Outsource, Supply, or Die
By Dr. Roger Selbert
Jun 25, 2002 - 6:33:00 AM

The most powerful companies of the 20th century were vertically integrated, controlling every state of production of every component and product they made. The most powerful companies of the 21st century will be vertically disintegrated, or virtual, companies, those that subcontract or outsource all functions not directly related to core competencies. By acting only as assemblers of components made by subcontractors, or sometimes as no more than coordinators of the production process, such companies are able to devote full attention and resources to the most important factors of success in the new economy: product design and development, building customer relationships, branding, marketing, positioning, communication, and selling.

Although the outsourcing trend has long been underway, the current pace and degree of its progress - propelled by new economy demands and characteristics - is worth noting. Recent articles in Forbes magazine and Financial Times of London examine the trend, and a recently published study confirms the efficaciousness of sticking to core strategies.

Many of the world's best-known consumer product brands are no longer produced by the famous names themselve (including, for example, Sara Lee, Baskin-Robins, Samuel Adams, the Gap, Mattel, Hasbro, Coca-Cola, Dove, Calvin Klein and Hain Celestial). In manufacturing, many high-tech giants outsource or subcontract for major portions of their output, including Gateway, Dell, Compaq, Kodak, Lucent, Sun, Apple, Cisco, Motorola, Hewlett-Packard, Ericsson and Handspring. At the service end, Verizon, Sprint and AT&T; now use contract help to deploy and manage their cellular phone networks. And in the pharmaceutical industry, according to consulting firm Arthur D. Little, outsourcing totals $30 billion a year.

There are several other major trends that underpin and reinforce the outsourcing/core competency trend (thereby suggesting it is a long-lasting, structural change). They include:

The just-in-time phenomenon (companies seeking to increase efficiency by having only needed resources at hand, and by reducing spending on fixed assets and inventory);

The need for speed to market and for flexibility (heightened competition and changing markets, consumer preferences, technologies, etc. require nimble business responsiveness);

Globalization (large companies need to outsource components and functions from most rational sources, and to service global markets);

The ascendancy of intangible factors such as brand recognition in creating value (the ratio of stock price to tangible book value for companies in the Standard & Poor's 500 is 7:1, six times the level of twenty years ago);

The rise of a subcontracting industry composed of new-breed companies whose own core competencies are supplying high quality fulfillment of brand companies' specifications.

The result is a shift in the basic business model paradigm, from the old economy's "do-it-all," to the new economy's "focus-on-what-you-do-best."

According to Chris Zook, director of worldwide strategy practice for consulting firm Bain & Co. and author of Profit From the Core (2001), 85% of companies that achieve sustained growth do so through the mastery of only one or two dominant, well-defined cores. Vertical disintegration is happening even in car manufacturing, historically one of the most vertically integrated of industries:

Ford Motor out sources 25% of component assembly on it Explorer SUV, uses the capital saved to buy such intangible assets as the Jaguar and Volvo names, and is rewarded handsomely by an appreciating stock price.

General Motors will soon be making just the outside and underbodies of its cars and trucks; it is putting various auto supply companies in charge of the interiors of each of its vehicles.

Workers assembling the Mercedes M-class in Vance, Ala. Build just 20% of the sport utility vehicle. The rests comes in big pieces ready-made by suppliers and trucked to the assembly line, where they are bolted on.

Former Chrysler vice chairman Bob Lutz is launching Cunningham Motor, a new luxury car company which will outsource everything: design, engineering, parts production, assembly, even most retailing - operating
as a true virtual company.

Of all industries that practice outsourcing, electronics component manufacturing companies are arguably the largest and most important subcontractors. Technology Forecasters expects the sector to continue to expand at 20%-25% a year on average in the next 5 years (although growth this year will be lower). Deutsche Bank Alex. Brown project that globally, the ration of electronics output that is outsourced will double to 30% over the next few years, and eventually to 50%. According to Lehman Brothers, the value of outsourced electronics goods will more than double within the next 3 years to reach $280 billion.

Growth Strategies Implications:
Subcontractors aren't immune from adversity - those in the electronics sector are taking deep hits due to the tech industry slowdown. But the long-term trend toward outsourcing is inexorable, so compelling are the economics for vertically integrated companies to shed factories and shift manufacturing from a fixed-cost to a variable-cost structure.

Dr. Roger Selbert is one of the country's best-known and most respected trend watchers, consultant and professional speaker. He is a Principal of The Growth Strategies Group, a consulting firm that uses trend research to help companies pursue their vision for growth. Dr. Selbert is also the editor and publisher of Growth Strategies, a four-page, biweekly newsletter that since 1981 has been accurately anticipating and analyzing economic, social, political, technological, demographic, lifestyle, consumer, business, management, workforce and marketing trends. For subscription information and more about The Growth Strategies Group contact him at 310-451-2990 Fax:310-828-0427 email: [email protected]


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