HOW HE SEES IT U.S. firms committing suicide by outsourcing

By SHIH-FEN S. CHEN
PROVIDENCE JOURNAL
WALTHAM, Mass. -- International Business Machines' recent decision to put its personal-computer business up for sale is another sad day in American corporate history. Having long ago outsourced the development and manufacturing of the product it helped to create, IBM is not even interested in carrying the personal computer anymore. So, following RCA, Schwinn and the like, another iconic U.S. brand is falling into foreign hands.
The buyer of IBM's PC division is its subcontractor Levono, China's leading computer maker. Last April, a similar deal was cut between RCA and TCL, the largest TV-set maker in China, which for years had been the subcontractor of RCA.
In both cases, is the acquisition of a hollowed-out business by its subcontractor a coincidence? If not, something must be terribly wrong with outsourcing.
Outsourcing emerges when products developed and consumed in the United States can be more cheaply made abroad. In a typical sourcing arrangement -- called original-equipment manufacturing -- U.S. firms transfer all design and production know-how to subcontractors, then buy back the output for sale at home.
At first glance, original-equipment manufacturing is a perfect offshore-sourcing structure. It lets U.S. firms enjoy low factory prices overseas without the hassles of managing their production facilities. And by taking back the finished product, the U.S. firms can transfer all technologies to subcontractors for free -- thus eliminating the contracting problems in licensing.
Playing to strengths
The beauty of outsourcing is that the parties can each perform the functions at which they excel: U.S. firms control development and marketing; foreign subcontractors take on manufacturing.
Critics of outsourcing focus mainly on the loss of production jobs to low-wage countries -- a non-issue in the eyes of free-trade advocates.
The debate, however, misses a hidden danger in outsourcing: free and complete flows of technology to subcontractors. The risk of technology loss in outsourcing has been overlooked in the business world, but it does catch the attention of the intelligence community.
In a recent op-ed piece in The Seattle Post-Intelligencer, a former CIA contractor pointed out that Boeing is outsourcing components from several foreign countries. According to a source within the firm, Boeing not only transfers complex machinery to subcontractors, but also sends engineers to train foreign operators. Such subcontractors receive lucrative contracts, advanced technologies, and professional instruction from Boeing -- all for free.
Furthermore, technology transfer in outsourcing is thorough. For subcontracting to work, U.S. firms must disclose all technical information to their foreign manufacturers, as incomplete knowledge transfer will harm the quality of the bought-back product.
For the same reason, the U.S. firms must also provide full and continuous technical support, to ensure that their subcontractors maintain quality.
Unlike with licensing, U.S. firms cannot withhold information from foreign subcontractors to prolong their technological leadership.
Outsourcing, indeed, provides an excellent platform for foreign manufacturers to absorb advanced technologies.
After closing its Chicago plant, in 1981, Schwinn sent equipment and engineers to Taiwan, and thereafter outsourced millions of bicycles from its supplier, Giant. Only six years into this alliance, Giant was able to introduce the world's first mass-produced carbon-fiber bicycle frame. In 2001, its non-resonance suspension system won the Bike of the Year award from Mountain Biking magazine.
Giant now sells such innovative products under its own brand -- in more than 50 countries -- charging a higher price than its former mentor did.
Without attempting to regain technological leadership, U.S. firms further farm out product development to subcontractors, making a bad situation worse. Through a new sourcing mechanism -- called original-design manufacturing (ODM) -- Giant develops and assembles bicycles for its Western clients without receiving any technical assistance from them. Taiwanese laptop makers (e.g., Asustek, Mitac and Quanta) provide similar services for Apple, Dell and HP.
Brand power
Yet even with the losses of both technology lead and production edge, U.S. firms can leverage their brand power to rein in subcontractors -- if they enjoy enormous consumer loyalty, as do Apple, Nike and Levi's. Those lacking a strong brand, however, face harsh competition, from which they can defend themselves sometimes only through bankruptcy protection.
This was what happened to Schwinn, which pedaled into Chapter 11 twice, in 1993 and 2001. To avoid the unavoidable, RCA and IBM each offered to sell their businesses to subcontractors, to try to squeeze a few more miles from their empty tanks before their cars stopped.
Ironically, the most valuable asset in such hollowed-out companies is their brand name -- which foreign acquirers can use to fool consumers who preach and practice "Buy America," to keep jobs at home.
It is naive to believe that U.S. firms can maintain their global dominance by delegating the dirty work of managing factories to subcontractors. To halt the technology bleeding, they must deploy foot soldiers to set up production around the globe, as Japanese and German manufacturers have been doing all along.
If the current trend of outsourcing is allowed to go on, the victim list will get even longer. The next firm to fall could well be Boeing, Motorola, Oracle, H & amp;R Block -- or any other company we can think of.
X Shih-Fen S. Chen is an international-marketing professor in Brandeis University's International Business School. His study establishing the role of outsourcing in international technology transfer is forthcoming in the Journal of International Business Studies. Distributed by Scripps Howard News Service.