Alive But Not Well, The State of Penang's SMEs

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Penang is caught in a new industrial climate that requires that it draws on its impressive past to meet global challenges. There is no reason why our SMEs cannot keep up with the innovations that MNCs are making, if governments and other actors stay focused.

Plenty has been written about Malaysia being locked inside the so called middle income trap. The view is that the country is too expensive to effectively compete with low cost countries and lacks sufficient technological sophistication to beat competitors from more developed economies. The often prescribed answer is for Malaysia to innovate itself out of this situation. The problem with such high level advice although absolutely correct means little to the people who have to do the actual innovating.

High technology came to Penang over 40 years ago and over time, Penang’s business culture has gradually transformed itself from doing trading to one that is heavily influenced by technology and science. The popular perception is that while Penang has significantly benefited from technology-intensive foreign domestic investments (FDIs), not enough spirit of innovation came with it. While Penang continues to manufacture high technology products, the creativity and skills necessary to develop these products further remained elusively off shore.

Is this perception true or is it just that a perception? While such analysis can never be fully conclusive, it is well worth the time to put what we know about the industry and the culture into sharper perspective, and hopefully provide some insights on what needs to be done to improve our chances of really innovating ourselves out of this trap.

Defining innovation
According to Albert Einstein, an innovator is a person who can effectively conduct “combinatorial play”. What this means is that such a person is capable of juggling many pieces of knowledge and technologies and combining them in ways that will effectively solve a problem. This is an interesting definition that holds a significance for how we design learning systems for the future. 

The ability to innovate should not be construed to apply only to research and development (R&D) and hence technical excellence. Innovation can occur in many settings, from all aspects of work and life. For example, the ability for an industrialist to collaborate with a vendor to supply a bundled solution should be considered an effective innovation as it strives to improve the value of the bundled product beyond the sum of both products individually.

A brief history of innovation in Penang
1970—1980

This was a time when industry was driven by direct availability of trainable manual labour. The semi-conductor industry at this time was still in its infancy. As a result of the high labour input in the manufacturing processes, the quality of the products was marginal at best. Process engineers were challenged to figure out ways to take the errors out of the production processes in an environment where workers were the ones responsible for most of these mistakes. Fortunately at that time, there was a working level supplier base of machine shops (sometimes backyard ones) that together with process engineers were able find solutions to these problems (i.e. developing jigs and fixtures to remove operator-dependent errors from various processes). Innovation flourished as a result of this win-win relationship between local small and medium enterprises (SMEs) and the multinational corporations (MNCs) . 

1980—2000
During this period, a new set of ideas about good manufacturing was injected into industry as a result of the quality revolution started by Dr Deming and adopted first in Japan. Industry in Penang embraced these new ideas and started incorporating them in its manufacturing processes. This was a time when there was a unique opportunity to differentiate Penang’s value from those of more developed countries through quality.

Jigs and fixtures started morphing into automation. This meant that there was a need to integrate mechanisms and electronics to simple tooling. The field of electro-mechanics became the rage. Many professionals from MNCs started to leave their jobs to start up or participate in companies delivering this value. To the MNCs, automation was, and still is the solution to a very wide variety of quality problems associated with the manufacturing process. Hence this development was strongly supported via orders and innovative funding.

The combination of the opportunity to excel, a ready market and a cluster of complementary competencies provided the platform needed for further innovations to happen.

Process automation provided the opportunities to learn, adapt and install world class quality systems into production processes and help put Penang’s manufacturing prowess on the world map. Normally, when people go for training, what they take home is seldom put into practice. It takes more time, effort and sequential innovation to turn theory into practice than people think. However, this time around, the situation was unique. Almost everything learned statistical quality control (SQC), quality control circle (QCC) and total productive maintenance (TPM) were worked on and adapted to the local environment. 

The growing recognition of Penang as place where quality was embraced played a big factor in helping to further the spirit of innovation. This was a time when industrial innovation was at its peak in Penang.

2000—2010
This decade demonstrated two major trends. One was the shift of the MNCs to a more global manufacturing outsourcing model. These companies started to worry about overdependence on single source models and began to develop multi-partner arrangements located at different regions of the world. The rapid adoption of global information technology (IT) systems made it much easier to operate such operational models. In addition, sourcing started to take on a more globalised nature. Economy of scale and virtual organisations became the new buzz words.

This in turn created great growth opportunities especially for local automation companies as they became the suppliers of choice for expansion into the various countries. This in turn created new challenges for the companies that now had to seek new ways to extend their reach both in marketing and in providing excellent after-sales service. The industry now had to work on creating a compelling brand for their products as their new customers were no longer located in close proximity to them.

Some companies succeeded in securing customer loyalty, but many failed and lost orders to foreign competitors. The industry was faced for the first time with an innovation challenge that was no longer based on technical excellence alone, but also, on the innovation of a profitable global value chain. Industry, with the exception of a few organisations, failed to innovate itself out of these challenges. However, the real impact of this was not fully felt until the 2000s, due to the lack of viable competitors at the initial stages.

By 2005, foreign competitors in the automation industry had become very significant. These had developed sufficient capabilities to duplicate Malaysian machines, and in some cases come up with better versions at lower prices. Listing the large local companies operating in the Penang area would show that the majority of them had been in existence for some time and very few new electronics automation equipment companies were established in the last 10 years.

This at-lining of new company formations indicated a serious problem for industry, considering that Malaysia was once among the top countries in the world which developed and manufactured these products.

However, the story was not the same for MNCs located in Penang. While local companies experienced slowdowns in innovative development, the MNCs were busy transforming themselves to move up the value chain to mitigate rising operating costs in Penang. Companies such as Intel, Agilent, Alterra, Motorola, Osram, Avago and many others began to invest heavily in R&D and Supply Chain Management competencies in exchange for moving high-volume, low-mix manufacturing away to lower-cost countries. The dynamic actually created new opportunities for local companies to participate in a new innovation-intensive environment. However, these changes attracted a large portion of the country’s technical and innovative minds to the MNCs, making it very difficult for local companies to do the same and become viable technology suppliers to the big boys.

Malaysia’s lack of capacity to produce sufficient talent, particularly in technical areas, is compromising opportunities for a new dawn for innovation. In 2010, a colleague conducted a small survey of a select group of companies (MNC and local) that are actively working on transforming themselves into innovation-based enterprises.1 Figure 1 shows the technologies they are working on.

From the chart, we can see a clear move away from the pure manufacturing of high-volume, low-mix products. While semiconductor manufacturing continues to be the dominant activity when added up together (contract manufacturing being mainly semiconductor-based), we also see an increased emphasis on “box” or system level products and design services.

Figure 2 shows the value they are delivering to their customers. This validates the findings from Figure 1. So-called “beyond manufacturing” activities are starting to become significant. This shift will have the potential to provide an excellent platform for innovation to take root. While most of these activities remain inside MNCs, they are mainly staffed by local technical experts, hence the potential of this knowledge being retained and enhanced in Penang.

The data indicates a few interesting conclusions:

  • Traditional process automation equipment businesses are no longer on top of the list;

  • Local companies are finding some success working with MNCs on the design chain;

  • Local companies are beginning to find their own markets beyond the MNCs;

  • Many are trying (some successfully) to compete with multinational contract manufacturers in the local environment;

  • Some established automation equipment companies are aggressively moving into more upstream technologies;  

  • Local companies are beginning to put more emphasis on human capital development;

  • Beginnings of software, firmware, advanced materials, integrated circuit (IC) and industrial design industries can be found;

  • The quality of innovation must be significantly enhanced to maintain competitiveness. 

Innovation in Penang — the challenges

In general, the ndings show that innovation is not dead in Penang. In fact, it is beginning to develop, despite the tough global economic environment. Figure 3 is an illustration of what we discussed earlier about the growth, decline and growth of the innovation spirit over the years.

As can be deduced from Figure 3, after 2010, MNCs were able to re-establish their innovation level after their transformation programmes. However, local SMEs had to struggle to meet the demands of these new markets. This situation was not totally unexpected. The new markets differ from the old ones in one fundamental way. Orders for manufacturing capacity expansion are much easier to justify for customers whose purchases are generally in volume. On the other hand, R&D purchases are generally project-based and subsequent volume purchases are dependent on the success of each project. In essence, the new markets hold much higher risks for SMEs.

Figure 4 shows the most significant problems these companies face as they seek to transform themselves.

Not surprisingly, the lack of technical resources heads the list. However, the comment that the competition is getting stiffer is also signi cant. Activities that used to be innovative enough are no longer considered so. The major challenges include the following: 

A. Not being able to recruit good technical people
Successful innovation requires more than just highly qualified new graduates. It also requires highly experienced experts, visionary business owners and managers to turn good ideas into profitable reality. The problem here is the lack of sufficient growth of the latter. Many MNCs have very good employment packages for retaining their best people and invest heavily to work with educational institutions to identify and train fresh graduates ahead of time. Such strategies have proved to be very effective in securing a strong pipeline of good people.

SMEs on the other hand tend to put such initiatives on the backburner. Local companies tend to look for people who can “hit the road running”, while MNCs proactively work on creating a pipeline of talent. One interesting finding is that the work attractiveness of some of the SMEs can be extremely competitive to those of the top MNCs, but still these companies are not able to attract good people. The strong branding of the MNCs tend to be an overwhelming barrier in the war for talent. Local universities tend to use skill competency training as their mode of training. Cross discipline training is generally not emphasised. This ends up developing people who are more competent than innovative. These shortcomings together with a poor command of English and the lack of hands-on lab training do not provide the basis for innovation to thrive. A possible solution is to incentivise SMEs to follow their MNC counterparts to establish a talent pipeline for each of their organisations. One very innovative approach is to have the government provide 50% support and also offer a fully funded training programme (whose curriculum is co-developed by participating companies) to support pre-selected fresh graduates’ first year salary while working for a company. This solves the need for fresh graduates to “hit the road running”. Increasing multidisciplinary curricula in our university system and enhancing the subsidy for existing Human Resources Development Fund (HRDF) programmes specifically to allow SME employees access to cross-discipline and innovation training would also help.

B. The competition is too tough
Many R&D customers source their design partners from all over the world. Their criteria for selection are generally very severe as failures and delays are extremely expensive.

In many instances, pure cost is not as important as technology contribution and speed to market. In this new environment, local SMEs compete with global competitors and not only with local players as in the past. Many are finding this tough going.

The situation is further complicated by the fact that customer R&D markets are generally not localised. Local technology suppliers and partners are required to meet the standards of the MNCs’ international counterparts. Getting into each of these design ecosystems is much more difficult than designing and developing process automation machines and solutions for locally based MNC facilities.

The current government Economic Transformation Programme (ETP) for the electric and electronic (E&E) industry can become an effective solution if executed properly. The idea to incentivise MNCs to create technology ecosystems will go a long way to rub some of the innovative spirit and skills off on participating SMEs. What is needed is a good process to select champion companies (these do not have to be MNCs) and provide sufficient incentives for them to create these ecosystems. 

The next important factor is to make test labs readily accessible to SMEs, which need these platforms for testing their ideas. Even today, test labs are not available in Penang. The lack of “invention labs” represents a big barrier to effective innovation. If one looks at the most innovative countries, we find that their companies have much easier access to these facilities, either through their own investment, universities, incubators or public-funded labs. They have been in the game for a much longer time than we have.

C. Lack of cost effective technical services

This is one of the most important but least invested areas for innovation development. Technical services include university collaborations, technology consultations, external experts, regulatory compliance labs, market specialists and strategic planners exactly the key services necessary to support successful commercialisation of ideas.

Most SMEs, while strong technically in their specialised fields, suffer from the lack of expert services to help them flesh out, define, integrate and position resulting products and services for maximum probability of success. Unlike their counterparts in more developed economies, these SMEs lack the learning base for integrating multidisciplinary ideas.

To overcome this, experienced local entrepreneurs and business leaders should be incentivised to share their knowledge with innovators and critique the resulting initiatives. In addition, the Malaysian diaspora can also provide consultation and training for locals. If we cannot attract talented Malaysians back physically, we should tap into their knowledge, experience and networks.

In addition, a meaningful subsidy programme for innovators should be created to enable them to tap into international consultants this can be moderated by local experts.

D. Government processes are too slow
We encountered this comment very often during our interviews. In general, there is agreement that existing government policies are designed to help industry innovate and grow. There are plenty of road shows that innovators are invited to attend and each of these shows normally introduces a wide variety of programmes to support the needs of industry.

For example, there are SME Corporation road shows, Malaysia External Trade Development Corporation (Matrade) road shows, Multimedia Development Corporation (MDec) road shows, Performance Management and Delivery Unit (Pemandu) road shows, Malaysian Industrial Development Authority (Mida) road shows and many more. For attendees, they cannot help but be motivated to think that there is indeed a solution for any bonafide problem they may encounter. However, details of criteria for support can be extremely difficult to ascertain and most of the time, applicants end up becoming frustrated and giving up because of requirements for them to provide details that are not readily available at the early stages of the development process. This situation is most prevalent when SMEs apply for financial incentives.

At the same time, services such as certification, contracts, customs and immigration also need to be speeded up. Good ideas need to be fully supported with accelerated support services; otherwise the energy is easily dissipated. One very good comment we received in our survey was that the local environment tends to throw a bucket of blue all over one’s new idea.

E. Lack of good market intelligence, reach and branding
MNCs with a local base used to be the traditional markets of local SMEs. The learning base required for these SMEs to extend their products and services into the international markets are still at the basic stage of development. Most of these companies are still groping around trying to understand the dynamics of the markets that they want to participate in. Compared to their international competitors, this lack of understanding and experience is a serious handicap.

Innovation can be an expensive activity, especially if products and technologies end up missing the market’s sweet spots. It is catastrophic if a product is so ill defined that it misses the market completely. There is little energy in such innovations.

A second problem is market reach and branding. Even if a competitive product can be developed, local companies will struggle to reach and service customers. They have yet to innovate and develop the sophisticated networks and channels necessary to scale up their businesses. In addition, Malaysian products do not enjoy premium brand awareness and strength. Sometimes local products can be superior, but the brand strength of competitors ends up carrying the day.

Innovation is not dead in Penang. In fact, it is slowly taking root despite a relatively unsuitable economic environment. The question is not how to establish the innovative spirit, but rather how to accelerate and expand on the innovation seed that has already been planted.

International market research data are easily available but at a price that individual SMEs cannot afford. Agencies such as MIDA or Matrade can help provide these resources and also enable innovators to build credible business plans around their ideas. These agencies can also aggressively provide brand and channel development funding for selected companies to reach and service international markets.

 

F. Lack of access to funding

This is a favorite complaint among entrepreneurs and innovators. Creating high technology contributions that are internationally competitive needs long-term funding, either in the form of “kick start” grants or loans to grow a company. Apparently, banks and financial institutions like to profess publicly that they have strategies for SME development. However, their operating model tends to remain conservative. In order to receive funding, a company must prove that it already has the collateral or it already has a healthy balance sheet. Both these conditions generally do not exist for innovators at the start-up phase.

Existing financial models will effectively cater for infrastructure development companies or for high technology companies that already have found success and can show a strong balance sheet. While this is good, the model does not contain sufficient risk funds to enable start-up innovation which is going to be critical to the development of a high income industry.

To overcome this, the credit guarantee scheme that is in place today must be enhanced. The problem is that local nancial institutions are not structured to fully understand the dynamics of technology innovation. They normally look at projections and balance sheets for decision making. The assessment of the potential of an idea and possible future returns are generally not considered. The solution is to provide more training to financial agencies for them to better understand the technologies at play and the potential these will have on future economic performance.

Many innovators feel that their bankers just want to know their financial histories and projections and do not really seek to understand their technologies. Subsequently most give up and their ideas never reach the starting blocks.

G. Malaysia is too expensive to be competitive
In an innovation-intensive industry, the word expensive is less correlated to physical cost than to enterprise productivity. A company’s physical infrastructure may be expensive, (sometimes this is necessary to provide the tools and human resouce (HR) benefits to retain top talent), but if winning technologies and products are launched and delivered in a very effective manner, the physical cost consideration can be mitigated. The root of this complaint lies in the fact that SMEs are finding it difficult to di erentiate their product offerings against tier 1 competitors and are forced to compete with lower-cost countries. Investment in the development of a competitive technology pipeline will go a long way towards solving this problem.

A possible solution is incentivising SMEs to purchase and use the latest design tools, consultants and cutting edge labs. In addition, they should be encouraged to adopt IT-based management systems to significantly improve people, infrastructure and supply chain costs. MNCs made these transformations during the 2000–2010 period, and there is every reason, given appropriate “kick start” funding, for SMEs to follow. The recent cloud computing paradigm shift is timed perfectly to facilitate this SME transformation.

Conclusion
Innovation is not dead in Penang. In fact, it is slowly taking root despite a relatively unsuitable economic environment. The question is not how to establish the innovative spirit, but rather how to accelerate and expand on the innovation seed that has already been planted.

The environment at present is too risk-averse to support ideas that are not yet fully known. However, there is a need to shift towards an investment paradigm that “does things that we do not know how to do yet” and not “does things that will guarantee success because we already know how to do it”.

There will be need for significant allocations of public funds especially in the “kick start” phase. These investments, if properly applied, will go a long way towards helping Malaysia escape the middle income trap. This is the challenge for all innovators, businesses, support industries and public agencies in the country.

 

Yoon Chon Leong is senior visiting fellow of the Penang Institute and is the head of BusinessWise Consulting Sdn Bhd.



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