The Rise of Modular Production Networks and the Impact on Global Industry

1. Timothy J. Sturgeon: Modular production network: a new American model of industrial organizationIn: Industrial and Corporate Change, Volume 11, Number 3, p. 451-496. Supporting Authors: Melissa Schilling and Kevin Steensma: The use of modular organizational forms: an industry-level analysis In: Academy of Management Journal. Dec 2001, Vol. 44. Iss. 6, p. 1149-1178. Opposing Author: Anthony Daboub: Strategic alliances, network organizations, and ethical responsibility In: S.A.M. Advanced Management Journal. Autumn 2002. Vol. 67, Iss.4, p. 40-50. Vivian Hermann IR 720

2. Summary • Market volatility and intensified international competition has lead to the development of a new model of industrial organization, the modular production network. • Lead firms focus on ‚core’ competence areas that are perceived as being essential to the formation of competitive advantages, especially product innovation, marketing and other activities related to brand development, while non-core functions, in particular manufacturing, are shifted out-of-house to global turn-key suppliers to reduce costs.

3. T. Sturgeon: Yes. Firms that outsource a large share of their manufacturing no longer have to carry the financial, administrative and technical burdens of fixed capital for production, allowing them to focus on product innovation. Product innovation […] has been freed from the shackles of large-scale investment in fixed capital for manufacturing of those products. ( pg. 465f) M. Schilling and K. Steensma: Yes. Technological revolution and increasing globalization have radically transformed the competitive landscape. For firms to survive, they must build dynamic core competencies and develop their human capital and manufacturing technologies in a way that enables strategic flexibility. One way that firms become more flexible is by making greater use of […] outsourcing. Question 1:Is deverticalization an effective solution for firms to withstand global competition?

4. T. Sturgeon: Yes. […] globalization means that there are fewer ‘isolates’ in the world economic system. […] it is clear that the modular production network model has put up a great deal of pressure on competing network emanating from Europe and Japan. (…) over time, national production systems could well co-evolve to become more compatible and interlinked with one another further increasing global economic integration as global-scale production system overlap.(p.490) Schilling and Steensma: Yes. (…) in highly competitive industries, as soon as one or a few organizations attain an organizational form that is more consistent with the demands of the environment, other firms may have to follow suit in order to survive. Question 2: Can global competitive pressure bolster the rise of a common organizational model in industry structure?

5. T. Sturgeon: Yes. As suppliers gain in financial strength, technical and operational competence, and geographic reach, the possibility arises for suppliers to take further step of developing their own end-products in competition with their customers. […] outsourcing of broad swath of activities formerly performed in-house raises the possibility that brand-name firms will lose process expertise […] and may turn out to be critical to ongoing success in product development. (p 488f.) Schilling and Steensma: Yes. Reliance on contract manufacturing may cause a firm to forfeit important learning opportunities, outing it at a disadvantage in the long run. By not investing in his own manufacturing, a firm might not develop competencies related to its products that enable the development of future products. Question 3:Is there a risk to firms to lose global market share by outsourcing competences to suppliers?

6. T. Sturgeon Yes. As suppliers gain in financial strength, technical and operational competence, and geographic reach, the possibility arises for suppliers to take further step of developing their own end-products in competition with their customers. […] outsourcing of broad swath of activities formerly performed in-house raises the possibility that brand-name firms will lose process expertise […] and may turn out to be critical to ongoing success in product development. Since 1984, Erak Clothing, a Turkish contractor, has manufactured jeans as a full-package producer for international brands, such as Calvin Klein, Guess, and Esprit. Following the creation of its own brand, Mavi Jeans, in 1991, the firm has been transforming itself into an original brand-name manufacturer and retailer. Mavi Jeans are now sold worldwide at more than 3,000 sales points, including Nordstrom, Macy's, and Bloomingdale's department stores, and five directly owned and operated flagship stores in Vancouver, New York, Frankfurt, Berlin, and Montreal. Source: N. Tokatli & Ö.Kizilgün: Upgrading in the Global Industry. In: Economic Geography. Jul 2004. Vol. 80. pg. 221. Question 4:Is there a risk to firms to lose global market share by outsourcing competences to suppliers?

7. Question 5: Does competition in the global economy foster the devaluation of manufacturing in industrialized economies? T. Sturgeon: Yes. US […] firms have generally placed manufacturing in a low position on the hierarchy of corporate esteem. U.S. brand-name electronics have been closing internal manufacturing operations which are often seen […] as draining resources away from more crucial innovation and sales activities. (p. 462) Indeed, an increasing number of lead firms have little or no internal manufacturing capacity at all. (p.475)

8. Question 5 cont.: Does competition in the global economy foster the devaluation of manufacturing in industrialized economies?

9. Question 6:Does the rise of the modular production network model leads to heavily increased outsourcing? T. Sturgeon: Yes. […] turn-key suppliers and lead firm co-evolve in a recursive cycle of outsourcing and increasing supply-base capability and scale, which makes the prospects for additional outsourcing more attractive. (pg.455)

10. Question 6 cont.: Does the rise of the modular production network model leads to heavily increased outsourcing?

11. T. Sturgeon: Yes. […] the emergence of large, globally operating contract manufacturers facilitates the build-up of external economies of scale. (p 477) […] the economies of scale and speed that build up in modular production networks surpass those of any single firm because they reside externally and can effectively be shared the industry as a whole. (p. 471) A. Daboub: No […] the specialization of firms in single areas of competence has resulted in fragmentation of the value chain and of ethical and legal responsibility. Many cases exemplify the ethical gaps that can occur because of the decentralized control in network organizations. Question 7: Does outsourcing to contract manufacturer leads to an all-around positive social and economic outcome?

12. T. Sturgeon: Yes. Trust, reputation and long-term relationships are not the only way to buoy external economies. As industries grow, open and de facto standards tend to emerge, codification increases and the capabilities of the supply-base deepens. These characteristics of industrial development make it possible for assets to become less specific over time, allowing outsourcing relationships to be maintained without intensely relational or hierarchical character. (p.480) A. Daboub: No. [There is] a positive relationship between reputation and the outcomes of alliances.Good reputation reduces the problems of transaction costs, agency relationships, and team production. When relationships are long term, interpersonal relationships of friendship and trust can create a stable culture that sustains interorganizational relationships and guides their activities. To the extent that this culture coordinates the activities of partners in a harmonious way, it contributes to organizational efficiency and is, therefore, a strategic asset. Question 8: Are social features such as trust and reputation unessential factors in vertically disintegrated production processes?

13. T. Sturgeon: Yes. External economies allow for the development of trust, industry- and locality-wide sharing of production capacity, greater opportunities for learning and technology transfer within the system, and a superior ability to reconfigure the functional elements of production according to rapidly changing output requirements and the rise of new Markets. (pg. 453) A. Daboub: No. In addition to creating economic opportunities, strategic alliances also create challenges and threats. […] profits must be split […] local laws could diminish flexibility and cooperation can create competitive foreign firms. […] the learning opportunities may not be symmetrical, i.e., one firm may learn more than the other. For this reason, strategic alliance can be considered an arena of competition or even a learning battlefield. Question 9: Do global networks and partnerships between suppliers, distributors and competitors create exclusively economic opportunities for involving parties?

14. Question 10:Does outsourcing to contract manufacturer leads to an over-all positive social and economic outcome? T. Sturgeon: Yes. […] the emergence of large, globally operating contract manufacturers facilitates the build-up of external economies of scale. (pg. 477) […] the economies of scale and speed that build up in modular production networks surpass those of any single firm because they reside externally and can effectively be shared the industry as a whole. (pg. 471)

15. Question 10 cont.: Does outsourcing to contract manufacturer leads to an all-around positive social and economic outcome? No. Source: www.businessweek.com • Rough estimates suggest that the U.S. has lost 400,000 to 500,000 information technology-processing jobs to outsourcing over the last few years. Source: Richard Locke: The Promise and Peril of Globalization: The Case of Nike. MIT IPC Working Paper 02-008. • The Ernst and Young audit, commissioned by Nike, reported serious health and safety problems at the Tae Kwang Vina plant, Nike’s Korean subcontractors. Toulene concentrations were said to exceed between 6 and 177 times acceptable standards in certain sections of the plant. • In June 1996, Life magazine published an article on child labor in Pakistan, which included a photo of a 12 year old boy stitching a Nike soccer ball. • Profit of Nike was shrinking.

16. Question 11: Is the modular production network becoming a major institutionalized model for industry structure? T. Sturgeon: Yes. […] the modular production network yields better economic performance in the context of globalization than more spatially and socially embedded network models. (pg. 451) The performance advantages of modular network are […] geographic flexibility [which] creates greater access to a variety of place-specific factors and markets. An important result of geographic flexibility is the system’s easy reach into areas with lower factor costs. (pg. 488)

17. Question 11 cont.: Is the modular production network becoming a major institutionalized model in industry structure? No. Source: J. Humphrey & O. Memedovic: The Global Automotive Value Chain. UNIDO 2003. Assembly plant investment in emerging markets by automakers. X=early 1990; X = late 1990s.

18. T. Sturgeon: Yes. Barriers to new entrants are lowered because competition can tap the same set of supplier and therefore gain access to leading-edge, global- scale production capacity used by established firms. (p.466) No Source: Entrepreneur. May 1, 2004. According to Heidi Neck, an author of the 2002 "Global Entrepreneurship Monitor (GEM)," a study funded by the Ewing Marion Kaufmann Foundation, the number of Americans planning to start new businesses decreased. A report released by Challenger, Gray & Christmas Inc. showed that the percentage of jobless managers who said they were starting new businesses dropped to an average of 6.8 percent in 2003. Compare that to the 1991-92 recession, when roughly 15 percent of jobless managers started companies of their own. Question 12: Does competition increases between firms in the modular production network?

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