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Outsourcing Innovation, from Sting-Rays to iPAQs 28 March 2005
Ever heard of a company named HTC? Chances are good that it both designed and manufactured your personal digital assistant (PDA).
According to a recent issue of Business Week, 70% of all PDA designs are outsourced to companies called “ODMs,” for “original design manufacturers.” Even though branded H-P or Palm, your PDA was probably designed and built by a company like Taiwan’s High Tech Computer (HTC).
Hewlett Packard’s iPAQ h1910 Designed and manufactured by HTC in Taiwan
Business Week put the innovation outsourcing story on a recent cover, but it is not a new one. We’ve been down this road many times before, with products ranging from bicycles to televisions to video cassette recorders to automobiles. As competition proliferates and product lines expand, “name brand” companies outsource both design and manufacture of their product offerings.
This kind of outsourcing is a good early indicator of geographic changes in industry leadership. HTC will be following a well-worn path as it moves from supplier to competitor. The volume from sourcing deals gives HTC the wherewithal and experience to start competing on its own.
In the past, this dynamic, which Clay Christensen described in The Innovator’s Dilemma in 1997, has resulted in the disappearance of many of the “name-brand” companies that have pursued it. In televisions, for example, RCA is no more.
Remember Schwinn Bicycles? Founded in 1895, the Chicago-based company was one of the pioneers of bicycle design in America. The company hit its peak in 1973, when it had a US-based labor force of over 2000, and produced the iconic Sting-ray bicycle.
Schwinn’s Sting-Ray, circa 1973
Asian imports began to dominate the bicycle market by 1980. During this time Schwinn sourced both the manufacturing and design of its low-end bikes to Taiwan-based Giant Bicycles, which rapidly became Schwinn’s major competitor.
Schwinn could not survive as a distributor alone. The company entered bankruptcy twice in recent years, once in 1993 and again in 2000.
Pacific Cycle bought Schwinn out of bankruptcy in 2001. They sell a 2005 version of Schwinn’s classic Sting-Ray, which is also a hit product.
Schwinn Sting-Ray, circa 2004
The new Schwinn Sting-Ray sells at Wal-Mart for about $180, which is a third of the price of the original in constant dollars. The bike is designed and built in Asia, as are practically all bicycles retailing for under $1000.
This is all economics as usual:
Ø Because price is such an important factor in most purchase decisions, companies have to choose a low-cost supplier (usually in Asia) for product manufacture.
Ø Because design and manufacturing are often very closely linked, it’s a logical step for outsourced design to come after outsourced manufacturing.
Will this sequence of events be as disastrous for this generation of companies as it was for companies in the 1970s and 1980s? It needn’t be, if this generation can develop different structures for their ODM agreements.
The arms-length transactional agreements that characterized industries like bicycles in the 1980s spurred the creation of new brand-name competitors like Giant Bicycle.
So this time around, companies should be looking for ways to bind their interests together for a significant period of time. Shared equity ownership helps, as does shared staff on new product teams.
These kinds of agreements entail commitments that endure over many years and many different new product designs – structures that have features more common in Japanese keiretsu than in US multinationals.
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