministry of Science and Technology, Beijing 100038, Chinae-mail: liuxl@nrcstd.org.cn

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J Technol Transfer (2007) 32:87–107DOI 10.1007/s10961-006-9002-2

Competing with MNEs: developing manufacturingcapabilities or innovation capabilities

Xudong Gao Æ Ping Zhang Æ Xielin Liu

Published online: 5 October 2006� Springer Science+Business Media, LLC 2006

1 Introduction

China’s joining the WTO has led to a new round of debate, in the past few years,over what types of technology strategies are effective for local firms (Lu & Mu, 2003;Zhang, 2001a; Zhao, 2003). Many people argue that the best choice is to developmanufacturing capabilities by buying technology from multinational enterprises(MNEs) and making China a manufacturing center for the world market. Othersargue that, to compete with MNEs, it is critical to nurture innovation capabilities anddevelop core technologies, and that, in this era of globalization, local firms will notbe able to develop competitive advantages by buying technology and developingmanufacturing capabilities—it is critical to nurture innovation capabilities anddevelop core technologies in order to compete with MNEs.

The existing literature on technological catch-up offers important insights but noconclusive answers to this debate. For example, many studies find that it is possiblefor local firms to compete against MNEs by developing strong manufacturingcapabilities (Amsden, 2001; Amsden & Chu, 2003; Kim, 1997, 1998; Westphal, Kim,& Dahlman, 1985). South Korea’s catching-up process is a typical example sup-porting this argument (Kim, 1997). The development of the consumer electronicsand home appliance industry in China also indicates that development of strongmanufacturing capabilities is a viable choice when competition from MNEs is notstrong (Xie, 2001; Zhang, 2001b).

There are also studies in the existing literature on technological catch-up sug-gesting that, when there are windows of opportunity, it is possible for local firms tocompete with MNEs by developing innovation capabilities and core technologies(Perez & Soete, 1988). Lee and Lim (2001) show that some firms in South Koreaactually have followed multiple technology strategies to catch up: path following,path skipping, and path creating. Some firms in China are also able to competeagainst MNEs by developing indigenous innovation capabilities. Founder, GreatDragon, Huawei, ZTE, and Datang are some examples (Shen, 1999; Wang, 1999;Zhang, 2000).

In effect, the existing literature on technological catch-up examines local firms’technology strategies from a resource-based perspective (Barney, 1986; Dierickx &Cool, 1989; Penrose, 1959; Kogut & Zander, 1995; Leonard-Barton, 1995; Makadok,2001; Peteraf, 1993; Pisano, 1994; Prahalad & Hamel, 1990; Teece, Pisano, & Shuen,1997; Wernerfelt, 1984), and studies local firms’ technology strategies by comparingthe technological resources of local firms with those of MNEs. The basic argument isthat local firms should choose to compete against MNEs by developing strongmanufacturing capabilities, because local firms do not have core technologies whileMNEs do. Only when there are windows of opportunity should local firms try tocompete against MNEs by developing innovation capabilities and core technologies.

From a resource-based perspective, the existing literature on technological catch-up leaves several important questions unanswered:

• The bulk of the existing literature has been conducted under the assumption that:MNEs have knowledge-based assets, unique resources, and core technologies,while local firms do not. Local firms are therefore advised to focus on developingstrong manufacturing capabilities. However, we know little about the difficultiesMNEs face when trying to compete in a host country’s market. This is animportant issue, given the accumulating evidence that MNEs are unable to make

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full use of their superior technological resources in host countries (Buckley &Casson, 1976; Gao, 2003; Hymer, 1976; Wang, 1999; Xu, 2002; Zaheer &Mosakowski, 1997).

• The existing literature generally has not examined systematically the potentialfor local firms to develop innovation capabilities and core technologies, althoughsome authors have pointed out that local firms might be able to catch up inemerging technologies (Hobday, 1990; Lee & Lim, 2001; Perez & Soete, 1988).Given the accumulating evidence that local firms can compete with MNEs byreinventing (not buying) mature technologies or by developing new technologies,it is important to explore in a more systematic way the opportunities for localfirms to improve their technological resources and the effect of these opportu-nities on the choice of technology strategies (Cusumano, 1985; Gao, 2003; Shen,1999).

• A large portion of the existing literature has been conducted mainly in countriessuch as South Korea and Japan where, because of protection of the local markets,competition from MNEs was limited, especially in the early stages of local firms’development. We still have only a limited understanding of the impact of directcompetition between local firms and MNEs on local firms’ choice of technologystrategies.

Developing a better understanding of the real gap in core technologies betweenMNEs and local firms is critically important to an examination of what the effectivetechnology strategies are for local firms. In this paper, we explore this issue byintroducing two concepts: ‘‘barriers to appropriability’’ and ‘‘opportunities forimprovement.’’

We define ‘‘barriers to appropriability’’ in terms of the difficulties MNEs have inusing their superior technological resources in a host country’s market. Barriers toappropriability arise when there are factors that constrain MNEs’ ability to fullyutilize their superior technological resources to compete with local firms. We define‘‘opportunities for improvement’’ as opportunities for local firms to improve theirtechnological resources. Opportunities for improvement arise when there are factorshelping local firms to develop innovation capabilities and core technologies.

Our analysis is organized as follows:

• We first introduce the concepts of barriers to appropriability and opportunitiesfor improvement.

• We then develop propositions that local firms can use to choose their technologystrategies to compete with MNEs. We also use two cases to illustrate two of thepropositions.

• We conclude with a discussion of opportunities for additional research.

2 Barriers to appropriability and opportunities for improvement

2.1 Barriers to appropriability

The existing literature has long recognized that there exist ‘‘liabilities of foreign-ness,’’ and that MNEs’ superior technological resources will not necessarily lead tocompetitive advantage when they globalize their businesses (Buckley & Casson, 1976;

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Hymer, 1976; Lou, 2000; Zaheer & Mosakowski, 1997). In this paper we introducethe concept of barriers to appropriability to further examine the difficulties MNEshave in using their superior technological resources to compete with local firms. Weidentify five kinds of barriers to appropriability: regulatory, information, resource,coordination, and commitment.

Although there is overlap between the concepts of barriers to appropriability andliabilities of foreignness, the differences are crucial. The concept of liabilities offoreignness mainly covers two kinds of barriers to appropriability: regulatory andinformation. The other three kinds of appropriability barriers (resource, coordina-tion, and commitment barriers) are not really covered by the concept of liabilities offoreignness. These three types of barriers to appropriability mainly arise from fac-tors such as competition between MNEs themselves, the huge size of MNEs, andMNEs’ low commitment to the specific host country market. These factors are notnecessarily specific to operating in a foreign market. They could also influenceMNEs’ utilization of technological resources in regional markets of their homecountries. We find it necessary to introduce the broader concept of barriers toappropriability in order to provide a better understanding of the difficulties facingMNEs when they compete with local firms in a foreign market.

Let us examine in detail the five kinds of barriers to appropriability. Regulatorybarriers (host or home country government regulations) are the most obvious bar-riers preventing MNEs from using their superior technological resources in hostcountry markets (Dunning, 1992; Hymer, 1976). The development of the Japaneseautomobile industry shows that regulatory barriers prevented US and Europeanautomobile companies from using their superior technological resources in theJapanese market. Leading US and European automobile firms had more advancedtechnologies than Japanese automobile firms, both before World War II and at itsend. Yet superior technological resources did not create competitive advantages forthe US and European automobile firms. Before World War II, Japanese governmentregulations did not allow foreigners to be the major shareholders in Japaneseautomobile firms. Mainly because of this policy, Ford and GM, the two dominantleaders of the Japanese automobile industry before World War II, had to leaveJapan. After World War II, the Japanese government basically prohibited the importof small cars until the early 1970s, when local firms had developed internationalcompetitiveness (Cusumano, 1985).

Information barriers arise from MNEs’ relative unfamiliarity with the uniquecharacteristics of a host country’s business environment. These characteristicsinclude customers’ tastes, business customs, supporting industries, the culture, andthe legal system (Buckley & Casson, 1976; Dunning, 1992; Hymer, 1976; Zaheer &Mosakowski, 1997). Because of their unfamiliarity with customers’ tastes, it’s hardfor MNEs to customize their products to meet local market demand. Similarly,MNEs will find it difficult to work with wholesalers and retailers if they are notfamiliar with the business customs of the host country. Lack of familiarity withmaterial or parts suppliers will also make it difficult for MNEs to choose the mostappropriate products and processes.

Resource barriers arise from resource constraints, especially financial resourceconstraints, that face MNEs when they try to employ their superior technologicalresources in a host country. Although a commonly accepted view in China is thatMNEs have the advantage in financial resources, in many cases this is not true. Infact, many MNEs face strong competition, mainly from other MNEs (Lester, 1998;

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Mowery & Nelson, 1999; Womack, 1991). The result is that many MNEs often havelow profit margins and have to operate on tight budgets. On the other hand, localfirms actually might enjoy higher profit margins. For example, according to the StateCommission of Economy and Trade, the 512 key local enterprises in China hadmuch higher average profit margins in 2001 than the Fortune 500. The profit/salesration for the former is 6% compared to 2.8% for the latter. Accordingly, it might benot easy for MNEs to find the financial resources to invest in a host country, eventhrough they have superior technological resources.

Coordination barriers arise from the complexity of coordinating activities withinMNEs (Bartlett & Ghoshal, 1989; Carroll, 1993; Chandler, 1962; Dunning, 1992;Doz, 1986; Freeland, 1996; Studer-Noguez, 2002). For example, Chandler (1962) hasshown that a firm needs to create new organizational structures in order to effec-tively manage its geographic expansion and diversification. Freeland (1996) furthershows that it is not easy to make a multi-divisional structure effective. He points outthat GM intentionally violated the axioms of efficient organization to create man-agerial consent. Doz (1986) also shows that coordinating business units around theworld is a complex and costly process for an MNE. Because of the great complexityof coordination, it is not easy for MNEs to transfer superior technological resourcesfrom one country to another.

Commitment barriers come from MNEs’ low commitment to a host countrymarket. For many MNEs, the home country market is of strategic importance(Bartlett & Ghoshal, 1989; Studer-Noguez, 2002). Home country markets might bethe key sources of revenue and profits. Also, superior technological resources mightbe developed mainly in the home country. In contrast, because a host country mightbe of peripheral importance in contributing to revenue and profits, or creatingsuperior technological resources, MNEs might have little commitment to the hostcountry’s market. This is supported by empirical studies (Amsden, 2001; Amsden &Chu, 2003; Gao, 2003; Zhang, 2000). For example, Amsden (2001) finds that foreigndirect investment plays a trivial role in the early stages of many latecomer countries’industrialization and development. Amsden and Chu (2003) also find that, thoughleading firms in Taiwan have increased their market share in mature high-techindustries, these firms were nationally owned large-scale firms rather than MNEs.Gao (2003) finds that MNEs in China’s telecom equipment industry chose to focuson the high-end market, operate in well-developed big cities, and ignore the less-developed cities and regions. They also chose to focus on transferring superiortechnological resources developed in their home country, without sufficientlyadapting them to meet local market needs. Low commitment to the host country’smarkets makes it hard for MNEs to effectively employ their superior technologicalresources.

2.2 Opportunities for improvement

Although the existing literature on technological catch-up emphasizes the huge gapsin technological capabilities between local firms and MNEs, and the difficulties oflocal firms developing technological capabilities, there is evidence showing that localfirms can compete with MNEs by developing new technologies, reinventing maturetechnologies, or transferring technologies. We introduce the concept of opportuni-ties for improvement to further explore the potential for local firms to improve theirtechnological resources.

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First let’s look at four kinds of opportunities for improvement in the developmentof emerging technologies: learning, cultural, incentive, and organizational opportu-nities.

Learning opportunities arise because entry barriers are low when a new tech-nology is emerging. A key feature of emerging technology is that the entry barriersare not high—this offers opportunities for many firms to try many different ways ofdeveloping the technology (Perez & Soete, 1988; Tushman & Rosenkopf, 1992;Utterback, 1994). For this reason, when technologies are just emerging, local firmsmight be able to develop equivalent or even better technologies than those devel-oped by MNEs (Gao, 2003; Hobday, 1990; Lee & Lim, 2001; Perez & Soete, 1988;Wang, 1999).

Cultural opportunities are the corporate culture advantages that local firms mighthave over MNEs in perceiving and developing emerging technologies. Some studieshave shown that a leading organization tends to develop the NIH (not inventedhere) syndrome, believing that it has a monopoly on knowledge in its field and failsto consider seriously the possibility that other organizations might produce impor-tant new ideas (Cohen & Levinthal, 1990; Hamel, Doz, & Prahalad, 1989; Katz &Allen, 1982). A typical example is GE. In the late 1970s, GE’s Major ApplianceBusiness Group (MABG) did not believe that Matsushita and other Japanese firmscould develop better refrigerator compressors, even when GE’s Canadian subsidiarywas about to buy Matsushita’s products (Magazine & Patinkin, 1989). Given thatlocal firms are followers and are thus less established, they should be less subject toan NIH syndrome. Accordingly, local firms might be able to take advantage ofMNEs’ less favorable culture to perceive and develop emerging new technologies.

Incentive opportunities come from the greater incentives that local firms mighthave, compared to MNEs, to develop and use emerging technologies. Many studieshave shown that incumbent firms are reluctant to develop and use emerging tech-nologies because these technologies might cannibalize their existing businesses(Foster, 1986; Henderson, 1993). Local firms, as followers, should be less worriedabout the cannibalization effects and should have greater incentives to develop andadopt new technologies. Local firms can take advantage of MNEs’ lack of interest indeveloping and adopting emerging technologies.

Organizational opportunities arise from the greater structural flexibility of localfirms. Many studies have shown that incumbent firms’ existing organizationalstructures and procedures have developed to support existing strategies and oper-ations. It is therefore difficult for incumbent firms to change these structures andprocedures and allocate necessary resources to support the development and utili-zation of emerging technologies, especially when the emerging technologies arecompetence-destroying (Christenson & Rosenbloom, 1995; Clark, 1985; Henderson& Clark, 1990; Tushman & Rosenkopf, 1992), when the technologies are not wellaligned with current corporate strategies (Burgelman, 2002), or when the technol-ogies fall out of the existing value network (Christensen & Bower, 1996). Given thatlocal firms are followers, they should be less locked into existing organizationalroutines and existing value networks, and should be in a more advantageous positionto develop and use emerging technologies.

Now we turn to a discussion of opportunities for improvement in mature tech-nologies. Here we identify two kinds of opportunities for improvement in maturetechnologies: reinvention and adaptation opportunities.

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Reinvention opportunities are the possibilities for local firms to reinvent matureproduct and process technologies. For leading firms such as MNEs, further invest-ment in mature product and process technologies usually leads to diminishingreturns (Perez & Soete, 1988). For local firms, however, reinventing mature tech-nology is of critical importance when MNEs are unwilling to sell mature technology,or when the cost of buying mature technology is too high. In these circumstances, itis desirable for local firms to invest in reinventing mature technologies.

Conditions that are conducive to the reinvention of mature technologies are:

• Much information about mature technologies is widely available. For example, itis possible to collect pertinent information by reading academic publications andindustrial publications, examining patent data, and studying products thatembody these technologies.

• Application of new tools, such as computer integrated manufacturing systems(CIMS), makes the process of reinventing mature technologies less timeconsuming and costly.

Empirical studies also show that reinvention of mature technologies can be a veryeffective way for local firms to improve their technological capabilities and tech-nological resources. One example is Toyota. After World War II, when manyJapanese automobile firms chose to tie up with foreign companies, Toyota chose tobuild its car business by studying foreign cars and pursuing independent productdevelopment. Toyota’s strategy turned out to be very effective and it soon becamethe leading automobile firm in Japan (Cusumano, 1985). Another example is theleading domestic telecom equipment firms in China. These firms have been verysuccessful in reinventing products, such as digital switches and backbone routers, bycollaborating with domestic research institutes and universities (Gao, 2003; Shen,1999). A third example is the development and application of computer integratedmanufacturing systems (CIMS) in China. This has helped many local firms toimprove their product design, development, and manufacturing capabilities. BeijingNo. 1 Machine Tool Plant actually won the CASA/SME 1995 Industry LeadershipAward because of its impressive achievements in developing and applying CIMStechnology to improve its technological capabilities (Wu, 2001).

Adaptation opportunities are the possibilities for local firms to improve theirtechnological capabilities by adapting mature technologies to the local environment.The literature on technological change and technology transfer has shown that bothproduct technology and process technology are developed to solve particularproblems in particular technical, business, social, and political contexts (Iansiti, 1998;Tushman & Rosenkopf, 1992; Utterback, 1994). Technology also has implicit andtacit aspects, rather than being fully specified (Pavitt, 1985). Technology must beadapted and modified to fit new contexts or environments.

The need for adaptation creates opportunities for local firms to improve theirtechnological capabilities. There are two possible situations. When there are barriersto MNEs adapting technology, local firms have an opportunity to develop bettertechnologies and gain competitive advantage. Even when there are no barriers forMNEs, the process of adaptation takes time and this could give local firms more timeto improve their technological capabilities.

Empirical studies show that adaptation opportunities can help local firms improvetheir technological capabilities. For example, Amsden and Hikino (1993) found that

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adapting existing technologies to the local environment is an important way thatlocal steel firms have improved their technological capabilities in Japan, SouthKorea, India, Brazil, and other late-industrializing countries. Toyota’s developmentof the lean production system is another example (Cusumano, 1985). Toyota startedto make cars by adopting the Ford production system. However, the original Fordsystem was designed for mass production of limited product lines and had funda-mental flaws. First, only the final assembly line achieved anything resembling acontinuous flow. Second, it was unable to accommodate consumer preferences forproduct diversity. Recognizing these flaws, Toyota began to adapt the Ford productsystem in 1948. By the mid-1950s, four of the most important techniques of Toyota’sfamous lean production system were in place.

In addition to internal development of emerging technologies and mature tech-nologies, the third opportunity for local firms to improve their technological capa-bilities is to transfer technology. One important means of technology transfer is tobuy production machinery from suppliers. According to Pavitt (1985), sources andpatterns of technological progress vary among sectors. In supplier-dominated sectorsand scale-intensive or production-intensive sectors, machinery suppliers play crucialroles in technological progress and it is possible for local firms to improve theirtechnological capabilities by buying production machinery from suppliers. ManyJapanese firms in the petrochemical and steel industries have been very successful inbuying production machinery from suppliers to close the technological gaps betweenthemselves and leading US and European firms, or even to leapfrog these leadingcompanies (Dertouzos, Lester, Solow, & the MIT Commission on IndustrialPerformance, 1989; Hikino, Harada, Tokuhisa, & Yoshida, 1998).

Technology transfer can also play an important role in helping local firms todevelop emerging technologies, reinvent mature technologies, or adapt technologyto the local environment. Emerging technology examples are Samsung, whichbecame as a major player in CDMA by transferring technology from Qualcomm(Chung & Lee, 1999), and Sony, which developed its famous Trinitron by trans-ferring technology from the US (Lyons, 1976). In mature technologies, technologytransfer played a significant role in helping many local firms in Japan, South Korea,and China to improve their technological capabilities (Amsden & Hikino, 1993;Cusumano, 1985; Gao, 2003; Lee & Lim, 2001; Liu, 2001; Zhang, 2001a).

3 Choosing technology strategies to compete with MNEs

From the resource-based perspective, a firm’s competitive advantage comes from itssuperior resources. A firm is therefore advised to choose its strategy based on itsresources (Barney, 1986; Dierickx & Cool, 1989; Penrose, 1959; Peteraf, 1993;Prahalad and Hamel, 1990; Teece et al., 1997; Wernerfelt, 1984).

We believe that, although a firm should consider not only its technologicalresources, it makes sense to analyze local firms’ technology strategies by focusing oncomparing the local firms’ technological resources with those of MNEs, whenchoosing its technology strategy. This is based on two observations:

• Existing literature on catch-up has shown that one key difference between localfirms and MNEs is that local firms do not have core technologies while MNEs do(Amsden, 2001; Amsden & Chu, 2003; Hymer, 1976; Kim, 1997, 1998; Westphalet al., 1985).

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• Some anecdotal evidence shows that it is very hard for local firms in China todevelop core technologies—but some firms are extremely successful in developingother competencies, such as marketing capabilities (Gao, 2003; Sun, 2001; Xu, 2002).

Based on the analysis of barriers to appropriability and opportunities forimprovement in the previous section, we now turn to the development of specificpropositions concerning local firms’ choice of effective technology strategies.

First let’s look at the situation when there are high barriers to appropriability.Under these conditions, it will be difficult for MNEs to use their superior techno-logical resources to gain a competitive advantage over local firms. For example, highbarriers to appropriability will make it hard for MNEs to set up manufacturingfacilities in the host country. As a result, MNEs will not be able to enjoy the benefitsof low labor costs, familiarization with the local business and social environment,and adaptation of their technology and products to the local market. Even if MNEswere able to export their products to the host country, they would have to pay hightariffs and their products are not customized to meet the local market demands.

In these circumstances, local firms can compete against MNEs by developingstrong manufacturing capabilities, even when it is hard for local firms to developtheir own core technologies because there are few opportunities for improvement.This is because local firms will enjoy all benefits of low labor costs, familiarity withthe business and social environment, and adaptation of technology and products tothe local market. They also do not have to pay extra taxes (tariffs). Accordingly, thedevelopment of strong manufacturing capabilities will make it possible for localfirms to offer low-cost, mature products with adequate quality to compete againstMNEs. This might help to explain how many Japanese and Korean firms have beenable to compete with MNEs by developing strong manufacturing capabilities inprotected domestic markets (Amsden, 2001; Dertouzos et al., 1989).

When there are many opportunities for improvement, local firms can still com-pete against MNEs by developing strong manufacturing capabilities and, in addition,compete against MNEs by developing innovation capabilities and core technologies.The existence of opportunities for improvement might help local firms narrow thegap in core technology between themselves and MNEs. In these circumstances, localfirms can offer not only low-cost, mature products but also advanced and newproducts. This might help explain how Founder and some telecom equipment firmsin China have been able to compete against MNEs by developing core technologiesand offering advanced products (Gao, 2003; Shen, 1999; Wang, 1999; Zhang, 2000).

The discussion above leads to the following two propositions:

Proposition 1: When there are high barriers to appropriability and many opportu-nities for improvement, the strategy of developing strong manufacturing capabilitiesis not the only choice. The strategy of developing innovation capabilities also wouldbe an effective way for local firms to compete with MNEs.

Proposition 2: When there are high barriers to appropriability and few opportunitiesfor improvement, the strategy of developing strong manufacturing capabilities is themost effective way for local firms to compete against MNEs. The strategy ofdeveloping innovation capabilities is unlikely to succeed.

Next, let’s look at the situation of low barriers to appropriability. In this situation,it will be easy for MNEs to use their superior technological resources in the host

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country to compete with local firms. For example, low barriers to appropriability willmake it easy for MNEs to set up manufacturing facilities. As a result, MNEs will beable to enjoy the benefits of low labor costs, familiarization with the local businessand social environment, and adaptation of their technology and products to the localmarket.

When barriers to appropriability are low, it will be hard for local firms to competeagainst MNEs by developing strong manufacturing capabilities, because local firmswill have no advantages in producing low-cost, mature products. Local firms mightbe able to survive in some niche markets that MNEs find unattractive.

When barriers to appropriability are low, local firms might be able to competeagainst MNEs by developing innovation capabilities and core technologies if thereare opportunities for improvement. This is because the existence of opportunities forimprovement might help local firms narrow the gap in core technology betweenthemselves and MNEs.

The foregoing discussion leads to the following two additional propositions:

Proposition 3: When there are low barriers to appropriability and many opportu-nities for improvement, the effective strategy for local firms competing with MNEs isto develop innovation capabilities. The strategy of developing manufacturingcapabilities will not be effective.

Proposition 4: When there are low barriers to appropriability and few opportunitiesfor improvement, neither developing manufacturing capabilities nor developinginnovation capabilities will be effective strategies for local firms to compete againstMNEs in the mainstream market. It might be possible for local firms to survive insome niche markets.

The four propositions introduced above are summarized in Table 1.

4 Case illustration of the framework

4.1 Research methodology

Although we have developed four propositions, in this paper we choose to illustrateonly Propositions 1 and 3, covering the choice of effective technology strategy whenthere are many opportunities for improvements. Our emphasis is on the importanceof developing innovation capabilities and core technologies, which has not been wellstudied in the existing literature.

To illustrate Propositions 1 and 3, we follow a ‘‘pattern-matching’’ case studymethod suggested by Yin (1989). In this research method, the proposition to beillustrated is the benchmark against which data and patterns are examined. If thedata support the prediction, the proposition is confirmed. Otherwise, the propositionshould be rejected.

Table 1 Barriers to appropriability, opportunities for improvement, and technology strategies

Many opportunities Few opportunities

High barriers P1: Innovation or manufacturing P2: Manufacturing, not innovationLow barriers P3: Innovation, not manufacturing P4: Niche market strategy

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For example, if the data show that a local firm can effectively compete againstMNEs by developing innovation capabilities and core technologies, in an environmentof high barriers to appropriability and many opportunities for improvement, thenProposition 1 is confirmed. On the contrary, if the data show that a local firm cannotdo so in that environment, Proposition 1 should be rejected.

Similarly, if the data show that a local firm can compete effectively against MNEsby developing innovation capabilities and core technologies in an environment oflow barriers to appropriability and many opportunities for improvement, Proposi-tion 3 is confirmed, but if the data show that a local firm can effectively competeagainst MNEs by developing strong manufacturing capabilities in that environment,Proposition 3 should be rejected.

To illustrate Proposition 1, we needed to select a firm that has relied mainly ondeveloping innovation capabilities in an environment of high barriers to appropri-ability and many opportunities for improvement; to illustrate Proposition 3, we neededa firm that has relied mainly on developing manufacturing capabilities in an envi-ronment of low barriers to appropriability and many opportunities for improvement.

We selected two companies, Dawning (http://www.dawning.com.cn/) and Hisense(http://www.hisense.com.cn/), to illustrate the two propositions. Dawning is a highperformance computer (HPC) producer. Hisense is a home appliance and consumerelectronics firm, with TV sets as its main business. Dawning has relied on developingstrong innovation capabilities to compete with MNEs. Hisense has relied mainly ondeveloping strong manufacturing capabilities to compete with MNEs. In the HPCindustry, the barriers to appropriability are high, and there are many opportunitiesfor improvement. In the TV set industry, the barriers to appropriability were rela-tively high before the 1990s but declined quickly over time, and there are manyopportunities for improvement.

Data was collected mainly through interviews, although archival data was used aswell. Interviews focused on the two firms’ technology strategies and their effec-tiveness, and on the barriers to appropriability and opportunities for improvement inthe two industries. Interviewees include top management (CEO, senior VP), boardmembers (Chair and Vice Chair of the Board of Directors), middle level managers(mainly R&D managers), R&D researchers, and manufacturing engineers. Inter-views ran from about an hour to as long as 4 h, but typically lasted 90–120 min. Wetook extensive notes during interviews because most of the interviewees preferrednot to be taped. We stopped when we believed that we had collected sufficientdata—it turned out that we had 21 interviews with 11 people.

In the following, we describe the two companies’ technology strategies, discussthe effectiveness of these strategies, and relate the effectiveness of the two strategiesto our propositions.

4.2 Dawning’s technology strategy and its effectiveness

Dawning is the leading local firm in the HPC industry in China in both market shareand technological innovation. Dawning originated with the setting up of the NationalIntelligent Computer Research Center by the Institute of Computing Technology atthe Chinese Academy of Sciences in 1990. The Research Center was set up todevelop key technologies in the area of high performance computing, one of the keytechnology areas supported by the ‘‘863’’ Program, the high tech program that Chinastarted in the late 1980s.

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Since economic reform, many firms in China have been able to buy technologyfrom MNEs, but Dawning has not had the opportunity to buy core technologies toenter the HPC industry. Accordingly, Dawning’s technology strategy has been ‘‘todevelop core technology internally.’’ More specifically, Dawning’s technologystrategy has four elements:

• Avoid technologies that are too radically new.• Avoid technologies in which incumbents have dominant advantages.• Focus on technologies that are emerging.• Focus on software technologies.

The first element is to avoid developing technologies that are too radically new.For example, although intelligent computing was the hot topic when the NationalIntelligent Computer Research Center was set up in 1990, Dawning did not believethat intelligent computers would be developed in the near future and decided not tofocus on this technology. Instead, Dawning chose to develop HPCs based on parallelcomputing.

The second element is to avoid developing technologies in which MNEs, such asIBM, HP, and Sun, have dominant advantages. For example, from the very earlydays of its development, Dawning decided not to compete in areas such as CPU andstorage because it believed that MNEs have dominant advantages in these tech-nologies.

The third element is to focus on emerging technologies. For example, the keytechnology for their first product, Dawning 1, was parallel computing technology. Inthe early 1990s, when Dawning 1 was under development, parallel computingtechnology was not mature and there was no commonly accepted industry standard.Similarly, in the mid 1990s, when cluster technology began to emerge, Dawningseized the opportunity and successfully developed its own core technologies such asthe cluster operating system (system software that connects many CPUs and makesthem work together at high speed).

The fourth element is to focus on software technology. Dawning believes that ithas advantages in software technology—one reason for the fast successful devel-opment of Dawning 1 was that the key technology for this product is software. Infact, most of Dawning’s key technological innovations are software intensive: theUNIX operating system, the cluster OS, and other system software.

To implement its strategy of developing core technologies internally, one ofthe key measures Dawning has taken is to attract highly talented people. Forexample, Mr. Li Guojie, former Chairman of Dawning, is a member of theChinese Academy of Engineering. Mr. Xu Zhiwei, the key designer of Dawning2000, was a professor at University of Southern California before joiningDawning. Though every effort has been made to improve their salaries, Dawningbelieves that money is not the only thing that attracts and motivates the firm’shighly talented people. A more important and more effective approach is tocreate an environment where employees feel that they are doing somethingchallenging, big, and important. One way to create such an environment is toarticulate the firm’s mission clearly. Dawning’s mission is to develop China’s ownHPC industry. Dawning’s people are primarily motivated by this mission, ratherthan by money. In fact, many of them could have much higher salaries at otherhigh tech firms.

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Dawning has developed strong innovation capabilities and a series of core tech-nologies. For example, Dawning 1,000 embodied several technological break-throughs. The wormhole routing chip creatively exploited a combination ofasynchronous and synchronous modes, and was one of the most advanced routingchips in the world when it was developed in 1995. Similarly, the parallel optimizingcompiler was assessed as one of the most advanced systems in the world by expertsfrom MIT and McGill University. Dawning also developed its own cluster operatingsystem in Dawning 2000 and Dawning 3000. Today, Dawning is ahead of foreignfirms in cluster OS and some SUMA (scalability, usability, manageability, andavailability) technologies. An Asian Technology Information Program Report,based mainly on Dawning’s technological achievements, also points out that ‘‘whenfocusing on Chinese R&D, small through moderate-sized systems (but not thelargest), and on system software, tools, and some related applications of HPC, theChinese are coming up from behind but are very near equality with the West’’(ATIP 00.025).

The development of innovation capabilities has made it possible for Dawning tosucceed in an industry with high entry barriers. The HPC industry was dominated byMNEs. As a latecomer, Dawning faced a lot of barriers in entering this industry. Inthe early stages, people did not believe that Dawning would be able to make highquality products and refused to give opportunities to Dawning. For example, manybig companies and government agencies have procurement lists specifying whichcompanies’ HPCs they are willing to buy. For a long time, Dawning was not on theselists and was not able to sell their products to these organizations. In some cases,organizations set unreasonable conditions. For example, one trading firm said itwould buy Dawning’s superserver only if Dawning agreed to pay any losses incurredwhen the server had problems, although they never required this of MNEs.

Dawning has succeeded in overcoming high entry barriers by providing high-quality products using the core technologies it has developed. For example, becauseDawning was not on the Ministry of Railway’s procurement list, it donated itsmachines to a university attached to the Ministry, for use in conducting research. Byusing the machine, the university and the Ministry recognized Dawning’s capabilityin making high quality HPCs. A particular opportunity for Dawning to show itscapability came when an MNE’s HPC was down at a railway station. Because theMNE could not offer timely service, Dawning suggested that the railway station useDawning’s product while the MNE’s HPC was being fixed. It turned out thatDawning’s product was better than the MNE’s and the railway station decided tobuy the Dawning machine.

4.3 Explaining the effectiveness of Dawning’s technology strategy

The effectiveness of Dawning’s technology strategy supports Proposition 1. That is,when there are high barriers to appropriability and many opportunities forimprovement, the strategy of developing innovation capabilities can be effective forlocal firms competing against MNEs. The strategy of developing strong manufac-turing capabilities, suggested by the existing literature, is not the only choice.

The first condition is that there are high barriers to appropriability in the HPCindustry. The major barrier is regulatory. Specifically, the US government does notallow industry leaders, such as IBM, Sun, and HP, to sell their advanced HPCs in

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China. On the one hand, this regulatory barrier makes it impossible for China to buythe very high-end HPCs that are of critical importance in areas like weather fore-casting, oil exploration, gene engineering, and military use. On the other hand, thisregulatory barrier also makes it hard for MNEs to use their superior technology togain competitive advantage in the Chinese HPC market. This helped to create ademand for Dawning’s products, especially at the high end of the market.

Another barrier is commitment. HPC industry MNEs do not see strategicimportance in the Chinese market—one result is that the services provided by theMNEs are limited. The commitment barrier has prevented MNEs from takingadvantage of their superior technology in the Chinese HPC market. As mentioned,an MNE’s failure to provide timely service for its HPC gave Dawning the oppor-tunity to demonstrate superior quality and persuade the railway station to buyDawning’s products.

The second condition is that there are many opportunities for improvement in theHPC industry. For instance, when the National Intelligent Computer Center beganto develop Dawning 1, the key technology, parallel computing, was not mature.Similarly, in the mid-1990s, cluster technology, the key technology for Dawning2000, Dawning 3000, and other more advanced products, was just emerging. Theseopportunities for improvement provided the opening for Dawning to developinnovation capabilities and narrow the gap in core technologies between itself andMNEs.

Dawning’s technology strategy effectively seized the opportunities for improve-ment to develop its own innovation capabilities and core technologies. As discussed,when it was founded in 1990, the National Intelligent Computer Center chose tofocus on the development of parallel computing technology. Because parallelcomputing technology was not mature, Dawning had the opportunity to develop itsown core technology. Because parallel computing technology was not too radicallynew, as was intelligent computing technology, Dawning was able to develop it in ashorter time. The result was the successful development of Dawning 1. This producthelped Dawning build its reputation as the leading Chinese company in the HPCindustry and was the basis for Dawning’s moving up to more sophisticated productsand markets.

Another example is Dawning’s decision to focus its R&D on cluster technology inthe mid-1990s. Because cluster technology was just emerging at that time, Dawningwas able to develop its own cluster operating system (OS) in Dawning 2000 andDawning 3000. Dawning was also very successful in developing new technologies toimprove product quality in scalability, usability, manageability, and availability(SUMA). Today, in fact, SUMA is considered the industry standard.

The development of innovation capabilities and core technologies not only makesit possible for Dawning to compete head-to-head with MNEs, but also createsstrategic opportunities for Dawning. To some extent, the rules of the game havechanged since Dawning’s technological breakthrough in Dawning 3000. The HPCsthat the US government allows to be exported to China are one level belowDawning’s most advanced products. Consequently, Dawning is competing with itselfrather than with the more powerful MNEs. This creates an opportunity for Dawningto earn a high profit margin and further fuel its technological innovation. If Dawningcan seize this golden opportunity, it will be possible for it to further narrow thetechnological gap between itself and MNEs.

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4.4 Hisense’s technology strategy and its effectiveness

Hisense is one of the leading local firms in the consumer electronics and homeappliance industry, with TV sets as its main business. It was founded in 1969 andentered the color TV industry in 1984. The short-term goal of the company is torealize sales revenue of 50 billion Yuan by 2005 and become one of China’s topthree electronics firms. The long-term goal of the firm is to become a world-famouscompany and make Hisense a globally known brand name.

Hisense’s technology strategy is to buy technology and develop strong manu-facturing capabilities. More specifically, its strategy has three characteristics:

• Buy advanced technologies from MNEs.• Develop strong technological absorptive capabilities.• Develop an effective quality management system.

The first characteristic of the company’s strategy is buying advanced technologiesfrom multinationals. Although buying technology from foreign firms is a commonpractice for local firms, Hisense has a policy of buying only advanced technologies,believing that this is more effective in competing with local firms and in catching upwith MNEs. For example, Hisense started color TV production in 1984 throughSKD/CKD assembly, as did other local firms, but took a different approach. Facingthe choices of buying technology from a Hong Kong firm for $1.5 million or fromMatsushita for $3 million, Hisense chose to buy from Matsushita, which had moreadvanced technologies. Similarly, when Hisense decided to enter the large screenTV set segment in 1993, it decided to buy Toshiba technology because it was moreadvanced than that of other firms. When it entered the flat screen TV and projectionTV markets, Hisense made similar choices.

The second characteristic of the company’s technology strategy is developingstrong technological absorptive capabilities. Hisense believes that the consumerelectronics and home appliance industry is characterized by rapid changes in productfeatures, functions, and performance. Buying advanced technologies from MNEs isnot enough in itself. It is critical to develop a strong capability to absorb thesetechnologies and be able to continuously develop new products to meet marketchanges.

Hisense has adopted several policies to develop technological absorptive capa-bility:

• In 1992, Hisense set up the Hisense Technology Center, the company R&Ddepartment, to promote technological progress in the company by absorbingtechnologies bought from outside. At that time, few local firms in China had theirown R&D departments. The establishment of the Hisense Technology Centershowed the company’s determination to improve technological capability. Todaythe Hisense Technology Center is recognized as one of China’s most advancedenterprise technology centers in the consumer electronics and home applianceindustry. In 2002, the Hisense Technology Center was ranked sixth among the289 Enterprise Technology Centers certified by the State Commission of Econ-omy and Trade.

• Hisense proactively hires people with advanced degrees. In 1992, the companyonly had two employees with Master’s degrees and 400 with Bachelor’s degrees.In 1999, it had 42 employees with PhD degrees, more than 260 with Master’s

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degrees, and more than 2,800 with Bachelor’s degrees (31% of all employees).Hisense is the only local company with so many PhD employees in the consumerelectronics and home appliance industry.

• Hisense very actively motivates its R&D people to innovate. One policy has beento significantly improve R&D people’s bonuses. Before 1992, as in other localfirms, there was little difference between the bonuses of R&D people and ofother employees. In 1992, Hisense changed its policy and made bonuses of R&Dpeople at the Hisense Technology Center much higher than those of otheremployees.

The third characteristic of Hisense’s technology strategy is developing an effectivequality management system. Hisense believes that ‘‘high quality will not necessarilymake a firm prosper, but low quality will surely destroy the firm.’’ This belief has ledHisense to take action to build an effective quality management system so that itsproducts are of high quality.

In addition to applying high quality control standards in the manufacturing pro-cess, Hisense believes it is important ‘‘to design in high quality,’’ using advancedtechnology at the design stage. Hisense also does extensive small batch productionsto evaluate product quality at the Hisense Technology Center, before going to largebatch production in the manufacturing plants.

Furthermore, Hisense has policies to ‘‘force’’ itself to make high-quality products.Since 1996, price wars have become the key weapons of many competing consumerelectronics and home appliance firms. In many cases, Hisense refused to join a pricewar, believing that price wars are not good for quality improvement and the firm’slong-term development. Hisense also chooses not to spend a lot of money onadvertising, believing that word of mouth more effectively communicates the highquality of its products.

Hisense has developed strong manufacturing capabilities. First, Hisense hasdeveloped the ability to monitor and select technologies. In 1993, when Hisensedecided to enter the large screen TV set segment, it compared technologies fromdifferent MNEs and selected the most appropriate ones. Second, Hisense hasdeveloped a strong ability to absorb and adapt technologies to meet local marketdemand. For example, although Hisense was not the first local firm to buy flat screenTV technology, in 1997 it became the first to locally mass produce flat screen TV sets,when this new market was emerging in China. A key reason is that Hisense had spentthe necessary time and resources to absorb the technology the company had bought.By developing a strong technology absorption capability, Hisense also was able todecrease the negative impact of price competition by quickly introducing newproducts when, after 1996, price wars became the key weapon for many firms tocompete. Eighty-five percent of Hisense’s 1998 sales revenue was from new products.

The development of strong manufacturing capabilities has helped make Hisenseone of the leading local firms in the TV set industry. In 1999, Hisense was named a‘‘Well-Known Brand in China’’ by the State Administration for Industry andCommerce (SAIC). In 2001, Hisense’s TV sets, refrigerators, and PCs were named‘‘Well-Known Products in China’’ by the SAIC. In 2001, Hisense also became one ofthe five winners of China’s ‘‘National Quality Management Award’’ granted by theNational Association of Quality. Hisense is also the only firm in the consumerelectronics and home appliance industry to win the ‘‘National Quality Award’’ forfour successive years.

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Although Hisense has become one of the most competitive local firms and anindustry leader in China, it still has many difficulties competing with MNEs. Forexample, at the high end of the market, Hisense still has to rely on MNEs to supplykey technologies. At the low end, the situation has changed since Hisense and otherlocal firms were able to capture market share from MNEs before the mid-1990s.MNEs are quickly localizing production in China and are now able to initiate pricewars to compete with Hisense and other local firms, even at the lower end of themarket.

4.5 Explaining the ineffectiveness of Hisense’s technology strategy

The relative ineffectiveness of Hisense’s technology strategy supports Proposition 3.That is, when there are low barriers to appropriability and many opportunities forimprovement, the strategy of developing strong manufacturing capabilities will notbe effective.

The first reason for the ineffectiveness of the strategy of developing strongmanufacturing capabilities is declining barriers to appropriability. There were rela-tively high barriers to appropriability, mainly regulatory, before the mid-1990s. Untilthen, the local market was protected by high tariffs. Before the mid-1990s, therewere also high commitment barriers. MNEs were slow to localize their productionand, as a result, did not have strong manufacturing capabilities in China. Hisense andother local firms were very successful in capturing market share and making profitsby buying technology and developing strong manufacturing capabilities.

The problem is that barriers to appropriability declined quickly after themid-1990s. For example, tariffs dropped sharply when China was trying to join theWTO. More importantly, MNEs speeded up their production localization in China.Localization made it possible for MNEs not only to utilize their superior technologydirectly in China to produce high-end products, but also to make low-cost productsfor the low-end market by enjoying the benefits of low labor cost and familiarity withthe local market—advantages once enjoyed only by the local firms. In theseconditions, development of strong manufacturing capabilities is no longer sufficientfor Hisense and other local firms to compete against MNEs, even at the lower end ofthe market.

The second reason for the ineffectiveness of developing strong manufacturingcapabilities is that this strategy makes it difficult for Hisense to develop stronginnovation capabilities and core technologies by seizing opportunities for improve-ment.

There have been many opportunities for improvement in the TV set industrysince the mid-1980s. For example, digital technology has been applied in TV sets fora long time. Projection TV, PDP, and LCD also employ many emerging technolo-gies. The problem is that Hisense, like other leading local firms, has chosen to focuson developing strong manufacturing capabilities. Because of this strategic choice,Hisense did not start to develop core technologies until the late 1990s, when itbecame increasingly difficult for it to buy more advanced technologies from MNEs.The result is that Hisense has not been able to seize the opportunities forimprovement that lie in developing its own core technologies, and has to rely heavilyon MNEs for key technologies. This makes it hard for Hisense to compete againstMNEs on the high-end market.

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5 Conclusion

The existing literature provides no conclusive answer to the question of what theeffective technology strategies are for local firms to compete against MNEs. In thispaper we have explored this issue by introducing two concepts: barriers to appro-priability, and opportunities for improvement. We discussed specific kinds ofbarriers to appropriability and opportunities for improvement, and developed fourpropositions to specify the boundary conditions for local firms choosing their tech-nology strategies. We also analyzed the different technology strategies of two localfirms, Hisense and Dawning, to illustrate two of the propositions. We find that theapplication of the concepts of barriers to appropriability and opportunities forimprovement shows promise in the analysis of local firms’ technology strategieswhen competing with MNEs. The propositions help to specify the boundaryconditions for local firms choosing their technology strategies.

This paper provides new insight into the analysis of effective technology strategiesfor local firms in competition with MNEs:

• The strategy of developing strong manufacturing capabilities will not necessarilyenable local firms to compete effectively against MNEs. When barriers toappropriability are low, it is not difficult for MNEs to gain strong local manu-facturing capabilities. Only when barriers to appropriability are high will localfirms be able to compete against MNEs by developing strong manufacturingcapabilities, because the high barriers to appropriability in the host country makeit difficult for MNEs to set up manufacturing facilities to use their superiortechnological resources to gain a competitive advantage over local firms.

• The strategy of developing strong manufacturing capabilities is not necessarilythe only choice, let alone the best choice, for local firms to use to compete againstMNEs. When there are opportunities for improvement, it might be possible forlocal firms to compete against MNEs by developing innovation capabilities andcore technologies. This is of crucial importance for local firms in this era ofglobalization.

The scope of this paper is limited and further research is needed:

• This paper analyzed two firms’ technology strategies to illustrate two of the fourpropositions developed. By studying more cases, future research could illustrateand test the four propositions in a more systematic and sophisticated way.

• This paper focused mainly on the analysis of two kinds of environmental factors,barriers to appropriability and opportunities for improvement. Firms (local orMNE) might develop different technology strategies based on different strategicpostures toward the two environmental factors. Some firms might be insensitiveto these factors, while others might be not only aware of these factors but alsoproactively creating and using these factors (Chen, 1996; Grimm & Smith, 1997).Future research could analyze these interactive competitive behaviors betweenlocal firms and MNEs.

• Recognizing the crucial importance of technological resources for local firms, thispaper focused on the relationship between technological resources and tech-nology strategies. Future research could further examine the impact of otherkinds of resources on the selection of technology strategies.

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• This paper introduced two concepts, barriers to appropriability and opportunitiesfor improvement, to study local firms’ technology strategies. Future researchcould explore whether it is possible to extend these two concepts to the analysisof local firms’ corporate strategies.

Acknowledgments The authors want to thank the MIT Sloan School of Management and the MITIndustrial Performance Center for providing financial support for this study, and thank Dawning andHisense for providing the opportunity for us to do the case studies. We also want to thank GeorgeFarris, Richard Lester, Yadong Lou and all other reviewers for their insightful comments andsuggestions. Special thanks go to Mingfang Li for his excellent leadership and professionalcommitment in organizing this special issue.

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