Ramchandran Jaikumar and David M. Upton

Go to start of paper

Table of Contents

Appears in "Globalization, Technology and Competition: The Fusion of Computers and Telecommunications", Edited by Stephen P. Bradley, Jerry A. Hausman and Richard L. Nolan, Harvard Business School Press, Boston, MA., 1993.

Graduate School of Business Administration,
Harvard University, Boston, MA 02163
Production capacity is now sufficiently flexible in some industries, to be viewed as a commodity. Technological change has raised the prospect of global markets for a variety of types of flexible manufacturing capacity. This paper outlines technological and commercial conditions under which markets for flexible manufacturing capacity are likely to arise, describes an industry in which a capacity market exists, and explores desiderata for such markets.


Conditions for Global Commodity Capacity Markets

Important changes in manufacturing technology have occurred in many industries. Machines for many processes are now very flexible, in that they may be programmed to perform a wide variety of manufacturing tasks and are able to accommodate diverse product characteristics while providing both high quality and low cost. Although the products manufactured by such technology are highly differentiated, the broad diffusion and standardization of the technology has made productive capacity comparatively common and indistinguishable. Indeed, for many highly differentiated products (metal-machined parts or socks for example), the precise source of the product is becoming much less relevant since the technology of production allows consistent quality and cost performance regardless of source. This suggests a novel situation --- one in which flexible capacity may be seen as a commodity --- inasmuch as units of flexible capacity are comparatively lacking in distinguishing qualities. The large number of product variations which such capacity may effectively produce mean that the primary input for the process is information, in the form of a well-codified, often computer readable product descriptions. Advances in global telecommunication mean that such information may be effortlessly transmitted between customer and source, making the precise location of the manufacturer progressively less relevant.

Diffusion of the supporting manufacturing technology to an ever-growing range of processes, along with advances in telecommunication have had far-reaching consequences, from the shop-floor to the global structure of industries. We are seeing fundamental change in such basic elements of production as firm size, the nature and form of product and process specifications, transaction processing, and labor.


Factory Size

Why should factories be large? Companies have traditionally collected the machinery of production into large factories for two reasons:


Technological economies of scale have never been strong in industries that produce highly differentiated products: machines in such industries are gathered together primarily to share overhead costs. With the new technologies, even this source of pressure to aggregate has been greatly relieved.

 Today's machines are highly reliable and require very little maintenance. What little is needed may be performed by operators. Because machining processes are under programmable computer control and are, in general, well understood and predictable, machines produce good quality output time after time, eliminating the need for separate quality departments to weed out defects. Finally, technological solutions make overhead due to information and material flow very small, regardless of the size of the operation. Minimum efficient scale for a modern manufacturing operation in many industries is a manufacturing cell of about six machines and fewer than a dozen people. Such a cell functions as a factory within a factory, effecting an entire production process under computer control, often including materials handling and inspection.


Product and Process Specifications

With computer-based manufacturing technologies, product and process specifications exist as computational procedures developed on specialized computer-aided design (CAD) systems. These procedures are transportable, via standardized telecommunication links, to the machine controllers that govern the manufacturing process. Moreover, to the extent that the people who write them are able to anticipate and solve every possible contingency, these procedures guarantee precise reproducibility, that is, every part made by any machine running a particular procedure will be exactly the same. These two characteristics of modern product and process descriptions---transportability and precise reproducibility---reduce the need in many industries to collocate engineering and design with manufacturing, except for pilot production. The standardization and predictability of the link between design and manufacturing weakens traditional dogma that insists that design engineers be on hand during volume manufacturing, to make design trade-offs as manufacturing problems occur. Technologies in many industries have solved this problem at its root---by anticipating and eliminating such problems systematically rather than on an ad hoc basis, allowing engineers to be absent from volume production and rendering the location of volume manufacturing less relevant. Indeed, manufacturing units need not necessarily even have their own engineering functions; in the context that is evolving, engineering and design can be effectively supplied by physically and functionally distinct organizations.


Transaction Processing

A certain economy of scale to which firms do have access in the new manufacturing context is through sales and distribution. With the right communication links, one marketing department can today serve the world.

 Figure 1 Traditional Firm to Market Scenario.


The traditional firm to market scenario is depicted in Figure 1, the electronic marketplace in Figure 2.

 Figure 2 Electronic Marketplace


In the latter, we envision direct links between individual facilities of a firm and the buyers of their products. Contracts in the electronic marketplace would likely be many and small, and the market system would learn through repeated transactions, enabling it, over time, to arrange almost universally ideal contracts. The speed of the system would be such that contracts would be renegotiated dynamically in the case of non-fulfillment, utilizing surge capacity among the manufacturers. Such a system minimizes transaction costs by effectively automating transactions. The telecommunications basis for such a system exists. All that is required is sufficient speed and memory, and reliability. If the memory is structured well, the market functions could be performed without human participation.


The existence of standard flexible technologies has decreased the need for firm-specific training. A number of industries may now draw from a pool of labor whose skill level is lower and more homogeneous. This, in turn, means lower costs for centralized training and personnel functions. For example, with standardized CNC machine tool technology, a person trained in CNC milling may very quickly learn CNC turning.



Collectively, these factors serve to substantially de-emphasize economies of scale and reduce absolute cost outlay at the plant level. Manufacturing concerns can now establish small, independent cells that operate effectively and economically with only a modest capital investment. Moreover, these small units of flexible capacity can be physically and organizationally separate from design, marketing, and engineering. Small minimum efficient scale, low capital requirement, and separability of volume manufacturing operations, by effectively lowering entry barriers, ensures the prospect of ample players in a market for flexible capacity.

Advantages of a capacity market.

There are a number of distinct advantages to organizing an industry's manufacturing network so that providers of flexible capacity compete, among them the following:

Commercial conditions.

The factors listed above will be most beneficial when demand is highly uncertain, the managerial costs of coordinating proprietary capacity are high, and transactions are small and great in number. Provided the technological conditions described above prevail, we would expect to see markets for flexible capacity develop in industries that face such commercial conditions.

An Example: The Disintegration of the Textile Industry in Prato

Dating from the 14th century, the textile industry in Prato, Italy has for centuries been the economic backbone of the Florence and Pistoia regions. Once, armies of artisans carded and dyed, spun and weaved. But with the technological changes that precipitated the Industrial Revolution, which brought increased economies of scale to the industry, firms grew in size and vertically integrated so as to be able to schedule and balance capacity in these various process steps. Because starving assets of input materials incurred substantial penalties, given the heavy required investment in production technology, great advantage accrued to coordinating the process steps directly to avoid such circumstances. Production equipment for the various process steps was collocated to facilitate coordination and the quick resolution of inter-process problems, and central marketing and design departments were maintained on site to work with production and match customers to production capacity and capabilities.


Rediscovery of Small Economic Scale

Most Prato mills were integrated in this way in the early 1970s, with fiber production, dyeing, spinning, and weaving performed within the same company. But many of these companies had progressively become unprofitable. Lower market prices, global competition, and rising internal costs had gnawed margins to the bone. Meanwhile, new dyeing and finishing techniques were becoming available and the market was demanding an ever-broader range of products from these new methods.

 Some mill owners recognized that their integrated mills were an encumbrance in the new regime. The processes had become so well understood, and hence specifiable, that the various steps were largely independent of one another, yet the flexibility of the individual processes remained constrained by the particular output of the upstream, and requirements of the downstream steps. Capacity, such as weaving or spinning, had become cheaper and economical in much smaller units, eroding economies of scale. The increasing overhead burden and need to effectively coordinate production of the broader product ranges and take advantage of new-found flexibility in each of the process steps led firms to look very closely at the manufacturing structure that had been the industry paradigm for a century. In the face of extinction, firms began to change.

 Many mills followed the example of the Menichetti family, which broke its mill into eight separate companies, one a realty company that leased space and services to the rest. As much as 50% of the stock in these companies, financed through profits, was transferred to employees. To ensure competitiveness, Menichetti insisted that each company find 50% of existing business outside the original business. At the same time, he established a New York-based marketing company to create new designs and match product with the best producer. This company was to provide no more than 30% of the business of any company in the Menichetti fold.

 Within three years, all units of the disintegrated Menichetti mill were running at 90% utilization, product variety had increased ten-fold, average in-process inventory been reduced from 4 months to 15 days, and attrition had reduced the labor force by a third while production had risen by 25% (largely due to the satellite firms investing in new technology). By 1980, all but one of the Prato mills had undergone similar disintegration, turning a sluggish, threatened industry into a thriving community of innovative, flexible companies, each a world class competitor. This process continued throughout the value chain (see Figure 3).


 Figure 3 Firms in the Prato Network by 1975


The predicament of textiles, which found itself on the brink of an important, global change, is by no means unique. Disintegration may have progressed further in textiles than in other industries, but the conditions outlined at the beginning of this chapter apply to a growing enclave of industries. Very similar circumstances prevail in small-batch metal machining, for example, with the flexibility of the machining cell and its small economic scale.1 But the lack of standardization of part programs, some remaining machine-tool specialization, and the indifference of machine-tool producers to small manufacturers have so far prevented the production of part-programmed machined products from following the example of textiles.2


Network Coordination and the Modern-day Impannatori3

The key to the success of the Prato system lays in the role of the modern-day impannatori. A throwback to medieval times, these agents provide central brokerage for the firms in the network, of which there are now between 15 and 20 thousand employing some 70,000 people. Today, several hundred such brokers draw from a hierarchical network of these thousands of suppliers. Brokers' thorough knowledge of the capacity, capability, and loading of each of the producers loosely collected in their folds enables them to source production for customers, find customers for spare production capacity, and intermediate in the negotiation process.

Effective management of this complex information set, coupled with trustworthiness and honesty, are the hallmarks of the successful impannatori. Indeed, it is this trustworthiness that avoids the problem that result from contracts that are difficult to specify---the trust ensures that what is needed is provided without the need for legal specification. Many specifications are thus based on a tacit understanding of industry standards. The complexity of the capacity assignment problem is rendered manageable by the autonomy of the various actors in the system, who are able to concentrate on being effective in their specialties while contributing to the performance of the network as a whole. Assignments of capacity are made through the market mechanism and the impannatori, enabling the system to avail itself of the most appropriate vendor and thus the full flexibility of the market for each element in the value chain.


Globalization and Communication

Among the technological changes dramatically expanding and changing the textile industry is codification. Today, cloth required by the world market may be uniquely specified with a code of 50 digits. Computer-aided design systems permit rapid local prototyping of a fabric before sourcing to a volume producer. Most importantly, computers facilitate an electronic marketplace in which the complexity of the production hierarchy can be "managed." Global telecommunications and continued disintegration suggest the possibility of trading options on both products and production capacity. For example, a fashion manufacturer uncertain of the season's demand for a currently imprecisely-specified product may ensure against a lack of supply by buying an option on the use of flexible capacity. Today, at least towards the end of the value chain, it is capacity, not product, that is a commodity. Units of flexible capacity are now relatively indistinguishable from one another and have the capability of producing myriad products. The products themselves, characterized by variety and customization to a particular fashion, and not at all commodity-like.


Manufacturing and Negotiation

Integration of advanced telecommunications and information systems holds promise for automating more fully the negotiation process in the Prato textile industry by speeding information flows and allowing requirements to be matched more quickly to supply. The extreme complexity of information flows, given the plurality of operators acting at different hierarchical levels (the top level comprising hundreds of Impannatori splitting control to thousands of suppliers and manufacturers), makes control of an automated negotiation system highly strategic. Such a system would be capable of integrating single elements of the network, support real-time monitoring of the entire negotiation process and its related services, and provide the necessary control to achieve optimization. It would enable the artisans and subcontractors, the largest group in the Prato system, to "see" the market, to discern market trends and review other suppliers' capacities in order to be able to react quickly to market demands. Access to such information would greatly stabilize the activities of the many small firms.

 Conditions for the effective marshalling of resources in manufacturing systems that are coordinated using negotiation methods are currently of interest at many levels. As the flexibility of manufacturing elements increases and effective units become smaller and more independent, it becomes increasingly advantageous to permit entities to negotiate with one another.

 Upton describes a negotiation system that functions within a plant.4,5 In this system, the partly completed product (such as a raw casting) is provided with a miniature manufacturing computer physically attached to it. This computer uses artificial intelligence techniques to negotiate the manufacture of the product (step by step) with the various processing entities in the system, such as transport vehicles and machine tools. Machines bid for the right to provide processing for the product and the product selects the best bid at each step.6 Bidding machines take into account their prevailing workloads, commitments and capabilities. After successfully visiting all the necessary stations, the semi-finished product (which might be a component for a large earth-mover, say) relinquishes its computer so that subsequent products may avail themselves of its experience, such as knowledge about unreliable performers and optimistic bidders. Thus, the system slowly builds expertise about itself in the product stream. This system is able to adapt easily to the removal and addition of machines, since removed machines stop bidding and new machines are simply told to start. The technique solves many of the problems of centralized computer-control in dynamic manufacturing systems.

 At the intra-company level, Jaikumar has considered the optimal behavior of users and providers of processing capability within the firm.7 He describes a negotiation system in which a firms' sales agents are the buyers of capacity and the production resource managers the providers. Jaikumar shows that such a decentralized system can both be optimal for the firm and provide an efficient incentive system. At the level of global coordination, we are most interested in exploring how a global, decentralized negotiation system might best be constructed for manufacturing.


Issues in System Design and Objectives

A number of factors must be carefully considered in attempting to establish a structure for a Prato-like market, among them: reliability; management information; brokerage; and commodity-like transactions.



Capacity must be reliable and there must be effective mechanisms for ensuring that unreliable suppliers discount appropriately. Information on the performance of previous contracts will enable the market to take into account both the quality and reliability of suppliers. The credit-worthiness of buyers must similarly be assured. How might such information be promulgated and what recourse provided to suppliers and buyers for correcting inaccuracies? For example, suppliers might be required to specify the proportion of the last hundred contracts on which they were late, or in which there was a dispute concerning quality.

There will inevitably be transactions in which one party is aggrieved, and assigns too much importance to one egregious event. For example, a firm may suffer badly because of one instance of failure and feel the need to take some punitive measure. Of course, the consequences of a party's actions are not relevant in determining its on-going performance, so the market should ensure that these kinds of occurrences are accommodated.


Management Information

What information does a supplier need in order to compete effectively in an automated market? Temporary differences in cost of capacity due to scheduling constraints are inevitable. Manufacturers currently making pink T-shirts, given sufficient demand, would very much like to continue doing so to avoid changeover costs; where should they seek buyers of such temporarily cheap capacity?

 What internal information about changeover costs does a firm need? Decisions about what price to bid on a job rely on timely and accurate internal information. The advantage will go to players that are able to reliably predict their own performance for the purpose of determining their own bids as well as to ensure satisfactory acquittal of the contract.



Under what conditions is it advantageous to use brokers of capacity? Clearly if communications can be organized effectively in a distributed fashion, the need for a centralized hub is reduced. With the ability to transmit and receive information throughout a global network, the role of a central broker as a channel for information is less clear. Individual firms could begin to access the network to determine customer requirements and bid directly on jobs as they arise. Users of capacity could themselves post requirements on the network (for products as well as for capacity options and futures).


Commodity-like Transactions

Methods for limiting damage arising from non-performance of contracts are essential. Some capacity providers will be able to provide insurance by maintaining spare capacity. A futures and options market in capacity would provide a hedge against increases in price, for example. Whereas product variety has previously limited such deals to commodity products, given the flexible capacity to produce commodity-traded products we will expect to see commodity-like transactions.

 Moreover, we need to explore the various methods by which different forms of capacity might be converted into financial instruments. Such forms would include futures markets and spot markets as well as options. The insurance of these instruments is also of interest, as is the entry and modus operandi of third parties into bilateral transactions, which might have a considerable effect.


The Growing Arena

The application of programmable computer control is likely to continue to broaden and increase in sophistication. As the physics of more and more processes becomes well-understood, it is becoming possible to automate them and allow a computer to control precisely the variants of the items they produce. This is true even of processes that have traditionally been craft-based and required tremendous skill.

 An example of such a process is sheet metal spinning which a flat plate of metal is rotated on a lathe-like machine and forced over a metal die using a mandrel. The metal deforms plastically. This operation has traditionally required very high skill on the part of the operator. Many different shapes can be produced (the process is most often used for the production of shades for industrial lighting) but it is easy to push too hard and tear the metal, or too softly and leave the metal too thick. This operation may now be carried out automatically under computer numerical control. Operators complain that the quality of the product is "not what we can do," but it will not be long until control has been refined to such an extent that a computer program will be able to produce dies, and spin customized products to order.

 The foregoing is an example of a process in the early stages of programmability; other processes are much further advanced and have been reliably programmable for a number of years. The chief constraint in such processes is no longer the physical manufacturing process, but the information required to tell the machine what to produce. For example, in the manufacture of electronic circuit boards, all manufacturing instructions may be completely specified by a set of computer programs, from drilling holes in the boards to the exact placement of surface-mount and through-hole components before soldering. What is more, these operations may be effected reliably and consistently by programmable machines running standardized programs. Despite the tremendous variation in electronic devices, circuit board manufacturing capacity is becoming a commodity. Many firms now produce boards for products ranging from modems to fashionable electronic toys in small facilities with only one or two programmable machines. They are often in competition with a large number of similar sub-contractors using identical machinery.

 Spring-making has traditionally involved the precise cutting of cams and gears to control an automatic spring making machine. This was a task requiring high skill and years of expertise. Some manufacturers were thus very much better than others, and required substantial skilled machine shops to produce the appropriate cams. Today, springs can be produced under programmable computer-control by small programmable machines that run a standardized program. Each machine is capable of interpreting the program and putting the appropriate kinks and hooks into any spring being produced. Such machines have dramatically changed the industry many small spring-making shops (often run by ex-employees of the larger manufacturers) now bid readily on spring-making jobs for small electro-mechanical devices.

 There are many other examples of industries in which the type of coordination described in this chapter is becoming practicable. Although the global computerization of such a market for flexible capacity has yet to be seen in practice, we believe that such markets will soon exist. As global telecommunications and information technology enable such manufacturers to compete efficiently, with standardized technology and minimal barriers to entry, sources of advantage for individual firms are hard to identify. This leaves small firms faced with the prospect participating in such a global market for flexible capacity with a very important question: "What is it now important to do well?"



Jaikumar, R. Japanese Flexible Manufacturing Systems: Impact on the United States. Japan and the World Economy. Volume 1 (2). 1987
Jaikumar, R. Statement before the Subcommittee on Innovation, Technology and Productivity of the Senate Small Business Committee of the US Senate. December 2, 1987.
The closest modern translation of this word is "rag-trader". Impannatori existed during the Renaissance as coordinators of artisans.
Upton, D. M. The Operation of Large Computer-Controlled Manufacturing Systems. Purdue University Ph.D. Dissertation, 1988
Upton, D. M. A Flexible Structure for Computer-Controlled Manufacturing Systems, Manufacturing Review, vol. 5 , no. 1, pp. 58-74, 1992.
The question of why machines should "want" to bid for the right to work results only from the anthropomorphic analogy, and not because this causes any inherent functional problem.
Jaikumar, R. Resource Allocation in Automated Flexible Manufacturing Systems. Harvard Business School Working Paper 88-026, 1988.