Tag: manufacturing

Playing with Dragons

We should be careful how we treat our customers.

Chinese manufacturing has been in the news recently with various exposes of factory conditions by the New York Times, the now discredited Mike Daisey and a fascinating look at US store chain Wal-Mart’s supply chain by Mother Jones’ Andy Kroll.

In his examination of Wal-Mart’s Chinese suppliers Andy Kroll interviews factory owners and managers with a common theme, they are all loath to be identified for fear of incurring Wal-Mart’s wrath.

This is wall of silence is familiar in Australia; the reluctance of local suppliers to speak about the conduct of the Coles’ and Woolworths’ policies has hobbled enquiries into the domestic retail market.

Another aspect Chinese and Australian have in common is how the retailers drive down costs with big buyers insist upon regular price reductions from their suppliers.

This is what happens when your business is a price taker that relies on one or two suppliers; you accept what you’re offered or lose a large chunk of your business.

With many of Australia’s industry sectors now dominated by one or two incumbents, this way of doing business is now the norm rather than the exception.

As a nation Australia’s finding itself in that position as well. Now our governments and business leaders have decided Australia will only dig stuff up with a few favoured, uncompetitive industries like car manufacturing being being protected, the entire country is in a position not dissimilar to a Foshan coat hanger manufacturer.

Having that dependency on one or two major customers is a risk and when the commodities boom turns to bust – commodities booms always do – our relationships with these customers will be tested.

When that test comes, the clumsy way the Federal government has banned Chinese companies from tendering to the National Broadband Network or blocked investment in mining projects may turn out to be mistakes.

This is the problem with being a price taker selling a commodity product, you become hostage to fortune and when the market turns against you there isn’t a great deal you can do.

In the early 2000s computer manufacturers like Dell and HP decided to sell commodity products then watched with despair as Apple captured the premium, high margin end of the market. Neither business has truly recovered.

Being trapped at the commodity end of a market is not a comfortable place to be, particularly if you don’t have a plan to move up the value chain.

If your business is currently selling low margin, commodity goods then it’s worthwhile considering what Plan B is should the market turn against you. You might also remember to be nice to your customers

At least you’ll show you have more forethought than our leaders in Canberra who seem to like to play with dragons without thinking through the consequences.

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Insanely profitable

Apple change the game again with some major ramifications

Apple’s announcement that they will start paying dividends to shareholders changes a number of things in Apple’s business model and those of many other businesses.

The sheer size of Apple’s cash reserves also illustrate how profitable the outsourced manufacturing model is as well the contradictary nature of special pleading by affluent corporations.

Moving a cash mountain

Not only is Apple’s business insanely profitable, but sales are growing exponentially. In the company’s conference call, CEO Tim Cook reported that 37 million iPhones sold last quarter and 55 million iPads sold in the last two years.

Apple’s CFO Peter Oppenheimer pointed out the company’s cash reserves increased $31 billion in 2011 and 2012 is on track for a similar result in 2012, leaving them plenty of money for investment along with a “warchest for strategic opportunities”.

Paying a dividend

The reluctance to pay dividends has been a feature of the US corporate for the last few decades and Apple are certainly not alone in not distributing their profits to shareholders.

Companies like Microsoft, Google and Oracle -even Yahoo! once upon a time – have been just as profitable as Apple and their efforts to shrink their cash mountains has had some perverse effect.

Many of these companies have squandered suprpluses on poorly thoughtout and badly executed buyouts of smaller businesses, this urge to avoid returning money to owner has been one of the drivers of the Silicon Valley VC Greater Fool model.

Another result of fat profits is the rise of flabby, overstaffed management ranks at some of these companies. Although this certainly isn’t the case at Apple where Steve Jobs ran a very lean machine.

The retail model

Unlike their major tech competitors Apple is a manufacturing and retail business as well. In 2012, 40 new stores are planned around the world.

This vertical control of their markets, from the beginings of the supply chain  to “owning” the end customer is anathema to modern MBA thinking and probably the area that gives them the greatest competitive advantage over their hardware competitors.

Justifying Mike Daisy

In some ways this announcement justfies Mike Dasy’s discredited criticisms about Apple’s Chinese suppliers.

The reason for manufacturing these goods in places like China, India or Vietnam is the vastly cheaper cost of doing business, not just in labour rates but in reduced environmental and safety standards.

Plenty of brand name clothing, footware and fashion accessory companies make similar massive profits to Apple with their ten, twenty and sometimes hundred fold markups on their products.

Repatriating profits

One of the big changes of Apple repatriating money is that is undercuts the special pleading by these extremely profitable companies that they should have a US tax holiday so they can repatriate their riches.

It’s now clear these companies can easily afford to pay the taxes of their home countries and it’s time they started to, along with returning dividends to their shareholders.

Once again Apple have changed the way others do business, how these changes affect the way we invest and governments treat companies is going to be one of the most interesting developments over the next decade.

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Losing the supply chain

When an entire industry moves offshore it isn’t just a few jobs that are lost

The New York Times’ weekend feature on Why Apple Manufacture iPhones in China focused on the underlying reasons why manufacturing has become concentrated in the PRC.

While much of the commentary on the article has – correctly – focused on how US manufacturing move to China is destroying the economic bases of the American working and middle classes, there’s also another serious consequence of the story; the destruction of the US supply chain.

The story itself emphasised this;

In part, Asia was attractive because the semiskilled workers there were cheaper. But that wasn’t driving Apple. For technology companies, the cost of labor is minimal compared with the expense of buying parts and managing supply chains that bring together components and services from hundreds of companies.

While wage costs are important, far more critical are the surrounding supply chains. Without those, even if you want to manufacture in the US or anywhere else you’ll struggle to find suppliers and skilled labour.

The amazing thing with the United States is the world’s most powerful economy has managed to dismantle most of their supply chains that took a century to develop inside twenty years whil China has built up most of theirs since they joined the World Trade Organisation in 2001.

For the United States economy, the effects are more subtle and dramatic than they first appear. The accompanying video to their story illustrates how the multiplier effect, the number of jobs created in the wider economy for each industry worker is as much 4.7 for a manufacturing job, while a service sector worker is less than 1.

That means less employment and less wealth.

For the US, and most the Western world, we were able to avoid the effects of becoming less wealthy over the last decade by spending big on credit cards. Homes that would have been out of reach to the average American – or Australian, Brit or Irishman – were kept accessible by easy, cheap credit.

As that credit dries up with the end of the Twentieth Century debt supercycle, the economic basis of this model is eroding.

For most of us in the Western, developed world it means we are going to become poorer. Chinese and Indian workers might catch up with our living standards, but that standard will be at a lower level that we anticipated a decade or two ago.

The most interesting consequence of the New York Times’ story is what happens to the managerial classes?

Right now they appear to be riding high as their companies’ profits increase and they award themselves trips to the Paris Ritz and receive 50 million dollar payouts when caught cheating on their expenses.

Over time though this cannot continue as the senior managers themselves have become major cost centres which will eventually have to be reduced.

Indeed Apple, the leader in the outsourcing trend, is unique among US companies in that it had a driven, visionary leader and doesn’t have a bloated, self indulgent cohort of bureaucrats managing the business.

With every stage of the deskilling of America and the offshoring of supply chains, there’s been the belief that “it could happen to me” to various groups of workers – we’re now seeing the same process happen in white collar professions like the law are subcontracted to Indian and Philipino service providers.

Senior managers should have no illusions the same will happen to them as the search for cost savings runs out of targets in the rest of organisations.

The biggest problem though is that loss of supply chains and industry knowledge. The question is, can you rebuild that capacity in decade in the way China did?

Supply company image courtesy of Stock Xchange and Andy McMillan.

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The world of smaller margins

Many of us are going to have become used to a less profitable market.

“We never get expensive trips anymore,” lamented the IT journalist, “every year we used to get a trip to Las Vegas, London or Singapore.”

The decline of journalist freebies is one symptom of the world of declining margins. In the case of the IT industry, most vendors have seen their profits shaved and the days of flying the press around the world to product launches and parties is an unaffordable luxury.

A recent Time story, When Whenzhou Sneezes, illustrates the problem on a broader scale.

In Wenzhou, a provincial Chinese city, factory owners found their margins were being squeezed and they could make better money in property speculation, which of course rarely ends well.

For the IT industry, we saw the rise of “crapware”, where computer manufacturers started added trial programs that slowed their systems and detracted from the customer’s experience.

That’s madness but Micheal Dell, the founder of Dell Computer, pointed out adding this rubbish allows them to sell computers $50 cheaper.

Assuming margins will always be fat, and then fighting market trends when those profits start to erode, are two serious management mistakes that are being repeated across industries and by entire nations.

Right now the world is changing and there are few sectors that have been profitable for the last twenty years that won’t be affected in the post-consumer society.

It might be worthwhile considering where your margins are and how they are changing, then resisting the temptation to do silly things. Although cutting back on journo junkets might not be a bad idea.

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