by: Issues: November / December 2008. Tags: Strategy. Categories: Featured and Strategy.

In stealth-like fashion, outsourcing can erode a manufacturer’s competitive advantage. Believing that profits will rise if it starts to outsource, a company can lose sight of the fact that it is gradually – and unwittingly – losing the capabilities that have differentiated it. But turning inward, specifically to employees, and enabling them to re-capture the company’s reputation for process innovation will help re-build a sound platform for success.

Not so long ago, innovative products could be made using processes that were developed in earlier generations. But this is no longer true for many manufacturing sectors, especially in a global economy in which demand is driven by product performance and value. For companies in these sectors, it is imperative that product innovation excellence be backed up by process innovation excellence.

Sadly, and almost unknowingly, many manufacturers surrender the possibility that their operations will ever represent a competitive advantage. It happens gradually, as internal functions such as the design, manufacture and repair of tooling, the overhaul of equipment, the fabrication of parts, and finally, the assembly of the products themselves are progressively out-sourced. This is not to say that external vendors necessarily do an inferior job. In fact, on average, they may do a superior job, and at a lower cost. The problem lies in the phrase “on average.” Instead of retaining the best-in class-capabilities exemplified by certain of its internal operations, the firm ends up having the same capabilities as its competitors. In this “me-too” environment even the largest firms increasingly come to rely on fewer and fewer distinctive competencies to drive sales and define their firm. In such situations, a supplier can vault from being a subservient “partner” to one that dominates a relationship, as it acquires most of the product and process technology. An analogy can be found in the world of investing, where the wisdom of maintaining a diversified portfolio is universally accepted. While the principle and wisdom of diversification applies to manufacturers, many of them respond to financial pressure by divesting themselves of more and more of their human and physical resources, thereby reducing a diverse portfolio of processes to only one or two. They thus expose themselves to the same risks as an investor with a portfolio that is not diversified.

The withering of competitive advantage

Manufacturing is not as separable from the rest of the organization as outsourcers would believe. Effective in-house manufacturing provides the best opportunity to harmonize product design specifications with process capabilities, as well as retain and protect intellectual property. It offers additional barriers of entry to potential competitors. The electronics manufacturing industry will be used to demonstrate the negative long-term impacts of outsourcing. The high labour cost of in-house manufacturing in North America relative to those of global competitors needs to be addressed through the creative deployment of the firm’s human resources. It will be suggested that many benefits accrue from a flexible job-design policy that encourages the transfer of routine equipment maintenance from technicians to operators. These benefits include the prospect of happier, more engaged employees. The key is to provide employees the same job security while offering alternative work challenges that are intrinsically rewarding and contribute to the company’s competitiveness. Several examples of such activities are provided below. For example, every employee can have good ideas, and a successful suggestion program allows everyone in the organization to contribute to safety, the environment and competitiveness. The reasons why such programs have not been successful in North America are discussed.

The evolution of the electronics contract manufacturing (ECM) industry provides a noteworthy object lesson in the loss of competitive advantage. In their early years, major original equipment manufacturers (OEMs) such as Apple, Dell, HP, IBM, Motorola, Nokia and Nortel performed most of their work in-house. Production of unpopulated circuit boards was often the first step to be out-sourced, since the photo-chemical and mechanical processes polluted the atmosphere and could potentially contaminate downstream operations. Over time, this move was followed by the outsourcing of circuit board layout design, which in turn was followed by the outsourcing of component assembly and testing, component procurement, in-bound logistics, electronic circuit design, product assembly, product design and out-bound logistics. At each step, manufacturers reduced their costs. But the biggest and the best of the OEMs also reduced their competitive position, as even the smallest of the OEMs’ competitors gained equal footing by taking advantage of world class ECM manufacturing capabilities and scale economies that the ECMs offered to all. Step by step, the increasingly hollowed-out firms lost one more capability that differentiated their products on the basis of process innovation, removed one more barrier to entry for new competitors, and helped increase their suppliers’ strength and volume.

If this was the end of the process, it could be (and frequently has been) argued that the savings from out-sourced production are still the best way to maximize shareholder value. But those obliging suppliers who add most of the tangible value, yet often receive a small fraction of the revenues, tend not to remain satisfied forever. Along the way the hollowed-out companies begin to lose the link between product and process innovation. Even the biggest mobile phone and computer companies have become mostly marketers and distributors of products designed and manufactured by others. And, in the process, ECMs morph into original design manufacturers (ODM) who, in addition to all of the previously listed ECM activities, start to identify market needs, design products to their own specifications and offer them either to their traditional customers (e.g., Motorola) or their customers’ customers (e.g., Bell). These are the last steps before they emerge as full-fledged marketers of their own brands. Now, an increasing number of advanced mobile phones world-wide bear the names of an ODM (e.g., HTC). This has also happened in the computer business, where traditional third-party suppliers (e.g., Acer) offer their own branded products in addition to producing for others.

A related but earlier trend in many industries is many manufacturers’ increasing reliance on equipment and tool suppliers for competitive manufacturing technologies. The trouble is that suppliers rarely have an incentive for giving one customer an edge over others. In fact, it is in the equipment and tool suppliers’ interests to promote competition among their customers for the latest and greatest equipment.

A good example is the American Connector Company (ACC) case of the early 1990s1. ACC worked with an equipment manufacturer to develop a new state-of-the-art assembly machine to produce its electronic connector products. ACC might have hoped that the new machine would have provided a sustainable competitive advantage. Perhaps not surprisingly, the supplier offered the machine to ACC’s competitors. Revealingly, a strong potential competitor declined the offer because it preferred to purchase proven, standard equipment and customize it in-house for its unique applications. Moreover, unlike ACC, who relied on contractors for most of its tool design and manufacture, the competitor designed and built all but the simplest tools in-house, allowing its engineers and technicians to constantly and concurrently innovate its processes and products. This resulted in significantly higher product quality at lower costs.

Equipment that is developed in house, or purchased in standard form and modified in house, allows its owner to obtain sustainable competitive advantages. Behind a factory’s closed doors and hidden from competitors, the intellectual property embodied in the equipment remains secure. Products that exploit in-house innovative process technology can blind-side the competition when the product’s attributes cannot be replicated without the hidden intellectual property. On the other hand, new products produced by processes that are known can be duplicated and refined by any competitor who purchases and reverse engineers them.

Process innovation is the crucial facilitator of product innovation

There is no doubt that product innovation can occur when manufacturing is outsourced. However, when certain processes are not under the control of the product innovator, there is little protection against the rapid entry of “me-too” products. Even worse, product developers lose touch with their outsourced suppliers’ newer capabilities. This is unfortunate, since suppliers can be expected to enhance their processes constantly. The result is sub-optimal product designs that fail to take full advantage of suppliers’ process innovations. On the other hand, one can be quite certain that ODMs will fully exploit their latest process innovations in the design and manufacture of their own branded or private label designs.

Samsung Electronics is one of the world’s largest and highest-rated manufacturers of electronic products. Its in-house manufacturing excellence is one reason for its rise to global dominance. Ji Oh Song, Executive Vice President of Samsung, speaking at a conference in Italy2 said, “If we got out of manufacturing, we lose.” He also indicated that keeping research and development in the same location as manufacturing “is very important and leads to faster market domination.”

Nurture Equipment and Tools

Much is made in the media of flexible plants, but there is little mention of the flexibility of the employees who work in them, —including the flexibility of maintenance technicians—particularly how that flexibility promotes process innovation. Numerous job-protecting labour contract clauses and workplace practices do not allow manufacturers to benefit fully from the skills in their workforces. Firms can enhance both operator and technician flexibility by addressing the job security issue directly, namely by committing to no lay-offs unless there is a specifically defined decline in sales. In return for job security, firms ask for relaxed job classifications. They proceed by asking technicians to identify a few of the simplest, most routine maintenance tasks and teach the equipment operators how to do these tasks. Both technicians’ and operators’ jobs will be enriched in the teaching/learning process. Once operators are trained they can relieve technicians of these routine maintenance tasks. Maintenance technicians can then use their freed-up time to perform the more psychically rewarding tasks of enhancing equipment under their care. Here are seven possibilities.

  1. Modify equipment so that it is quicker and easier to inspect and repair. For example, fit quick access panels, add quick disconnects, or reduce the need to share scarce resources like cranes and forklifts.

  2. Modify procedures, equipment or tooling to take advantage of the small, finite number of jobs each machine is required to perform, as opposed to the full variety of tasks and settings for which the equipment or tool was originally designed. This initiative, which has been well developed in the just-in-time literature, can reduce losses of time and material during changeovers or cleaning. Although many published examples involve stamping and injection-moulding machines, the techniques are broadly applicable. Order-of-magnitude improvements are routinely accomplished, with dramatic savings in capacity, space, lead times and inventory investment.

  3. Modify equipment so that operators can perform their own changeovers. The key step is to analyse the reasons why operators are not able to perform the task on their own and then eliminate those reasons. When shop rules ban operators from doing work that requires tools such as wrenches, it may be acceptable to attach the tools to the machine permanently.

  4. Modify equipment to increase its operating speed or improve its precision. A well-known grocery products manufacturer demonstrated the efficacy of this approach in one of its European plants. Its engineers and technicians had customized an older packaging machine so that it operated significantly faster than even the newest machines that the equipment manufacturer offered to others. It illustrated the common truth that skilled in-house personnel can come to know more about their equipment than the manufacturer of the equipment.

  5. Identify the root causes of continuing defects and develop devices that prevent these mistakes from re-occurring. In this regard it is helpful to be philosophical and adopt the position that all defects are the result of human error. Of course, if the defect is produced by a machine, it is easy to blame the machine. But machines are rarely the root cause. Either the design specification is stretching the machine’s capabilities or the machine is not being properly maintained. There should be a bias to view defects as learning opportunities for all concerned and not a reason for disciplinary action. If employees expect to be punished they will hide the errors or their results—regardless of who was at fault.

  6. Add deeper, more thorough inspections. By probing into equipment more deeply it may be possible to detect certain components’ imminent failures and to replace them before their malfunction results in greater equipment damage, as well as lost scheduled operating time and associated delivery delays.

  7. Replace or augment scheduled inspections with condition monitoring. Measure and analyse the foreign-material content in equipment lubricant reservoirs, and track changes in equipment operating temperatures and vibration levels to identify component wear, so that degraded parts can be replaced before they fail or result in equipment failure.

In addition to being the key building blocks of continuous process innovation, all of these activities have the potential to satisfy employees’ needs for self-actualization and increase their feelings of self-worth. The result is a terrific synergy between operators and maintenance technicians. The more satisfied technicians become with their new challenges, the more engaged they will become, and the more they will want to teach operators routine tasks. The more maintenance work that operators master, the more their job satisfaction will increase. In fact, with an effective apprenticeship training program, it may be possible to assist operators to become full-fledged technicians, something which can increase their income and job satisfaction. Their employer also gains by creating a new source of technicians who are already familiar with the firm’s products, processes and procedures.

Cultivate suggestions for continuous process innovation

Employee suggestion programs can be a key component of process innovation. Sadly, such programs are rare. Some managers believe, mistakenly, that their employees are unlikely to suggest anything useful. Therefore, they don’t even ask for suggestions. Many other managers view suggestion submissions as transactions requiring payment according to their value. The trouble is that most suggestions, regardless of their validity, do not save enough to pay the people making the suggestions meaningful monetary rewards. For the small number of suggestions whose value is truly significant, there remains the thorny issue of ownership. One sure way of deflating morale is to pay the author for a suggestion that was actually someone else’s idea. The problem can be further compounded in three ways. The first is by not providing sufficient guidance on the types of suggestions needed. Management needs to be clear that it is looking for suggestions to improve safety, the environment, quality, cost and customer responsiveness—not the length of the breaks or food selection in the cafeteria. If most suggestions are aimed at the former areas, the fraction accepted and implemented will be higher, with positive impact on employee buy-in, since it avoids having to reject well-meaning, but unwanted suggestions. Second, failing to empower lower-level managers to acknowledge, approve and implement suggestions will create unacceptable delays. Suggestions that do not adversely affect any of the above issues, while improving one or more of them, need to be approved at the lowest level in the organization that has the budget authority to approve the expenditure for the change. In many cases, this means that suggestions could and should be approved quickly and implemented by first-line supervision. It should be noted that changing supervision and management mindsets from one of “business as usual” to one that embraces continuous process innovation will be the greatest challenge in some organizations. Finally, staff members can quickly discourage employees from making suggestions if they attempt to minimize their value. Under these conditions, the stream of suggestions will dry up.

The failure of many previous suggestion programs in North America needs to be compared to the success of the minority of employers who routinely receive many suggestions per employee per year and pay little for them. For example, as early as the 1980s, Toyota received more than one suggestion per employee every month. And it implemented almost all of them! Effective suggestion programs downplay monetary rewards. Instead, recognition is given by senior management in the form of posted displays, photographs, presentations, etc., opportunities to travel to company-sponsored events where they present their ideas, and small gifts whose value is not linked to the value of the suggestion. Teams, as well as individuals, are encouraged to submit suggestions and their contributions are recognized as such.

In summary, manufacturers wanting to compete with innovative products that will be produced by distant partners would do well to review the history of such partnerships. All too often the short-term increases in profits that are obtained by outsourcing are followed by long-term declines in product competitiveness. This decline results from poor communications between product and process designers, and the loss of intellectual property. To offset the undeniably higher wages of Canadian employees, management needs to work hard on increasing employee flexibility. Adapting the respective roles of equipment operators and maintenance staff and encouraging suggestions are fundamental to success.

  1. ACC is Harvard Business School case number 9-693-035. The name of the actual company has been disguised.
  2. Manufacturing and Technology News, Volume 11, No. 11, June 2004.