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The Architectural Attributes of Components and The Transaction Patterns of Detail Design Drawings --- A Case Study on China’s Motorcycle Industry

Ge Dongsheng and Fujimoto Takahiro (Graduate School of Economics, University of Tokyo)

(Faculty of Economics Department, University of Tokyo)

Abstract In this case study, we spotlight the strategic choice of transaction patterns of component’s detail design drawings in China’s motorcycle industry. During the particular product development process that is featured as a reverse engineering-based one, diverse patterns were observed in the dyadic transactions between an individual assembler A and its supplier, even for the same components. To explore the explanation of this phenomenon makes us turn to the perspective of product architecture and examine the architectural attributes of the component under different transaction patterns. Results firstly show that the reverse engineering-based nature of product development opens the chance for suppliers to develop focal model’s components independently of assemblers’ requirements. Furthermore, to increase the likelihood of transacting with assemblers, suppliers coordinate with each other in the bottom-up way to make the easy-for-installation subassembly of components, which is defined here as “the localized modularization”. This supplier’s design strategy contrasts with the top-down reverse engineering of the focal model by assemblers with the aim of making the Purchased parts system adopted as the transaction pattern. We then extract multiple equilibria from our case study in which the supplier-led “localized modularization” design strategy and the Purchased parts system choice, the assembler-led top-down integral design and the Drawing-supplied system are matched respectively. As the supplier-led equilibrium dominates the assembler-led one in the lead-time shortening and cost reduction, assemblers such as company A began to make the transition to the former one, which results in the observed diverse transaction patterns even for the same component. We finally show a paradoxical outcome of the superior supplier-led equilibrium and attempt to analyze the future direction of China’s motorcycle industry. Key Words: Transaction Patterns; Detailed Design Drawings; Reverse Engineering-based Product Development; Architectural Attributes; Localized Modularization; Strategic Coordination; Motorcycle Industry; China

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1 Introduction

The strategic decision-making on the “Make-or-Buy” issue has gathered great academic concerns from both economics and management science fields. From the perspective of economics, the strategic meaning of the make-or-buy issue lies in the governance of opportunistic behaviors that are likely to increase the transaction costs under the incomplete contracts (Williamson, 1985, 1999; Grossman and Hart, 1986). While from the standpoint of management science, the main strategic concern is on how to take advantage of outsourcing and manage the efficient supply chains (Womack et al., 1990; Nishiguchi, 1994). We consider these two research branches are complementary in the sense that they put weight on the different stages of the added value realization process. Focusing on the incentive issues, the economics analysis mainly emphasizes the distribution of the added value with its creation assumed beforehand. Differently, the management studies tend to break up the black box of the added value creation process and explore the sources of the heterogeneity and the competence of the firm. With more details and complexities of the inter-firm relationship arrangements as well as the boundary determination of the firms are incorporated into the analyses in management field, discussions on the “make-or-buy” has been developed to the more refined levels. In this paper, we attempt to spotlight the make-or-buy decisions on the detail design drawings of components, rather than merely the manufacturing outsourcing. The “transaction patterns” are defined here as the different ownership allocations of components’ detail design drawings between assemblers and suppliers. On the basis of the classifications made in previous studies (Asanuma, 1989; Clark and Fujimoto, 1991; Fujimoto, 1997), we explicitly specify the transaction patterns under our scrutiny

are ① the Drawing-supplied system; ② the Drawing-entrusted system; ③ the

Drawing-approved system and ④ the Purchased parts system.

The Drawing-supplied (DS) system can be considered as the in-house making case of the detail design by assemblers. After completing the detail design of components, assemblers provide the drawings to suppliers for manufacturing. Contrarily, the Drawing-approved (DA) system can be regarded as the outsourcing case. Suppliers carry out the detail design after assemblers specify the blueprint parameters of components such as configuration, weight and size, etc. By possessing the property right of the design drawings, suppliers generally continue to manufacture the components once the detail designs are approved by assemblers. Under the Drawing-entrusted (DE) system, assemblers outsource the components’ detail design

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but claim the ownership of design drawings by paying suppliers the design fees, and may switch to other suppliers for manufacturing (Fujimoto, 1997). Therefore, the DE system has the hybrid nature in the sense that it’s the same as the DA system from the aspect of design task outsourcing, while it’s identical with the DS system since design drawings are owned by assemblers. The so-called “design-in” or the “black box system” actually includes the DA and DE systems as the two categories (Fujimoto, 1997). Finally, the Purchased parts system is identical with the spot market transaction. Suppliers design and manufacture the components without the detailed specifications from assemblers and assemblers procure the components directly via the product catalogues. This classification of transaction patterns refines the “make-or-buy” discussion by explicitly separating the design and manufacturing issues. This separation has special implications for the strategic management because the outsourcing of manufacturing and that of design tasks call for different ways of the inter-firm coordination. In the case of manufacturing outsourcing, the detail design drawings of components are available in which nearly all the parameters are specified ex ante. Therefore, the inter-firm coordination is conducted according to the definite criteria at the processing stage. Quite differently, the outsourcing of detail design introduces more uncertainties in transactions since only rough design blueprints are available beforehand. Inherently featured as the trial-and-error process, the inter-firm coordination on design has to solve the problems such as identifying the source of design quality problems and dealing with the inevitable design changes. Furthermore, another important strategic aspect of design outsourcing is how to arrange the distribution of the added value realized in transactions. If the outsourcing leads to the increasing bargaining power of suppliers, assemblers may not get the merits as what they expect (Fine and Whiteney, 1996). Therefore, although the design outsourcing has the merits of shortening the lead-time due to the parallel progress of development project, reducing cost and improving quality through supplier’s “design-for-manufacturing” efforts, these merits cannot be achieved without conditions. As an important strategic management issue, the conditions for the “make-or-buy” of the detail design, or the conditions by which the alternative transaction patterns are chosen, need to be clarified. Fujimoto and Ge (2001) make a tentative study on the strategic choice of the transaction patterns from the perspective of product architecture. Within the setting of a transaction dyad (one assembler and one supplier) in the Japanese auto industry, we firstly controlled the transaction attributes such as “asset specificity” (Williamson, 1985) and the transaction-related organizational capabilities defined as the “relational skill” (Asanuma, 1997), which have been used to explain the make-or-buy decisions. Then the observed diverse patterns for transacting the different auto parts make us to

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examine the component’s attributes. Following the definition of the product architecture as “the scheme by which the function of a product is allocated to physical components and by which the components interact” (Ulrich, 1995), we specify the “architectural attributes” of components in terms of “the degree to which the components interact functionally and physically within the product system”.1 After an empirical study on 33 sample auto parts in the dyadic setting, we got the results that “the inter-component functional modularity” had the significantly positive effect on the choice of the Drawing-approved (DA) system, while had the significantly negative impact on the choice of the Drawing-supplied (DS) system. Since the Japanese auto maker in our study is competitive in the global auto industry, we can get the further implication from these results that the matching of the design outsourcing strategy and the architectural attributes of components is important to the firm’s competence. As the architectural attributes of components are also endogenous variables to be determined, they can reflect the architectural design strategy of firms. Therefore, the above implication can be restated in the way that the matching of the design outsourcing strategy and the architectural design strategy is important to firm’s competence. How robust will be the perspective of the components’ architectural attributes to influence the transaction pattern choice? How will the matching of architectural strategy and design outsourcing strategy influence the competence of firms in more general sense? In order to satisfy these intellectual curiosities, we steer our attention to another industry in another region --- the motorcycle industry in China. The Chinese motorcycle industry has acquired the largest share in the global motorcycle production since 1997. With the advantage in the low cost and price, the made-in-China motorcycles have great appeal for the customers in developing countries such as China, Vietnam and have achieved the competence in the low-end market segments. In this paper, while trying to get further insight on the matching of architecture and design outsourcing strategies, we also attempt to explore the source of the fast growth achieved in the Chinese motorcycle industry. This paper is structured as follows. In section 2, we make a survey on the researches on the strategic “make-or-buy” issue. Then before entering the details of the inter-firm coordination, we introduce three stylized facts of China’s motorcycle industry in section 3, which reflect its current situation, its development stages and the nature of product development. In section 4, we conduct a case study in a 4-player network setting in which the inter-firm relationships are decomposed into three types. One is the

1 Note that the architectural attributes of components that we defined only focus on the external interdependence between components, other than the internal attributes of the individual component.

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transaction dyad between one assembler and one supplier. The second is the transaction triad that includes two assemblers and one supplier. We want to examine the competition between two assemblers even they simultaneously transact with the same supplier for the same component. The third is another transaction triad that includes two suppliers and one assembler. We can see that the coordination between suppliers can determine the architectural attributes of motorcycle components in a bottom-up way and then influence the choice of transaction patterns by assemblers. In the following section 5, we attempt to frame our findings from the case study in a “strategic coordination framework” in which the technological and transactional aspects of the inter-firm coordination are discussed. We then analyze a paradoxical phenomenon in the current Chinese motorcycle industry --- “the collective competence” but “the individual vulnerability”, which is important to foresee the future direction of the industry. Finally in section 6, we summarize the conclusions and show the subjects for future study.

2 Literature Review

2-1 The Economics Studies on the Strategic “Make-or-Buy”: Concerning the boundary of the firm, the nature of the “make-or-buy” issue has been stressed as the strategy for governance from the perspective of economics. Two theories make the great contribution to this governance view of the “make-or-buy”. One is “transaction cost economics’ (TCE) and the other is “property right approach” (PRA). Both theories share the same human behavior assumptions of “bounded rationality” and “opportunism”. Due to the bounded rationality, human cannot draft the contracts to incorporate all the possible contingencies ex ante and the incomplete contract is inevitable. Opportunism, defined as “self-interest seeking with guile” (Williamson, 1985), then is likely to make the transaction parties to take advantage of the incomplete contract in order to get more share of the added value ex post. The “hold-up” problem is one representative example of the opportunistic behavior when the added value has to be created by investing in some specific assets. The party who conducts the specific investments that have much less salvage value will be held-up during the renegotiations in the ex post stage of the transaction. The expectation of this scenario will result in the hesitancy of the investing party so as to make the investment level inefficient. This kind of market failure stemming from the incomplete contracts and opportunism is thought capable of being avoided by vertical integration, in which market negotiations are replaced by administration within the firm. Since this line of research focuses on the “hold-up” problem that is likely to happen after the specific investment, we consider this governance view as putting weight on the distribution of the added value.

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Williamson specifies three dimensions of transaction attributes in his TCE framework – asset specificity, uncertainty and frequency of exchange. When these three attributes are high, the hold-up problem will be more likely to happen in the ex post stage of transaction. Therefore, vertical integration is predicted as an efficacious governance structure to economize the ex post transaction costs such as “the maladaption costs”, “the haggling costs”, “the set-up and running costs ” of governance structure and “the bonding costs of effective secure commitments” (Williamson, 1985, pp.21). Klein, Crawford and Alchian (1978) also predicts that the advantages of vertical integration increase as assets become more specialized to transactions. Their reason is that the quasi-rent created by specific assets – “the excess of its value over its salvage value, that is its value in its next best use to another renter”, is vulnerable to appropriation during the renegotiations in the market transactions. Empirical evidence of the theoretical hypotheses drawn from the transaction cost economics has been provided in several seminal studies on auto industry. Monteverde and Teece (1982) investigated 133 auto components manufactured by GM and Ford and found that the “specialized, nonpatentable technical know-how” associated with the development of any given auto component, positively affects the vertical integration of component production. Masten et al. (1989) extended the Monteverde and Teece’s study by examining both physical and human capital’s effects on 133 auto parts in the U.S. auto industry. Their findings showed that the physical capital had not so strong influence on the vertical integration as the specialized technological know-how. In Walker and Weber’s empirical study on the U.S auto industry (1984), the supplier market competition that serves as an indicator of asset specificity, together with the comparative production costs between buyer and supplier and the volume uncertainty, was shown to have positive effect on the vertical integration. The “Property right approach” defines the ownership as the “ex post residual right of control” (Grossman and Hart, 1986), which is the “right to choose the missing aspects of usage resides with the owner of the assets” (Hart, 1989). The definite ownership allocation of assets to either transaction party at the ex ante stage, as what PRA argues, can be a device to deal with the “hold-up” problem since it can transfer the bargaining power to one party and avoid the frictions in the ex post renegotiation. The allocation of assets ownership to one party is equal to the vertical integration discussed in TCE. Although the fundamental insights are similar between TCE and PRA, some differences exist and lead to different empirical meanings (Holmstrom and Roberts, 1998). First, the specific physical asset, or non-human capital, is the only subject of discussion in PRA, while in TCE, both physical and human assets are discussed. Secondly, there is no detailed discussion on the transaction attributes and there is no

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prediction on the effect of asset specificity magnitude on the firm’s boundary in the arguments of PRA. Therefore, PRA opens less opportunity for the empirical testing. Thirdly, different with the TCE framework that compares vertical integration and other governance structures, PRA stresses that which party in the transaction claims the ownership of the specific assets is also important to achieve the efficient solution. PRA concludes that the party whose investment generates more added value should own more assets. In summery, both TCE and PRA offer the conditions under which vertical integration is chosen and can be considered as the theory of “Make”. Since both mainly focus on a dichotomy of market transaction and vertical integration, there is gap between the simplified theory and the realistic world where “transactions in the middle range (between market and vertical integration) are much more common” (Williamson, 1985, pp.83). 2-2: The Resource-based View of the “Make-or-Buy”: Instead of making “transaction” as the only analysis unit for discussing the incentive problems, the resource-based view of the “make-or-buy” issue in the field of management science also makes “project”, “process” or “product” as the analysis units to incorporate more details and complexities of the outsourcing practices in the real world. When discussing the determination of the firm’s boundaries, its main concern is the construction of efficient supply chains in which the synergies of different resources can be achieved to contribute to the competence of the firms. Since the resource-based view includes a wide scope of researches focusing on various details of the “make-or-buy” issue, we will make our survey limited to our main concern --- the “make-or-buy” of the detail design in the assembling industry. Asanuma made a seminar study to refine the “make-or-buy” dichotomy by examining the Japanese automobile and electronics industries. Between the two polar cases of the in-house making and the spot transaction of standardized parts, Asanuma points out that there are also two transaction patterns between the “core firm” (the “assembler” in our term here) and their suppliers. One is the “Drawing-supplied system” (Taiyozu) under which the core firm makes the detail design of auto parts and outsource the manufacturing to suppliers. The other is the “Drawing-approved system” (Shoninzu) under which the detail design of auto parts are also entrusted to suppliers together with the manufacturing. As the next step of his analysis, Asanuma extracts the concept of the “relation-specific skill” 2 as the underlying factor that distinguishes the transaction patterns. 2 In his later work, Asanuma deleted the “specific” term and redefine the concept in terms of the “relational skill”. This change stresses the point that the skills accumulated by suppliers are not always specific to certain assembler. It implies that suppliers can establish multiple transaction relationships in a wider scope.

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The “relation-specific skill” is “the skill required on the part of the supplier to respond efficiently to the specific needs of the core firm”. According to the stages of product development process in which suppliers can participate, Asanuma specifies four dimensions of the “relation-specific skill” that can be arrayed in a vector presentation as (X1, X2, X3, X4). In detail, the four capabilities required by the core firm are: X1: the development capability in response to the specification from the core firm and ability to maker proposals on specification improvement; X2: the processing development capability and cost reduction capability through value engineering efforts; X3: the quality and timely delivery assurance capability; and X4: the cost reduction capability in the production stage. (Asanuma, 1989, pp.22-24) Therefore, the choices of transaction patterns depend on the dimensions of supplier’s capabilities. Whether suppliers are equipped with the “development capability” is the divergent point for choosing the Drawing-approved system or the Drawing-supplied system. Represented in the form of the capability vector, the DS system corresponds to the vector (0, X2, X3, X4), while the DA system corresponds to (X1, X2, X3, X4). Fujimoto (1997) further makes refinement of the Asanuma’s classification by making the gray zone between the DS and DA systems definite as the ”Drawing-entrusted system”. Although Asanuma ever represented this gray zone by the relation-specific skill vector (X1, 0, X3, 0), he didn’t give a name to it. Furthermore, Fujimoto clarifies that these transaction patterns also differ in the ownership allocation of detail design drawings between assemblers and suppliers. This recognition is important since it shows the essence of the transaction patterns is the “make-or-buy” problem of the detail design. When the DS and DA systems can be considered as the exemplary “make” and “buy” cases respectively, the Drawing-entrusted system is the hybrid form lying between the two. Under this system, assemblers outsource the detail design tasks to suppliers, but claim the ownership of design drawings by paying the design fees to suppliers. Controlling the ownership of the drawings, assemblers are capable of switching to other suppliers for manufacturing. The assertion by Asanuma that the “relation-specific skill” determines the transaction patterns choice assumes implicitly the long-term inter-firm transaction relationship. Differing with the governance view, Asanuma argues that the relational capabilities of suppliers are the bottleneck that constrains the design outsourcing where outsourcing is desired. He also points out that the supplier’s share of “the relational quasi-rent” (Aoki, 1988) realized from the specific investments will be higher in the DA system than in the DS system and this will motivate suppliers to evolve by accumulating the

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relational skills. However, is it desirable for assemblers to make design outsourcing to suppliers without conditions? Asanuma didn’t discuss this problem in the special setting of the Japanese auto industry. Fine and Whitney (1996) distinguishes the outsourcing in two categories --- the “outsourcing for capacity” and the “outsourcing for knowledge”. The former case does not pose the problem of shifting the bargaining power from assemblers to suppliers since there is less information asymmetry about the component design and production for assemblers. The Drawing-supplied system is similar to this case in that it mainly aims to take advantage of the manufacturing capacity of suppliers. However, in the case of outsourcing for the knowledge of suppliers, assemblers have the risk of losing some bargaining power if the necessary knowledge becomes the “black box” to them. The Drawing-approved system tends to increase the specialization between assemblers and suppliers, which is likely to develop to the kind of outsourcing for knowledge. Furthermore, if suppliers grasp the chance of setting up the component standard in the industry where the network externality exists, then assemblers who procure such kind of components are likely to be inversely locked in (Arthur, 1988). This “lock-in” problem differs with the “hold-up” problem in that the vulnerable party is the assembler in the former case and the supplier in the latter, and there is no network externality condition in the “hold-up” case. Without the assumption on the inter-firm long-term cooperation relationship, the discussion on the outsourcing for capacity or for knowledge has more general meaning for the strategic management. It has the implication that the vertical integration of the crucial knowledge may be necessary to avoid the weakening of the assembler’s bargaining power. Nevertheless, there are still some practices observed in the realistic world that call for the explanation beyond these analyses based on the units of “transaction”, “capability” or “resource”. For example, Fujimoto (1997) observes that in the dyadic transactions between Toyota and one of its suppliers, diverse patterns such as the Drawing-supplied system, the Drawing-entrusted system and the Drawing-approved system coexist for the different auto parts such as steering wheel, weather strips, vibration proof rubber and the interior parts. When the “asset specificity” and the “relation-specific skill” are controlled in the dyadic transaction setting, the factors influencing the transaction pattern choice need to be explored from new perspectives. In order to investigate the attributes of different components, we turn to the perspective of product architecture. 2-3 Product Architecture and the “Make-or-Buy”: Product architecture is “the scheme by which the function of a product is allocated to physical components and by which the components interact” (Ulrich, 1995). This concept contains mainly three aspects. First, it establishes the structure of the functional elements. Secondly, it reflects the mapping from the functional elements to

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physical components. Third, it defines the interfaces among interacting physical components, which specify how they fit together, connect, communicate and so forth (Ulrich, 1995; Ulrich and Eppinger, 1995). Modularity is a dimension to measure the way of the function-component mapping and the coupling degree of the interface specifications. The typical modular product is characterized as (1) each component implements a single function (the so-called “one-to-one mapping”), and (2) the interfaces between the components are well defined or standardized (Ulrich, 1995). As a result, the product system can be a loosely coupled kind and the mix-and-match of components can be possible (Weick, 1976; Schilling, 2000). In contrast, the product with extremely low modularity has the properties that (1) one component always implements multiple functions (function sharing) or one function requires multiple components working together to be achieved (the so-called “complex mapping”), and (2) interfaces among tightly coupled components are ill defined (Ulrich, 1995; Sanchez and Mahoney, 1996). The notion of product architecture has the inherent linkage with the management issues because constructing the functional structure and specifying the interfaces can mirror the fundamental organizational issues such as the division of labor and coordination. Especially, the modular architecture has recently attracted a lot of academic attentions from the field of management science. Sanchez and Mahoney (1996) address that the standardized interfaces of modular architecture enable the “embedded” (or autonomous) coordination and facilitate the effective learning. The loosely coupling system can also reduce the cost and difficulty of adapting to the changing environment and thus increase the strategic flexibility of the organization (Sanchez, 2000). Langlois and Robertson (1992) discuss the implications of modular system from both supply and demand sides. On the supply side, modular system can breed autonomous innovation and achieve rapid trial-and-error learning. On the demand side, it can increase the product differentiation and blanket the product space more completely. Baldwin and Clark (2000) summarize the power of modularity as (1) increasing the range of manageable complexity, (2) allowing the concurrent work, and (3) accommodating uncertainty. Besides the merits of the modular architecture, its potential negative side such as the necessary redundancy in the interface design and the sacrifice of the optimal performance in the static sense are also addressed. Sharon and Eppinger (2001) relate the make-or-buy decision of the auto component production to the complexity of automobile design. By complexity, they mean” (1) the number of product components to specify and produce, (2) the extent of interactions to manage between these components (parts coupling) and (3) the degree of product novelty” (pp.189). With “product” as the analysis unit, their complexity concept is similar to the product architecture. Through an empirical study on the luxury-performance

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segment of the global auto industry, they show that when the product complexity is high, the vertical integration of the component manufacturing is more attractive. Baiman, Fischer and Rajan (2001) use the agency theory model to examine the relationship between the product architecture and the supply-chain performance metrics. They conclude that the “separated architecture”, in which components are decoupling and no function sharing exists, can facilitate the performance measure of the suppliers and therefore relieve the “external contractability problem”. Although their tentative efforts relate the product architecture to the make-or-buy issues, they still discuss the simplified dichotomy case and don’t study the make-or-buy of the detail design on the refined level. Fujimoto and Ge (2001) attempt to discuss the make-or-buy of the detail design drawings from the perspective of product architecture. Instead of discussing on the product level, we focus on the component level and define the components’ architectural attributes as “the degree to which components interact both functionally and physically within the product system”. By looking at both the mapping from the functional elements to physical components and the interface complexity, we decompose the architectural attributes of components into two measurable constructs --- “the inter-component functional modularity” and “the inter-component physical modularity”. Our empirical study on the 33 sample auto parts in the dyadic transaction setting gets the results that only the “inter-component functional modularity” has significantly positive effect on the choice of the Drawing-approved system, while has the significantly negative influence on the choice of the Drawing-supplied system. These results firstly reveal that the architectural attributes of component are meaningful to explain the choice of transaction patterns. Since the high functional modularity of the components can facilitate the identification of design problems and the clarification of the responsibility between firms, the outsourcing of detail design can be conducted at small coordination costs. With the long-term transactions in the background of this study, the physical interactions between components seem not to be a big problem for the Japanese firms. When the inter-component functional boundaries are well defined, the closed communication and the long-term cooperation experience between the Japanese auto maker and its supplier can make the design changes conducted smoothly so that the physical interface designs can approach to the optimal level. As the effective outsourcing has been recognized as one competence source of the Japanese auto maker, the factors influencing the outsourcing decision is also important to the firm’s competence. Our results then imply that the widely adopted Drawing-approved system (Shoninzu) and the high inter-component functional modularity can be considered as a well-matched strategy package. Since the architectural attributes are also the endogenous variables determined strategically, the above implication can be restated in the way that the matching of the architectural design strategy and the outsourcing strategy can impact the competence of the firm.

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How robust is such recognition towards the matching of the architectural strategy and the design outsourcing in the research setting other than the Japanese auto industry? If the long-term inter-firm cooperation is not an accepted assumption, then what kind of matching of the two strategies will be achieved between assemblers and suppliers? With these questions in mind, we attempt to make the examinations on the different region and industry. Our focus, this time, is the motorcycle industry in China.

3 China’s Motorcycle Industry: Stylized Facts

3-1 Current situations of China’s motorcycle industry: The total production of motorcycles in China has been increasing remarkably in 1990s and has gone beyond 10 million units since 1997. Reaching 11.5 million units in 2001, China’s motorcycle industry is said to dominate half of the global production. Mainly targeting the low-end market segments with the low price, the motorcycles made in China have wide appeal in both domestic and oversea markets in developing countries. In 2001, the export is estimated to be around 2.7-3 million units.3 The uprising of China’s motorcycle industry has posed a threat to the global leader Honda since Honda’s market share in China and other Asian countries dropped sharply after the entrance of Chinese firms.4 Geographically, the motorcycle firms in China are clustered around three regions --- Chongqing city, Guangdong province and Zhejiang province. Among these regions, Chongqing city is outstanding in that its annual production capacity has been beyond 5 million units and the annual production and sales have been constantly around 3.3 million units. Furthermore, Chongqing is taking the lead in motorcycle’s exportation. In 2001, the export to Vietnam is around $3,000 million and accounts for 2/3 of the overall export sales in China. There are many famous representative motorcycle firms such as “Jialing”, “Jianshe”, “Lifan”, “Zongshen”, and “Longshin” in Chongqing city and their brand values has been increasing in both domestic and oversea markets. Why can the Chinese motorcycle industry achieve such fast growth in 1990s? One of the institutional reasons is that the market economy mechanism has been introduced in the industry with a large scale. During the transition from the planning economy to a market one, the economic reform in China has adopted the “gradualism” in which experimental reforms are carried out incrementally under the control of government. The motorcycle industry, differing with the automobile industry in the degree of strategic 3 http://www.business.sohu.com 4 During our interviews in Honda, it’s said that its market share is less than 5 percent in China and its share in Vietnam also dropped from nearly 90% to 30% since the entry of the Chinese makers in 1997.

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importance to the national economy, has been considered as the experiment field that can be freed from strict government regulations. Therefore, with few policy constraints, the motorcycle industry in China has relatively free entries and the market competition has been the driving force for the fast growth of the industry (Ohara, 2001).5

■ Stylized fact 1:

Driven by the competition based on market economy mechanism, the motorcycle industry in China has achieved fast growth in 1990s and has gained price advantage in the low-end market segment both domestically and abroad. 3-2 Development stages of China’s motorcycle industry: We divide the development path of China’s motorcycle industry into 4 stages. First, from 1950s to the end of 1970s, it’s the “exploration stage”. The first motorcycle in China was developed in 1951 to meet the military needs during the Korea War. It’s a clone of “K500”, a Germany model that was ever used in the Second World War. From 1979, under the government policy of “switching the military production to the civil demands”, some military firms like Jialing began to manufacture motorcycles. Nevertheless, because of lacking technological know-how, most firms were not successful in the product development. The second stage starts from the end of 1970s to mid-90s, which can be called the “technological cooperation stage”. During this period, Japan’s motorcycle makers entered China by providing technology licenses to some state-owned big firms. Honda established the cooperation relationship with Jialing in 1981, Yamaha and Jianshe, Suzuki and Qingqi, ChangLing, followed to set up the technological cooperation soon. Since the economy reform just begun in China, the limited purchasing power of consumers made the motorcycle market still small. Additionally, both the government control and the advanced technology provided by the Japanese makers made the entry barrier of the industry high. An oligopoly structure then came into being in China’s motorcycle industry and it can be considered as a Chinese version of the “big four” structure in Japan. The difference with the Japanese firms was that the lack of competition pressure made the Chinese firms stagnant in product development and technological innovation. It was not strange to see that the same motorcycle model has been manufactured for more than a decade. 5 Even if the government controls the industry entry through a register system, many assemblers are

actually manufacturing motorcycles without official permissions. In addition to the 147 companies officially

registered on the government catalogue, more than 1,000 small-scale firms are said to exist which make

market competition fierce and no individual assembler dominant in the market. Even top firms have less

than 10 percent of market share.

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The third stage is from mid 90s to the turn of the new millennium, when the private-owned firms entered the industry and showed their vitality. We call this stage “the Uprising of private-owned firms stage”. After Dengxiaoping’s speech advocating the further economic reform in 1993, the private-owned enterprises have been encouraged to develop and the market environment has become more competitive. Several small-scale assemblers like Zongshen, Lifan and Longxin in Chongqing who started up in the beginning of 90s as the engine makers grasped chance and grew into big assemblers within very short period of time. Lifan Group, as the domestic leader of motorcycle exportation, achieved 100 million dollars in export sales to the developing countries such as Vietnam, Iran and South Africa, etc. in 2001. The uprising of the private-owned firms in China’s motorcycle industry broke down the oligopoly structure and injected vitality by intensifying the competition. Although the difference in the nature of the ownership still exists, it’s not the important point when all the firms are competing under the market mechanism. Therefore, during the analysis of the motorcycle industry in China, it’s more appropriate to regard the state-owned assemblers and the private-owned ones as the “incumbent firms” and the “entrant firms” respectively. The fourth stage starts in 2001, when efforts for establishing new market order have been made. With the free entry of new assemblers in China’s motorcycle industry, the price war was triggered not only in the domestic market but also in the oversea Vietnam market. In 2001, the export units increased 61.4% compared with the previous year, but the sales increased only 12.7%. The average export price dropped sharply from $700 to $200.6 The minute profit margin or the deficit situation makes motorcycle firms difficult to make investments in R&D and upgrade their products. In order to go out of this destructive situation, several large-scale assemblers has begun to take the strategic actions. The Private-owned assemblers are endeavoring to increase their brand value and seeking cooperative foreign partners in Europe and Taiwan. The state-owned incumbent assemblers are trying to strengthen the alliance with the Japanese makers. Jialing and Honda signed an agreement on the further cooperation on Dec. 15th 2001. In order to increase the share in the market with great potential, Honda further established a new joint venture in China with the Sundiro Group in September 2001, who used to be a private-owned assembler copying the Honda’s products. Besides the strategies taken by the big assemblers to shake the small ones out of the overcrowded industry, the government intervention policies such as the prohibition of the new entry and the forceful elimination of the assemblers without the official approval is being enacted as well. We call this stage the “the new order seeking stage”.

6 http://www.business.sohu.com

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■ Stylized fact 2:

The development path of China’s motorcycle industry shows the big change occurred after the entry of the private-owned firms. The new market order will be determined by the strategic actions of the incumbent state-owned firms, the entrant private-owned firms and the foreign assemblers. 3-3 Nature of the new product development in China’s motorcycle industry: The nature of the new product development in China’s motorcycle industry has been recognized as the “modified duplication”, which means the assemblers in China generally copy the hit models of the oversea makers while making the modification on the aspects of function, quality, or cost to achieve the differentiation (Ohara, 2001). Although this kind of product development has the problem of infringing upon the design patents of the original models and many assemblers are confronting the lawsuits raised by the Japanese makes, our main concern here is the empirical study on the inter-firm coordinating practices during the development stage, not the normative evaluation. 7 We agree with Ohara on the basic facts of the product development in China’s motorcycle industry, nevertheless, we use the “reverse engineering-based product development” to replace the “modified duplication” concept because the it is a process concept by which details of product development can be scrutinized. Reverse engineering (RE) is “essentially the development of the technological data necessary for the support of an existing production item developed in retrospect as applied to hardware system” (Ingle, 1994). Particularly, RE can be considered as a four-stage process that includes “data evaluation”, “data generation”, “data verification” and “data implementation” (Ingle, 1994). To utilize this general description of reverse engineering in our special context of China’s motorcycle industry, we redefine the four stages in more specified terms. Figure 1 compares the process of reverse engineering-based product development and the general new product development. First, “data evaluation stage” is redefined as the “screening stage” of focal models. Differing with the general new product development, RE-based product development starts not from the abstract product concept, but from the selection via screening the existing models available. The chosen model to be reversibly engineered is called “the focal model”. Secondly, “data generation” is further decomposed into two stages.

7 As a matter of fact, imitation is necessary for followers to learn from the leader firms. Retrospective studies on Japan’s motorcycle industry revealed that the Japanese assemblers also adopted the similar imitation strategy to catch up with the leading European firms during 1950s (Tomituska, 1980; Demizu, 1990).

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Corresponding to the “system-level design” in which the blueprint and the fundamental layout of product are determined, the stage of “disassembly” focuses on the decomposition of the focal model and the identification of interfaces that link components together. While the system-level design decides the product architecture (Ulrich and Eppinger, 1995), the disassembly stage is to reveal the focal model’s architecture in which the interfaces among between components are detected. The degree to which the interface protocol of the focal model is decoded will influence how divergent of the reverse engineering from the original design. The “components’ reverse engineering” corresponds to the “detail design” in which the complete design parameters --- size, configuration, weight and tolerance, etc. --- of components are to be definitely determined. “Data verification” stage is redefined as the “reassembly and testing” stage, which contrasts the “prototype and testing stage” in NPD. Finally, “data implementation” is actually the manufacturing stage that follows design stage in the NPD process.

Figure 1 RE-based PD and NPD NPD RE

Note: Based on Ulrich and Eppinger (1995) and Ingle (1994) The comparison of the RE-based product development and NPD has the important implications for the inter-firm relationship during product development process. Starting from the abstract product concept, NPD is generally assembler-led process. Assemblers must determine the product concept and establish the “functional structure” (Pahl and Beitz, 1984). When suppliers are involved into the product development process, they usually participate from the detail design stage. In the case of the RE-based product development, because of starting from the screening and

Concept Development

Detail Design

Prototype Testing Reassembly & Testing

Component RE

Focal Model Screening

System-level Design Focal Model Disassembly

Manufacturing Manufacturing

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selection of the focal model from the existing products, it’s possible for both assemblers and suppliers to carry out the development in a parallel way from the very beginning of the process. Suppliers can disassemble the focal model and then make the reverse engineering of relevant components, either under the requirements of assemblers or on the self-judgment. When suppliers conduct the reverse engineering of the components of certain focal model independently, one necessary condition is that the supplier’s expectation of the focal model should be matched to that of the assembler. In the Chinese motorcycle industry, the RE-based nature of product development therefore opens the possibilities for assemblers and suppliers to conduct the parallel development of focal models. With the uprising of the private-owned assemblers from mid-90s, the demands for motorcycle components have been also increasing. As a result, many private-owned suppliers are established to meet the needs. The active involvement of suppliers into the development stage is important to change the structure of China’s motorcycle industry.

■ Stylized fact 3:

The reverse engineering-based product development in China’s motorcycle industry makes it possible for suppliers to participate in development process in a parallel way with assemblers.

4 Transaction Patterns in China’s Motorcycle industry: A Case Study

4-1 Case Setting: The three stylized facts summarize the points that we want to emphasize in this study. Firstly, the competence of China’s motorcycle industry in both domestic and oversea markets justifies our choice of research subject. Our main concern, to iterate, is that the matching of architectural strategy and design outsourcing strategy has impact on the competence of firms. Secondly, the competition between the entrant private-owned assemblers and the incumbent state-owned assemblers is important to understand the situation of China’s motorcycle industry. Thirdly, suppliers are actively involved in the reverse engineering-based product development process and they can possibly develop the focal model’s components even without the requirements from assemblers beforehand. On the basis of these stylized facts, we make our setting for the case study in a four-node network form. Two assembler nodes represent one incumbent state-owned assembler and one entrant private-owned assembler, while two supplier nodes represent two complementary suppliers in the sense that their components coordinate

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to realize certain function of motorcycle. Figure 2 shows this simple setting.

Figure 2 Case Setting of the Inter-firm transactions in China’s motorcycle industry Assembler nodes A B Supplier nodes X Y As the next step to make our analysis tractable, we decompose this four-node inter-firm network into dyads and triads and examine their economic meanings. Firstly, the set of dyadic relationship includes 6 elements that can be shown as {(A, X); (A, Y); (B, X); (B, Y); (A, B); (X, Y)}. Since we focus on the inter-firm transaction relationships here, (A, B) and (X, Y) are not directly relevant in this study and are omitted. So {(A, X); (A, Y); (B, X); (B, Y)} is the set of dyads that reflects transactions between a pair of one assembler and one supplier. This is identical with the setting of Fujimoto and Ge (2001) with the aim to control other influential factors such as asset specificity or the organizational skill of the assembler and supplier. The triads set is {(A, X, Y); (A, X, B); (A, Y, B); (B, X, Y)}, which reflects the relationships among three firms. This set further can be decomposed into two subsets. One is {(A, X, B); (A, Y, B)} that shows the relationships between two assemblers and one supplier, the other is {(A, X, Y); (B, X, Y)} that shows the relationships between two suppliers and one assembler. Therefore, in such a 4-node network setting, we make the case study on transaction patterns in China’s motorcycle industry by examining the dyadic and triadic relationships between assemblers and suppliers. 4-2 Data Collection: Since no previous studies put emphasis clearly on the choice of transaction patterns of components’ detail design, our analysis bears some exploratory nature. The difficulty in collecting and analyzing the quantitative data in our research setting makes interview and archive data collection as the main approach in our study. During the semi-structured interviews at the firms in Chongqing city in Jan. 2002, the authorities of the product development and the procurement departments in assemblers, the presidents and component development staffs in suppliers were our respondents. The cross investigations on the transactions of the detail design of the components in multiple assemblers and suppliers are believed to relieve the subjective biases of the respondents.

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We chose four companies in our network setting, whose names are not allowed to publicize on the confidential agreements. They are the state-owned assembler Company A, the private-owned assembler Company B, the frame maker X, and the fairing/cowling components maker Y. Frame is the backbone of motorcycle, it has close relationship with other components like suspension and engine. The design of frame itself is said to reflect the motorcycle’s design philosophy (Tsuji, 1999). Fairing/Cowling components are basically the exterior components that have great impact on the fashionable appearance of motorcycle models. As the reverse engineering-based product development is the mainstream in China’s motorcycle industry, the design and manufacturing of exterior components are very important. Furthermore, there is close interaction between frame and fairing/cowling components because the latter must be well mounted on the frame. In the following, we’ll discuss the choice of transaction patterns of the frame and fairing/cowling components. According to the explanations of our respondents, the Design-entrusted system is mainly chosen for the styling design of motorcycle models, seldom adopted for the individual components. So the transaction patterns spotlighted here are the Design-approved system, the Design-supplied system, and the Purchased parts system. 4-3 Transaction Dyads: One Assembler and One Supplier When we examined the dyadic transactions between assembler A and frame maker X, fairing/cowling components maker Y, we find that diverse patterns have been chosen even for the same component. While assembler A makes the in-house design of frame and fairing/cowling components and adopt the Design-supplied (DS) system, on the other hand, it also chooses the Design-approved (DA) system or even the Purchased parts system sometimes. To explore the reasons why this phenomenon exists is the main purpose of this case study. First of all, let’s look at some details. Assembler A is the incumbent state-owned firm, who has been playing an important role in China’s motorcycle industry. Interviews were conducted at the product development department and the procurement department. The product development department (called as “technology center”) of assembler A had only tens of staffs In 1993, but now it has been expanded to have 400 staffs. Before, the staffs were mainly the graduated students from professional high schools, now more than 95% of the staffs are graduated from universities whose average age is 33 years old. Five branches constitute the development center. Besides one “product planning department”, there are three research institutes that are responsible for the styling, frame and structural design; the engine development and the fundamental researches on materials, environment technology and noise treatment, respectively. There is also a testing station. Although assembler A has the technological cooperation

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relationship with the Japanese motorcycle firm, the fierce market competition makes it enter the mainstream of the reverse engineering-based product development. The procurement department belongs to the so-called “Material Company”, which is one of assembler A’s subsidiaries. It contains five operational units, in which three units are specialized to purchase components from suppliers, and two units are responsible for material procurement. Figure 3 shows the organization scheme of the “Technology Center” and “the Procurement Department”. When looking at this organization scheme, we can see that ‘frame” appears in both Technology Center and Procurement Department columns. As mentioned before, frame is the backbone of motorcycle. It fulfils the functions that guarantee a rigid attachment between the front suspension, the steering head, the rear suspension and the rear fork, and at the same time, holding in place the engine, the rider and all the auxiliaries such as fairing, lights, fuel tank, radiators, batteries, etc. (Cocco, 1999). When designing frames, the first important issue is the overall weight and its distribution on front and rear sections of motorcycle. This weight distribution has close linkage with handling. Additionally, engine configuration and the specific requirement on styling and functions should also be taken into account (Tsuji, 1998). For such a vital component, the general perception will be that the design should be made in-house. Nevertheless, our interviews of the Procurement Department reveal that assembler A not only conduct the frame’s design in-house, but also make design outsourcing to the frame suppliers. Introduced by the respondent at Procurement Department, we made further investigation on a frame maker X.

Figure 3 Assembler A’s Product Development and Procurement Departments

Technology Center Procurement Department

product planning department Operation Unit Ⅰ

(Concept making) (Rubber, plastic components, emblem mark, etc.)

Research Institute Ⅰ Operation Unit Ⅱ

(Frame, styling, structure design) (Frame, press parts, mechanically manufactured parts)

Research InstituteⅡ Operation Unit Ⅲ

(Engine development) (Casting parts, engine gears, wheels)

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Research Institute Ⅲ Operation Unit Ⅳ

(Materials, environment technology, & (Metallic materials) noise treatment)

Test station Operation Unit Ⅴ

（non-metallic materials）

Frame maker X is a company with more than 20-year history. It used to be a Tier 2 supplier of assembler A. When the market economy was developed in China’s motorcycle industry, company X went out of the closed supplier system of assembler A and tried to develop more motorcycle components by taking advantage of its good welding skills. X finally chose frame as its main product in 1995 because the profit margin was relatively high. Investigations at frame maker X further convinced that diverse transaction patterns of frame exist. Firstly, under the Drawing-supplied system, assembler A carries out the detail design of frames and provides the drawings to supplier X. In some details, assembler A first makes screening and selects the focal model for reverse engineering, then tries to disclose the design data through decomposing the focal model and analyzing the frame and its interactions with other key components. The detail design drawings provided to supplier X specify not only the frame configuration, installation parameter and the materials used, but also the way of welding and the tolerance. Secondly, under the Drawing-approved system, after selecting the focal model, assembler A asks supplier X to design the frame while controlling the frame’s form, installation design and the materials to be used. Thirdly, frame maker X also conducts the development independent of requirements of assembler A. In this case, if the expectations on the hit models are consistent between supplier X and assembler A, Assembler A will utilize the frame developed independently by Supplier X in mainly two ways. One is showing the requirements for modification of the frame designs to supplier X in order to install the frame smoothly. This is similar to the Drawing-approved system. The other is directly purchasing the frame from supplier X and making the coordination internally. This so-called “fast development” system is similar to the Purchased parts system, in which assemblers just choose the component from the catalogue of suppliers. Differing little with the case of frame, transactions of the fairing/cowling components between assembler A and supplier Y also have diverse patterns. Supplier Y was a private-owned company established in 1994. Now it has fixed assets of more than 2

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million dollars and 2,300 employees whose average age is 30 years old. While producing the fairing/cowling components, Supplier Y also purchases the motorcycle lamps from lamp suppliers and generally deliver the subassembly of the fairing/cowling parts and the lamps to assembler A. The main functions of the fairing/cowling parts are to improve the aerodynamic characteristics and the handling of the motorcycle. Since fairing/cowling parts account for a fairly large part of motorcycle’s visual design, they are the important exterior parts. There are two ways of mounting fairing/cowling parts on motorcycle. One is the “handle mount type”, and the other is the “frame mount type” (Sasaki, 1994; Cocco, 1999). When questioned the transaction patterns with assembler A, supplier Y showed that there were two main patterns defined in its own terms, “the independent development” and “the request development”. The former is similar to the Purchased parts system in that supplier Y independently makes the focal model selections and then develops and manufactures the fairing/cowling parts. The latter is close to the Drawing-approved system in that the component development by supplier Y is conducted under the modification requirements from assembler A. The static observations above clearly show that the diverse patterns exist between assembler A and suppliers X, Y, even for the same component transacted. When our interview went further to investigate the dynamic change in the proportion of the various patterns adopted, the respondent from the procurement department told us that reform of the procurement system had been undergone in assembler A. The reform is transferring the decision rights from Technology Center to Procurement Department on the evaluating and selecting of suppliers, and the choice of the transaction patterns. Before the reform, Technology Center took the control on the transactions with suppliers, while Procurement Department just fulfilled the implementation and had only the limited recommendation right. After the reallocation of the decision rights, Procurement Department centralizes the purchasing function and constrains the right of Technology Center to directly transact with suppliers for the components within five units only during the product development process. This reform is said to let Technology Center concentrate on the product development and meanwhile to establish a more market-oriented procurement system that can make a good use of suppliers’ development capabilities. As one result, the proportion of the Drawing-approved system and the Purchased parts system has been increasing. Why did this reform occur to increase the Drawing-approved system and the purchased parts system? Discussions in the dyadic transaction setting cannot give a satisfactory answer to this question because the market competition intensified by the entrant private-owned assemblers doesn’t enter this analysis. Therefore, as the second step of our analysis, we further make our discussion in a triad setting that includes two

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assemblers and one supplier. We want to show the competition between the entrant private-owned assemblers and the incumbent state-owned assemblers even when they procure the same component from the same supplier.

4-4 Transaction Triads Ⅰ : Two Assemblers and One Supplier

Assembler B is a private-owned firm established in 1992. Started as an engine maker, company B has now grown into a large corporate group with 20,000 employees and the total assets of 400 million dollars. Its products are exported to 14 countries. Since assembler B was originally an engine maker, most of other components have been purchased from suppliers. For example, our investigations in frame maker X revealed that when X began to produce motorcycle frames in 1995, assembler B was one of the main transaction partners. To understand that why the procurement system of assembler A has been reformed, the respondent from A’s Procurement Department gave us a few examples of inter-firm competition within Chongqing’s motorcycle industry. In 2001, both assembler A and B started a product development project almost at the same timing. The target of their reverse engineering was the same one Honda’s model that was expected to be welcome on the Vietnam market. Aligning with the expectations of assemblers, suppliers also selected the same focal model and conducted the component development independently. Among the suppliers who competed to develop the frame of the focal model, frame maker X was one of the top suppliers whose lead-time was short. Under such situations, the development strategies of the incumbent assembler A and the entrant assembler B diverged at the point of the “make or buy” of the frame’s design. In assembler A, the development project was led by Technology Center. Since historically assembler A has got instructions from the Japanese motorcycle makers, it had been used to conducting the product development in the top-down way and put emphasis on the quality control. The frame was design internally by following the general process below. Firstly, after the selection of the focal model, the styling design drawings are made and evaluated. Then the layout drawings and structural design drawings are to be completed. The next step is to make the mud mock-up of the focal model’s structure. If the mock-up can reflect the focal model’s structure perfectly, the detail design of the motorcycle structure begins by using laser scanning to get the 3-dimension data. The detail design of the frame and other structural components are conducted afterwards. When the interference among components is under good control, the design drawings are provided to suppliers for manufacturing. It’s said that 6 months are needed from the detail design of components to the completion of manufacturing. After components are developed, the prototype is to be made for testing.

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In contrast, instead of designing frame in-house, assembler B was searching for the supplier who had independently developed the frame of the focal model. When the supplier was found, the procurement staffs went to the supplier’s place with 100 thousands dollars cash and signed the purchasing contract. This pattern of transaction is similar to the purchased parts system. By the same means of procuring the necessary components, Assembler B then made the assembly of motorcycle quickly and sent the products in Vietnam market at half of the price of the original Honda’s model. The agreement signed by assembler B and the frame maker had an exclusive item that the supplier should not sell this focal model’s frame to other assemblers. But such specification lacked enough enforcing power in the industry. As the result, many assemblers were able to produce the same focal model by accessing to the frame and other components. Then the price war was triggered in Vietnam market, where the price dropped sharply from $500 to $100. Insisting on the strict development procedures, Assembler A didn’t participate in the trend of purchasing the frames from suppliers. Then the trial and error process made the lead-time in assembler A longer than the entrant assembler B. When A’ s product entered Vietnam market, the timing was so late that the price war had made no makers profitable. In the case of the fairing/cowling components of the same focal model, similar things happened. The fairing/cowling components maker Y firstly conducted the component development independently. As introduced above, supplier Y not only produces the fairing/cowling components, but also purchases motorcycle lamps and conducts the subassembly. Therefore, the good coordination between the headlight, taillight and the cowling parts makes assembler B and other many assemblers bid for the access to supplier Y’s products. Even if the price rose to double the ordinary level, many private-owned assemblers still competed to get the procurement. In stark contrast, the incumbent assembler A still kept the stance of the top-down development. Even adopting the Drawing-approved system when procuring the fairing/cowling components from supplier Y, assembler A was strict towards the design quality and asked several times for design changes until making the approval. Furthermore, during the development process, the components that didn’t reach assembler A’s criterion were returned to supplier Y. Instead of dealing with these components as the defects, supplier Y sold them to assembler B. After half a year, when supplier Y finally met assembler A’s requirements, the timing for A’s products to be on the market was too late. Having experienced such a big failure, assembler A decided to reform its procurement system by switching the decision rights on the choices of suppliers and transaction patterns from Technology Center to Procurement Department. While maintaining the internal development of some key components like frame, assembler A also make

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effective utilization of supplier’s development capabilities by outsourcing the detail design tasks. Consequently, transaction patterns become diversified and the proportion of the Drawing-approved system and the Purchased parts system has been increasing. From the above case in the triad setting, we can see that the competition between the incumbent state-owned assembler A and the entrant private-owned assembler B has the root in the “make-or-buy” of the detail design drawings of motorcycle components. The outcome shows that the design outsourcing strategy can take advantage of supplier’s capabilities and make the development project progress in parallel way, therefore can shorten the lead-time. Nevertheless, Technology Center of assembler A insisted on the top-down development and refused to purchased the parts from suppliers because of the quality control concern. Is the design outsourcing a sacrifice of the product quality? Our investigations gave the answer that is “No”. As a matter of fact, under the different decisions of the detail design, the quality management is conducted through different mechanisms. The strategy of the top-down in-house design internalizes the quality control in assembler, while the design outsourcing strategy entrusts the quality control to suppliers in a bottom-up way. The facts that assembler A resisted to purchase the frame and fairing/cowling parts from supplier X and Y could be attributed not to the quality problem of these individual components, but to the mismatching of these independently developed components with other parts that were developed internally in assembler A. In contrast, assembler B’s success can be considered as a good matching between the design outsourcing and the quality control entrusting. As mentioned before, frame and fairing/cowling parts are interactive with each other and with other components as well. How can suppliers achieve the bottom-up quality control of component design in such situations? To clarify this problem makes the examinations on single component supplier not sufficient. Therefore, in the next section, we’ll discuss the coordination between suppliers in the development process in more detail within another triad setting that includes two suppliers and one assembler.

4-5 Transaction TriadsⅡ : Two Suppliers and One Assembler

As mentioned above, the reverse engineering-based product development in China’s motorcycle industry makes it possible that suppliers can carry out the development of focal model’s components even without requirements from assemblers. However, there are mainly two risks in such independent development process. One is the forecasting risk that the expectations of assemblers and suppliers on the focal model may not be matched. The focal model-specific investment by suppliers would be futile if assemblers don’t choose the same model. The second risk is the mismatching occurred during the reassembling stage between the components that are developed by different suppliers in the decentralized way.

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The coordination among suppliers is one effective mechanism to reduce these risks. Our investigation in Chongqing city reveals firstly that some informal networks have been emerged among the entrepreneurs of the private-owned motorcycle assemblers and suppliers. For the private-owned firms that mostly started up in the early 1990s, the situation of lacking technology, capital and experts within the individual small-scaled firms at the beginning made the inter-firm cooperation essential. The partnership was very open and fluid at first, but with the building-up of reputation and the increasing frequency of cooperation, some entrepreneurs gather more often to exchange market information and establish their networks of partners. Furthermore, the special living habit of Chongqing’s people of going to restaurants and teahouse in the leisure time makes these places for gathering the business people. The information exchange in such informal networks of entrepreneurs is actually the coordinating activity for matching the expectations on the future focal models. When coming to the agreements on the particular model, these entrepreneurs will choose the partners to carry out the development. The president of the frame supplier X is a member of one network where he met the leader of fairing/cowling parts maker Y. Secondly, in order to reduce the mismatching risk in the reassembling stage, suppliers often coordinate with each other during the decentralized component development process. Since frame and fairing/cowling components have high interactions in installation, the coordination cases between supplier X and Y are not rare. During the component development for the same focal model, communications between the development staffs from each supplier are relatively frequent. They also exchange the sample components to make subassembly tests. When the incompatibility problems occur, they usually negotiate to reach at a satisfactory compromise on the design solutions. Since frame also interacts with engine, suspensions and other key components, the change in frame design is said to be limited in a smaller scope to avoid the chain reaction of other components’ designs. So supplier Y generally compromises to incorporate more design modifications and meanwhile is compensated by a larger average profit margin. Therefore, this kind of coordination between suppliers actually achieves the bundling of the two components. Although assemblers procure the frame and fairing/cowling parts separately, they hold the information that the components produced by supplier X and Y coordinate well and prefer to purchasing their products. Besides the inter-firm coordination between suppliers, another option for suppliers to deal with the design problems of the interdependent components is the internalization of the coordinating efforts in one supplier. Supplier Y in our case study is such an exemplary firm. In addition to producing the fairing/cowling parts, supplier Y also purchases motorcycle lamps such as headlights and taillights from lamp makers and

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conducts the subassembly. Instead of calling for lamp suppliers to make design changes during the development process, supplier Y conducts the cowling parts design under the constraints of the available lamps. Since the installation of lamps, especially the headlight with the cowling frame is one crucial quality point influencing the appearance of motorcycle, supplier Y internalizes this important subassembly to guarantee the quality. So we can see that the coordinating efforts made by suppliers on motorcycle components designs either internally or externally with other firms are the means to reduce the reassembling risk and to secure the design quality of components. However, attention should be paid to the fact that such design coordination is very “local” in the sense that it’s conducted only in the close neighborhood of the components developed by the suppliers. Furthermore, this local coordination generally aims at the subassembly of components whose bundling feature can be considered as a kind of “modularization”. Aoki (2002) defines the “modularization” as “the decomposition of one complex system or process into several subsystems according to certain predetermined interface protocols, so as to make these subsystems capable of being designed independently or semi-autonomously”. In this definition, the decomposition according to the “predetermined interface protocols” implies the top-down planning nature of modularization. Nevertheless, as our case study shows, the reverse engineering of focal models in the Chinese motorcycle industry is different with this planned top-down activity. It’s the autonomous endeavors of suppliers that conduct the decomposition of focal models in the bottom-up way. We thus term this kind of coordinating activity of suppliers as the “localized modularization”. Borrowing the words of Aoki, we define it as “the decomposition of one focal motorcycle model into several subsystems that can be independently or semi-autonomously designed, through the bottom-up coordination efforts of suppliers whose attentions are only in the close neighborhood of their own products during the reverse engineering-based product development process”. This “localized modularization” strategy taken by suppliers is different from the design thought of the assemblers who carry out the reverse engineering internally in the top-down style, as what the assembler A did in our case study. The difference mainly lies in the interpretation of the interface protocols of the original focal model. The centralized coordination in assembler A’s product development department tends to decode the interface specifications as accurately as it can. The clone results are the specified interface design between the highly interactive components. In contrast, the trial and error made by suppliers to conduct the “localized modularization” aims to make the inter-component interfaces relatively well defined so as to make the responsibility for the design quality more clearly specified. Especially when suppliers conduct the “localized modularization” not only with one partner but with several

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partners, the standard of the component design of one specific focal model should be established to reduce the coordination costs. Therefore, we can say that even with the same focal model targeted, the different design methodology of the top-down reverse engineering by assembler and the bottom-up “localized modularization” by suppliers actually leads to the different product architecture of the focal model. The competition between assembler A and assembler B who incorporates the “localized modularization” by suppliers can then be considered as the architecture competition. The next question is what the incentives for suppliers to adopt the “localized modularization”? As shown by the case, the achievement of the easy-for-installation subassembly through the suppliers’ coordinating efforts will increase their bargaining power in the transactions where assemblers bided to buy their components. The supplier’s success in developing the well-coordinated subassembly can also increase its transaction scope since many assemblers need them to shorten the lead-time and gain the first mover advantage.8 Because the Purchased parts system is the pattern that can achieve the transactions of a wide scope, we can say that the incentives of suppliers to take the “localized modularization” strategy is to realize the Purchased parts system in the transactions with assemblers. Another interesting result when suppliers establish transaction relationships with multiple assemblers is that the network externality will reduce the costs of the components independently developed by suppliers. As more assemblers procure the components from one supplier, the economy of scale can be achieved. Therefore, the cost reduction of components becomes dependent upon the number of transacting assemblers. The positive feedback works when more assemblers purchase the components from the supplier, other assemblers will be more motivated to enter the transaction relationship with the same supplier. With such consequences in mind, suppliers’ incentive to adopt the localized modularization is further strengthened. When the “localized modularization” not only can shorten the lead-time of assemblers, secure the design quality, but also can reduce the costs, then a stable equilibrium --- (supplier’s localized modularization, assembler’s choice of the Purchased parts system) --- is formed between assemblers and suppliers, in which the mutual expectations of the firms are matched and no one wants to deviate until the other does. This equilibrium dominates the other one in which the assembler A’s in-house integral design and the choice of the Drawing-supplied system are matched. So we get the answer here that why assembler A reforms its procurement system and makes the transaction patterns diverse even for the same components with the same supplier ---

8 As what we introduced in the previous section, when the supplier developed the focal model’s frame that assembler B wanted, assembler B attempted to control the frame supplier from transacting with other assemblers by signing an exclusive purchasing agreement. But such agreement was lack of self-enforcing power since suppliers cannot keep to their words when other assemblers come.

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it’s the transition from the dominated equilibrium to the superior one. In this case study, we have taken three steps to explain the question that why diverse patterns are observed in the dyadic transactions between one assembler A and one supplier even for the same component in a backward style. To summarize our logic, (1). The coordination between suppliers achieves the “localized modularization” during the independent development of focal model’s components. Through modifying the architectural attributes of the components, this design strategy facilitates the assembling for assemblers and meanwhile increases the likelihood of transacting with multiple assemblers under the Purchased parts system for suppliers. (2). The entrant private-owned assembler B incorporates the “localized modularization” strategy of suppliers by directly purchasing their components. Since the outsourcing of the design and manufacturing to suppliers can shorten the lead-time, reduce the costs and meanwhile entrust the quality control to suppliers, during the competition with the incumbent assembler A, assembler B enjoyed the great advantage. (3). Assembler A learned the lesson from the failure in the development competition and undertook the reform of the procurement system. While introducing the Purchased parts system to utilize the merits of the “localized modularization”, its development department also continues to conduct the in-house design of the key components like frame. Therefore, the diverse patterns co-exist between one pair of assembler and supplier even for the same components transacted.

5 Discussions

5-1 The Multiple Equilibria: (architecture strategy, transaction pattern choice) From the case study on the inter-firm transactions in China’s motorcycle industry, we can see that the decisions on the architectural attributes of motorcycle components and the transaction pattern choice interact to construct the multiple equilibria. In the mainstream of the reverse engineering-based product development, the incumbent state-owned assembler A controlled internally the specifications of the interfaces between highly interdependent components, which resulted in the choice of the Drawing-supplied system when transacting with suppliers. On the other hand, the entrant private-owned assembler B made the active design outsourcing of components under the Purchasing parts system in response to suppliers’ localized modularization strategy. Using the following notation, we can show these multiple equilibria more straightforward.

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Equilibrium 1: (A, T (A)). “A” is for the “Architecture strategy” and “T” is for the “Transaction Pattern choice”. Equilibrium 1 reflects the top-down reverse engineering of the focal models led by the assembler. After the architectural attributes of components are determined, the Drawing-supplied system is chosen to match the centralized development process. Unless assemblers adopt the design outsourcing, this equilibrium is also a stable one since assemblers take a firm control on both the development and transaction decisions. Equilibrium 2: (A (T), T (A (T)). This equilibrium reflects the supplier-led “localized modularization” and the adoption of the Purchasing parts system. Firstly, suppliers carry out the independent development of focal model’s components with the aim of achieving the open transactions with multiple assemblers under the Purchasing parts system. The “localized modularization” is such a means to realize this goal since the lead-time shortening, cost reduction and the quality guarantee will make assemblers choose the Purchasing parts system as what suppliers expect. As our case study show, Equilibrium 2 dominated Equilibrium 1 in the development competition as long as the product development’s nature in China’s motorcycle industry is still a reverse engineering-based one. Because the fundamental nature of the inter-firm transactions is the coordination on the basis of specialization to realize the added value, the two equilibria extracted from our case study can further shed light on the inter-firm strategic coordination during the product development process. We consider that the strategic coordination includes two aspects: the technological aspect that focuses on the added value creation and the transactional aspect that emphasizes on the distribution of the created added value. 5-2 Strategic coordination: 5-2-1 The Technological Coordination: In Fujimoto and Ge (2001), we point out that although design outsourcing9 has the merits of shortening the lead-time, reducing costs and improving quality through the “design-for-manufacturing” by suppliers, these merits are not realized without conditions. We propose that the architectural attributes of components --- “the inter-component modularity” have impact on the achievement of design outsourcing merits. Our logic is that if the inter-component modularity is low, during the 9 In the research setting of the Japanese auto industry, the Purchasing parts system was not included in our examination because few auto parts can be transacted with multiple suppliers like the standardized one.

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trial-and-error design process, the “monitoring cost” will be incurred in that the source of design problems are hard to identify. Additionally, the low inter-component modularity will also increase the “adjustment cost” since design changes in one component will trigger the changes in other components designs. Therefore in such case, the centralized design coordination within the assembler is likely to incur lower costs than in the design outsourcing case. Contrarily, when the inter-component modularity is high, the difference in design coordination costs is not so salient between the internal design and the design outsourcing and the merits of outsourcing can be realized under the Drawing-approved system. We call this kind of matching of components’ architectural attributes and the transaction pattern choice as the “technological coordination” because its main consideration is the economizing on the “monitoring cost” and the “adjustment cost” during the rent creation process. The incentive issue such as the distribution of the rents between assemblers and suppliers is not touched. The Equilibrium 1 extracted from the examination on China’s motorcycle industry is supporting the above logic of the technological coordination. In the assembler-led top-down reverse engineering of the focal model, assembler A adopted the Drawing-supplied system during the frame transaction with supplier X for the same purpose of reducing the monitoring and adjustment costs since the frame design is highly interacted with other components. Interestingly, in the supplier-led bottom-up revered engineering in which the frames were transacted as the Purchasing parts, it is not contradictory with the above logic. The coordinating efforts among suppliers to realize the “localized modularization” actually internalized the monitoring and adjustment costs to the supplier side. After the specifications of the interfaces between frame and other components are well defined through suppliers’ coordinating efforts, the architectural attribute of the frame has become more modular and assemblers can purchase it directly. In Fujimoto and Ge (2001), we focus on a transaction dyad --- one assembler and one supplier --- in Japan’s auto industry with the inter-firm long-term cooperative relationships implicitly assumed. The case study on the Chinese motorcycle industry here makes such dyadic setting insufficient because the long-term cooperation is absent. We therefore introduced the simplest network form --- the triads into the analysis. The introduction of triads expands the coordination framework since in addition to the technological coordination during the rent creation process, the distribution of the rents between assemblers and suppliers are discussed as well. The distribution of rents between firms is called here as the “transactional coordination”. 5-2-2 The Transactional Coordination: The aspect of transactional coordination focuses on the distribution of the added value created in which the bargaining power of firms is important. In his seminal works,

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Asanuma ranks the supplier’s share of the “quasi-rents” realized in the transactions in

the decreasing order as ① in the Drawing-approved system, ② in the

Drawing-supplied system and ③ in the Purchasing parts system (Asanuma, 1989).

The reason is that under the Drawing-approved system, assemblers control less information on supplier’s development activity than under the Drawing-supplied system. The Drawing-supplied system is ranked higher than the Purchasing parts system because the nature of the added value created in Japan’s auto industry is “the relational quasi-rent” from the transaction-specific investments (Aoki, 1988), and it should be higher than the rent generated from the general purpose investments. Following this logic, Asanuma further proposes that the evolution paths of suppliers should be from either the Drawing-supplied supplier or the Purchasing parts supplier to the Drawing-approved supplier. The Asanuma’s logic shows that one source of the supplier’s bargaining power is the asymmetry of the design information. Fujimoto (1997) further distinguishes the difference of supplier’s bargaining power under different transaction patterns from the perspective of the ownership allocation of the detail design drawings. Under the Drawing-approved system, suppliers own the design drawings and cannot be switched by assemblers in the following development process. While under the Drawing-supplied system, assemblers control the design drawings and can impose competitive pressures on suppliers who bid for the manufacturing task. The essence of this logic is that the ownership claimant of the design drawings can strengthen the firm’s bargaining power by increasing its outside transaction options. Therefore, the asymmetry of design information between assembler and supplier, and the outside options of firms are two factors influencing the firm’s bargaining power during the transactional coordination. Findings from the case study on China’s motorcycle industry reveal that the Purchasing parts system, instead of the Drawing-approved system provides suppliers the highest rent share. This difference with the discussions on Japan’s auto industry results from the different nature of the product development. In Japan’s auto industry, the product development process begins from the abstract product concept and suppliers participate into the product design process at the detail design stage after the blueprint design parameters are available. In contrast, in the reverse engineering-based product development in China’s motorcycle industry, suppliers can develop the focal model’s components independently so long as their selection of the focal model is consistent with that of assemblers. Under such situation, the investments made by suppliers are not specific to the transaction relation as in Japan’s auto industry, but are the focal model-specific in nature. Consequently, neither is the quasi-rent the “relational” one generated from the relation-specific investment, but is the “focal model-related

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quasi-rent”. With no particular assembler as the targeted transaction partner beforehand, suppliers try to transact with assemblers as more as they can to disperse the investments costs after they successfully developed the focal model’s component independently. Therefore, the Purchasing parts system becomes the most lucrative transaction pattern for suppliers in China’s motorcycle industry. The “localized modularization” is the effective strategy taken by suppliers to realize the transactions with assemblers under the Purchasing parts system. Through the coordination among suppliers, the subassembly of interactive components of the focal model is achieved that is easy for assemblers to install. Since the component designs are specific to the focal model, they are not “standard” in the general meaning, but only are accepted by assemblers as the “standard” for certain selected focal model. Therefore, in addition to the outside options acquired by suppliers under the “localized modularization”, the design asymmetry of components still exists to increase the bargaining power of suppliers. To summarize, the “localized modularization” is not merely a technological coordination strategy for suppliers to internalize the monitoring and adjustment costs for securing the design qualities of components, but also a strategy of increasing their bargaining power to gain a larger share of “the focal model-specific quasi-rents”. The case study on China’s motorcycle industry, therefore, shows not only the inter-firm technological coordination where the components’ architectural attributes influence the transaction patterns choice, but also the transactional coordination where the incentive for choosing more profitable transaction pattern influences the determination of the architectural attributes of components. 5-3 the Paradox of the (localized modularization, the Purchasing parts system) Equilibrium in China’s motorcycle industry: We have pointed out that suppliers choose the “localized modularization” strategy to increase their bargaining power in transactions. Assemblers compromise this kind of intention because they have benefits such as the lead-time shortening and the cost economizing in return. So there seems to be a win-win situation between assemblers and suppliers in the (localized modularization, the Purchasing parts system) equilibrium. As a matter of fact, China’s motorcycle makers collectively have been competitive in the low-end market segments. Nevertheless, the price war that is triggered both domestically and abroad makes most assemblers in deficits. The assemblers then impose more pressures on suppliers by requiring further cost reduction and default more often on the payments of procurement. The “win-win” situation seems to turn into a paradoxical “lose-lose” one in the Chinese motorcycle industry. The cause of the pricing war that makes assemblers and suppliers into the “lose-lose”

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situation lies in the overcrowding of industry, which in turn is related with the widely chosen Purchasing parts system on the basis of the suppliers’ “localized modularization” strategy. Firstly, the entry barrier of the industry is lowered for the newcomer assemblers since the motorcycle components are easily accessed. The network externality that leads to the cost reduction further justifies and motivates the entry of assemblers. Secondly, the exiting pressure for assemblers is weak since the competitions on the motorcycle market lack continuity. In the reverse engineering-based product development, the important things are the selection of the focal model and the searching of suppliers who develop the focal model’s components independently. Failures in the previous round of competition don’t have the necessary relations with the next round in which a new focal model is selected. Therefore, there are too many assemblers in the gamboling-like competition in China’s motorcycle industry. Meanwhile, new suppliers also enter to meet the increasing needs, which further intensify the competition. Finally in such an overcrowding industry, the product differentiation is hard to make and the price war is triggered. 5-4 the progress direction of China’s motorcycle industry: How to solve this paradox? The solution will profoundly influence the future direction of the motorcycle industry in China. The shakeout is necessary. When the number of assemblers becomes small, assemblers can realize the scale economy internally, which can restrain the network externality as the cost reduction mechanism through which the bargaining power of suppliers has been strengthened so far. It can also make suppliers easier to make commitments to certain assembler and as the result the shakeout can also occur in the suppliers market. How to reduce the number of firms in China’s motorcycle industry? We can see that the government intervention and the firm’s strategies are the two main options available in the current situation. As oversea makers incessantly raise the lawsuits of design patent infringements against the Chinese assemblers, the government starts to take actions to emphasize the intellectual property rights. It’s also making a stricter control over the register system that provides the legal approvals for assembling the motorcycles. New motorcycle assemblers are not allowed to establish from 2002 and the existing assemblers are being screened for the forceful elimination by government. However, the government intervention in China always has the problem of enforcement. The efficacy of the policy in the actual operation process is somewhat in doubt. Furthermore, since the government doesn’t have the sufficient information on the firms, the administrative selection of the survivors may not be an efficient solution. The strategies chosen by firms for survival are important in the motorcycle industry that is based on the market economy mechanism. With no technological cooperation with the Japanese makers, the entrant private-owned assemblers are confronting more

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severe pressures from the litigation concerning the intellectual property rights. To avoid being the targets of such kind of lawsuits, several firms have established the joint development relationships or entrusted styling design to European or Taiwan’s makers in order to acquire the design originality. From now on, the entrant private-owned assemblers may focus on the styling design and the engine technology that are important to make originality, while still making outsourcing of other components. Another strategy adopted by the private-owned assemblers is the brand strategy through the diversification. The Lifan Group is making diversified investments in the liquor making, the safety door manufacturing and a professional soccer team that plays in the domestic League A. With the “manhood” as the core concept of its brand, Lifan Group carries out the diversification with the aim of building up its brand value. Lifan is also intensifying the advertising expenditure on Vietnam market and its brand is said to be as the same popular as Honda. Another private-owned assembler Zongshen Group is adopting the similar brand strategy by owning the unique motorcycle race team in China and attending the motorcycle race globally. Such brand strategies are complementary with the reverse engineering-based product development since when the product differentiation is hard to make, consumers are likely to choose the better-imaged one. Additionally, the infrastructure construction of the sales and after-sale service centers is also an important strategic factor. The private-owned assemblers like Lifan and Zongshen have established the sales and the after-sale service center networks domestically. Zongshen is assuring the consumers to solve the product problems within 24 hours in Sichuan province and within 48 hours nationally. For assemblers without such infrastructure, the survival likelihood may be small. The Japanese maker such as Honda is also taking the strategy in the Chinese market. While raising the lawsuits against the copy assemblers on the one hand, Honda also tries to penetrate into the procurement network in China on the other hand. In September 2001, Honda established a new joint venture in China with a private-owned assembler Hainan Sundiro in order to acquire the Sundiro's experience and expertise in the Chinese market. Honda’s imitating strategy of the Chinese assemblers is effective to increase its market share of the models in the mid-price range. Once the price gap between the products of Honda and those of the Chinese assemblers becomes sufficiently small, Honda may be the most competitive maker in China’s market with its sophisticated technology and the powerful brand image. When the shakeout of assemblers occurs as the result of government intervention or the firm’s strategies, supplier network may also be reorganized. Suppliers who make good coordination of interactive components and accumulate the know-how through

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the sophisticated inductive learning from the reverse engineering of multiple focal models may evolve into the system suppliers in the future.

6 Conclusions and Future studies

In this paper, we made a case study on the interactions between the architectural attributes of components and the transaction pattern choices in China’s motorcycle industry. We found that in the reverse engineering-based product development process, the incumbent state-owned assembler A made a top-down design of the focal model, while the entrant private-owned assembler B took advantage of the “localized modularization” strategy taken by suppliers, which is the bottom-up design in nature. Because the Drawing-supplied system and the Purchasing parts system are the transaction patterns to match the above different design philosophies respectively, we say that there are two equilibria in which the architecture strategy and design outsourcing strategy aligns with each other. In the market competition, the lead-time and cost economizing advantages achieved by (the supplier-led localized modularization, the Purchasing parts system) is shown to be superior to (the assembler-led top-down design, the Drawing-supplied system). As more assemblers transit to the former equilibrium, a paradoxical phenomenon occurs that the price war is triggered when product differentiation can hard be realized. We finally discussed some strategy options for assemblers to survive in China’s motorcycle industry. Since the research on China’s motorcycle industry from the perspective of product architecture is few, our study is exploratory and further investigations are needed to get deeper insights. Besides case studies that are based on the qualitative data, we also attempt to conduct more rigorous empirical research by using the quantitative data in future studies. Reference

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