Reassessing supply chains. China’s on-again, off-again embargo of rare earth exports in 2010, in which it withheld materials that are critical for sophisticated electronics and electrical equipment, demonstrated the risk of overreliance for supplies on any single developing country. In an environment where nationalistic and political considerations may swamp purely economic ones, industrial companies can be hard hit. The best of them are balancing their supply chain dependencies, creating more flexible footprints that can be altered as market and competitive conditions change, and diversifying their sourcing.
Broadening their geographic reach. Given the continually changing global environment, companies are also rethinking the mix of countries in which they operate. For example, China is losing its position as the preeminent low-cost nation. Escalating wages now place compensation rates in China well above those in Bangladesh, Pakistan, and Vietnam. Moreover, as wages go up and China’s currency inevitably appreciates, the absolute cost of doing business in China will continue to rise to the point that low-cost regions of the West — perhaps eastern Europe or Mexico — could become more desirable for products destined for Europe and the Americas.
- Preparing for currency instability. Inextricably linked to a reassessment of the supply chain is the role that global currencies play in determining relative costs of exports, imports, wages, and supplies. China has been warned numerous times by other countries and global bodies that it must let the renminbi appreciate to levels more in line with the nation’s stunning growth rate. If that happens, wage and commodity price escalation will become even more of a concern than it already is.
Meanwhile, the U.S. dollar remains historically low relative to the yen, euro, and Canadian dollar. This potentially helps American manufacturers by making exports cheaper and imports more expensive. But companies in countries that do business with the U.S. and that rely on the American market for a large portion of their sales are putting pressure on their governments to fight back against the soft dollar. That drumbeat got louder in October after the U.S. Federal Reserve announced its new US$600 billion quantitative easing program.
It’s not at all clear how the dust will settle in the global currency flap, but the inability of G20 countries to reach consensus on the issue at their November meeting in South Korea raises the specter of a full-fledged currency war. Leading industrial firms will manage this volatility by adding exchange rate fluctuations to cost considerations when reevaluating supply chains and manufacturing footprints. Currency hedging, commodities derivatives, and minimizing foreign exchange exposure will all be employed to protect against wide swings.
- Spending more wisely on R&D. Booz & Company’s annual Global Innovation 1000 survey last year revealed that in 2009 the industrials sector trimmed its research and development budget by about $1.3 billion, or nearly 2.5 percent; however, when calculated as a percentage of sales, which were down across the board in 2009, industrial firms’ R&D spending actually rose.
With revenue under pressure throughout 2011, and R&D budgets at least equally constrained, industrial firms will work more diligently to maximize the effectiveness of their R&D investments. This could take many forms; one valuable approach will involve placing engineering facilities in multiple sites around the world to enhance their proximity to customers, lower costs, and improve access to emerging pools of technical talent.
Some industrial companies will increase the return on their R&D budgets by taking advantage of so-called frugal engineering — avoiding needless expenses by incorporating only the features and functions needed for particular markets (such as low-cost consumers). General Electric has had success with this approach in marketing its low-cost Mac 400 electrocardiogram, as has Texas Instruments with its LoCosto chip for relatively feature-free cell phone handsets.