The speed of change in the world economy means it is vital for UK industry to improve its innovation infrastructure, argues David Sainsbury

Manufacturing has been undergoing a major period of change in recent years and, if we are to seize the opportunities open to us as a country, we need to adopt a new approach.

Early manufacturing companies were typically vertically integrated, undertaking as many operations as possible on their own premises. As skills, capabilities and demand increased, subcontractors emerged that could supply parts, sub-systems or services competitively. Typically, such subcontractors would develop long-standing relationships with their customers.

Over the past 20 years, these relatively stable arrangements have changed as competition and customer demand for greater variety have grown. These trends have been encouraged by the removal of trade barriers and falling costs of transportation, increasing the exposure of all manufacturers to global competition. Meanwhile, the reduction of cycle times for innovation has forced companies to adopt new models for product and service development. Manufacturing in the modern world is networked, global and fast.

In this environment, companies can focus on a single activity in the value chain. The electronics company Flextronics, for example, concentrates on production as a contract manufacturer. The pharmaceutical company GlaxoSmithKline has strength in multiple activities, including R&D, production and distribution. BAE Systems, a defence company, has a co-ordinating role across the value chain as a systems integrator.

Companies are adapting and engaging in one, some or all of the links in the value chain — from R&D through production to service provision. Company decisions about which activities to engage in (either in-house or outsourced) are complex. They are influenced by many factors, including the maturity and complexity of the product and its production processes, maturity of the sector and the history and ownership of the company. In each case, a deep understanding of the value chain and the links between activities provides significant advantage, as companies can tailor their activities to their capabilities and context.

Managing complex distributed value chains is demanding, especially in areas where technology is changing rapidly and relationships with suppliers and partners are shifting. The ability to manage these can be a significant competitive advantage.

Companies that can co-ordinate across the full value chain often have the opportunity to capture disproportionate value from their integration activities. Apple Computer undertakes product design and co-ordinates across the chain, including offering music downloads as a service. Its latest iPod video player has more than 450 parts, with production outsourced to Japan, China and other Asian countries. The chip that controls the player is sourced from the company PortalPlayer, which licenses microcircuit designs from another company, ARM.

ARM is a successful UK microcircuit design company that licenses its designs to a network of partners. It does not have production facilities but a sophisticated knowledge of production processes and excellent links between design and the final user of the product.

In emerging industries, companies can capture significant value from production activities. As new industries emerge from the science base, production is typically more closely linked to R&D and involves higher skills and more sophisticated processes. Production in regenerative medicine, for example, involves an advanced knowledge of biology coupled with sophisticated process and automation knowledge. The company Intercytex recently demonstrated significant developments in producing skin substitutes.

In industry sectors with intrinsically complex production processes, significant value can be captured from this stage of the value chain. In biopharmaceuticals, for example, there are close links between development and production. In this industry, product performance is determined by the production process. The skills and sophisticated process technologies required make biopharmaceuticals a high-value production activity.

It is worth noting that regulators may require continuity from prototype development to production. The fact that production may allow the capture of value from new ideas can sometimes be overlooked — particularly where production is seen as a 'standardised' or commodity activity. But early development of production capability may provide a more rapid and protectable route to market than outsourcing, and it avoids the risks of losing vital production knowledge and intellectual property.

These high-value production activities need to be clearly understood so that, where appropriate, support can be targeted to assist their development. For high-cost economies such as the UK, the activities likely to thrive are those that are complex and high-value-adding, and those that act as a key part of a global value chain. Depending on the circumstances, these activities may include R&D, design, production or service: none should be ruled out when developing strategies and policies.

The need for a better understanding of the skills required to manage the design and operation of globally distributed, flexible value and supply chains is increasingly recognised. The UK has made good progress in recent years in meeting the challenge of globalisation and upgrading its industry, but we should not underestimate the speed of change in the world economy, and the need to improve the innovation ecosystem.

Excerpt from the Sainsbury Review, The Race to the Top: A Review of Government's Science and Innovation Systems

Lord Sainsbury is the former parliamentary under secretary of state for Science and Innovation