Take note: Laptop supply chain is not what you'd expect

U.S. sales of notebook PCs outpaced desktop computers for the first time in 2005, garnering 53.3 percent of the total PC retail market, according to research firm Current Analysis. Behind the notebook industry's success lies a flexible, time-sensitive supply chain that straddles the globe in the design, manufacturing, configuring, and delivery of merchandise to customers. Top-selling brands such as Dell, HP, Apple, and Compaq are all based in the United States, but the computers themselves (like most consumer electronics these days) are manufactured half a world away in China. What's interesting about the notebook supply chain is the fact that many of the players for these high-tech products rely not on technology at all, but rather on personal relationships, to get the job done.

Pop into your local Starbucks on any given day and you're bound to spot any number of professionals tapping away on laptop computers. Ditto any U.S. airport, and even many restaurants and bars. The notebook computer has become the symbol of the current always-on business generation, and is fast becoming a necessity in corporate life. In fact, U.S. sales of notebook PCs outpaced desktop computers for the first time in 2005, garnering 53.3 percent of the total PC retail market, according to research firm Current Analysis.

Behind the laptop industry's success lies a flexible, time-sensitive supply chain that straddles the globe in the design, manufacturing, configuring, and delivery of merchandise to customers. Top-selling notebook brands such as Dell, HP, Apple, and Compaq are all based in the United States, but the computers themselves — like most consumer electronics these days — are manufactured half a world away in China.

This alone does not raise eyebrows; what's interesting about the notebook supply chain is the fact that many of the players for these high-tech products rely not on technology at all, but rather on personal relationships, to get the job done. These findings are part of a recent study, "Technology and Organizational Factors in the Notebook Industry Supply Chain," commissioned by the W. P. Carey School's Center for Advanced Procurement and Supply Research (CAPS), and conducted by The Personal Computing Industry Center at the University of California, Irvine, and San Francisco State University's Institute for Next-Generation Internet.

"This research study is one of several commissioned by CAPS designed to get beyond the headlines and to help business executives understand how to do business in China. This report has many useful insights for other industry verticals," said CAPS Director Philip Carter, a professor of supply chain management at the W. P. Carey School.

"We were interested in discovering how information technology is affecting the way companies do business in China," where they are balancing the age-old notion of guanxi (a network of close interpersonal relationships) with technological advances, says William Foster, a research scientist with the Institute for Next-Generation Internet and co-author of the study.

A four-tiered process

Production of notebook PCs is largely concentrated in one small area within an hour of Shanghai, China, and spearheaded by Original Design Manufacturers (ODMs) that are owned and managed by the Taiwanese. "Flagship" PC companies such as Dell, Apple, HP, and Gateway contract with Taiwanese ODMs to design and manufacture laptops. In turn, ODMs work with a group of third- and fourth-tier suppliers to source various computer parts and components.

"Dell, for example, has its ODMs manufacture the motherboard, while components such as the hard drive and the monitor are put on in a separate factory," says Foster. The ODM will partner with a third-tier supplier that manufactures connectors, for instance, and that third-tier supplier will source wire for its connectors from a fourth-tier supplier, he explains.

This multi-tiered supply chain has worked well for the flagship PC companies, providing production cost advantages and allowing them to reduce research and design budgets by leaning on the Taiwanese experts. The ODMs and suppliers, by focusing on core competencies, also remain profitable.

Marriage of High- and Low-Tech

Interestingly, a technology dichotomy exists between the flagship-ODM relationship, which operates at a high technological level, and the ODMs' dealings with companies further down the supply chain, which depend much more on personal relationships. "A flagship company's enterprise resource planning [ERP] system will communicate directly with the ODM's ERP system, saying, 'This laptop needs to be manufactured according to these specifications for delivery later in the week.'

A continual replenishment system exists between flagships and ODMs; there is a constant back and forth between the computer systems," explains Foster. "But computers at an ODM don't talk to computers at third- or fourth-tier companies." Third-tier suppliers may use a web interface to accept orders from the ODMs, and some have invested in limited ERP systems, which they utilize mostly as financial management tools. But the technology stops there. Third-tier suppliers often use face-to-face meetings, phone calls, and faxes to supply forecasts and orders to their fourth-tier suppliers, says Foster.

Business between ODMs and their suppliers is more of an informal affair, set up and maintained through the vast network of interpersonal relationships known as guanxi. According to Foster, because these companies do business together based on existing relationships and without contracts, it is a friendlier business environment, with both sides "working for a win-win solution all the time."

"It is a productive strategy to have everyone in the supply chain working with each other instead of in conflict," he explains.

Though such a low-tech, laissez-faire arrangement in a high-stakes, multimillion-dollar industry seems shocking by American business standards, it works quite well for the laptop supply chain. For a company that sells one type of wire, for example, to the same ODMs it has dealt with for years — and where the respective managers are probably neighbors, family members, or friends — pouring money into a high-tech ERP system is actually a competitive disadvantage, the research shows.

"If these third- and fourth-tier suppliers had to invest heavily in IT, they might no longer be profitable," explains Foster. "Up to this point, they have seen no advantage to having their workflow and processes automated. In fact, doing so could actually undermine the personal relationships that get things done."

Surprisingly, the lack of a seamless, end-to-end IT connection has not hurt the flexibility of the laptop supply chain. Dell's famous "direct by Dell" model — the company carries no inventory and places orders with suppliers only after a customer has already paid for a laptop — is possible because its ODMs and lower-tier suppliers are able to configure, customize, and deliver notebooks in about one week from the time they receive an order from Dell.

"The notebook supply chain is scalable on a daily as well as weekly or monthly basis," says Foster. "And, because of guanxi, if a supplier can't handle the volume needed to scale up to meet the flagships' demands, they can even turn to their own competitors for help. The personal relationship trumps the competitive one."

Nothing is perfect

Of course, no supply chain is without impediments. Current and potential problems facing the notebook industry's U.S.-Taiwan-China business triangle are myriad, finds the study: there are problems meeting delivery dates, quality issues leading to customer dissatisfaction and high warranty costs, the risk of supply chain disruption due to lack of inventory, and the risk of excessive concentration of the supply chain in China.

The increasingly competitive nature of the laptop industry also means the flagship companies must continually keep an eye out for ways to cut costs, which can ruffle some feathers among the ODMs. "The flagships aggressively compete with the ODMs against each other," reports Foster. "They want to make sure they are not dependent on one ODM."

In addition, the laptop companies face the same risks and challenges faced by all American companies reliant upon sourcing in China. Longer lead times, port congestion, language barriers and time differences, export trade and government safety regulations — even avian flu and the threat of geopolitical clashes all come into play.

"All the laptops in the world are manufactured in this area. It's a very big risk, and it is not clear what the solution is," admits Foster.

Ultimately, for both the laptop industry and others dependent on Asian sourcing and manufacturing, balancing the benefits and the risks comes down to having a firm grasp on what the outsourced supply chain actually entails. Shipping off production to China in the name of lower costs without understanding how business works in Asia is not always a fortuitous move.

"Almost every company in the United States is manufacturing in China, and most companies do not fully understand the supply chain they are in. They often rely on their Chinese partner to handle the supply chain down to the supplier level," says Foster.

"The most important thing this research does is highlight and explain to American companies exactly how the Chinese supply chain works," he adds. With enterprises continually looking to China to streamline production while cutting labor and R&D costs, that knowledge is not likely to fall out of favor anytime soon in American business circles.

Bottom line

• The supply chain for the indespensible notebook computer has its roots in relationships.
• Companies doing business in China are disadvantaged if they do not understand the age-old notion of guanxi — a network of close, mutually beneficial interpersonal relationships.
• Guanxi lends flexibility to the laptop supply chain that enables companies to manage customer-responsive services like Dell's famous "direct by Dell" model.