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Horizontally Integrated Or Vertically Divided?

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Horizontally Integrated Or Vertically Divided? Horizontally integrated or vertically divided? A comparison of outsourcing strategies at Ericsson and Nokia ”Outsourcing is one of the most misunderstood concepts in use today” Jorma Ollila Working paper October 2002 Lars Bengtsson and Christian Berggren 2 (22) PREFACE In this report we try to compare the outsourcing strategies of Nokia and Ericsson, delimited to the production of radio base stations. The results from a preliminary version of this report rendered a great interest in media during summer year 2002. The results and implications have, however, in several cases been over-interpreted and even misinterpreted. We thus feel impelled to elucidate the ambition and status of the report. This is a working paper which aims at illustrating various choices and discuss their consequences, in order to elaborate questions for our further research. A follow-up study, in which we analyse current outsourcing strategies is in progress. The analysis in this report is delimited to one business area within Nokia and Ericsson, namely the radio base station business. The description of other business areas mainly serves as a background to the comparison. The working paper mostly deals with the situation and planned activities as they appeared during early spring year 2002. During late spring and summer of 2002, the market situation has dramatically changed for the telecom companies. In order to conclude this report, we have chosen not to include the efforts made to deal with these new conditions. The descriptions and analysis are based on the picture given by the interviewees and the material we have had access to. We cannot exclude that there are alternative and complementary images of the companies. The rapid changes within the companies have also led to a situation in which the strategies are expressed and interpreted differently in various parts of the organisations. The overall strategies of the corporations have not been available to us. We have thus not analysed the relations between our descriptions and these overall strategies. Despite these limitations we believe that the questions, decisions and consequences concerning costs and competence, which are elaborated in the report, are of general interest. We hope that the analysis may provide a valuable contribution to the discussion on outsourcing and its effects, which is a topical question in many companies. Gävle in October 2002 Lars Bengtsson Christian Berggren University of Gävle University of Linköping 3 (22) CONTENTS PREFACE .................................................................................................................................2 1 BACKGROUND....................................................................................................................5 1.1 THE FUTURE OF MANUFACTURING: A COMMODITY OR A STRATEGIC COMPETENCE?..........5 1.2 OUTSOURCING IN THE TELECOM INDUSTRY – ONLY ONE WAY FORWARD? .........................6 1.3 PURPOSE OF THE REPORT....................................................................................................7 2 NOKIA AND OUTSOURCING...........................................................................................9 3 ERICSSON AND OUTSOURCING..................................................................................11 4 LEARNING FROM NOKIA OR ERICSSON? COMPARING TWO OUTSOURCING STRATEGIES .........................................................................................14 4.1 TWO ALTERNATIVE STRATEGIES FOR OUTSOURCING ........................................................14 4.2 RISKS AND COSTS. AN ANALYSIS OF JUSTIFICATIONS AND OUTCOMES. ............................15 4.3 INDUSTRIALIZE WITHOUT VOLUME PRODUCTION? THE PROBLEM OF CORE COMPETENCE 18 4.4 LEARNING FROM NOKIA OR ERICSSON? ...........................................................................19 REFERENCES .......................................................................................................................21 4 (22) 5 (22) 1 BACKGROUND 1.1 The future of manufacturing: A commodity or a strategic competence? During recent years there has been a strong trend within Swedish industry towards outsourcing of manufacturing and resources supporting manufacturing. An indication is the decreasing level of value-added within the engineering industry, from 31% in 1990 down to 25% in 1998 (VI 1999). This outsourcing trend signifies a changing view on the significance of manufacturing. Quite a few companies have begun to view manufacturing as an undifferentiated standard activity (e.g. Arnold 2002), a ”commodity” which easily can be sourced from external market actors in the new “network economy”. A representative case of this attitude could be found in Harvard Business Review 2000: ”Does Manufacturing Matter? The short answer is: not much. And that´s a good thing” (Ramaswamy & Rowthorn 2000). In the research on production and outsourcing, however, several authors have pointed to the problems of large-scale outsourcing. The outsourcing decisions are often justified by cost considerations, but paradoxically it has turned out to be quite difficult to sort out the actual cost effects of outsourcing decisions, not only in the long-term, which is always difficult, but also the short-term outcomes. The costs, ex post, of manufacturing at contract manufacturers, are often different from the quoted price, ex ante. Various transaction expenses, such as the costs of transferring products, equipment and knowledge from the customer firm to the contract manufacturer are left out of the analyses, and so are the costs and potentials of various production learning curves, etc. Against the ”manufacturing-as-commodity”-perspective, a perspective on manufacturing as a strategic competence within technology-based firms has been formulated (e.g. Brown et al 2000; Pfeffer & Sutton 2000). Whereas the outsourcing trend tends to downgrade the value of manufacturing knowledge and process engineering skills, this perspective points to the need of investing in advanced manufacturing processes and competence development. From this view follows the importance of making the strategic role of manufacturing visible inside and outside the firm. Otherwise valuable resources might be lost as a result of short-term financial considerations. Since outsourcing tends to be an irreversible process, these resources might be impossible to recover. If the role of manufacturing competencies remains neglected and ”invisible”, there could be an increasing gap between actual productivity in the down-graded production departments and the productivity increases which might result from a commitment to invest in strategic production development. This potential productivity gap has motivated a new research project on the consequences of outsourcing for renewal and learning capabilities in technology-based firms (Bengtsson 2001). A key question concerns the role – if any – of manufacturing for the long-term competitive positions of the studied firms. According to the project proposal, there is a need for an elaboration of the future-oriented and company-unique capabilities, which are or could be realized in advanced manufacturing operations. In previous studies five categories of such potentially strategic competencies have been singled out (Berggren & Bengtsson 2000; Bengtsson & Berggren 2001): 6 (22) • Operational skills in achieving high levels of quality, productivity, flexibility and delivery precision. The links between these capabilities and the competitiveness of innovative firms have been demonstrated in several studies. • Competence in logistics and sourcing. Manufacturing skills constitute an important basis both for evaluation of suppliers and knowledge exchange with the suppliers. • Competence in design for manufacture, experiences of participation in cross-functional development and in analyzing and communicating manufacturing consequences of design decisions. • Competence in industrialization (process engineering and production ramp-up). The ability to achieve a rapid ramp-up from try-out runs of new products to high volume production in a short period of time is of increasing importance for competition in global industries. This competence is based on several production-related capabilities, such as process planning, industrial engineering and materials management, test development and prototype fabrication. A systematical development of product-process flexibility in the production system is a key condition for achieving such a competence in industrialization. • Competence in environmental management. The experience of structured quality and environmental management efforts in well-run manufacturing units could serve as a model for company-wide environmental management systems, including management of supplier activities. As long as the potential and actual capabilities of manufacturing are not visible, not understood and not appreciated at corporate levels, it is difficult to evaluate the possible contributions of a firm´s production operation to the future competitiveness of the firm. In this situation efforts to estimate the merits and demerits of outsourcing remain elusive. In financially hard times firms are tempted to find “silver bullet-solutions”, by for example selling off manufacturing divisions, to get rid of visible costs tracked by stock market analysts. In these circumstances it is particularly important to understand the full costs of outsourcing, and the potential role of manufacturing competencies for effective product development,
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