Recession or reset?
Much of the rhetoric of the politicians in the West when “selling” their economic stimulus packages to a skeptical public has been focussed on returning to economic conditions that existed in 2003-2006. There are many sceptical voices across the political and financial spectrum, some based upon wishful thinking, some based upon analysis. Some of the analysis is country specific and some of the analysis takes broader trends into consideration. I am not an economist or a politician, so I am sure there are many that can argue with my analysis. I am also not an innocent bystander having seen my net worth shrink by 40% in a 6 month period from September 2008. I would love to return to an economy that would restore my net worth to its original value. I just don’t see it happening. Macro-economic trends coupled with the historically high levels of consumer debt in the West point to a long period of readjustment and a reset of expectations. In a world economy where an economic rate growth in China in excess of 5% is seen as a disaster, while in the West this growth rate would be celebrated and the central bankers of the G7 applauded for their wise stewardship, we can only pause to consider what this all means.
In a study just published by Boston Consulting Group (BCG) titled “Globally Advantaged Manufacturing – Winning in the Downturn and Beyond”, the authors point out that China, India and other rapidly developing economies (RDE’s) contributed only 25% of global GDP in 1990, compared with 51% for the G7 industrialized nations. By 2007 the RDE’s share of global GDP grew to 42% and is projected to overtake that of the G7 by 2009, much of this driven by outsourcing and off-shoring by companies based in the G7. One caveat is that this analysis predates the current recession. More importantly though is the surge in demand for goods and services in the RDE’s. This is the tipping point. As the BCG authors point out, “For many products, RDE demand already outstrips that of more developed markets in terms of volume”. Perhaps the most telling remark in the article is that “Given the price sensitivity of RDE markets, products often must be designed and manufactured locally to meet the necessary price points.” However, many brand owners in the West have outsourced manufacturing to RDE countries in order to reduce the cost of production of goods destined for markets in the West. They don’t have the knowledge of local demand nor the manufacturing capabilities in RDE’s.
In another BCG study titled “The 2009 BCG 100 New Global Challengers” published in Jan 2009, the authors look at companies emerging from the RDE’s to not only take major market share in their countries of origin, but also in the Western economies. Many of these are still in the “boiler room” and have not necessarily gained market presence in consumer markets, but this is only a matter of time. We have only to look at the bankruptcy of Nortel and the emergence of Huawei in telecommunications equipment, and the purchase of the IBM PC division by Lenovo, a largely unknown PC manufacturer in the West with a dominant market presence in China. Who in the West would have imagined in 2000 that Jaguar would be owned by an Indian company, or that Volvo’s car division might be bought by a Chinese company? The authors point to some of the advantages these companies have, including “… privileged access to high-growth markets and resources, freedom from legacy assets in high-cost, slow growing countries, and access to low-cost labour pools”. And of course the outsourcing of manufacturing to RDE’s by companies in the West has only served to develop a skilled labour pool in the RDE’s. These companies are now looking for ways to expand into Western markets, and the recession has provided many ready opportunities for cash rich RDE companies. Just as an aside, something very similar happened in the .com bust in 2000-2001 when much of the fiber-optic bandwidth was bought up by RDE companies, especially companies from India, when the likes of Worldcom filed for bankruptcy.
Looking closer at the US economy specifically, Steven Hansen, in his blog Seeking Alpha, wrote an article titled “This Recession Is a Reset to a New Normal” in which he states that “We will exit this Great Recession in the New Normal. It will be a world of overcapacity in many sectors of the economy, poor employment conditions, abandoning of innovation, and credit abuse.” The graphs in Steven’s article were particularly startling and revealing given the long period over which the data is plotted, although as a semi-skilled applied statistician I think some of the trend lines are suspect. Nevertheless what is apparent from the graph is that growth in both capacity and output from US based manufacturing has dropped markedly since 1999. Perhaps more importantly the gap between capacity and output has increased. Clearly this is a result of the outsourcing and off-shoring of manufacturing to RDE’s, which in turn has led to the emergence of a middle class and hence a consumer market in the RDE’s, the very point that BCG is making.
Yet there are quite a few voices that paint a different story. In an article titled “The BRICs: An Analysis” in Nouriel Roubini’s blog on Forbes.com, he points out that “… India and China are net commodity importers, while Russia and, to a lesser extent, Brazil depend on commodity exports” . Commenting on each of the BRIC countries, Nouriel makes the following observations:
- Brazil – “The expansion of the middle class and strength of the nascent housing sector require large investments in infrastructure and education and adequate micro-planning. The expansion of potential growth will only take place if this appropriate framework is built.”
- India – “Increasing the potential growth rate from the current level will therefore require raising infrastructure and energy investments, agriculture yields, government savings, education spending and implementing labor law reforms. But most of these reforms are politically challenging and will happen at a snail’s pace in the coming years.”
- China – “The real question: Can China pump up domestic demand soon enough? Chinese private consumption’s share of GDP fell steadily over the last decade to around 35%, meaning it may have a long way to go to pick up the slack of the export sector and export-oriented investment.”
These are all true statements. While the GDP of the RDE’s has grown rapidly, much of this has been through outsourcing by Western companies to satisfy Western demand. The consumer demand in the RDE’s has not begun to reach the levels required to sustain the growth rates experienced in the RDE’s over the past decade. However, as pointed out by BCG, this is less of a problem for RDE based companies because of their lower cost base, and a major issue for Western companies used to designing products for affluent consumers.
In his blog, “Supply Chain Matters”, Bob Ferrari writes about US based auto suppliers struggling to find new markets, in which he refers to an article in the Wall Street Journal titled “Auto Suppliers Attempt Reinvention”. The central point in Bob’s article is that addressing new markets is not a trivial matter, specifically that companies “… may well have the design and production capabilities related to product technology, but the other open question is whether you have the supply chain business process capabilities to compete with other existing players in your new industry venture.” While much of Bob’s article is focussed on auto suppliers satisfying local demand from OEM’s, many of the points he makes can be readily applied to Western companies trying to address the needs of the consumers in the RDE’s. In a separate article, Bob refers to a book “Poorly Made in China”, and analyses many of the issues that arise from outsourcing manufacturing to one of the RDE’s in which legislation and social norms are very different from those to which the which the Western based companies are accustomed. The lessons to be learned on the supply side are only a precursor for the knowledge that needs to be gained to design, market, and sell products in the RDE’s.
The other day I came across a case study on Nirma that exemplifies for me the way in which Western manufacturers need to respond to the challengers of adapting to the new normal. Many Western-based washing powder manufacturers have been marketing and selling their products in India for many years, largely to the more affluent city dwellers. The manner in which the products where packaged and sold was very similar to that used to Western consumers: Large, half-empty boxes with at least 500g (1lb) of washing powder. In many cases, even the formulation of the washing powder was the same, despite the fact that much of the washing is done by hand and not in washing machines. The rural poor were not a target market for the Western based companies because the concepts of packaging and distribution and margins available were deemed not to be profitable. An Indian company, with much greater knowledge of the local market, particularly the rural poor, started selling washing powder to the rural poor in small paper packets of about 25g through local merchants. The financial outlay for each purchase was much lower and the packets were much easier to transport than the bulky boxes of other products. In no time at all they had gained a large market share, not only amongst the rural poor, but also amongst the urban poor. And the company was making a profit too. Hindustan Lever, an Indian division of Lever Brothers, studied Nirma’s approach for some time, including studying ways to reduce their own cost base in order not only to sell to the poor in India, but to do so profitably. Hindustan Lever has been able to claw back market share from Nirma and now both have approximately 40% of the washing powder market. I have heard the Procter & Gamble also studied Nirma and brought the practice of selling much smaller quantities in compact packaging back to the US to address the “seniors” and “empty nesters” markets more appropriately.
I believe it will be a long time before demand in the West returns to 2006 levels, so Western companies have little option to regain revenue other than to address the demand in RDE’s. Much has been written about how outsourcing and off-shoring of manufacturing by Western companies has made supply chains a lot more complex, but this body of work has focussed on getting products to Western markets, not on addressing global demand, much of it in RDE’s. The concept of the long-tail, focussed on providing a wide range of products specific to as many market segments as possible, exacerbates the issue of supply chain complexity even further, and adding geographical dispersion of demand across country and cultural boundaries adds even more complexity. As pointed out by Bob Ferrari in the case of the auto suppliers, moving into new markets requires a lot of study and learning to be successful.
While there are many strategic issues to be addressed, companies will need many of the tools and capabilities being used to address the lack of visibility and coordination caused by outsourcing. Top on the list is visibility into their operations on a global basis, especially demand, to monitor their financial and operational performance, and the ability detect and respond to changes very rapidly. This is especially true if the company is used shared manufacturing capacity in the RDE’s to satisfy both Westerns and RDE market demand. Without the ability to balance demand and supply on a global basis, and to respond to changes in a rapid and effective manner, the risks of addressing RDE consumer demand are enormous.Google+