Can Outsourcing Save Sony?

In a serious departure from tradition, Sony is considering outsourcing TV manufacturing, as CEO Howard Stringer moves to slash costs

Outsourcing isn't a word that executives in Japan like to toss around. Japan Inc. prefers to tie its fortunes to state-of-the-art factories that churn out chips, cars, and flat-screen TVs for the global market. But when Sony (SNE) Chief Executive Howard Stringer announced on Jan. 22 that he was considering drastic cost-cutting steps for the company's core electronics division, outsourcing topped his to-do list.

The shift marks a minor victory for Stringer. After more than three years at the helm, Stringer finally appears to be breaking the company's addiction to manufacturing, and to be channeling ever more resources into developing and designing products that users crave. To show he now really means business, the Welsh-born American CEO has said he will close five or six of the company's 57 plants globally and slash the company's budget for factories and chipmaking equipment by a third over the next fiscal year, ending March 2010. "There is no aspect of Sony that isn't being examined right now," Stringer told journalists in Tokyo last week. "We have to move very, very quickly and control our costs."

Sony will spend the next couple of months drawing up a detailed plan. But Stringer appears to have made up his mind about outsourcing one product: TVs. The TV division accounts for 10% of Sony's overall sales but hasn't made a profit since it launched the Bravia brand of flat-panel TVs in 2005. By the March 2008 fiscal yearend, the division's three-year losses had reached $2.3 billion. Goldman Sachs (GS) predicts the division could bleed another $1.1 billion this year.

An In-House Tradition

The shift toward outsourcing is the clearest sign yet that Stringer wants Sony to act more like Apple (AAPL) or Cisco (CSCO). They consistently earn fatter profit margins by designing their own products and leaving manufacturing to others, and have made serious inroads into portable music players and home entertainment systems, where Sony was once king. In contrast, Sony, like many Japanese tech manufacturers, still makes many of its own products in-house, a process known as vertical integration, which "tends to lead to higher overall costs because you need extra layers of management to coordinate all the activities," says Robert Kennedy, a professor at the University of Michigan's Ross School of Business and author of The Services Shift.

Sony's domestic factories account for half of overall sales. They provided a boost to earnings while the yen was weak and overseas demand strong. But recently, when the yen surged and the global economy faltered, Sony found itself badly exposed. The sudden reversal was partly to blame for Sony's grim earnings forecast this fiscal year—an expected $2.9 billion operating loss, its first in 14 years.

Before the global financial crisis wiped out consumer spending, Sony seemed confident the TV unit would soon be profitable. The company's LCD-TV sales had risen over the past three years, from a little over 1 million units to as many as 15 million expected this fiscal year. Last year, Sony was second in global LCD-TV sales, behind Korea's Samsung Electronics.

But the TV unit's problems are now confounding Stringer's efforts to fix what ails Japan's best-known tech brand. Sony officials say they are rushing to centralize TV development and design and consolidate production in Japan after closing one of two domestic plants.

"Before the electronics division can be healthy, TVs must be profitable," Ryoji Chubachi, who heads the electronics unit, said last week.

Keeping Secrets

What will Stringer's outsourcing strategy look like? So far, he isn't saying, but experts predict Sony will continue to make ultra-thin high-end TVs on its own. That's where the company can command a premium and earn higher margins. Keeping cutting-edge technology in-house also prevents innovations from being leaked to rivals.

For the small and midsize sets, however, Sony might hire one or more manufacturers in Taiwan or Hong Kong. Wistron, Qisda, AmTRAN Technology, TPV Technology, and Foxconn International, a subsidiary of Taiwan's Hon Hai Precision Industry, have all made LCD TVs for Sony in the past but only in small volumes—less than 8% of Sony's overall TV production last year, according to estimates from market researcher iSuppli. "You might want to keep the premium product, but the commodity product you don't need to be manufacturing yourself," says Macquarie Securities' David Gibson. "It's a simple principle of globalization."

In practice, though, it's anything but simple. To be sure, Sony already relies on contract manufacturers to make some of its point-and-shoot Cybershot digital cameras, Vaio laptops, and PlayStation video game consoles, but Sony's TV unit has always jealously protected its secrets, and outsourcing would mark a serious departure from traditional practice. Currently the company buys the specialized sheets of glass from its joint venture with Samsung and ships them to high-security plants in Asia, North and South America, and Europe for assembly. Most of its suppliers get design specifications for specific parts but know little about the entire assembly process.

Outsourcing doesn't work that way. It involves more collaboration and information-sharing. Gartner (IT) analyst Yuko Adachi says many U.S. companies begin discussions with contract manufacturers as early as the conceptual or design phase. "It's more of an alliance," she says. Many tech giants have tried to outsource manufacturing to tech companies in Asia, only to end up repeatedly sending teams of designers and engineers to help those companies get up to speed, says iSuppli analyst Adam Pick. Still, says Pick, "If managed properly, [outsourcing products] can be a phenomenal bonus."

But outsourcing alone isn't going to help Stringer, who has other priorities as well. For instance: wedding Sony's products to its vast library of movies, TV shows, and music. Last fall, Sony streamed the Hollywood blockbuster movie Hancock to Sony TVs connected to the Internet. At this year's Consumer Electronics Show in Las Vegas, the company showed off Net-linked TVs featuring software from Yahoo! (YHOO) that lets viewers check out content from popular Web pages. The key to success there, too, lies in making TVs more efficiently. "We have to find a way to embrace network services, to provide the kind of sustainable differentiation that will give us attractive margins," Stringer said. "In order to do that, we've obviously got to bring down the cost of our televisions."

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