[Last] Episode: What is changing in manufacturing

Usually when we refer to production, factories and industries, we all think about the production function. As we now an output is mainly made by Labor, Capital and Land. The way they combine together is called technology. As I reported in my previous posts technology is deeply changing. During the 20^th century technology had a lot of innovations. By thinking on processes we shifted from the mass production of the beginning of the century to lean production in the 1990s. Yet we needed a huge amount of capital, land and labor. Thus, companies moved from richer countries to poorer as the process of globalization gathered pace. Poorer countries allowed the same production level for less capital, land and labor costs. Costs not technology. Yes, the famous abroad outsourcing process wasn't a technological breakthrough. It was simply a movement, allowed by transport cost reduction and internet communication, from a high-cost place to a low-cost place. The technology of production didn’t change at all or so. But now something is changing. New production machines as 3D printing allows people to produce some products (even iPhone or car parts) directly at home (at $ 1,299 you can buy a 3D printer). Furthermore, people having ideas and no money now can go online and see their ideas produced and sold, and they gain 30% of the profit. I don’t know if this is a revolution but it seems to me. For sure is big change. Let’s see what and how is changing in production.

The figure of the entrepreneur and the role of capital in production could change. Henry Ford needed heaps of capital to build his colossal River Rouge factory; his modern equivalent can start with little besides a laptop and a hunger to invent.

The factory will change. The factory of the past was based on cranking out zillions of identical products: Ford famously said that car-buyers could have any colour they liked, as long as it was black. But the cost of producing much smaller batches of a wider variety, with each product tailored precisely to each customer's whims, is falling. The factory of the future will focus on mass customisation—and may look more like the 18th century weavers' cottages than Ford's assembly line.

The geography of supply chains will change. An engineer working in the middle of a desert who finds he lacks a certain tool no longer has to have it delivered from the nearest city. He can simply download the design and print it. The days when projects ground to a halt for want of a piece of kit, or when customers complained that they could no longer find spare parts for things they had bought, will one day seem quaint.

The role of labor in production will change. Labour costs are growing less and less important: a $499 first-generation iPad included only about $33 of manufacturing labour, of which the final assembly in China accounted for just $8. Offshore production is increasingly moving back to rich countries not because Chinese wages are rising, but because companies now want to be closer to their customers so that they can respond more quickly to changes in demand. And some products are so sophisticated that it helps to have the people who design them and the people who make them in the same place. The Boston Consulting Group reckons that in areas such as transport, computers, fabricated metals and machinery, 10-30% of the goods that America now imports from China could be made at home by 2020, boosting American output by $20 billion-55 billion a year.

Source: The Economist, Special Report on Manufacturing and Innovation, A third industrial revolution, April 21^st 2012.

Second Episode: From mass production to smart production.

Additive manufacturing is not yet good enough to make a car or an iPhone, but it is already being used to make specialist parts for cars and customized covers for iPhones. Additive manufacturing is only one of a number of innovative production equipment leading to the factory of the future. Conventional production equipment is becoming smarter and more flexible too.

For example, Volkswagen is implementing a new production strategy called MBQ. By standardizing the parameters of certain components they hope to be able to produce all its models on the same production line (Again economies of scale).

Factories are becoming vastly more efficient. Nissan’s British factory in Sunderland, opened in 1986 is now one of the most productive in Europe. In 1999 it built 271,157 cars with 4,594 people (59 cars per capita). Last year it made 480,485 cars with just 5,462 people (88 cars per capita).

As the number of people directly employed in making things declines, the cost of labor as a proportion of the total cost of production will diminish too. This will encourage makers to move some of the work back to rich countries, not least because new manufacturing techniques make it cheaper and faster to respond to changing local tastes.

The materials are changing as well. Carbon-fibre composites, for instance, are replacing steel and aluminum. Sometimes it will not be machines doing the making, but micro-organisms that have been genetically engineered for the task. Software are going smarter. And the effects will not be confined to large manufacturers, much of what is coming will empower small and medium-sized firms and individual entrepreneurs. Launching novel products will become easier and cheaper. Communities offering 3D printing and other shared production services are already forming online.

The consequences of all these changes amount to a third industrial revolution, as The Economist wrote in April 2012. The first began in Britain in the late 18^th century with mechanization of textile productions. The second  began in America in the early 20^th century with the assembly line and the era of mass production.

As manufacturing goes digital, a third great change is now gathering pace. It will allow things to be made economically in much smaller numbers, more flexibly and with a much lower input of labor. The first two industrial revolutions made people richer and more urban. The third?

Source: The Economist, Special Report on Manufacturing and Innovation, A third industrial revolution, April 21^st 2012.

Pilot: Additive Manufacturing & economies of scale

Today I was going through The Economist's special report on manufacturing and innovation (published in April 21st 2012) and I decided to start a set of posts to explore some interesting insights about what The Economist called a third industrial revolution. (Please note the "a" instead of "the", we will see if there will be a change about it in the next few years) 

Additive Manufacturing is the process of producing parts by successive melting of layers of material rather than removing material, as is the case with conventional machining. Hence, choosing an AM technology for production provides great benefits for the entire production value chain. The geometrical freedom allows you to engineer/design your part as you envision it, without manufacturing constraints. This can be translated to extreme light-weight designs, reduced part counts or improved bone ingrowth for a medical implant. It is also a fast production route from CAD to physical part with a very high material utilization and without the need to keep expensive castings or forgings on stock.

What could it mean?

Try today to go to a factory and ask to make you a single hammer to your own design. The producer would have to design and produce a mould, cast the head, machine it to a suitable finish, turn a wooden handle and then assemble the parts. You will be presented with a bill for thousands of dollars!

Thus, it would be efficient only if you produce a certain amount of items, as the well-known concept of economy of scale says.

What is a technology breakthrough? It is any significant or sudden advance, development, achievement, or increase, as in scientific knowledge or diplomacy, that removes a barrier to progress (i.e. the jet engine was a major breakthrough in air transport or internet was a major breakthrough for communication). When this happens usually a market structure changes as production changes.

Thanks to 3D printers and other additive manufacturing tools, economies of scale matter much less. In fact, its software can be endlessly tweaked and it can make just about anything. The cost of setting up the machine is the same whether it makes one think or as many things as can fit inside the machine. As a normal printer, it will keep going at about the same cost for each item (Obviously you would take into account the fixed cost and amortization of the machinery – so economies of scale still matters but much less).

Learning by biographies should be part of management studies

Earlier today I felt on an old copy of Time (October 17, 2011) dedicated to Steve Jobs.

The article on page 38 by Grossman and McCracken captured my attention and inspired me this post. I don't know why, but I missed this article on that issue and I am thankful I found it now.

I was thinking yesterday that going back centuries ago, people studied the biography of the great people to study how to live, to learn by their experience. Nowadays we focus more on the concepts, on the examples, on the case studies. But, back in high school I remember that my teacher of literature and latin said to us to study the life of the authors before reading the poems.

Well, I thought, why do we study concepts and theories of management without reading biographies? We all say that every organization is made by the people, the organizations' culture is made by the people, the organizations' strategies are made by the people.

Here is why I approached to this article and I advise anyone to find a copy of the article and read it. It is a very well written business story on Steve Jobs' career and ventures.

In Italian business schools we study theories over theories and, in the last decade, we discovered the importance of case studies. Case studies in management are a great tools of learning, they give you the possibility to gain a sort of "soft experience" by acting as if you were the real actor in a certain context.

What we are missing, in my modest opinion, is to study the life of the men who pursued certain strategies, achieving outstanding goals. For example Steve Jobs. Steve Jobs went against any management rule, he didn't listen to a lot of management theories, he diversified a fully integrated company. Biographies such his, or Bill Gates and Warren Buffet should be studied in management classes along with theories and case studies.

I believe this is "History of Management" or it is what "History of Management" should be. We study Henry Ford, or Fayol and Barnard. All of them were directors who changed the world with their vision, we should update, specially in Italy, our way of study management by adding biographies to our background.

By the way, I want to end this post with following quote by the famous Stanford's speech in 2005.

"Don't be trapped by dogma, which is living with the results of other people's thinking. Don't let the noise of others' opinions drown out your own inner voice. And most important, have the courage to follow your hearth and intuition. They  somehow already know what you truly want to become. Everything else is secondary."

Vertical Integration - notes from my last lesson

In the XIX and XX centuries, companies had been growing in size and scope, absorbing transactions that had previously taken place across markets. Coase’s thought indicated the increased efficiency of the firms in organizing economic activity to two main factors: technology and management techniques developing.

On the same way of thought, Galbraith predicted that the inherent advantages of firms over markets in planning and resource allocation would result in increasing dominance of capitalist economies by a small number of giant corporations. This was a famous wrong prediction in management and business administration.

In fact, by the end of the 1990s, we assisted to a sharp reversal of the trend toward increased corporate scope. The new dominant trends have been downsizing and refocusing on core business.

The contraction of corporate boundaries points to markets increasing their efficiency relative to firms’ administrative processes.

The turbulence of the business environment increased the costs of administration within large and complex firms and increased the need for flexibility and speed of response. Internet and PCs diffusion revolutionized market transactions.

Let’s shift our attention to the underlined corporate strategy within these issues. Vertical integration is a growth strategy through which a firm becomes owner of vertically related activities. The greater is the ownership over subsequent stages of the supply chain, the greater its degree of vertical integration. The extent of VI is indicated by the ratio of a firm’s value added to its sales revenue: the more a firm makes rather than buys, the greater its value added relative to its sales revenue.

There are different types of Vertical Integration: backward (or upstream) vertical integration, and forward (or downstream) vertical integration.

The benefit of VI are:

• Technical economies from integrating processes: the cost savings that arise from the physical integration of processes. (but doesn’t necessarily require common ownership!)
• Thus, vertical integration can avoid transactions costs.
• Superior coordination (firm’s system-ness)

We must look beyond technical economies and consider the implications of linked processes for transaction costs.

Let’s consider the value chain for steel cans, which extends from mining iron ore to delivering cans to food processing companies. The production between steel and steel strip is typically vertically integrated. While between steel strip and steel cans there’s  a very little vertical integration. The predominance of market contracts in this step is the results of low transaction costs in the market for steel strip: there are many buyers and suppliers are low.

Across steel production and steel strip production there is vertical integration essentially due to technical economies. These two processes use the same plants and the same knowledge, and the output of the first must fit the input requirements for the next stage, so these companies must invest in integrated facilities. In this situation a competitive market economy is impossible: each steel strip producer is tied to its adjacent steel producer. The market becomes a series of bilateral monopolies. There is no market price, because the price is set by bilateral negotiation between each producer and each supplier. It all depends on bargaining power.

This situation if regulated by market rules will lead to inefficiencies.

The culprits in this situation are transaction-specific investments. Within these steps both the producer must adapt their production to the needs of the other party. Each seller is tied to a single buyer which gives each the potential to hold up the other. This results in transaction costs arising from the difficulties of framing comprehensive contract and the risks of disputes and opportunism. The problem of hold up could be eliminated by contracts that fully specify prices, quality , quantities, and other terms of supply under all possible circumstances. The problem is uncertainty about the future, it is impossible to anticipate all eventualities during the contract period. Contracts are inevitably incomplete.

Internalizing a transaction imposes administrative cost. The size of this cost depends on several factors.

Differences in optimal scale between different stages of production

• Suppose you are a manager of FedEx, for your delivery service you require vans that are designed and manufactured to meet your particular needs.
• There is an incentive for FedEx to avoid the ensuing transaction costs by building its own vehicles
• Would this be an efficient solution? (discuss with the class)
• Almost certannly not: you will have inefficiencies due to the high fixed costs to set up  plant, you don’t have the knowledge, and you don’t have the critic mass required to set up all this investment
• Same is for brewery

Developing distinctive capabilities

• A key advantage of a company that is specialized in a few activities is its ability to develop distinctive capabilities in those activities.
• Technology based companies as Xerox, Kodak and Philips cannot maintain IT capabilities that match those of IT services specialists such as IBM and Accenture.
• The ability of these specialists to work with several customers stimulates learning and innovation.
• When one capability builds on capabilities in adjacent activities, vertical integration may help develop distinctive capabilities. Let’s think about IBM, that shifted from mainframe industry to IT service by developing distinctive capabilities.
• The key is the link between the set of capabilities

Managing strategically different business

• The latters problems are part of e wider set of problems. The management systems and organizational capabilities required for a manufacturing could  be very different from those required for another one.

The incentive problem

• VI changes the incentives between vertically related businesses.
• In a market mechanism the seller is motivated to ensure the buyer satisfaction. The buyer is motivated to secure the best possible deal.
• These are named high powered incentives
• With VI, the incentives are low powered
• You can fire someone who did the wrong thing, but you will do it when could be too late

Competitive effects of VI

• VI could be used to extend a monopoly position.

Flexibility

• Both VI and market transactions can claim advantage with regard to different types of flexibility.
• When you need rapid responsiveness to uncertain demand, there may be advantages in market transactions
• VI may also be disadvantageous in responding quickly to new product development opportunities that require new combinations of technical capabilities.
• Where the system-wide flexibility is required, VI may allow speed and coordination in achieving simultaneous adjustment throughout the vertical chain.
• VI is also a central theme of brand identity

Compounding risk

• To the extent that VI ties a company to its internal suppliers, VI represents a compounding risk insofar as problems at any one stage of production threaten production and profitability at all other stages.

But it all depends!

The idea of vertical  integration is the anathema to an increasing number of companies. Most of yesterday’s highly integrated giants are working overtime at splitting into more manageable, more energetic units – i.e., de-integrating. Then they are turning around and re-integrating – not by acquisitions but via alliances with all sorts of partners of all shapes and sizes. (Tom Peters)