Something Not to Like About Sara Lee?
The virtualization of the
American corporation proceeds apace. Inform the gods of re-engineering and
outsourcing that another convert has been won. Two weeks ago, Sara Lee Corp.,
the venerable manufacturer of baked goods, Jimmy Dean sausages, Hanes T-shirts,
Kiwi shoe polish, Brylcreem and, yes, the Wonderbra, announced that it would be
divesting itself of its manufacturing operations to become a company whose main
business was the marketing of its brands. Others could make the products. Sara
Lee just wanted to make them popular.
Investors' reaction to the announcement was immediate and positive,
unsurprising since the decision fit nicely with current thinking on the
importance of leanness and farming out production. Underlying Sara Lee CEO John
Bryan's avid embrace of what he called "de-verticalization" was a confused
combination of reasonable assumptions, misplaced analogies, and an overwhelming
desire to cater to Wall Street's desires--all packaged with the obligatory
rhetorical appeal to the demands of the market.
In thinking about "de-verticalization" the most obvious
risk is succumbing to nostalgia for the days when companies "actually made
something." When Henry Ford first constructed the mammoth River Rouge and
Highland Park complexes, where automobiles were essentially built from scratch,
those factories seemed to many to be symbols of the exaltation of efficiency
over all other goals. Now, with the onset of outsourcing, globalization, and
the virtual corporation, those old factories have acquired a patina of humanist
authenticity they could not have had in their own time. (Assembly-line work,
after all, was seen as replacing the "real" production of skilled
laborers.)
Nostalgia,
though, tends not to be very useful in understanding either the past or the
present. Bryan's rhetorical question--"What is a product and what makes a
product?"--is a good one. In Sara Lee's case, the product is not just the
physical snack cake or shoe polish. The product is that cake with the Sara Lee
name attached or the shoe polish with Kiwi on the cover. And if what Sara Lee
can do best is make those products more desirable by making those names more
desirable, it's hard to argue that anyone would be better off with the company
pursuing the Fordist dream. The idea of comparative advantage applies to
companies and individuals as well as to nations.
For all that, however, there's a lot of smoke
being blown about Sara Lee's restructuring in particular and about the supposed
evils of vertical integration in general. Press accounts invariably suggested
that Sara Lee's divestment of manufacturing operations would free cash
"currently tied up in low-margin activities." "Slaughtering hogs and running
knitting machines are businesses of yesterday. And they have low returns,"
Bryan said of those operations. But it only makes sense to speak of low returns
and low margins if you're making products to sell to others.
Sara Lee
doesn't run knitting machines to sell fabric to other companies. It runs them
to supply the fabric it uses in its own products. And in theory, it should be
able to make that fabric for itself for less than it would cost to buy it from
a third party, because there will be no profit margin built into the price. The
margins are higher, not lower, than they will be after the knitting machines
are sold. That was one of the crucial appeals of vertical integration: It cut
out the middleman. It's possible, of course, that a company that specializes in
making fabric will be able to do it more efficiently, so that even with the
markup Sara Lee will still come out ahead. But Sara Lee is the third-largest
textile producer in the United States. It seems safe to assume that, by now,
it's figured out how to knit efficiently.
Vertical integration does mean that you need to invest
heavily in fixed assets and then keep investing in upkeep and upgrades. If you
can avoid those costs and still make the products you want at a reasonable
price, you're ahead of the game--which is why Coke makes syrup and not bottles
and Nike contracts out all its manufacturing to hungry Third World workers. (If
the ethics of outsourcing abroad bother you, read Slate's "In Praise of Cheap
Labor," by Paul Krugman.) But vertical integration also offers major
benefits. It keeps you from having to haggle with suppliers over prices, gives
you total supervision over quality, and allows you to control production. One
of the key impetuses for General Motors' push for vertical integration, for
example, was its perennial struggle with Fisher Body, a major supplier who kept
holding up GM for price increases. Once GM acquired Fisher, the problems
stopped.
Today, of
course, it's hard to find anyone who will defend vertical integration. But
that's essentially the product of two factors, neither of which has anything to
do with vertical integration per se. The first is American business's newfound
assurance that competition is the necessary progenitor of efficiency. Since
vertical integration replaces the market with the firm--that is, the company
makes the product instead of allowing others to bid for the chance to make
it--it must be a mistake, for we know the market's decisions are always right.
The second, more important, factor is the experience of the U.S. auto industry
in the late 1970s and early 1980s. Since the Big Three automakers' move toward
more outsourcing and less in-house parts production has coincided with their
return to profitability, it has seemed logical to pronounce vertical
integration an idea whose time came and went.
The problem with this logic is that the auto
industry abandoned vertical integration for one reason: labor costs. The Big
Three didn't give up on it because of just-in-time manufacturing or Japanese
business models or a desire to focus on the brand. They did it because they
didn't want to pay union wages when they didn't have to. Outsourcing parts
production means that instead of paying a United Auto Workers member $45 an
hour in wages and benefits, Chrysler can buy parts from a nonunion firm paying
its workers $14 an hour. Even with the supplier's profit built in, Chrysler's
still getting a bargain. But it's hard to see how this lesson applies to
industries or companies--like Sara Lee--that aren't dealing with the UAW or the
United Steelworkers.
The
really disconcerting thing about Bryan's decision, though, is that it seems so
blatantly to be more about gaining the favor of Wall Street than about
improving the performance of the company. Sara Lee has been a terrific
bottom-line company for the last three years, but its stock price has not risen
as sharply as its competitors'. In his post-announcement interviews, Bryan was
blunt about how much this bothered him. "It is increasingly obvious," he said,
"that the investment community does not like asset-intensive companies."
What the investment community does like is short-term
measures designed to boost share prices. So all the money from the sales of the
manufacturing operations, $3 billion, is going to a share buyback program,
which is to say that instead of being used to create new wealth, it will simply
be redistributed from the company to investors. That's not redeploying assets
to take advantage of what Sara Lee does best. It's redeploying assets to boost
the stock price.
At this point, of course,
that kind of maneuver should come as no surprise, since companies now seem to
spend as much time looking at the stock ticker as at their production lines.
But there is, nonetheless, something melancholic about it, and this is where
the lament about companies actually making products has real resonance. To give
up on River Rouge in order to build your brand is one thing. But to give up on
River Rouge to buy back shares? That's something else entirely.
