Design is local but manufacturing and distribution are international

Part 2 of a series.

Let’s recognise that Capitalism has brought a billion people out of absolute poverty over the past decade, that it is an astonishing way to allocate talent and enthusiasm to its best use, and that it’s not going anywhere soon.

In 2008, I wrote a research paper looking at the impact of globalisation on South Africa’s recently opened (post-Apartheid) economy, as well as the likely trends for the future.

The textiles industry, which had been a massive employer for South Africa, had been crippled. In 2008, from my report:

“Over the past ten years, labour unions started to take hold of the environment which led to a lot of fragmentation in the industry,” says Noel Paulson, Edcon’s Group Quality Executive. “A lot of the factories found that dealing with labour issues for the manufacturing process was very time-consuming and costly.

As a result there was this CMT [cut-make-trim] rise which changed all the dynamics. So we moved from having close relations with a select few manufacturers to dealing with a very wide range of small to medium CMTs who, in some cases, are here-today-gone-tomorrow-types. We now deal with “design centres” who cut down all overheads and just had designers who would inform the buyers what the range would look like for the 2008/2009 season. The buyers would then place their orders with the design centre who then outsources the work to a CMT. Some CMTs are quite big but there are a lot of small ones countrywide. Some of them opened up as a result of government incentives to set up manufacturing sites in Newcastle, for instance.”

“CMTs have become a nightmare to manage, as a result. The whole image that retail does not want to do business with the local market is there, but they’ve [local manufacturers] become very nonchalant about quality and efficiency. Locally manufactured products would give us a great advantage because of the quick turn-around time and flexibilities in fulfilling on orders. But they need to up their game. This is why the concept of clusters … would have helped because it’s supposed to get all stakeholders [mills, manufacturers and CMTs] in one place to discuss industry issues because we were in a crisis.”

Let me unpack that for you, and you will see here how South Africa’s textile industry experience is a microcosm for the rest of the world.

South Africa, similarly to many western nations, offered inducements and incentives to companies to open in specific places. That led to a highly-distributed supply-chain. In South Africa, that means textiles manufacturing in Johannesburg and, 2,000 kilometres away, CMT in Cape Town and Durban. Johannesburg is, conversely, nowhere near the ocean, so imported input materials (such as thread) arrive in Cape Town and Durban and any completed garment has been shipped back and forth across the country multiple times.

Consolidating this supply-chain would massively increase efficiency both in reducing the cost of transport, and the time involved in producing a completed garment.

That required all industry stakeholders – factory owners, government and unions – to cooperate. They did not and industrial employment in the industry has collapsed.

That does not mean that there is no textiles industry.

Let me put across Gavin’s rule of modern manufacturing:

Design is local but manufacturing and distribution are international.

Remember that idea of manufacturing clusters? Turns out China are masters at it, and they arrived at it by accident.

When Deng Xiaoping began reforming the Chinese economy in the 1970s, there was no way the politburo was going to accept random foreign companies opening up anywhere in China. So they began a policy to create small, geographically-bound Special Economic Zones in which companies would be permitted to invest. See if you recognize some of these names: Shenzhen, Shanghai, Guangzhou, Xiamen … yep, some of the most industrially active parts of China.

At first there was no coordination, but there was proximity. China started by leveraging its cheap labour. In the 1980s, the industry most ripe for disruption by cheap labour was textiles. Textiles mills, component manufacturers and CMT works opened up with abandon.

Very soon, large brands in the US and EU realised they could consolidate their supply chains by coordinating these various factories to create an integrated process. The Chinese are a quick study and – as stated by Noel Paulson above – the concept of design centres soon followed.

That meant that US and EU (and South African) manufacturers were not competing with Chinese companies. Design and fashion taste are local, after all. It meant that South African designers could fly to China, spend a few days sharing their concepts with a design centre in Shenzhen and then receive their products a few weeks later.

American manufacturers are competing with American designers paired with Chinese manufacturers. It’s been the killer combination.

And it has changed everything.

The pairing has driven astonishing economic growth throughout Asia, driven down prices for all manufactures, and destroyed manufacturing jobs in the wealthier parts of the world.

People with the skills to design new products can quickly gain access to enormous manufacturing capacity. People with manufacturing skills in the US and EU are left finding jobs in the services sector selling the manufactures they used to make.

To get a sense of just how mad this can be, read this account of three extremely young men from the US who flew to China to buy a product they designed.

No, seriously, go read it. If you want to understand the threat facing US manufacturing, you have to read this:

This is what the whole trip was about. It felt great to arrive and meet everyone. It was a real place, with real people working. We weren’t being scammed. We were so relieved to see the factory matched the pictures we were sent. There was tons of natural light and high ceilings — it was quite nice.

Seriously, the whole blog is like this. These chaps have no idea what they’re doing, but the Chinese are keen on the business and not out to rip them off. It all works.

Think on that … it’s the genuine miracle of Capitalism. All these people, no cultural connection, common language, or idea what each other are actually up to, somehow making it work to produce and sell a product.

Kickstarter and the erosion of rural economies

Every day hundreds of new manufacturing projects are launched on Kickstarter and their competitors. Each are introduced by dreamers, whether they be inexperienced 25-year-olds with no idea what they’re getting into, or industry veterans with huge ambition.

They pair their design knowledge, and local market experience, with the complex and integrated manufacturing capacity in China.

An entire industry has developed in China to facilitate Chinese manufacturers supporting Kickstarter products. Yes, American consulting firms help American designers build manufacturing supply-chains in China.

But this has gone further. You can now order small scale factories in the mail. Ikea-like, the components arrive in a container, you assemble them and – within a few days – you’re off and running. Small factories like these can be run semi-autonomously and are behind the growth of artisan manufacturing from craft beer, to artisan bakeries, small-scale food processing, custom clothing, and even small-scale engineering works.

You’ll notice something. All these businesses are tiny.

The structure of these businesses – with low capital costs, minimal and highly-skilled staff, and low overheads – means that they don’t need to sell anywhere near as much as their competitors to achieve profits.

But market size is finite. You only need so many headphones or clothing. When you shift some of your purchases to these small startups, you’re reducing your expenditure on established manufacturers.

Yes, established companies make a great deal of money, but think about it from an economic perspective. If your economy grows by 3% then that is also the average profit of every company (growth comes from profits). If one company experiences massive profit growth then others must experience losses.

If Uber and Amazon suck up customers, then established companies begin to fail. Worse, if hundreds of tiny companies each profitably nibble at big manufacturers, and sell direct to the public, they grind established companies down without them ever knowing who to fight. It’s like a bull driven insane by millions of mosquitoes.

Carrier – like any company – is not firing people or moving jobs because they want to. It’s far easier to keep doing the same thing. No, they’re doing this because it’s the only way for that company to remain competitive.

Moves by Donald and Putin don’t reduce the power of the oligarchy, they reinforce it.

Once it is in the power of government to punish companies for “normal” behaviour it quickly changes the way companies are run. New investors, and those who wish to run their companies honestly, reduce investment since they’re not prepared to submit to this new system.

Those who are sufficiently cynical and dishonest can reap astonishing benefits even as industry atrophies and jobs are shed.

That might look like a devil’s trap. Leverage fines and tariffs on companies that don’t hire American (or outsource capacity) and you reduce investment overall, or don’t do these things, and see tiny companies leverage astonishing efficiency and capture entire markets causing people to lose their jobs.

There are other factors at work, though. Internal migration …

From the UN World Urbanisation Prospects report (PDF):

Globally, more people live in urban areas than in rural areas, with 54 per cent of the world’s population residing in urban areas in 2014. In 1950, 30 per cent of the world’s population was urban, and by 2050, 66 per cent of the world’s population is projected to be urban.

With the telecommunications revolution, we were led to believe that distance no longer matters.

That is wrong.

Network effects have never been more important. New ideas are much more powerful when immersed in a stew of ambitious people within a polyglot and vibrant culture. Increasingly, cities are where young, educated and ambitious people want to live.

And if cities are filling up with diverse, educated, young and ambitious people, who is left in small rural towns?

That’s right, mono-cultures filled with conservative, older people.

There is now a cultural cliff between those living in cities and those living in the towns clustered nearby. Cities – with their high rents and limited space – have even experienced a resurgence of manufacturing. It turns out that it is far easier to start a complex manufacturing business (and all modern factories require a mix of automation, engineering, design and raw labour) in a city where everyone is close by than in a rural area where highly-skilled people may not wish to live.

Companies based in small towns have suffered accordingly. The “talent” don’t wish to live there, and the workers don’t wish to move. That tension is resolving badly. As John Gapper says in the FT, “Angry voters were made on factory floors.”

And there is a consequence to this gulf played out in elections. The US and UK use a rather nebulous constituency system (electoral college) for voting. This apportions voters by geography and gives each unit an electoral representative. Urbanisation means that rural voters get an outsize influence on policy and voting simply because fewer are required to nominate a representative. Cities are becoming disenfranchised (one of the reasons Hillary Clinton won the popular vote by 2.5 million, but still lost the presidency).

In one of the more comprehensive analyses of those who voted for Donald, Doug Saunders of The Globe and Mail declared that “The real reason Donald Trump got elected? We have a white extremism problem.”

Americans who live in cities of 50,000 or more overwhelmingly voted for Ms. Clinton, by a margin of 59 to 35 per cent. But “small city or rural” residents voted for Mr. Trump by almost the same margin (62 to 34), with the suburbs almost equally split between the two.

This migration and differentiation been happening for decades and the difference has created a frightening divide, at once economic and cultural.

People who move from rural areas to diverse cities may not be liberals when they arrive, but they rapidly become far more liberal than they were. And that divide – liberal, polyglot cities – surrounded by atrophying conservative towns, drives each to the extremes.

The divide becomes self-reinforcing. Ohio is to pass a Foetal Heartbeat Bill that would ban abortions as soon as a foetal pulse is detected (as early as six weeks in). And within this sea of increasing conservatism, cities offer sanctuary to undocumented immigrants.

People offended by either of these policies are more likely to move, driving further liberalism or conservatism.

Into that divide have stepped the populists.

Continued in Part 3, or read Part 1.