HOW TO REGAIN THE PRODUCTIVE EDGE Beyond the star performers, many U.S. companies and industries still do not produce well enough. MIT's new report, exclusively excerpted here, tells why -- and what America must do.
By Sylvia Nasar REPORTER ASSOCIATE Rahul Jacob

(FORTUNE Magazine) – EXPORTS ARE BOOMING, manufacturing productivity is advancing smartly, and in 1988 the FORTUNE 500 had their most profitable year ever. Why, then, is a high-powered commission of MIT professors warning that American industry is in grave trouble? The answer is that the battle is far from won. Get beyond the star performers and the shrunken dollar, and you find a deep reservoir of outmoded attitudes and policies. That is the somber conclusion of Made in America, the report of MIT's Commission on Industrial Productivity. Says the report: ''American industry is not producing as well as it ought to produce, or as well as it used to produce, or as well as the industries of some other nations have learned to produce.'' The exclusive excerpts on the following pages underscore the seriousness of the message. The commission counted among its 16 members the institute's provost, the dean of engineering, the dean of the Sloan School of Management, and a Nobel laureate in economics, Robert Solow. It was convened in 1986 when MIT began worrying about its future as the top American training ground for technologists. Says Richard Lester, a professor of nuclear engineering who was the commission's executive director: ''How could it be, we wondered, that the U.S. cannot translate technical leadership into commercial leadership?'' Though it had a clear consensus that important American industries were losing ground to Japanese and European competitors, Chairman Michael Dertouzos confesses that the commission nearly fell apart in academic acrimony between economists and engineers. The differences were settled through reality testing. With a budget of $1.3 million and aided by 30 faculty members from departments as diverse as political science and materials science, the commission conducted field studies in eight industries that together account for more than one-fourth of U.S. manufacturing. They were commercial aircraft, computers and chips, consumer electronics, chemicals, steel, autos, machine tools, and textiles. After two years, 550 interviews, and more than 150 visits to factories in the U.S. and abroad, the commission deliberated until it narrowed the perceived problems and solutions to a critical few. Readers of this 340-page tome (MIT Press, $17.95) will have to struggle to mine those nuggets. Too many overlapping lists of imperatives, strategies, and recommendations clutter the report, and key examples are often a considerable distance from the conclusions they support. Some opinions are arguable, such as the blanket disparagement of takeovers. FORTUNE readers will find many familiar themes and examples, especially of companies that have become more competitive. The book is nonetheless highly instructive, especially when it takes up specific industries. The accumulated evidence is startling not so much because it is new, but because it points so consistently at the same problems. Though the report is short on remedies for individual industries, its conclusions apply widely. America has to pay much more attention to manufacturing if it hopes to reap the benefits of its primacy in research and development. That means, among other things, continually improving product design and production processes and rewarding those engaged in that gritty enterprise. The decline of the American machine-tool industry serves as a cautionary tale of how both makers and buyers paid too little attention to manufacturing. Their failure slowed innovation, undermined quality, and kept producers from responding quickly to customers' needs. The report's single most useful recommendation is that American companies should measure their performance -- in raising quality, lowering cost, and innovating -- against the best companies wherever they are. Says Sloan school dean Lester Thurow: ''We have consistently tended to underestimate the competition.'' The commission also calls on U.S. executives to fundamentally rethink how they hire and manage their work force. Using the successful high-wage textile industries of Japan, Italy, and West Germany as models, the commission faults the untiring efforts of American managers to squeeze out the most work for the least pay. The real key to success is training and motivating workers to exploit fully today's sophisticated machinery. The most sweeping conclusion, and perhaps the most striking one, takes the commission far from its early focus on productivity to urge more cooperation in all aspects of business -- within companies, between companies and their suppliers and customers, and among companies in the same industry. The notion doesn't sound fuzzy when you read about how well it works in Europe and Japan. There's room for cooperation between government and industry too -- not heavy- handed ''industrial policy,'' but in education and training, R&D, and antitrust and trade strategies. The commission does not spare MIT itself, which graduates 1,500 engineers, 350 managers, and 50 economists every year. Engineering students need to learn to work as teams -- on practical problems, no less -- as well as individually. They need broader educations to overcome the myopia of excessive specialization. The Sloan School of Management has to train MBAs better to manage technology and human resources, as well as prepare students for the increasingly global nature of innovation, production, and marketing. MIT says its academic advice is applicable to other universities and business schools as well, and is setting an example. The institute has already launched a Leaders for Manufacturing program to give MBAs and engineers hands- on team experience on the factory floor in companies like DEC and Boeing. Four of the excerpts that follow are drawn from detailed industry studies. The fifth makes the case for greater cooperation, and the sixth summarizes the commission's prescriptions.

-- TEXTILES: Trying harder is not enough. Between 1975 and 1986, productivity in U.S. textile mills increased an average of 5.6% a year. Yet the industry continues to lose ground to overseas producers. The reason, says MIT in this excerpt, is that much of the investment in new equipment has been misdirected. Success in the modern garment trade does not come from low wages or even higher productivity. West Germany, for example, is the world's third-largest exporter of textiles even though wages are substantially higher than in the U.S. Nor has Germany relied on protection; it imports four times as much textiles and apparel per capita as the U.S. American producers have traditionally focused on driving down the costs of long production runs. But as incomes rise, the mass market increasingly fragments into niche markets. The Germans, Italians, and Japanese have learned to exploit these; they compete not only on cost, but in quality, style, originality, and prestige. Melbo Clothing, a Japanese menswear manufacturer, is planning for the day when customers will be able to order a single suit by computer, specifying the fabric, size, style, and delivery date. The foreign competitors are not just small firms. GFT in Turin, Italy, with 1986 sales of $666.6 million, remodeled itself two decades ago to make shorter runs and produce for more targeted market segments. GFT is now beginning to manufacture in the U.S. Producing long runs of standard goods for the mass market rewarded American companies so handsomely for so long that they could not imagine other ways of doing business. One textile mill manager related a chance meeting with an executive from Hartmarx, a major menswear manufacturer, who expressed astonishment at the mill's low prices and then said he would gladly pay more for special services and features. The mill's sales representative had never discussed such options with Hartmarx, because he assumed he could sell more by keeping prices down. In their single-minded pursuit of low labor costs, American companies have also underestimated the importance of education and training. Not one of the U.S. industry representatives whom the MIT Commission interviewed considered the educational qualifications of workers a significant factor in productivity. European and Japanese textile and apparel executives, by contrast, told of process and product innovations that would not have been possible without skilled, highly educated workers able to exercise initiative. Melbo said its workers submit about 6,000 suggestions per year for improvements in manufacturing processes. The American industry is beginning to respond. Milliken has reduced its average production run from 20,000 to 4,000 yards and can dye lots as small as 1,000 yards. Apparel makers, textile and fiber firms, and retailers have recently joined to launch the so-called Quick Response program, designed to improve the flow of information among the various groups and speed order times. The program's goal is to cut the 66-week cycle from fiber to retail in the U.S. to 21 weeks. But the industry still has a long way to go.

-- CONSUMER ELECTRONICS: Already surrendered. From dominating the world consumer electronics business in the 1950s, the U.S. has slipped to a feeble also-ran. No turnaround is in sight -- and that, says MIT, is a potentially grave problem. The mass markets for such products are critical to sustaining the development of advanced technologies that make a country a world leader. How the U.S. lost the lead is history worth reading: The tale incorporates every failing from weak manufacturing to ineffective trade policy. American firms dropped out in stages. First they contracted abroad for assembly of simple products, then the making of components, and then complete systems. After abandoning most manufacturing, the firms gave up R&D, managerial control, and finally marketing -- except for a few that have become outlets for foreign producers. Cheaper labor provided Japan and other Asian countries their first advantage. But other factors soon became more important, including lower capital costs, higher R&D spending, and more sophisticated manufacturing organization. In the battle for the home video recorder market, the U.S. surrendered without ever firing a shot. Ampex of Redwood City, California, held the original recording patents and by 1970 had a prototype consumer system it planned to market. But even with the help of a joint venture partner in Japan, it lacked the engineering know-how to transfer the design to mass production. After losing $90 million, it abandoned the venture in 1972 to concentrate on the high-end market for broadcast equipment. The Japanese took advantage of technology they had developed in building TVs, such as flexible and programmable equipment for automatically inserting components in circuitboards. Much of the early work on these machines was done by American companies, but the Japanese exploited it sooner. More important, Japanese design and manufacturing engineers cooperated closely to simplify both the product and the process. The Japanese were -- and are -- especially effective in finding the right balance between incremental improvements and radical breakthroughs. American engineers would push a technology to its utmost before presenting it to the manufacturing engineers, with the usual result that costs would be higher and the program more likely to slip. The Japanese teams of design and production engineers, by contrast, would start with highly sophisticated technologies, but apply them very conservatively, and work their way down a preproduction learning curve. The version that reached the market would be well proven, yet it would incorporate the leading-edge technologies that could readily be extended to make the device more sophisticated in future generations. Japanese trade policy also worked strongly against the U.S. The Japanese chose sectors of the industry to capture, set low prices, and persisted until virtually all U.S. manufacturers either quit or sold out to foreign competitors. Cases filed under antidumping laws were tied up in litigation for so long that even if adequate penalties had been imposed, they would have been too late. Antitrust regulations effectively kept major American firms from joining forces to preserve at least parts of the industry. The regulations didn't stop the foreign competitors from buying up American operations. Large market opportunities remain, among them the technology for linking computers with video, sound synthesis, and compact laser disks to create new forms of interactive entertainment and education. But the few U.S. producers left are too few and too weak to develop them, even with aggressive joint- development programs.

-- SEMICONDUCTORS:Entrepreneurialism's Achilles' heel. The U.S. share of the world semiconductor market has shrunk from 60% in the mid-1970s to around 40%, while the Japanese share has almost doubled to 50%. The decline is worse than the figures suggest, because the U.S. has lost ground in some of the most advanced and important technologies. Another case of triumphant industrial policy by the Japanese? Only partly. Americans celebrate the entrepreneurial vigor of their semiconductor industry, with its small, innovative firms run by bold risk takers. In MIT's view, that structure is part of the problem. Most of the American merchant producers that supply the open market are young, relatively small firms; many depend on semiconductor sales for all their revenues. The capital equipment and service sectors are also largely fragmented. In 1986, 55% of these firms had sales of under $5 million, and many were on the verge of failing. The structure dates to the 1950s, when antitrust pressure forced AT&T to license its patents and refrain from open- market competition. IBM and AT&T produce mainly for their own use. Other large companies, among them Ford and GE, could have been powerful contenders but managed acquisitions poorly or went after higher returns in unrelated businesses. In Japan large vertically integrated companies such as Hitachi, NEC, and Fujitsu dominate production. All have sales of over $10 billion. Semiconductors contribute only 10% to 25% of total revenues; their own equipment makers, ranging from computers to consumer electronics, use roughly a quarter of the output. Companies within these conglomerate groups have close ties with each other, with large Tokyo banks and other financial institutions, with their suppliers, and with the federal government. They ride out cycles in the volatile business, building capacity during downturns so they are ready when demand recovers. In the typical American pattern, a start-up firm explodes into prominence but cannot repeat its successes. The early products become obsolete; as sales fall and markets become more competitive, the company is unable to finance growth or train people adequately. The boom-and-bust cycles lead to further cutbacks, erratic commitments to suppliers and customers, and massive layoffs. Employees defect to new startups. To stay afloat, the company sells its proprietary knowledge, often to foreigners. Many companies eventually leave the market. The American decline began about a decade ago, as rapid innovation became less important than the manufacturing skills for mass-producing the elaborate chips exploiting very large scale integration (VLSI). The new technology demanded large capital investments, expanded R&D, and huge product-development projects. This tilted the competitive advantage to the big, stable, well- financed companies, most of them Japanese. VLSI also required closer relationships between component suppliers and final systems producers, another advantage for vertically integrated companies. Sematech, the joint venture between the industry and the Department of Defense, might help the U.S. maintain or regain leadership in fabrication technology, quality control, and related fields. But what the military often wants -- unsurpassed performance in combat conditions -- is not what the civilian industry needs: reliability and low cost. One promising development is that AT&T and IBM are showing signs they may be more willing to sell to other U.S. firms. Without rationalization, the American merchant semiconductor industry is likely to decline even more rapidly. In this business, David cannot beat Goliath.

-- AEROSPACE: An endangered lead? The U.S. commercial aircraft industry remains the world leader and is America's biggest exporter by far. But MIT's radar sees clouds on the horizon. Other countries are spending more heavily than the U.S. on aviation research, and international partnerships -- Airbus Industrie and engine- manufacturing consortiums -- tend to diffuse the new technologies among the cooperating nations. Though most of the competition has been coming from Europe, the Japanese government has picked aerospace as a key technology area for the 21st century. Opinion is sharply divided about Japan's potential to become a force in commercial aviation. The Japanese have many apparent disadvantages -- they do not yet have the industrial infrastructure to build airframes and engines, and their domestic market is too small to support one. But they are pressing ahead anyway. By the early 1980s government aid to jet engines almost equaled that given to computers and exceeded that for telecommunications and energy. Some researchers believe Japanese work in materials processing, electronics, and computers could well be the foundation for commercial aviation. The rise of foreign competition is less alarming than the emerging weaknesses in the U.S. industry. Deregulation of the airlines has shifted competition from performance to price. That has yielded some good results -- manufacturers are being forced to design and build more efficiently. But | airlines no longer contribute either their own engineering input or prelaunch progress payments to the airframe makers. Leasing intermediaries have weakened close customer relationships. Military technology needs have diverged increasingly from commercial needs. As a result, the testing of systems under real or simulated operating conditions, which is the longest and most expensive stage in new technology development, has become the weakest link in the American R&D chain. Seed funding for programs to prove risky new processes and transfer them to the shop floor has been sparse and is shrinking. American companies are cutting costs and raising quality, and the Aerospace Industries Association has shaped a consensus about the key technologies to pursue for the 1990s, such as advanced sensors and rocket propulsion. It is trying to forge a cohesive, strategically targeted development effort that includes industry, government, and academia. So far, however, the U.S. is draining its technological reserves faster than it is replenishing them.

-- THE CASE FOR COOPERATION. Some forms of economic partnership practiced elsewhere seem to confirm the American suspicion that ''cooperation'' is hard to distinguish from collusion. MITI steers investment to selected Japanese companies; West German toolmakers divide market segments among different companies. But other types of cooperation are consistent with America's free- market convictions -- and imperative if it is to compete globally. Market economies are founded on individual enterprise and competition, but they cannot work without cooperation and the pursuit of collective goals. Our studies revealed many instances in which U.S. companies or industries fell behind for lack of cooperation -- among people within the companies, between companies and suppliers or customers, and even between companies. The players may have been acting rationally within their own circumstances, but they accomplished far less than they could have with greater cooperation.

Overspecialization and bureaucracy make coordination difficult within companies. American firms tend to have hierarchies arranged as an organizational tree; people working in different departments often have to go up the tree to their lowest-level common superior and then back down. Information flows slowly, if at all, from marketing to R&D to production. Professionals have difficulty working in teams with specialists in other disciplines. Decisions that should be integrated instead are made sequentially. In Japanese firms, by contrast, the hierarchy has fewer levels. People in one layer generally know people in the layers immediately above and below, and can talk to them regardless of departmental boundaries. The linkages among companies, suppliers, and customers should be conduits for technology and other innovations that raise productivity. Many foreign companies take advantage of these opportunities for technology transfer, but U.S. firms often miss them by keeping suppliers and customers at arm's length. Some American industries are trying to strengthen relations with their suppliers, but a look at carmakers, who have been among the most ambitious, shows how far the U.S. has to go. At an MIT seminar early last year, a senior executive with one of the Big Three contrasted the recent experience of his firm with that of a leading Japanese manufacturer. Each had embarked on a major effort to get its suppliers to cut costs. The U.S. company got a 0.25% cost reduction; the Japanese, a 6% reduction. The main reason, the executive said, was that the Japanese company had a long-term relationship with its suppliers. Each had helped the other out in the past and knew it could count on help again in the future. The U.S. machine-tool industry fell behind its competition partly because its members could not cooperate. Its many small producers, worried about possible antitrust prosecution, did not get together to develop interface standards for numerically controlled machines. Users, as a result, were slow to buy the new machines for fear that future ones would be incompatible. In Japan, by contrast, MITI encouraged one company, Fanuc, to develop the controls. Fanuc got 80% to 90% of the home market during the 1970s -- and 40% to 50% of the world market by the early 1980s. West German machine-tool builders, encouraged by their powerful trade organizations, follow a pattern of so-called cooperative specialization, with each firm producing a narrow range of machines to limit competitive overlap. The Germans also rely on close working relationships and a communications network among companies, trade associations, unions, and government agencies to support training and build a consensus on research projects. Since Congress passed the National Cooperative Research Act in 1984, the Department of Justice has received more than 200 applications to engage in cooperative R&D ventures. But the act gives antitrust exemption only to R&D activities. The U.S. may also need to exempt joint manufacturing and marketing consortiums. The legal freedom to act may not be enough to overcome custom and attitude. Several years ago the Japanese set up a coordinated industry-government program to develop X-ray lithography, a new technology that will very likely play a vital role in manufacturing future generations of fast, powerful semiconductors. So far the Japanese industry-government combine has spent as much as $700 million. In the U.S. only IBM is making a serious commitment to the new technology, and its efforts are on a much smaller scale. IBM is looking for development partners in government and industry, but has yet to strike a deal.

-- PRESCRIPTIONS FOR CHANGE. What must the U.S. do to make its industries more competitive? MIT lists five broad imperatives.

-- Focus on manufacturing: Make a major new commitment to excellence. Find new measures of corporate performance, such as quality and product development time. Top managers must be more involved in production details. Business schools should place more emphasis on managing technology and manufacturing processes. -- Cultivate a new economic citizenship: To use new technologies well, companies will need broadly skilled workers who have a larger responsibility for organizing production. Learning must be a regular part of the job and retraining a part of normal worklife. In exchange for asking maximum effort from their employees, corporations should offer greater job security and more participation in profits, ownership, and control. -- Blend cooperation and individualism: In the best American companies, values of solidarity, community, and interdependence have already created important economic advantages. Internally, companies must replace compartmentalized hierarchies with flatter organizational structures. Externally, they should rely less on legalistic and often adversarial contracts in dealing with suppliers and customers, and more on mutual trust and long-run relationships. -- Learn to live in a world economy: Understand other languages, market customs, tastes, and legal systems. Adopt the best technologies and practices wherever they happen to be. The U.S. should insist more actively on open trade by others in Europe and Asia. -- Provide for the future: Basic schooling must educate students more rigorously, especially in science, technology, and foreign languages. Business must shift its reward systems to favor long-term investments over quick payoffs. America should create an ''information infrastructure,'' a network linking large numbers of personal, business, and government computers, to speed the flow of information. Economic policy should stimulate business investment by cutting the federal budget deficit, favoring investment over consumption, and providing incentives for saving.