You still think outsourcing is a good idea?

Last Updated on April 15, 2017 by Dave Farquhar

Don’t be fooled by the topic I put this in: This has potential implications for any area of manufacturing.

Lionel, the most famous U.S. maker of toy trains and model railroads, has been found guilty of industrial espionage and ordered to pay $40 million to competitor MTH Electric Trains.

What happened? Well, both Lionel and MTH outsource their production. As it turned out, some work that was done for MTH ended up in Lionel designs as well.I really don’t think anyone has a good grasp of what happened, but the story I heard is that a contractor who worked for MTH’s subcontractor designing locomotives moonlighted for Lionel’s subcontractor, and that he reused some work that he did on an MTH design on a Lionel design. MTH claims Lionel knew about this. Lionel claims it did not.

Regardless of who you believe, somebody was wronged. R&D work for one company ended up benefiting its competitor, and now that mistake is costing lots of money.

As a consumer, I’m disappointed because I’ve been led to believe that Lionel and MTH do their own designs and outsource production to Korea and China. Evidently they outsource some of their lucrative R&D as well.

Apologists for both companies have said that Korean companies tend to be related by blood or marriage and that workers routinely move from company to company, taking trade secrets with them and using them. That’s the corporate culture. U.S. corporate culture, of course, is exactly the opposite. We demand that you somehow forget all of your proprietary trade secrets when you change employers. Or at least don’t use them in your new job.

The products involved in this case aren’t the $20 locomotives you see at Hobby Lobby or Toys ‘R Us either. We’re talking premium products that sell for five figures here. I’ve seen them in person–they’re definitely impressive looking. But they’re playthings for people who make six figures per year, minimum. I like O gauge Lionel stuff an awful lot. But I don’t expect to ever own one. They cost more than I’m willing to pay for a computer.

I suspect that with those kinds of profit margins, they could have afforded to build them in Michigan or New Jersey, where Lionel understands how its workers work and its workers understand how its employer works. That’s the scenario if you assume Lionel is innocent. If you assume Lionel is guilty, well, that scenario makes industrial espionage much more unlikely. It’s always best not to allow yourself to be tempted to do something wrong–it’s easier to avoid temptation than it is to resist it.

And if they’d had to raise the price of a $1,400 locomotive by another $100, I doubt too many people would have screamed. Especially if the words “Proudly made in USA” were prominently featured on the package.

There’s some question whether there’s even room in a $100 million hobby for both Lionel and MTH. When your industry is worth $100 million as a whole, and you have to share that pie with four or five competitors, you can’t really afford a $40 million jury award, can you?

Saving a few bucks in labor and R&D may have just cost Lionel its life.

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5 thoughts on “You still think outsourcing is a good idea?

  • June 7, 2004 at 10:31 pm

    Lionel will appeal. That’s also corporate nature here in the good ol’ US of A. It may be another three or four years before they have to pay any money at all.

    And given your thoughts on computers, my vanilla bean frappaccino probably cost more than what you’d be willing to spend. Sorry, Dave – you set yourself up for that one. 😉

    Dustin D. Cook, A+

  • June 8, 2004 at 3:25 am

    Without getting into any other arguments for or against outsourcing, the situation you’ve described is hardly unique to foreign countries. As a former Air Force member who has since worked for Boeing and Lockheed. We are constantly reminded to avoid precisely the situation that befell Lionel. In fact I had to get an ethics evaluation from the AF before these companies would hire me. In this case, breaking the ethics law could mean could mean losing out on lucrative government contracts for years. Even so it still happens, sometimes accidently, sometimes deliberately, hiring good ol’ boy Americans. Some companies are simply willing to gamble they won’t get caught. The issue here is if Lionel knew about it and either OK’d it or deliberately turned a blind eye. If Lionel had properly advised their sub-contractor of it’s conflict of interest requirements and the sub-contractor made the violation, then they in turn are liable. Which would be interesting if the sub-contractor went under and MTH had to go elsewhere as well. Anyway, the point is, this problem might get blamed on outsourcing to foreign companies but it doesn’t really fly because 1. The problem is just as much an issue for stateside workers as foreign. 2. Asian companies have just as much interest in protecting their intellectual property when they outsource to Asian subcontractors as US companies so the culture is aware of the same problems and processes for dealing with it. In the end it all boils down to the integrity of individuals.

    Aside from the general obsenity of making absurd profits off of cheap labor. Like it or not, Labor has become just another product like hamburgers and computers. Labor pools must now compete for business just like car companies compete for our business. As brand loyalty has become a thing of the past, corporations are no longer compelled to treat employees as long term resources (once wistfully called "family").

    Some things you must love because they’re impossible to like

  • June 8, 2004 at 9:58 am

    I think when you outsource product design you’re starting to loose control of your buisness. In the best case, you’re ceasing to be a manufacturer at all, and are turning into a marketing company. Worst case, you’re destroying the company for a short-term boost. (Hmm… Destroy share-holder value to maximize share-holder value. Sounds brilliant… No, that other thing; Stupid.) If they send core R&D work out to a whole other legal/cultural jurisdiction, well, what do they expect?

    It seem like companies don’t want to actually do anything anymore; The holy grail is to set up some structure that just spins out money, and maybe the occasional lawsuit. An alternative, no more original than my parenthetical comments, would be to do cool stuff, and use any profits to do more cool stuff. They’re making high-end model trains. Isn’t this something you’d want to do for fun, if you could?

    I don’t even know where to begin on the issue "intellectual property." We’ve long since passed out of the realm of reason on this one. Metal detectors in the lobby; Guards with night-vision goggles in the theater; Perpetual copyrights, dubious patents, pointless trademark disputes; "Propriatary" information that everyone knows; The very term "intellectual property," implying that this stuff has some kind of common-law status. After all, these aren’t secret plans for a new missle. It’s like, "Teacher, Johnny’s copying my picture of a train!" And now the courts are clogged with this stuff.

    Why, when I was a boy…

    Sorry; I lost my head there for a minute.

    I’m just glad I’m not like those wicked Pharisees…

    • June 8, 2004 at 12:32 pm

      Setting up a structure that spins out money has been the business
      of business for a long time. Making products that are useful or
      desirable is simply a means to an end. There are lots of
      companies that just identify product requirements and then
      coordinate and mangage specialty sub-contractors to bring that
      product to market. If there are no over-riding reasons, technical or
      legal, to keep R&D inhouse then it’s just another cost to be
      controlled. If the spirit of preserving American locamotive icons
      moves overseas – so what – it won’t be the first icon to travel, just
      the latest. Intellectual property is a legitimate idea that also handily
      fronts the endless legal battles of business warfare – subdueing the
      competition with escallating legal costs. Lawsuits have also become
      a primary means of enforcing statutory compliance. Prison? that’s
      for low class, no talent thugs.

      The trend of globalization is for the interests of business to
      supercede the interests of nations. ("what’s good for GM is good
      for America" – I think thats vintage WWII) Business money has a
      far greater impact on American politics, regardless of party, than
      any single group of individuals. Americans as a broad group are
      enslaved by debt, or put another way, they are owned by their
      possessions. Our greatest hope may lie in the necessity of business
      to keep Americans sufficiently employed, so they have enough
      money, so they can continue to be manipulated into buying more
      stuff. That is until other countries (or alliances – think Euro}
      become wealthy enough to be more interesting. There are many
      reasons to criticize outsourcing and globalization – be sure to pick
      the right ones.

      Some things you must love because they’re impossible to like

    • June 9, 2004 at 11:27 am

      The odd thing is, both of these companies are privately held. The difference is MTH is still owned by its founder and possibly one or more wealthy train fanatics. Lionel is owned mostly by an investment house that’s very dissatisfied with its investment. Its official stance is, "Lionel’s always for sale." Neither firm seems to be thinking particularly long-term though. MTH outsourced as much as possible to cut costs. Lionel presumably did it for the same reason. So Lionel is essentially a marketing firm that sells trains that isn’t particularly good at marketing and is run by people who don’t have all that much interest in trains.

      Lionel did appeal but the legal battles seem to be ruinous for both companies. One thing that came out is that Lionel’s annual revenues are about $50 million and MTH is about $40 million. Both have admitted now that they’re in trouble financially. Both are tied up in other lawsuits too. Union Pacific has sued Lionel for the unauthorized use of its logos (this is definitely a case where both companies have managed to not be in the right–UP abruptly changed its licensing terms after a century and made them pretty obnoxious to boot, and Lionel essentially said no, sue us, and proceeded to blatantly infringe on some of its highest-priced, most marketed products) and a company called QSI has been trading lawsuits back and forth with MTH regarding patent infringements on electronic sounds.

      All of this over stuff that people can (and sometimes do) build happily in their basements… Come to think of it, that’s how MTH got started. Literally by a 12-year-old kid named Mike making trains in his parents’ basement in 1980.

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