Supersmart Manufacturing Tools are Lowering Prices on TVs, Bulbs, and Solar Panels

 
 
Electronics manufacturers are finding it increasingly difficult to stay ahead of low-cost competitors, says Willy Shih.
 
 
by Sean Silverthorne

As technology commoditization begins speeding up again, it’s a great time to be a consumer in search of a state-of-the-art flat panel TVs, but less comfortable for manufacturers hoping to make a profit. That’s according to recent research by Willy Shih, Robert and Jane Cizik Professor of Management Practice in Business Administration at Harvard Business School, who recently published a paper on the topic of technology commoditization in MIT Sloan Management Review.

According to Shih, manufacturers are able to duplicate the latest technology used in cutting-edge products much more quickly and cheaply than ever before. The reason? Tools are being developed that have more knowledge baked into them, meaning manufacturers don’t have to develop as much custom technology to compete.

Sean Silverthorne: Can you explain what you mean when you say that knowledge, particularly tacit knowledge, is now being embedded into the tools and building blocks used to make products?

Willy Shih: Knowledge is one of the core resources in a company, and translating that knowledge into processes that produce products and services is how companies create value. There are two types of knowledge—explicit and tacit. Explicit knowledge is something that is documented and is something we can search for. Maybe we look it up in a library, a recipe book, or an instruction manual for making something. As long as you can write it down or clearly explain it so other people can understand it and duplicate what you have done, it is explicit. Tacit knowledge, on the other hand, is trickier. It is know-how that is carried around in the heads of people that hasn’t necessarily been written down, and combines skills, prior experiences, and ideas that are not easily expressed. “We can know more than we can tell,” was how Michael Polanyi described it in his book Personal Knowledge in 1958. Sharing tacit knowledge is obviously harder, and that’s why it is often extremely valuable.

Knowledge gets embedded in tools when machine makers distill specialized know-how that might be critical to making something into mechanisms within that machine that allow the process to become routine and repeatable. Let’s use an example. Many of us have seen glassblowers who manipulate a glowing hot lump of molten glass and shape it into a bottle or some other shape. That artisan skillfully extracts the glass from the furnace when it is at the right working temperature and uses a variety of tools to blow, cut, or deform it into the desired shape using skilled hands and air pressure from the mouth.

These are skills that he or she developed over many years of practice. Can she explain how to do it to an apprentice? Probably, but it will take time and practice to learn all the tricks and perfect the art, making a lot of mistakes along the way. Yet there are machines that do produce all kinds of glass objects every day, from mason jars to windscreens for cars. What the machine makers did was devise mechanisms to incorporate that know-how. By carefully measuring and observing, they figured out the right temperatures and pressures and devised molds or handling devices to produce the right shape, or the right sequence of temperatures to heat, then cool and anneal the workpiece. They took a process that used a lot of tacit knowledge that required a lot of experience and practice to perfect and made it routine and predictable.

Production tools have always incorporated some amount of knowledge; that is the very essence of what they are, after all: instruments for making it easier to produce something. What the paper points out is the level of sophistication of this knowledge embodiment has increased dramatically, making it easy to make things that have long been very difficult or even impossible to produce otherwise. All you need is the money to buy the tool, and you can go into the business of making the widgets that the tool produces. And these days, those tools are not only for production, but they are also the tools for designing things—the computerized design and modeling systems for sophisticated electronic and mechanical parts. They make it far easier to design things like the automatic transmission of a car or a complex computer chip than what we used even a few years ago. You don’t need a generation of experience anymore; design and production are getting democratized and more accessible through the widespread availability of such tools.

Silverthorne: What’s an example of this commoditization occurring in practice?

Shih: We see much of this commoditization happening at the level of many intermediate goods—components—that get incorporated into other products. For example, the extremely complex process of making the flat panel displays that go into television sets has been commoditized. As consumers, we see this in the ever-decreasing retail selling price of flat panel TVs. The screen sizes get bigger, the resolution moves from HD to Ultra HD to 4K, and the prices keep dropping. This happens in spite of the fact that it costs $6.5 - $8 billion to build an advanced flat panel factory. We see the same phenomenon in energy-efficient LED lightbulbs, which keep getting cheaper. And solar panels.

One way to think about what is driving this style of commoditization is economics. Most manufacturers gave up making their own manufacturing tools long ago. They couldn’t afford to, as it was too expensive, and the technology was getting too complicated and specialized. A company that specializes in making tools, on the other hand, can spread those costs over multiple customers. The latest generation lithography tool for making semiconductor chips costs over €100 million [$116 million] apiece (and a semiconductor fab needs multiple units), and has taken years to develop. Only a specialist who can sell to many customers can afford to do it. And there’s the rub—tool makers are motivated to sell to as many customers as possible—which means everybody in the business or who they can convince to enter the business. So, the capability to make that complex tool-dependent product becomes accessible to everybody who has the money.

Many such cases have been worsened by government subsidies designed to encourage manufacturing growth in specific areas. At the height of the boom in LED manufacturing, Chinese local governments would pay for 100 percent of the cost of the metal organic chemical vapor deposition (MOCVD) tool used to make LEDs, so naturally what followed was a dramatic over-expansion of capacity and commoditization of the output. No flat panel display factory anywhere in the world is built today without billions of dollars in subsidies. The groundbreaking in Wisconsin that President Trump just attended is receiving around $3 billion from the state. So that industry goes through frenzies of overbuilding, which is inevitably followed by excess capacity and a collapse in pricing.

Silverthorne: Over the next two to three years, what products are particularly susceptible to being commoditized?

Shih: I think high volume, high tech hardware products where the production process involves more machine/automation and less labor are vulnerable, especially anything incorporating electronics. It’s also instructive to watch industries China is subsidizing where there are dramatic capacity expansions. It’s actually amazing how cheap (for the level of quality you get) it is to buy a camera lens for a smartphone or things like image sensors. I think components that support IoT will almost certainly face this pressure. Again, we’ll see this primarily at the level of intermediate goods, and that will pass through to lower selling prices on a range of products.

On the design tool side, I think the commoditization will be more directly visible. One form it will take is the democratizing of design—expanding access to more users who couldn’t afford to produce such high quality work before. It used to take a company with a lot of resources to do sophisticated engineering designs, but now a startup with a computerized design system and a 3D printer can make amazingly sophisticated parts.

One interesting situation that I wrote a case on was the company Rhythm & Hues, a well-known visual effects (VFX) company. The case question was what circumstances led them to (1) win four Oscars for their work on Life of Pi, (2) win a British Academy of Film & Television Arts (BAFTA) award, and (3) file for Chapter 11 in the same 30-day period? Well the design tools for visual effects incorporated more and more know-how, so plenty of people around the world could acquire the capability for doing the VFX work. The Hollywood studios lowered their costs by off-shoring the VFX work, and Rhythm & Hues had to compete with lower cost regions and with off-shore contractors who received subsidies. You didn’t need years of experience and crafts skills so much anymore.

Silverthorne: What are the implications of this acceleration for tech companies, and what can they do to protect themselves?

Shih: Companies need to understand their vulnerabilities. If you are a company that uses tools with this kind of high embodiment of know-how and you can’t protect complimentary assets like recipes or trade secrets vis-à-vis how you use them, you are likely already facing or soon will face commoditization pressures because there just aren’t many entry barriers that can protect you. If your suppliers are in this position, it may actually help you over the short term, but you really need to think, what is the competitive moat around your business as those suppliers move downstream, potentially into competing with you, as they struggle to earn some kind of return? If your inputs are all becoming commodities and you don’t have a lot of differentiating complimentary assets as part of your value chain, you will likely be impacted next.

To me it’s a tough challenge. As the tools get better and cheaper, it’s not enough to just crank out products with them. You have to add value in other ways, maybe with differentiating software or wrap-around services, or you have to move upstream to more complex systems or push the frontiers of what’s doable. You have to have a major part of your value-add in hard-to-replicate areas that require expertise or experience that you can’t just buy off the shelf in some advanced design or manufacturing tool. An industrial design firm was recently showing me some of the new software packages that can provide “good enough” design solutions—solutions that formerly constituted their bread and butter work. They have had to move up-market to more complex work that requires much more client hand-holding. This is a dangerous pattern—it’s Clay Christensen’s innovator’s dilemma.

It’s interesting to watch what Apple has done over the last decade. They formerly were heavy users of commodity products, often made by competitors. But they have shifted to designing more and more of their own microprocessors and ancillary silicon chips as well as unique, difficult-to-produce hardware. They recognized the commoditization and the dangers of being strictly assemblers of commodity parts. And, of course, their penultimate differentiation has been software. But, as Android software continues to improve, they are facing highly competent competitors like Huawei, Xiaomi, Oppo, and Vivo, who tap the power of the commodities marketplace. Interestingly, Huawei is starting to follow Apple’s path as well. Commoditization has a lot of benefits for consumers, but it’s really tough on manufacturers.

Post A Comment

In order to be published, comments must be on-topic and civil in tone, with no name calling or personal attacks. Your comment may be edited for clarity and length.