High Velocity Means High Risk

2014-12-02 08:00:00

By: Charlie Barnhart

Dec 2, 2014  (Originally Published on 12-18-2007)

Business is an inherently risky proposition and today’s maximum velocity business models based on complex, highly leveraged solutions make the situation even more perilous. Never the less, the trend is clear – electronic product companies (or OEMs) continue to outsource more functions, more often, to more geographically remote locations than ever before. Why do they do this? Some might say they do so to coldheartedly bolster corporate profits by chasing low-cost labor around the world, and given the sometimes negative human impact resulting from liaises faire globalization the argument is compelling. But the main (or operative) answer is that companies must continuously gain competitive advantage if they are to survive in today’s marketplace, where competitors exploit even the slightest level of indecisiveness. So what is a conscientious manager to do?

  1. A good first step would be to acknowledge that high velocity means high risk, and

  2. Secondly, accept accountability for any issues resulting from this risk.

This approach transforms risk from an unknown into something manageable. A case in point would be choosing an Original Design Manufacturer (or ODM) for a new product. This approach provides OEMs with increased velocity in product introduction as well as a lower purchase price than is typically achievable with an Electronic Manufacturing Services company (or EMS) building an in-house OEM design, thus producing a threefold advantage – lower design cost, lower manufacturing cost, and reduced time-to-market.

But what about risk?

Referencing a report from an earlier writing, we find a list of potential pitfalls with the ODM model:

  • Loss of internal expertise and competencies

  • Unrecoverable loss of IP and/or market opportunity

  • Diminished institutional understanding of IP value

  • Dilution of Brand and/or differentiation

  • Shift of organizational focus from bottom-line to top-line

  • Unintentional creation of enterprise momentum

  • Simultaneously increase of supply and geographic exposure

  • Increased cost/complexity of maintaining adequate surveillance

  • The theoretical “kinetic energy risk” to business (i.e., the v2 factor)  

Recognizing there are more items in the above list than we can address in this commentary, let’s focus on those risks that align most closely with our three advantages, of:

  1. Lower design costs

  2. Lower manufacturing costs

  3. Reduced time-to-market

Starting with lower design cost the most applicable pitfall is unintentional creation of enterprise momentum, as performing product design outside the company can result in the unintentional elimination of a capability or resource core to a businesses' success. For example, there is always some probability – all be it slight – that a key engineer may decide to ‘jump ship’ as a result of seeing his/her co-workers being laid-off or passed over for additional training as a result of designs being outsourced to ODMs. Should this occur what would it cost to replace the resource? Does the probability of occurrence, multiplied times this predicted cost, produce a number smaller than the potential saving from outsourcing the design?

The next advantage lower manufacturing cost results (at face value) from ODMs benefiting from a broader level of participation in the sub-tier supplier selection process than EMS companies, which affords them greater influence in these relationships thus lowering material costs. And as material cost is the largest single element of cost-of-goods in virtually every electronic product, this can equate to a very significant cost savings for the OEM. Yet, as ODMs and their supply base are located in close proximity, this model also simultaneously increases supply and geographic exposure. Because not only your ODM, but also all of your ODMs' suppliers and suppliers' suppliers are probably located in China, they may be subjected to the same infrastructural, monetary, and geopolitical risks. How long, and at what cost, would it take to replace this supply base? What percentage of your company’s revenue and profits would be derived from this product? Do the estimated savings outweigh the potential impact of a catastrophic failure of the supply solution?

Our final advantage is reduced time-to-market. If real estate is all about location, location, location, then the electronic industry is all about timing, timing, and timing. Having the right product, at the right place, at the right time makes or breaks a business offering. Especially in a market sector as fickle as consumer products which is where ODM solutions are often applied. Given that reduced time-to-market is all about velocity, Physics tells us that kinetic energy, or the energy of motion, is calculated as one-half the mass of an object, times its velocity squared.

Kinetic energy = ½ mass X velocity2

In other words, the larger something is and the faster it moves the more kinetic energy it possesses. But there is an interesting consequence of the final element of the equation, velocity squared, i.e. whenever you multiply a number by itself, the result is geometric--not linear--expansion. Let’s take a closer look to see what this means.

If you square the number 2, the answer is 4. But if you square the number 3, the answer is 9, an increase of 225% for only a 50% increase in the original number. Throw a stone just a little faster and it impacts its target with considerably more force. Or reduce the time-to-market by increasing the velocity of the process and, if the analogy holds true, the risks grow dramatically. Even as a theory, it is a very scary thought.

If you attended a business school you probably heard of the “potential energy” effect, which is the force accumulated within an enterprise as it grows larger, which eventually (if left unmanaged) will bring the organization tumbling down. The analogy in nature, from which this effect is derived, is that whenever you lift an object it instills into it potential energy and this energy is fully expended only when the object falls back to its original height. So a kinetic energy risk has a well-documented parallel in business theory in addition to a strong basis in common sense, a combination that is hard to ignore.

Bottom-line, maybe someday, someone will perform the necessary design-of-experiments to fully validate the theory. In the meantime, perhaps a little paranoia when increasing the velocity of business processes would be wise. Remember it was once said, “Paranoia is only a disease when it is unjustified.” Given the velocity of change in the electronics industry, the economy, the US and the world – a little paranoia seems more than justified.

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