When a Supplier Becomes a Competitor
For decades, companies have resorted to outsourcing in various industries. However recently, the trend has been taking new guises, going beyond the purchase of individual components offshore. In many industries, firms use suppliers for entire product lines, which they then market under their own brands. For instance, over the last decade, cell phone makers have been outsourcing manufacturing activities by signing Original Equipment Manufacturing (OEM) agreements, and in a growing number of cases, also design functions with Original Design Manufacturing (ODM) agreements. Apple selects suppliers for components such as displays, microprocessors and hard drives, and relies on OEM (in particular, the partnership with Hon Hai Precision) for assembling iPhones. Motorola has gone further, by deciding to outsource design, too.
We are also witnessing outsourcing agreements concerning services. For example, when Arca decided to shift from mechanical to chemical assembly to assemble its trailers (by employing an innovative 3M glue), it showed that outsourcing is not only about purchasing parts but also about buying solutions. A key component of the agreement are the consulting services on the production process that 3M provides Arca, helping the company optimize the input of glue while at same time obtaining a safe and durable product.
These trends in outsourcing respond to pressures in the competitive environment. For cell phones, these trends started in the early 2000s, in reaction to excess capacity engendered by the business downturn. The diffusion of the solutions business in outsourcing in addition to production is motivated, on the suppliers' side, by the need to differentiate and customize sales, and on the clients', the search for suppliers better able to support them in their business objectives amid increasingly fierce competition.
However, over time outsourcing in response to competitive challenges can generate its own competitive threat. Several OEM and ODM cell phone suppliers have set up their own branded product lines, sometimes on local markets (e.g. Amoi in China), in other instances by turning into global competitors, like HTC and Huawei have done, and becoming serious threats for established players. The purchase of manufacturing solutions increases the exchange of information and thus the possibility of adverse spillovers creating new entrants. How can companies see off these competitive threats?
Outsourcers usually resort to non-disclosure agreements, such as the contract clauses obliging 3M not to reveal information concerning the Arc production process, thus defending its competitive advantage in manufacturing vis-à-vis business rivals. Beyond legal enforcement, there is also an incentive for discretion, since it is a necessary condition for 3M to develop new business opportunities with Arca, as well as maintain credibility with potential clients.
Marketing also plays a critical role in the staving off the implicit competitive threat raised by the new forms of outsourcing. Customer firms which have prevented OEM and ODM from accessing knowledge about their customer base (i.e. end consumers of smartphones) have weakened the competitive strength of the rival branded products launched by their outsourcees. Typically, outsourcers that are market-oriented and have superior marketing skills are in a better position to protect their market knowledge from nosy suppliers. Also, brand & customer loyalty programs that are launched by market incumbents shield the outsourcer from loss of market share due to consumers shifting their preferences towards rival products launched by suppliers.