Online Extra: Quanta's Bumpy Road to Innovation

As more companies get into the outsourced design business that CEO Barry Lam pioneered, can it remain a major player?

Barry Lam, chairman and founder of outsourcing giant Quanta Computer, has always taken pride in the fact that his company isn't simply a contract manufacturer. The world's leading producer of notebook PCs was one of the first Taiwanese companies to start designing products for its customers. Today, the original design manufacturer (ODM) business model that Lam helped pioneer has caught on worldwide, as companies like Flextronics (FLEX ) devote more resources to doing the sort of outsourced design work the Taiwanese started.

Now that the big North American outsourcing specialists have finally gotten into the design business as well, what does Lam have in store next?

To learn the answer, hop in a Taipei taxi and head southwest on Highway 1 toward Chiang Kai-shek International Airport. After driving for about 15 minutes through the grey sprawl of the Taiwanese capital and then the green hills circling the city, you'll need to turn off at the Linkou exit. Drive past the roadside stands where scantily clad women sell betel nuts, and soon you're on Wenhua Road in the Huaya Technology Park, a tidy suburban campus of semiconductor fabs and electronics factories.


  Quanta's corporate headquarters is the first building on the right. And across the street, workers are now finishing up Quanta's big new R&D center –- a glass and steel complex that, when it opens later this year, will not only provide space for thousands of engineers but also house a new Quanta Museum of Innovation.

The new R&D headquarters reflects how important it is for Quanta to take on even more tasks for its customers. "We have to do advanced research," Lam says. One reason is because the ODM business is becoming more competitive. Moreover, customers increasingly are becoming more reliant on their ODMs. In the past, a Western or Asian company hiring Quanta to design and manufacture its PCs would also keep a good part of the work in-house. That's no longer the case.

"What has changed is that more and more customers need us to design the whole thing," says Lam. "The market is so competitive. There are so many products that are similar. So we are forced to invest in innovative research in new products that are one or two years ahead of the market."


  Examples of the sort of work Quanta is now doing include research on next-generation displays. It's currently a major player in thin-film transistor liquid-crystal displays, or TFT-LCDs, through Quanta Display, a separately listed subsidiary that's one of Taiwan's major producers of the key component in LCDs.

But Lam says his researchers are working on newer things, like organic light-emitting diodes, or OLEDs -- seen by many in the electronics industry as the next big thing to replace LCDs and plasma displays in cell phones, computers, and TVs. Quanta is also emphasizing research into digital home systems, such as home servers and home multimedia players. Lam says Quanta is in talks with both Microsoft (MSFT ) and Cisco (CSCO ) on setting up R&D joint ventures.


  Like so many other Taiwanese execs at the island's ODMs, Lam points to Apple's (AAPL ) iPod as the gold standard of innovation. "This is surely what we have in mind," he says. "We have to think differently."

If so, Quanta still has a long way to go. Its commitment to R&D is impressive, but its total spending is still just a couple hundred million dollars, a paltry 1% of sales. And while its top-line growth has been impressive -- according to an analyst survey by I/B/E/S, Quanta's 2005 sales are likely to hit $12.2 billion, up 15% from last year and a two-and-a-half times increase from 2002 -- profit margins are shrinking.

Dell (DELL ) has been relentlessly driving down prices for notebook PCs at the same time that fewer potential customers remain because of consolidation among the top computer brand names. The most high-profile deal recently: IBM (IBM ) getting out of the business by selling its PC division to China's Lenovo.


  Fewer customers translate into a weaker position for ODMs like Quanta, whose gross margins have fallen below 5%. Last fall, it twice announced plans to spend as much as $107 million to buy back stock. But investors still don't seem to be reassured. In February, both Goldman Sachs and Citigroup downgraded Quanta's stock, which has dropped by about 33% in the past year.

Market skittishness. Shrinking margins. Growing competition. Quanta has a bumpy road ahead. Since founding the company in 1988, Lam has overcome a lot of challenges. As he tries to make Quanta a source of outsourced innovation, he's facing perhaps his toughest test yet.

By Bruce Einhorn in Hong Kong

Edited by Patricia O'Connell

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