The Enemy Within
Though all outward signs suggest unfettered growth, the base of manufacturing suppliers in the United States is fast crumbling away. Here's why it's happening, how American companies have become their own worst enemies, and what to do about it
As his limousine sloshed through the rainy summer twilight in Tokyo a few years ago, a high-ranking U.S. executive explained that his company was about to close a multibillion-dollar aircraft-procurement deal with a con-sortium of Japanese suppliers -- even as the skyrocketing yen made them among the world's most expensive manufacturers. "They come to us with offers to fund and build a complete wing or fuselage," he marveled, "not just for a bunch of parts orders. If we'd let them, they'd design and build the whole airframe.
"Our profit," he continued, "is really in aircraft distribution and service, not manufacturing. Package procurement deals like these save us millions in supplier-oversight and management costs."
Those words ought to chill the heart of every small and midsize manufacturer in the United States. As multinational companies like GM, IBM, and General Electric downsize, they increasingly shift complex design and manufacturing responsibilities to their vendors. Rather than dealing with scores of individual suppliers, those giant companies are willing to pay premium prices to purchase high-quality finished products from trouble-free, self-supporting supply chains -- irrespective of individual company's skills or of national exchange rates.
This new supply-base competition marks an important change in the global economy. In the past a company's efficiency or technical capabilities alone would have generated success, but the big winners in today's global economy are those groups of companies that can offer one-stop design and manufacturing services to brand-name multinationals.
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Despite perceptions that U.S. manufacturing prospects have improved, supply-base competition may be bad news for the United States. Unlike those in most of Asia and parts of Europe, U.S. manufacturers and policymakers barely recognize the profound changes taking place in international economic rules. Too often, they pursue outmoded strategies that fail to achieve anticipated business or employment growth.
Nowhere is that more evident than in manufacturing, where the United States' primary competitors have built regions with fully integrated production networks involving literally hundreds of companies to provide one-stop shopping for product-hungry nameplate multinationals. According to the industrial logic of the recent past, the late 1980s and 1990s should have been the heyday of U.S. manufacturing, driven by a remarkably weak dollar and unparalleled domestic cost advantages. Instead, while the total value of manufacturing industry shipments rose 75% from 1980 to 1990, roughly keeping pace with the growth of the U.S. gross domestic product, the rate of company creation in manufacturing was the most anemic of any U.S. sector, increasing just 18% over that decade and slowing even more in the '90s. Over the same period, manufacturing employment actually fell by 10%, the only major U.S. industrial group to register a workforce decline.
More troubling still, and largely unexpected by conventional U.S. industry and policy experts, foreign penetration of the U.S. supply base -- especially by manufacturers in high-cost places like Japan and Europe -- rose dramatically despite the weak dollar.
To a nation weaned on the dream of individual entrepreneurship, those statistics are sobering evidence of the unanticipated new challenges of international supply-base competition. It's no longer enough for a small or midsize company simply to be the lowest-cost or most efficient producer; the company must also contribute to and help maintain the highest standards among each of the suppliers with which it collaborates to design and build products for global markets.
Throughout the world, each company's survival increasingly depends on the weakest link in the supply chain it supports. Chrysler once tried to learn why a key engine part was failing at an unacceptable rate. Tracing back along the product's supply chain, it found that all the assemblers, designers, finishers, and machinists adhered to world-class standards. But a clay vendor for a casting company that sold raw metal to the downstream manufacturers had gone bankrupt; no other company sold clay with the proper consistency. Scores of efficient, quality companies were threatened by the failure of a seemingly insignificant link in their supply chain.
That's the new supply-base competition. And because the United States is behind the pack when it comes to meeting those novel challenges, it risks the accelerating loss of its high-growth small and midsize suppliers; employment declines in major industries (even as U.S. multinational companies' sales grow); and the continued disintegration of the nation's premier urban manufacturing centers.
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The phantom manufacturing boom
The United States' failure to adapt to the new supply-base competition helps explain why the anticipated exchange-rate-triggered manufacturing boom never seemed to materialize here. To be sure, nameplate companies' sales in many U.S. industries did rise in the '90s. But the United States continues to measure its manufacturing success almost exclusively on the basis of the number of "American" products sold by its dominant multinationals. However, with the absence of close ties between domestically based multinationals and suppliers, which are typical in countries like Japan, U.S. nameplate companies' sales are an increasingly misleading indicator of the true health of the country's supply base. U.S. multinationals are more and more meeting their distribution and service needs with goods designed and manufactured by much more integrated, capable, and responsive production networks from abroad.
Other countries strongly discourage domestic-supply-base displacement by promoting joint efforts among large and small companies to solve price, quality, or other market problems. If foreign procurement levels in Japan were even a small fraction of what they are in the United States, Japanese multinationals would face enormous political and industrial pressure from the government and the nation's well-organized suppliers.
Even in late July 1995, after a bruising trade battle with the United States over opening domestic markets and with the yen still at absurdly high levels, a Japanese government survey of more than 1,200 suppliers and their large-company customers revealed that 95% of the respondents were seeking joint price or quality-improvement strategies to deal with growing cost disadvantages. Just 5% stated that they would even consider increasing their overseas production or procurement activities. Minimal domestic-supply-base disruption provides Japanese suppliers with a stable market from which they can develop and offer increasingly sophisticated, coordinated production services to multinationals worldwide -- a strategy that overcomes their country's severe competitive-cost disadvantages.
The large U.S. nameplate companies and their suppliers operate in a much different world. U.S. multinationals face few political or industrial barriers to shifting procurement abroad. With few exceptions (see "It Can Happen Here," below), tightly knit, self-sustaining industrial regions that support fully integrated supply chains are rare in the United States. The result is a weakening supply base even as U.S. nameplate companies' sales increase.
Even though opening up Japan's notoriously closed automobile-component-manufacturing networks was the key issue in the recent U.S.-Japan automotive-trade dispute, the increasing reliance of U.S. companies on better-organized Japanese suppliers precluded from the outset any thought of imposing sanctions on actual parts imports. Indeed, because it failed to address the different organization and capabilities of U.S. and Japanese auto-supply chains, the Clinton administration's purported trade "victory" will do little to enhance, and will likely further harm, U.S. auto-industry employment and skill development.
The lesson is clear: in an era of multinational outsourcing and downsizing, countries that enable their small-scale suppliers to jointly coordinate and sell their production activities will triumph in world markets. Those that ignore such realities will suffer continuing employment losses and generate far less robust business growth.
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Strategies for the new competition
In a world where coping with existing business challenges already presses the limits of most small-company managers, dealing with the new supply-base competition may seem an impossible task. Even thinking about competition with organized suppliers from other countries seems alien, if not just plain wrong, in the United States' individualistic business culture.
Programs espousing joint research and development or other collective business endeavors -- consortia, regional technology "alliances," or big company/supplier "partnerships" -- often degenerate into pork-barrel spending boondoggles or mask efforts to squeeze even lower prices out of the U.S. supply base. Worse still, politicians from the smallest rural town to Capitol Hill celebrate the fragmentation of concentrated U.S. supplier regions -- fed by a smorgasbord of relocation subsidies and tax breaks -- as business "development" when in fact it weakens the United States' productive economy.
What can small businesses learn from all this? They must begin to think strategically about the need for long-term allies in product development and marketing. Companies that try to sell an isolated component in an anonymous parts market will almost certainly be supplanted by competitors that offer far more comprehensive ties to up- and downstream manufacturers. Just as new management strategies are necessary to foster the internal flexibility and skill modern markets require, learning to build alliances with other companies supplying discrete industries must become a priority management objective.
Most big companies now understand that self-managed supply chains are crucial to their own competitive success. Chrysler's procurement managers once tried to fill their company's parts requirements by encouraging suppliers to compete solely on the basis of price. They learned, however, that not only did this approach destabilize and thus weaken their suppliers, but also that critical opportunities to jointly improve product design and quality were being lost.
When Chrysler began to develop its best-selling cab-forward vehicles, it elected to coordinate the entire design and manufacture of many subsystems -- brakes, steering, electronics -- with a group of like-minded suppliers, becoming totally dependent on them for technologies it no longer maintained in-house. In return, Chrysler treated its suppliers in a far more collaborative fashion, relying on and working with its supply chains to perfect its worldwide products.
Small U.S. companies in other industries need to exploit these trends and seize opportunities to combine with affiliated companies and offer one-stop design and procurement services to their common customers. There are a variety of strategies for achieving these goals (see "Resources," below). All try to secure a share of worldwide procurement markets by allowing companies to compete as a fully integrated supply chain, not just as individual parts makers.
Small-company leaders also need to be far more discriminating about the public policies they endorse and the candidates they support. The plethora of business-relocation subsidies dangled by state and local officials may seem like a bonanza, but it actually harms each industry's supply base by fragmenting producers into artificial geographic regions and encouraging low-cost, rather than high-skill, manufacturing.
Trade policies that supposedly open markets like Japan to multinational companies' sales without also dealing with the problem that many such sales are likely to be in the form of foreign products marketed under a U.S. brand name may be good news for a few shareholders of big companies but bad news for the companies' suppliers. The most critical public-policy task for small companies in the United States is to make supply-base development a central industrial issue in this country -- as it is in most of the United States' advanced competitors.
U.S. industrial vitality depends on recognizing that simply becoming the most efficient, talented company is not enough to ensure success. Today business survival also depends on ensuring that all the participants in a supply chain achieve and operate at similarly high standards and collectively market their skills to global distributors. That is the challenge for small companies -- and the United States -- in the 21st century.
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David Friedman is a research fellow in the MIT Japan Program and a partner in a Los Angeles law firm.
U.S. Computer Equipment and Peripherals
Large U.S. computer companies enjoyed a major revival during the 1990s. Domestic shipments of computer equipment and peripherals jumped from $55 billion in 1991 to $66 billion in 1994. Yet much of that seeming growth was accounted for by imports -- largely from Asia -- repackaged as U.S.-labeled goods. Those imports doubled in value from 1990 to 1994, from $23 billion to $46 billion. Despite the boom in local shipments, U.S. computer-supply employment actually fell in the '90s, from 250,000 to fewer than 190,000 jobs, a 24% decline.
U.S. Automotive Parts and Accessories
Similarly, American automobile companies enjoyed a tremendous revival during the 1990s, as U.S.-nameplate vehicle shipments rose by more than 25%. Domestic parts shipments also increased by nearly 20%, to $112 billion by 1994. Imported parts integrated into U.S. automotive components and subassemblies, however, rose even faster, growing from $20 billion to $28 billion, a 40% jump -- including a 33% rise in Japanese imports alone. While nameplate companies recorded banner profits, American auto-supply-industry employment declined by more than 8% from 1990 to 1994 as the industry shed nearly 50,000 jobs.
ARE THERE NONMANUFACTURING NETWORKS?
Supply-base competition is the most advanced in conventional manufacturing sectors, because that is where the United States' major competitors, especially in Asia, have focused their efforts. Traditional service industries -- restaurants, cleaners, utilities, and the like -- also enjoy a degree of competitive protection because they still depend on geographic proximity to their customers.
All that may soon change. Many manufacturing and service sectors are now merging into hybrid industries -- computerized metal cutting, digital marketing, and on-demand legal-research services, for example, all combine hardware, software, and service products in ways that depend on integrating a variety of skills into a final product. As this transformation takes place, customers will increasingly look for suppliers that can package everything into a neat final product, and manufacturing's supply-chain-management skills will become crucial in services as well.
New information-delivery systems also reduce many of the geographical limits to service sectors. It's not uncommon for a client to secure research and legal counsel from top-quality, computer-savvy lawyers thousands of miles away via electronic mail and the Internet. Software and hardware service support for many U.S. computer companies is now provided by consultants via telephone from India. Service providers that once might have been able to get contracts to serve a contiguous region now have to compete with communication and engineering companies on the other side of the globe -- exactly the problem that gives rise to supply-base competition.
network, or supply chain: a group of specialized companies that combine their skills to produce final goods for world markets
fully integrated supply chain: links top-quality manufacturers from raw-materials suppliers to final assemblers in the design and fabrication of a final product
nameplate companies: multinationals with brand names like GM, Xerox, or Apple that buy goods and services provided by integrated supply chains and then sell these products under their own, more famous company names
IT CAN HAPPEN HERE
Silicon Valley and Hollywood are among the most visible U.S. supply-chain successes. Both are made up of a mixture of large companies -- brand-name computer companies and film studios -- and thousands of highly specialized suppliers that provide them with products to sell. In most cases, the suppliers drive job and technological growth. Software and hardware developments, and major film innovations, are the product of project-by-project collaboration among ever-shifting groups of suppliers that design and produce what they sell to their customers.
Hollywood and Silicon Valley work because no other regions in the world boast similarly dense, fully elaborated supply networks. Other regions may lure away an isolated company, and some can support the less dynamic mass-production elements of each industry, but in virtually every case, a company that wants to succeed in computers or filmed entertainment still has to have a close relationship with Silicon Valley or Hollywood to remain at the cutting edge of production and design.
The employment and business-development benefits each region enjoys are the result of a number of innovative industry practices. In Hollywood, unions and payroll companies long ago helped solve the now-ubiquitous problem in the world economy of job instability -- a by-product of project-by-project employment. Payroll companies save suppliers millions in overhead by hiring all the workers for a film, acting as the employer of record, and simply reconstituting their workforce as needed for subsequent productions. Unions increase Hollywood security by permitting their members to pay more during periods of work than during downtimes, all the while keeping health and other benefits intact.
Unlike Route 128 in Massachusetts and other once-premier computer regions, Silicon Valley companies moderated what would have been debilitating cutthroat price competition and secrecy by developing elaborate cross-licensing arrangements that permitted companies to jointly share in breakthrough developments, information that would then be integrated freely up and down the supply chain. Trade agreements with Japan forcing the purchase of U.S. components and public/private consortia like Sematech are also credited with providing the means and opportunity for once-struggling U.S. companies to better coordinate the region's supply chains.
In both Hollywood and Silicon Valley, full-spectrum suppliers have learned to collaborate in ways that no other areas have yet been able to copy. They sustain high-skill, high-wage jobs, technological dynamism, and business growth by succeeding where many other U.S. industries fail: in supporting and building competitive supply chains, not just nameplate multinationals or isolated parts vendors.
Among the best summaries of how competitive regions succeed in the new economy -- based on Silicon Valley -- is AnnaLee Saxenian's Regional Advantage (Harvard University Press, 617-495-2577, 1994, $24.95).
The Hollywood story is explained in "Why Every Business Will Be Like Show Business" (Inc., March 1995, [Article link]), by Joel Kotkin and David Friedman.
"Small Business Networks: Tools to Promote Economic Success," by Gus A. Koehler (California Research Bureau, 916-653-7843), is a recently compiled analysis of American efforts to build supplier networks that is aimed specifically at small companies.
The National Institute of Standards and Technology publishes A Catalog of U.S. Manufacturing Networks (NIST, 301-975-2000).