Myths of Globalization

Reading the summary of Scotiabank CEO Rick Waugh’s speech last night to the Toronto Board of Trade is interesting. But more interesting is the uncritical reaction to what he prescribes by those who heard his speech. As Waugh tells it, globalization is the key to what ails business and if firms are to be competitive in a modern global economy they had better start focusing on emerging markets.

Much of what Waugh says seems, on the surface, sensible, but the premise of his talk that globalization is both desirable and necessary for firms requires closer examination.

In public discourse on globalization, there is a widespread view that the big markets are in the large developing countries such as China, India, and Brazil. However, much of world trade is still centered on the developed countries. It’s important to remember that ten developed nations – Canada, USA, UK, Germany, France, the Netherlands, Sweden, Switzerland, Japan and Australia – still account for a large portion of world trade. Thus, while firms should certainly keep developing countries on their radar screens, transacting business in the markets of developed countries may yield more benefit, at least in the short run.

Secondly, while Waugh argues that globalization allows firms to drive greater volumes and achieve economies of scale, this is not always true for all businesses. Economies of scale may exist for some firms, but so may diseconomies of scale. Bigger is not always better. What’s important is that a firm operate at least at its minimum efficient scale, taking advantage of economies of scale if they exist. However, even if scale economies exist, getting bigger brings attendant problems that can, if unmanaged, erode a firm’s performance and competitiveness, undoing the unit cost advantages gained through scale economies.

Thirdly, going global by offshoring operations into lower labour cost markets does not always bring the gains promised by cheaper labour. What’s important is final delivered cost, not wage costs. So firms who offshore operations such as manufacturing often find themselves blindsided by higher material costs and lower productivity and quality, all of which raises costs. Which is why there is now a significant movement for reshoring among US manufacturers.

Fourthly, taking a service business such as Scotiabank global is quite different from taking a manufacturing firm global. While there are similarities, there are also differences, such as establishing market access through distribution channels, dealing with local suppliers, product localization, and the like. One size does not fit all and success for a large service business such as Scotiabank does not guarantee success for a manufacturer.

Fifth, and finally, there is the myth that any firm with money can go global. Firms often underestimate the challenges associated with going global. Firms selling into a foreign market are often at a disadvantage relative to local producers. Customer tastes and preferences are likely to be different, reliable local suppliers may be difficult to find, and local authorities may be difficult to deal with.

Domestic success does not guarantee global success. Before attempting to penetrate international markets, firms should first assess their ability to successfully compete in such markets. In particular they should assess not only their financial resources and track record with exporting, but also their  intangible assets such as brand recognition and awareness,  the firm’s value proposition and it’s fit with international markets, the degree to which the firm’s core competencies are exportable, and the presence of economies of scale, if they exist.

It is easy to be seduced by the allure of global markets, but clear thinking is required as a first step.

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Sometimes No Strategy is a Strategy

No one ever said formulating strategies for competitive advantage was easy. And, sometimes, a firm may not be quite ready, not the circumstances appropriate, for formulating a strategy. This is so because strategy always needs to be considered from the perspective of a particular firm and its circumstances.

Firms that are earning the industry rate of return should certainly the explore the possibility of creating a competitive advantage through an appropriate strategy. But in some cases, where the forces for change are not strong or compelling, an appropriate action is to maintain the current orientation and let a new strategy pattern emerge, rather than forcing one or copying a rival. In such cases, the firm can leverage its stable position to work on the business, focus on addressing current problems and constraints, and then let a new strategy emerge from that work over time.

The real challenge in strategy is to detect those subtle signals that presage a shift in a firm’s competitive position and standing. When this happens, a firm has no choice – it must strategize to preserve its position, adapt to the coming change, or leverage the developing situation. Change doesn’t have to be ongoing and no competitive advantage is forever. Periods of stability can interrupt change. The ability to switch on strategic thinking when needed is the essence of strategic management.

Local Competitiveness

What makes a local (or regional) economy competitive? Three factors can be identified:

  1. The strength of the competitive advantage of the firms within tradable clusters which make up the local economy. Since competitive advantage implies greater profitability, if local firms have strong competitive advantages, this will translate through to strength in the local economy.
  2. The presence of scarce resources within the local region. Firms within local economies may derive their competitiveness from an endowment of scarce resources within their region. These “scarce resources” may not just be tangible assets such as natural resources, but may consist of intangible assets of a strategic nature such as specialized skills, learning, and knowledge.
  3. Network effects derived from tradable clusters. Clusters are geographically concentrated and supportive networks of producers, suppliers, and associated organizations such as academia, etc. The very presence of a cluster within a region can lead to the creation of a critical mass of economic activity with associated spillover effects which accrue to cluster members.

Just like a competitive firm, competitive advantage in a local economy is derived from distinctiveness – non-reproducible capabilities in one or more of the tradable clusters or sectors that makes up the region’s economy. This distinctiveness may be derived from the capabilities of individual firms comprising the cluster, the network effects which the cluster enjoys, or special access to strategically important assets that the cluster enjoys.

The challenge for local governments is to identify the sectors or clusters in their local economies where existing distinctiveness can be either exploited, or new distinctiveness developed. In this sense, governments should pick winners – clusters or sectors whose competitiveness is derived from distinctiveness, which will further benefit from access to economic development initiatives and resources.

TPS is a Non-Reproducible Capability

Despite the widespread popularization of the philosophy, principles and techniques of the Toyota Production System (TPS) as Lean thinking, few firms applying Lean have enjoyed anywhere near the same results as Toyota.

There is a simple reason – TPS as practiced by Toyota is a non-reproducible capability.

A firm’s capabilities are bundles of knowledge, skills, technologies, routines and resources. Distinctive capabilities are those which, due to their nature, are non-reproducible by competitors. TPS is such a capability.

What makes a capability distinctive and non-reproducible? Because it is synthesized over time from ever-evolving streams of knowledge, skills, and technologies, much of the accumulated experience that underpins TPS  is tacit knowledge – knowledge that is implicit, rather than explicit, and therefore difficult to transmit or replicate.

Thus, while the visible aspects of TPS can be replicated – the tools and techniques – the capability as a whole cannot.

This is what one would expect – if a distinctive capability could be reproduced, then it is not distinctive and would confer no competitive advantage. Competitive advantage has its source in distinctive capabilities. That fact alone should suffice to explain why attempts to replicate TPS fall short of Toyota’s results, and why Toyota continues to maintain and grow its competitive advantage.

Profit or Revenue Maximization?

Microeconomic thinking about firms starts from the premise that the goal of a firm is to maximize its profit. This assumption fits quite well with reality where we see firms striving to maximize their profits for a variety of reasons, not the least of which is to provide the highest possible return to the firm’s owners or shareholders.

On the other hand, a firm which strives to maximize its revenue is not necessarily maximizing its profit, since total revenue is only one half of the profit equation, where Profit = Total Revenue – Total Costs.

There are, however, a few scenarios in which maximizing revenue in the short run is a reasonable objective for a firm to pursue. One scenario is where the firm is opening up a new market and acquiring customers to build market share and presence before competitive entry is desirable. Another scenario is where the firm’s demand and cost curves are such that marginal profits are greater than zero up to a certain maximum. This maximum be imposed by a constraint such as plant capacity, etc. In such a case, the maximum level of output will also be the level at which the firm maximizes both revenue and profit, and so the firm should produce output at that level.

Profit maximization requires firms to determine the best output and price levels which maximize the firm’s return. It is not just about increasing the amount you sell.

Why I Don’t Always Do Takt Time

Leaving aside the usual arguments about trying to produce to the rate of customer demand through takt time pacing in some environments (i.e., mixed model production, non-repetitive manufacturing, etc.), the most compelling reason (and one I never see mentioned in the Lean press) for not moving directly to takt pacing is that producing at takt time may not be profit maximizing.

Simply put, a firm’s customer demand may result in an output level that is either above or below the output level required to maximize profit, given the firm’s cost structure and other relevant constraints. Synchronizing to this level of customer demand through takt time would keep a firm in either of these situations from maximizing profit.

Blindly applying takt time can become an end in itself and obscure the pathway to profit maximization. It is better to start with basic firm economics and establish how a firm can produce the optimal level of output with fewer inputs, or produce more output with the same inputs. What I’m really trying to do is help the firm develop a superior production technology that is either neutral, capital-using, or labour-using, depending upon whether the marginal product of capital is increased in the same proportion (neutral), greater proportion (capital-using or capital deepening), or lesser proportion (labour-using or labour deepening) than the marginal product of labour.

Anorexic Processes

Sometimes processes can be too lean. When this happens, human labour (the variable input) is unable to sufficiently work a firm’s physical capital (the fixed input) – its equipment, machines and technology. In a word, a process can become labour constrained.

Labour constrained processes are anorexic. Because there is insufficient variable input (labour) relative to the firm’s fixed input (physical capital), output (or total product) is lower than it should be, given the firm’s stock of physical capital. As a result, the firm is unable to maximize its profit.

Process anorexia often occurs as a result of either misguided policies or indiscriminate cost-cutting. Policies that specify hiring a lower than required level of labour, or those which seek to overburden employees, can result in a labour constraint. Similarly, downsizing or indiscriminate cost-cutting can often result in too little labour to work a firm’s physical capital. The solution, in both cases, is to remove the cause of the constraint.

In the short run, rational producers will try to produce in that area where the average product and marginal product curves cross and before marginal product goes below zero. Good Lean practitioners raise the marginal product by increasing process value-add. Lean processes are efficient, but they are never anorexic.