Carolyn Sherwood-Call

English

Research Papers in Economics

FRBSF WEEKLY lETTEA
Number 92-09, February 28, 1992
The Product Life Cycle and the
Electionic Components Industry
Since the early 1980s, many observers have wor-
ried that Silicon Valley may be losing its position
as a leader in high technology industries. They sug-
gest that high costs in Silicon Valley have driven
firms to shift production to less costly sites. These
concerns are consistent with the views of some
economists, who argue that the factors affecting
firms' location decisions may vary during a prod-
uct's life cycle. In this view, innovation in a partic-
ular industry tends to be concentrated in a region
that offers access to technological expertise, even
if costs in that region generally are high. As the
market for the new product grows and produc-
tion technologies are standardized, proximity to
the innovating region becomes less important,
freeing firms to seek lower costs elsewhere. Thus,
according to this theory, infant industries may be
concentrated in high-cost regions, while mature
industries are more likely to be located where
production costs are low.
At first glance, recent trends in electronic com-
ponents employment among the western states
appear to be consistent with the hypothesis that
lower-cost regions are gaining ground at the ex-
pense of innovating regions such as Silicon Valley.
For example, between 1982 and 1987, employ-
ment in the electronic components industry in
California fell 1.8 percent and rose by more than
75 percent in three low-cost western states, Idaho,
Nevada, and Utah.
This Weekly Letter examines the broader geo-
graphical trends of activity in the electronic
components industry since 1977 to determine
whether the concerns about movement to low-
cost regions are in fact justified.
The product life cycle
The product life cycle theory emphasizes the
changes in the importanceofvarious factors in
firms' location decisions during aproduct's life
cycle. The first stage ofthe product life cycle is
innovation, which is characterized by geographic
concentration. Innovations may be more likely to
occur in some regions than in others, because a
critical mass of related activity can increase the
efficiency of each plant in the industry. For one
thing, a region with a cluster of related activities
is likely to have the business service and finan-
cial infrastructure in place to serve firms with
similar needs. Moreover, workers with appropri-
ate skills are likely to be more plentiful in such a
location, and ifthese skills are relatively unusual
in the general population, the location will be
particularly appealing to firms. For innovations
in which work force characteristics and local in-
frastructure are critical, proximity to these factors
is likely to outweigh other cost considerations in
the innovation stage. Therefore, an initial cluster
of activity could occur even in a location where
the general level of costs is high.
After the innovation comes a stage of transition,
in which increased demand for the product
makes investment in production technology fea-
sible, and the technology of production can be
transferred from one location to another. At this
point, firms are not tied to the site ofthe original
innovation as closely as they were in the first
stage. Nevertheless, the continued need for tech-
nological expertise as the production process is
refined may lead the firm to confine its site search
to a smaller region than it might otherwise ex-
plore. Thus, in the second stage, the industry
may spread out somewhat from its initial con-
centration of activity.
The third and final stage of the product life cycle
is standardization, when technological innova-
tions are complete. At this point, production is
"footloose" and the research activities that were
concentrated in the innovating region are no
longer crucial to the production process. There-
fore, site location decisions can be based prima-
rily on the costs of production that are not related
to innovation.
If these factors have been at work in the elec-
tronic components industry, which makes suchWages and Salaries in the Top Ten MSAs Producing
Electronic Components, 1977
FRBSF
products as semiconductors and printed circuit
boards, and if the initial production was concen-
trated in high-cost areas, wages and other direct
costs should have become more important loca-
tionai determinants over time, while attributes
associated with technological expertise should
have become less important.
While these kinds of changes seem plausible,
there are reasons for skepticism about whether
they have in fact occurred for electronic compo-
nents makers. Most importantly, the pace of
technological change has been so rapid that even
the "standardized" components change every
few years. "Standard" memory chips, for exam-
ple, have grown in their memory capacity with
stunning frequency. With products changing so
often, production processes and equipment
change frequently. This suggests that technolog-
ical expertise may continue to be important to
production, thus limiting the extent to which
standardized production processes can be
implemented.
Characteristics of innovating regions
The characteristics of the innovating regions also
will affect how the location of production activity
will change over time. If there were an incentive
to shift activity away from these regions since
1977, labor costs in these cities would be ex- .
pected to have been relatively high. The Chart
plots labor costs for the ten metropolitan areas
that were the most important electronic compo-
nents producers in the u.s. during 1977. The
Chart shows that labor costs in the San Jose area
(which includes Silicon Valley) were indeed rela-
tively high, with the average hourlywage and
average annual salary in the electronic compo-
nents industry well above the national average.
The high costs in the area around Silicon Valley
do appear to have provided firms with the in-
centive to shift activity to lower-cost regions.
However, for these ten cities as a group, costs
were not particularly high. In fact, the average
annual salary for nonproduction electronic com-
ponents workers actually was lower for these
cities than it was nationally. These figures suggest
that, even if production and nonproduction ac-
tivities become less closely linked over time, as
the product life cycle theory suggests, the shift of
activity away from these innovating regions may
not in fact occur.
Percent of
U.S. Average
1115
~ 110
105
--"..................--J 100
95
90
85
• Wage I Salary 80
Trends in u.s. activity
indeed, the data on regional market share do not
indicate a significant exodus of activity from the
innovating regions. Data from the Census of
Manufacturers reveal that the ten metropolitan
areas that were the most important electronic
components producers in 1977 experienced only
a small decline in their share of u.s. activity by
1987, from 38 percent to 37 percent. The single
most important metropolitan area, San Jose, actu-
ally increased its share during the decade, from
10 percent to 11112 percent. Information on the
years since 1987 is more spotty, but suggests that
if there was a decline in these regions' share of
total u.s. activity, that decline probably was rela-
tively small.
Statistical analysis of U.S. data suggests that firms
in the electronic components industry did not
become more sensitive to high costs during the
1977 to 1987 period. Indeed, the statistical rela-
tionship between wages and employment is
positive across the entire sample of electronic
components producing regions, rather than neg-
ative as one would expect if firms were seeking
low labor costs without regard for the produc-
tivity of the workers they hire.
The product life cycle theory also predicts that
the link between production and nonproduction
activities should weaken over time. Statistical
analysis does suggest that the linkage between
production and nonproduction activities proba-
bly has become looser over time. However, theother evidence suggests that this change is not
due to firms' shifting away from high-cost regions.
International comparisons
Many have noted that producers of electronic
components seem to have pursued iower costs
by shifting production overseas. Ifthis is so, then
the U.s. share of world electronic components
production should have fallen over time. No
consistent production activity data are available
across countries, but some suggestive informa-
tion is available. According to the Semiconductor
Industry Association, the share of U.S.-based
companies in total world semiconductor pro-
duction fell quite dramatically during the 1980s.
U.S.-based companies accounted for 67 percent
of world semiconductor production in 1977, but
that share fell to 60 percent in 1982, 45 percent
in 1987, and 38 percent in 1988. It is likely that
these numbers understate the decline in the
share of production taking place in the U.s.,
since the U.S.-based companies moved some
of their production offshore during this period.
It is worth noting that even though the U.S. share
of the world market has fallen substantiaiiy, the
level of activity in the U.S. continues to be much
higher that it was during the late 1970s. The value
of 1987 sales (adjusted for inflation) by U.S.-based
semiconductor makers was almost twice the
value of sales in 1977. In addition, between 1977
and 1987, total U.S. employment in the electronic
components industry grew 53 percent, although
it fell 3Y2 percent between 1987 and 1991.
Conclusions
This Weekly Letter has examined geographic
trends in the electronic components industry, to
see whether they have been consistent with ex-
pectations based on the product life cycle theory.
According to this theory, as the market for a new
product grows and production becomes stan-
dardized, locations with low labor and land costs
should become increasingly important to pro-
duction activity, while costly innovating regions
should see a decline in activity. For the electronic
components industry, this suggests that high-tech
centers such as Silicon Valley should have shrunk
over time, while most of the industry's activity
should have shifted to low-cost production sites.
The evidence presented in this Weekly Letter
suggests that there has not been a major exodus
of electronic components activity from innovating
regions in the United States. The regions that
were important producers in 1977 remain so
today, and despite a modest decline in recent
years, now have a far higher level of activity than
they did then. The rapid growth in low-cost states
such as Idaho, Utah, and Nevada does not nec-
essarily contradict these findings, because those
states' employment bases were so small in 1977
that the actual number of jobs added in these
states has been relatively modest. These findings
reflect the facts that the pace of technological
innovation in electronic components has been
rapid enough to limit the extent of standardiza-
tion in the industry, and that most of the impor-
tant innovating regions in the u.s. were not par-
ticularly high-cost locations to begin with.
At the same time, though, the decline in U.s.
producers' share of world production has been
dramatic. This suggests that the lure of lower
costs abroad has been an important force in the
industry, and that if the forces described by the
product life cycle theory are at work, they are
working in an international rather than a domes-
tic context. Still, these forces have not yet been
strong enough to pull production away from the
industry's initial innovating regions.
Carolyn Sherwood-Call
Economist
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Index to Recent Issues of FRBSF Weekly Letter
DATE
9/13
9/20
9/27
10/4
10/11
10118
10/25
1111
11/8
11/15
11/22
11/29
12/13
12/20
1/3
1110
1117
1/24
1131
2/7
2114
2/21
NUMBER
91-31
91-32
91-33
91-34
91-35
91-36
91-37
91-38
91-39
91-40
91-41
91-42
91-43
91-44
92-01
92-02
92-03
92-04
92-05
92-06
92-07
92-08
TiTlE
The Gulf War and the u.s. Economy
The Negative Effects of Lender Liability
M2 and the Business Cycle
International Output Comparisons
Is Banking Really Prone to Panics?
Deposit Insurance: Recapitalize or Reform?
Earnings Plummet at Western Banks
Bank Stock Risk and Return
The False Hope of the Narrow Bank
The Regional Concentration of Recessions
Real Wages in the 1980s
Solving the Mystery of High Credit Card Rates
The Independence of Central Banks
Taxpayer Risk in Mortgage Policy
The Problem of Weak Credit Markets
Risk-Based Capital Standards and Bank Portfolios
Investment Decisions in a Water Market
Red Ink
Presidential Popularity, Presidential Policies
Progress in Retail Payments
Services: A Future of Low Productivity Growth?
District Agricultural Outlook
AUTHOR
Throop
Hermalin
Furlong/Judd
Glick
Pozdena
Levonian
Zimmerman
Neuberger
Pozdena
Cromwell
Trehan
Pozdena
Kim
Martin/Pozdena
Parry
Neuberger
Schmidt/Cannon
Zimmerman
Walsh/Newman
Laderman
Schmidt
Dean
The FRBSF Weekly Letter appears on an abbreviated schedule in June, July, August, and December.

The product life cycle and the electronic components industry

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