Tuesday, March 8, 2011

More on the limits to outsourcing?

Sometime back, I had blogged about how outsourcing and expanding supplier networks had played an important role in Toyota's recent vehicle recall problems,

"As it has gained sales, Toyota has moved away from some of the business practices it adopted in its years of slow but steady growth. One example is its decision to buy parts from companies around the world, rather than from a small group of Japanese suppliers that have been longtime partners. For example, the pedals in the vehicles affected by the production and sales stoppages come from a supplier’s Canadian plant... The move to expand its supplier network was necessary to save money, given cost pressures on Toyota and other manufacturers... But the shift also makes it harder for Toyota to control quality."

Now Paul Krugman points to similar problems at Boeing, most famoulsy with delays facing its 787 Dreamliner. In order to cut costs and improve efficiency, Boeing ignored warnings and aggressively farmed out design and manufacture of crucial components to suppliers around the nation and in foreign countries such as Italy, Sweden, China, and South Korea. The 787 is expected to have 30% foreign content, to a mere 5% in 747. Its objective was to source modules from across the world and assemble it at Seattle. However, this is what happened,

"Some of the pieces manufactured by far-flung suppliers didn't fit together. Some subcontractors couldn't meet their output quotas, creating huge production logjams when critical parts weren't available in the necessary sequence. Rather than follow its old model of providing parts subcontractors with detailed blueprints created at home, Boeing gave suppliers less detailed specifications and required them to create their own blueprints."

Boeing's 1997 merger with McDonnell Douglas also accelerated the push towards more outsourcing,

"The merged company appeared to prize short-term profits over the development of its engineering expertise, and began to view outsourcing too myopically as a cost-saving process."

This aggressive outsourcing was not complemented with appropriate strengthening of the quality supervision and more intensive management of the supplier network. Some of the contractors and suppliers, sub-contracted the work, leaving Boeing with limited ability to supervise design and manufacture.

In this context, Paul Krugman draws attention to the work of Nobel laureate Oliver Williamson about the limitations of the market in co-ordinating activity among small firms or individuals and the consequent persistence of large firms. He writes,

"Williamson (talked about) the difficulties of writing complete contracts; when the tasks that need to be done are complex, so that you can’t fully specify what people should do in advance, there can be a lot of slippage and strategic behavior if you rely on market incentives; in such cases it can be better to do these things in-house, so that you can simply tell people to do something a particular way or to change their behavior."

I completely agree with the trade-off, though the big challenge lies in identifying how much to trade-off and what.

1 comment:

KP said...

Dear Gulzar,

An article by Nayan Chanda of the Yale Center for the study of Globalization touches on the soft aspects that make a "perfect" contract less than possible.

In engineering the "soft and strategic aspects coalesce" to create breakthroughs - and is not the same as running a mundane task like payroll (which can be outsourced quite easily).

Short term leadership - particularly in industries like IT and consumer electronics where managers are incentivized to capture short term trends - produce a larger share of disconnected and fluffy managerial talent whose competence and values are never really tested for their true worth ( and a whole lot of free riding on the wave lifts a bunch of meidocre managers).

Such short term managerial trends applied to "long-term" industries produces short term profits and a long term hollowing out of core competence.

Nayan Chanda's article is here


I hope the conclusion is not

- the need for better contracts
- higher level of competence in the partners to outsource to.