Restoring American Competitiveness

Here is the text (without exhibits and graphics) of the article
“Restoring American Competitiveness” by Gary P. Pisano and Willy C. Shih
which appeared in the July/August 2009 issue of the Harvard Business Review.

If you like to listen to music while you read,
perhaps the following would set an appropriate mood :-)

Restoring American Competitiveness

By Gary P. Piano and Willy C. Shih

Decades of outsourcing manufacturing
has left U.S. industry without the means to invent
the next generation of high-tech products
that are key to rebuilding the economy.

Idea in brief [I.e., summary!]
  • Thanks to destructive outsourcing and faltering investment in research,
    the U.S. has lost or is on the verge of losing
    its ability to develop and manufacture a slew of high-tech products.
  • To address this crisis,
    government and business must work together
    to build the country’s industrial commons
    the collective R&D, engineering and manufacturing capabilities
    that sustain innovation.
    Both must step up their funding of research
    and encourage collaborative R&D initiatives
    to tackle society’s big problems.
    And companies must overhaul
    the management practices and governance structures
    that have caused them to make destructive outsourcing decisions.
  • Only by rejuvenating its high-tech sector
    can the U.S. hope to return to the path of sustained growth
    needed to pay down its huge deficits
    and raise its citizens’ standard of living.
    [There is, of course, a simple way to reduce the government’s debt and deficit:
    Spend less on non-productive purposes, such as health care for the aged,
    which enriches only the medical community.]

As the United States strives to recover from the current economic crisis,
it’s going to discover an unpleasant fact:
The competitiveness problem of the 1980s and early 1990s didn’t really go away.
It was just hidden during the bubble years behind a mirage of prosperity,
and all the while the country’s industrial base continued to erode.

Now, the U.S. will finally have to take the problem seriously.
Rebuilding its wealth-generating machine—
that is, restoring the ability of enterprises
to develop and manufacture high-technology products in America—
is the only way the country can hope to pay down its enormous deficits
and maintain, let alone raise, its citizens’ standard of living.
Reversing the decline in competitiveness will require two drastic changes:
  • The government must alter the way it supports
    both basic and applied scientific research
    to promote the kind of broad collaboration
    of business, academia, and government
    needed to tackle society’s big problems.
  • Corporate management must overhaul
    its practices and governance structures
    so they no longer exaggerate the payoffs and discount the dangers
    of outsourcing production and cutting investments in R&D.

Section 1
The Competitiveness Problem

For much of the last two decades,
the stunning growth of the U.S. economy
was widely hailed in academic, business, and government circles
as evidence that
America’s competitiveness problem was as obsolete as
leg warmers and jazzercise
[Holy Crow! I didn’t even realize that jazzercise was obsolete.]
The data suggest otherwise.
Beginning in 2000,
the country’s trade balance in high-technology products—
historically a bastion of U.S. strength—
began to decrease.
By 2002, it turned negative for the first time
and continued to decline through 2007.
(See the exhibit “A Sign of Trouble.” [Omitted here.])

Even more worrisome,
average real weekly wages have essentially remained flat since 1980,
meaning that the U.S. economy has been unable to provide
a rising standard of living for the majority of its people.
This undoubtedly is one reason
Americans have attempted to borrow their way to prosperity,
a strategy that clearly is no longer tenable.
[Really, sane people should have seen it was never sustainable.]

What, then, was actually happening when it seemed things were going so well?
Companies operating in the U.S.
were steadily outsourcing development and manufacturing work
to specialists abroad
and cutting their spending on basic research.

In making their decisions to outsource,
executives were heeding the advice du jour of business gurus and Wall Street:
Focus on your core competencies, off-load your low-value-added activities,
and redeploy the savings to innovation,
the true source of your competitive advantage.
But in reality, the outsourcing has not stopped
with low-value tasks like simple assembly or circuit-board stuffing.
Sophisticated engineering and manufacturing capabilities
that underpin innovation in a wide range or products
have been rapidly leaving too.
As a result, the U.S. has lost or in in the process of losing
the knowledge, skilled people and supplier infrastructure needed
to manufacture many of the cutting-edge products it invented.

Among these are such critical components as
light-emitting diodes for the next generation of energy-efficient illumination;
advanced display for mobile phones and new consumer electronic products
like Amazon’s Kindle e-reader;
the batteries that power electric and hybrid cars;
flat-panel displays for TVs, computers, and handheld devices;
and many of the carbon fiber components for Boeing’s new 787 Dreamliner.

A similar trend is undermining the U.S. software industry.
Initially, companies outsourced
only relatively mundane code-writing projects to Indian firms
to lower software-development costs.
Over time,
as Indian companies have developed their own software-engineering capabilities,
they have been able to win more complex work,
like developing architectural specifications
and writing sophisticated firmware and device drivers.

Equally alarming is the U.S.’s diminished capability to
create new high-tech products.
For example,
nearly every U.S. brand of notebook computer, except Apple,
is now designed in Asia,
and the same is true for most cell phones
and many other hand-held electronic devices.

We have heard managers rationalize outsourcing decisions
by saying that they can always reverse course
if the quality of the work isn’t good enough,
if the anticipated cost savings prove ephemeral,
if supply-chain complexities or risks are too great,
or if the work turns out to be more strategic
than they originally thought.
But this logic overlooks
the lasting damage that outsourcing inflicts
not only on a firm’s own capabilities
but also on those of other companies that serve its industry,

including suppliers of advanced materials, tools, production equipment,
and components.
We call these collective capabilities the industrial commons.

Section 2
The World Is Not Flat

Centuries ago, “the commons” referred to
the land where animals belonging to people in the community would graze.
As the name implies, the commons did not belong to any one farmer.
All were better off for access to it.
Industries also have commons.
A foundation for innovation and competitiveness,
a commons can include R&D know-how,
advance product development and engineering skills,
and manufacturing competencies related to a specific technology.

Such resources may be embedded in
a large number of companies and universities.
Software knowledge and skills, for instance,
are vital to an extremely wide range of industries
(machine tools, medical devices, earth-moving equipment, automobiles,
aircraft, computers, consumer electronics, defense).
Similarly, capabilities related to thin-film deposition processes
are crucial to sophisticated optics;
to such electronic products as semiconductors and disk drives;
and to industrial tools, packaging, solar panels, and advanced displays.
The knowledge, skills, and equipment related to
the development and production of advanced materials
are a commons for such diverse industries as
aerospace, automobiles, medical devices, and consumer products.
Biotechnology is a commons not just for drugs
but also for agriculture and the emerging alternative-fuels industry.

More often than not,
a particular industrial commons will be geographically rooted.
For instance, northern Italy is home to a design commons
that feeds, and is fed by, several design-intensive businesses,
including automobiles, furniture, apparel, and household products.
The mechanical-engineering commons in Germany is tightly coupled to
the country’s automobile and machine tool industries.
The geographic character of industrial commons helps to explain
why companies in certain industries tend to cluster in particular regions—
a phenomenon noted by Michael Porter and other scholars.
Being geographically close to the commons is a source of competitive advantage.

What about the popular notion that distance and location no longer matter,
or, as Thomas Friedman put it, “The world is flat”?
While we agree with the general idea
that geographic boundaries on trade are falling
and that the global economy is more intertwined than ever,
the evidence suggests that when it comes to knowledge,
distance does matter.
Detailed empirical work on knowledge flow among inventors
by out HBS colleage Lee Fleming
shows that proximity is crucial.
An engineer in Silicon Valley, for instance,
is more likely to exchange ideas with other engineers in Silicon Valley
than with engineers in Boston.
When you think about it, this is not surprising,
given that much technical knowledge, even in hard sciences,
is highly tacit and therefore far more effectively transmitted face-to-face.
Other studies show that the main way
knowledge spreads from company to company
is when people switch jobs.
And even in America’s relatively mobile society,
it turns out that the vast majority of job hopping is local.

This helps to explain why commons persist in specific locations
in a era when huge amounts of scientific data
can be accessed easily from anywhere.
For example, even though virtually all the raw data from the Human Genome Project, the decade-plus effort to map the human genome,
is available electronically all over the world,
the drug research it has generated
is heavily concentrated in the Boston, San Diego, and San Francisco areas.

Once an industrial commons has taken root in a region,
a powerful virtuous cycle feeds its growth.
Exports flock there because
that’s where the jobs and knowledge networks are.
Firms do the same to tap the talent pool, stay abreast of advances,
and be near suppliers and potential partners.
The Swiss pharmaceutical giant Novartis, for instance,
chose to move its research headquarters
from Basel, Switzerland to Cambridge, Massachusetts,
to be close to universities and research institutes
that are global leaders in biosciences
and the hundreds of biotech firms already in the area.
And its presence, in turn,
has increased the Boston area’s pull on yet more firms and individuals.
These dynamics make it difficult
for other regions that do not yet have a vibrant biotechnology commons
to attract biotech companies, even with generous incentives.

Our research on
the semiconductor, electronics, pharmaceutical, and biotech industries
has found that
commons are even more important to countries’ and companies’ prosperity
than is generally believed.
That’s because innovation in one business can spawn whole new industries.

A historical example is the birth of the modern pharmaceutical industry.
It began in the late 1800s in Switzerland and Germany
because the earliest drugs were based on synthetic dye chemistry
and the two countries were home to
large chemical companies with strong research labs and
deep technical expertise in synthetic dye production.

A current example is the solar panel industry,
which is booming in Asian countries such as
India, Japan, Taiwan, Korea, and especially China.
India owes its position to Moser Baer,
a leading manufacturer of optical storage media,
which used its capabilities in thin-film coating and manufacturing
to move into solar panels.
China’s, Japan’s, Taiwan’s, and Korea’s successes stem, at least in part,
from their deep expertise
in processing ultrapure crystalline silicon into wafers
and applying thin films of silicon onto large glass sheets—
capabilities developed by their semiconductor foundries
and their manufacturers of flat-panel displays.
(China has another advantage:
It is the production base for the mundane components
like power semiconductors, controllers, and housings
that are needed to produce full panels.)

Although the U.S. still produces about 14% of the world’s photovoltaic cells,
it no longer is a significant player in crystalline silicon-based solar panels,
the prevailing technology.
Some U.S. manufacturers such as Temp, Arizona-based First Solar
are trying to become players in thin-film solar, the newest technology.
But the decline of the domestic infrastructure
in thin-film deposition and electronics manufacturing
puts them at a big disadvantage.

Section 3
Erosion of the Commons

When a major player in an industry
outsources an activity, cuts funding for long-term research,
and gains a short-term cost advantage,
competitive pressure often forces rivals to follow suit.
As potential employment opportunities shrink,
experienced people change jobs, moving out of the region,
and students shy away from entering the field.
the commons loses a critical mass of work, skills, and scientific knowledge
and can no longer support providers of upstream and downstream activities,
which are, in their turn, forced to move away as well.
This is what happened to the industrial commons serving a number of high-tech sectors in the United States.

Consider the commons supporting the personal computer industry in the United States.
In the late 1980s, original equipment manufacturers in the United States
initially began to outsource the assembly of printed circuit boards
to specialist contractors in South Korea, Taiwan, and China.
These specialists offered significant cost savings,
partly because of their location in low-wage countries
and partly because of the economies of scale they achieved
by serving lots of OEMs.
The OEMs understandably didn’t see the move as strategically risky
because they held the critical intellectual property and design skills
(they provided the contractors with detailed specifications)
and because manufacturing the boards
wasn’t a source of competitive advantage.

Ferocious competition and razor-thing margins, however,
prompted many of the contractors, particularly those in Taiwan,
to seek higher-value-added work.
They persuaded the OEMs to allow them to assemble
a greater share of the overall product,
and from there they moved into compete product assembly.
Given that many of the components were also sourced from Asia,
a logical next step was to take over the management of the supply chain
from their American customers.

Then came design.
Initially, these firms took over design-engineering tasks on a contract basis.
The OEM typically would still provide
the high-level conceptual design and specifications,
contracting with the Asian supplier to do the detailed engineering.
Eventually, though,
the suppliers took over those activities as well for products like notebooks,
which require designers to interact frequently with manufacturing.
The result:
These “original design manufacturers,” as they describe themselves,
ended up designing and manufacturing virtually all Windows notebook PCs.

The standard exception is Apple,
whose design capability in the U.S.
for both notebook computers and consumer electronics
has been critical to its success.
Although Apple has outsourced
the manufacture of its notebooks, iPod, and iPhone,
it has been able to preserve a first-rate design capability in the States so far
by remaining deeply involved in the selection of components,
in industrial design, in software development,
and in the articulation of the concept of its products
and how they address users’ needs.
But for how long can it continue to do so?
Given the perennially ruthless competition Apple faces
and the continuing migration of design capabilities away from the U.S. to Asia,
Apple’s challenges promise to increase.

After a contractor has evolved into an ODM,
there’s little to prevent it from launching its own brand
and becoming a competitor to its OEM customers.
That’s exactly what happened in consumer electronics,
where U.S. pioneers like RCA and Sylvania in television manufacturing
ultimately became nothing more than brands
that were traded like playing cards among Asian manufacturers.

Most U.S. companies in the notebook PC business
now seem headed for the same fate.

The electronics-outsourcing story
exposes several pieces of conventional wisdom as myths.
One is the popular belief that an advanced economy like the United States
no longer needs to manufacture
and can thus thrive exclusively as
a hub for high-value-added design and innovation.
In reality, there are relatively few high-tech industries
where the manufacturing process is not a factor
in developing new—especially, radically new—products.

That’s because in most of these industries product and process innovation
are intertwined.
So the decline of manufacturing in a region sets off a chain reaction.
Once manufacturing is outsourced,
process-engineering expertise can’t be maintained,
since it depends on daily interactions with manufacturing.
Without process-engineering capabilities,
companies find it increasingly difficult to conduct advanced research
on next-generation process technologies.
Without the ability to develop such new processes,
they find they can no longer develop new products.
In the long term, then,
an economy that lacks
an infrastructure for advanced process engineering and manufacturing
will lose its ability to innovate.

Another myth is the prevailing view that
the migration of mature manufacturing industries
away from developed countries like the United States
is just part of a healthy, natural process of economic [development]
that allows resources to be redeployed to higher-potential businesses.
We certainly agree that a dynamic global economy leads to
shifting patterns of production and trade.
We also agree that shedding certain activities
that no longer provide opportunities for innovation
and redeploying resources to others
can spur economic growth and raise living standards.
If that hadn’t occurred in the U.S.,
its economy would still be largely agrarian and probably quite poor.
But this logic has been taken to a dangerous extreme.

It ignores the fact that new cutting-edge high-tech products
often depend in some critical way on the commons of a mature industry.
Lose that commons, and you lose the opportunity
to be the home of the hot new businesses of tomorrow.
We mentioned one example earlier:
The migration of semiconductor foundries to Asia,
which caused a sharp decline in silicon-processing and thin-film-deposition capabilities in the U.S.,
greatly reducing, if not eliminating,
its chances of becoming a major player in solar panels.

Another example is batteries for hybrid and electric vehicles
like GM’s forthcoming Chevy Volt.
The Volt’s lithium-ion battery—the highest-value-added component in the car—
will be manufactured in South Korea.
GM had no choice but to look abroad.
Rechargeable-battery manufacturing left the U.S. long ago.
Most innovation in batteries in recent decades has been driven by
the increasing demands of consumer electronics products
for more and more power in smaller and smaller packages.
When U.S. companies largely abandoned
the “mature” consumer electronics business,
the locus of R&D and manufacturing—
not just for laptops, cell phones, and such
but also for the batteries that power them—
shifted to Asia.
Yes, there are some efforts
(including one by General Electric-backed A123Systems)
to resurrect rechargeable-battery manufacturing in the United States.
But given the state of the U.S. commons relative to Asia’s
players like A123 face an uphill battle.

So do U.S. automakers.
Japan’s and South Korea’s strong battery and car industries
give them an advantage over U.S. companies
in developing electric and hybrid cars.
And, as the New York Times reported in April [2009],
China’s leaders want to make their country
one of the world’s top producers of hybrid and all-electric cars
within three years.
Chinese battery maker BYD has announced plans
to begin selling hybrid and electric cars in the United States and Europe in 2011.

Section 4
Restoring the Commons

During the 1980s and early 1990s,
when outsourcing by U.S. firms and inroads by Japanese companies
last raised concerns about U.S. competitiveness,
there was a heated debate about the remedies.
Some called for Washington
to follow the lead of Japan’s Ministry of International Trade and Industry
and provide special support for important industries.
Others exhorted American companies to stop outsourcing for patriotic reasons.
Neither of these recommendations is a realistic way
to preserve U.S. competitiveness and jobs.

As Robert Reich astutely pointed out nearly 20 years ago
in his provocative article “Who Is Us” (HBR, January-February 1990),
the national identities of large corporations have become meaningless.
Given the realities of global competition and capital market pressures,
it is too much to expect executives
to demonstrate an allegiance to a particular location
merely because it is their company’s nation of origin.
[Really? How about the fact that they are chartered by a particular government?]
Nor does it make sense for Washington to favor multinationals
that happen to be headquartered in the United States
and discriminate against foreign-based corporations
that run large operations in the country;
both sets of companies are important contributors to the American economy.
[We see this playing out in the Boeing/EADS competition for the next USAF tanker.]

That said,
it is in the interests of Washington and all companies that operate in the U.S.
to work together to reinvigorate the country’s industrial commons.

Washington’s interest is obvious:
to revitalize the all-important high-tech sector.
Why should companies care?
America is an important market.
If a company, regardless of its nationality, is a player there,
building or sustaining local capabilities is in its interest.
Beyond that, a commons, regardless of where in the world it’s located,
can be a source of long-term competitive advantage for all its members.
So whether you’re the U.S. firm IBM with a major research laboratory in Switzerland,
or the Swiss company Novartis operating in the biotech commons in the Boston area,
sacrificing such a commons for short-term cost benefits is a risky proposition.

We don’t claim to have an elaborate master plan for repairing the U.S. commons.
But especially at a time when
Washington’s efforts to save the banks and the U.S. auto industry
are reigniting the industrial policy debate,
we think it would be helpful to
challenge some widely held perceptions about government involvement,
suggest ways to learn from programs that worked in the past,
and offer some ideas on what management needs to do.

Section 5
What Government Should Do

All too often,
the debate about what role Washington should play in supporting innovation
degenerates into a battle between two extremes:
the laissez-faire camp and advocates of centralized industrial planning.
Listening to them, you’d think there could be no middle ground.

History says otherwise.
While the U.S. has perhaps the most market-oriented economy in the world,
federal and, to a lesser extent, state governments
have long played a central role in supporting technological innovation.
In the early twentieth century,
the agricultural experimental stations created by state governments
were instrumental in spawning innovations like hybrid corn
that enormously boosted agricultural productivity.
In the 1950s and 1960s,
the Department of Defense spurred innovation in semiconductors
through procurement and targeted research programs.
In the 1960s through the 1980s,
DOD- and NASA- sponsored research contributed heavily
to building American science and engineering capabilities
in chip design, aeronautics, and satellite communications.

Not all government programs have been successful, of course.
The supersonic transport program of the 1960s
and the thermal solar and synthetic fuels initiatives in the late 1970s and 1980s
are examples of failure.
In general, government has been effective in its support for innovation
when it has acted as a customer
seeking a solution to a concrete,
compelling need
or when it has been a patron of basic or applied research
that has the potential for broad application.
Conversely, its support of innovation has generally failed
when it has not had a user’s stake in the outcome
or when it has bet on unproven technical solutions
that require extensive knowledge
of commercial applications or market realities
that it lacked.
With this in mind,
we offer three broad suggestions for what Washington should do
to rebuild the industrial commons:

5.1 Reverse the slide in the funding of basic and applied science
Innovative activities can be grouped into three broad categories,
whose boundaries are admittedly a bit blurry.
Basic science research
seeks to deepen our understanding of first principles,
such as the genetic mechanisms that regulate how cells grow and divide.
Applied research
seeks to extend that knowledge
to answer more specific questions about real-world problems,
like which particular genes are involved in cancer.
And commercial R&D
focuses on finding marketable solutions—
for example, discovering, developing, and testing a drug
to treat a certain type of cancer.
We can think of applied research as the bridge between
basic research and commercial R&D.

Washington has long been the supporter of basic research in the U.S.
and a major provider of funding for applied research.
No country, in fact, has invested more in basic research than the United States,
and three-quarters of the funding has come from the federal government.
Through such agencies as the National Science Foundation
and the National Institutes of Health,
Washington has spent an inflation-adjusted total of $1.2T since 1953.
By funding knowledge, supporting skilled scientists and technical personnel,
and underwriting vibrant research universities
that have acted as magnets for the laboratories of private enterprises,
this support has been a vital stimulus for commercial innovation in the United States.
(We can’t emphasize enough the importance of world-class universities
in building a commons.
[We would hardly expect otherwise :-)]
Silicon Valley would never have become what it is
without the presence of universities like Stanford and Berkeley.)

But while U.S. government funding for basic scientific research,
adjusted for inflation,
grew at a healthy pace through the 1990s,
it began to drop in 2003 and has been flat or declining slightly since then.
That’s a worrisome trend.

Government funding for applied research has declined even more sharply.
Historically, federal funding
was split relatively evenly between basic and applied research,
reflecting their equal importance.
However, since around 1990, that has no longer been the case:
Government funding for applied research declined 40% from 1990 to 1998.
Even though it then rebounded,
it’s flattened in recent years
and is still way behind funding for basic research
(see the exhibit,
“A Flagging Commitment to Scientific Research” [omitted in this blog post]).

This is troubling because government support for applied research
has been just as important to U.S. industrial competitiveness
as its support of basic research.
Government-sponsored endeavors
that have made a huge difference in the past three decades include
DARPA’s VLSI chip development program and Strategic Computing Initiative;
the DOD’s and NASA’s support of composite materials work;
the NSF’s funding of supercomputers and of NSFNET
(an important contributor to the internet);
and the DOD’s support of the Global Positioning System),
to mention a handful.

In most instances, these programs required a long-term commitment.
Consider the internet,
which sprang from a decades-long applied research effort
that began in the late 1960s,
when the federal government’s Advanced Research Projects Agency, or ARPA
(later renamed DARPA when it became part of the Department of Defense),
issued its first request for proposals to build a four-site computer network.
Creating the internet involved little or no new basic science.
It did, however,
require significant investments in applied research
on packet switching, communications protocols, and networking infrastructure—
investments that the private sector probably would never have made
because the time horizons were too long and the payoffs too difficult
for any one company to capture.
The way the project
spurred collaboration among researchers in an array of companies and universities
catalyzed the growth of basic networking-related capabilities,
led to innovations such as the multi-protocol router,
and resulted in the creation of a number of companies,
including Cisco Systems, Juniper Networks, and Extreme Networks.

The U.S. cannot afford to be complacent.
Governments in other countries like
Singapore, China, Korea, and the United Arab Emirates
are intent on fostering growth or building new world-class research universities.
They are also investing heavily in applied science,
hoping to replicate the success of Taiwan,
whose Industrial Technology Research Institute built the foundations for
that country’s highly successful semiconductor industry.

5.2 Focus resources on solving “grand challenge problems”
Climate change,
a dependence on expensive dirty hydrocarbons,
a lack of potable water,
the ravages of diseases—
these are some the grand problems plaguing the world
that will require fundamental advances in knowledge to solve.
Governments are often uniquely positioned
to mobilize and coordinate the efforts of
the numerous organizations needed to confront these huge challenges.

[Well, perhaps not all governments.
Anyone want to fund a Zaire-run technology initiative?]

At its peak, for instance, the ARPA networking initiative involved
dozens of private companies and universities.
Under the purview of the Department of Energy and the NIH,
the Human Genome Project involved
a similar number of laboratories from around the world.

Such government-sponsored collaborative efforts have two benefits.
First, they leverage resources:
A dollar spent on research goes much further
when the fruits of that spending are shared broadly.
Second, they help to create networks of collaborators
that cut across academia and industry,
which can provide a foundation for an industrial commons.

the granting process for much of the scientific funding in the U.S.
is biased toward lower-risk, incremental projects (“normal science”)
that fits neatly into established academic fields
and is weighted against higher-risk, high return research that spans disciplines.
To address this bias, the peer review process
that such agencies as the NSF and NIH employ to award grants
must be reformed.
Currently, panels of academic scientists,
each often composed of individuals from within a single discipline,
make these decisions.
Instead, groups comprising experts in a range of disciplines
from the academic, business, and policy-making communities
should be choosing the problems
and deciding how best to structure basic and applied research programs
to seek solutions.
It is especially important for
government policy makers involved in these decisions
to have strong scientific backgrounds
(as they do in Taiwan and Singapore).

5.3 Let ailing giants die
Throughout the world, governments have provided significant financial support
to industrial companies
struck by the economic crisis.
As we were writing this article,
Congress and the Obama administration were considering
whether to give teetering GM more aid
or let it go into bankruptcy proceedings.
We oppose more support.
There are rare instances when companies cannot be allowed to fail
because of vital national interests (national security)
or systemic effects (the impact that the failure of a big player like AIG or Citigroup would have on the interconnected financial system).
Auto companies don’t fall into either category.
[But labor unions want to keep the bankruptcy-causing benefits they negotiated,
and have great influence on Democratic politicians and administrations.]

Advocates of aid to the auto companies have argued that,
in addition to preserving the huge number of jobs at those enterprises,
a key reason to continue to prop them up is to preserve the supplier base.
Lose these giants, they say,
and you will lose feeder industries
(machine tools, advanced metal fabrication, molding, and so on)
crucial to the country’s industrial base.
We disagree and for two reasons believe that
the potential impact on the U.S. commons has been exaggerated.

companies that are failing as a result of poor management or misguided strategy
often suck the vitality out of the commons in which they participate,
and government bailouts almost never succeed
in restoring such companies to full health.
Indeed, one cause of the U.S. automakers’ current predicament
is their failure to nurture a strong industrial commons.
Several studies have documented a marked difference
between the ways U.S. and Japanese companies
have managed their supplier bases, for instance.
Toyota has always understood the concept of industrial commons.
It treats key suppliers as long-term partners,
shares development work with them,
and sticks with them over the long term.
When a Toyota supplier is struggling,
Toyota sends in its own people to help.
In contrast,
U.S. auto companies have generally treated their suppliers as adversaries.
They have kept them on a tight leash.
They offer them only short contracts.
They all too often base their purchasing decisions largely on price.
When a supplier has a problem,
the U.S. auto company’s typical response has been to terminate the contract.

Second, the bailout debate (in both the United States and Europe)
completely ignores the global nature of the auto business
and the contribution foreign-based companies make to the U.S. industrial commons.
Not every player in the U.S. auto-manufacturing sector is a basket case.
There are plenty of healthy factories.
Most of them are owned and operated by foreign-based corporations
like Toyota, Honda, Nissan, and BMW.
These companies are contributing to the U.S. industrial commons.

If anything,
Washington should encourage even more participation in the commons
by foreign companies.
An immediate case in point: the Fiat-Chrysler deal to save Chrysler.
The Italian company has agreed to transfer
its technology for producing highly efficient diesel engines to Chrysler
in exchange for a substantial minority stake—
contributing precisely the kind of clean technology
that the Obama administration wants the U.S. to pursue.
Ironically, some in Congress opposed the deal
because they didn’t want to use taxpayer money
to benefit a “foreign” company.
They just don’t get it.

Section 6
What Businesses Must Do

Government support of basic and applied research can fertilize the soil,
but it takes private companies willing to make long-term investments in risky R&D
to build a commons.
The management challenge is a familiar one
of balancing long-term and short-term performance.
Here are six suggestions for striking that balance:

6.1 Make capabilities the main pillar of your strength
Companies pour enormous amounts of resources into marketing to build brands.
But with the exception of a few industries like soft drinks,
brands are only as good as the distinctive products they represent.
Creating and making distinctive products requires
an array of strong technical, design, and operational capabilities.
Given how demanding and sophisticated
customers throughout the world have become,
marketing cannot overcome weak innovation for long.
Apple, Intel, Corning, Amazon, and Applied Materials
are companies that understand this.
They realize that the only way to stay ahead of competition
is to maintain an innovation advantage over the long term,
and the only way they can do that is
if they invest in new, differentiated capabilities.

6.2 Stop blaming Wall Street for short-term behavior
We’ve heard it over and over again from executives:
“We’d love to build capabilities over the long term,
but Wall Street,
with its relentless pressure to produce ever-higher quarterly earnings,
won’t let us.
We have no choice.
We have to outsource.”

This devil-made-me-do-it defense does not hold up.

When companies promise to increase return quarter after quarter,
that’s what Wall Street expects.
But when they articulate a credible long-term strategy
and demonstrate a capacity to execute that strategy,
the capital markets have given them the necessary room to achieve it.
In his first letter to the shareholders in the 1997 annual report,
Amazon CEO and founder Jeff Bezos explained that
his company would take a long-term perspective
in its strategy and operating decisions.
This message has been consistently reinforced in every subsequent letter.
So short-term investors know Amazon is not the company for them.
Sure, Amazon’s stock has taken some hits now and then
when the company has suffered a setback.
But Bezos and his team have understood that the stock will rebound,
and they have staked the course.

[That’s one example.
But what those executives were saying in the first paragraph
has been widely reported to be the case.
This issue is crucial, and deserves close scrutiny.]

6.3 Recognize the limits of financial tools
Most companies are wedded to highly analytical methods
for evaluating investment opportunities.
Still, it remains enormously hard to assess long-term R&D programs
with quantitative techniques—
even sophisticated ones like
real-options valuation and Monte Carlo simulations.
Usually, the data, or even reasonable estimates,
are simply not available.

Nonetheless, all too often these tools become the ultimate arbiter
of what gets funded and what does not.
So short-term projects with more predictable outcomes beat out
the long-term investments needed
to replenish technical and operating capabilities.
Managers would serve their companies more wisely by recognizing that
informed judgment is a better guide to making such decisions
than an analytical model loaded with arbitrary assumptions.
There is no way to take the guesswork out of the process.

6.4 Reinvigorate basic and applied research
In the 1980s and 1990s, corporate research laboratories fell out of favor.
They were deemed wasteful because many of their efforts could not be linked to
the immediate business needs of their companies.
Several—including Bell Labs and Xerox PARC,
the birthplaces of many critical technologies
that underpin important industrial commons-
withered, disappeared, or were jettisoned by their corporate parents.
Their resources were redeployed to business units.

[Let’s be clear on some of the reasons here.
In the two specific examples here, they are quite clear.
The demise of Bell Labs is directly and unarguably due to
the decision of a federal judge, Judge Greene.
The demise of Xerox PARC was due to the inability of Xerox,
the office equipment company,
to turn its wonderful innovations into salable products.
(See the obituary of its founder, Jacob Goldman
for some further information.)
Steve Jobs and Bill Gates, on the other hand, saw the use for their products.
I am personally familiar with this situation,
having made a technology assessment trip to Silicon Valley in 1981
to assess the technology prospects for
a certain government office automation project
for which I was then the program manager.]

It’s true that laboratories like PARC generated many inventions
that didn’t serve the needs of their owners’ core businesses.
(It’s widely known that
Xerox was content to let other companies
commercialize many of PARC’s inventions,
like the graphical user interface, Ethernet, and ball mouse.)
[Note: Some authors, in particular Clyde Prestowitz,
have erroneously credited the graphical user interface (GUI)
to Steve Jobs and Apple.
It was, as noted above, due to PARC.]

But the fact that PARC’s labs were generating inventions
that Xerox’s core copier business couldn’t use
should have told Xerox’s executives something:
that there were huge opportunities outside the core.
[I think these authors may asking too of the Xerox executives.
The potential of the newly defined graphical user interface and the LAN
to revolutionize office automation,
while with hindsight of enormous significance and potential for profit,
were clear at the time to some youthful nerdy types,
without worries about the effect on legacy hardware companies (such as Xerox)
like Jobs, Gates, and some others,
but it’s a stretch to say that the inevitability was obvious to management types.]

Their inability to read and react to those signals was the result of
their flawed resource-allocation processes and strategies, not of PARC.

Of course, focused R&D that serves customers’ needs is vitally important.
But so is the capacity to explore.
Recognizing this, a few companies, including IBM and Corning,
have maintained strong corporate research capabilities
and look to them to spur the next major wave of business opportunities.

6.5 Collaborate
While we want large companies
to dedicate more resources to basic and applied research,
we’re not suggesting that they return to
the days when corporate labs were largely insular places.
Rather, they should follow the lead of
companies like Corning, IBM, and Novartis,
which recognize that their scientists needn’t, and shouldn’t, go it alone.
They understand the value of the commons as a source of research capability.

IBM’s leaders, for example,
saw that the company could no longer afford on its own
to make the investments required
to stay on the cutting edge of semiconductor-manufacturing processes.
Accordingly, over the past decade Big Blue has built
what it calls a “radical collaboration” model
in which it and a set of commercial partners
share research capabilities and a common manufacturing platform,
even though some of them compete downstream.
IBM calculates the value of the benefits it receives from this relationship
to be five to 10 times the amount it invests.

6.6 Create technology-savvy boards of directors
To effectively govern a company
whose competitive advantage rests on science and technology,
a board needs to have the same feel for technology
as it has for finance and accounting.
Boards—including those of many American high-tech corporations—
are populated with plenty of lawyers, finance, and accounting experts,
and CEOs from other companies.
Scientists are a very small minority.
And while many corporations have scientific advisory groups,
we have not yet come across one
whose board has a science or technology committee.
[I wonder how Hewlett-Packard stands in this regard.
Its founders, Walter Hewlett and David Packard, were outstanding engineers,
and they made it into a great company.
When they died, their controlling holdings passed to, I believe, their daughters,
who selected Carly Fiorina as their CEO.
Carly’s background was in marketing.
The next CEO, Mark Hurd, also lacked an engineering background.]

Regulations and good corporate governance call for
audit, compensation, nominating, governance, finance, and executive committees.
Shouldn’t the boards of companies
whose company heavily depends on science or technology
also have a committee to ensure that all is well in this area?
[One might ask the same question concerning those companies in the finance area
that bet so heavily on the reliability of quantitative tools.]

Alfred Chandler, the noted Harvard business historian,
described how American companies like DuPont and General Motors
gained prominence in the twentieth century
by developing and integrating R&D, manufacturing, and marketing capabilities.
These enterprises did not create these capacities
to be good corporate citizens.
They were pursing competitive advantage,
and they understood that these capabilities were essential to that goal.
Today, the United States is at an analogous juncture,
but the challenge is no longer to create capabilities
to manage the large-scale, vertically integrated enterprises
of the twentieth century;
it is to build anew the technological operational capabilities
needed to conceive and produce high-value goods and services.
We must recognize that the capacity to undertake
advanced process engineering and complex manufacturing
is as important to continued innovation
as are strong universities and a robust venture capital industry.


If major venture capital firms like Kleiner Perkins and Sequoia Capital
announced they were leaving the U.S. to go to, say, India
because they saw more profitable investment opportunities there,
it would cause an uproar.
Outsourcing by high-tech manufacturers should do the same.

It’s unfortunate that the warning cries of the 1980s and early 1990s
were ignored.
[Subject for another article: Why were they?
Clyde Prestowitz has some well-researched answers to that in his excellent book
The Betrayal of American Prosperity.]

Much has been lost since then,
but it’s not too late to rebuild the industrial commons.
Only by rejuvenating its innovative capabilities
can America return to a path of sustainable growth.

[As I have elsewhere, let me point out that
all the American innovation in the world
will not restore America to prosperity when corporate bosses
transfer the innovative technologies to lower-cost countries for exploitation.]

Here is as much as I can type of the exhibits,
until I think of a better place to put them.

Going... Going... Gone

Many high-tech products can no longer be manufactured in the United States
because critical knowledge, skills, and
suppliers of advanced materials, tools, production equipment, and components
have been lost through outsourcing.
Many other products are on the verge of the same fate.
  • Semiconductors
    • Already lost
      “Fabless” chips.
    • At risk
      Flash memory chips.
  • Lighting
    • Already lost
      Compact fluorescent lighting.
    • At risk
      LEDs for solid-state lighting, signs, indicators, and backlights.
  • Electronic displays
    • Already lost
      LCDs for monitors, TVs, and handheld devices like mobile phones.
      Electrophoretic displays.
      for Amazon's Kindle e-reader and electronic signs.
    • At risk
      Next-generation “electronic paper” displays
      for portable devices like
      e-readers, retail signs, and advertising displays.
  • Energy storage and green energy production
    • Already lost
      Lithium-ion, lithium polymer, and NiMH batteries
      for cell phones, portable consumer electronics, laptops,
      and power tools.
      Crystalline and poly-crystalline silicon solar cells, inverters,
      and power semiconductors for solar panels.
    • At risk
      Thin-film solar cells (the newest solar-power technology).
  • Computing and telecommunications
    • Already lost
      Desktop, notebook, and netbook PCs.
      Low-end servers.
      Hard disk drives.
      Consumer-networking gear
      such as routers, access points, and home set-top boxes.
    • At risk
      Blade servers, midrange servers.
      Mobile handsets.
      Optical-communication components.
      Core network equipment.
  • Advanced materials
    • Already lost
      Advanced composites
      used in sporting goods and other consumer gear.
      Advanced ceramics
      Integrated circuit packaging.
    • At risk
      Carbon composite components
      for aerospace and wind energy applications.

A Sign of Trouble

The U.S. trade surplus or deficit in high-tech products,
rounded to the nearest billion
(+ is a surplus, - is a deficit).

2000 +28G
2001 +5G

2002 -18G
2003 -27G
2004 -37G
2005 -44G
2006 -38G
2007 -54G

Note: Sectors included are:
biotechnology, life sciences, optoelectronics, information and communications, electronics, flexible manufacturing, advanced materials, aerospace, weapons, nuclear technology, and computer software.

Source: National Science Board, “Science and Engineering Indicators 2008”

Why Amazon’s Kindle 2 Can’t Be Made in the U.S.

The Kindle 2 e-reader was designed by Amazon’s Lab126 unit in California.
The vast majority of its components are made in China, Taiwan, and South Korea,
and it is assembled in China, a center for such work.

Flex circuit connector: made in China
U.S. supplier base eroded as
the manufacture of consumer electronics and computers
migrated to China.

Electrophoretic display: made in Taiwan
Its manufacture requires expertise developed from producing flat-panel LCDs,
which migrated to Asia with semiconductor manufacturing.

Highly polished injection-molded case: made in China
U.S. supplier base eroded as
the manufacture of toys, consumer electronics, and computers migrated to Asia.

Wireless card: made in South Korea
South Korea used
its infrastructure for designing and manufacturing consumer electronics
to become a center for making mobile phone components and handsets,
especially products using CDMA technology,
which is widely used in South Korea.

Controller board: made in China
U.S. companies long ago outsourced the manufacture of printed circuit boards
to Asia, where there is now a huge supplier base.

Lithium polymer battery: made in China
Battery development and manufacturing migrated from the U.S. to Asia
along with the development of consumer electronics and notebook computers.

A Flagging Commitment to Scientific Research

The federal government has been the dominant provider of funding for basic research in the United States and a major underwriter of applied research.
But in recent years, the gap between the two has widened.
The disparity could undermine the competitiveness of the country’s high-tech sector over the long term.

U.S. federal government funding for research (in constant 2000 dollars)
[There follows a line graph.
I cannot reproduce it here,
but here are the start and end values for the two amounts being compared:]

1980: Basic=$11.4G, Applied=$11.5G
2006: Basic=$31.2G, Applied=$21.4G

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