WINTER 2011
V O L . 5 2 N O. 2
By Francesco Zirpoli and Markus C. Becker
What Happens When You
Outsource Too Much?
REPRINT NUMBER 52208
O R G A N I Z AT I O N S T R AT E G Y
THE ANATOMY
OF AN AUTO:
A complex product such
as a car can be decomposed at different levels
of granularity, from large
chunks (e.g., the front
end, including bumpers,
lights, radiator, etc.) to
small components (e.g.,
a brake disc) up to little
metal parts.
What HappensWhenYou
OutsourceToo Much?
With complex products such as automobiles, integration is a
key element of performance. That means managers must
understand which activities and competencies they can safely
outsource and which they need to keep.
BY FRANCESCO ZIRPOLI AND MARKUS C. BECKER
WE LIVE IN AN ERA in which business disaggregation is the norm. In industry after industry, managers have taken deliberate steps to separate their value chains and shift important activities and functions
to outside suppliers. The outsourcing trend became increasingly visible during the 1990s, when companies such as IBM began to outsource not just manufacturing but also design activities. The trend reached
its peak within the past decade, when even companies such as Boeing started outsourcing innovation activities. But what happens when companies become too dependent on outside suppliers and cede them
too much control if they lack the same degree of understanding and awareness about how important
product or service elements fit together and what’s necessary? Once management lets go of critical internal
levers, how does it go about reestablishing them?
COURTESY OF HYUNDAI MOTOR CO.
THE LEADING
QUESTION
How can
companies
make the right
decisions
about outsourcing?
FINDINGS
!Keep activities
in-house that have
direct impacts on
product performance.
!Maintain control
over activities that
are highly interdependent with the
technologies that
impact on the performance of the
overall product.
WINTER 2011 MIT SLOAN MANAGEMENT REVIEW 59
O R G A N I Z AT I O N S T R AT E G Y
These questions arose during a multiyear research
project examining supply strategy relating to new
product development at a major European automotive company (see “About the Research”). In the late
1980s, the company — which we call Alpha — had direct supply relationships with more than 3,000
suppliers, most of them small companies. The suppliers were mostly involved in the production of
components, and only to a limited extent in the design
of components. In the early 1990s, however, management began shifting increasing amounts of design and
engineering work to suppliers. That trend was hastened by the proliferation of electronics in cars, which
was beyond the traditional competence base of automotive manufacturers. Although all companies shift
activities to outside suppliers, Alpha pushed outsourcing even further. By the mid-1990s, Alpha began to
outsource the design of complete systems, such as
dashboards, seats and safety systems, to suppliers that
had the ability to provide entire systems. (See “The
Anatomy of an Auto,” p. 59.)
To senior management, outsourcing entire
systems — including the design of those systems —
seemed like the right direction. Similar supply
arrangements were already common in other industries such as computers. By becoming less integrated,
Alpha management hoped to increase flexibility (by
being able to switch suppliers and technologies), reduce lead times (by taking advantage of concurrent
engineering) and cut development costs while improving product quality (by utilizing suppliers’ specialized
ABOUT THE RESEARCH
We systematically observed the consequences of a lean product development approach on a company’s competencies and knowledge domains and the extent that
implementation of design outsourcing affected the sustainability of an outsourcing
strategy. We chose the context of the automotive industry, one of the most complex
in terms of technologies and players involved in innovation processes. We selected a
major automotive manufacturer, “Alpha,” with products in all major market segments.
The company had maintained a fully integrated design function internally before adopting an extreme outsourcing strategy. We studied the manufacturer’s two research
centers and its first-tier suppliers. We observed changes over a 10-year period, during
which we collected archival data and company documents and conducted interviews
with its employees, its research centers and eight first-tier suppliers. We interviewed
34 managers, including most of Alpha’s top managers in charge of the product development process: the chief technology officer, the senior vice president of human
resources, the vice president of product portfolio management, the director of vehicle
concept and integration (the manager responsible for systems integration for chassis
and vehicle), four of the five vehicle-line executives and key executives in the design
and engineering division. Within supply companies, we interviewed account managers, project managers and in some cases the CEOs.
60 MIT SLOAN MANAGEMENT REVIEW WINTER 2011
expertise). With its new networked innovation strategy,
Alpha expected to build close relationships with 350
first-tier suppliers, mostly suppliers of systems, thereby
significantly reducing the number of direct supply
chain relationships. With independent suppliers, outsourcing coordination would become easier.
Between 1996 and 2001, Alpha underwent structural changes to support the new strategy. As it
outsourced design work, experienced engineers who
had worked inside Alpha’s functional units designing
suspensions, dashboards and electric systems went to
work for suppliers. Alpha was still involved with establishing overall targets, specifications and overseeing
costs; it set the technical performance targets of the
components, provided the physical constraints and
benchmarked the technology and cost in order to get
state-of-the-art technology at the right price. But as
the internal engineering teams got smaller and less up
to date on the specific design and technical issues,
more and more responsibility shifted to outsiders.
Although internal engineers still managed key
functions (development schedules, technical coordination, performance and costs), increasingly
suppliers were the ones putting together the “black
box” components that defined the overall product.
The most influential suppliers went so far as to integrate entire chunks of the car.
Consider how a vehicle’s safety system was designed, managed and integrated. In the 1980s, Alpha
designed safety systems in-house and outsourced
components such as the seat belts and brakes to suppliers, providing them with the technical
specifications. During this period, it continued to
maintain responsibility for integrating all of the purchased components. But in the 1990s the company’s
responsibilities and those of its suppliers changed
(see “How Alpha’s Supply Chain Changed”). Rather
than dealing directly with dozens of smaller suppliers
providing components for the system, Alpha asked
larger suppliers to provide entire systems, thereby
shifting responsibility for managing and integrating
the safety system from the inside to the outside.
It wasn’t long before management identified problems with this approach. By moving so much
new-product design work to outside companies (in the
space of 10 years, the percentage of design work being
performed externally rose from between 25% and 35%
to 85% of the value of a car, more than most comSLOANREVIEW.MIT.EDU
petitors), the company lost its grip on
many of the elements that shaped design
decisions and outcomes. The pre-development phase was when the concept of
the vehicle was worked out and when decisions on performance trade-offs were
made. But without any direct involvement
in the component design and engineering process, key decisions — for example,
how the suspension felt or where the
ventilation control knobs were located —
were now in the hands of suppliers that
didn’t know the customers or what customers expected as well as Alpha did.
In the new design regime, Alpha
didn’t become involved in integrating
the main components until many of the
most important decisions impacting performance
were baked into the product (and at which point, undoing them was difficult and costly). However,
making changes late in the process was not only complicated; redesigns also were expensive and led to
delays in product launches. Moreover, it meant that
products could not be fully tested, which often led to
assembly problems or product recalls.
By 2005, top management realized that pushing
outsourcing deep into the product development
process had seriously altered the technical heart of
the company. As Alpha’s director of vehicle concept
and integration explained, there was a “substantial
lack of technological competence in key areas and
in the way [we] interpreted system integration.”
With this realization, management began to rethink
its approach to outsourcing and to decrease the
amount of design work it moved outside.
Defining the Problem
How did management define the problem? Did managers see an inherent problem in the way lean
development undermined the company’s competencies and knowledge base? Or did they see it more as a
case of poor implementation of the company’s product
design strategy? As we interviewed managers, we learned
of several key issues they saw impinging on Alpha’s ability to manage new product development effectively.
■ Managers noted that it was difficult to integrate
systems without having in-depth knowledge about
the technologies underlying each system.
SLOANREVIEW.MIT.EDU
HOW ALPHA’S SUPPLY CHAIN CHANGED
From the mid-1980s to early 1990s, Alpha designed the passenger safety system and had
many direct links to suppliers that made components (such as seat belts and airbags) to its
specifications. But starting in the mid-1990s, that changed. Alpha set the performance targets
but a system supplier designed the passenger safety system, bought the components and
integrated them into the car.
Old Structure
New Structure
Mid-1980s – Early-1990s
Mid-1990s – 2005
Alpha
Alpha
Safety System Supplier
Air Bag
Supplier
Seat Belt
Supplier
Steering
Wheel
Supplier
Other
Suppliers
Air Bag
Supplier
Seat Belt
Supplier
Steering
Wheel
Supplier
Other
Suppliers
Navigating and balancing the various technical,
cost and performance objectives presented major
trade-offs that were hard to sort out simultaneously. Engineers realized that these trade-offs were
difficult to resolve without in-depth knowledge
about the technologies underlying the systems that
make up a car.
■ Because of internal staff reductions and engineers’
weakened abilities to remain up to speed on specific technical issues, managers said Alpha had no
choice but to lean more heavily on outside suppliers during the pre-development phase. This sowed
the seeds for problems during later phases of the
product development process.
There is an important difference between integrating physical systems and integrating the performance
of such systems. Moreover, component-specific
knowledge is crucial to the ability to integrate systems
and performance; and learning by doing holds the key
to maintaining component-specific knowledge.
To understand how to build effective network innovation strategies, we explored the balance between
having sufficient architectural and componentspecific knowledge internally to design new models,
and outsourcing such knowledge by leveraging external sources of innovation. The ability to strike this
balance — knowing what kinds of activities and
competencies companies can delegate to suppliers
and what they need to keep — has significant strategic implications for companies that design and
manufacture complex products.
■
WINTER 2011 MIT SLOAN MANAGEMENT REVIEW 61
O R G A N I Z AT I O N S T R AT E G Y
Physical Systems Versus
Systems Performance
Cars are designed to deliver certain levels of performance in areas such as safety, handling, fuel
consumption and noise. Different systems are made
up of multiple parts and components, but assessments about performance are focused on how the
systems interact with one another. For example, the
vehicle safety system includes brakes, seat belts and
air bags. However, in the event of a collision, many
other elements, including the design and position of
the engine or the configuration of the chassis, can influence what happens. Another problem with
decomposing performance is that many factors such
as speed, noise and vibration are interdependent. As
a result, there are limits to how fully one can specify
how much an individual component or system contributes to vehicle-level performance.
Managing the technical interdependencies between individual components presents challenges for
overall product performance. Engineers need to
make trade-offs (for instance, between a component’s
technical performance and its cost), but the exact nature of the interdependencies is not always known or
predictable. To be able to make such performancebased trade-offs competently, it’s not enough for
engineers to have systems-level knowledge. They also
need to have an understanding of components,
something that many Alpha engineers lost as the
number of opportunities for learning by doing diminished. That raised important questions about the
prerequisites for making performance trade-offs and
how companies should be organized. We found that
there are several contributing factors to success.
Developing Component-Specific Knowledge In
making performance trade-offs, it’s not enough to
be informed in a general way about the key technological trade-offs involved in designing components
and subsystems. Managers need to have detailed
knowledge and understanding of how subsystems
interact within the products to achieve different outcomes. Such knowledge is sometimes called
“architectural knowledge.” One of the main issues
Alpha encountered was the difficulty of setting the
cross-system functional requirements, which
stemmed from its insufficient knowledge of the underlying components. Prior research has shown that
62 MIT SLOAN MANAGEMENT REVIEW WINTER 2011
knowledge of underlying components is essential for
identifying the consequences of different trade-offs
and making the best decisions regarding overall
product performance.1
Component-specific knowledge is key to architectural knowledge, and it plays an essential role in
determining the performance of complex products.
Researchers have studied the extent to which organizations can achieve a necessary level of understanding of
the components that make up systems by using indirect means such as listening posts, shadow engineering,
co-location or careful monitoring of technological advances (through scientific conferences, journals,
industry meetings, etc.). Although such methods may
be informative, they are not sufficient for providing the
elevated level of understanding that allows managers
to make detailed performance trade-offs.2
Our research supports the view that componentspecific knowledge is an essential building block that
complements and strengthens a company’s architectural knowledge.3 Without it, Alpha failed to develop
systems integration capabilities that allowed it to work
successfully with outside suppliers. When all is said
and done, this knowledge is best acquired by being
immersed in the details of component development
work, providing opportunities for learning by doing.
Practicing “Learning by Doing” The problems
with performance integration do not always manifest themselves right away. At the point when Alpha
began implementing its outsourcing strategy, engineers still had deep and extensive knowledge of the
underlying systems, and they were able to guide
suppliers’ engineering work. However, without new
learning opportunities, their competencies related
to systems and components design eroded sharply
over the next few years. The company tried to compensate for the loss of learning opportunities,
primarily through co-location. For example, during the pre-development phase, suppliers of key
systems such as safety systems, dashboards and
seating systems were invited to co-locate their engineers in Alpha’s design and engineering facilities.
The goal was to encourage communication and
collaboration and to promote as much knowledge
transfer as possible early in the development cycle.4
Despite these efforts, the engineers’ ability to remain on top of the design process deteriorated.
SLOANREVIEW.MIT.EDU
Rather than working “hands-on” alongside suppliers on design and engineering problems, they acted
more as supervisors — detailing the specifications
and managing the schedules. Separating Alpha’s
engineers from both the underlying design of components and new opportunities to learn by doing
weakened their ability to make sound decisions that
ultimately affected vehicle performance.
This experience supports the argument that operational details and strategy are tightly integrated. In
particular, it underlines the importance of learning
by doing as a key lever for acquiring and maintaining
the detailed knowledge that’s needed for determining
performance trade-offs. Other approaches such as
co-location are not a substitute.
safety system in protecting the passengers depends
on the design of the different subsystems of the safety
system (including seat belts, brake systems and the
anti-lock brake system), and how they interact. Other
factors include how the engine absorbs the shock, the
layout of the front end of the car, and the material and
design of the dashboard — elements that are not part
of the safety system per se. In cases where interdependency is high and where performance affected by the
component or system is key for customers (i.e., the
first criterion is respected), the company may want to
reacquire as much knowledge as possible from suppliers quickly; in cases where it’s low, components can
be easily outsourced and later integrated.5
Organizing for Learning
Adopting Mechanisms for Technological Renewal To the extent that component-specific
knowledge is essential and that the best way to acquire this knowledge and remain up to date is
through learning by doing, companies need to find
ways to identify which knowledge and development
work should remain in-house. Our automotive industry research indicated two criteria companies
should apply in determining what they need to keep:
(1) things that have a direct impact on key product
performance and (2) things that have a high degree
of reciprocal interdependency with technologies that
help determine overall product performance. The
first criterion refers to how relevant a component or
subsystem is to a key performance of the product.
For example, a critical performance element for a
sports car is “handling.” Given the first criterion, an
auto company will want to develop and maintain
deep in-house knowledge about the components
and systems that significantly influence handling.
Without this knowledge, developing an attractive
product would be difficult, if not impossible. This
suggests that the automaker should focus on all subsystems that have a significant impact on handling
(the steering system, suspension and so on).
The second criterion suggests paying attention to
a different matter: whether the component-specific
knowledge that’s key to achieving a given performance is associated with a component or subsystem
that is highly interdependent with the rest of the vehicle. Consider our earlier example of the safety
system. In a frontal collision, the performance of the
SLOANREVIEW.MIT.EDU
So how can a company organize itself to maintain
component-specific knowledge and learning opportunities to deliver innovative products that perform
the way customers expect? Our research at Alpha indicated some important organizational guidelines.
First, companies need to organize so they can develop, maintain and reestablish the competencies
identified above. Second, it is not enough to reestablish component-specific knowledge and to invest
resources in pulling together physical systems and
components. In order to meet high performance
standards for the overall product, companies also
need to have the ability to experiment, test and use
trial and error across the entire product.6 Without
this ability, there are no guarantees that reciprocal
interdependencies between the individual performance of systems and components will be adequately
addressed. However, experimentation and testing
can’t be conducted casually — it needs to be well organized.7 One of Alpha’s responses was to increase
the number of inside people with skills such as virtual simulation that were considered important for
pre-development. These skills enhanced efficiency
by allowing engineers to represent performance
without having to build expensive prototypes.
Performance integration has to be recognized as a
critical organizational task that’s built into the structure of the company. As other researchers have noted,
it requires resources and holding someone responsible
for making it happen.8 But there is still another important strategic element that has to do with timing:
when the design interventions occur. For example, in
WINTER 2011 MIT SLOAN MANAGEMENT REVIEW 63
O R G A N I Z AT I O N S T R AT E G Y
the automotive industry, the number of interdependencies increased as the design process moved along
and specifications were frozen. The earlier that interventions can be made, the less disruptive and costly
design changes will be.9 The ideal, of course, is to design products that are right the first time. However, to
the extent that this is not realistic, having the ability to
manage experimentation will permit better and more
efficient performance integration.
Interestingly, Alpha’s experience also shows that
managing outsourcing by relying on the modularization of the product can have fundamental flaws.
Modular product architecture may make good
sense for dealing with physical integration, but it is
not adequate for resolving issues of performance.
Focusing on product-level performance pushes
companies to build and maintain enough competence to resolve the important performance
trade-offs. That means organizations need to manage
and maintain the right component-specific knowledge. The economic argument — that design and
engineering outsourcing provides cost savings and
increased efficiencies — can be offset by taking into
account other strategic considerations. Decisions
about which design tasks to outsource to suppliers
and which ones to keep need to be made by looking at
the whole picture rather than only short-term cost
and efficiency. Once the critical competencies are
identified, an essential task of managing innovation
is developing and maintaining them properly.
Francesco Zirpoli is an associate professor of management at Università Ca’ Foscari, in Venice, Italy. Markus
C. Becker is a professor of organization theory at the
Strategic Organization Design Unit, University of
Southern Denmark, in Odense, Denmark. Comment
on this article at http://sloanreview.mit.edu/x/52208,
or contact the authors at smrfeedback@mit.edu.
REFERENCES
1. A. Takeishi, “Bridging Inter- and Intra-Firm Boundaries:
Management of Supplier Involvement in Automobile
Product Development,” Strategic Management Journal
22, no. 5 (2001): 403-433.
2. The insight into the essential role of component-specific
knowledge to design larger systems has been a central
finding of research in the automotive industry. Interestingly,
the same conclusion was also reached by research on innovation in the comic book industry. In this industry, Taylor
and Greve found that combining knowledge requires a
deep understanding of knowledge, rather than just information scanning or exposure. Their research hints at a
64 MIT SLOAN MANAGEMENT REVIEW WINTER 2011
reason why shadow engineering, listening posts and the
monitoring of technological advances might not be sufficient to maintain component-specific knowledge at the
cutting edge. See A. Takeishi, “Knowledge Partitioning in
the Interfirm Division of Labor: The Case of Automotive
Product Development,” Organization Science 13, no. 3
(2002): 321–338; Takeishi, “Bridging Inter- and Intra-Firm
Boundaries”; and A. Taylor and H. Greve, “Superman or
the Fantastic Four? Knowledge Combination and Experience in Innovative Teams,” Academy of Management
Journal 49, no. 4 (2006): 723–740.
3. Takeishi, “Knowledge Partitioning.”
4. R. Lamming, “Beyond Partnership” (London: Prentice
Hall Europe, 1993); and W.M. Cohen and D.A. Levinthal,
“Absorptive Capacity: A New Perspective on Learning
and Innovation,” Administrative Science Quarterly 35, no.
1 (1990): 128-152.
5. Prior research has identified a further criterion that
companies should consider in making decisions about
what to keep. It has to do with technological “newness,”
and it is especially important in technologically advanced
areas where product performance integration is complex
and where product architecture and company boundaries
influence each other. In these situations (for example,
products using new powertrains), having a higher level of
component-specific knowledge can be strategically vital.
Toyota Motor Corp.’s success at leveraging its hybrid
electric and gas engines in its Prius and other models offers a good example. See Takeishi, “Knowledge
Partitioning”; and S.K. Fixson, Y. Ro and J.K. Liker, “Modularisation and Outsourcing: Who Drives Whom? A Study
of Generational Sequences in the U.S. Automotive Cockpit Industry,” International Journal of Automotive
Technology and Management 5, no. 2 (2005): 166-183.
6. G. Gavetti and D. Levinthal, “Looking Forward and
Looking Backward: Cognitive and Experiential Search,”
Administrative Science Quarterly 45, no. 1 (2000): 113137; and G.P. Pisano, “Knowledge, Integration, and the
Locus of Learning: An Empirical Analysis of Process Development,” Strategic Management Journal 15, no. S1
(1994): 85-100.
7. In response to the challenges, Alpha managers began to
seek out ways to back away from their black-box sourcing
strategy. They did this in part by increasing the number of
inside people with skills such as virtual simulation that
were considered important for pre-development. These
skills were seen to enhance efficiency in pre-development
activities by allowing engineers to represent performance
without having to build expensive prototypes.
8. S. Brusoni and A. Prencipe, “Making Design Rules: A
Multidomain Perspective,” Organization Science 17, no.
2 (2006): 179-189.
9. S. Thomke and T. Fujimoto, “The Effect of ‘FrontLoading’ Problem-Solving on Product Development
Performance,” Journal of Product Innovation Management 17, no. 2 (2000): 128-142.
Reprint 52208.
Copyright © Massachusetts Institute of Technology, 2011.
All rights reserved.
SLOANREVIEW.MIT.EDU
PDFs ■ Permission to Copy ■ Back Issues ■ Reprints
Articles published in MIT Sloan Management Review are
copyrighted by the Massachusetts Institute of Technology
unless otherwise specified at the end of an article.
MIT Sloan Management Review articles, permissions,
and back issues can be purchased on our Web site:
www.pubservice.com/msstore or you may order through
our Business Service Center (9 a.m.-7 p.m. ET) at the
phone numbers listed below. Paper reprints are available
in quantities of 250 or more.
To reproduce or transmit one or more MIT Sloan
Management Review articles by electronic or
mechanical means (including photocopying or archiving
in any information storage or retrieval system) requires
written permission. To request permission, use our Web site
(www.pubservice.com/msstore), call or e-mail:
Toll-free: 800-876-5764 (US and Canada)
International: 818-487-2064
Fax: 818-487-4550
E-mail: MITSMR@pubservice.com
Posting of full-text SMR articles on publicly accessible
Internet sites is prohibited. To obtain permission to post
articles on secure and/or password-protected intranet sites,
e-mail your request to MITSMR@pubservice.com
Customer Service
MIT Sloan Management Review
PO Box 15955
North Hollywood, CA 91615
Reproduced with permission of the copyright owner. Further reproduction prohibited without permission.
Purchase answer to see full
attachment