People Innovation Excellence

Building Walls – Building Supply Chains

ISE Magazine -Volume: 49, Number: 11
By Bublu Thakur-Weigold and Pavel Hnát

IEs must break down silos and let the world know where real manufacturing value resides

We live in interesting times. Newly elected governments on both sides of the Atlantic are planning to build (or re-establish) walls to keep neighbors out and – presumably – jobs in. An American administration is willing to spend billions to build a brick-and-mortar symbol of economic nationalism, while preparing to renegotiate NAFTA. In Europe, the United Kingdom has voted to leave the European Union, confident that Brexit will allow the nation to be more prosperous on its own. France narrowly voted against a resurgent National Front arguing for a “Frexit” along the same ideological lines.
Economists can help industrial engineers or managers understand these developments. Looking back on history, they will emphasize that events like these are neither new nor surprising. They define three dominant views of the world’s political economy: the first comes from the philosopher (and customs official) Adam Smith, whose liberal vision was of a barrier-free world in which markets regulate themselves. The second are neo-Keynesians (named after John Maynard Keynes, the prodigy who faced Britain’s postwar devastation), who argue for a national economic system upheld by government interventions designed by enlightened leaders and their economic advisors.
The third position is held by the Marxist theorists, who keep a watchful eye on egregiously unfair distributions of wealth, i.e., the ones that cannot be addressed with peaceful means. History shows that the popularity of these world views alternates every few decades, switching whenever economic turmoil hits the system.
If we consider current events in this light, the neo-Keynesians are seizing leadership positions in interventionist governments. They are progressively replacing Adam Smith’s view with a nation-based system of domestic economies. Convinced that economic integration means that local jobs will be lost to cheap foreign labor, voters believe that politicians can make the economic system work for them. They trust that national champions shall rescue their factories and return jobs to native soil. Indeed, after almost a decade of crisis management and unprecedented interventions (think bailouts), the Keynesian view is firmly ascendant.
But do nations really become richer and more secure if they work in splendid isolation?
With globalization affecting almost every detail of our lives, this question is more urgent and complex than ever. For decades, economists in the West had clear answers: Trade is the basis for growth and closed (or “autark”) economies always fail. But economics is also about trade-offs. Exposure to trade always creates local winners and losers, even when the national economy grows as a whole. Developed countries like the United States, Britain and France are all richer because of the international division of labor, especially with lower-wage regions in Europe and Asia. Factory assembly work does not pay the rent, not even in the U.S. rust belt.
IEs shaped the postwar global supply chain
This list of politically explosive questions and answers demonstrates how influential the work of the humble industrial engineer has become following the second World War. In the course of those decades, containers made the transport of goods cheap, technology made it easy to share information, and the walls between East and West collapsed.
The supply chains that grew out of these changes bear the IE’s signature. The network optimizations of industrial engineers computed where a factory should be built, their make-or-buy calculations selected the supplier best-suited for the job and then they set the maximum price for a profitable contract. These and countless other microdecisions are what economists describe as “the behavior of firms.”
As it turns out, while IEs worked to reconcile the trade-offs of efficiency and customer service, they were shaping globalization. This is a lot of responsibility to carry. The world continues to redistribute work at a fast pace. Specifically, the G7’s (Britain, Canada, France, Germany, Italy, Japan and the United States) share of world manufacturing as measured by GDP has declined by nearly 20 percent since the 1970s. This decline is almost exactly mirrored in the rise of China’s share of manufacturing.
At first glance, the picture is disturbing, since it suggests that rich countries are losing something they cannot afford to live without. In particular, nation-centered economists tend to equate productivity literally with the activity in factories, which their textbooks describe as an alchemy of labor, machines and land. But the reason manufacturing has been shifted to regions with lower wages is because factory work, as it is carried out in low-wage countries, is neither sophisticated nor lucrative. It is the research that went into designing faster chips, the iPhone and other products that adds the highest value to the final product.
A smile shows where the real money is
Taking apart an electronic device designed in the United States and then assembled in Asia shows that the most money went into the activities that required brainpower and judgement – research and development, design, distribution and marketing. In other words, the arcane management of demand and supply. The uneven way in which value is created (and remunerated) along a supply chain are aptly described as the “smile” curve. More value is created at the two ends of the supply chain than in the middle. Its logic should be familiar to any supply chain designer.
Industrial engineers know that it is not plain cost-cutting or low wages that make a company competitive. High profits and low cost are the outcome of supply chain strategies like postponement, the Toyota Production System, supplier integration, sales and operations planning, vendor managed inventory, fast fashion, cross-docking and much more. Process innovations like these have enabled companies to deliver more to their customers with fewer and fewer resources.
The challenge of matching supply to demand under conditions of uncertainty is the rocket science behind Apple’s business success, not the low wages of China alone. Politicians often see no more than the brick-and-mortar of the factory, when the money-making magic comes from the end-to-end system that balances the intricate global flows of information, finance, innovation and trust. Companies create sustainable, well-paying jobs when this complex system remains productive and profitable in the face of uncertainty.
Because it can be daunting, let’s recall what uncertainty exactly means. It’s not just unpredictable customer sales but new products developed at great expense that may or may not be duds, prices of raw materials and components that fluctuate while the selling price is fixed, supplier bankruptcies, fluctuating transport times and renegotiated tariffs and trade agreements.
In the non-management literature, governance is frequently associated with quasi-monopolistic multinational corporations roving the world to exploit the defenseless. Clichés of capitalist excess should be addressed by qualified engineers who know that supply chain management is more than command and control of weak nodes or squeezing suppliers (and workers). The systems intelligence that goes into the governance and coordination of the nodes in the value chain should be one of the high points of the smile curve. It is what enables industry profitability over long periods of time.
Whatever the nationality or party line, the logic of the smile curve is virtually impossible to defy. Rather than bring poorly paid jobs back to locations that lost them for good reason, we should be encouraging political leaders to improve the boundary conditions that help enterprises prosper and create jobs over the long run.
What makes companies like Apple and Daimler AG, parent company of Mercedes-Benz, competitive are the institutions that uphold basic laws so contracts between supply chain partners can be enforced. Banks that provide financing for industrial upgrades fuel the competitiveness of any country.
Arguing for the larger socio-economic picture
Needless to say, the solutions will require commitment and a readiness to overcome silos between disciplines, revise mental models and tear down walls of whatever variety.
No easy task, since economists are notorious for their own differences in opinion. Keynesian economics works only in the short run, in the spirit of its author’s famous quip, “In the long run, we are all dead.” Marxism sees no solutions at all within the established system and considers revolution inevitable. And even liberal economists struggle to bridge differences between what works in the domestic economy and what works in the globalized system. And so arises the unspeakable irony that the free markets of the Western nations, which were once proud to have “triumphed” over a bankrupt communism, are today resorting to the political micromanagement of their most successful enterprises. This is nothing other than a form of central planning.
IEs tend to think in short to medium-term business horizons. These are the months or years in which process technologies kick in. But the deindustrialization of the G7 countries took place over decades, balanced by the growth of new high-tech industries. This was precisely when supply chains were set up to span the globe and take advantage of newly open markets, sources and cost structures.
Engineers are not in the habit of paying attention to that larger socio-economic picture. Now, as walls and social upheaval loom large, it would be unwise to ignore the long-term consequences of the models and calculations and leave the design of global supply and value chains to the less qualified. They must weigh in, help negotiate geopolitical sensitivities and defend the hard-won, free and efficient flow of goods, information, finance and people.

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