Chip Taylor

Manufacturing disintegration

Don Iannone notes Chrysler's new outsourcing arrangement:

Chrysler has a new eight-year agreement that has the potential to radically change the way Chrysler--and all automakers--build vehicles, finance their factories and manage labor. The main idea: Let others shoulder the capital and labor costs of building a car.

Rather than buy parts and the machinery to assemble them into vehicles, Chrysler will outsource 60% of the production responsibility for a new Jeep Wrangler--and many of the factory jobs--to its suppliers. Those companies will have to put up the capital for machinery and pay the workers. By enlisting suppliers as partners, Chrysler will shed one-third of the $900 million capital investment for the new Jeep factory.

The idea is based on the premise that when suppliers are left to themselves they will design, build and operate a factory more cheaply than their customers can. "If you ask them to do it for themselves, you'll be surprised how much the price comes down," says Chrysler Group Chief Executive Dieter Zetsche. It's the same reason a housing contractor is likely to design his own home with more care and for less money than he would charge others.

More details are in this Forbes article.

Don asks, "What does this really mean?"

He knows more than he's letting on, but I'll throw in my two cents worth.

1. On the surface, this is part of the continuing vertical disintegration of manufacturing. Producers are turning over larger and larger portions of the final product to suppliers. Yoram Barzel explains why producers want to do this. He uses, interestingly enough, the example of Chrysler's outsourcing of convertible conversions:

Chrysler could have operated very differently. It could have created a separate department or division to make convertibles. In that case, however, the head of the department owuld necessarily have been a Chrysler employee. Since employee pay is not strictly a function of performance, the incentive of the manager to economize would not have been as strong as that of the residual claimant to the conversion operation. Inducements such as bonuses and stock options would have helped but could not have resolved the problem fully.

So it's largely about creating performance incentives, just as Zetsche said.

2. I think technology makes this feasible on a larger and larger scale. I recently read an article about how computer-aided design has improved the assembly tolerances in airliners. The same sort of technology makes it easier for producers to manage joint production by many suppliers. Consequently, we'll see more and more of it.

The entire auto industry is moving to outsource bigger chunks of vehicles, but progress has been slow because of union opposition. General Motors is outsourcing the full interior for two upcoming sedans. BMW, Porsche and others have outsourced production of an entire vehicle to a manufacturer like Magna or Karmann.

3. Not only does it reduce costs on the outsourced portions, but in the long term it helps in negotiations with the union regarding work left in-house.

Union leaders, initially aghast at Chrysler's proposal to let suppliers run the body and paint shops, saw they had little choice but to listen. "You can't dismiss any idea that'll enable you to stay in business--especially when you're competing for jobs," says Mahaffey. "It was clear they were going to build [those vehicles] someplace else if we couldn't work out an agreement."

...

The union also agreed to let Chrysler outsource peripheral jobs like materials handling and janitorial services. Janitors earn about the same as assembly workers--$60,000 to $100,000 per year. Chrysler says the work could be outsourced for 20% of that.

4. Bottom line: A more competitive Chrysler.

Chrysler needs to somehow narrow the $750-per-vehicle cost gap between it and its Japanese rivals, a gap faced by General Motors and Ford, too.

That seems to me to be in the long-term interests of Chrysler, its employees, and the communities in which its plants are located.