Competing Without an Ally: U.S. Manufacturing Faces Unique Challenges
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Indiana Manufacturers Association – Executive Memo – September 2004
By Ronald Dukes
“Keep good jobs on U.S. soil” seems to be the rallying cry and heartfelt promise of every politician this election year. Manufacturers know these anger-inducing sound bites get print and face time but lack substance. They do little to communicate or deal with the complexities of business based in the U.S. that must operate in a global world.
Indiana manufacturers have been particularly hard hit. From May 2000, the state’s employment peak, until September 2003, Indiana lost 154,600 jobs; and 61.3 percent of these have disappeared from the manufacturing sector.
But job loss is just the tip of the iceberg. The cataclysmic threat is the potential shift of manufacturing innovation to other countries. In analyzing the findings of his recent study, Securing America’s Future: The Case for a Strong Manufacturing Base, economist Joel Popkin concludes that should the U.S. manufacturing base continue to shrink at the current pace, the American way of life as we know it faces extinction.
The strength of U.S. manufacturing has always been its creativity and ability to produce quality at a reasonable price. Pressure from investors and Wall Street for profits and rising costs exacerbate the situation. Shrinking margins mean less to allocate for Research & Development.
Popkin’s study supports this observation. In the past two years, spending on research and development shifted into low gear, with the increases growing at half the pace seen during the past 10 years.
Existing products that have been reissued with improvements has been the trend. This is a compromise that currently pacifies customers but doesn’t completely satisfy their craving for the new and original. It maintains cash flow but fails to address how to generate much-needed capital for research and development.
Such a pullback could have incredible repercussions on the nation’s competitive positioning and economy. Two-thirds of all private-sector R&D comes from manufacturing. A large proportion of these innovations are utilized by other industries.
To grow and continue to create jobs, manufacturers must please customers. They are increasingly demanding, the catalyst for manufacturers to seek methods to continuously reduce costs while maintaining product quality.
“I view the issue of competitiveness primarily from an operational and profit and loss standpoint. Actually, a lot boils down to what does it take to satisfy customer needs, providing quality service at a price they want. If they don’t see this, then they will go to wherever they can to get it. This is basic to running a company,” says Joseph C. Muscari, Executive Vice President and Group President, Asia and Latin America, Alcoa Corporation.
Supposedly, the adverse effects of isolationism were made blatantly apparent in the 1940s, and imperialism has been viewed unfavorably for a century. Yet the basic premise of a global economy and conducting global business escapes constituencies of manufacturers. Manufacturers must know, sell to, and serve different types of customers located throughout the globe. Utilizing strategic processes and practices are vital, and that includes having operations abroad. Often the relationship is reciprocal.
“Since Alcoa has investments all over the world, we take a more balanced view in terms of how we look at global sourcing. Our challenge is how to best serve our customers globally,” says Muscari.
“I have businesses that export product to the U.S. I also have a trading company that exports product from the U.S. into China and SE Asia. It’s a two-way street for a number of our products. Some of our high-valued aerospace products – which are high technology and require a lot of knowhow -- and sheet products are sourced into Asia from North America,” explains Muscari.
Muscari continues, “The question is: Will they be competitive long term? We are working hard to maintain those positions.”
An executive at a major U.S. manufacturer adds, “At the end of the day, you have to manufacture where you sell because it is difficult to manage your lines of supply.”
High school consumer economic classes teach that price is a factor in customer satisfaction and consumption, making it an integral factor in overall competitiveness. Many U.S. companies that have moved operations to achieve cost savings are more competitive.
“The differential in cost depends on the product. The U.S. plants may have an advantage for some of the higher-tech, lower-labor cost products. When you move higher-labor content into low-cost countries, then you start to see the advantages of moving to countries with lower labor costs and good infrastructures,” points out Muscari. “Basically, today, with modern manufacturing approaches, you can have very competitive plants anywhere in the world.”
But mass frustration concerning job losses obscures a potentially explosive little secret that would stun the regular guy on the street. The competitive edge gained by having off-shore operations has had a positive effect on the nation’s economy. It increases the consumer’s buying power.
“Part of the low inflation rate in the U.S. is driven by the ability of the consumer to pay less for things or not have them subject to high inflation. Therefore, for the manufacturer, being competitive comes from being able to smartly source and go head-to-head with their competitors,” states Muscari.
Consumers may not understand the effect such shopping power has on manufacturers. They may cling to misconceptions about who actually controls product pricing, believing prices are dictated by the factories. They hold retailing champions of low prices in high regard, unaware of the influence these behemoths exert.
No doubt the advent of an independent, large commercial distribution system, characterized by unique organizations like Wal-Mart, significantly improved competitiveness. But industry pundits are questioning whether the pendulum has swung too far, allowing these distributors to damage the health of American manufacturing and negatively affect the overall economy.
Says one senior executive at a major U.S. manufacturer, “Manufacturers get stripped to the bone. A significant portion of a manufacturer’s margins is drawn into distribution. In essence, the shifting of power into distribution denudes the margins that manufacturers have to spread across their base.”
The executive explains, “Our country’s regulated environment and the push toward independent distribution created a competition between distribution and the factory. Manufacturing in the U.S. couldn’t redeploy margins. As a result, the manufacturer is hampered in developing many new technologies because those margins were not available to use in bringing out new, innovative products.”
Distribution companies are singularly focused in their pursuit of goods for the lowest price. To U.S. manufacturers, it’s a familiar story. But to manufacturers in China, it is a new, unpleasant experience.
Faced with strong competition from other Chinese factories for orders from U.S. retailing giants, one manager of a Chinese factory had to lay off half his workforce while keeping up the same rate of production. Other cost-cutting measures had little effect. The manager said the factory was barely profitable.
If Chinese factories are feeling the screws turn, can consolidation and closings be far off? More relevant to the competitiveness of U.S. manufacturers is how quickly they can identify the next China so that strategic investment can be made before operations – and customer satisfaction – are disrupted.
No doubt this will bring another round of finger pointing, blaming big business for the nation’s ills. While politicians publicly mourn the loss of jobs, how many will connect it to the pervasive, uncompromising attitude of entitlement of the U.S. citizenry? This mindset fuels manufacturing’s outsourcing and sows the seeds for its demise.
“Our society says that corporations will bear the brunt of social costs in certain ways and the government bears some of these costs,” says a manufacturing executive. “As a result, it creates a less competitive situation for many U.S. manufacturers.”
A recent study by the National Association of Manufacturers and Manufacturers Alliance/MAPI revealed that non-production costs add approximately 22 percent to unit labor costs of U.S. manufacturers not levied on other major global competitors. The extra costs are corporate tax rates, employee benefits, tort litigation, regulatory compliance, and energy.
“How Structural Costs Imposed on U.S. Manufacturers Harm Workers and Threaten Competitiveness,” conducted by economist Jeremy Leonard and funded by Emerson, found these external costs to be twice the size of average direct labor costs, which are 11 percent.
Footing the bill for these costs has overshadowed the strides U.S. manufacturers made in reining in costs to remain in the game. Since 1990, manufacturers have realized a 54 percent increase in productivity. Manufacturing prices have declined for the last seven years.
That speaks volumes about the ingenuity and superior abilities of manufacturing leadership. Should the burden of these external costs be eased, U.S. manufacturing could regain its prominence in a global world, as well as with its constituencies at home.