A New Industrial Revolution: The Innovation Economy and Manufacturing

The factors that led to economic success in the industrial era are well known: access to land, labor, raw materials, capital, machinery, and innovation. Today, all of those traditional advantages are falling away except one: innovation. We are leaving the industrial economy and entering the innovation economy, where manufacturing is a commodity and the idea […]

MANUFACTURING, BY DEFINITION, IS THE PRODUCTION OF THINGS ON A LARGE SCALE. FROM HENRY FORD ONWARD, THE ABILITY TO MASS PRODUCE PRODUCTS HAS GENERATED UNTOLD AMOUNTS OF WEALTH AND TRANSFORMED THOUSANDS OF COMPANIES INTO HOUSEHOLD NAMES. BUT THAT ERA IS COMING TO AN END.

The factors that led to economic success in the industrial era are well known: access to land, labor, raw materials, capital, machinery, and innovation. Today, all of those traditional advantages are falling away except one: innovation.

We are leaving the industrial economy and entering the innovation economy, where manufacturing is a commodity and the idea – intellectual property (IP) – trumps all.

Those ideas won’t be limited to the products or services that you sell, either. Amazon’s 1-Click idea (now patented) has nothing to do with the products that Amazon sells, only with how they are purchased. Indeed, managing innovation throughout the value chain – from research and design to delivery and aftermarket service – has become the key to corporate success.

Companies that own and leverage the rights to products and services – rather than those that manufacture, sell, or distribute them – will be the most highly valued. Calling cards such as “Designed by Apple in California,” will become much more common as the value shifts from making things to dreaming them up (see “What Became of the Factors of Production?”).

Instead of designing, manufacturing, and delivering products, companies will design, manufacture, and deliver IP. Current and emerging production technologies, including mass customization, nanotechnology, and 3D printing, are already letting manufacturers rethink their traditional approach of producing enormous quantities of highly standardized products.

Customers will be at the center of this new economy. Today manufacturing is designed for manufacturers. In the innovation economy, manufacturing will be designed for – and in part by – customers.

The customer relationship will no longer be simply about better customer service or more targeted marketing initiatives. In the innovation economy, companies will have to incorporate customer feedback directly into the value chain. No matter what the channel, whether in-person, social media, or apps and devices, customers will become active participants in all parts of the value chain, from development to delivery.

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What Became of the Factors of Production?

The basic elements of success in the industrial age have varied little over the years. Those with the land, labor, raw materials, capital, machinery, and innovation were more likely to win. But the playing field is quickly leveling. Here’s why:

  • Raw materials matter Sustainability efforts enable companies to get more from natural resources. And synthetic materials open up the options even more.
  • Labor costs are lev The game of labor arbitrage is fast becoming a losing venture. In China, the Western manufacturer’s go-to location for low-cost workers, average labor costs have more than doubled since the beginning of 2007, according to Ernst & Young.1 The Organisation for Economic Co-operation and Development (OECD) says its advanced member countries accounted for 60% of GDP in 2000. That shrank to 51% in 2010 and is predicted to drop to 43% in 2030.2 As the GDP gap between the developed and developing world continues to close, educational and per capita income parity will become the norm around the globe.
  • Investment is more Since 2010, developing and emerging countries absorbed more than half of all foreign direct investment (FDI), and as of 2012, FDI to developing economies exceeded those to developed countries, according to the United Nations Conference on Trade and Development.3
  • Capital goods costs will Access to machinery has been a key differentiator for centuries. The steam engine powered the industrial revolution. The power loom revolutionized the textile industry. But the concept of manufacturing as the pure assembly of components is fading. Many massive, multimillion-dollar pieces of machinery will eventually be replaced by cost-effective 3D printers that can fit in a home office.
  • Land is less Land is more productive than ever, thanks to technology and sustainability advances. Agricultural production is also more efficient. The 21st-century version of land – frequency spectrums for telecommunications, orbital patterns for satellites – can be enhanced through technology.

That leaves innovation as the dominant determinant of corporate value. As a result, companies will have to reorganize around innovation to identify and gain maximum value from their intangible resources.

The Third Unbundling of Manufacturing

All of this leaves traditional manufacturers in a tough spot. It’s no longer enough to make things well or inexpensively or with high quality (though those are all still important). For manufacturers to shift their focus to the primary driver of value – the idea – they must rethink their entire approach.

Of course, we’ve faced major transitions like this twice before. Before the industrial revolution, when the majority of production was food, the countries with the largest populations, such as China and India, had the greatest GDP. But as energy advances led to lower transportation costs, products made in one country could more easily be consumed in another, and global trade increased. It was manufacturing’s first big unbundling.

Then, in the late 1980s and early 1990s, advances in information technology enabled the manufacturing process to be broken down into discrete pieces that could be coordinated across a multicompany – and often a multicountry – supply chain. As a result of this second unbundling, manufacturers could outsource more of their value chain and take advantage of a growing global workforce in such countries as Brazil, China, India, and Russia.

Today, manufacturers stand on the edge of industry’s third unbundling, as the intellectual capital behind a product is uncoupled from its production.

The Rise of Intangibles

Just as traditional assets such as land, labor, and machinery have diminished in competitive value, the worth of intangible assets has skyrocketed. In the innovation economy, the majority of enterprise value is derived from a company’s intellectual capital. The total value of intangible assets in the U.S. economy jumped from U.S.$5.5 trillion in 2005 to U.S.$9.2 trillion in 2011, according to the economic advisory firm Sonecon,4 which also notes that such intellectual capital today is a critical success factor in most industries.

This year, the U.S. Department of Commerce’s Bureau of Economic Analysis (BEA) began including research and development investment in the nation’s GDP calculations, about two-thirds of which comes from the private sector. BEA leaders noted that intangible assets play a similar role to tangible capital in the modern economy and that the inclusion of R & D is just the beginning of a further exploration into the value of intangibles to overall economic growth.

Human capital.

Individual employees’ skills, such as professional expertise and skills, social abilities, entrepreneurial engagement, and the ability to innovate and respond to changes, are an increasingly large slice of company value.

Relationship capital.

In these hyperconnected times, the business relationships a company has with third parties have become critical to overall value. These include customer relationships, marketing and distribution partnerships, brand value, supplier relationships and networks, and manufacturing contracts.

Structural capital.

Know-how is no longer just contained within the minds of individuals. There’s immense value in a company’s collective knowledge, such as business processes and infrastructure, working methods, information systems, intellectual property (patents, copyrights, and trademarks), organizational design, and corporate culture.

Extreme Customization and Commoditization

Few of us can remember a time when there wasn’t mass production of nearly everything we own, a time before Henry Ford said, “Any customer can have a car painted any color that he wants, so long as it is black.” Yet prior to that time, built-to-order was the rule rather than the exception. Automobiles were handmade by skilled craftsmen, a labor-intensive and expensive process. Ford’s assembly line made cars more affordable, but at the cost of individuality.

Mass production will not go away entirely in the innovation economy, but it will diminish and be augmented by the kind of ethos that prevailed before Ford became a household name. Today’s consumers are tech savvy and demanding. They want their cars in the color of their choosing with their handpicked options. And they want them now.

As Frost & Sullivan points out in its research on the future of manufacturing,5 mass production and individual customization are merging.The result? Customers will drive both extreme commoditization and extreme customization.

Depending on their passion for the product, customers will want it either exactly to their specifications or with the most common features at the lowest possible price. A flat-screen TV in black or gray? Or one in the perfect color for the bedroom?

Continuous Customer Involvement

Either way, it’s clear who will be in charge. Once simply the recipients of products at the tail end of the manufacturing value chain, customers will be active participants in the middle of the process – co-innovators, co-marketers, and, thanks to new technologies such as 3D printing, even co-producers. The Jetsons had it right: In the future you will push a button in your house, and out will come a finished product.

Organizations need to adapt through insights derived from continuous customer involvement at every step along the value chain and be willing to quickly and constantly redesign their offerings as the make-for-me future arrives.

One food manufacturer, for example, recently introduced a new cheese blend to the market that it thought would be a hit. But it quickly realized via social media that consumers thought it just tasted like American cheese. The company readjusted the cheese ratios, reworked the packaging, and reintroduced the product to market, all within a couple weeks. Sales soared. That kind of responsiveness will soon become the norm, whether you’re making cheese or cruise ships.

As customers play a greater role in innovation, production will become innovation-based rather than cost-based. Many manufacturers will move production closer to their customers while taking advantage of a global network of talent inside and outside their walls to give customers what they want (see “The New Value in Globalization: Innovation Not Cost Cutting”). Companies will take advantage of hyperconnectivity and “Big Data” to connect customer communication channels with product lifecycle management systems to incorporate ideas from their new partners in innovation in a timely and efficient fashion.

The New Value in Globalization: Innovation Not Cost Cutting

In the past, manufacturers went global to cut costs, setting up shop in emerging economies to take advantage of differentials in labor costs or of incentives provided by local governments. But playing the labor arbitrage game will be a losing proposition in the long term.

Globalization isn’t dead, of course, but geographic strategies are beginning to shift. Companies will invest in more geographically diverse workforces and partnerships in order to better capture the desires of their customers around the world and translate them into innovative products and services more quickly. Manufacturers will also move production closer to customers around the globe to decrease product cycle times and increase their make-to-order capabilities. In the future, globalization will be driven by innovation, not costs.

Mass Production Loses Its Grip

As manufacturers move production closer to their customers, mass production will scale down. Manufacturers must get away from the idea that success means shipping large lots between major transportation hubs. MIT’s Production in the Innovation Economy (PIE) project interviewed 250 companies over two years to research what happens when companies become pure innovators, leaving manufacturing and physical implementation behind to focus on R&D, design, and services. Olivier de Weck, executive director of the PIE project, calls this process “breaking the tyranny of bulk.”

New production technologies, such as nanotechnology, additive manufacturing, robotics, self-assembling components, and biomanufacturing, will enable advances in efficiency, flexibility, and overall productivity (see “Production Technologies of the Innovation Economy:

Additive Manufacturing”). Companies will figure out how the strict quality controls they have in place in their large, centralized factories can translate into a much more distributed production and logistics environment. Physical quality control will shift to digital quality control as the number of partners involved in the process balloons.

Production Technologies of the Innovation Economy: Additive Manufacturing

Additive manufacturing is the method of making products and components by depositing thin layers of material using a digital blueprint (as opposed

to traditional subtractive manufacturing, which uses machine tools such as lathes or milling machines to remove material to produce an object).

Examples include 3D printing, laser sintering, and cold spray coating.

Nanomanufacturing

Referring to manufacturing at the atomic level, nanomanufacturing can be either top-down (reducing larger materials down to the nano scale) or bottom-up (building things from molecular components).

Self-Assembling Components

Self-assembly, the process by which components interact with each other spontaneously to build an ordered structure, has been a focus of research for years at the molecular level, but it holds promise at larger scales as well.

Biomanufacturing

Biomanufacturing is the process of producing products out of biological materials, from pharmaceuticals and chemicals to paper and food.

Robotics

Industrial robots have proven their worth on the shop floor for repetitive tasks, but future advances in machine learning and predictive analytics will enable a more proactive robotic workforce that could make it less cost prohibitive to move production facilities closer to customers.

The Danger of Forgetting How to Make Things

At the same time, companies will need even closer connections to their partners in these distributed value networks for quality control and continued innovation. The danger, the MIT PIE researchers write in a preview of their full report,6 is that as innovation is decoupled from production, and as companies shift more of the commercialization of their ideas out the door, “their capacity for initiating future rounds of innovation will be progressively enfeebled.”

The researchers point out that a byproduct of getting products to market is institutional learning. As engineers and technicians on the factory floor flag problems and come back to the design engineers for resolution, manufacturers learn, among other things, how not to repeat mistakes with the next launch.

Close the Learning Gap with Tighter Relationships

But not all learning needs to be of the firsthand variety. The MIT research underscores how important it is for companies to maintain closer connections to the larger ecosystem in which they operate to ensure that innovation continues to flow into the company and is translated rapidly into market-ready products. Customer co-innovation and business-to-business (B2B) collaboration are just two new forms of innovation that are growing in importance (for more examples, see “The New New Innovation”).

Closer connections with this new web of partners, whether a contract manufacturer or a 3D printing provider, can also help mitigate the inherent risks, such as technical issues and supply chain delays, of innovating on the front end and relying on a third party to deliver the finished product.

As engineers and technicians flag problems, manufacturers learn, among other things, how not to repeat mistakes with the next launch.

The New New Innovation

Historically, corporate innovation has been an inside-out job. All new ideas came out of the central brain trust within the company: R&D.

Those ideas were thrown over the wall to other parts of the company, where someone else produced them, marketed them, and eventually sent them off to the customer. This top-down process was slow and claustrophobic, with little in the way of a feedback loop.

Tomorrow’s innovations are more likely to come from the outside in or from the bottom up. And they will be collaborative. No more cloistered PhDs in R&D Ideas will stream in from outside corporate walls, across geographic borders, and from customers and suppliers. Through the use  of increasingly sophisticated and ever-cheaper monitoring and communications technologies, innovation will be marked by continuous input and improvement.

In the future, anyone will be able to innovate. That means companies will need to embrace a number of new partners and new methods for innovation. They will need to:

Challenge suppliers to innovate. Subcontractors and supply chain partners will be integral in the ideation process. Many companies used to outsource component manufacturing to suppliers but dictated their own designs. Going forward, they’ll also challenge subcontractors to come up with their best ideas for component design, while using collaboration and monitoring technologies to maintain control over the overall engineering of the products to mitigate the inherent risk of increased technical problems or production delays.

Let constraints drive innovation. Whereas companies in developed economies historically came up with ideas for products that would be force-fit into developing markets, now they are developing ideas coming from those developing countries. This process has been coined reverse innovation7 by Vijay Govindarajan and Chris Trimble of the Tuck School of Business at Dartmouth. Reverse-innovated products developed to meet the needs of developing nations, such as battery-operated medical instruments in rural India, end up having desirable features for the developed world as well.

Prepare for individuals to become market disrupters. The out-of-nowhere solo innovators and entrepreneurs in the online world, such as Facebook’s Mark Zuckerberg, are just the tip of the iceberg. Zuckerberg and his ilk can do what they do because the tools they need are dirt cheap. Soon, the same will be true in manufacturing. Access to tools like 3D printers means that individual innovators need not be so concerned about traditional barriers such as access to capital, economies of scale, and physical production requirements.

Go beyond co-innovation. The idea of co-creation8 – that business value will be increasingly delivered by company and customer together

  • is more than a decade old but is becoming increasingly relevant as new technologies enable customers not only to co-innovate but also to co-design, co-market, and even co-produce.

The market leaders in the post-industrial world must be poised to develop the best ideas coming from any direction – customer or supplier, emerging market or individual entrepreneur – for competitive advantage in the innovation economy.

The Make-for-Me Future

Reorganizing supply chains around customers will require new thinking, new processes, and new infrastructure. Companies will continue the push toward lean and efficient operations that deliver the right product to the right customer at the right time.

With a supply chain that is more distributed, is local, and works in real time, manufacturers will need to approach customer service and expectations in new ways. Customers will have the same expectations – safety, quality, traceability, and social responsibility, to name a few – whether they buy their new oven at an appliance superstore or at the nearest 3D printing provider.

Manufacturing systems will have to compensate for a much more distributed supply chain and shortened time to market. For example, companies will have to come up with ways to test products that are printed locally to ensure consistency, quality, and customer satisfaction. And with working conditions in developing countries already an issue in traditional supply chains, companies will have to figure out ways to monitor the ethics of suppliers that the company never deals with directly (see “Six Steps for Reorganizing Around Innovation”).

Six Steps for Reorganizing Around Innovation

For manufacturers to shift their focus to innovation as the primary driver of enterprise value, they must successfully manage a number of key trends:

Keep manufacturing local and innovation global. Resources, labor, and management will go local to get closer to the customer, while innovation processes will become collaborative and globally connected to better understand the customer in as many different geographies and contexts as possible.

Track ideas, not just parts. When customers buy ideas instead of products, companies will need to revamp their systems to monitor their IP from ideation through a much more distributed production and logistics environment to maintain quality and meet local needs.

Monitor intangibles. As the value of intellectual capital, such as talent, brands, customer and supplier relationships, business processes, and corporate culture, eclipses that of physical and financial assets, companies must learn to track, measure, and manage them the way they have their financial and physical assets. Manufacturers must embrace new methods for placing a value on these increasingly important but more difficult to measure investments.

Join the manufacturing web. The traditional value chain is exploding into pieces, requiring manufacturers to become more agile and collaborative. The social manufacturing web will include connections to public research laboratories and universities, customers, suppliers, and networks of smaller, localized production facilities.

Double down on efficiency in manufacturing processes. As value increasingly shifts away from the assembly line, there’s less room for waste in manufacturing methods. Manufacturers must squeeze every bit of productivity out of machines, people, and processes and outsource when others can better achieve the objectives of cost, quality, and speed.

Shrink product lifecycle times. Manufacturers will need to harness their global innovation processes to deliver IP to the customer as quickly as possible, whether in the form of a finished product or something that’s 3D printed.

Building a Better Manufacturing Model

Companies that make these fundamental changes to succeed in the new innovation economy have the clear potential for returns, such as better products, faster delivery, more engaged customers and suppliers, and increased agility, efficiency, and capacity management. But the benefits could extend beyond individual enterprise success.

For all the technological advances that have been made, today’s highly centralized manufacturing model for producing and transporting finished products remains costly and environmentally unfriendly, and embracing offshoring and outsourcing has only exacerbated those issues. By reorganizing around innovation, manufacturers can not only reduce their impact on the environment but also drive higher value for customers and investors.

There’s more.

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The SAP Center for Business Insight is a program that supports the discovery and development of new research-based thinking to address the challenges of business and technology executives.

  1. Jack Yuan, China’s Productivity Imperative (Ernst & Young, 2012), http://www.ey.com/Publication/vwLUAssets/China_productivity_imperative_en/$FILE/China-Productivity-Imperativpdf.
  2. Åsa Johansson et , Looking to 2060: Long-Term Global Growth Prospects (OECD Publishing, November 2012), http://www.oecd.org/eco/ outlook/2060%20policy%20paper%20FINAL.pdf.
  3. James Zhan et , “World Investment Report 2012” (United Nations Conference on Trade and Development, June 2012), http://unctad.org/en/ PublicationsLibrary/wir2012overview_en.pdf.
  4. Kevin Hassett and Robert J. Shapiro, What Ideas Are Worth: The Value of Intellectual Capital And Intangible Assets in the American Economy (Sonecon, September 2011), http://www.sonecon.com/docs/studies/Value_of_Intellectual_Capital_in_American_Economy.pdf.
  5. Rebecca Tucker, “Bringing It All Together: Manufacturing Execution Systems and the Art of Collaboration” Frost & Sullivan (December 2010), https://www.frost.com/sublib/display-market-insight.do?id=212971555.
  6. A Preview of the MIT Production In The Innovation Economy Report (Massachusetts Institute of Technology, February 22, 2013), http://web.mit.edu/ pie/news/PIE_Prepdf.
  7. Vijay Govindarajan, “What Is Reverse Innovation,” Vijay Govindarajin’s Blog, Tuck School of Business at Dartmouth, September 2009, http://www.tuck.dartmouth.edu/people/vg/blog-archive/2009/10/what_is_reverse_innovhtm.
  8. K. Prahalad and Venkat Ramaswamy, Co-Creation Experiences: The Next Practice in Value Creation (Wiley Periodicals Inc. and Direct Marketing Educational Foundation Inc., 2004), http://deepblue.lib.umich.edu/bitstream/handle/2027.42/35225/20015_ftp.pdf.

 

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About the author:

Rob Hand is vice president of business development and innovation at SAP Labs.

Ruediger Eichin is research manager and innovation coach at SAP.

Reiner Bildmayer is a senior researcher at SAP.

Stephanie Overby is an independent writer and editor, focused on the intersection of business and technology.

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Innovation Economy