We need to do stop constantly playing catch-up by reacting to the change long after it has passed us. It is time for us to get ahead of the curve and prepare for the changes that will surely come to almost all industries in the next two to five years – Pic by Shehan Gunasekara
Note to reader: I am a long-time reader of many opinion pieces that have appeared on this publication. This is my first contribution and hopefully not the last. I have read many articles over the past few years and personally enjoy the shorter versions most. In writing this article, I have realised the difficulty in striking a balance between the details and making the article short enough to keep the reader engaged. My solution is to write what is effectively an executive summary which appears below under the heading ‘the short and sweet’. This section summarises the detail in the article without the reader needing to go through the whole thing. I just can’t resist adding in the detail (there is just so much to talk about) and this will appear under the heading ‘the nitty-gritty’. You have been warned, if you don’t want to spoil the end and can bear with all the words in the article, then skip the ‘short and sweet’ section.
Spoiler alert: Irrespective of which section you read, what I am trying to present is summarised in one paragraph. No, globalisation isn’t dead and buried and probably won’t die out that easy. No, I am not going to present the future here. The fact of the matter is that the pandemic has exposed several weaknesses in global supply chains. Business leaders will need to think long and hard about what the future will look like for their organisations. There is change afoot and this presents an opportunity to position ourselves and organisations or even our nation to benefit from these changes. Different companies and countries will take different routes; some will succeed while others fail. The worst thing we can do is to do nothing. There will be some things I get wrong below and even more things I miss out. The idea is to spark discussion, I would encourage others to contribute their thoughts and views and even contradict mine. Let’s get the conversation going and the thought bubbles flowing.
THE SHORT AND SWEET
Over the last few years, there have been many debates on the benefits and short comings of globalisation. Ultimately, globalisation has changed the world, like it or loath it. The shockwaves caused by the COVID-19 pandemic over the last 18 months have the potential to shake current global practices to their core.
Business leaders spent the decades following World War II looking for ways to optimise production and maximise profit margins. Examples of business practices that have developed over this period include ‘just in time’ production, product specialisation, production outsourcing and business/knowledge process outsourcing.
There aren’t a lot of products that we use today that don’t rely on multiple inputs from different suppliers spread across the world. This means that a disruption in one part of the world could be felt by consumers everywhere, now think about a disruption the likes of which we have not seen in a hundred years (before the whole world become so integrated). The impacts of these disruptions will be felt for a while more to come.
The first few weeks of March and April 2020 were a very uncertain period. As nations went into various forms of lockdown, questions were being asked about the economic impacts of the restrictions. Could the world economy really collapse because we forget to cover our mouth when we cough? Governments had to limit the movement of people to try and control the spread of the virus.
These limits on people moving also meant that consumers were not able to spend money in restaurants or go on holidays, which would lead to job losses that cascaded from one industry to another, the uncertainty about the future would also cause consumers to limit their spending and that would exacerbate the problem by leading to reduced consumption and employment across the economy. Many governments stepped in to encourage consumers to keep spending by offering hand outs and tax cuts. All in the name of keeping the circular flow of income…. flowing. And spend they did.
In March and April 2020 many shipping lines braced for a collapse in consumer spending and the shutdown of factories around the world, so they limited their capacity by idling ships. All the stimulation from governments meant that consumers now wanted to spend their money but had to do so from the comfort of their homes. This led to a surge in the sale of PlayStations and TVs or laptops, screens and desks and chairs as people had to set up home offices. All these items needed to be shipped from factories to the consumers and the shipping companies were not ready. Ports are now struggling to cope with the number of ships calling in to dock with many workers off sick at the same time.
In another part of the world, car manufacturers braced for an economic downturn by cutting planned production. The manufacturers who produced semiconductors (no, not a trainee bus conductor) used in cars had two choices, either cut down on their own production or exploit the new opportunities in the consumer electronics space which was experiencing a boom in demand.
Roll forward 14 months of working from home and the demand for cars in most countries has picked up significantly, but there aren’t cars to buy. A major reason is that manufacturers are having a hard time sourcing semiconductors for their cars. A decision made by a semiconductor manufacturer who doesn’t even have a direct relationship with the car maker has resulted in production delays and potentially $110 billion in lost revenue.
Disruptions have always been something business leaders had to contend with. The pandemic has however exposed a gaping hole in global supply chains. Placing too much reliance on external suppliers, especially those operating in other countries, could leave companies vulnerable and unable to meet the needs of their customers.
Business leaders are forced to rethink their how their business operate in the post-pandemic world. This will result in new opportunities as well as threats to our own businesses. Our options are to either do nothing and react to the changes long after it is too late, or to get ahead to the curve and position ourselves to take advantage of the changes that are certain to come.
This article is focused on provoking discussion about what the trade structure of the future will look like and how we, as Sri Lankans, can best position ourselves for the future. The past few weeks (or even months) have seen many of us form an opinion about the Port City and what it means for Sri Lanka’s future. While there is plenty for all of us to think about how the Port City will change our future, there are other events occurring globally that we need to be aware of.
One such example is the production issues faced by car manufacturers across the world. The past year was unlike any we have experienced in our lifetime. The whole world was plunged into chaos by the pandemic which is still raging (a little bit too close to home at the moment). Just 12 months ago, who would have thought that the worst of the pandemic in terms of new cases detected, new variants emerging, and the number of deaths would be in the middle of 2021.
There seemed to be a rational hope that 2020 was just a bad year (one in a century kind of bad) but come 31 December and we can hit the reset button and 2021 would be a good year or at least a (somewhat) ‘normal’ year. Most of us even got sick of hearing the phrase ‘new normal’ which got overused over the span of nine to 12 months. We got used to queuing up outside supermarkets (two metres apart of course), ATMs, or even needing to join a virtual queue to place an order online because the systems just were not designed to handle the kind of volume they were seeing. Some even queued for long hours near liquor shops.
While we were getting used to all these changes that the pandemic made necessary, companies were also adapting. Early in the pandemic (think back to March or April last year) a large number of factories were closed, first in China and then elsewhere in the world, particularly in European countries like Italy which were badly hit by the pandemic in 2020.
The closure of a large number of factories and the expectation that global shutdown to limit the spread of the virus resulted in most shipping companies wanting to limit their capacity and anchoring ships which would normally carry anything from your new car to the mobile phone or computer you are reading this on. All this is well and fine, except for the knock-on impact that would be felt not just in China and Italy but across the globe because of the beauty of globalisation.
Just in time
By the end of the 2010s global supply chains have well and truly embraced the concept of ‘just in time’ or JIT production and inventory control. Pioneered in Japan (particularly at Toyota) in the 1970s, JIT is a system of production and a management philosophy which aimed to cut costs and eliminate waste by procuring and delivering everything as and when it is required.
The benefit of this approach is that manufacturers and retailers get to minimise the cost of holding stocks but still have inventory available at hand when required.
Another concept that sprung up post-World War II is the idea of ‘competitive advantage’. Instead of one manufacturer producing all components that go into a product, they will purchase components from other manufacturers further down the supply chain.
So for example, a manufacturer who produces shirts would focus on stitching the shirt from cloth that they bought from manufacturer who specialises in producing cloth and the buttons on the shirt could come from a third manufacturer. By focusing on a limited number of items to be made in a production line, each manufacturer down the line will be able to specialise and bring down cost. They also have the option to supply to a large number of buyers which will enable them to benefit from ‘economies of scale’.
The economies of scale arise when a manufacturer sees reduction in the average cost of production as the volume of output increases. Going back to our example above, the button manufacturer will be able spread the salary of their CEO over a larger number of buttons and benefit from economies of scale that way. They will also be able to afford more specialist employees who are able to improve their production efficiency. The end result is that the specialist button manufacturer is able to produce a button for cheaper than a shirt manufacturer who decided to produce all the components themselves.
The concept of competitive advantage has taken a step further in recent years with companies tending to focus more and more on what they do best. A good example of this is the production of iPhones. Apple believe that they are great at designing and marketing high end mobile phones, but the they are not that good at setting up factories to produce these mobile phones.
Apple has handed over the manufacture of their iPhones to specialist manufacturers who have access to cheap labour and more efficient supply chains so Apple is able to make a bigger margin on every phone the die hard fans queue up overnight to get their hands on (as well as every other phone they sell). Thirty years ago, who would have thought that a brand name famous for their phones just about everywhere there is electricity would not own and run their own factories.
The third concept that has resulted from globalisation is the outsourcing model. While the example of Apple producing phones in China is an example of outsourcing production, the main area covered in here is the service industry. Business Process Outsourcing (BPO) and Knowledge Process Outsourcing (KPO) have been fields that have greatly benefited countries like India and Sri Lanka. Both countries have an abundance of relatively skilled labour at relatively low wages. Developed countries like the US, the UK and Australia have wages that are comparatively much higher.
Companies have stepped in to exploit this difference in wages and offer clients in developed countries all kinds of services at a much cheaper rate (including the entrepreneur’s profits). Any of you who visited Bengaluru (as Bangalore is now known) somewhere in the late 1990s and then again more recently would see the stark difference in that area. Most of this development is the result of companies setting up BPO and KPO operations in the city and has created a thriving middle class with tens of thousands employed by foreign companies operating in the area.
Cars and semiconductor chips
In a year where forex saving import restrictions saw a scarcity of some items (what might be termed luxury goods) in Sri Lanka, it might be easy to miss what is happening in other countries.
If we believe some of the figures posted in the media, global car manufacturers are facing the possibility of $ 110 billion in lost revenue in 2021. To put that in context, Wikipedia says the GDP of Sri Lanka is $ 85 billion which apparently, ranks us at number 66 out of 195 and sit just behind Ethiopia. So, if every single one of us (all 22 million) worked for a full year we still won’t earn the equivalent of the amount car manufacturers around the world are expected to lose in 2021 alone.
The reason for this expected loss is a group of components that are used in almost all modern cars, the semiconductor chips. The cars that Karl Benz or Henry Ford produced a long time ago would have used a grand total of zero semiconductors, but today we essentially drive computers (or spaceships if that makes you feel better about spending many times more in taxes than the value of the car).
Manufacturers are faced with two possibilities to deal with the shortage of chips, they can either shut down whole production lines or even plants or cut back on some features in their vehicles. Shutting down a production line means laying off people, which means some workers are not going to be paid for a while.
Laying-off workers result in bad publicity and also a potential shortage of skilled workers later when manufacturing picks up again. Nissan has already started producing cars without navigation/infotainment systems, but there are certain things that just can’t be removed from a car such as a brake system or power steering. The shortage is already in its fifth months and there are no good options available
The main reason for the production headaches described above, is the fact that manufacturers rely on specialist producers of most components that go into their cars. They key reasons for the shortages are described as ‘a fire in a factory near Tokyo, severe weather in Texas and a drought in Taiwan’. That description almost makes globalisation feel like a bad word.
Another reason for the shortage of chips is the fact that car manufacturers cut back on production early in the pandemic and the specialist producers diverted their production lines to produces less components for cars and more components for household electronics which were seeing a boom in demand.
Impact on BPO/KPO model
Another outcome of the more recent surge in COVID-19 cases in India is the impact it has had on the BPO/KPO model which most global companies now use. With the situation going from bad to worse in India at the moment, a large number of workers are calling in sick or need to take time off work to take care of sick family members.
In countries like the UK and Australia where the pandemic is now relatively under control, customers are finding it hard to grasp why a situation thousands of miles away is causing delays in their projects. Companies still need to be audited (yes, even that has been outsourced to an extent) and call centres still need to respond to consumer queries.
Reconsidering in the face of change
The factors described above will not kill the globalisation trend that we have seen over many decades. However, the disruptions that are caused are significant enough for business leaders to reconsider certain aspects and whether the current operating models are suitable for their organisations. Car manufacturers are already reconsidering their supply chain models to minimise the impact on their factories from an event many layers down on the supply line.
Those of you working in the shipping industry will be all too familiar with the large delays and increased cost resulting from ships idling for a period of time and then racing to fill consumer demand in a short period of time. Many global organisations will also start considering their BPO/KPO models which will ultimately have an impact on a lucrative industry back home in Sri Lanka.
Change is inevitable, the COVID-19 pandemic was an external shock that changed the whole world in a very short span of time and in very unexpected ways. In some ways it expedited what was always coming while in other ways it has caused a complete rethink of how we all operate in the world.
What we need to do is stop constantly playing catch-up by reacting to the change long after it has passed us. It is time for us to get ahead of the curve and prepare for the changes that will surely come to almost all industries in the next two to five years.
(The writer is a qualified actuary working as a consultant to life insurance companies.)