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Forging the 21st-Century Supply Chain

The American middle class? It's oh-so-20th Century. As Ernst & Young told us last week, the biggest opportunity for merchandisers in years to come is the emerging consumer in China, India, Brazil, Eastern Europe and other places far from U.S. shores.

Now hear Josh Green, chief executive officer of global sourcing and procurement specialist Panjiva: "To me, the defining economic event of the 20th Century was the rise of the American middle class. For the 21st Century, it's the rise of the global middle class."

Not everyone has gotten the message. Green believes the many companies that are still focused exclusively on serving American consumers - who, let's face it, aren't doing a whole lot of consuming these days - are living in a "bubble" of outmoded thinking.

The warning signs are there for all to see. Wages rates in China are steadily climbing, undermining that nation's image as a paradise (for employers) of cheap labor. To be sure, Chinese manufacturing wages remain ridiculously low in comparison with those of the West. And conditions at many Chinese factories are still shocking by anyone's standards. But the picture is changing, and that's good news for workers and far-seeing businesses alike.

A manufacturer's first impulse, of course, is to pull up stakes and look for the next country with citizens who are so desperate for any kind of employment that they'll work for pennies an hour. And we're not running out of those places yet. Vietnam, Cambodia, Malaysia, Bangladesh and other under-developed economies still offer the prospect of cut-rate workforces for global suppliers. But if Panjiva's Green is right, they'll never replicate the model that has made China so attractive to business.

The main obstacle, he says, is their relatively small labor pools. It's tough enough for any developing economy to build up the necessary infrastructure and adopt export-friendly policies that attract foreign investment. But you still need a certain number of bodies to do the work. Where else but China could a contract manufacturer like Foxconn employ hundreds of thousands of workers in complexes that are larger than most cities? India, perhaps, but that country lacks the sophisticated network of ports, roads and railroads - not to mention the cooperative bureaucracy - that make it a tenable alternative.

So we're left with a country that seems determined to shrug off its image as a factory for the rest of the world, in favor of developing an economy that's geared to the needs of its own rising middle class. And without a viable "new China" on the horizon, global manufacturers are being forced to adopt a new mindset. "Labor arbitrage," says Green, "is not a good strategy in the long run."

Manufacturers will still need to be in China - but to serve the Chinese market. The same goes for growing demand in those other emerging economies. Green agrees with Ernst & Young that the key to success won't lie with companies that can beat down labor rates to their lowest possible levels. Advances in technology will spur demand for high-end manufacturing that requires a greater level of skill and less hands-on involvement by human workers. Much of the repetitive grunt work will be taken over by robots, as is already the case on most automotive assembly lines.

I hope he's right. Up to now, we've witnessed the irony of the most sophisticated electronic devices being assembled essentially by hand, because labor in China has been so plentiful and cheap. The theory is that higher wages will drive manufacturers to embrace more automation, freeing workers from the most mind-numbing (and physically hazardous) tasks. Of course this development raises the question of how China will bootstrap itself into a middle-class society if large numbers of people are thrown out of work by technology.

Assuming that there will be enough "good" jobs in China's evolving economy, companies serving that market will be forced to some extent to make do with higher production costs. The winners will be those that develop an intimate knowledge of emerging markets everywhere, tailoring their goods accordingly. Businesses looking to capitalize on the trend will have to do more than just churn out the cheapest product.

We're already seeing some successes, even in the U.S. Green cites a couple of examples. Peek is a New York-based start-up that combines inexpensive smartphone technology with the cloud, for consumers in emerging markets. Sanergy builds sustainable sanitation systems for poor urban areas.

The shift isn't going to happen overnight. Green says emerging economies in Southeast Asia, Eastern Europe and Latin America will still be jockeying for low-end manufacturing business. With their limited populations, however, they'll never achieve China's level of success in that sector. They won't be able to keep wages down as long as China did.

"People are talking about moving beyond China, but it's not a simple thing to just pick up and move," says Green. "Other geographies have drawbacks. People are learning more, becoming more realistic."

And what about the U.S.? How can it put a stop to the hollowing out of its own middle class? By serving the needs of the rest of the world, in addition to its own. That takes companies that can get the most out of a highly skilled and educated workforce. (And motivated too, in the wake of the Great Recession and a grindingly slow recovery.) A global pipeline can flow in both directions.

Next: A U.S. manufacturer that stayed home.

- Robert J. Bowman, SupplyChainBrain

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