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 / Winter 2009 / Issue 57(originally published by Booz & Company)


An Essential Step for Corporate Strategy

More recently, at its formation in the mid-1990s, Inc. went against the general trend of outsourcing and the dominant pattern among Internet retailing startups by building a vertically integrated network of fulfillment centers that would assemble and ship the orders customers submitted over the Web. Amazon invented and continues to perfect the operating model for Internet fulfillment, and it knew that outsourcing would put its competitive advantage at risk. “We would be the teacher and then they would offer those services to our competitors,” explained a senior operations executive in the early days. 

2. Facility capacity. Assuming a company envisions a sufficient competitive advantage from some degree of vertical integration, the specifications for the facility come to the forefront. Should a company aggressively build capacity ahead of demand or take a more conservative path of adding capacity only in smaller increments and only when market uncertainty subsides? Consider the example of Copeland in 1987. Then a division of Emerson Electric Company, Copeland introduced the scroll compressor, a fundamentally new design concept for initial application in residential air conditioning. The company built capacity ahead of demand and even continued with a capacity expansion in 1989 despite initial demand that fell short of forecasts. Management was convinced — correctly, as history showed — that new regulatory efficiency standards would favor the new technology, and it created a competitive advantage that it retains today. Today, the scroll technology dominates the market; Copeland’s design leads the industry, and Copeland maintains unmatched scale economies.

3. Facility location. Choosing where to site facilities also requires trade-offs in designing the operations footprint, regardless of whether the facility is in-house or outsourced. Inditex (the Spanish clothing company better known by its leading brand, Zara) maintains scale-intensive pattern-cutting operations in-house and subcontracts the labor-intensive sewing to small mom-and-pop facilities in the surrounding region. Most fashion retailers outsource cut-and-sew operations to Asia to tap into low labor costs, but they face long supply chains requiring early design decisions and advanced volume commitments. Inditex’s more responsive supply chain fits its strategy: In-house cutting offers enhanced control and helps offset some of the labor-cost disadvantage of the geographic location of its sewing plants.

Plant location decisions must also balance intellectual property risk and the cost of transportation. Accordingly, the Intel Corporation builds most of its high-tech wafer fabrication facilities in the developed world to protect its intellectual property, and Chinese appliance maker Haier Group built a refrigerator plant in South Carolina to avoid the prohibitive cost of shipping big refrigerators across the Pacific to the U.S. market.

4. Process technology. Finally, the structural footprint decision should address the process technology used in the facility. Again, consider the case of Copeland’s scroll compressors. A dozen years after the introduction of its new design, Copeland felt compelled to add a Chinese plant to its operations footprint: Many competitors were producing in China by then, and the labor-cost advantage of the region could offset some of Copeland’s scale advantage. Accordingly, Emerson opened a new scroll compressor plant in Suzhou in 2000. But Copeland made distinctly different decisions regarding process technology at this new plant. Concerns over intellectual property protection, for example, led the company to exclude proprietary process technology and import the critical scroll plates from its U.S. plants. 

Operations Capabilities

Although the structure of a company’s operations footprint represents a critical set of strategic decisions, management also needs to focus attention on the use of operations activities to build distinctive, strategically relevant capabilities. Porter properly dismissed the pursuit of operational effectiveness without a clear linkage to the company’s competitive differentiation, but he underestimated the importance of building these capabilities.

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