Feature

posted 30 Jan 2007 in Volume 10 Issue 5

Knowledge transfer

Knowledge: to share or protect?

When companies outsource, they have to make a crucial decision that could affect profitability: what knowledge should they share and what should they protect?

By Graeme Burton

The name of Schwinn used to be synonymous with quality bicycles in the US. Robust, well-made and well-designed. It was an engineering-led company. So by the time it had decided to outsource production to a Taiwanese manufacturer, it was clear that the company had already lost its way.

Yet it still harboured substantial reserves of technical know-how about bike construction, knowledge that the company’s management clearly undervalued – if they valued it at all – when the decision to outsource was made.

It followed years of rising labour strife and a botched factory relocation from Chicago, Illinois to Greenville, Mississippi – undertaken in a bid to cut staff costs and to overcome a long-running dispute. But it proved a failure because the company struggled to find suitably skilled staff in the small city in that part of America’s deep south.

That should have provided a warning to the MBAs that had swept into the company in the 1980s with Edward Schwinn – the fourth-generation Schwinn to run the company – about the value of workers’ knowledge, but it didn’t. Its next step was to seek a partner in an even cheaper jurisdiction abroad to make the bicycles, to which it would slap on its high-class marque.

Engineers shuttled to and from Schwinn’s headquarters in Chicago to Taiwan to forge a new relationship with Giant Bicycles, providing not just the equipment to make the products, but also the technical know-how. Schwinn may have been struggling, but it still enjoyed a tremendous amount of corporate knowledge in making quality bicycles.

Initially, the relationship worked well. Its partner, Giant Bicycles, produced the bikes to a high standard and both Schwinn’s sales and profitability recovered.

But when the company sought a second source from a supplier in mainland China – it was, after all, risky to depend entirely on one manufacturing partner – Giant’s management felt betrayed. In response, it started making and selling bicycles direct to the US market, bikes built to the American company’s standards, but without Schwinn’s mark-up.

The company crumbled and never recovered, plunging into chapter 11 administration first in 1992, and later in 2001. Today, Schwinn is just one of the many brands of consumer products conglomerate Dorel Industries.

“They shut down the production plant in the US and sent all the equipment and engineers to Taiwan to teach Giant how to make bicycles to meet the quality standards in the US – and for free,” says Shih-Fen Chen, assistant professor of international business at the Richard Ivey School of Business at the University of Western Ontario in Canada.

Fairytales

The Schwinn story has almost become a business parable or folk story, a warning to others about the potential dangers of offshoring for the naïve, ignorant or unwary. What it really highlights is the critical importance of corporate knowledge – not just in terms of patents or raw, communicable knowledge, but the tacit know-how of staff in terms of what they do everyday and why they make a product or fulfil a service in a certain way.

When a company – especially a market leader – outsources the manufacturing of its products or the fulfilment of its services to another company in another jurisdiction, it may achieve a short-term financial boost, but it also takes a range of other risks that need to be acknowledged and managed.

Many of these risks are subjective, hard to quantify and ultimately under-estimated compared to the hard financial savings that the chief financial officer can present to support such a move. Furthermore, a transfer of knowledge to the new partner is essential if the relationship is to work – the outsourced manufacturer can scarcely make the products to the required standard unless there is a concomitant transfer of the know-how behind it.

However, there is rarely an individual of sufficient stature among most companies’ senior management – a chief knowledge officer, for example – to speak out in defence of a company’s knowledge, to sound the warning and ensure that the move is also considered from a knowledge perspective, as much as a financial one.

That was one of the conclusions of a joint study by Eindhoven University of Technology and KM consultancy Squarewise. The responsibility for safeguarding corporate knowledge in such a move is more commonly fragmented between the chief technology officer, a legal officer, human-resources director and/or an innovation manager.

Not only is it frequently a secondary consideration for people in these roles, but they are rarely trained or briefed to consider the value of an organisation’s knowledge and intellectual property from a strategic perspective.

“Although they might be investing millions, very often there’s no one there whose prime responsibility is to look after the know-how of the company,” warns Squarewise partner Arno Boersma.

Such warnings do not just apply to Western companies looking to outsource to China, Taiwan, Vietnam or Thailand, but also to a lesser extent to companies in Asia looking to expand into the US and Europe (especially Eastern Europe, for lower-cost labour combined with access to the rich European Union market).

This has been recognised by Chinese computer maker Lenovo, following its purchase of IBM’s PC division. “It has recently appointed many Western executives who were running the Asian business for Dell,” says Boersma. The idea is to acquire their know-how to help Lenovo maintain the position in Western PC markets inherited with its IBM PC acquisition.

The American way

While the Harvard Business Review is arguably the most widely read business periodical in the world and American business schools litter the globe, it would be a mistake to think that US-derived business practices are observed globally.

Indeed, in terms of establishing business relationships in China, both Chen and Boersma believe that European companies (and executives) may have the edge because of a more people-centric business culture.

The Dutch approach – which Boersma is naturally most familiar with – is highly consensus oriented (even if people have a tendency to talk too much, he suggests). “People try and find a common ground. The more people-driven approach works best in China because relationships are such a big part of the culture,” he says.

Such relationships can also cut across corporate boundaries. That can aid knowledge sharing, but also increases the risk of ‘knowledge leakage’ because the concept of intellectual-property rights is very much weaker. “Knowledge and intellectual property in many Asian countries are considered a public good, but in Western society it’s considered private property. That is a big difference,” says Chen.

“Each time I go back to Taiwan, or to China, to deliver a lecture they will sometimes, without asking, set up video-taping equipment in the room. I need to tell them, ‘Take it away. I came here, based on the compensation, to deliver the lecture, rather than the reproduction rights’,” he adds.

Such cultural differences therefore need to be considered carefully before an organisation, for example, outsources the production of a high-tech product – not just to China, but anywhere in the world if the product has a high potential value. A strategy for protecting that knowledge then needs to be worked out.

Organisations need to ask themselves two questions, says Chen. First, how strong – realistically – is the company’s brand? Sportswear manufacturer Nike has outsourced for years, very successfully, and it can do so because of the strength of its brand.

Second, how fast-moving is either the design or the technology? In the sports-shoe market, designs change annually, perhaps faster and, as the market leader, Nike also sets the standards that others follow.

“If your company’s technology is mature, you are not updating the technology to counter competitors and you don’t have a strong brand name to protect your market, you will get into trouble sooner or later,” warns Chen.

Again, for Nike, the sports-shoe market changes annually, perhaps faster, and it can also protect its own proprietary technology or know-how by, for example, manufacturing key parts, such as a shoe’s innovative sole, in its factories and simply have its outsourced manufacturer assemble the shoe around them.

Local culture

Of course, the risks of ‘knowledge leakage’ are very much less if the organisation is moving production to a wholly-owned factory or subsidiary, instead of outsourcing, but this will present a whole new set of challenges.

“One senior manager wrote to me to tell me that in his company, every time it sent someone [who was invariably male] overseas to manage a subsidiary, he ended up divorcing his wife and marrying a younger, local girl,” says Chen.

That’s often the least of any organisation’s worries when cultural standards are misunderstood by management on the ground.

Japanese car-maker Mitsubishi catastrophically misjudged a claim for sexual discrimination at its plant in Illinois when it sacked the women who had made the original complaint – sparking the biggest sex discrimination case ever in US corporate history.

At one point, the Japanese manager of the car-factory became so incensed that he closed down the plant for one day and hired a fleet of buses to take all the staff to the state capital to protest at the action – dramatically escalating the confrontation, rather than contributing to a solution.

“In Japan you have a much bigger gender gap and sexual harassment in the workplace is not such a big deal. In the US, it is,” says Chen. “Even today, you can see this big gap in culture. So sending a manager to a foreign country to manage the operations, you just don’t know what trouble you could get into.”

Mitsubishi had to fly in a manager from Tokyo experienced in running car-plants overseas to clear up the mess. In the meantime, Mitsubishi sales in the US plunged as the story went nationwide.

That is why so many companies choose to outsource instead – it is simply easier and the financial costs and risks are much lower.

Grand designs

For many companies operating in commodity markets, there is little they can do. They lack the financial muscle and know-how to establish an overseas subsidiary, so need to outsource to remain competitive. But if the company has any special knowledge there is always a risk that it is only training its future competitors. Samsung, for example, used to make televisions for Sony. Today, it is the biggest television manufacturer in the world.

Former Pfizer chief learning officer Victor Newman, now an independent consultant, echoes Chen’s strategy: if there is a high-tech or proprietary element within an outsourced manufactured product, can it be manufactured separately, so that there is no transfer of knowledge required over how it is made?

Such a strategy needs to be carefully thought through. It was, for example, tried by IBM in the design of the PC in 1980, points out Newman. Almost every element of it was outsourced – quite contrary to the traditional IBM way – including the microprocessor and operating system.

IBM’s marketing strategists reasoned that they could retain control by simply designing, building and protecting the basic input-output system (BIOS) that dictates how the various parts in the PC interact with each other. What they did not realise was how easily this one part could be reverse-engineered and cloned. The first IBM PC appeared in September 1981 and the first clone, the MPC 1600, was released in June 1982. In other words, it is a strategy that can be easily and quickly undermined.

But for a company even as big and as well-known as Schneider Electric, the knowledge aspect is secondary to the need to manufacture at the lowest possible cost in order to remain competitive in the global marketplace in which it operates, believes Martin Dugage, knowledge-management director at Schneider Electric.

The reason is that so many of Schneider’s products are in commodity markets. “Most of our products are relatively straightforward. [They are based on technology] that has been round quite a while. We do have some advanced, high-end products, but manufacturing of these is not usually transferred,” says Dugage.

For Schneider, therefore, one of the biggest knowledge-transfer challenges is not ‘knowledge leakage’ but how to transfer the know-how behind its manufacturing best-practice when it moves manufacturing from a site in Europe or the US to South-East or East Asia.

“When we ramp up the system over there, then we realise that a lot of good practice and knowledge has been lost in the process,” says Dugage. This includes much of the tacit knowledge that a workforce builds up over many years making a product – know-how that has to be learnt all over again by new workers elsewhere.

Indeed, given the perishable nature of knowledge – today’s high-tech gadget is tomorrow’s commodity product – it is arguably this aspect of knowledge transfer, when product manufacturing is outsourced, that deserves as much attention as the more closely examined risk of knowledge leakage.

Graeme Burton is managing editor of Inside Knowledge and can be contacted by e-mailing, gburton@ark-group.com.