Winter, the development of the economy moves according to a “survival of the fittest” logic, with the likelihood of survival
increasing with firm profitability. Profitability is determined by the effectiveness of company-specific routines (ways of doing
things) that are passed on as the firm develops in the same manner that genes are passed on in biological systems. The “search”
routines which firms apply to crisis situations (e.g., the need to respond to a competitor by developing an innovative new
product) determines the likelihood of their survival as they adapt, or “mutate,” in response to new situations.
Because successful firms tend to invest in additional productive capacity, the dynamic process of industrial evolution tends to
create larger firms and more concentrated market structures over time (up to the point where market concentration begins to
stifle competition and hence, innovation). Nelson and Winter devised computer simulations that produce these results, using the
variables of aggressiveness of investment policies, realization of potential productivity gains, the degree of difficulty in imitating
the firm’s innovations, and how successful the firm’s innovative efforts are. In the simulation where the value for the first variable,
aggressiveness of investment policies, was assigned a high value, imitation was made more difficult, latent productivity was
better realized, and as a result, industry structure showed markedly higher levels of concentration than in simulations where
capital investments were suppressed (in the real world, a firm might restrain investment to restrict output growth and keep
prices high).
The assumptions in this model point out the key problem with using the Schumpetarian approach to predict the evolution of
industry organization. In this schema, firms tend to get larger over time because successful innovations lead to higher profits and
greater investments in productive capacity that put them further ahead of their competitors. Aggressive capital investment
becomes a barrier to entry for new and existing firms and as a result, firms become larger and market structure more
concentrated over time. But what if we allow for the possibility that increases in market share can be organizationally delinked
from increases in firm-specific capital investment? In the American electronics industry, for example, firms are increasingly
relying on outside sources (i.e., contract manufacturers) for manufacturing capacity. If a firm successfully innovates (e.g.,
develops a personal computer with dramatically better price/performance characteristics than any existing competitor), it can
quickly ramp up production through its contract manufacturers without the lag or risk associated with building up internal
capacity. In the turnkey network market concentration may increase, but industry structure remains relatively disaggregated.
Moreover, barriers to entry based on the holding of productive capacity by leading firms fail to develop.
3. Turnkey Contract Manufacturing in Electronics
In April, 1996, Apple Computer announced that it was selling its largest United States personal computer (PC) manufacturing
facility in Fountain, Colorado to a little-known company called SCI Systems. Apple had just posted the largest quarterly loss in
its history ($740M) and had narrowly avoided being taken over by Sun Microsystems, so it may not have been suprising that it
was shedding some of its assets. What seemed strange about this deal was that, according to Apple management and industry
pundits alike, Apple’s troubles did not stem from poor demand, but from its inability to meet demand.(4)
Why would a company that is having trouble meeting demand sell one of its most important production facilities? One could
easily imagine an effort to improve responsiveness and efficiency at existing facilities, but a move to decrease capacity at such a
moment, on the face of it, seemed foolish. Did Apple plan to make up for the resulting loss in manufacturing capacity by
expanding its remaining facilities in Ireland or Singapore, moving production to lower-cost offshore locations? A closer look at
Apple’s restructuring strategy and its partner in the deal, SCI, provides some answers to this puzzle and serves as a thumbnail
sketch of the organizational sea-change that is currently underway in the electronics industry.
First, the sale to SCI did not mean that Apple computers would no longer be produced in the Colorado facility. On the
contrary, the deal included a three-year agreement for SCI to continue to manufacture Apple products in the plant. SCI is the
largest of an emerging cadre of specialized firms whose sole business is to provide electronics manufacturing services to the
industry on a contract basis; accordingly, companies like SCI are known as “contract manufacturers.” SCI had the right to use
the plant’s production lines to manufacture products for any of its other customers as well as Apple, which at the time included
more than fifty firms including Hewlett Packard and IBM, companies that compete directly with Apple in the PC market. The
majority of the five-year-old plant’s 1,100 workers were to stay on as SCI employees.
So, Apple wasn’t selling one of its U.S. plants to some burgeoning local electronics company and moving its own production
offshore: it was contracting with SCI to continue to manufacture Apple products in Colorado. According to Apple CEO
Gilbert Amelio, the company’s strategy was to outsource production to companies such as SCI in order to reduce Apple’s
manufacturing overhead and inventory carrying costs while concentrating the company’s resources more intensively on
marketing and product design (Electronics Buyers News, 1996). As Kwok Lau, Apple’s Director of operations put it, Apple
was moving to a “variable cost position” vis-?-vis its manufacturing operations. This meant that more of the company’s
manufacturing assets were to be held by outside companies. Instead of using fixed assets, namely production facilities owned
and operated by Apple, to manufacture computers and peripheral equipment bearing the Apple nameplate, the company was
to use the production assets of specialized outside suppliers, such as SCI. After the sale, Apple was able to alter the volume of
its production, upward or downward, on very short notice without installing or idling any of its own plants and equipment. Of
particular interest to Apple’s management was the improved “upside flexibility” (i.e., the ability to quickly ramp up production
volumes to meet unexpected surges in demand) that the deal with SCI provided.(5)
Another oddity about the press reports surrounding SCI’s acquisition of Apple’s Fountain plant was the following statement by
Fred Forsyth, Apple’s senior vice president of worldwide operations: “By outsourcing the manufacturing activities of our
Fountain site to a company of SCI System’s size, experience, and broad business base, Apple has the opportunity to benefit
from SCI System’s economies of scale” (Apple Computer, 1996). Although SCI is a large company, it is less than a third the
size of Apple. How could a company of SCI’s size achieve greater manufacturing and component purchasing scale economies
than a company whose market share in the PC industry has hovered between number one and three since the birth of the
industry in the late 1970s? The answer lies in the fact that SCI’s sole business is contract manufacturing. The company has no
internal product development capacity. Its sales and marketing activities are limited to developing its business as a manufacturer
of other firms’ products. In fact, despite its size, and the fact that it manufactures no products under its own name, SCI’s twenty
world-wide plants may well contain more manufacturing capacity than any other single electronics firm.(6)
Was the Apple/SCI deal unusual? Certainly not. If anything, according to some industry watchers, some of Apple’s problems
stemmed from the fact that it had been too slow to “outsource” its manufacturing operations, even though nearly 50% of the
company’s manufacturing was already performed by contractors prior to the sale. By selling the Colorado facility to SCI,
Amelio was simply placing Apple more completely on a bandwagon that was already well underway. Since the mid-1980s, and
particularly in the 1990s, large and well-known American electronics companies such as Apple, IBM, NCR, Philips, ATT,
Hewlett Packard, and DEC have been abandoning their internal manufacturing operations in droves and turning to contract
manufacturers such as SCI to build their products. At the same time, many younger, faster growing electronics firms, many of
them based in Silicon Valley, CA, have always used contract manufacturers; few have built internal manufacturing capacity even
as they have grown (e.g., Sun Microsystems, Silicon Graphics, and Cisco Systems).
Increased outsourcing has created an unprecedented boom in contract manufacturing revenues. From 1988 to 1992 the sum of
revenues generated by 1995’s largest twenty contractors grew at an annual rate of 30.7%. Since 1992, however, revenue
growth has been accelerating dramatically year by year: from 1992 to 1995, revenues grew 46.4% each year, with the fastest
growth coming from 1994 to 1995, when revenues expanded 51.2% (see Figure and Table 1). At the time of this writing, the
unprecedented growth in the industry is showing no sign of slowing down (for example, SCI’s revenues grew 65% to more than
$5.3B in calendar year 1996).
Revenue growth for contractors has come from several sources. First, the purchase of a customer’s facility often includes at
least short-term prospects for increased business as the contractor assumes responsibility for current and future production
volumes. Besides increased volume, contractor’s revenues have increased from component purchasing and the provision of new
services. Increasingly contractors have been purchasing components for their customers in what is known in the industry as a
“turnkey” contract. In this arrangement, the contractor essentially acts as a lender to its customers by purchasing and holding
component inventories. Cash outlays are only recouped as finished products are delivered to the customer. Turnkey component
buying increases the flow of capital through the contractor, driving up revenues and creating strong market linkages with
component suppliers. Also, contractors have been vertically integrating in relation to their specialty, manufacturing. Besides
basic electronics manufacturing processes, such as circuit board assembly, most contractors have added a range of back- and
front-end services, such as process R&D, design for manufacturability, product-specific process development and
documentation, various forms of testing, final product assembly, final packaging, software loading and document duplication,
and shipping to distribution. Some contractors have added repair services, not only for products manufactured in their plants
but by customer plants as well. The contractors that have grown the fastest have specialized in advanced manufacturing
processes, such as surface mount technology, which drive product miniaturization and performance forward.
Figure 1. Revenues; 1995’s Top Twenty Contract Manufacturers, 1986-1995
(billions of current dollars)
Table 1. Revenues; 1995’s Top Twenty Contract Manufacturers, 1988-1995
(thousands of current dollars)
CM Revenues (thousands of $)
Annual Average Growth Rates
‘88
‘92
‘95
‘88-’92
‘92-’95
‘94-’95
Top 5
1,077,366
2,433,127
7,772,792
24.4%
47.3%
51.9%
Top 6-20
606,000
1,534,200
4,672,382