Is the Future in Contract Manufacturing?

9 June 2009 at 1:09 pm 4 comments

| Benito Arruñada |

The purchase of Opel by Magna shows the strength of contract manufacturers and their strategies, which I discussed with Xosé H. Vázquez in our 2006 article in the Harvard Business Review. Once thought of as a lifebelt for the decreasing margins of large-brand owners, contract manufacturing has now become a major source of competition. Shanghai Automotive Industry Corporation (SAIC), which learned the business by producing initially for Volkswagen and GM, has actually started to sell its own cars in Europe and North America. It has even bought R&D knowledge, acquiring from bankrupt MG Rover the drawings needed to build the Rover 25, Rover 45, and Rover 75.

The economic crisis is accelerating this process. The need to liberate assets to increase ROI has been facilitated by technological and organizational change. This is stimulating business practices at the corporate level that are pushing outsourcing practices to dangerous limits. The wrong management of contract manufacturing will thus increasingly provoke knowledge leaks to direct competitors and the loss of internal manufacturing knowledge; more importantly, it will continue to eliminate barriers to entry, allowing large distributors and contract manufacturers themselves to market their own brands much more easily.

Entry filed under: Former Guest Bloggers, New Institutional Economics, Strategic Management, Theory of the Firm. Tags: .

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4 Comments Add your own

  • 1. Peter Klein  |  9 June 2009 at 1:13 pm

    The Penske Group, which is buying the Saturn brand from GM, provides another example. Penske owns a dealer network but has no manufacturing facilities and plans to outsource production back to GM or another builder.

  • 2. srp  |  9 June 2009 at 8:00 pm

    It seems that the key question is how “commodified” manufacturing skills become in a given context. To the extent that tight design/manufacturing interfaces and/or special manufacturing skills remain differentiators, these manufacturing organizations may capture significant value.

    But suppose a design and marketing outfit can go to any one of a number of producers with excess capacity to make its stuff and still get the same cost and quality performance. Then you shouldn’t expect to earn a high return on a manufacturing investment even if you also start producing your own brands.

  • 3. Michael E. Marotta  |  10 June 2009 at 6:07 am

    WHEN STUDENTS BECOME PROFESSORS

    A few weeks ago, I read THE MAN WHO FOUND THE MONEY about John Stewart Kennedy, the investment banker for many railroads in the 19th century, including J. J. Hill’s lines. Kennedy startted out as a contract supplier to the construction camps. Henry Ford worked (twice) for Thomas Edison. Silicon Valley saw Shockley spawn the “Fairchildren.”

    Contract manufacturing means that consumer goods and services can be formulated to meet a market perceived by a designer. This frees the marketer, minimizing capital requirements and widening the latitudes of flexibility in product or service.

    This works well for USB thumb drives and call center support. You cannot contract for the routine production of something that never existed before.

    While the leading edge always belongs to innovation, more profits may be destined for early adopters or routine followers. Thus, we all benefit from increased choices at prices we prefer.

    Comparative advantage and division of labor suggest that the contract manufacturer who launches their own label will be rare, and therefore interesting to study.

    On the other hand, do professors mind when students — especially former assistants — become professors, competing against them? The new prof teaches Intro 101 until they can capitalize on their specialties, launching their own brand after learning production.

    Mike M.
    “Cow with Bay Leaves”

  • 4. Ned  |  11 September 2009 at 7:45 am

    It seems very difficult to judge whether the future is of contract manufacturing or not, but the current market surely shows a booming factor for companies providing contract manufacturing services.
    The recession has hit many big brands and diverted the interest towards contract manufacturers. But pulling out the R&D to these can hinder the success and growth rate of any big brand.

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