In the huge volume of comments, both on Forbes and elsewhere, how people felt about the issue of outsourcing seemed to depend in part on where they were sitting.
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Some readers in Asia welcomed the creation of jobs into their countries, at the same time as readers in the developed countries bemoaned the loss of jobs in their country.
In a spirit of optimism, Tim Ferguson of Forbes offered, “As long as Taiwan remains a center of this technology, and as long as Taiwan retains economic and political freedom, the world is a net winner.” Others argued hopefully that “a country does not need to manufacture anything in order to be a world power”, apparently undismayed by the loss of jobs and knowledge in the economies of many developed countries.
What were those managers thinking?
The balance of opinion in developed countries was however mainly concern at the loss of whole sectors of once-vibrant economic activity. Many readers asked: What were these managers thinking?
Where did the leaders of these companies think we would end up after 30 or 40 years of gutting manufacturing? What about companies that moved operations to China and were forced to give up technology as a price of entrance? After giving up the technology, what did they think was going to happen? (“mattw0699”)
Retaining “the secret sauce”
The answer as to what these managers were (and still are) thinking has been supplied by other readers. They explain that the managers believe that they are retaining “the secret sauce”, which protects their competitive edge:
Hard drive manufacturing is a prime example. The bulk components such as platters, circuit boards and cases are made and assembled in various Asian countries (Malasia, China, Singapore, etc.). But the drive suspension (a very precise part of the drive head) is still made in the US.
The magic is all in the drive head and by withholding that from outsourcing the majority of the world wide hard drive market is still held by Western Digital and Seagate. The FoxConns, Asus and Abits of the world can’t go directly to Best Buy because someone had the foresight to keep the secret sauce in a US kitchen. ( “motytrah”)
Another reader writes that the outsourced items are “little do-hickeys” with low value and so don’t really matter in the overall scheme of things:
A lot of component manufacturing does take place overseas. For many elements this is because they have become an extremely commoditized enterprise. The majority of the little do-hickeys you see on a circuit board are worth pennies or less and have next-to-no margin. That being said, those components are often being integrated into products and onto circuit boards that are designed by Americans and American companies. These components only have value in application. The design (and productization) is what gives the components value, so these makers are entirely reliant on someone coming up with ideas on how to use them. (“Amco”)
Sliding down the slippery slope: Dynamic RAM
But other readers are less hopeful about the ability to retain “the secret sauce” and so avoid following Dell down the slippery slope to irrelevance. Those “little do-hickeys” might seem cheap in themselves, but the lessons to be learned in improving their manufacture in the end could turn out to be highly valuable. (In cost accounting and economics, which usually don’t explicitly value knowledge, this loss is invisible and so doesn’t get taken into account.)
Outsourcing thus has some resemblances to a performance-enhancing drug with apparent short-term gains but disastrous long-term consequences. Like other drugs, once you start taking it, it’s hard to stop.
Thus one reader gave the example of failed efforts to retain “the secret sauce” in the case of dynamic RAM.
I remember seeing the beginning of the end, and remarking on it at the time. Dynamic RAM is boring. It’s just the same structure over and over and over. Plus it isn’t profitable. Everybody wants a lot of it, so they don’t want to pay much per increment. The semiconductor companies sent their dynamic RAM manufacture overseas, while assuring their employees and stockholders that high-value chips like microprocessors would continue to be made in the US. That’s where the expertise was!
It happened just as you describe. As the overseas manufacturers ramped up their dynamic RAM capability, they discovered and developed techniques for manufacturing that made them cheaper and more reliable — techniques that weren’t shared with the American companies.
Of course, process technology is applicable to anything made by that process. Improved process technology for dynamic RAM also made better, faster, more reliable microprocessors with higher yields, and the American companies that weren’t keeping up with process improvements couldn’t continue to compete. More and more ICs manufacturing moved overseas, until we reached the situation we’re at now — almost no no semiconductors are made here in the US.
The big element was that giving up dynamic RAM manufacture meant giving up both control and knowledge of the process technology, and the end was inevitable from there. (riclocke)
Once you adopt the cost-cutting mindset, readers argued, it will eventually seem to make sense to outsource even the secret sauce:
Eventually (according to the bean counters) it ‘makes sense’ to increase profit at the risk of losing the store. I’ve seen it done in both small electronic engineering companies as well as a Fortune 500 steel company – for both of which I contributed its technical “secret ingredient”. In the end, that too was outsourced. (“threejeeps”)
Separating design from manufacture is problematic
Thus some readers argue that although outsourcing might have made sense in the static environment of yesteryear, in today’s world with its requirement of continuous improvement for survival, outsourcing production to a foreign firm 12,000 miles away inherently entails significant risk:
Manufacturing is an important part of security and innovation for a company. Outsourcing creates an environment where seamless communication with manufacturing is very difficult and probably not in the best interest of the manufacturer. This is not good for the quality and continuous improvement of the product. This loop is critical to the competitiveness of products in the marketplace where performance, quality, and cost are intertwined. (“elvis2u”)
Other readers argue that the loss of knowledge is even more important than the loss of jobs:
Exporting the manufacturing work erodes the knowledge and experience that makes innovations, improvements and future competitiveness possible. In the long run, losing the process engineering knowledge seems more important than any near-term loss of jobs and profits. US businesses are not just moving the work; they’re losing the know-how. We have reached or will soon reach the point where domestic manufacturing will never recapture the business, even if we were to regain parity in things like labor costs. That’s what is most important and threatening to our domestic economy. (“mojomojoman”)
The analogy to performance-enhancing drugs
Outsourcing manufacturing can thus produce an apparent gain in terms of short-run profits, but with significant long-term consequences. The analogy of a firm outsourcing manufacturing to an athlete taking performance-enhancing drugs to get a short-term boost in performance is striking. The fact that it might be legal doesn’t make it wise. The activity may appear to make sense from a limited short-term perspective, but as an overall strategy, it often accelerates the death of the enterprise as well as that sector of the economy.
“Investment bankers made us do it”
Readers also point to the role of investment bankers in pressuring firms to outsource. For instance:
I used to work for a Fortune 500 corporation whose decision to go to China was driven almost exclusively by the analysts, who told management they couldn’t support a buy recommendation if the company had no plans to be in China. But since the executives who make the decision are compensated with hefty stock options, it wasn’t long before corporate was offering Mandarin lessons. I think these people understand the long term implications of these decisions perfectly well, and they’re very sympathetic to the poor b—-ds who will come after them and have to sort this mess out – after those options have been exercised, of course.
The unholy alliance between the analyst community and executives heavily incentivized by stock options – given cover by the simplistic apologia of cost accountants who coo about labor savings in China but forget about the six-figure travel expenses – helps explain why manufacturing has left. (“hamilcar35”)
In an earlier article, I noted the suggestion of The New Yorker that activities of investment bankers sometimes resemble those of “slumlords in pin-stripe suits”. But if the critics of outsourcing are correct, the situation is worse. If outsourcing is like taking a performance-enhancing drug, then investment bankers can be seen as drug dealers in pinstripes. They are engaged in it for the precisely the same reasons as real drug dealers: because it makes extreme amounts of money. Better still, it’s legal.
What is the government thinking?
Other readers (such as mattw0699) wonder about the role of government. What is government thinking as it watches the phenomenon? Is the government asleep at the wheel?
Why for instance don’t they notice the lack of a level playing field? Or worse: why don’t they realize that it isn’t a playing field at all? Why don’t they realize that the other people on the field aren’t playing a game? Why don’t they see that the system is being deliberately rigged. For instance:
It isn’t just a business decision about where to manufacture, sometimes it has been crafted by the coordinated policies of suppliers and manufacturers and even governments in these countries. It’s not a coincidence or a simple business dollar-driven decision.
For instance, in some cases there are key components which are plentiful in supply if you manufacture within their borders, but suddenly become constrained, completely unavailable, or absurdly priced if you want the same component exported so you can manufacture in the US. We’re talking 300 to 500 percent of the price. Who can afford that? It’s a coordinated action between the suppliers of components and manufacturers in these countries, and sometimes government policies or tariffs. Simply put, you can’t buy the parts out of country, so you have no choice. Ironically, the in-country manufacturer can get you all it wants and at a fraction of the cost. They’ve carefully rigged the system.
Not everyone in government has been asleep at the wheel. Senator Carl Levin of Michigan is quoted in an excellent article this week in the New York Times by John Gertner:
Our companies are not competing with those companies in Korea and Japan. They’re competing with those governments that are supporting them. It’s naïve to believe that we just have to let the markets work and we’ll have a strong manufacturing base in America.
Are there national security risks?
Are readers being paranoiac when they take the next logical step and point to the national security risks in the situation? One reader poses a hypothetical example:
Consider this: Boeing, aircraft manufacturing, needs a new flight computer for its new aircraft it is designing. Unfortunately, the US company that made the whizzbang flight computer decided it was more profitable to outsource the manufacturing and subsequent design upgrades to Country X. Now, suppose we go to war with Country X, where are we going to get the flight computer for both military and commercial aircraft? (“threejeeps”)
Another reader is concerned that the situation is not just hypothetical:
Boeing is already proceeding down this path. With commercial aircraft manufacture, the single most difficult and exacting task is the construction of the wing and other airfoils. Boeing is farming out the manufacture of the wing to companies in Japan and Korea and losing its ability to manufacture aircraft.
Still another reader writes:
Does anyone remember the last recession, more than twenty years ago? In Houston, big oil fell on its nose. Masters-level geologists were flipping burgers for minimum wage — if they were lucky. The problem wasn’t just oil, or recession: it was the lack of diversity. A large town had become a one-trick pony. The problem with a one-trick pony is that it can’t get its own feed or paw its way through ice on the water tank. It doesn’t wear its hooves down and needs to be shod. So the pony has to farm all these services out. And God help the pony, if somebody refuses to serve him. He might get pretty hungry.
Anybody given any thought to what happens if China no longer ships products to us? What if we are so dependent upon them that we lose our independence, a la Mid East oil? What if we can’t afford to alienate them, and readily work with governments whose human rights platforms appall us? Oh, wait, that’s already happening!
Global interdependence may create big financial gains, but it weakens the ability of governments to negotiate major shared issues — like war, climate change or natural disasters. And government’s job is supposed to be to protect us, or at least, that’s the campaign promise. (“rjtaylor”)
National policy implications
So here’s the picture that some readers see emerging:
* Companies are taking the performance-enhancing drug of outsourcing for short-term profits, while undermining the future of their own companies as well as the sector.
* Investment bankers are pushing the performance-enhancing drug of outsourcing, urging it on companies so that they too can join in the short-term profits.
* Cost accountants are administering a measurement system that ignores the real long-term costs of loss of knowledge and production capacity.
* Economists at the Fed and elsewhere are producing studies that show that there really is no problem at all.
* Countries hosting the outsourcing are doing their utmost to encourage more consumption of the drug of outsourcing for as long as possible.
* The governments of developed countries, facing loss of jobs and declining economic growth, are borrowing vast amounts to finance their own large deficits from the very countries that produce the drug of outsourcing. It’s as if the police decided to dip into the profits made by those producing the drug of outsourcing.
* In the process, large sections of the economy have already been lost. Many more sectors are at risk, including areas that appear to be of high strategic importance.
Where is the national interest?
Even those who recognize the importance of “one-world” thinking and the value of free global trade are dismayed at apparently trusting the future entirely to the kindness of strangers, particularly when the interest of those strangers lies in continuing a phenomenon that appears to be at odds with the national interest.
Why, they wonder, are these seemingly intelligent, highly educated people going about their business as if this is a perfectly normal and healthy state of affairs?
The answer is not hard to find. As Upton Sinclair remarked: “It is difficult to get a man to understand something when his salary depends on his not understanding it.”
The process is driven forward inexorably by the monetary incentives for the “producers”, the “dealers” and the “police”, as well as the “consumers” of the performance-enhancing drug of outsourcing. Meanwhile it’s the jobs, the economy and the future of the country that are put at risk.
Solving the problem
The key to solving the problem is first understanding it. Thus as explained in part 3 of this series, it’s not just a problem of the decline of manufacturing. The root cause of the problem is the decline of management itself: it affects software as well as manufacturing. Outsourcing and the loss of whole sectors of the economy are only one of the negative consequences of anachronistic management practices of Shareholder Capitalism, i.e. the idea that the be-all and end-all of a company is making money for its shareholders. Once a firm adopts short-term profit-making as its goal, the company and everyone in it are inexorably drawn into a set of activities with negative long-term consequences like outsourcing.
Solving the problem thus requires a recognition that we are now in the Age of Shareholder Capitalism, as explained by Roger Martin in his classic HBR article. In effect, traditional management focused on short-term money-making has to give way to radical management where the goal becomes that of delighting the customer with continuous innovation.
Once continuous innovation becomes the be-all and end-all of the firm, outsourcing can be seen in its true light as a dangerous performance-enhancing drug that risks undermining the firm’s, and the country’s, long-term future.
Investors are already playing a role in the transition, as they value more highly the companies of the future that practice continuous innovation such as Apple [AAPL], Amazon [AMZN] and Salesforce [CRM], as compared to companies practicing traditional management, such Wal-Mart [WMT], Cisco [CSCO] OR GE [GE]. Investors are increasingly realizing that short-term financial gains are ephemeral: the companies that will generate real value are those that do what is necessary to continuously innovate.
Source:http://www.forbes.com/sites/stevedenning/2011/08/30/amazonkindle-part-5-is-outsourcing-a-national-security-issue/
