Souping Up The Supply Chain

Today's supercontractors are turning manufacturers into models of efficiency

Even in this "just-in-time" age, the production line that churns out Hewlett-Packard ink-jet printers in Newark, Calif., is impressive. In response to electronic orders from customers around the country, parts trucked in moments earlier are loaded onto a 110-foot assembly line. Finished printers fly off the other end--and soon are aboard another truck heading to a distributor. The operation is seamless and speedy. But then, what would you expect from one of America's premier high-tech corporations?

You might think the factory belongs to Hewlett-Packard Co. Instead, it's owned by Solectron Corp., a contract manufacturer. What's more, even as Milpitas (Calif.)-based Solectron pumps out HP's printers, its 24 production lines are simultaneously assembling everything from pagers to television decoding boxes for some of the biggest brand names in electronics.

Solectron is part of a new breed of U.S. supercontractors that promise to revolutionize manufacturing well into the next century. They command dozens of factories and supply networks around the world. Increasingly, they also manage their customers' entire product lines, offering an array of services from design to inventory management to delivery and after-sales service. Their unusually flexible operations are surprisingly profitable, producing returns on assets in the range of 20%.

"Outsourcing," a practice that has been around for decades, doesn't begin to describe the phenomenon. In place of traditional contracting relationships between client and supplier, arrangements with companies such as Solectron represent a sort of extended enterprise--a set of partnerships between product developers and specialists in components, distribution, retailing, and manufacturing.

The resulting organization can be so tight as to behave like a single, closely knit company--only better. Its strategies can slash time and costs out of the supply chain, the process between the invention of a new product and the time it reaches the consumer. Customers say they have achieved cost efficiencies of 15% to 25% already. And that, says James E. Morehouse, a logistics expert at A.T. Kearny Inc., is only 5% to 10% of U.S. industry's potential savings.

BUSTED BARRIERS. The effect on innovation could be huge. Spinning off manufacturing and other noncore functions allows industrial titans to focus new investment where it gets the most bang: on research and marketing. Because the strategy reduces the need for capital and in-house operations expertise, moreover, startups face far lower barriers in bringing new technologies to market.

In 1996, for example, Egyptian-born engineers Zaki and Shlomo Raqib came up with a modem, capable of advanced services such as teleconferencing, that could be deployed over any cable system without needing costly upgrades by cable operators. But while their Santa Clara (Calif.) company, Terayon Communications Systems Corp., had $45 million in venture capital, it lacked manufacturing facilities. So it went to Solectron, and four months later Terayon's modems were being shipped to cable operators in the U.S. and abroad. In terms of manufacturing capability, boasts Zaki Raqib, "this puts us on a par with the Motorolas of the world."

COST BENEFIT. Far from eroding American industry, the new manufacturing paradigm is one of the surprise strengths of America's high-tech economy. Because independent contractors can better meet demands for quick delivery, the U.S. is actually becoming more competitive as a production base--even in mass-volume assembly work. As Asia's cheap wages are offset by higher shipping costs, "the cost difference between the U.S. is now virtually gone," says Michael E. Marks, chief executive at Flextronics International USA Inc., a major contract manufacturer.

Not everyone is abandoning their factories. Compaq Computer, Intel, National Semiconductor, and Merck are among the corporate giants that keep manufacturing in-house to protect their competitive edge. They fear losing control over intellectual property and quality, or that secrets will leak to competitors. They also worry about losing touch with clients and industry trends.

But in many industries, vertical integration is giving way to virtual integration. General Motors Corp.'s Aug. 3 decision to spin off its $31 billion Delphi Automotive Systems components unit is part of the auto industry's shift toward "modular" production, where prefabricated chunks with scores of parts are supplied by outsiders and bolted together at the last minute. Delphi, for example, makes full instrument panels for M-class sport-utility vehicles assembled at Mercedes Benz's modular plant in Vance, Ala. Some experts believe the Big Three also will eventually sell off their engine and auto assembly plants.

The same trend is emerging in pharmaceuticals, where the cost of bringing a new drug to market--as high as $500 million--and the high risk of failure have long been barriers to entry. Covance Inc., one of the world's largest contract research organizations for drugmakers, has just opened a $55 million plant in North Carolina's Research Triangle Park that CEO Christopher A. Kuebler likens to a "sterile version of a microbrewery," capable of making up to five biological drug products simultaneously. Among its first customers is seven-year-old StressGen Biotechnologies Corp. of Victoria, B.C., which has hired Covance to make its new vaccine for treating cervical cancer.

The movement is much further along in electronics, where a $90 billion contract manufacturing sector is growing three times faster than overall electronics sales, according to Technology Forecasters Inc. of Alameda, Calif. Semiconductor startups can turn to a growing number of silicon-wafer foundries--highly flexible shops willing to produce small runs of a few thousand units at first and ramp up to mass production if demand takes off. That allows "fabless" Silicon Valley design houses like Xilinx Inc., 3Dfx Interactive, and Broadcom Corp. to market innovative telecom, graphics, and video chips that power the myriad multimedia gadgets of the Digital Age. With billions of dollars in new capacity coming online, analysts expect the supply of new chips to explode.

As virtual integration evolves, futurists envision a time when product developers, manufacturers, and distributors will be so tightly linked through data networks that inventory will all but disappear. Companies will make goods based on the daily needs of retailers. Even automobiles will be assembled to a customer's specifications within days, just as Dell Computer Corp. and Cisco Systems do now with computers and networking equipment. A sunset industry no longer, manufacturing will help drive innovation.

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