This article first appeared in Forum, The Edge Malaysia Weekly on August 12, 2024 – August 18, 2024
Innovation relies on making risky investments in assets like property, machinery, equipment and software, but these must be funded either by internally generated cash flow or external sources such as debt or equity in order to bring products from design concepts to market.
In a competitive tech market, reaching scale, scope and speed depends on the company’s value proposition, where the market broadly accepts that there is huge potential value that can be realised in the near future. The higher the potential value-added that the tech company can generate, the more investors are willing to pay a premium for its shares. The higher the market cap valuation, the more these tech companies can sell their shares or options to finance their ability to deliver their products to market. This is the virtuous circle of high-growth tech start-ups.
Most start-ups do not make it to unicorn status as they falter or are unable to move beyond proof of concept to market recognition, often not just due to funding constraints or technological barriers to commercialisation. These start-ups often fail at the governance level, particularly if they do not have the management or financial discipline to take a concept, transform it into a workable prototype and then scale to market profitability. Thus, the business model of many start-ups is simply to sell their ideas to a large tech platform, which may incorporate that innovation, idea, product or service into their array of supply chain innovations. In other words, start-ups end up being idea fodder for giants.
Clearly, the US is the prime tech market cap leader, with just the top four mega market-cap tech companies (Apple Inc, Microsoft Corp, Nvidia Corp and Broadcom Inc) achieving a combined US$10 trillion market cap valuation. All four companies are based in the San Francisco/Seattle West Coast tech corridor, reflecting the cluster concentration effect of talent and innovation.
If we look at the Taiwan tech cluster, Taiwan Semiconductor Manufacturing Corp leads the pack with nearly US$1 trillion in market cap, 30 years after the company’s initial public offering in 1994. The other top Taiwanese tech companies, such as Hon Hai Precision Industry Co Ltd, MediaTek Inc and Quanta Computer Inc, are either original equipment manufacturers for other branded companies or hardware manufacturing-oriented. We then looked at the top four tech companies in the Chinese and Malaysian stock markets by market cap to compare how their value-added creation compares with that of their US and Taiwan counterparts.
Moore’s law is an empirical observation of the progression of the number of transistors installed on a single chip. The US tech companies’ significant concentration in Silicon Valley had a cluster effect of concentrating skilled labour, venture capital and a willingness to experiment to commercialise ideas or inventions originally made by the defence industry. After these tech companies were listed, maintaining stock market favourite status meant that they are subject to quarterly reporting and asset-light strategies, forcing some companies to focus on chip design and software (talent-heavy, but equipment-light) so that those remaining in the vertically integrated design-to-manufacturing model like Intel became bogged down by heavy long-term investment in hardware and research and development (R&D), which can generate good profits if they hit the right chip that the market wants.
The fabless model (focusing on chip design) means that you are not dragged down by legacy equipment that destroys value if the chip runs out of shelf life and you may need to invest in very expensive new lithographic equipment and chip designs.
Notice, therefore, that the top four US tech companies are software or fabless (asset-light) entities, whereas the Taiwanese, Chinese and Malaysian companies are mainly manufacturers for other tech companies, so they are much more asset-heavy than their US counterparts.
In short, so far, the market valuation winners are those who spend most on tech R&D to generate knowledge advantages so that they can concentrate on software and intellectual property rights or branding/patent income, rather than working hard on equipment manufacturing, based on the designs and brands of others. The smart companies are those that are asset-light, whereas those asset-heavy companies with low tech are struggling to generate high returns. Getting profitability depends very much on choosing the right market niche and business model.
The value-added numbers are calculated based on published financial data, using the difference between revenues and costs, where the costs include not only expenses such as personnel, administrative and logistics but also the cost of capital.
Because the cost of capital exceeds the return on investment in some cases, some companies add value while others do not. Because of their superior branding and software income, Apple and Microsoft added the biggest value creation in terms of market cap among the top four US companies between 2012 and 2023, but their growth momentum was slower than that of Nvidia, which grew more than 50 times faster over the same period. As expected, US companies’ value-added-to-revenue ratio was the highest in the four regions at over 50% during the period.
By comparison, Taiwan’s tech value-added-to-revenue ratio was the second highest, at 28% to 33% during the period, except for a dip in 2023. The top four Chinese-listed tech companies had the lowest value-added-to-revenue ratio at the mid-teens level (14% to 16%) but in 2023, it dipped because the leading chip manufacturer, Semiconductor Manufacturing International Corp struggled to generate sufficient returns over the last decade.
The value-added for the Malaysian tech industry as a whole is difficult to measure as we do not have separate data on the Malaysian operations of multinational corporations operating in Malaysia. Based on the top four listed Malaysian tech companies — namely, Inari Amerton Bhd (KL:INARI), Malaysian Pacific Industries Bhd (KL:MPI), MyEG Services Bhd (KL: MYEG) and Vitrox Corp Bhd (KL:VITROX), the trend of value-added-to-revenue ratio has been steadily rising from around 20% to the 30% range. We plan to widen and deepen the study to understand how these trends are emerging from the different types of industry niches.
The preliminary data confirmed what South Korean Professors Kim and Lee surmised, that within Asia, Taiwan and China concentrated on shifting production based on reliance on foreign technology towards localisation of knowledge, while Malaysia continues to rely on foreign companies and their tech lead while slowly building up local capacities. We need much more granular data to establish the relationship between innovation and value-added.
It was also very clear from the available published data that in 2023, the combined tech value-added of Taiwanese, Chinese and Malaysian companies were significantly below that of the top US firms. The Chinese data show that they are still struggling to get profits even as they increase their R&D expenditure. That explains why Chinese tech companies are not performing so well in terms of stock market valuations overall compared with the US and Taiwanese companies.
For the tech stock market to develop, it will be important for both foreign and local investors to understand in depth the business models of the listed companies and how they fit into the global tech supply chain. Given the complex geopolitical situation, the global tech supply chain is under stress from technological developments, energy and key mineral supplies, sanctions as well as the talent and R&D capacities.
The demand for graphics processing unit chips and increasing investments in data centres to exploit the exploding artificial intelligence market is keeping the industry booming so far, but even companies like Intel are shedding some staff to ensure they remain lean and fit for the intense competition ahead.
How Malaysian companies grasp the opportunities and deal with the threats in this complex field will make for exciting times ahead in the coming days.
Tan Sri Andrew Sheng writes on Asian global issues. Loh Peixin is a research associate at the George Town Institute of Open and Advanced Studies, Wawasan Open University. The authors are engaged in a major study of the tech industry in Penang.
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