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Thus Spake MIT: How are American Companies Faring in the Global Economy?

By Bill Schweke on 04/23/2007 @ 04:40 PM

Tags: Ideas in Development, Economic Development, Global Economy, Recommended Readings

Every few years, a cross discipline group of MIT scholars put on their walking shoes, go into the field, and see “what companies around the world are doing to make it in this global economy.” The Berger study is the latest – a five-year identification and analysis of 500 international companies. The effort aims to “discover which practices are succeeding,” “which are failing,” and “why.” Spurred by the “rising fear in America that no job is safe,” the researchers wished to explore whether these anxieties are justified. The Center visited facilities around the world, “asking questions about which parts of the manufacturing process are carried out in their own plants and which are outsourced, who their biggest competitors are, and how they plan to grow their businesses.” Are managers working to offshore jobs “Benedict Arnold” CEO’s? Or, is this just the latest phase in globalization, responding to the latest fall in the price of moving information and moving goods, where the benefits will markedly out-weigh the costs and pain caused by the inevitable dislocation that accompanies downsizing, relocations, and closings?

Let’s start with a little history.  Earlier last century, the model for big corporations was Ford – a massive and vertically integrated firm that provided parts, arranged consumer financing, and built the cars.  Called Fordism in the academic literature, this model appears to be dead.

Why?

“Just in time” inventory control, planning, and production, total quality management, and continuous improvement were the first catalysts for change in corporate strategies and tactics.  (But the hope originally was that the overall thrust of these tools would help to reform “the vertically integrated company model to make it more efficient, more flexible, and more capable of driving innovation into production and the marketplace.”)  This was how Japan was doing it.

Another breakthrough tilted firms in a different direction.  This was “codification” – the use of software that allowed companies to give suppliers exact information in a digital format on how to carry out parts of the production.   This would allow a smooth handoff of a function.  So, the stage was set.

Improvements in communication, driven by the increased use of information technologies and transportation costs, access, scale, and speed are some of the enablers for this increased out-sourcing and off-shoring.  Described with phrases such as the “fragmentation” of production, “modularization”, the corporation as a “nexus of contracts,” and the “virtual” corporation, this strategy exhibits a tremendous momentum, as an increasing number of firms embrace this template. 1

Other motivators include labor costs, which differ dramatically between developed and developing countries.

Policy changes, regarding tariffs, quotas, currency controls, immigration, domestic content requirements, and imports have further freed markets, heated up the competition, and made the “modularized” company a profitable and feasible (and possibly necessary) reality.    Consequently, firms with international business goals must tailor their own responses to these events and trends. 

• They must “match the best or outsource to the best.”
• “Grow out of a legacy.  Companies’ best practices will vary – even in the same sector, even for the same product – depending on each firm’s history, the way each has built up particular human and technical resources, and the differences between the societies in which the firms grow up.’
• “Low-wage strategies lose.”  Wages are still only a small element in overall costs.  Productivity and unit costs matter more.  Many low-wage countries offer poor overall climates for investment, due to failing states, corruption, crime, and chaos.  Those that try to win by exploiting low-wage labor will face new even lower wage competitors as time goes by.  For a developed economy like the US, this is no way to create a durable advantage.  “The activities that succeed over time are, in contrast, those that build on continuous learning and innovation.  These allow companies to build capabilities—brand name, property, specialized skills, reputation – all of which are out of reach to companies whose only assets are their access to cheap labor.”
• “To win, choose.”  There is no single recipe for success.  So, from defining a product to producing it, what does the firm want to out-source and what remains in-house?  These must be custom-fit decisions, not copy-cat imitations.

 

the book’s field lesson include:

• Many models of success; no silver bullets.
• What’s important are having access to the right capabilities not what industry you’re in.  There are no sunset industries.
• Functions are being reshuffled.  What’s manufacturing?  What’s services?  They are being recombined in new ways.  Think outside the box as you choose the optimal combination of partnerships, out-sourcing, in-housing.
• Cheap labor is not a winning strategy.
• Don’t build a competitor.
• Meeting the Chinese challenge is no easy matter and more corporate and policy thinking is needed.
• US business cannot be complacent.  They have no birthrights to their competitive advantages.  Technological “leapfrogging” can happen quickly.
• A firm’s legacy is a renewable resource.
• There is a lot of good job creation.  The problem is that it may not match the places and skilled occupations that are losing employment.
• Flexibility, open markets, and good education for all are critical.  An improved and more fiscally sufficient Trade Adjustment Assistance program is needed.

In sum, the MIT team generally likes what they see, although they do suggest we don’t know enough about the scale and impacts of current off-shoring and we do need a better China/India strategy.  The authors also think that the US is better at running modular operations than many of our competitors.

The Lester and Piore book on Innovation is sort of a “Minority Report.”  They were part of the Center’s team, but they believed that there were some concerns that were not well voiced.  They looked at a range of industries from blue jeans to electronics. 

They express some fears about taking modularization too far, especially as it affects product development and design.  There are often synergies between design and manufacture, and the integration between producer and final customer that can be lost through too rapid and radical fragmentation efforts.  In addition, the concentration on core competencies can inordinately make it harder for the creative side of the brain to operate efficiently.  They contrast the term, “interpretation”, to “analysis” and argue that fragmentation strategies, concerns about short-term share returns, and aiming to have all company units meet some company metric may be harmful.  For instance, dismantling boundaries by moving the Bell laboratories further away from other operations and imposing more financial oversight and hierarchy is not necessarily the best way to empower the “creative class.” 

Thus, Lester and Piore are issuing certain warnings regarding modularization.  Not only should we be careful to build up a competitor, we should make sure that we are paying close attention to the differences that characterize a company’s functions.  Out-sourcing choices or converting some part of the firm into a separate company may be more costly over the long-term.

So, where does this leave us?

The drivers and enablers for modularized management are very powerful forces.  The adoption of modularization has already gone pretty far and will be difficult to curb.  From a shareholder and customer view, it makes a lot of sense.  But there is a role for further research on causes, effects, and scale of off-shoring (e.g., ratio of good versus bad jobs, latest trends in out-sourcing, etc.).  There are also a number of good books that I will be reviewing soon that delves more into the job creation, loss, vulnerability, and turbulence question. But even with what we know now, we do need to upgrade our transition assistance for dislocated workers. 

I don’t believe we know enough about the issues that Lester and Piore raise to offer any clear recommendations.  More research and communication with firms is required.

in conclusion, although I hate to be fatalistic about these phenomena, it may be neither possible nor desirable to try to halt it.  Complimentary policy reforms are probably required.  It is one thing if this is all happening in a context, where we spend more on displaced worker transition aid, we are engaged in a major effort to become energy independent, and it is much easier to organize a trade union in the private sector.

That’s a different world, dude.

Suzanne Berger and the MIT Industrial Performance Center, How We Compete. New York: Doubleday, 2005. ($27.50)

Richard K. Lester and Michael Piore, Innovation: the Missing Dimension. Cambridge: Harvard University Press: 2004. (Paperback 2006 edition).

1 “Modularity is a term used here to describe the technological and organizational possibilities for breaking apart a production system that might once have been contained within a vertically integrated company and having independent companies carry out these functions.”