Thursday, January 8, 2009

November 2004: Out-Sourcing & Off-Shoring

The globalization of business and commerce is seemingly inevitable. Actually, it has already happened. Economic conditions, in terms of wages, exchange rates, duties and incentives change faster than plants can be built and relocated. I have seen it happen in almost every industry from cars to clothes.

In my lifetime, the textile mills of New England moved to the Carolinas and more recently off shore to who knows where in Asia and Latin America. The Rag Industry, the sewing and assembly of clothes, used to be heavily concentrated in New York. Regular production has moved to low wage countries, often in Free Zones within those countries. The only production that remains in New York is for samples and prototypes used to test designs and for selling lines to the buyers of the chain stores or at trade shows. I sit on the train with second and third generation family heads running their clothing businesses. I hear them talking, often complaining how their business has changed from their father’s and grandfather’s days. I see them on the planes to the Dominican Republic and Guatemala going to visit their own factories if they are big or those of suppliers if they are more modest in size.

Free Zones are interesting. These are tax and duty free zones set in countries where goods can be warehoused as if they are still at sea in international waters. Goods can be sent to other countries from Free Zones without incurring any export taxes and fees. Goods stored in Free Zones only incur import duties and taxes when nationalized, that is, brought into the country for sale. Free Zones are also ideal for light manufacturing or assembly where the capital, i.e. machines, needed is minimal. Free Zones are perfect for the sewing or assembly of clothes.

There has been a lot of buzz in the media about the off-shoring of call centers. When you dial an 800 number for any kind of customer service from any kind of store or utility you could easily end up talking to someone based in the Philippines, India, or Dominica instead of someone from Omaha or Poughkeepsie. This latest wave of jobs moving out of the US to lands of much cheaper labor is bothersome to people for two reasons. First, the accents and knowledge of American English of those answering the phones and trying to help make communication difficult, frustrating, and even at times humorous. This problem can and will be resolved by time and training. In a few years, we probably will not even be able to tell the difference. The other source of consternation with the off-shoring of these call center jobs is that most of us thought that these were jobs that would have to remain here because of the language skills required by the customer service representatives and what we believed were prohibitively high international long distance rates. The communications costs, of course, have dropped like a stone over the past ten years due to competition and the rapid expansion internet and satellite services. It was inevitable this would happen, but it caught many people by surprise.

I was in Montevideo, Uruguay a few years ago. I was visiting a free zone to see if there were opportunities for contract warehousing. I noticed a building in this Free Zone of about a dozen warehouses and small factories that was festooned with satellite dishes and antennae. When I asked what the building was, the representative of the Free Zone giving us the tour informed us that it was the Mercosur Call and Information Processing Center for Merrill Lynch servicing Uruguay, Argentina, Chile and Paraguay. The call center was in the Free Zone so they did not have to pay any taxes on telecommunications. Learning this was the first example of the globalization of Call Centers for me and it took me by surprise.

No one I know wants to close and operation, factory, warehouse or call center. There is no pleasure in that. There are many reasons, however, for which there is no choice. First, there is the economic motivation. When conditions change, be it transportation costs, wages, taxes or duties that make a facility unnecessary or redundant, such a facility must be closed. Otherwise, ones competitors facing a similar condition will act and be able to lower costs, prices and thus take market share from you. Secondly, facilities age and become obsolete in a few different ways. The physical structure may be too small for the projected volume of business and there may be no need to expand. A factory or warehouse could be, as was popular many years ago, multi-storied. Today, such multi-storied facilities are inefficient. The building could be filled with asbestos making it more cost effective to tear down rather than renovate or expand. But, mostly it is cost that drives the closing of facilities and either out-sourcing or off-shoring them. When confronted with such a situation, a cold hard fact of business is that a change must be made. No one likes closing facilities and putting people out of work. But, businesses have to drive cost savings to stay competitive, in business and to grow. It is better to put some people out of work, create fewer newer jobs elsewhere than to jeopardize the entire company by operating on a higher cost basis than ones competitors.

With globalization, there are subtle changes we almost never think about. In thinking about Latin America, for example, more and more production overtime is centered in Brazil, Mexico or out-sourced and off-shored to China. As a result, the industrial base in smaller countries such as Panama and Uruguay and larger countries like Peru and Argentina simply evaporate. Jobs are lost and these countries are left with increasingly lower paid agricultural and service jobs. They import more and more of their industrial goods and export agricultural or other commodities assuming they are lucky enough to have the natural resources.

It is one thing to replace a plant or warehouse that is either too small or too antiquated with a new more efficient facility in the same general area. It is entirely something else to close a facility and incorporate that volume into a facility in another country. Walking through a closed factory or warehouse always makes me feel a little sad. Walking through a closed facility whose volume of business has been off-shore, really increases the sadness. This is true even when the reason for the closure makes the best business sense. I know many of my colleagues feel the same way. No one wants to close things, we would rather build and expand things.

I remember reading a quote from Henry Ford when I was in college. He said, “if you need a new machine and do not buy it, you will end up paying for it anyway and still not have it.” He was and is absolutely correct. The same applies to facilities and parts of businesses. If you need a newer, more efficient and consolidated factory, warehouse or office and do not make the move, you will end up paying for it several times over and still not have it. You could weaken and put your business at risk.

It would be easy to say I worry more, in this regard, about Uruguay and Armenia than the US. The US economy is massive and jobs get created and off-shored as we innovate and create new industries and businesses. This may be true of the larger cities here, but I think one only needs to visit the smaller towns off the interstates and look beyond the chain stores and strip malls to get the feeling that there is also an impact in this country.

Currently, we are worried about the job losses to China. It seems to be a very real fear. We read stories in the papers and business magazines that the increase in steel, petroleum and cement prices are due to the increased consumption of these commodities in China with their building boom and increase in cars and trucks. Oil consumption is increasing at a rate of 7.5% per year. China is the world’s largest consumer of cement at 495 million tons per year, followed by the US at 102 and India at 84. China’s steel consumption in 1995 was 13.5% of global consumption. This year that number has grown to 31%. This is incredible growth.
It was in the 1980s and early 1990s, we were worried about Japan Inc and their economic engine. Japan was the major recipient of the imbalance of US imports and exports. Cars, consumer electronics and other home goods were the reason for their success. When a Japanese company bought Rockefeller Center in New York and other icon properties, the media was rife with reports on our economic decline in the face of seemingly the superior Japanese system. We learned and implemented Japanese production and quality methods. We closed that gap while the negative parts of Japan’s economic boom, their real estate bubble, imploded and dragged their economy down.

Korea has also made headway. The copied the Japanese model in creating corporate empires like Hyundai, Samsung and LG. They have taken the lead in microwaves and telephones. Their cars are getting better every year. Yet, we were never worried about Korea Inc like we were about Japan Inc.

China, however, is another matter. An ever increasing amount of our production has been outsourced to China. Somehow this move to China seems more ominous than any previous migration of jobs and production. Is it truly different? Or is the intensity just due to the fact that it is happening now? I think it is the latter. There is definitely a large adjustment going on.
What it all comes down to is the quality of life. As a youngster, somewhere around the 4th, 5th or 6th grade, I bought a book entitled What is Communism?. I bought it through the Scholastic Book Club. I ordered this particular book because in the early and mid-1960s, I heard a lot about communism, Cuba, the USSR, China, Vietnam, the domino theory, and the Cold War. I didn’t know enough about any of these things to have any kind of opinion. So, I got this book to see if it would help.

It was definitely the right book, read at the right time. It was well done and geared to my reading level. It gave me the history of Marx and Engle, providing a clear overview of their philosophy. In its purest form, communism made a lot of sense. The book covered the birth of the Soviet Union, the passing of Lenin, his entombment under glass (most fascinating to a grade school kid), the murder of Trotsky, the rise and despotism of Stalin, the annexation of the Eastern European countries and finally Khrushchev. It was clear to that the communism of Stalin was indeed evil and I understood us vs. them and good vs. evil definitely from the American point of view. What really struck me about the book was the last chapter. After all the philosophy, history and politics, the last chapter of this children’s book contained a table comparing how many hours an average person needed to work to purchase a variety of items, dress shirts, shoes, suits, dresses, washing machines and cars. It was shocking that the average Russian had to work five to ten times longer to buy the same item of clothing. The difference was astronomical for more expensive goods like appliances and cars. In the end, our way of life was better because we could more easily buy things. We had freedom and were a more efficient market.

I wish I still had the book. I tried to find updated tables that compared not only the US and Russia but other representative countries in the world. We have continued to make things less expensive as a percent of average wages and thus hours worked. I know that because of Wal-Mart, TJ Maxx and Costco, a dress shirt costs less in terms of hours worked than ten, twenty, or even thirty years ago.

So, is this globalization so bad? We continue to have more for less. In my lifetime, the average household has gone from no TVs, to one TV to almost a TV in every important room of the house. We have gone from one car per household to at least two. We have gone from one telephone per house, to several per house, to everyone having their own personal cell phone. The innovation and importance of computers is without parallel.

It is funny that we were seriously talking about a four day work week in this country in the mid-1970s. This was just around the time that the oil crisis hit and Japan Inc. began its ascendancy. Now, thirty years later we are faced with increases in gas prices again and the fear of China Inc. changing the value and quality of our lives. I will be concerned but will stay more optimistic this time through simply because we came through the last one better then many expected.

Out-sourcing and off-shoring will continue, it is a fact of globalization. I imagine that in ten or twenty years we may see production moving from China to Africa. We just have to be prepared to manage, innovate and lead in this continually changing world.

1 comment:

  1. I recently came accross your blog and have been reading along. I thought I would leave my first comment. I dont know what to say except that I have enjoyed reading. Nice blog. I will keep visiting this blog very often.

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