The Modular Organization

by Gregory G. Dess and Joseph C. Picken

As Charles Handy, the author of “The Age of Unreason“, has noted:

“Organizations have realized that, while it may be convenient to have everyone around all the time, having all of your workforce's time at your command is an extravagant way of marshalling the necessary resources. It is cheaper to keep them outside the organization, employed by themselves or by specialist contracts, and to buy their services when you need them.“

To capture Handy's vision, the modular organization type outsources non-vital functions, tapping into the knowledge and expertise of best-in-class suppliers of goods and services, but retains full strategic control. Outsiders may be used to manufacture parts, handle logistics, or perform accounting activities. The organization is actually a central hub surrounded by networks of outside suppliers and specialists, and parts can be easily added or taken away. Both manufacturing and service units may be modular.

The Shift to Modularization

In the personal computer industry, the shift to the modular structure has been pioneered by relative newcomers like Dell, Gateway, and CompuAdd, as well as by workstation innovators like Sun Microsystems. These companies either buy their products ready-made or purchase all the parts from suppliers and perform only the final assembly. Their large, established competitors-IBM, Hewlett-Packard, and Digital Equipment-produce most of their parts in-house. As a result, the smaller modular companies typically outperform their older rivals in profitability.

Michael Dell, founder and CEO of Dell Computer, points out some of the advantages of the outsourcing strategy that made the company the top performer in the S&P 500 in 1997:

“There are fewer things to manage, fewer things to go wrong. You don't have the drag effect of taking 50,000 people with you. Suppose we have two suppliers building monitors for us, and one of them loses its edge. It's a lot easier for us to get more capacity from the remaining supplier than to set up a new manufacturing plant ourselves. If we had to build our own factories for every single component of the system, growing at 57 percent per year just would not be possible. I would spent 500 percent of my time interviewing prospective vice presidents because the company would not have 15,000 employees but 80,000.

“Indirectly, we employ something like that many people today. There are, for example, 10,000 service technicians in the field who service our products, but only a small number of them work for us. They're contracted with other firms. But ask the customer, 'Who was that person who just fixed your computer?' The vast majority think that person works for us, which is just great. That's part of virtual integration.“

How much can a company outsource and still remain competitive? The example of Monorail, a successful new entrant in the hotly contested personal computer industry, illustrates how outsourcing virtually all value-producing activities can be a viable competitive strategy.

The Case of Monorail

Sleek, black and beautiful, Monorail PCs take up only 20 percent of the space needed by most of the other personal computers sold today. Cutting-edge technology, striking design, and low cost have boosted Monorail's sales in three short years from a start-up company to the 14th largest PC maker in the world. CEO Douglas Johns wants Monorail to achieve $2 billion in sales by 2003. Monorail's success results from its lean structure; the company outsources everything but management, product design, marketing, and logistics.

Take a typical order. Monorail sells through CompUSA. When an order arrives, FedEx is electronically notified to deliver parts to contract manufacturers, which assemble the final product and ship it to CompUSA within two to four business days. Meanwhile, the invoice is electronically routed to SunBank's credit and billing department. SunBank then factors Monorail's invoices, quickly remitting cash to the company. Should the customer have a question, a call center in Tampa provides Monorail's 800 customer support.

Letting go of core competencies could be a recipe for disaster, but it works for Monorail. Its secret? Ask Monorail executives what they believe to be their core competencies, and they'll give you a list of just two: management expertise and partnership development. Monorail understands the importance of close ties to suppliers. Its veteran management team has considerable experience in identifying and partnering with suppliers. Monorail develops mutually beneficial relationships with its suppliers and keeps the needs of its partners in mind when it designs its products. Consider shipping. Monorail contracts with FedEx to provide shipping and inventory management, just as most direct mail resellers do. But Monorail partnered early with FedEx, and asked the critical question: What computer design works best for FedEx to handle? The solution? Design the PC to fit into a standard FedEx shipping box, thus driving down handling problems and costs. Designing for logistics rewards Monorail with some of the lowest shipping costs in the business.

Monorail's relationships with other partners work the same way. Here, too, the question is: How can we best leverage the talents of our suppliers? Not surprisingly, Monorail finds no shortage of potential partner prospects. Suppliers understand that the skills and knowledge they learn from partnering with Monorail can be applied to other ventures. Meanwhile, Monorail enjoys the flexibility of outsourcing and the benefits of tightly cohesive partner relationships.

Focus on Core Competencies

Apparel is another industry in which the modular type has been widely adopted. Nike and Reebok have succeeded by concentrating on their strengths: designing and marketing high-tech, fashionable footwear. Nike has very limited production facilities, and Reebok owns no plants. These two companies contract virtually all their footwear production to suppliers in Taiwan, South Korea, and other low-cost-labor countries. Avoiding large investments in fixed assets helps them derive large profits on minor sales increases. By being modular, Nike and Reebok can keep pace with changing tastes in the marketplace because their suppliers have become expert at rapidly retooling for the manufacture of new products.

In a modular company, outsourcing the noncore functions offers three advantages: First, it can decrease overall costs, quicken new product development by hiring suppliers (whose talent may be superior to that of in-house personnel), avoid idle capacity, realize inventory savings, and avoid becoming locked into a particular technology. Second, outsourcing enables a company to focus scarce resources on the areas where it holds a competitive advantage. These benefits can translate into more funding for research and development, hiring the best engineers, and providing continual training for sales and service staff. Finally, by enabling an organization to tap into the knowledge and expertise of its specialized supply chain partners, it adds critical skills and accelerates organizational learning.

The modular type enables a company to leverage relatively small amounts of capital and a small management team to achieve seemingly unattainable strategic objectives. Freed from the need to make big investments in fixed assets, the modular company can achieve rapid growth. Certain preconditions must exist or be created, however, before the approach can be successful. First, the company must work closely with suppliers to ensure that the interests of each party are being fulfilled. Companies need to find loyal, reliable vendors that can be trusted with trade secrets. They also need assurances that suppliers will dedicate their financial, physical, and human resources to satisfy strategic objectives such as lowering costs or being first to market. Second, the modular company must make sure that it chooses the right competence to keep in-house. An organization must be wary of outsourcing critical components of its business that may compromise long-term competitive advantages.

Organizations applying the modular concept must develop a strategic plan that identifies core competencies and areas that are important for future development, and then attempt to outsource noncritical functions. For Nike and Reebok, the core competencies are design and marketing, not shoe manufacturing. For Honda, the core competence is engine technology. These companies are unlikely to outsource any activity that involves their core competence.

Becoming “Hollow“

While adopting the modular form clearly has some advantages, managers must also weigh its advantages. For example, mindless outsourcing in the pursuit of temporary cost advantages can lead to firms' becoming “hollow“ and losing their competitive advantage. The world leader in the bicycle business for almost a century, Schwinn, filed for bankruptcy after it outsourced most of its production in response to a labor strike. Schwinn's demise can be traced to its inability to protect its technology, its failure to establish global brand equity, its lack of innovation, and severe labor-management problems. Instead of addressing these basic problems, Schwinn responded with a poorly devised strategy rooted in its inability to keep high-value activities in house, failure to invest in core competencies, and preoccupation with short-term cost control instead of viewing outsourcing as a strategic weapon to improve its competitive position.

Gregory G. Dess holds the Carol Martin Gatton endowed Chair in Leadership and Strategic Management in the University of Kentucky. Joseph C. Picken is president of Joseph C. Picken and Associates, a management consulting firm. This article is excerpted, by permission of the publisher, from Beyond Productivity: How Leading Companies Achieve Superior Performance by Leveraging Their Human Capital by Gregory G. Dess and Joseph C. Picken. Copyright 1999, Gregory G. Dess and Joseph C. Picken. Published by AMACOM, a division of American Management Association.