01 Dec 2009
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Losing Our Competitive Edge

Manufacturing Outsourcing Is Crippling U.S. Innovation
by Gary P. Pisano

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Today, many people are looking to high-technology sectors — like alternative energy — to be the growth engine that revives the U.S. economy and gets it back on track. This may be more difficult than suspected. During the boom years, when all seemed well, capabilities that underpin innovation in a wide range of products were continuing to deteriorate.

My HBS colleague Willy Shih and I described in “Restoring American Competitiveness,” an article in the July-August 2009 Harvard Business Review, how the United States has lost or is in the process of losing the ability to manufacture many of the cutting-edge products it invented. These include the batteries that power electric and hybrid cars, light-emitting diodes (LEDs) for the next generation of energy-efficient lighting, and critical components of solar panels, among others.

How did this happen? A big part of the reason is the outsourcing of development and manufacturing work to companies abroad. The result: a damaging deterioration in the collective capabilities that serve high tech. This industrial commons includes not just suppliers of advanced materials, production equipment, and components, but also R&D know-how, advanced process development and engineering skills, and manufacturing competencies.

Making matters even worse is something that has been largely ignored: In addition to undermining the ability of the United States to manufacture high-tech products, the erosion of the industrial commons has seriously damaged the country’s ability to invent new ones.

The prevailing view of the past 25 years has been that the United States can thrive as a center of innovation and leave the manufacturing of the products it invents and designs to others. Nothing could be further from the truth. This logic is predicated on utterly false assumptions about the divisibility of R&D and manufacturing and basic competitive dynamics.

Yes, there are some instances where R&D and manufacturing are separable. But these are the exceptions. In the vast majority of high-tech products (and even some low-tech products like apparel), knowledge about manufacturing helps you design products and get them to market quickly. What this means is that when manufacturing capabilities migrate from a country, design and R&D capabilities eventually follow. That’s exactly what’s been happening in many high-tech industries in the United States over the past twenty years.

Proponents of outsourcing propagate a dangerous misconception: You focus on R&D and turn over the low-margin commodity manufacturing to contractors in Asia. You make out like a bandit because you have the intellectual property, and your contractors have so much competition they cannot afford to charge you more. Markets are great. But wait a minute. All this assumes your manufacturing partners are content to subsist on your table scraps. But what if they have their eye on the prime rib too? Once they have learned to manufacture your product, they are in a much better position to move up the food chain into manufacturing and designing more sophisticated components and subsystems and, eventually, the entire product.

This is exactly what has happened in high-tech industry after high-tech industry. Unless business executives operating in the United States recognize the importance of manufacturing and grow wiser about outsourcing, the industrial commons — and the country’s economy — will continue to decline.

HBS professor Gary P. Pisano specializes in technology strategy and management innovation. This article appeared online October 1, 2009, as part of The HBR Debate: “Is the U.S. Killing Its Innovation Machine?” Edited for space.

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