Fearing R&D's Flight

Opposing Strategies

The dilemma that results from separating manufacturing from R&D is not confined to the semiconductor sector. It reaches across the full range of U.S. industry, notes economist Joel Popkin in his new study for NAM. His research "Securing America's Future: The Case for a Strong Manufacturing Base" identifies manufacturing as a significant key to innovation at all levels.

Popkin states that "manufacturers' investment in physical and human capital, R&D and productivity are intertwined and together provide substantial economic benefits. This is the method by which innovations become an integral part of the economic process and lead to widespread improvements in productivity."

Actually the benefits are far greater than what productivity might imply, says John A. McFarland, president and CEO, Baldor Electric Co., Fort Smith, Ark. McFarland, whose mantra is "I don't want to sell Chinese motors to my customers," passionately believes that separating research and product development from manufacturing does customers an injustice in terms of product value and service. (He claims the shortest lead times in the industry.)

His argument: "When you go to China, India or wherever, why are you going? You're going to achieve one thing -- a better cost. However the customer does not make his decision to buy based strictly on cost. Customers are also interested in other product attributes. These include quality, performance, availability plus a lot of other issues that don't get resolved by outsourcing manufacturing."

McFarland maintains that the lower pricing might be one -- but not all -- of the significant factors in any buying decision. "We believe that we can satisfy the other three-fourths by producing the products where customers, research and development, and manufacturing can easily and quickly interact. Being price competitive can be resolved with R&D, product development, employee training and investments in automation equipment." He says the greatest product cost improvements at Baldor have been made through R&D improving the product design.

McFarland sees time and product variety as two emerging issues in the marketing of industrial products. He asks: "How do you offer more product variety and simultaneously improve the time issue by moving the manufacturing site thousands of miles from the R&D function? At Baldor the R&D function sits right next door to the plant. We can design a new motor in the morning, test it in the afternoon and have it in production the following day. With globalization, it is very tempting to think that long production runs of a small number of products will satisfy the market. That's not the way our customers buy."

Popkin's research emphasizes that manufacturers invent the future by closely integrating R&D with manufacturing. He says manufacturers are responsible for almost two-thirds of all private sector R&D -- $127 billion in 2002. Spillovers from this R&D benefit other manufacturers and non-manufacturing firms because, Popkin explains, they are magnified by geographic proximity, enabling innovation in one area to freely stimulate products and processes in other areas.

Popkin's study warns that if the U.S. manufacturing base continues to shrink at its present rate, and the critical mass is lost, the manufacturing innovation process will shift to other global centers.

Steve Goldman views his new fabless semiconductor business model as passionately as Baldor's McFarland views servicing his customers with U.S.-made products. Both see faster economic gains with their approaches. The difference is that Goldman doesn't share McFarland's insistence on keeping R&D and manufacturing united in the U.S.

Chairman and CEO of Power-One Inc., Camarillo, Calif., Goldman is convinced that by going fabless for a new product line, he is gaining value for all his corporate constituencies.

His company, one of the 10 largest power conversion equipment vendors, is ranked in the S&P 500. The company's whole focus is on powering the communications and technology infrastructure -- everything from small networking equipment to cell stations and optical backbone. It has sales, manufacturing and R&D spread across China, the Dominican Republic, Ireland, Norway, Slovakia, Switzerland and the U.S.

Goldman says his company's maXyz (pronounced max-sys) product, on which patents are pending, differentiates Power-One by placing it in the silicon-based power conversion and management market. The device, the size of a contact lens, is a power unit for telecommunications and replaces conventional circuit-board-mounted electronic components. While maXyz is being outsourced, the product nonetheless represents the biggest R&D initiative in the company's 30-year history. The R&D investment represents almost 17% of sales in an industry where 4%-5% is traditional.

Goldman describes the maXyz R&D initiative as a strategy for uniquely repositioning the company for accelerated success as the economy recovers. "Our mission was to use our R&D initiative to change the [competitive] playing field." As a result of bringing in new technology Goldman says all of his traditional competitors are no longer a business factor for the maXyz line. "Our new competitors are semiconductor companies."

He fervently believes that the R&D initiative is the fundamental component for Power-One's business strategy. "We began our investment at the right time, with the right technology, looking not too far ahead and not too close."

To make sure technology is the answer meant Power-One had to use maXyz to depart from the industry norm of being an assembler and integrator of the intellectual property of other companies. "With maXyz we will no longer buy silicon chips and components from big corporations and integrate them on a circuit board to provide a total solution for the customer."

Why change?

"The profit margin wasn't there. The people making the real money are those supplying those components, who were developing intellectual property (IP) and patents with 45%-60% gross margins. We were achieving 40% gross margins at best, but now with our own IP we can raise that to 50% plus. The industry norm is about 25%. So instead of being an IP aggregator, we're evolving as an IP generator. In innovating maXyz we've developed more patents in the last 12 months than in the last 25 years."

The differing approaches of Goldman and McFarland raise three critical questions for U.S. manufacturers:

• Can U.S. companies retain high-technology manufacturing preeminence without maintaining strong U.S. ties to both R&D and production?
• Can U.S. companies justify and retain U.S. production capacity in spite of startling disparities in global wages?
• What, if anything, should the U.S. government do to ensure an innovative manufacturing economy remains strong in the U.S.?

How U.S. manufacturing executives answer those questions will shape America's future as a nation. Vannevar Bush's call for leadership in science is as important today as it was more than a half century ago.