European Management Journal (2008) 26, 314 324

journal homepage: www.elsevier.com/locate/emj

The integrators new advantage The reassessment

of outsourcing and production competence in a global
telecom firm
Lars Bengtsson a,*, Christian Berggren b

a
vle, Department of Industrial Engineering and Management, SE-801 76 Ga
University of Ga vle, Sweden
b
ping, Department of Management and Engineering, SE-58183 Linko
University of Linko ping, Sweden

KEYWORDS Summary For a long time, the telecom equipment industry has been at the forefront of
Outsourcing; outsourcing and relocating production operations to contract manufacturing firms located
Production; in Asia and Eastern Europe. Recently, however, leading firms have begun to revise this
Integration; strategy, based on their recognition of the continual importance of technological leader-
Telecom; ship and integration capabilities. Using a case study of a key company, this paper explores
Ericsson the dynamics of outsourcing and production strategies in the telecom equipment industry.
One of the central aspects under study is the interaction of product development with
industrialisation and production. The paper analyses issues such as component standardi-
sation versus differentiation and technological integration, the value of deep integration
capabilities for cost reductions, and why production competence and the rapid industriali-
sation of products incorporating new technologies have acquired renewed importance,
despite the global trend towards lowest-cost locations.
2008 Elsevier Ltd. All rights reserved.

Introduction
I recently learned about some shocking (at least for
anybody in the telecom supply chain business) news
about Ericssons plans to insource some of their manufac-
turing especially of radio base station transceivers. . .. It
is shocking since everybody in the industry is actually
doing the opposite. . . As you may know, we at Nortel
actually went further than anybody else and practically
outsourced our entire supply chain to Flextronics and
* Corresponding author. Tel.: +46 26 648802.
E-mail address: lars.bengtsson@hig.se (L. Bengtsson).
within the next couple of years Nortel will have no man-
ufacturing sites. (Supply manager at Nortel, personal
communication, November, 2005).
In the debate about the structure of rapidly changing,
technology-based sectors such as the telecom equipment
industry, the disintegration, outsourcing and offshoring of
manufacturing and other non-core functions have been
seen as irresistible trends (Shi and Gregory, 2003, 2005;
Sturgeon, 2002; Arnold, 2000). According to a consensus
view, Western-based locations of these firms should con-
centrate on R&D, product development and marketing,
whereas manufacturing and supply management should
be outsourced to contract manufacturers, who are

0263-2373/$ - see front matter 2008 Elsevier Ltd. All rights reserved.
doi:10.1016/j.emj.2008.05.001
Outsourcing and production competence in a global telecom firm
increasingly relocated to low-cost sites in Eastern Europe
and Asia.
One major telecom company to follow this trend has
been Nortel. Ericsson, the leading system supplier of mobile
networks, has also moved in this direction. Underlying these
strategies was the assumption that key components in mo-
bile telecom networks, for example in the radio base sta-
tions, were undergoing a rapid process of standardisation.
Such a shift to a phase where efficiency is prioritised over
innovation would give generic contract manufacturers supe-
rior economies of scale in purchasing and production. The
PC industry was seen as the future model for the telecom
industry as well.
Based on studies in other fast-moving sectors, however,
researchers such as Christensen have cast doubt on the be-
lief in irresistible trends. Christensens analysis of the tatives at both corporate and business unit level in Sweden.
disk drive industry demonstrates the dynamic variation be-
tween periods of standardisation, when technological func-
tionality is good enough and competition moves to cost
and convenience, and other periods, in which new applica-
tions and customers increase the demand for technological
performance, which gives integrated equipment makers the
upper hand (Christensen et al., 2002).
Purpose
Inspired by Christensen, this paper revisits firm structures
and innovation dynamics in the telecom equipment indus-
try. Taking the industry leader in mobile networks, Ericsson,
as an example and using the framework developed by Chris-
tensen et al. (2002) as our theoretical lens, this paper will
analyse the dynamics of different outsourcing strategies.
In particular, we choose to focus on the roles of the indus-
trialisation process and of production in overall product
development. Whereas Nortel implemented full-scale out-
sourcing of production, Ericsson changed tack midway and
since 2005 emphasizes the importance of internal industri-
alisation competence, including high-volume production.
This shift has intrigued actors in the global telecom industry
and prompts a reassessment of conventional wisdom.
The case will illuminate the dynamics involved in
achieving cost advantages through specialisation on the
one hand, versus the need for innovation capability based
on integration, on the other. In contrast to our initial
expectations, it turns out that in the rapidly changing high
tech areas we are studying, these pressures are converg-
ing in the same direction. Thus, the case illustrates the
advantages of being a deep system integrator even in
situations where there are plenty of cost-efficient con-
tract manufacturers available worldwide. Furthermore,
the case provides several arguments as to why production
capability is still highly valuable in high tech innovation
processes.
Methodology
The analysis presented in this article is based on a case
study approach combining comparative and longitudinal as-
pects. First we compare two companies at one point in
time; and second we compare strategies at one of these
companies at two points in time. The longitudinal perspec-
315
tive, inspired by Van de Ven and Huber (1990) and Leonard-
Barton (1990), is a key aspect of the paper, shedding light on
strategic changes in production and outsourcing strategies
and their rationale which would not be possible to uncover
in a single-point comparative study.
The first interview round took place in 2002 and was de-
signed as a comparative case study, where we focused on
the outsourcing and production strategies in the network
divisions of Ericsson and Nokia. These two cases were cho-
sen while they represented two contrasting approaches to
outsourcing. Besides enhancing the validity this method is
recommended for building theory from cases as it more
clearly highlight the differences of the studied phenome-
non (Yin, 1994; Voss et al., 2002). We formally interviewed
individually over ten Ericsson managers and union represen-
Of these were four sourcing and supply managers, one man-
ager of product introduction, two production managers and
several union representatives. At Nokia in Finland we inter-
viewed two production managers, one general sourcing
manager and two union representatives. In addition to
these sources, we made use of non-public material such
as consultant reports as well as official reports and com-
pany documents filed at the US Security and Exchange Com-
mission. The comparison offered an opportunity for a more
fundamental discussion of outsourcing than the narrow fo-
cus on implementation prevalent in the literature at that
time. To validate the data we sent it back to the intervie-
wees for corrections. The ensuing working report, later
elaborated in Berggren and Bengtsson (2004) was exten-
sively discussed with among both the company
representatives.
In 2005 and at the beginning of 2006, we got the oppor-
tunity invited to revisit Ericsson and meet managers and ex-
perts in sourcing, supply management and business
structure at the corporate level. In this study we chose
not to include Nokia Networks, since it basic productions
strategies were basically unchanged.
This opportunity was triggered by a re-evaluation of pro-
duction and sourcing decisions, which had recently taken
place within the company. In this longitudinal case study
round we formally interviewed two sourcing managers and
one supply management expert at corporate level, two sup-
ply managers and two production managers at business unit
level. We essentially repeated the same questions on the
motives, strategies and effects of outsourcing which we
had investigated in the first round. In addition, we asked
the respondents to explain how and why the company had
re-evaluated their strategies. The answers were again
checked by sending them back to the interviewees. Using
this approach allowed us to systematically analyse the
changes in both arguments and managerial actions over
time. Additional information on Ericssons outsourcing and
production strategies has been provided in discussions with
company representatives at research seminars and courses
held at our Universities during 2006 and 2007. The inter-
views have been complemented with official corporate
information as well as internal information and analysis on
changes of the industry structures. Because of the sensitive
nature of the issues, and the competitive market situation
some precise figures and details on components are not
disclosed.
316
In this paper we disregard business cycle variations and
focus on the long-term perspective, comparing previous
and current motives and actions connected to the outsourc-
ing of production. This comparison allows us to further
understand the factors of importance in this context, in par-
ticular the interface between product development and
production.
Outsourcing imperatives vs integration
advantages
Since the 1990s there has been a strong trend towards out-
sourcing in Western companies (Outsourcing Institute, 2005;
Quelin and Duhamel, 2003; Kakabadse and Kakabadse, 2002,
2005). Although the initial focus of outsourcing was IT man-
agement, it is now used for a variety of activities, including
core processes such as product development (Quinn, 2000)
and production (McIvor, 2005; Bryce and Useem, 1998).
Globalisation and the emergence of high-growth, low-cost
economies in Eastern Europe and Asia have resulted in out-
sourcing increasingly meaning geographical relocation and
offshoring.
In this article we define outsourcing as the process when
an internal activity, in our case production, is transferred to
an external supplier (cf. Gilley and Rasheed, 2000). Insourc-
ing is the opposite process, i.e. the re-internalisation of for-
mer outsourced activities (cf. Caputo and Palumbo, 2005).
In line with GAO (2004), we distinguish outsourcing from
offshoring. Outsourcing means externalising production
activities to external suppliers. Offshoring refers to sourc-
ing from an internal or external source located abroad.
The focus in this paper is on outsourcing of production at
Ericsson. Due to supplier relocation, this has increasingly
also become the same as offshoring.
There are a number of motives for outsourcing produc-
tion. One is the expectation to reduce costs and invest-
ments. Another motive is that outsourcing enables a
company to focus on core competencies, and to learn from
innovative suppliers (Outsourcing Institute, 2005). At the
same time, experience from advanced production and prod-
uct development processes indicates that there are advan-
tages in integrating and co-locating key processes, when a
company is striving for both cost efficiency and innovation
capability (cf. Ulrich and Ellison, 2005). In the following sec-
tion we will discuss this ambiguity further by presenting the
various results concerning the effects of production out-
sourcing on costs and on innovation capability reported in
the literature.
Moreover, since the case is related to the transformation
of the telecom equipment industry, we will also discuss how
industry dynamics affect motives and decisions on outsourc-
ing and vertical integration.
Cost driven outsourcing
Cost reduction is a main driver and motive for outsourcing.
By outsourcing, the principal company wants to avoid
investment in production facilities, to free resources and
to take advantage of the suppliers economies of scale
and lower labour costs (Beaumont and Sohal, 2004; Out-
sourcing Institute, 2005). Despite its popularity, however,
L. Bengtsson, C. Berggren
the outsourcing of production seems to have ambiguous ef-
fects on costs and firm performance. Several authors claim
a positive relationship (e.g. Gorg and Hanley, 2005) while
others report no significant relationship between outsourc-
ing and performance (Laugen et al., 2005; Mol et al.,
2005; Gilley and Rasheed, 2000).
Transaction cost economics (TCE) has been a popular
framework to analyse the motives and effects of different
types of outsourcing. According to this theory, assets and
competencies with high specificity tend to be deeply
embedded in existing routines and should be kept in house.
Assets with low specificity could be outsourced. High risks of
supplier opportunism make it more costly to externalise the
activity, and visa versa (Williamson, 1975). In line with TCE
assumptions, some studies indicate that separating activi-
ties with high specificity has negative impact on perfor-
mance (Murray et al., 1995; Poppo and Zenger, 1998). In
other cases, perceived cost advantages are consumed by
additional transactional costs, such as logistics costs for
longer transports and increased stock, longer lead-times
and risks of delays in delivery and market introduction.
There are also costs for managing the transfer of products,
knowledge and equipment to the outsourcing partner (Har-
land et al., 2005; Hendry, 1995). These additional costs
could reduce the expected benefits significantly (McKinsey,
2005; Jackson et al., 2001). The trade-off is well summa-
rised by Mol et al. (2005) who conclude that outsourcing is
a balancing act between lower manufacturing costs abroad
and lower transaction costs locally.
Outsourcing as a vehicle for innovation
There are also arguments for outsourcing which stress the
link between outsourcing and innovation. One is that out-
sourcing may free resources from non-core activities, and
that these resources could then be spent on innovation
activities (Medina et al., 2005). This strategy is presented
as a means to allow a company to focus on its core com-
petence, which could increase its ability to implement fast
product development (Harland et al., 2005). Another inno-
vation argument is that outsourcing for market reasons
may open up for new product and services (Loch et al.,
2007). Further, it is argued that by outsourcing, firms
can get access to new competencies at partner companies
and in this way build new innovation capabilities (Loch
et al., 2007; Baden-Fuller et al., 2000; Quinn, 2000; Quinn
and Hilmer, 1994). This idea refers to the fact that ad-
vanced technological products are increasingly developed
in inter-organisational processes, and involve webs of geo-
graphically dispersed firms and production sites (Brusoni
et al., 2001). Thus, when their products incorporate a
range of technologies, to be competitive firms have to rely
on external partners. Some studies claim that external
cooperation and partnering relations with outside special-
ists may be as efficient for innovation and knowledge cre-
ation as internal processes (Dyer and Nobeoka, 2000). In
this wider context, the significance of production compe-
tence for innovation and competitiveness has been ques-
tioned and it has been suggested that product
development could be completely separated from produc-
tion (Arnold, 2000).
Outsourcing and production competence in a global telecom firm 317

There are, however, other factors which call the overall which are based on increasing levels of standardisation
rationality of extensive outsourcing into question; factors (Utterback, 1994). The standardisation of interfaces and
calling both for a reinterpretation of the basic idea of core modular product architecture make it possible to decom-
competence and for a new look at the needs for successful pose products into independent subsystems which are easier
knowledge integration. to outsource to external actors (Sanchez, 1995; Baldwin and
Clark, 1997; von Hippel, 1990). Strebel (1996) has added to
this understanding by describing industry changes as an evo-
Integration needs and advantages of internalising
lutionary cycle, characterised by one innovation phase in
production which firms compete by providing divergent customer val-
ues and one convergent phase in which competition focuses
In the literature, the general effects of outsourcing on
on efficiency. The shift between the two phases is called the
firms innovation capability are not clear (Smith et al.,
breakpoint. One indicator for a breakpoint, leading to the
2007). This has several explanations. First, it seems impor-
start of a convergent behaviour is an increase in the similar-
tant to distinguish outsourcing driven by cost motives from
ity of products and services on the market. The breakpoint
outsourcing driven by innovation motives. Some studies
for divergence is harder to anticipate, but can be triggered
indicate that outsourcing for cost reasons may damage the
by declining growth rates which induce increased experi-
industrialisation and innovation capability of the firm (Dank-
mentation, or technological breakthroughs, which attract
baar, 2007; Berggren and Bengtsson, 2004). Similarly, Plam-
new entrants.
beck and Taylor (2005) argue that although contract
A fundamental basis for distributed innovation is special-
manufacturing may help to improve capacity utilization
isation through standardisation and product modularisation.
and thus lower costs, it may also weaken the incentives
Inversely, when product interfaces are insufficiently de-
for innovation by shifting the focus from innovation to costs.
fined, there is a need for an interactive technical dialogue
Secondly, outsourcing represents a learning dilemma. In the-
between research, development, production engineering,
ory, outsourcing may open doors to external expertise and
etc. and it is argued that these organisational interfaces
support inter-firm learning processes. Several studies, how-
are best internalised (Ulrich and Ellison, 2005). Several
ever, point out that organisational fragmentation and a loss
studies indicate that for complex and rapidly changing prod-
of critical internal skills, such as process expertise or the
ucts, such integration capabilities are crucial, i.e., capabil-
architectural knowledge needed for effective sourcing,
ities to rapidly industrialise and market the new products,
make it difficult to realise this innovation potential (Stur-
and the knowledge to make proper sourcing decisions (Stur-
geon, 2002; Hoecht and Trott, 2006). These risks are partic-
geon, 2002; Ulrich and Ellison, 2005).
ularly prominent in cases when systemic or interdependent
Christensen et al. (2002) and Christensen and Raynor
innovations are involved (Chesbrough and Teece, 1996).
(2003) further explore these dynamics. They show how com-
The leads us to the need for a re-interpretation of the
peting on standardisation, low cost and customer flexibility
core competence model (Prahalad and Hamel, 1990), as it
relates to disintegrated industrial structures, while compet-
has been used in practice. The core/non-core distinction
ing on innovation and product functionality calls for close
has often been used to justify whether an activity should
personal communication and integration of key functions
be nurtured internally or externally. According to this line
like research, design, production and marketing. The logic
of reasoning, activities defined as non-core become candi-
behind this is as follows: In sectors where functionality is
dates for outsourcing. Firm competencies, however, are of-
not good enough, firms compete on technology and more
ten systemic, i.e. there is a dependency between core
advanced products. In order to be at the forefront, product
competencies and those competencies which support the
architects do not use industry standards but prefer interde-
core. This means that a firms ability to exploit its core com-
pendent architectures, which demand an unstructured tech-
petence may be damaged if everything defined as outside
nical dialogue between various specialists. The transaction
the core is outsourced. The problem is further aggravated
costs are minimised through integrating and colocating de-
by the fact that competencies are dynamic. Due to techno-
sign, production and procurement. In contrast, in sectors
logical and market changes, the core of today may be non-
where functionality is more than sufficient, firms compete
core tomorrow, and vice versa.
by means of speed, flexibility and customisation. Product
Compared to those studies, which focus on outsourcing,
architectures evolve towards modularity, enabling specia-
few have explicitly analysed the opposite phenomenon,
lised and non-integrated providers to succeed, because
the processes of insourcing and integration. One way of dis-
structured technical dialogues have minimised transaction
tinguishing the motives for insourcing is to simply look at
costs.
the arguments against outsourcing, such as low capacity uti-
As noted above, there is a tendency that over a long per-
lization, loss of competence, increased dependency on sup-
iod industries evolve from integrated firms towards non-
pliers and reduced control over business processes (e.g.
integrated and specialised structures (Utterback, 1994).
design and production) (Caputo and Palumbo, 2005).
However, many industries also display a cyclical pattern
(Strebel, 1996). In their study on the disc drive industry,
Industry dynamics Christensen et al. (2002) noted that occasionally perfor-
mance gaps occur, and this is revealed by an increased cus-
The outsourcing internalising dilemma may also be ana- tomer demand for functionality. When this happens, the
lysed from the perspective of industry dynamics. Product need for managerial and technological reintegration in-
life cycles are typically characterised by a shift in focus creases. Christensen et al. (2002) concluded: if they con-
from functionality to process efficiency and cost reduction, sciously and capably manage the swings between
318
interdependence and modularity, integrated firms ought to
have long-term performance advantages over non-inte-
grated firms.
To sum up, on the general level there seems to be justi-
fications for both outsourcing and internalising production
processes. Thus, there is a need for more differentiated,
sector-level studies taking the possibly cyclical nature of
industry dynamics into account and asking questions such
as: When, under what circumstances, is the standardisa-
tion/separation logic prevalent? When will integration
advantages carry the day? In this paper we address these is-
sues by taking a closer look at the changing perception with-
in the Ericsson Company of the significance of production
competence for the innovation processes during the 2000
2005 period.
Outsourcing production in the global telecom
equipment industry two contrasting models
Disintegration, outsourcing and the offshoring of manufac-
turing have characterised the global telecom equipment
industry since the late 1990s. Original equipment manufac-
turers (OEMs) of network products, such as Ericsson, Nokia,
Alcatel and Nortel, have turned to contract electronics
manufacturers like Flextronics, Sanmina-SCI and Solectron
for the assembly of modules and subsystems. This has re-
sulted in a dramatic growth in the industry for electronic
manufacturing services (EMS). In the supposedly maturing
telecom sector, those firms who serve several different
OEM-customers, have been perceived to possess superior
production efficiencies and economies of scale in purchas-
ing. Suppliers of components, e.g. integrated circuits and
processors, constitute a third important actor, not to be
confused with the contract manufacturers. These compo-
nent suppliers provide key technologies and auxiliary sub-
systems to both OEMs and contract manufacturers. In this
paper, our focus is on the outsourcing relations between
OEM and EMS firms, who together form emergent global
manufacturing networks (Shi and Gregory, 2005).
The general trend to outsource production to EMS-firms
has been supported by a view modelled on the computer
industry, according to which future OEM competitiveness
requires a focus on core activities such as product develop-
ment and marketing, while at the same time letting go of
production and supply chain management (Arnold, 2000).
The growth of the manufacturing services (EMS) sector
started when EMS companies took over the responsibility
for manufacturing plants in stagnant technology segments,
such as equipment for fixed networks (Shi and Gregory,
2003, 2005; Lindroth and Ha nstrom, 2002). Gradually, these
companies have built capacity for global sourcing and coor-
dination of the purchasing activities of their local plants.
During recent years contract manufacturing firms have
started to move up the value chain, not only offering pro-
duction capacity, but also industrialisation and design capa-
bility, as well as responsibility for supply chain logistics. A
similar development within consumer electronics has low-
ered the barriers for new entrants (Shi and Gregory, 2005;
Fraser et al., 2005) making it possible for OEMs without
manufacturing knowledge to enter the market by exploiting
the existing structure of contract manufacturers. All these
L. Bengtsson, C. Berggren
factors indicate that there is an increasing specialization
and de-integration, which explains the decision referred
to in the initial quotation we at Nortel actually went fur-
ther than anybody else and practically outsourced our en-
tire supply chain to Flextronics and within the next
couple of years Nortel will have no manufacturing sites.
All OEM-firms did not go down the same route however,
and it turned out that industry dynamics were more cyclical
and less linear than assumed in the PC-model view. In the
following we will discuss the routes chosen by Nokia and
Ericsson and why Ericsson changed tack at around 2005.
Two outsourcing models
In 2004, North American Nortel Networks decided to take a
decisive step. As part of its strategy to focus on areas which
can provide true competitive differentiation the com-
pany announced its intention to divest substantially all
of its remaining manufacturing activities, including product
integration, testing, and repair operations, including the
management of the supply chain and related suppliers
(Light Reading, 22 January 2004). A few years earlier, the
Ericsson network division had opted for a similar outsourc-
ing logic. After having outsourced plants making modules
and components for the stagnant fixed network business,
Ericsson decided to apply the same solution to its bleeding
mobile phones division. A strategy of disintegration was also
developed for the companys core product sector: mobile
network equipment. According to the year 2000-version of
this strategy, product design, test development and the
industrialisation of radio modules and complete radio base
stations were to be retained as core competencies. All other
volume production was to be outsourced.
Not all companies took this restructuring route, how-
ever. In a comparison between the Nordic competitors
Ericsson and Nokia in 2002, we could discern the two differ-
ent outsourcing models illustrated in Figures 1 and 2. One
model could be described as the Horizontally Integrated
Model, which means that the OEM firm and its suppliers
are each responsible for selected modules during the entire
product life. The OEM maintains strategic modules and pro-
cesses in-house: first and foremost the manufacturing of
transceiver units (the heart of a radio base station) and
the majority of the assembly and testing of complete radio
base stations. Modules viewed as non-strategic are sourced
from selected system and component suppliers with whom
the OEM is working intimately. To safeguard overall flexibil-
ity and high levels of capacity utilization in its own plants,
the OEM also utilizes contract manufacturers as capacity
providers.
The contrasting model could be called a Vertically Di-
vided Model. In this model, the product-owning company
takes care of industrialising strategic modules and systems,
while contract manufacturers are in charge of basically all
volume production. At the end of the industrialisation pro-
cess, a transfer project is set up to convey product and pro-
cess knowledge and production technology, including
dedicated test systems, to the selected contract manufac-
turers. As Figure 2 illustrates, it is a composite model which
is both horizontally sliced and vertically divided. Key mod-
ules, as well as the testing system and the product as a
whole, are developed and industrialised in-house, and then
Outsourcing and production competence in a global telecom firm 319

Capacity suppliers (EMS)

Product-owning company (OEM):

Product Core components, tests,final
development assembly and entire system
Radio base
stations
Systemand component suppliers:

e.g.Integrated circuits, servers, filters,

combiners,power units,cabinets, etc.

Industrialisation Volume production Phasing out

Figure 1 A horizontally integrated model of outsourcing.

Contract manufacturer:
Product Strategic components,tests and
c
Tran
sy fina egi

development complete station After sales

ire s, at
ste l

sfer
nt st tr

Radio base and repair

m
,e ,te y: S

stations
bly ts n
m en pa

System and component suppliers:

se on m
as mp t co
co duc

e.g. IC, computer, signal cards

o
Pr

power units, climate, mechanics

Industrialisation Volume production Phasing out

Figure 2 A vertically divided model of outsourcing.

transferred to contract manufacturer firms. For non-core
modules, system suppliers are also responsible for the
industrialisation.
The vertically divided model applied by Ericsson around
the year 2000 was justified by four main arguments, in
accordance with specialisation logic:
 Cost advantages. By collaborating with high-volume con-
tract manufacturers, the company expected product cost
to be reduced significantly.
 Increased flexibility and reduced risk over-capacity in a
turbulent global industry.
 Capital advantages. In a booming market the outsourcing
model would enable rapid output expansion with small
investments.
 Focus on core competencies. Assuming an increasing
degree of component standardisation, it was argued that
Ericsson, as a knowledge company, should focus on
product and technology development and not on non-dif-
ferentiating production processes.
We are no longer outsourcing: rethinking
outsourcing and investing in manufacturing
For several reasons the vertically divided outsourcing model
was never fully implemented at Ericsson. One reason was
the disastrous downturn in the telecommunications market
in 20022003, which meant that no extra manufacturing
capacity was needed. To safeguard internal capacity utiliza-
tion in this downturn, Ericsson maintained substantial vol-
ume production in house. This, however, was not the only
factor at play. When we revisited the sourcing strategy at
Ericsson in 20052006, we encountered a new perspective
on the dynamics of the telecom equipment sector, related
to standardisation and industrialisation capabilities. As the
Nortel manager above observed, Ericsson had indeed
started to re-evaluate the significance of having manufac-
turing competence and volume production in house.
At this time, Ericsson had decided to insource production
activities from low-cost regions in Eastern Europe to its
Swedish plants. This decision was motivated by operational
factors, such as a need to fill up free internal manufacturing
capacity, and a dissatisfaction with the quality and produc-
tivity of a particular contract manufacturer. At the same
time however, the company had begun a more general reas-
sessment of the values of outsourcing and in-house produc-
tion competence. In the revised outsourcing strategy
espoused by our Ericsson interviewees, integrated industri-
alisation and manufacturing capabilities were to be kept
in-house, including volume production of core modules such
as radio units and the assembly of complete radio base sta-
tions (node production). The basic idea was to have one ma-
jor node production plant in each of the companys three
supply chains, serving Europe, America and Asia, respec-
tively. At the time, two key units, located in Sweden and
China, combined competence in industrialisation with vol-
ume production capacity. The share of in-house production
had increased and amounted to about 40% of the products
designed by Ericsson.
We are no longer outsourcing. The long term contracts
are running out and we have not planned to prolong them,
remarked a senior supply chain specialist in October 2005.
This did not mean an end to outsourcing, however, rather
it implied an open-ended position where both in-house pro-
duction and outsourcing were possible.
320
The rebalanced sourcing strategy is similar to the inte-
grated model depicted in Figure 1. This means that Ericsson
seeks to maintain control over the entire process from spec-
ification, design and industrialisation to the production of
core modules and final assembly. The production of core
modules is located so as to maximise economy of scale
and is to be close to R&D. Ericsson collaborates intimately
with system and component suppliers, who produce various
modules such as filters, computers, cabinets, etc. Advanced
Application Specific Integrated circuits (ASICs) are designed
by Ericsson but produced by independent manufacturers in
Asia. The EMS companies are to a large extent used as
capacity manufacturer for increased volume flexibility,
rather than as fully-fledged manufacturing service compa-
nies responsible for production, industrialisation and de-
sign. The modules and sub-units produced by the EMS
companies are mainly industrialised in Ericssons master
plants in Sweden and China.
The motives given at Ericsson for reducing outsourcing
levels and upgrading its internal production concerned gen-
eral price and risk considerations, but also included the
importance of having integrated industrialisation capabili-
ties to enable the Company to pursue further cost
reductions.
The expected cost advantage of outsourcing
decreases
In the period studied, 20002005, while price competition
had increased the cost advantage of outsourcing production
had decreased. One reason had to do with the size of trans-
fer costs. Ex-post cost analysis within Ericsson showed that
hidden costs for the transfer projects, including increased
logistics and lead times, and costs for risk elimination dra-
matically decreased the benefits of lower wages and mate-
rials at the EMS-firms. According to Ericsson experience, the
transfer costs alone could amount to as much as 2025% of
the product costs. This figure corresponds to cost levels
estimated by other studies (McKinsey, 2005; Harland
et al., 2005; Jackson et al., 2001).
According to corporate analysts at Ericsson, there were
also other reasons for questioning previous cost arguments
in favour of outsourcing. One of these reasons was that
low labour costs had become less important. The miniaturi-
sation and integration of electronic components, in combi-
nation with automation technology, had reduced the work
content and its relative costs compared to material costs.
Table 1 provides a comparison of the costs for producing a
typical radio base station module in three different loca-
Table 1 Comparison of cost structure for producing a typical module in 2005. Aggregation of Ericsson data
Ericsson unit in Sweden (%)
Material and components 86.4
Production 5.8
Material handling 3.9
Tests 3.9
Profit 0 5.3
Sum 100
L. Bengtsson, C. Berggren
tions: an Ericsson unit in Sweden (index 100%), an EMS unit
in South America and an EMS unit in Asia.
In the automated production units in Sweden, the costs,
which add value (sum of production, material handling and
tests) amount to about 14% of total costs, of which roughly
half is wages. The corresponding sum is 23 times higher in
the more manual EMS-plants located in so-called low-cost
countries. The EMS profit adds to the total costs for
Ericsson.
Another reason for the increased emphasis on internal
capabilities in our Ericsson interviews in 20052006 con-
cerned standardisation. Around the year 2000, the company
had expected a rapidly increasing share of standardised
components in its radio base stations. This would have given
the EMS-firms a clear cost advantage due to their bigger pur-
chasing volumes. But contrary to these expectations, stan-
dardisation measured in terms of component value
had actually fallen. The material costs for all purchased
electronic components and subsystems in a radio base sta-
tion constitute a dominant share of its total cost, amounting
to 80% or more. In 2005, the proportion of Ericsson-specific
components (designed and/or specified by Ericsson engi-
neers) amounted to 85% of the total material costs com-
pared to 80% five years earlier. The shrinking share of
standardised items in this bill of materials significantly re-
duced the economies of scale in purchasing that the EMS
manufacturers were supposed to enjoy (Figure 3).
When standardisation is low, manufacturers of compo-
nents (processors, memories, etc.) are eager to get OEM-
firms such as Ericsson, to design-in their components. This
gives Ericsson a bargaining advantage that EMS firms do
not have. As a result of all these factors, in 2005 only 2
3% of the purchasing volume had been entrusted to the
EMS firms.
The significance of integrated processes for cost
rationalisation
In order to industrialise effectively you need volume pro-
duction competence, a sourcing manager at corporate le-
vel observed in an interview in January 2006, reflecting the
new significance Ericsson attributed to manufacturing com-
petence and volume production. The plants in Ga vle, Swe-
den, and Nanjing, China, therefore incorporated capacity
both for industrialisation and full-scale production.
The shortening of product life cycles has made product
redesign increasingly frequent and important, both for
updating functionality and for using component integration
as a means to drive cost reduction. A company like Ericsson
EMS unit in South America (%) EMS unit in Asia (%)
86.4 86.4
15.0 20.3
3.1 5.4
2.8 7.7
6.2
112.5 126.1
Outsourcing and production competence in a global telecom firm
Profit
Profit
Value added Automation
decreases VA Value added
Standard Standard
components
Specific
components
increases
Specific Specific
components components
Present Future
situation situation
Figure 3 Changes in cost structure.
performs such product revisions once or twice every year.
One conclusion from analyses at Ericsson is that this poten-
tial is best realised when the company controls design,
industrialisation and production internally, making it a deep
system integrator. Physical proximity, integrated work
teams and comprehensive ICT support are all regarded as
integration mechanisms in this process. Integrated pro-
cesses have proven valid for cost reduction not only in com-
plex subsystems but also in simple components like closure,
due to increasingly stringent demands on rapid customer
adaptations.
When industrialisation and production are outsourced,
effective cost reduction slows down. Contract manufactur-
ers benefit from the general price reduction in electronic
components, but lack position or competence to redesign
and introduce new components by themselves (see Figure
4). Analyses within Ericsson (e.g. of transceiver units which
is a core component) reveal that the potential for cost
reduction by redesign and replacement of components
amounts to about 2025% of the total product cost for each
new product revision. This could be compared to the gen-
eral price index reduction in the industry of about 1% per
month (or 1012% per year), which is only half of the reduc-
tion based on product redesign. The ability to pursue such
product-based cost reduction aggressively is a clear advan-
tage for the integrated firms and the lack thereof a corre-
sponding disadvantage for disintegrated firms, which have
to depend on contract manufacturers.
Figure 4 The potential of cost reduction when redesigning
products compared to price index.
321
Rapid industrialisation crucial for developing
frontier technology
The importance of maintaining technological leadership
constituted a third motive for upgrading internal production
competence at Ericsson, although this was not entirely ex-
plicit in the interview answers. Several examples showed
the need for an integrated innovation process when devel-
oping frontier technologies, in spite of efforts to outsource
both development and manufacturing.
One example concerned the outsourcing of a digital plat-
form. Since industrialisation is closely related to volume
production capability, Ericsson experimented with out-
sourcing the entire industrialisation process to a contract
manufacturer. The partner satisfied the requirements, and
met its goals for time, costs and quality. After a few years,
however, Ericsson decided to insource the product. The
main reason was that the continued technological upgrading
of the product required proximity to the product develop-
ment functions and integration into the wider platform
development.
Another example concerned the use of total outsourc-
ing (design, engineering and production). To benefit from
a partners innovation capability, a black box model was
tested. This meant that Ericsson purchased a function (mod-
ule), where the entire development, design and production
was outsourced. While the outsourcing in itself satisfied
their demands, Ericsson nevertheless decided to insource
the module. A key reason was that it was too hard to syn-
chronise the continued development of this module with
the overall technological development at Ericsson. Thus,
this example demonstrated how outsourcing is dependent
on a stable system of standardised modules and interfaces.
Compared to the situation in consumer electronics or the
automotive industry, the technological development of
architecture and components in the telecom equipment
industry proceed at a much faster pace, especially within
the leading firms. Some peripheral equipment, such as
power supply units and climate systems, is standardised,
but all the core modules remain specific to the OEM-forms,
and are subject to frequent changes. This tends to make
outsourcing arrangements unstable.
Conclusion: reassessing the role of production
in the innovation process
Several observations, which demonstrate the dynamic bal-
ance between outsourcing trends and integration needs in
this industry, can be made from the case. Around 2000, it
was generally believed that the telecom equipment industry
would follow the conventional industry life cycle and enter
a process of rapid standardisation of key products and com-
ponents. This opened up the market for generic manufac-
turers who could provide both economies of scale and
low-cost locations. Ericsson and its competitors started to
sell out its plants and planned to divest all volume produc-
tion. These plans were implemented at Nortel, but never
fully realised at Ericsson, partly due to a dramatic market
decline.
The crisis gave the company time to reconsider its posi-
tion, and it was found that the idea of a radical shift to
322 L. Bengtsson, C. Berggren

PC industry logic was not materialising. Instead, stan-
dardisation actually decreased between 2000 and 2005,
leaving less room for generic manufacturers at the front
end of the industry. In this environment, a strategy to main-
tain industrialisation and production competence during the
entire product life cycle seems to give deep system integra-
tors such as Ericsson an advantage. The sourcing strategy
emerging in 2005 at Ericsson was guided by the following
arguments:
 Automation and a low share of standardised components
undermine the economies of scale for EMS-firms.
 Cost reduction based on the rapid introduction of new
OEM-specified components requires deep system integra-
tion competence, including industrialisation and manu-
facturing and strengthens the role of OEM capabilities.
 Black box outsourcing (both R&D and manufacturing) to
contract manufacturers may reduce module cost but
jeopardise platform synchronisation in a fast-changing
industry.
These arguments represent a shift from disintegration/
outsourcing logic to integration logic. The shift is summa-
rised in terms of costs, innovation and competitive priorities
in Table 2.
The arguments and shift in logic indicate that it is advan-
tageous for OEM-firms to retain comprehensive industriali-
sation and production capabilities. The choice to re-
internalise these competencies at Ericsson was based on
the companys leading role in technology, something which
provided the opportunity to drive component design (and
future standardisation). Firms competing on other parame-
ters may arrive at different choices. The framework devel-
oped by Christensen et al. (2002) partly explains these
industry dynamics. Christensen and colleagues found that
in rapidly evolving sectors, such as the disk drive industry,
competitive conditions may change direction, from technol-
ogy to cost and convenience and then again back to
technology. Such a change may support a process of
re-internalisation, since competing on the forefront of tech-
nology and functionality favours integrated processes and
companies. The case presented here demonstrates that
these ideas also apply to the telecom equipment sector.
Our findings can in two ways be contrasted to the argu-
ments of authors who stress outsourcing as a vehicle for
innovation (e.g. Loch et al., 2007; Baden-Fuller et al.,
2000). First, these authors tend to ignore the fact that the
technological interdependencies present in high tech sec-
tors like the telecom equipment industry, call for integrated
innovation processes (e.g. Dankbaar, 2007; Ulrich and Elli-
son, 2005). Second, they do not recognize that there are
times when insourcing is a strategic option for building inno-
vation capabilities. This alternative has been mentioned by
McIvor (2005) in his analysis of the outsourcing process, but

Table 2 Comparison of disintegration and integration logics

Disintegration logicexpectations
Costs
EMS-firms reduce costs
through low-cost location
and economies of scale
EMS-firms reduce material
costs through large
purchasing volumes
Contract manufacturing
enhances flexibility and
risk spreading and reduces
investments
Lessons learned from outsourcing Motives for new integration logic
Wage share less important Total cost and
due to automation productivity improvements are more
important than wage level.
Transfer costs are Rapid cost reduction requires integration
substantial. of product design production
Bargaining power only Component suppliers eager to negotiate
applies to standard directly with OEM-firms to get their
components components designed-in.
The share of OEM-specific
components increases.
Flexibility is not free. Control over the entire value chain is
Market volatility crucial. Contract manufacturer used
threatens EMS firms mainly as capacity supplier
productivity and profit.

Innovation
Focus on core competence, Disintegration makes The OEM firm needs integrated development
outsource non-core technology upgrading and processes to build innovation capability.
synchronisation harder
to achieve
Production is a Time-to-market is Production competence crucial for
non-differentiating process. increasingly important. an efficient innovation process

Competitive priority
Focus on cost and Industry dynamics are Focus on both innovation capability and
flexibility based on non-linear: competition cost reduction based on rapid product
modularisation and both on cost and redesign and industrialisation
standardisation functionality, falling
standardisation
Outsourcing and production competence in a global telecom firm
only in passing. Since our findings question the overall ratio-
nality of outsourcing, we believe that it would be fruitful to
analyse the relation between insourcing and innovation in
future studies.
As discussed above, there is considerable evidence in the
literature that general cost advantages promised by out-
sourcing are often reduced, or even dwarfed, by various hid-
den costs (McKinsey, 2005; Harland et al., 2005; Jackson
et al., 2001). These factors also apply in this case. The most
important finding, however, is that deep system integrators
enjoy an advantage in cost reductions based on rapid prod-
uct redesigns, an advantage not available to general con-
tract manufacturers. Thus, in contrast to the findings by
Christensen, the case demonstrates that in technology-
intensive sectors characterised by high clock speed, deep
integration capabilities are important for competing both
on functionality and cost.
The findings provide insights into why competence for
industrialising and manufacturing products incorporating
the newest technologies may acquire new importance for
Western firms, in spite of the global search for lowest cost
suppliers. In fast-paced industries, this capability could be
decisive for the overall innovation process. The case adds
complexity to the concept of distributed innovation, since
it illustrates the advantages of being deep system integra-
tors even in situations where there are plenty of high-vol-
ume contract manufacturers available worldwide. A
reassessment of beliefs in irresistible global trends may
have implications both for operations management and for
product development management.
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Lars Bengtsson is Professor in Innovation
management at the University of Ga vle,
Sweden. He currently leads a research pro-
gramme which focuses on the significance of
manufacturing competence, outsourcing
and integration strategies for continuous
innovation capability in industrial firms.
Christian Berggren is Professor in Industrial
management at the University of Linko ping,
Sweden and director for the KITE research
program, Knowledge Integration and Inno-
vation in Transnational Enterprise (http://
www.liu.se/kite). His current research
focuses on the competition for sustainable
vehicles in the automotive industry, and the
importance of integration competence for
combining complex technologies and
achieving effective industrialization.