Taiwan’s original-design manufacturers (ODMs), such as Wistron, a contract producer of desktop and laptop computers, and Asustek Computer, a major supplier of printed-circuit boards, make an impressive share of the world’s high-tech goods for major branded companies, including HP, IBM, Microsoft, and Sony (exhibit). But the sales figures conceal growing signs of uncertain times ahead. Taiwan’s labor costs are higher than those in nearby countries, and contract manufacturers such as Flextronics (based in Singapore) and Celestica (based in Canada) are edging into the market, putting Taiwanese manufacturers at risk. Meanwhile, the world’s high-tech markets are in the grip of a wrenching slowdown.

The first response of Taiwan’s ODMs was to migrate their more labor-intensive production capacity to China. Our research with several of Taiwan’s leading high-tech players indicates that their next move should be to cut their operating costs. To be sure, the move to China has proved beneficial—the ODMs quickly reduced their total manufacturing costs by 10 to 30 percent, depending on the type of business. Relocation not only helped lower their labor costs in general but also provided them with access to China’s large pool of engineering talent and with proximity to a big and rapidly growing...