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It’s called moving up the economic value chain: U.S. companies are increasingly conceiving and creating products that are built elsewhere. Prosaic manufacturing, with its razor-thin profit margins and ruthless competition, has been outsourced to Asia. But researchers who study innovation are starting to see a worrisome after-effect: the ability to innovate sometimes disappears with the manufacturing.

Harvard Business School professors David Pisano and Willy Shih set many businesspeople to rethinking whether manufacturing matters with a 2009 Harvard Business Review article titled “Restoring American Competitiveness.” Besides lamenting that outsourcing manufacturing reduces U.S. job prospects and worsens the trade imbalance, the academics argued that economies where manufacturing skills vanish are less likely to harbor future innovation. Because American companies stopped making LCD displays, for example, there was no domestic expertise to build screens for Amazon’s Kindle reader, even though its crucial technology was developed in Cambridge, Massachusetts. Because expertise in thin-film deposition has moved to Asia with most semiconductor production, Chinese companies have a leg up in solar panel manufacturing.

The academics characterize the ecosystem of innovation as a kind of industrial commons. Every company shares the skills and knowledge that underpin an industry. “The tragedy of the commons is that when a company takes the short-term view, they don’t worry about the value of the commons,” Shih says.

The commons problem is easily seen in an industry like fishing. If one fisherman doubles his effort, he can double his income, but if all of them double their effort, the fishery will be rapidly depleted. Industrial commons are somewhat different, because participants are contributing to the knowledge base and supply chain rather than just consuming resources, but when a company outsources manufacturing it depletes the commons just as surely as overfishing does.

When companies outsource their manufacturing work, suppliers close or move, engineers learn different skills, local colleges drop some job-training courses, and the whole ecosystem shrinks. Even if a given company employs just as many engineers and designers as before, they will be part of a smaller community. In their article, Pisano and Shih noted that lots of knowledge is still transferred among engineers in face-to-face meetings and that according to some research, most industrial knowledge is transferred when people switch jobs. A smaller ecosystem in which manufacturing is delegated to offshore organizations makes such transfers more difficult.

Moreover, offshore manufacturers tend to build on their manufacturing expertise. Driven by pressure to boost profits, they take on a growing share of the design work for many products. Today, except for Apple’s products, nearly all laptops are not only built in Asia but designed there as well.

Shih, who is 57, was a veteran manager at IBM and Eastman Kodak before coming to Harvard in 2007. From his fourth-floor office in a building he shares with marketing and finance professors, he says that now he is able to understand issues that he “couldn’t quite articulate” when he was at Kodak.

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Credit: Conrad Warre

Tagged: Business, Business Impact, Advanced Manufacturing

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