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									LUCIANO CIRAVEGNA AND GIULIANO MAIELLI



Outsourcing of new product development and the opening of

innovation in mature industries: a longitudinal study of Fiat

during crisis and recovery.


    DRAFT VERSION – FINAL VERSION APPEARED IN International

Journal of Innovation Management, Vol. 15, No. 1 (February 2011) pp. 69–93

    Please reference accordingly.


ABSTRACT

     During the 1990s mature industries, such as car manufacturing, restructured their
production and innovation processes, changing from vertical integration to high outsourcing.
Open innovation is antithetic to vertical integration. Analyzing whether this restructuring
influenced the emergence of open innovation is an important step towards improving our
understanding of open innovation (Chesbrough and Crowther, 2006).
     During the 1990s Fiat, one the largest European car producers, increased the extent to
which it involved external firms in new product development (NPD). Unlike its competitors,
Fiat outsourced the NPD of core products, resembling the opening of innovation that ―radical
innovators‖ implement in high technology industry (Laursen and Salter, 2006, p. 137).
However, it failed to transition towards open innovation because its ―opening‖ to external
firms also entailed downsizing in-house NPD divisions, which caused a ―hollowing out‖ of its
knowledge (Becker and Zirpoli, 2003). The products developed through this system did not
perform well. After a dramatic decline in market shares, Fiat changed its NPD system: it
reduced outsourcing of NPD, whilst opening it to customers for the first time. This
contributed to the development of highly successful models, which fuelled Fiat‘s recovery
after 2004.
     The paper explains the Fiat case by looking at the drivers of its organizational changes
from a historical perspective. It argues that Fiat‘s cost-cutting routines, developed because of
its intangible specialization in small vehicles, explain why it opened NPD to suppliers but
failed to adopt open innovation. The case study is relevant for the study of open innovation
because it provides evidence of the relationships between outsourcing and open of innovation
in a mature industry that went through a profound process of restructuring during the 1990s.




                                                                                              1
1. Introduction



   Following Chesbrough and Crowther (2006), the literature on open innovation has

recently also started to focus on mature industries, as opposed to the high tech

innovative industries which initially inspired the emergence of this new innovation

paradigm. Open innovation is antithetic to the vertically integrated business model

that characterized mature industries, such as the automotive and white goods

industries, in the 1950-1980 period. Since the late 1980s mature industries have

moved towards highly fragmented and outsourced organizational models, such as

different interpretations of lean production (Freyssenet et al, 1998; Sako, 2004;

Womack et al, 1990). However, it is not clear yet whether and how the fragmentation

and de-verticalization of mature industries affected the emergence of open innovation

models. This paper explores the issue by providing a longitudinal analysis of Fiat‘s

case. It analyzes whether and in which way Fiat‘s increasing involvement of external

firms in new product development (NPD) during the 1990s affected its adoption of a

more open innovation model in the late 2000s.

Since the 1990s it has become common practice for original equipment

manufacturers (OEMs) such as car makers, to involve suppliers and consumers in new

product development (Bonaccorsi and Lipparini, 1994; Füller et al, 2006; Langner

and Seidel, 2009; Petersen et al, 2003, Takeishi, 2001). Until the 1990s Fiat combined

a closed innovation model for its core products with high supplier involvement in the

NPD of niche products. This was consistent with the profile of incremental innovators

in mature industries (Laursen and Salter, 2006, p. 137) and indeed with the strategies




                                                                                    2
of the majority of European car manufacturers.1 However, as part of a broader

strategy to respond to its crisis, between the 1990s and 2002 Fiat increasingly

involved suppliers in the design and engineering of core products for which the

company had effective capabilities, in particular, cars competing in the lower end of

the market which represented the bulk of its total output. By doing so, Fiat created the

opportunity for an early transition to open innovation, resembling the profile of

radical innovators of high tech industries (Laursen and Salter, 2006, p. 137). In this

sense, Fiat developed a NPD process that was more open than that of its competitors.

However, this radical opening of NPD did not lead to improved performance in

product development but to the contrary. The models developed were badly received

by consumers and Fiat‘s market shares declined until it partially reversed its NPD

strategy, reducing outsourcing of NPD for its core models and asking customers to

contribute (Table IV).

In order to explain 1) why Fiat diverged from established practices of other European

car companies by opening NPD in a more aggressive way, and 2) why that process

did not lead to an improved NPD performance, this study draws on previous work on

intangible specialization (Maielli, 2005b), which argues that Fiat‘s strategies have

been shaped throughout its history by routines designed to cut costs. Since Fiat‘s

management was more concerned about cutting costs than incorporating external

knowledge, the involvement of suppliers in the entire design and engineering of new

core products did not lead Fiat to adopt an open innovation business model, only to

extremely outsourced NPD. Fiat did not invest in the necessary organizational

structures to absorb and integrate external knowledge for the creation of new core

products. Instead, it cut in-house NPD teams and divisions, and by doing so came

1
 This is the case with Mercedes, Porsche, BMW and Audi-Volkswagen Sport Utility Vehicles and
with the New Mini for BMW.


                                                                                               3
dangerously close to ―hollowing out‖ its architectural knowledge (Becker and Zirpoli,

2003). Fiat‘s cost cutting priority, which emerged from its intangible specialization in

inexpensive compact cars, impeded it from transitioning to open innovation.

     The study also provides evidence that Fiat changed strategy after 2003. On the

one hand, the company internalized large shares of design and engineering of core

products in order to profit from its intangible specialisation in small cars and regain

control of architectural knowledge. On the other hand, it opened the NPD of core

models to customers, and continued to involve suppliers to provide designs, ideas and

components. Models developed under this less outsourced, yet more open, innovation

model, such as the Panda, Grande Punto and the 500, were developed at a faster pace

than in previous years, and were also very well received by European consumers.

     The case study offers important insights into the difficulty of finding the right

balance between opening innovation and delegating it to external firms, between

leveraging knowledge from outside and eroding in-house knowledge and capabilities.

The paper suggests that finding that balance was a key factor in optimising

outsourcing in the 1990s as it has been a key factor in optimising open innovation in

the 2000s.

   This paper is organized as follows: section two discusses the literature on open

innovation and outsourcing, section three outlines the research methods, section four

outlines Fiat‘s NPD strategies since the 1950s, section five analyses Fiat‘s opening of

NPD and outsourcing of it to suppliers during the 1990s, then its adoption of an

partially open and less outsourced innovation model during 2000s. Section six

explains the drivers of Fiat‘s peculiar NPD opening strategy by looking at how it

developed its intangible specialization and how the latter came to affect the decision

making processes of the company.



                                                                                      4
   2. Literature review



   The literature on innovation originally featured two main streams (Brown and

Eisenhard, 1995), one addressing the relationship between innovation and growth, and

one focusing on organisational design and supply chain. Open Innovation has

emerged as a new stream that draws extensively on both but offers the possibility of

re-interpreting them. Open Innovation facilitates the flow of knowledge among

organisations, encouraging voluntary spin-offs as opposed to involuntary spill-overs

(Chesbrough et al, 2003, p. 5-12). As a paradigm, it helps to analyze the shift from

vertical integration and close R&D (Chandler 1990; Baumol 2002) to an open model,

where ideas and knowledge flow freely between organisations and individuals

(Chesbrough and Rosenbloom, 2002). Open Innovation entails a managerial

organization designed to scan external knowledge, optimize absorptive capacity

(Cohen and Levinthal, 1990), and disseminate knowledge (West and Gallagher,

2003). In this sense, Open Innovation represents ―the cognitive device that focuses on

the evaluation of R&D projects‖ (Chesbrough et al, 2003, p.9). It is antithetic to the

vertical integration paradigm, in which firm boundaries are a function of transaction

costs.

   Evidence of Open Innovation has been found mainly in innovative industries

(Chesbrough and Crowther, 2006) in which competing designs tend to emerge

continuously and radical innovators have an obvious incentive to ―draw deeply‖ into

external sources (Laursen and Salter, 2006, p. 137) to acquire technology for their

core products. On the other hand, mature industries tend to engage with the

incremental innovation of a standard design, while product knowledge is widespread



                                                                                    5
across the supply chain. Accordingly, incremental innovators tend to draw more

broadly but less intensively on external sources than radical innovators (Laursen and

Salter, 2006, p. 137). They involve suppliers but mainly for the production and

innovation activities that fall outside of their specialization, while developing their

core products internally (Laursen and Salter, 2006, p. 146).

   Open innovation is antithetic to the closed innovation processes that characterize

vertically integrated manufacturing before the 1990s. However, since the 1990s

mature industries have been through a dramatic process of restructuring characterized

by vertical disintegration of production and high outsourcing (Piore and Sabel, 1984 -

Harrison, 1994; Womack et al, 1990). It still unclear whether these changes in the

organization of production have also led to an opening of innovation processes. The

validity of open innovation as a paradigm would be strengthened if elements of it

were found in more mature industries where incremental innovation prevails, such as

the car industry (Chesbrough and Crowther, 2006).

   There is a rich literature that analyzes the involvement of external companies in

automotive NPD, correlating it with different measures of NPD performance. (see for

example Langner and Seidel, 2009; Takeishi, 2002). However, it is still unclear

whether the increasingly collaborative NPD (Takeishi, 2001) of the automotive

industry constitutes a step towards adopting open innovation, or only a form of

outsourcing of innovation activities. This longitudinal analysis of the Fiat case aims to

provide new evidence from one of the car makers that most aggressively outsourced

NPD (Becker and Zirpoli, 2003).

   The literature on open innovation illustrates that moving towards ―open

innovation‖ is not a simple or costless task. Unless OEMs adjust the organizational

structures in charge of NPD for the search of external knowledge, its absorption, and



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the sharing of internal knowledge with external actors, involving suppliers in NPD

does not lead to open innovation. The literature on automotive NPD, although starting

from a different perspective, provides a similar warning: involving suppliers in NPD

entails partitioning NPD tasks, which entails maintaining a highly sophisticated

knowledge of the architecture of products developed – architectural knowledge. If

OEMs over-delegate NPD, they may erode their architectural knowledge, which is

fundamental for NPD performance, as well as for adopting open innovation (Becker

and Zirpoli, 2003; Chesbrough and Rosenbloom, 2002; Takeishi, 2002; Von Hippel,

1990).

   The relationship between knowledge partitioning and architectural knowledge is

central to the literature on NPD (Brem, 2008; Takeishi, 2001, 2002) and, arguably, to

the literature on open innovation. Architectural knowledge is the OEM‘s ability to co-

ordinate task partitioning in NPD in order to develop problem solving

interdependence - as opposed to dependence - with its suppliers (Von Hippel, 1990)

Architectural knowledge affects an OEMs‘ ability to absorb external knowledge for

NPD and efficiently partition processes into tasks and to outsource the execution of

some of them. For this reason architectural knowledge is also essential for an OEMs‘

capacity to move towards more open innovation models. Loss of architectural

knowledge on the other hand can lead to problem solving dependence (as opposed to

interdependence) (Becker and Zirpoli, 2003).

   Since the 1990s Fiat has shifted from outsourcing NPD of non core products, to

involving suppliers in the development of new core products, and outsourcing to them

a rising share of the activities related to NPD. In this sense Fiat could have ―drawn

more deeply‖ from external sources in developing its core products, or in other words,

switched to an open innovation model. However, its accelerated outsourcing of NPD



                                                                                    7
and downsizing of in-house NPD divisions gradually eroded its own architectural

knowledge (Becker and Zirpoli, 2003).

    In order to explain how an OEM performs organizational changes, such as

opening innovation to external actors, it is helpful to look at its intangible

specialization – the relationship between its output structure and intangible assets

such as the routines underpinning process design and task partitioning (Maielli,

2005b). In line with Takeishi (2002, p 321) and Maielli (2005b) this paper argues that

task partitioning within the firm affects knowledge reproduction, which in turn affects

the way tasks and knowledge are partitioned outside the firm when an organisation

opens NPD.

   From the 1950s to the 1980s, architectural knowledge at Fiat was shaped by

routines designed to minimize costs (Maielli, 2005b) while NPD was highly

integrated. Cost-driven process design and task partitioning were better suited to the

small, low complexity cars that made up the largest output share. NPD of large and

sport cars was highly externalized. However, Prahalad and Hamel (1990, p. 84)

suggest that companies might unwittingly surrender core competencies to suppliers in

the quest for cost reduction and this happened at Fiat when it opened the design and

engineering of core products to suppliers. Drawing so deeply into external sources

was, in fact, not aimed at increasing quality and innovation rates, but rather at cutting

costs. This opening led to the erosion of architectural knowledge of core products and

to low competitiveness between the late 1990s and 2004.




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3. Methods and Data sources




The paper analyses NPD at Fiat through a longitudinal study of Fiat, drawing upon a

diverse range of sources that have allowed us to identify the early steps in the opening

of Fiat‘s innovation process, as well as the factors that drove these strategies. The

focus is not on the general innovation process of Fiat, but on the way it opened one

particular aspect of innovation: new product development.

We first collected information from archival sources and Fiat‘s official documents

(e.g. their annual reports) to evaluate the use of external sources in NPD that Fiat

made up to the 1990s, and also to assess the factors that influenced decision making

processes in its corporate history. Second, we collected information on Fiat‘s opening

of the innovation process to develop new core models (vehicles in market segments
                 2
A, B and C)          between 1990 and 2007, the period during which it declined and

recovered. Third, we collected information on market share of the products launched

during the crisis and recovery periods, which we used as a proxy to discuss how NPD

affected product performance. Last, we collected information on the NPD outsourcing

and opening of other European car manufacturers, in order to verify how consistent

they were with those of Fiat.

In order to verify how ―open‖ Fiat NPD was, we examined whether external firms and

consumers were involved and the type of products they helped to develop. In order to

analyse the link between the opening of NPD and the outsourcing of it to external

firm, we also gathered information from Fiat (and cross referenced it with the

information provided by providers of NPD services) on the percentage of the cost of


2
 Segment A = super compact cars, such as the Fiat Panda, B = compact cars, such as the Fiat Punto or
Ford Fiesta, C = mid-sized hatchbacks, such as the Fiat Tipo, Bravo or VW Golf


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NPD that was outsourced to external firms for each new core model developed

between 1983 and 2007 (Table I). The qualitative information provided by the

interviewees also allowed us to identify the reasons why Fiat opened its NPD to

external actors. External firms corroborated the accounts of Fiat‘s managers and ex

managers, explaining how Fiat used their competencies, and which priorities it

established with them. They confirmed that between 1990 and 2002 cost cutting

became more important, prevailing over generating innovative products, or increasing

time to market vis a vis competitors.

Data was collected in person by the authors as part of a broader research project on

Fiat‘s strategies and products, starting in 1998 and finishing in 2007, from Fiat

archives, Fiat‘s corporate publications and also through direct interviews conducted at

Fiat Auto‘s headquarters, the Mirafiori plant, and at the factories and offices of ten

design and engineering service suppliers.

The interviews were semi-structured and open ended, and followed up by phone and

email interviews where required. Interviewees include three retired senior officers at

the Fiat design centre (Centro Stile Fiat) who were in charge during the changes in the

innovation model analysed in the paper; a senior Fiat Auto manager; the CEO of

Giugiaro; two senior designers at Pininfarina; the Director of LMS Italy, the Italian

subsidiary of a Belgian automotive engineering service that has a long standing

partnership with Fiat, and seven other NPD service providers from Turin that do not

wish their companies to be named.




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4. Fiat and its use of Turin “carrozzieri”3 in new product

development before the 1990s


    Before the Second World War Fiat, like most other European car makers

developed a varied range of models, all of which were produced in relatively small

numbers, and with low levels of mechanization (Berta, 2006). At the time Fiat

developed new products by relying an array of small companies located in and around

Turin, some of which specialized in the parts that defined the style of a vehicle, such

as the car body and interior, and others in mechanical parts, such as engines and

carburettors (Annibaldi and Berta, 1999).

    After the Second World War, Fiat and other European car makers progressively

―closed‖ their product innovation model as they adopted the organizational

innovations introduced by American companies such as Ford and GM: vertical

integration, mechanization and multidivisional organizational structures, including

large in-house product design and engineering departments (Chandler, 1990). From

the 1950s Fiat and other producers of volume cars also adopted unibody frames

because they were cheaper to manufacture in high numbers, as they allowed the use of

high speed presses and more automated processes (Castronovo, 1999). The switch to

unibody frames strengthened the trend towards closed innovation in the car industry,

as most independent providers of NPD services did not have the resources and

competencies necessary to develop and manufacture automobiles based on this




3
  ‗carrozzieri‘, a term that originally meant horse cart makers, has become the term commonly used in
the Italian language to identify firms that provide services related to the development of new
automotive product, and in particular product design, engineering, modelling, prototyping, testing, and
car body construction. Notably, there is no equivalent term in the English language, as car designers
fails to capture the more technical aspects of product development performed by carrozzieri, such as
product testing and fine tuning.


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technology. Unibody frames pushed OEMs to vertically integrate not only production

but also innovation processes (Greggio, 2002).

    Between 1950 and 1980 Fiat adopted a closed innovation model for the cars that

constituted the bulk of its sales, namely small utilitarian cars but it also continued to

involve external firms in the development of non core products, such as luxury

vehicles, or special versions of existing models (Berta, 2006; Volpato, 1996). In Italy

there were also a number of specialist producers (Maserati, Ferrari, Lamborghini, De

Tomaso, and Dallara) which did not adopt unibody frames but developed other

techniques, such as steel tubular spaceframes and carbon fibre spaceframes. These

high performance car companies, of which Maserati and Ferrari are now owned by

Fiat, used a more open NPD process, where new solutions and designs often

originated from discussions with external providers of car body styling and design

services. This provided an important source of demand for the carrozzieri and also

helped them become globally known as some of the cars they contributed to

developing, such as the Alfa Romeo Spider and Ferrari Testarossa became icons of

style and technology in the industry.4

    By the 1980s the carrozzieri had developed, thanks to the use of information

technology, such as Computer Aided Design (CAD) an increasingly sophisticated and

diversified range of services, ranging from ideas and simple sketches on paper, to the

development of vehicles that are fully functioning and were being produced on a pilot

assembly line.5 As a consequence, the automotive cluster of Turin, where Fiat is

based, gradually became an important hub for global automotive design, providing

NPD services to several OEMs, not just Fiat (Rolfo and Vitali, 2001). European

consumers were becoming more sophisticated and demanding an increasingly varied
4
  Interviews: E.P., CEO of Giugiaro, 2007; F. C., Director of R&D at Pininfarina, 2007. The Alfa
Romeo Spider featured in the movie ―The Graduate‖, the Ferrari Testarossa in the series ―Miami Vice‖.
5
  Interview: E.P., CEO of Giugiaro, 2008


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range of cars, and NPD service providers allowed OEMs to develop cars in market

niches where they did not have design or engineering capabilities, especially open

roof, coupes, and sport versions of existing cars.

    Fiat location in the cluster gave it superior knowledge of the capabilities of local

firms. Up to the late 1980s it leveraged the capabilities of the Turin carrozzieri to

develop a broad model range without having to dedicate vast resources to R&D in

fields where it did not have intangible specialisation. Although Fiat often asked the

largest carrozzieri, especially Bertone, Pininfarina and Giugiaro, to provide their ideas

on product design for all of its cars, it maintained strong in house NPD capabilities

and strong control over the development of new ―core models‖ – cars that could

potentially, and did in many cases, become ―order winners‖ in their market segment,

and which constituted an important share of total sales and revenues for the company6

(Takeishi, 2001).

    From the early 1990s Fiat‘s performance started to decline. A detailed analysis of

the crisis of the early 1990s is beyond the scope of this paper. It is sufficient to say

that the crisis was a result of the increasing integration of the European market which

exposed Fiat to more competition and brought into prominence the lower productivity

of the Italian industrial system as a whole when compared to Germany and France

(Volpato, 1996, p.214). Between 1993 and 2003 Fiat reduced its production of cars

by 40% (Berta, 2006). At Mirafiori, Fiat‘s biggest plant, only 40% of its installed

capacity and about 19% of the available space were used (Ciravegna, 2006). The next

section outlines Fiat‘s response to its crisis, which entailed changing the way it

performed NPD.




6
 Interviews: A.T., Senior manager at Fiat Auto, December 2008; E. P, CEO of Giugiaro (2007), F. C.,
Director of R&D at Pininfarina (2007, 2008): R.D., Research Engineer, Pininfarina (2007).


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5. Changes in NPD during Fiat’s crisis and recovery



In order to tackle the quality and low productivity issues that affected it, Fiat re-

organized following the principles of lean production (Bonazzi, 1994). Firstly, it

outsourced a higher percentage of its cars to suppliers, between 50% and 70% of the

total product value, depending on the model (Enrietti and Lanzetti, 2002). Secondly, it

reduced the number of direct suppliers and simplified its supply chain (See Table I).

Thirdly, it changed its NPD process, opening it to external firms at an earlier stage

and for a greater range of tasks, including the development of production processes

(Becker and Zirpoli, 2003). Lastly, it began to outsource a rising percentage of the

NPD of its core models to external companies.



Table I: Fiat’s direct suppliers (1987-1997).
   1987     1988      1989     1990     1991       1992   1993   1994   1995   1996   1997


   1200     1050       990      723       670      560    520    410    380    370    350


Source: Enrietti, 1997; Province of Turin, 2003a



    As discussed in previous sections of this study, Fiat had a long tradition of

involving external firms in the development of its new products, especially consulting

on style and. Fiat also often outsourced the development of niche products to external

firms, such as open roof cars. However, during the 1990s, Fiat began to outsource the

development of its core products, including the definition of product parameters

(competitive factors) according to the forecasted requirements of the market to

external companies (Becker and Zirpoli, 2003).




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       Table II: Percentage of the cost of NPD outsourced (1983-2007)
    Fiat       Year    Market     New       Product using     Product based    Outsourcing of
    model              niche      product   a modified        on existing      product design,
                                            existing          chassis          development and
                                            chassis                            engineering7
    Uno        1983    B          X                                            30

    Tipo       1988    C          X                                            30

    Punto      1994    B          X                                            45

    Bravo      1995    C                                      X                59
    Brava
    Punto II   1999    B                                      X                70

    Stilo      2001    C                    X                                  55

    Panda      2003    A          X                                            20

    Grande     2005    B          X                                            20
    Punto
    Bravo      2007    C                                      X                20

    500        2007    A                                      X                20

Source: Elaboration based on interviews with A. T. , Senior manager at Fiat Auto, December 2008; E.
P, CEO of Giugiaro (2007), F. C., Director of R&D at Pininfarina (2007, 2008): R.D., Research
Engineer, Pininfarina (2007) and information provided by seven other NPD companies, and the senior
ex managers of Fiat Centro Stile.




       The escalation of Fiat‘s outsourcing of NPD culminated with the Bravo/Brava and

Punto II, where Fiat outsourced the majority of the activities necessary to develop its

products (Table II). This constituted a break with the past: whereas before external

firms were used to complement Fiat‘s expertise and provide new ideas, for example

new styling solutions, or specific services to improve aerodynamics, during the 1990-

2002 period Fiat delegated most of the NPD activities necessary to create its new core

models to them. Notably, the innovation model was only opened to suppliers, but it


7
  Estimated percentage of the total cost of developing a product carried out by external firms. The
products based on existing chassis or modified existing chassis require an overall lower NPD effort,
lower NPD costs, and shorter development times. For example, the development of the Fiat 500 mainly
involved an effort to design the car body and interior (and respective components), given that it is
based on the Panda, and shared the engines and structural components of other models. Developing the
Panda on the other hand involved a major engineering effort to create a new chassis.


                                                                                                 15
was kept closed to consumers, whose appreciation of Fiat‘s model vis a vis the cars

developed by its rivals fell during this period.

       Fiat‘s highly outsourced NPD differed from that practiced by other OEMs.

German automotive manufacturers, for example, outsourced the development of

specific products to diversify their offerings in market niches where they were not

specialized, especially off road vehicles.8



Table III: Core models and NPD outsourcing of European OEMs
        Brand                     Fiat           BMW              Audi               Peugeot          Renault

    Core models 1990s-       Punto, Punto   Series     3,   A3, A4, A6         206             Twingo
    2002 (where              II             series 5                                           Clio
    intangible                                                                                 Clio II
    specialisation lays)
    Models with high         Punto, Punto   X3, Mini        A2,          S4,   306 cabrio      Espace
    levels of outsourcing    II                             Convertible        406 coupé
    NPD                                                     models             1007


       Source: Elaboration based on interviews


        BMW and Audi resorted to external providers of NPD as well as manufacturing

services to launch SUVs, whilst they retained the development of luxury and sport

cars, such as the BMW series 3 and 5, the Audi A 3, A 4 and A 6, and the Mercedes

class C and E, which historically provided the bulk of their sales, and were associated

with their brand image, in-house. This is consistent with the profile of incremental

innovators in mature industries (Laursen and Salter, 2006, p. 137). Notably, Fiat did

not leverage the involvement of suppliers in NPD to broaden its product offering, for

example by launching a SUV when demand for this type of car was booming in

Europe, as the German car makers did (Ciravegna, 2006).



8
    Interview with the R&D Director of Pininfarina, 2007 and with the Director of LMS Italy, 2008.


                                                                                                           16
    Fiat opened NPD for its core products, as radical innovators do (see Table III).9

First it involved suppliers not only as providers of ideas and concepts, but also in the

engineering and definition of performance targets of its core products. Secondly, it

partitioned NPD tasks, outsourcing an increasing share of the operations necessary to

develop the new cars as well as the industrial processes necessary to manufacture

them and the organization of the supply chain. Subsequently, it started to partition its

knowledge by delegating more NPD operations to suppliers, and downsizing the

organisational units where NPD knowledge had been accumulated and maintained,

such as product development teams and the Centro Stile Fiat (Fiat‘s corporate Design

Center).10

    The outsourcing of a large share of design and engineering of core products

represented an opportunity for Fiat to initiate a transition towards open innovation.

Fiat however failed to develop the necessary organizational structures and routines for

the reception of external knowledge because changing its innovation processes to a

more open system was not among the objectives of its management. As will be shown

in the next section of the paper, the business model underpinning NPD was geared to

cost reduction rather than towards knowledge search and absorption. This impeded an

early transition to open innovation, and reduced control over the products developed.

    Fiat‘s management decision to pull resources from the NPD of core products, to

delegate to external firms rather than just absorb their knowledge, and to downsize the

organizational structures in charge of NPD began ―hollowing out‖ its manufacturing

knowledge (Becker and Zirpoli, 2003). This could contribute to explaining Fiat‘s

failure to launch successful products, and the consequent decline in its sales between


9
  Interviews with three retired senior officers of Fiat Centro Stile, the company‘s corporate design
centre, 2006.
10
   Interviews with three retired senior officers of Fiat Centro Stile, the company‘s corporate design
centre, 2006.


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the late 1980s and 2002 – the period during which its NPD outsourcing reached its

highest levels (Table IV).11



     Table IV: Fiat market share in selected years
Year                              Italy                             Europe
1987                              53.7%                             12%
1998                              40.5%                             11%
2005                              28%                               6.6%
2009                              32.8%                             8.8%
Sources: Archivo Storico Fiat (1996: 131—135); Enrietti and Fornenego (1989: pp. 70–73, Tables 5.1,
5.2); Volpato (2002); http://www.piazzaffari.info/settore-auto/quota-di-mercato-fiat-raggiunge-88-nel-
2009.html


     Table IV shows that Fiat‘s market shares decreased throughout the 1990s with an

accelerated drop between 1999 and 2005. Between 2001 and 2002 Fiat‘s declining
                                                                                          12
sales brought it close to bankruptcy. In 2002 the CEO Paolo Cantarella                         stepped

down amid high criticism of his neglect of the car business in favour of Fiat‘s

financial and insurance businesses (Berta, 2006). Between 2002 and 2004 Fiat went

through several changes in its top management caused by disagreements about how to

tackle its crisis, but also by the unexpected deaths of its chairman Giovanni Agnelli in

2003 and its successor Umberto Agnelli in 2004 (Volpato, 2009).

     Sergio Marchionne took over as CEO in 2004 and adopted a radical series of

changes at Fiat, hiring new mid-level managers, such as operations managers, and

substituting large numbers of executives. One of the key elements of Marchionne‘s

corporate restructuring was a strong refocusing on the core business – developing and

making small cars for the European customer (Volpato, 2009). In order to do so, he
11
   Other authors (see for example Fine and Whitney, 1996) have pointed out that excessive outsourcing
can have negative implications not only on product performance, but also on supply chain
management: If the OEM becomes too reliant on suppliers in terms of the knowledge required to
develop new products, this may offset the existing governance structure, putting into question the
authority of the OEM to coordinate and direct automotive projects.
12
   Paolo Cantarella was Fiat CEO between 1992 and 2002.


                                                                                                   18
reduced the outsourcing of NPD for core models and strengthened product

development teams. Sales of the Panda and Grande Punto, developed with this less

outsourced NPD system, allowed Fiat to recover and return to profitability by 2006.

     Fiat continued to involve suppliers in key areas in which they had higher

competencies, such as the interior design of the Fiat 500. 13 It also opened innovation

for the first time to consumers, launching a website called ―500 wants you‖14, where

potential customers of the Fiat 500 could contribute to the design of the product. The

comments and feedback were discussed and integrated in the final stages of NPD. The

website attracted 500,000 visits in only 50 days.15 The Fiat 500 was developed with a

shorter lead time than most of the 1990-2004 models, and involved a high number of

external firms in the product conceptualization phase. For example, the interior design

and some of the engineering phases of NPD were performed by Fiat jointly with

suppliers. According to our interviews, it was the most ―open‖ NPD Fiat ever realized

in terms of the extent to which Fiat was willing to leverage ideas from external

sources.16 Nonetheless, Fiat retained control over the characteristics of the product

and outsourced only a small share of NPD. The Fiat 500 won several design

competitions, such as the EuroCarBody 2007, Car of the Year 2008, and the 2009

Design Car of the Year at the New York International Auto Show and will be the first

Fiat to be sold in the US market since the 1980s.

     While the increasing outsourcing of design and engineering throughout the 1990s

up to the early 2000s is certainly not the only explanatory variable for Fiat‘s poor

performance, it is certainly noticeable that the recovery of Fiat occurred precisely

when it began launching core models developed with a less outsourced NPD. The

13
   Interviews with A. T. , Senior manager at Fiat Auto, 2008 and F. C., Director of R&D at Pininfarina,
2007.
14
   http://www.fiat500.com/
15
   http://www.fiat500.com/news_interna.asp?menu_or=news&id=20
16
   Interviews with A. T. , Senior manager at Fiat Auto and the senior ex managers of Fiat Centro Stile.


                                                                                                    19
next section discusses why Fiat outsourced the NPD of its core vehicles, arguing that

its well entrenched organisational preference for cost-cutting strategies led it to blur

the difference between opening the innovation system and outsourcing, to the point

that it externalized the operations that historically contributed to its growth as an

OEM; its capability to design and develop small compact cars for the European

market.


6. Intangible specialization, outsourcing and the definition of

performance objectives and competitive factors


This section links the specialization of Fiat in the lower end of the market to Fiat‘s

NPD strategies. It explains why in the 1990s Fiat began to draw more deeply into

suppliers‘ knowledge (as radical innovators tend to do) but failed to perform an early

transition towards open innovation. At the centre of the analysis there is the

relationship between intangible specialization, architectural knowledge and product

competitive factors.

       Intangible specialization causes a company to excel only in specific segments

of a given market, even if the company competes in a range of segments of that

market (Maielli, 2005b). If tangible assets (production tools and technology) are fairly

flexible, but a company‘s output-mix is constantly skewed towards a specific segment

(specialization), output structure is driven by intangible factors such as technical

knowledge organizational knowledge, and company culture, hence ―intangible

specialization‖.

          Although Fiat is a generalist manufacturer, its output mix has always been

skewed towards small utilitarian cars which tend to be between 60% and 70% of the

output. As demonstrated by Maielli (2005b, pp 255-266), Fiat‘s intangible



                                                                                     20
specialization in the lower end of the market stems from two interrelated factors,

namely the predominance of production engineers in the design hierarchy and the

accumulation of technical routines in process/product design geared to cost control,

both factors driven by the necessity to contain costs.

       It is worth noting that cohesiveness of process engineers and operation

managers as an occupational group, their predominance within Fiat‘s strategic

decision making, and internal relations shaped by life-time employment were all

factors shaping Fiat‘s processes of knowledge accumulation toward intangible

specialization in the lower end of the market. Routines for technology selection were

geared to control costs and routines for problem solving were geared to minimize

process complexity (Giacosa, 1988, Maielli, 2005b). During the 1970s, Fiat‘s

engineers in charge of NPD opposed a strategic attempt to increase output in the

upper end of the market, which had been conceived by Fiat‘s top management at the

end of the 1960s (Maielli, 2005b). In this sense, intangible specialization reflected

upon output-mix optimization strategies. It also reflected upon NPD strategies: small

cars were developed in-house while large and sports cars were developed by specialist

suppliers. This was perfectly consistent with the profile of incremental innovators

within mature industries (Laursen and Salter, 2006, p. 137).

   This remained the case throughout the 1980s, a period in which Fiat enjoyed

considerable success. NPD of small cars was carried out internally. Engineers could

profit from their intangible specialization and 70% of the output consisted of cars in

segment A (Fiat Panda, Peugeot 106) and B (Fiat Uno and Ford Fiesta) (Maielli,

2005b). The development of upper range cars was achieved by opening NPD to the

Swedish specialist, Saab which supplied the platform for the Fiat and Alfa Romeo

cars competing in the E segment (BMW 3 Series).



                                                                                   21
   As mentioned, however, Fiat entered another period of stagnation during the

1990s. According to a managerial culture where cost reduction featured as the most

important performance objective, Fiat responded to the 1990s crisis through an

aggressive cost reduction strategy, which in turn shaped the involvement of suppliers

in NPD for core products. Fiat outsourced up to 70% of design and engineering of the

products in which it was intangibly specialized (core products) to cut costs.

   By opening the entire cycle of design and engineering of core products to

suppliers, Fiat acquired the opportunity to draw more deeply from the knowledge of

external firms as radical innovators do (Laursen and Salter, 2006, p. 137). However,

our interviews with senior NPD managers at Fiat and with the NPD service providers

of confirmed that the move towards a highly outsourced NPD was driven by the

necessity to cut costs and inspired by the cost control culture underpinning Fiat‘s

routines for process selection. It aimed at reducing the number of in-house processes

rather than seeking new and different knowledge. Such a business model was far from

being the heuristic device toward the assessment of new R&D projects which should

underpin open innovation as described by Chesbrough (Chesbrough and Rosenbloom,

2002).

   Absorptive capacity, or the capacity to absorb knowledge from external

organizations, is a fundamental competitive factor for companies that choose open

innovation models instead of vertically integrated in-house innovation (Cohen and

Levinthal, 1990). Fiat downsized the divisions in charge of NPD, which had a strong

accumulated NPD knowledge. By doing so, its capacity to absorb NPD knowledge for

core products declined, and with it the chance of adopting open innovation. The high

involvement of external firms in the development of new core products could have

been a first step towards open innovation, had Fiat not prioritized downsizing and cost



                                                                                    22
cutting in NPD. Instead Fiat eroded its own task co-ordination and knowledge-

partitioning capabilities in NPD for the products in which it was intangibly

specialized, namely small utilitarian cars.

   In order to understand this point, it is important to analyze the relationship

between organizational performance objectives, product competitive factors and the

development of architectural knowledge. Performance objectives are those objectives

that an organization should achieve from an operational point of view (typically

quality, flexibility, dependability, speed and cost). Competitive factors, on the other

hand, are those characteristics that make a product competitive in the market. As far

as competitive factors are concerned, a distinction is typically made between

―qualifier‖ and ―order winning‖ factors. The former are basic conditions to qualify a

product for a specific market, while the latter are those characteristics that customers

value when choosing a specific product. Architectural knowledge is crucial to

incorporating order winning factors into NPD.

   Performance objectives and competitive factors vary across products and across

the stages of the product life-cycle. In mature industries such as car manufacturing,

tangible specifications of quality, such as reliability, durability and safety might well

be seen as qualifier competitive factors while intangible specifications of quality such

as style, driving pleasure and, for specific segments of the market, characteristics

associated with status and life-style might well be considered order winning factors.

Because intangible characteristics of quality appears to be so important in defining

other winning factors, intangible specialization is a key determinant of the

competitiveness of products and might well explain why generalist manufacturers

tend to be competitive only in one or two segments of the market rather than across

the board (Maielli, 2005b). In this regard, the relationship between a firm‘s ranking of



                                                                                      23
process performance objectives and the definition of competitive factors is very

relevant.

   The emphasis of Fiat engineers on cost and complexity minimization along with

speed optimization facilitated the accumulation of architectural knowledge in the

lower end of the market as small utilitarian cars are easier to manufacture then large

and more complex cars. Because product designers had to develop their projects

according to strict cost parameters they had to focus on making their designs lighter

and simpler. This led to cars which were extremely efficient in terms of weight to

power ratio, inexpensive and easy to service. The search for the reduction in the total

number of body parts also inspired simple design and successful styling (Giacosa,

1988). The 500 and the Panda (segment A), the 127, and the Uno (segment B) were

all prized for style and driving characteristics as well as low fuel consumption and

reliability. Between the 1960s and 1980s Fiat set the benchmark for ―order-winning‖

competitive factors in the lower end of the market, while pursuing cost as the most

important performance objective of its processes.

   The outsourcing of product design and manufacturing of small cars during the

1990s was also consistent with the routine of ranking cost as the most important

performance objective. However, in the 1960s, 1970s and 1980s Fiat engineers had

developed the dynamic capability to translate the search for decreasing production

costs into benchmark competitive factors for the product (Giacosa, 1988). Fiat cars

were easy to manufacture but also purposeful, light and fuel-efficient, very

competitive in their own segments.

   By outsourcing the design and engineering of its core models during the 1990s,

Fiat externalized the definition of order winning factors of its core products such as

the Punto. In doing so, Fiat lost control of the mechanism that had enabled the



                                                                                    24
company to turn intangible specialization into commercial success. By losing control

of task partitioning Fiat also lost control of knowledge portioning. In other words,

extreme outsourcing enabled Fiat to keep the definition and ranking of performance

objectives in-house by setting cost targets for suppliers, but did not enable the

company to keep in-house the development and control of competitive factors which

were de facto determined by suppliers of design and engineering services. Thus, Fiat

broke the strategic integration between process and product design which had

contributed to specializing the company in the lower end of the market in the previous

decades by developing in-depth architectural knowledge for the whole range of lower

end products.

   As already pointed out, new management under the guidance of Sergio

Marchionne, changed again NPD strategies after 2003/2004, reducing outsourcing.

His corporate restructuring of Fiat entailed radical changes in the top and middle level

management. These helped him overcome the cost cutting routines and priorities that

affected previous NPD strategies. Given that Fiat was going through its most severe

crisis in history, his reforms were perceived as a last attempt to save the company and

thus accepted rather than resisted (Berta, 2006; Volpato, 2009).

   As shown in Table III, Fiat internalized NPD by a substantial degree under

Marchionne‘s management. Innovation was opened to suggestions from customers as

far as style and brand awareness was concerned, while the technical development of

new cars was carried out in-house, in the attempt to profit from intangible

specialization while absorbing ideas and knowledge from external sources. This is

consistent with Illi Albers and Miller (2010) and their assessment of car

manufacturing as an industry in transition toward opens innovation. Moreover, this




                                                                                     25
emphasizes the relevance of retaining architectural knowledge and profit from

intangible specialization when opening the innovation process.



7. Conclusions



Evidence of the emergence of an open innovation paradigm has so far been provided

by high-tech and innovation driven industries, while similar evidence in mature

industries, such as the automotive industry, is still scarce (Chesbrough and Crowther,

2006). The automotive industry has shifted from vertical integration of production to

vertically disintegrated, highly outsourced organizational forms for both its

production and innovation activities. However, it is still unclear if in some cases the

adoption of highly outsourced NPD led to more open innovation. This paper

contributes to the study of open innovation in mature industries with a longitudinal

analysis of Fiat‘s product innovation strategies over the last 20 years. The link

between NPD and open innovation lies in the relationship between an organisation‘s

ability to absorb and diffuse knowledge from external organizations and its ability to

retain architectural knowledge. The case of Fiat is significant, as its opening of NPD

during the 1990s shares some of the characteristics of radical innovators that opened

their core innovation activities, whilst also being a case of outsourcing that led to

knowledge partitioning and declining NPD performance.

   Over the last twenty years, car manufacturers have increasingly subcontracted the

design and engineering of niche models while retaining design and engineering of

core products. They have also increasingly opened the development of new

components to suppliers (Fuller et al, 2006; Takeishi, 2001). This is consistent with

the profile of incremental innovators in mature industries which tend to draw widely



                                                                                    26
but not deeply into suppliers‘ knowledge (Laursen and Salter, 2006, p. 137). Fiat, on

the other hand, outsourced a large share of NPD of its core products, including

product design and engineering. In theory, this is more consistent with the profile of

radical innovators in new industries which tend to draw more deeply from a limited

number of highly specialized suppliers. However, Fiat‘s opening of NPD did not

intend, and as a result, did not achieve, a shift to an open innovation business model.

   Involving a large number of external actors in NPD as Fiat did between 1990 and

2002 does not automatically lead to open innovation - unless an OEM actively seeks

to integrate external knowledge and perform innovation in more open ways. As

Chesbrough points out, adopting opening innovation means adopting a different

business model. It entails developing organizational structures and routines to

coordinate inflows and outflows of knowledge without eroding architectural

knowledge (Chesbrough et al, 2003).

   The business model underpinning Fiat‘s highly outsourced NPD strategy was not

geared to the recognition and incorporation of useful knowledge from outside the

organization. Like most of its strategic decisions, it was influenced by the company

routines that aimed to reduce costs. The result of this highly outsourced opening of

NPD and downsizing of in house NPD divisions was an erosion of Fiat‘s architectural

knowledge. Under this system, Fiat developed core products that were badly received

by consumers, and thus its sales continued to decline.

   In 2004 Fiat‘s CEO Marchionne refocused corporate priorities from cost cutting to

improved NPD performance, and substituted a large share of the middle level

managers that supervised and implemented Fiat‘s accelerated outsourcing of NPD

during the late 1990s and early 2000s. He brought the NPD of core products back in-

house, and revamped NPD divisions whilst opening the innovation process



                                                                                      27
concerning component and interior design to customers and suppliers. These changes

allowed Fiat to fully exploit its intangible specialization and develop successful core

models. This study provides evidence that outsourcing innovation activities can have

negative effects on the performance of car makers if it leads to an erosion of their

architectural knowledge, and if they fail to develop the mechanisms to absorb and

integrate the knowledge of the external actors involved.

    The evidence presented in this paper from the Fiat case supports Chesbrough‘s

thesis: open innovation is not only about involving external resources in the

development of new products (which many manufacturers in mature industries have

been doing over the last two decades through outsourcing partnerships); it is also and

especially about developing a business model geared to the scanning and

incorporation of useful knowledge produced outside the firm. The difference between

open innovation and outsourcing lies in the business model and the performance

objectives that such a model emphasizes.




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