Can Outsourcing Save Sony?

Outsourcing isn't a word that executives in Japan like to toss around. Japan Inc. prefers to tie its fortunes to state-of-the-art factories that churn out chips, cars, and flat-screen TVs for the global market. But when Sony (SNE) Chief Executive Howard Stringer announced on Jan. 22 that he was considering drastic cost-cutting steps for the company's core electronics division, outsourcing topped his to-do list.

The shift marks a minor victory for Stringer. After more than three years at the helm, Stringer finally appears to be breaking the company's addiction to manufacturing, and to be channeling ever more resources into developing and designing products that users crave. To show he now really means business, the Welsh-born American CEO has said he will close five or six of the company's 57 plants globally and slash the company's budget for factories and chipmaking equipment by a third over the next fiscal year, ending March 2010. "There is no aspect of Sony that isn't being examined right now," Stringer told journalists in Tokyo last week. "We have to move very, very quickly and control our costs."

Sony will spend the next couple of months drawing up a detailed plan. But Stringer appears to have made up his mind about outsourcing one product: TVs. The TV division accounts for 10% of Sony's overall sales but hasn't made a profit since it launched the Bravia brand of flat-panel TVs in 2005. By the March 2008 fiscal yearend, the division's three-year losses had reached $2.3 billion. Goldman Sachs (GS) predicts the division could bleed another $1.1 billion this year.

An In-House Tradition

The shift toward outsourcing is the clearest sign yet that Stringer wants Sony to act more like Apple (AAPL) or Cisco (CSCO). They consistently earn fatter profit margins by designing their own products and leaving manufacturing to others, and have made serious inroads into portable music players and home entertainment systems, where Sony was once king. In contrast, Sony, like many Japanese tech manufacturers, still makes many of its own products in-house, a process known as vertical integration, which "tends to lead to higher overall costs because you need extra layers of management to coordinate all the activities," says Robert Kennedy, a professor at the University of Michigan's Ross School of Business and author of The Services Shift.

Sony's domestic factories account for half of overall sales. They provided a boost to earnings while the yen was weak and overseas demand strong. But recently, when the yen surged and the global economy faltered, Sony found itself badly exposed. The sudden reversal was partly to blame for Sony's grim earnings forecast this fiscal year—an expected $2.9 billion operating loss, its first in 14 years.

Before the global financial crisis wiped out consumer spending, Sony seemed confident the TV unit would soon be profitable. The company's LCD-TV sales had risen over the past three years, from a little over 1 million units to as many as 15 million expected this fiscal year. Last year, Sony was second in global LCD-TV sales, behind Korea's Samsung Electronics.

But the TV unit's problems are now confounding Stringer's efforts to fix what ails Japan's best-known tech brand. Sony officials say they are rushing to centralize TV development and design and consolidate production in Japan after closing one of two domestic plants.

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