Why Toshiba Is Clamming Up

Forget licensing -- the electronics giant is keeping innovations out of rivals' hands

There's an eerie silence these days in the elevators at Toshiba Corp.'s (TOSBF ) 36-story Tokyo headquarters. A sign pasted on the door of every car reads "Quiet Please," and employees either whisper or hold their tongues as they shuttle between floors. Why the prohibition on chatter? Toshiba wants to make sure outsiders don't overhear any secrets.

It fits nicely with a campaign by new Chief Executive Atsutoshi Nishida to keep key technologies close to the vest. As a Toshiba executive for two decades, Nishida watched promising innovations become commodities as the company licensed newfangled memory chips, hard drives, and other ideas to rivals. Without a stable but low-growth business in power plants and infrastructure, Toshiba might have seen its last days. "Now is the time for us to think about our survival," Nishida says.

So six months after taking the helm at Toshiba, Nishida is hoping to end the vicious cycle of tech commoditization. His plan boils down to guarding the technologies that help the conglomerate distinguish its products from rival offerings. The strategy won't apply to everything, but it will mean select innovations, such as next-generation memory chips, hard drives, and batteries that were developed in-house will stay in-house. And Toshiba has a message for anyone who dares piggyback on its patents without permission: See you in court.

That thinking stands in stark contrast to the way the high-tech industry operates today. Most companies try to persuade others to adopt their technologies, then reap the benefits of their innovation through licensing fees. While Nishida is a believer in some open standards to help new products spread, the share-the-wealth model often drives margins down near zero -- as hordes of low-cost manufacturers in China, Taiwan, and elsewhere jump in. Indeed, Toshiba has been a beneficiary of this system, earning decent royalties during the past decade from both its DVD and flash memory technologies. But those licensing deals haven't ensured profitability: The peak years for royalty payments on DVDs have coincided with the company's leanest period. So Nishida says Toshiba will now do better by keeping its smartest innovations to itself and charging more for its own products that include them.

A few years ago, Toshiba was too preoccupied with getting its house in order even to consider such a strategy. It has missed its profit targets in four of the past five years, spurring layoffs of 20,000 employees -- 11% of its workforce. Today, though, brisk sales of semiconductors and electronics have Goldman Sachs Japan Ltd. (GS ) forecasting profits for Toshiba of $762 million -- 66% better than the company's estimate -- on sales of $51 billion. Next year, Goldman expects the company's earnings to jump an additional 30%.

A lot of Toshiba's innovations will be largely invisible to consumers. Its research engineers, for instance, are working on smaller, denser, and less power-hungry flash memory chips that are expected to hit the market next year. In the past, Toshiba would have sold that technology to other chipmakers. But this time, says Nishida, Toshiba will make the new chips by itself -- although they'll probably end up in devices made by other companies. Similarly, Nishida says Toshiba will be the sole manufacturer of hard drives with a technology that can boost capacity by up to a third, and of a new type of battery for gas-electric hybrid cars that can be recharged in just a minute or so.


Other Toshiba innovations will be immediately recognizable. In 2007 the company expects to market Toshiba-branded cell phones, music players, and other gadgets powered by refillable fuel cells that convert liquid methanol into electricity. Also in 2007 -- just in time for the Beijing Olympics -- Toshiba hopes to open a $1.8 billion factory making high-definition flat-screen TVs using a technology it developed in conjunction with Canon Inc. (CAJ ) that uses less power and delivers a sharper picture.

Toshiba is backing its strategy with action. On Sept. 29 it took a long-simmering dispute with Korea's Hynix Semiconductor Inc. to the U.S. International Trade Commission in Washington. Toshiba says Hynix owes it hefty royalty payments for flash memory chips, which Toshiba invented -- but Hynix says Toshiba actually owes it money. One big reason for the stepped-up action: The chips are the semiconductor industry's fastest-growing sector. Toshiba is laying out $1.9 billion this year to triple flash output by next March, and it doesn't want others to benefit from its research. "Toshiba will increasingly sue rivals in patent rights cases that can't be settled with negotiations," says Taisuke Kato, who heads Toshiba's intellectual-property division.

It's a hardball strategy for a company that has been lax for years about its most valuable assets. And it could well be effective even when secrets are picked up in elevators.

By Kenji Hall and Peter Burrows

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