Outsourcing Innovation

The cover story of the current issue of Business Week is on "Outsourcing Innovation".  It’s generally a pretty good report on the rise of Original Design Manufacturers (ODMs) in Asia and the growing trend to outsource product innovation.  The stats on the role of ODMs are impressive – they supply the designs for 65% of the world’s notebook PC’s, 70% of the world’s PDA’s, 65% of the MP3 players, 30% of digital cameras and 20% of mobile phones.  And that’s just the beginning – their growth rates show little sign of slowing down and they are expanding their activities into other product categories like networking equipment. So much for the notion that offshoring just involves low skill manufacturing operations.

But the article is frustrating on a number of levels.  First, it reflects the Western bias by talking about innovation only in terms of product innovation.  In fact, some of the most impressive achievements of offshoring operations involve process innovations, rather than product innovations. These process innovations often provide a foundation for interesting product innovations. When Western companies outsource product design to ODMs, they are in fact outsourcing the process of product design.  The ODMs configure and manage this product design process in very different ways relative to Western companies.  In many respects,the process innovations are the really interesting story, but largely missing in this article.

Second, the article tends to talk about outsourcing in zero sum terms. That is, if you outsource, you lose that activity.  It misses entirely the positive sum relationships that a few companies are establishing – by outsourcing to highly specialized and aggressive companies, companies can build relationships that help them to get better faster in the activities that they retain while at the same time creating opportunities for their outsourcing partners to get better faster as well. 

Third, the article tends to generalize too much.  For example, it asserts that "ownership of design strikes close to the heart of a corporation’s intrinsic value." Well, maybe.  I have argued in an HBR article on "Unbundling the Corporation" (sorry, it’s only available on the Web for purchase from HBR) that most companies are an unnatural bundle of three very different businesses – customer relationship businesses, infrastructure management businesses and product innovation and commercialization businesses.  Offshoring and outsourcing are manifestations of more fundamental trends that are forcing companies to make strategic choices about what business they are really in.  If you choose to be in product innovation and commercialization, then design is central to your company’s value.  But if you focus on one of the other two businesses, then you will end up shedding design.  The problem is that few companies are making this strategic choice explicitly – it is being made on a de facto basis by incrementally slicing out design activities in the quest for near-term operating savings. That can get you into trouble.

Finally, the article gives very little sense of the trajectory and pace of capability building.  The real story about offshoring is not a snapshot of activity or relative skills at any one point in time.  It is about the extraordinary speed with which offshoring service providers are building capability through rapid incremental product and process innovations.  Look at where many of these ODMs were just three years ago versus today and then listen to them talk about their investments for capability building over the next three years.

Oh, and then there’s the Western arrogance talking about a new division of labor between left brain routine tasks that will get farmed out to offshore locations and right brain "creative" tasks that will stay onshore.  This kind of complacency could get us into real trouble.

PS – the BW article talks about Apple’s iPod as an example of in-house product design. That’s not entirely true – Apple orchestrated a very interesting design process network to mobilize a variety of third party players, most notably PortalPlayer, in designing the guts of the iPod.