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Unlimited Partners

Fast-changing markets are forcing companies to redefine the art of subcontracting.
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Ron Dickey drives to work in a Rolls-Royce these days, but he came up the hard way. Starting at 17 with a job sweeping a garment factory floor, he worked his way through the industry ranks as a cutter, a sewing-shop foreman, and eventually head of production for major southern California manufacturers.

Thus, when Dickey decided to go off on his own in 1979, the thing he knew best was production. In an industry dominated by fast-talking salespeople and high-flying designers, Dickey believed that he could succeed by putting out a superior product for the high end of the women's budget-garment market. "There is so much garbage out there," he says quietly, sitting behind a Mickey Mouse telephone in his office at So What! of California Inc. "Everyone else tries to be number one in sales, but I figured that if you went for the quality and offered it at budget prices, you could make it."

But with only $25,000 from the second mortgage on his house, and an additional $25,000 from a partner (who later left the company), Dickey knew he could not finance his own sewing operation. For that, he would need $100,000 to cover start-up costs alone. So, like hundreds of other Los Angeles garment manufacturers, Dickey went looking for subcontractors -- small, independent shops that perform much of the sewing work in California's multi-billion-dollar garment industry.

Today, So What! boasts sales of $15 million, and the 43-year-old Dickey could easily afford to bring his sewing in-house. Yet he still prefers to contract it out instead. Mainly, Dickey says, he uses subcontractors (referred to simply as "contractors" in the garment trade) so he can focus his own efforts on such other areas as quality assurance, product design, and marketing. "If I had another one of me to run the factory, I would do it myself and make money with it," he explains as he inspects garments arriving from the adjacent sewing shop of Kee Kwon, his top subcontractor. "But there's only one of me, as far as I can see."

Less Can Be More

Dickey's reliance on such independent contractors as Kwon, who employs more than a hundred workers in his sewing operation, reflects a growing trend among entrepreneurs in diverse industries. Indeed, some observers believe that in today's markets, it is more important than ever for an entrepreneur to build strong working relationships with subcontractors.

"This is one of the ways for a small company to maintain its competitive advantage of speed and flexibility, one of the ways it can be creative," says Paul M. Kelley, managing partner of Zero Stage Capital Equity Fund, a seed venture capital firm in Cambridge, Mass., that specializes in investments of less than $150,000. In addition, Kelly points out, subcontracting allows a young company to leverage its capital and human resources, thereby minimizing the need for outside equity or bank debt while facilitating the management of growth. "Less can be more if you have good instincts," he concludes.

This is particularly true in the brave new world of microelectronics, where product cycles get shorter every year and the ability to move quickly into new markets is crucial. Safi Qureshey, president of AST Research Inc., an Irvine, Calif.-based maker of microcomputer add-on boards, uses subcontractors to assemble most of his company's products. Despite skyrocketing sales -- $12.7 million in 1983, $63.8 million last year, and $58 million in just the first two quarters of fiscal 1985 -- Qureshey thinks that using subcontractors for the labor-intensive printed circuit board assembly process helps AST retain its entrepreneurial character.

"To survive, we have to be a $100-million company that work like a $10-million company," says the bearded, 33-year-old native of Pakistan. "We can't afford to build a huge labor force and management bureaucracy and still keep on top of our market. Our subcontractors give us the freedom to do that."

Similar reasoning applies to older but still volatile industries, such as jewelry. Jewelry manufacturers rely heavily on subcontractors for soldering, prepackaging, and other services. Fully half of the estimated 800 to 900 jewelry establishments in the Providence metropolitan area -- where nearly a quarter of all the nation's precious jewelry is made -- perform these crucial subcontracting tasks.

By contracting out specialized jobs, says Steven Brown, president of Bazar Manufacturing Co., in Cranston, R.I., manufacturers can limit the hiring of new employees who might be subject to layoffs during the industry's seasonal fluctuations. "It's a kind of risk-spreading," explains Brown. "Some people hire everyone and then just lay them off when times get bad. I wouldn't do that. I use subcontractors instead."

The Large Shop Is Yesterday

To some extent, the current shift toward subcontracting is part of a nationwide trend toward small-scale manufacturing. Where once the model for American industry was the fully integrated giant factory -- able to take raw materials in one door and send a finished product out the other -- today, many manufacturers use subcontractors to perform key functions. Average factory size has been diminishing in recent years, and small manufacturers with fewer than 100 employees have been the only part of the industrial sector with increased payrolls.

This shift is particularly apparent in the garment industry. Under severe pressure from foreign competitors -- which last year captured more than half of the market, up from 4.5% in 1956 -- U.S. garment makers have sought ways to cut costs, particularly in the labor-intensive sewing side of the business, and to concentrate their efforts on sales and design, areas in which they feel they have a distinct competitive advantage.

So pervasive is this increased use of subcontractors that it is changing the structure of the multi-billion-dollar U.S. garment industry. Long dominated by strong labor unions, the industry -- which has lost an estimated 270,000 jobs since employment peaked in 1973 -- has moved away from in-house manufacturing and toward increased specialization, with much of the work done at small, usually nonunion sewing shops. Even in New York City, the cradle of the unionized garment manufacturing industry, only half of the more than 150,000 workers are members of a union; nearly 70% work for contractors. As one New York manufacturer put it, "If I went with the ILG [International Ladies Garment Workers Union], I'd be out of business in a matter of months."

The prevalence of nonunion subcontractors is even more pronounced in more rapidly growing industry hotbeds, such as Los Angeles, where union members represent only 20% of the total work force. In Los Angeles, the nation's second-largest garment center, there are an estimated 3,000 sewing shops, most of them unorganized, serving fewer than 400 manufacturers.

"Everyone's shifting to contractors in recent years," says Howard Klein, president of Rich & Me Inc., a California manufacturer of women's sportswear that last year boasted sales of $12 million. "People have become more specialized. The large shop is yesterday. Specialization is the thing that is going to turn this industry around."

But even in such largely nonunion fields as electronics, the need to cur costs and sharpen company focus in the face of determined foreign competition has led to increased use of subcontractors. According to a report prepared for Solectron Corp., a San Jose, Calif.-based electronics subcontractor, high-tech assembly houses now hold 21.6% of the U.S. market for printed circuit board assembly, and they enjoy revenues of more than $6 billion. By 1988, according to Solectron estimates, American-based subcontractors will have captured almost 25% of the market, with sales of nearly $16 billion.

"People are beginning to realize that it's cheaper, and if you use the right subcontractor, you can have better quality," says Winston Chen, president of Solectron, where sales have risen from $1.2 million in 1978 to $54 million last year. "And the customers don't have to spend $10 million on the most sophisticated equipment; they can share the cost with everyone else. In essence, the smart ones are using our money as well as our services."

A Two-Edged Sword

There are, of course, some drawbacks to dependence on subcontractors. Many assembly houses, as Chen acknowledges, put out inconsistent or just plain shoddy merchandise, while some companies seem unable to maintain a steady business relationship with outside contractors. "One of the biggest problems American companies face is the poor quality of vendor relationships," observes Xebec Corp. chairman and chief executive officer Jim Toreson. "This is one of the key areas where our overseas competitors are ahead of us."

As usual, it is the Japanese who are farthest ahead. Japan's economy long has rested upon a large and efficient base of subcontractors -- including about 65% of all Japanese small-scale manufacturers -- that perform many key tasks for manufacturers of all sizes. These subcontractors are highly skilled; the majority recently claimed in a national survey to have technical expertise in their fields equal, or superior, to that of their clients. And they play a far larger role in their industries than do their counterparts in the United States. Auto industry subcontractors, for example, manufacture some 70% of a Japanese car, while U.S. suppliers account for only 30% of the average American-made automobile.

Kiyoshi Suzaki, a Japanese manufacturing expert and now a consultant at Los Angeles-based Theodore Barry & Associates, says that by relying on subcontractors, Japanese companies can concentrate their efforts on such things as research and development, product design, and marketing, often with devastating results for their non-Japanese competitors. Subcontractors also make it possible for larger companies to offer "lifetime employment" to their workers, a major reason why big Japanese businesses can still attract the best and the brightest to their ranks.

But what makes this remarkable system work, Suzaki says -- particularly given the importance the Japanese attach to high-quality manufacturing -- are the close, almost intimate relations between many subcontractors and their customers. "In cultural terms, the Japanese supplier relationships are more trust and long-term oriented, while Americans tend to be arm's length and short-term oriented," notes Suzaki, a former Toshiba Corp. executive. "If you do arm's length, you have to negotiate on everything, and it's very inefficient in the long run. In Japan, the parent company tries to help the subcontractor and the subcontractor tries to help the parent. But here, no one is helping anyone at all."

For American companies, there can be severe costs associated with this everyman-for-himself attitude. Today's subcontractor, for one thing, may end up as tomorrow's competitor. Several years ago, Bazar's Steve Brown gave some soldering work to a "very ambitious, talented guy." Then the solderer got tired of being a subcontractor and wnet into business as a jewelry manufacturer, in direct competition with Bazar. "You have to be careful who yopu give work out to," Brown warns.

An even more serious problem is that some entrepreneurs, in the drive to cut costs, involve themselves with subcontractors whose business practices are unsavory. This is particularly true in the Los Angeles garment industry, where an estimated 90% of the work force is made up of illegal aliens. Aware that the illegals are unlikely to complain about improprieties, some subcontractors exploit their employees under conditions that recall turn-of-the-century sweatshops. In 1981, for instance, a reporter from the Los Angeles Herald Examiner, posing as a Spanish-speaking illegal alien, spent nine days working at a dank, poorly ventilated sewing shop in the city's garment district. Her total compensation amounted to $71.24, or about one-third of the legal minimum wage.

While acknowledging that such abuses exist, many manufacturers continue to employ the offending contractors, using as a justification their desperate struggle with even lower wage competition from developing countries in the Far East and Latin America. "Our job is to design and sell garments, not to be policemen," says Howard Klein of Rich & Me. "In this town right now there are a lot of problems that arise from owning your own factory. You are open to all sorts of problems with the undocumented. If you use an independent contractor, those become their problems."

Yet to Ron Dickey, such attitudes represent exactly the sort of short-term thinking that all too often plagues subcontracting arrangements in this country. Dickey is deeply concerned about the conditions under which his garments are stitched together. He has worked with roughly 100 subcontractors over the past five years (currently, he uses 25). Unlike many sales-oriented garment manufacturers, Dickey has an intimate knowledge of life on the factory floor -- and he knows that a poorly ventilated workplace and underpaid workers can undermine a subcontractor's ability to produce efficiently.

"Dirty places produce poor-quality product. With a sweatshop, you never know where you are at," Dickey says, as he inspects the clean, well-ventilated factory of Kee Kwon. "If you're giving them business, it's your responsibility. I could say, 'forget it,' but it doesn't cost much to keep a place clean and keep good records. In the long run, it pays. The guy who runs a clean shop is more likely to stay in business longer and do better work. And he's much less likely to get closed down by one of the agencies."

A Sense of Shared Goals

Finding someone honest and aboveboard, Dickey says, is only the first step in building a successful subcontractor relationship. It is equally important to establish a steady, manageable work load for subcontractors so that they, too, are not forced to hire or lay off large numbers of employees suddenly. "You have to remember," Dickey adds, "that the contractor is a businessperson, too."

In exchange for his consideration and respect, Dickey feels he can demand high-quality work from his subcontractors. Other factories where he has worked have absorbed up to 10% of defective garments. But Dickey uses a quality-inspection staff of 30 workers to check each garment carefully as it arrives at the company's main plant in City of Industry, a Los Angeles suburb. Largely because of this practice, which allows him to monitor the quality of each of his subcontractors, he claims to have reduced his defects rate to a remarkable .1%.

"People say that quality is the contractor's problem, but from my point of view it goes both ways," Dickey says, pulling a thread from a recently arrived garment. "Bad quality hurts everyone. I mean, it has my name on it. I have to build up So What! as a label. If we keep the quality up, then it becomes easy for the salesman to sell the brand. It all comes around at the end."

But even in high-technology electronics, where illegal labor is much less of a factor, finding a good subcontractor is no easy feat. Shortly after Safi Qureshey and his partners, Albert Wong and Tom Yuen, founded AST Research, they started looking for a reliable assembly house to meet the quickly increasing demand for their product -- add-on boards for the IBM Personal Computer that enhance the computer's functions and expand its memory. But at first their efforts were unsuccessful. One subcontractor, for instance, gave AST a good price, but when the time came for delivery, he called to say that his production machinery had broken down.

For a while, the three young engineers sidestepped their problems by soldering their own boards, supplementing their efforts with help from Wong's family. But as sales kept increasing, reaching $400,000 by June 1982, the company's lack of production facilities began to emerge as a major bottleneck to growth. "We couildn't possibly stuff all those boards ourselves," Wong recalls. "We needed help, and we needed it badly."

Fortunately, AST soon hooked up with Henry Nguyen. A former karate instructor who had led his family out of Vietnam on a homemade boat in 1978, Nguyen had himself worked as a PC board stuffer in San Diego. In 1980, with $37,000 borrowed from family and friends, he launched his own assembly house, QN Electronics Inc.

When he got his first work from AST, Nguyen was still in a tiny shop in Santa Ana, Calif., earning only a meager living for himself and his small staff. This year, QN Electronics should top $2.5 million in sales, with AST accounting for nearly half that figure. And even though AST could now easily afford in-house production, Safi Qureshey has no intention of scrapping his close relationships with Nguyen and his other subcontractors. "We have grown up together with them," Qureshey explains. "We see the subcontractors more like partners than anything else. They are the crucial element."

To make sure the partnership continues to work, AST has taken extraordinary steps to make QN feel like an integral part of the make QN feel like an integral part of the company's overall operation. Nguyen, for instance, is kept up-to-date with the latest development projects at research-intensive AST so he can tailor his own hiring and equipment to AST's needs. Equally important, Nguyen allows AST's vice-president for quality assurance, Leo Beaulieu, and his staff open access to QN's production lines so that his boards always meet AST's strict specifications.

"We actually sit on their lines and work with their people one-on-one," says Beaulieu. "It's not like a hostile a part of the daily routine. We let them know what we want, and Henry tells us how they think it should be done. It's a cooperative program. They are really an extension of AST."

Beyond the Specs

This sense of shared goals is the crucial factor in building good subcontractor relations, according to Bill Elder, president of Genus Corp., a manufacturer of semiconductor equipment in Mountain View, Calif. Subcontractor relations are particularly important to Elder, whose company has relied almost exclusively on subcontractors ever since it was founded three years ago.

Elder's decision to go with subcontractors was based largely on his experience as a top manager and eventually president of Eaton Corp.'s Kasper Instruments Division. "I saw how screwed up it was to try to run a small technology division with a big labor base," the Scottish-born Elder points out. "When I started Genus, this was central to our strategy. We wanted to minimize the problems of direct labor and concentrate on creating a cutting-edge product instead."

In order to achieve Genus's goal of being a technological leader -- the company spent 27% of its $17-million 1984 revenues on research and development -- Elder decided to leave all of its manufacturing operations except final assembly and testing to its subcontractors. He then began figuring our how to assure the quality and reliability of the subcontracted parts.

One solution was to design products with subcontracting in mind. Genus engineered its major product -- a technically advanced $400,000 machine that puts chemical coatings on silicon wafers -- so that it could be easily assembled from modules. At the same time, the company (like AST and So What!) also set up an elaborate quality-assurance program, complete with a full-time engineering staff of three, to make sure each product from the roughly 110 vendors would be inspected before final assembly.

While Genus is a tough and demanding customer, it has also taken extraordinary steps to develop close relations with subcontractors. Twice a year, for example, Genus holds meetings with all its vendors to explain its plans for the coming six months. "When we first held our vendors' meetings, I thought we'd have terrible attendance," recalls vice-president of operations Richard Beck. "I was startled to see about 90 of them there. They really wanted to hear what we were up to."

What impresses Genus's vendors is not so much what the company says, however, as the fact that it bothers to listen to them. Beck points out that the subcontractors are themselves skilled technicians and tradesmen: They have a great sense of pride and don't like to be treated like mindless underlings, expected to turn out products by rote.

One Genus subcontractor is Niles Machine & Tool Works Inc., which makes the crucial chuck that rotates wafers during Genus's coating process. Niles plant manager Bruce Gomes believes that Genus's engineers have benefited from his company's nearly three decades of experience working with metals.

"A lot of engineers think they are Almighty God, but the ones from Genus are smart enough to know they don't know everything," says Gomes, whose Newark, Calif., plant employs 24 workers and last year had sales of more than $3 million. "For instance, on that chuck, they may know the physical dimensions on paper and have an engineer calculate the temperature and strength, but he doesn't know how to build it. He may not understand the materials. But since they listened to us about what we know, we gave them the benefit of our knowledge. So in the end, we wrote the specs together. "

To provide further incentives to subcontractors, Genus give "vendor of the month" awards to outstanding suppliers in various fields. The award consists of little more than a plaque and a free lunch, but it still seems to send subcontractors two all-important messages: They are considered part of the Genus team, and their efforts are appreciated.

Largely because of this collegial attitude, it is not unusual for subcontractors to identify their interests alomost totally with those of Genus. Consider Joe Fernandez, president of Fern Electric & Control Co. and a two-time "vendor of the month." As the man who builds the part that controls the flow of heat and chemicals into the Genus machine, Fernandez's loyalty is of inestimable value to Genus. And Genus, in turn, is invaluable to Fernandez; last year, the company accounted for some 30% of Fern Electric's more than $1 million in sales.

As one way to express his loyalty, Fernanadez takes it upon himself to make sure that Genus gets a fair deal from other vendors that supply parts for the control mechanism. So last summer, when Fernandez noticed that a supplier suddenly had raised the price of a filter used by Genus from $36 to $108, the subcontractor sprang into action.

"I got so upset I couldn't sleep," Fernandez recalls. "This was total bull they were trying to pull. I got on the phone and told Genus not to buy that part. Yeah, I could have passed the price on, but the whole thing boiled me something fierce.

"The way I see it, I have to look out for Genus. After all, you want them to stay around to give you their business. So I went into the shop and built the damn thing myself."

Last updated: May 1, 1985




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