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The Organizational Delinking of Production from Innovation

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- 1 - Does Manufacturing Still Matter? The Organizational Delinking of Production from Innovation Timothy J. Sturgeon Working Paper 92B August 1997 ©Copyright 1997 Timothy J. Sturgeon, formerly a BRIE Research Associate, is currently a visiting scholar at Center for Technology, Policy, and Industrial Development at MIT (the Massachusetts Institute of Technology). (1 Amherst St. E40-227, Cambridge, MA 02139 email: [email protected]) This paper was presented at the International Conference on New Product Development and Production Networks--Learning from Different Experiences in Different Countries, Wissinschaftszentrum Berlin fur Sozialforschung (WZB), March 20 - 22, 1997. Generous support for this work was provided by the Alfred P. Sloan Foundation.- 2 - Introduction Evidence from the electronics industry suggests that a new American model of industry organization is emerging in the 1990s. American electronics firms are outsourcing an increasing share of their production. As this practice grows, manufacturing capacity is building up in turnkey production networks that consist of specialized and highly capable merchant suppliers that provide the industry with a functionally coherent set of commodified production services. When firms that supply external productive capacity develop a merchant character, as they have in the American-led electronics industry, manufacturing capacity is essentially shared by the industry as a whole, reducing costs and spreading risks in an increasingly volatile world market. As such merchant external economies develop, the link between innovative capacity and market share, on one hand, and firm size and scope, on the other, begins to break down. This link was the cornerstone of Schumpeter's conception of industry structure and his explanation for the rise of the large, vertically integrated industrial firm in the early part of the twentieth century. Firms that outsource a large share of their manufacturing no longer have to carry the financial, administrative, and technical burdens of fixed capital related to production (i.e., plant and equipment), allowing them to focus on innovation and become more organizationally and geographically flexible. At the same time, such brand-name firms are no longer buffered from competitive pressure by large in-house fixed capital. Barriers to entry are lowered because competitors can tap the same turnkey production networks and therefore gain access to leading edge, global-scale production capacity (unless specific institutional constraints are present). Thus, for the innovating firm, competitive outcomes become more tightly tied to product-level innovation (i.e., product definition, development, and design) as productive capacity migrates into turnkey networks. At the industry level, turnkey production networks make it possible for market share to change hands without the idling of any productive capacity, mollifying the "destructive" aspect of innovation predicted in Schumpeter's conception of "creative destruction." This paper explores the implications of the following hypothesis: that a significant share of American firms are adapting to volatile and intensely competitive market conditions by "outsourcing" manufacturing functions to specialized merchant suppliers. At the same time, "brand-name" firms have reasserted control over product definition, design, and marketing functions, which are largely being kept in-house, despite the spate of high-profile "strategic- 3 - alliances" formed in the 1990s. In essence, I argue that market-creating innovative capacity is being hoarded in-house while market-supplying productive capacity is being allowed to migrate into external economies that can be shared industry-wide. Such external scale economies are coming to reside in a cadre of specialized merchant suppliers that offer access to a functionally coherent set of production functions as a service to their customers, the brand name firms. The emerging organizational split between innovation and production is usually enabled by highly formalized links at the inter-firm boundary. The hypothesis is derived from research on product-level electronics manufacturing (computers, communications equipment, consumer electronics, etc.), where such an organizational shift, from in-house to outsourced manufacturing, has been dramatic in recent years. However, even superficial observations strongly suggest that comparable changes are underway in many other sectors as well (e.g., apparel and footwear, toys, data processing, home furnishings and lighting, semiconductor fabrication, food processing, automotive parts, brewing, enterprise networking, and pharmaceuticals). The aim of this paper is not to prove that the shift is occurring in every American firm, or even to provide a detailed analysis of the changes in the electronics industry. I have presented the latter evidence more fully elsewhere (Sturgeon, 1990, 1991a, 1991b, 1992, 1997; Sturgeon and Cohen, 1996). Instead, the model of industry organization derived from the electronics case is exposed to one of the key theoretical tools that have been developed to predict and explain industry structure and economic development: Schumpeter's notion of innovation in the giant firm. It is my opinion that the emerging split between product-level innovation and production in American industry is clear enough to take the next step of testing, and perhaps modifying, the analytic tools that we currently have at our disposal. 1. From the Modern Corporation to Production Networks: A Paradigm Shift Through the mid-1980s, the dominant paradigm for the study of industrial organization and economic development was the modern corporation as best defined by Chandler (1977). There was good reason for this focus. By the 1950s, the large multidivisional (and increasingly multinational) enterprise, with its extensive managerial hierarchy, had become an undeniable force in economic development, not only in its heartland, the United States, but also in other countries where its features were adopted as a model for local firms. Regardless of analytic stripe- 4 - (e.g., neoclassical, Weberian, Marxist), the large, multidivisional, hierarchically-controlled corporation provided a set of ordering assumptions for theorists interested in explaining its rise and inner logic (theories of the firm), as well as for those working on problems of economic development where the modern corporation


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