Examination Thesis, 2010
29 Pages, Grade: 78/100
2. Paper Scope
3. Consumer Electronics Market Environment Dynamics
4. Strategic Rationale: outsourcing vs. insourcing decisions
5. Evolution and impact of outsourcing on the domestic electronics manufacturers
6. Differences between Insourcing and Outsourcing approaches
7. Microsoft Hardware outsourcing strategy
a. Rational behind the decision
b. Outcome and future market trends
In today’s global market, competition has become a race to acquire skills and competencies as well as a battle for market position especially in the domestic electronics industry where companies increasingly compete on responsiveness and flexibility, placing a premium on ﬁrst-mover advantages.(Bryce et al., 1998)
According to Slack, strategic decisions and tactics aimed at maintaining profitability and growth are derived from a firm’s capabilities, resources and processes. (Slack et al., 2009b). Improving those performance drivers leads to competitive advantages that are significant in winning and maintaining customers, while gaining more business to the firm. (Slack et al., 2009a).
Porter believes that a firm can outperform its rivals if it can establish a difference that it can preserve. This could be through delivering greater value to its customers or creating value at a lower cost, or both. Such differentiation arises from the choice of strategic objectives and how activities are performed better than rivals across the value chain. (Porter, 1996a)
Each company decides on which performance building blocks (Figure 1) they wish to excel at to deliver a unique mix of value, and how to configure their value chain for best fit (Neely, 2008). This is done either through focusing on core competencies inside the firm itself, or leveraging external capabilities through outsourcing and partnerships.
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Figure 1: Building Blocks of Competitive Advantage Adapted from (Neely, 2008)
The goal of this paper is to discuss the main strategic reasons behind outsourcing, its importance to the domestic electronics industry and whether it can provide a sustainable competitive advantage to that sector. Furthermore, this paper will highlight the rationale behind outsourcing decisions verses insourcing, and its relationship to a company’s strategic capabilities.
To illustrate the arguments, the paper utilizes management tools for an in-depth analysis of Microsoft’s hardware outsourcing manufacturing strategy, global value chain, capabilities and resources management and tactics. This is looked at in context of how to achieve competitive advantage in the global gaming market focusing on the Xbox gaming consoles.
Today the global consumer electronics is currently valued at more than $199.6 billion. In 2012, the global consumer electronics market is forecast to have a value of $260.7 billion, an increase of 30.6% since 2007. Sales of video equipment form the most lucrative segment of the consumer electronics market, accounting for 75.8% of total revenues (Datamonitor, 2009).
The consumer electronics market is an arena of tough competition; however, new entrants could be tempted by the healthy growth figures as there is room for growth. Entrants need to understand the market competitive forces identified by Porter. These include the bargaining power of the buyer (large retailers), the bargaining power of the seller (consumer brands), the threat from other new entrants, the threat of substitute products and the rivalry among the firms in the industry (Porter, 1996a, Porter et al., 2006).
Buyers may choose to offer consumer electronics under their own brands. This would be costly if it involved a true integration into manufacturing. Instead, the usual approach is to contract a manufacturer to make the products (Datamonitor, 2009).
Suppliers in this market include manufacturers of test gear, electronic components and related products. Another important group of suppliers offer manufacturing services. Although many consumer electronics companies, such as Sony, operate their own manufacturing facilities, others may outsource certain tasks (e.g. circuit board production) to third parties, and in some cases may rely on Electronics Manufacturing Service companies (EMS) for more substantial parts of production (Datamonitor, 2009).
Since there are fewer barriers to international trade and transport costs are not significant for many products, firms can scan the entire world for the cheapest production location or low wage outsourcing partners (Mellahi et al., 2005).
However, becoming an EMS supplier to a consumer electronics giant is complicated. Suppliers must prove that they are financially sound with a good outlook for the future. They must prove that their particular skills base would merge well with that of the company, that they are e-commerce-ready and have a strong distribution network, and crucially, that their product is superior to those of rivals. Suppliers are also required to meet environmental standards so that they fit in with the big electronic brands. Bringing their operations up to scratch can be costly, and consequently once the investment is made the supplier will be keen to hold onto its largest clients. This weakens supplier power (Datamonitor, 2009).
Manufacturers need to be sure of high quality supplies, to avoid the cost of replacing unreliable products (to say nothing of the effect on their brand reputation). This strengthens suppliers, and can be viewed as imposing a switching cost that inhibits switching away from suppliers whose reliability is known to the manufacturer (Datamonitor, 2009).
There are several barriers to entry faced by potential new players. Fixed costs are fairly high, as is initial capital outlay, especially if a company proposes to set up its own production plant. Scale economies are generally important in this market, with the possible exception of high-end ‘boutique’ products. Companies that have already established manufacturing scale in similar markets may have an advantage over small start-ups that lack their expertise and purchasing power (Datamonitor, 2009).
Rivalry is strongly affected by the number and size of players in the market. While it is a moderately easy market to enter, the need to recover the cost of investment in manufacturing equipment, specialized staff and a logistics network raises exit barriers, which intensifies rivalry (Datamonitor, 2009).
To highlight the dynamics in the market, Figure 2 focuses on the gaming consoles submarket to illustrate those forces using Porter’s five forces framework.
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Figure 2: Adapted: (Michael Porter Five Forces Model, 2009, Porter et al., 2006)
According to Porter, the value chain analysis determines where cost improvements could be made or value added, through distinguishing between primary and support activities, while assessing the value added by each (Porter et al., 2006). Hill & Jones agree and add that the concept of value creation lies at the heart of competitive advantage (Hill et al., 2001, Recklies, 2001).
The “profit rate” margin available within the value chain depends on the structure, how the margin spreads across all elements of the value chain and negotiation power of each member of the value system (Figure 3). Since it is determined by the difference between price customers pay and all costs incurred with the production and delivery of the final product, controlling production costs becomes crucial to maximize chain surplus (Hill et al., 2001, Recklies, 2001).
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Figure 3: The relationships between surplus and elements of the Value Chain
Competitive advantage can ultimately be attributed to the ownership of a valuable resource that enables the company to perform activities better or more cheaply than competitors regardless if it is sourced in or out of the organization. Valuable resources enable firms to produce superior value for their customer and are determined by and evaluated against different market forces. Such value can be achieved through production differentiation strategies (innovation, efficiency, quality or customer responsiveness (Figure 1) as well as identifying how valuable each resource is to help focus efforts and identify opportunities for outsourcing or insourcing (Figure 4). However, most companies focus their efforts on choosing countries, vendors and negotiating prices, but they don’t spend time first evaluating which processes they should outsource verses which they shouldn’t. (Aron et al., 2005, Collis et al., 2008, Venkatesan, 1992).
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Figure 4: What makes a Resource Valuable (Collis et al., 2008)
As they need to decide which activities could be outsourced and assess the longer term implications, (Gottfredson et al., 2005, Kotabe et al., 2001) many electronics manufacturers adopt a resource based view to analyse their value chain and reveal unique capabilities and true value of resources (Collis et al., 2008, Venkatesan, 1992). This is done alongside the use of different business tools (e.g. strategic group analysis and Porter’s five forces model) to understand their industry structure and identify their competitive position amongst rivals, to achieve “strategic fit” when faced with the dilemma of whether to “build or buy” (Mellahi et al., 2005, Porter et al., 2006).
The decision is often associated with lowering cost or making more efficient use of capital assets (Bryce et al., 1998, wikipedia.org, 2009), as the evolution of outsourcing in electronics reveals.
Through analysing their value chains and core capabilities using frameworks like VRIO, VRIN and capability assessment maps, many electronic manufacturing companies came to realize that sourcing strategies need to consider future scenarios. By monitoring the dynamic sector trends they recognize that outsourcing represents an opportunity for cost and quality advantages, gaining access to both new and fresh ideas and providing flexibility to remain competitive (Gottfredson et al., 2005, Kotabe et al., 2001).
The traditional vertical value integration approach provided firms with a number of clear advantages including creating barriers to entry for competitors, protecting product quality and improved scheduling through insourcing and owning most resources. However, it is also associated with limitations like cost disadvantages, technological fast changes, risk of capital investment, demand uncertainties and lack of incentives for suppliers to continue providing best quality at the lowest costs. (Gottfredson et al., 2005)
For over a century, companies competed on the basis of the hard assets they owned. In the 1980s, the basis of competition in electronics manufacturing began to shift to intangible capabilities. Microsoft, for example, became the de facto standard in the computing industry through building its strong brand and skills in developing and marketing software products (Gottfredson et al., 2005), without the need for substantial investments in hard assets.
In the early 1990s, when demand was relatively predictable, competition was less fierce, and products were simpler, vertical manufacturing strategies were still the rule for electronics manufacturers in a global market worth $100 billion, with less than 5% manufacturing outsourcing. During the mid-1990s continuous competitive pressure to simultaneously innovate quickly and aggressively cut costs continued, leading to shorter product life cycles and increased pressure to decrease time to market. A number of electronics manufacturers used outsourcing to quickly and cost effectively enter new markets and to generate new revenues (Delattre et al., 2003, Farrell, 2004).
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