Another example of the fusion of manufacturing and services – and policy recommendations

As I have noted many times in this blog, one of the hallmarks of the emerging Intangible Economy is the fusion of manufacturing and services. Intangibles (mislabeled as “services”) are key inputs to the manufacturing process. And more and more companies provide solutions (that look like “services”) not just products.
Here is another example of this strategy (which MIT Professor Michael Cusumano called an “enduring” strategy) from a piece in today’s New York Times on “A Futurist Looks at Where Cars Are Going”. In an interview, Eric Larsen, head of research in society and technology at Mercedes-Benz Research and Development, notes:

We have a business called Boost, where minivans drive children after school. They are like school buses, but door to door, and parents can track them with a phone app. They have a concierge as well as a driver, because the driver can’t leave the bus and walk the kid right to the door. A 7-year-old needs that. In this case, we’re selling a mobility service rather than a product.(emphasis added)

By the way, he still sees a demand for cars as products, with American’s buying cars for transportation (especially in the suburbs) and as status symbols.
The importance of this trend however continues to be overlooked by policymakers. About a year ago the National Academy of Engineering (NAE) – the sister organization to the National Academy of Science – issued a report, Making Value for America: Embracing the Future of Manufacturing, Technology, and Work, clearly focuses on how manufacturing is changing. Given the importance to understanding this trend to our economic future, let me repeat below what I said about the report when it first came out.
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Engineers who get it: understanding the new production system beyond manufacturing v. services

The Changing Nature of Production

The reports lays out its framework right at the beginning:

Business and policy leaders need a holistic understanding of the value chain in order to take effective action in response to the changing manufacturing and high-tech sectors. To systematically identify and successfully address customers’ needs and capture higher returns, businesses must draw on in-house capabilities and external partners to carry out a set of interlinking activities spanning economic sectors. For example, in order to sell cars, automotive companies engage in research, product development, supply chain logistics, production, and sales, as well as pre- and postsale customer services such as maintenance, financing, and information and entertainment capabilities.

While companies have always been involved in a range of activities that cross economic sectors, it is increasingly difficult to recognize clear dividing lines between manufacturing, the production of software, and the provision of services in a company’s product offerings. The service content provided by manufacturers has grown in importance, accounting for a larger proportion of total revenues in many industries. At the same time, companies primarily known for software and services have branched into providing manufactured products. (emphasis added)

The report goes on to emphasize the point:

While companies have always been involved in activities that cross economic sectors, it is increasingly difficult to meaningfully categorize companies along manufacturing value chains as providing mainly goods or services. Many companies that traditionally focused on producing and selling goods have developed service-type business models. For example, Rolls-Royce offers a “power by the hour” service that lets customers rent the use of a jet engine rather than purchasing one. Rolls-Royce retains ownership of the engines, monitors their real-time performance, and manages their maintenance and replacement. Such service content has grown in importance among manufacturers. Deloitte Research (2006) found that the fraction of manufacturers’ revenues generated by services has grown to approximately 20 percent in the medical device, industrial product, and telecommunication equipment industries and as high as 37 percent in automotive and 47 percent in aerospace. Service content is even more pronounced among many of the world’s largest manufacturers, whose main offering is defined by after-sale services.

At the same time, companies primarily known for software and online services have branched into designing and producing manufactured goods. Amazon, for example, established a hardware team that developed the Kindle e-reader and Fire TV digital media player, and is developing a smartphone to more effectively deliver its offerings to customers. Google is partnering with contract manufacturers to produce wearable technology products such as Google Glass.

Apple is a case in point. The report lays out the Apple value added chain which runs from raw materials to content. Many companies, from Corning to the New York Times play a role in that value chain. But Apple itself has a major role in assembly & sale of products, software and on-line services. Is Apple a hardware, software or IT services company?

The report demonstrates how different locations and divisions of other major companies can be classified across the manufacturing/services divide. For example, Ford Motor Company is a manufacturer headquartered in Dearborn, MI. It has a wholesale trade business in Livonia, MI. There are numerous retail trade dealerships (with a tight connection to that division of Ford). There are various professional and technical services parts to Ford ranging from R&D to engineering to software development to marketing. Finally, there is an automotive repair division in Wayne, MI. The report highlights similar structures for GE and Procter & Gamble.

Hence the report’s emphasis on a value chain approach. I would argue that it is more a “changing factors of production” and a “serve the customer needs” approach. Intangible factors of production and thus of competitive advantage are noticeable in all areas of the values chain and might be considered “services” if they were done by a separate organization: R&D, product design, supplier relations & supply chain management, marketing & brand management, customer relations, etc. It is next to impossible to separate out the “service” from the “manufacturing” in the inputs, in the throughputs (aka, processes) or in the outputs.

Likewise the end goal has shifted from simply efficient production to meeting customer needs. This is reflected in the report’s core concept of “making value.”

Although it is not yet in widespread use, the concept of making value is a particularly effective way of examining the success and failure of individuals, businesses, communities, and nations. Making value is the process of using ingenuity to convert resources into a good, service, or process that contributes additional value for a person or society. While value creation is often used to refer to the ability to provide things of worth for the customer or user, making value is used here to emphasize the entire system of activities that is necessary to conceive, produce, and deliver these things–especially the design and production processes that often receive less attention in discussions of value creation. (emphasis in original)

It is important to stress that “making value” is about serving customer needs, not about optimizing the value chain for a particular good or service.

This “making value” framework builds upon, but is a break from, earlier STEM/R&D focused reports. Interesting that the focus of the project evolved from Making Things: 21st Century Manufacturing and Design (title of an NAE forum in 2010 – see earlier posting) to Making Value: Integrating Manufacturing, Design, and Innovation to Thrive in the Changing Global Economy (title of a 2012 NAE forum – see earlier posting).

But even the report shows how difficult it is to shed the old vocabulary. To be clear, the report should use the term “production system” or “production value chain” rather than “manufacturing.”

Driving Factors

The report sees three factors driving this change: globalization, advances in computing and automation (digitization) and improved production processes such as lean manufacturing. The result of these forces, they argue, is major change in the nature of work. This shows up as a reduction in the number of front-line manufacturing production workers and a shift in required worker skills.

Much has been said by many reports and studies about globalization and digitization. This report’s inclusion of organizational and process changes is an important and refreshing addition to the mix.

The report contains a entire chapter on the opportunities presented by digital technologies. As they state,

The challenges presented by increasing competition and the changing nature of work, and the opportunities presented by digital technologies, will require US companies and communities to strengthen their ability to innovate and create value.

This is a useful expansion of the earlier chapter on the forces of change. I wish however the report had gone into as much depth on the issues of globalization and the changing nature of work. Each of these topics could have used a chapter as well.

I would have also added another factor to the mix: the increasing importance of intangibles as a factor of production. Business models have shifted from economies of scale to customization. Part of that is due to digitization. But digitization alone was not responsible for the shift in business models. Companies are seeking to differentiate themselves more and compete less on price based. This differentiation has natural focused on customization and better meeting customer needs. The new focus necessarily relies more on knowledge and intangible assets, such as relationships and customer data.

This shift to more knowledge and intangible asset input is directly reflected in the change in worker skills needed. The issue is more just tech skills, however. The report touches lightly on this topic:

It is not enough, for instance, for an IT worker to be proficient in technical issues; because of the ever more integrated and collaborative nature of jobs and companies, employers would like their IT workers to understand the analytical and business development side of their jobs as well, and such employees are much harder to find than workers who can do just one or the other …

They do make one important statement with respect to skills:

The shift in the skills needed for production jobs is indicative of a larger transformation across all aspects of the value chain and all sectors of the US economy.

Recommendations

The report offers a dense array of recommendations that reflect this different view. For example, there is more attention to the issues of business models. The recommendations are grouped around five points to create a “value creation ecosystem”:
   (1) widespread adoption of best business practices,
   (2) an innovative workforce,
   (3) local innovation networks,
   (4) flow of capital investments, and
   (5) infrastructure that enables value creation.

Of special interest to me is their concluding discussion of “federal programs that monitor the condition of various activities in US-based manufacturing and high-tech service value chains.”

As the report implicitly states, the policy questions are not about picking a certain part of the value chain to specialize in, i.e. the old manufacturing versus services debate. Rather, policy issues revolve around finding ways to strengthen all elements in the “making value” process. One of the recommendations specifically states:

The United States needs to encourage new business creation across the value chain to stimulate innovation and job creation. (emphasis added)

I wish the report had highlighted this important point a little more.

Some of the policy ideas are not new. But many of the recommendations are new or new twists on old recommendations. The focus on best business practice brings the policy discussion back to issues of lean manufacturing and associated principles – something that the Baldrige Award is supposed to promote. It also refocuses on the idea of spreading best practices. Specific recommendations include urging companies to examine their business models “to search for missed opportunities to leverage distributed tools and coordinate manufacturing and product lifecycle services.” They also urge companies to implement best practices (including such as Lean Production and researchers to study and find effective ways to teach best practices.

Importantly, the report promotes the concept of design thinking:

An iterative process of understanding customer experiences, building and trying out a prototype, improving the solution, and applying lessons learned to the next innovation are all critical to maintaining a competitive advantage.

While there is no specific recommendation on design thinking, it should fall under the general heading of promoting best practices. I have long argued that to foster design thinking, we should fund five colleges or universities to create design schools (d.schools) similar to the Stanford d.school (Hasso Plattner Institute of Design). The proposal builds upon the “manufacturing universities” proposal to grant 25 universities $5 million each per year for four years to revamp their engineering teaching and research activities toward manufacturing and engage in greater joint industry-university research projects. At $5 million per year for five schools, the total budget for creating new design schools would be $25 million. (See also earlier postings.)

The workforce recommendations look at much more than technical STEM education.

Critical thinking and creativity are as important as technical skills. It is not enough to learn facts and procedures by rote; students need to learn to evaluate a situation by asking questions, observing, collecting further information, and subjecting the collected data to a thoughtful analysis to identify mistakes and weaknesses and come up with alternative possibilities. Creative critical thinkers constantly probe and evolve their own interpretations and ideas.

Many of the recommendations focus on improving the education system, including closer ties between businesses, local school districts, labor, community colleges, and universities and for more focus on “team-based engineering design experiences and learn to use emerging digital and distributed tools.” They also support national skills certifications and efforts to improve education cost-effectiveness.

The report goes well beyond education to address issues of teams and diversity. They specifically call on business to recruit a more diverse workforce, universities and community colleges to improve inclusion of traditionally underrepresented groups and Congress to reform immigration policy. Other than the mention of team-based experiences in college, there appear to be few any specific recommendation on teams per se. I would add however that helping companies understand the importance of and build teams is part of promoting best practices.

I especially like their call for more employer based training:

Despite the sizable returns employers can receive from training programs, both employers and employees report that the current level of employee training, especially in small businesses, is not adequate …

Thus one of their recommendations is that “Businesses should establish training programs to prepare workers for modernized operations and invest in advancing the education of their low- and middle-skilled workforce.” Interestingly, this is part of the best practices set of recommendations. That the report believes worker training is a best practice speaks volumes.

Another workforce recommendation is that “Congress and state legislatures should create incentives for businesses to invest and be involved in education programs.” This includes tax credits or other incentives. While the report mentions continuing workplace education, they only specifically mention incentives for programs for students and displaced workers. I would go beyond this to explicitly include tax credits for on-the-job training for the existing workforce aka a knowledge tax credit. The best program for a displaced worker it to upgrade their skills so they are either less likely to lose their job and/or more likely to quickly get a new one.

Concerning developing local innovation networks, their recommendations are a mixed bag. They call for more research on understanding the declining rate of new business creation. They urge local stakeholders to work together to create networks and for metro area and state governments to do a better job coordinating efforts both internally and geographically. They reiterate their recommendation for on spreading best practices, specifically as part of the Advanced Manufacturing National Program Office. They call on the SBA to “continue to help more young businesses become globally competitive” including connecting with local innovation network.

The discussion of capital investment addresses the long-standing concern about short-term investment and the issue of capital for start-ups. They specifically recommend that Congress should modify the capital gains tax rates to incentivize holding stocks for five years, ten years, and longer and make the R&D tax credit permanent. They also recommend the “Federal agencies should facilitate industry and government cooperation to identify shared opportunities to invest in precompetitive research in long-term, capital-intensive fields.” These recommendations are fine as far as they go but I would have liked to see more discussion of innovative financing tools for start-ups. I would have also added proposals to better utilize intellectual property (IP) in the lending process. Specifically, the Small Business Administration (SBA) and U.S. Patent and Trademark Office (USPTO) should convene a working group of lenders, regulators and other interested parties to develop a common template to be used when describing and valuing IP and intangible assets used implicitly or explicitly as collateral. The Intellectual Property Office in the United Kingdom (UK IPO) is already undertaking such an activity. Any U.S. effort should communicate, and to the extent possible coordinate, with that activity. (See also earlier postings).

The infrastructure recommendations covers information, communications and computing as well as the traditional categories of transportation, water, waste and energy. Their recommendations focus on investing in a world-leading wireless infrastructure and access to a world-leading infrastructure for high-performance computing. Nothing, unfortunately on traditional infrastructure. I would have liked to have seen a discussion of ideas such as the National Infrastructure Bank.

Finally the report looks at the problem that has been at the heart of my work: both statistics and Federal programs are not in-line with this new economic structure. On statistics, they recommend that

Federal agencies should develop methods of accounting for the complex relationships between manufacturing, services, and information and consider multiple ways of collecting and organizing national statistics.

Such an analysis would, I believe, go a long way to helping us break free from the existing out-dated view of the economy. Statistics are a window through which we see the world. But yet our current statistical system is more like looking through the rear view mirror. We need better metrics upon which to base our policies.

On policy, the report recommends that

Federal programs that contribute to innovation should be directed and optimized as appropriate to assist software and service providers as well as manufacturers. Federal programs to revitalize manufacturing in the United States, such as the Advanced Manufacturing National Program Office (AMNPO), the Manufacturing Extension Partnership, and the Advanced Manufacturing Partnership, should not lose sight of the importance of software and service providers.

Of the many recommendations in the report, if these two recommendations alone are embraced by the policy community then the NAE will have secured a breakthrough in the policy debate. As I argued in my report Rethinking Innovation Policy – Reposing to an RFI:

First, we should recognize that the barriers between “manufacturing” and “services” are eroding. Service activities are increasingly linked manufacturing activities. In fact, companies such as the German Mittelständler companies are successfully competing in “old” industries based on that linkage. They offer knowledge — not low cost. Knowledge is what gives them a superior product and knowledge is what makes their services so valuable. But is it not just generic knowledge. They are selling their knowledge as a means to create solutions for their customers. Their customers want the knowledge to be specifically applied to them – not some abstract concepts. That is the “service” part of the equation. So, all of the activities described above for helping manufacturing should recognize that these manufacturing companies are already in the “service” business.
Next, it should be recognized that all of the activities described above for helping manufacturing also apply to services. Service industries are becoming more knowledge-intensive and need to understand and better their intangible assets. MEP could be further expanded to a offer assistance to service providers — just as the Baldrige Award was opened up to service businesses. Promoting innovative service delivery activities the government procurement process and through the establishment of demonstration and technology diffusion programs is also just as important as in manufacturing. Likewise, research on the organizational and business model aspects of service delivery should be undertaken.
The bottom line answer to both questions [raised by the RFI] is as follows: our goal should be to help American companies make the transformation to a more knowledge-intensive, information-fueled innovative production process — in all sectors and in all industries. Some of those industries will be labeled “manufacturing.” Some will be labeled “services.” Some will be a combination of both. What we label it is less important than the action we take to help make the undertaking of these activities here in America as productive, competitive and wage/job creating as possible.

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When the report came out, the NAE committee promised it would be undertaking efforts to educate policymakers, business leaders and others as to the importance of the framework and recommendations. These efforts are especially needed now a more and more attention is turned to our manufacturing strategy and its role in addressing issues of middle-class economic and inequality. I continue to wish the committee all the best in these efforts.

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