THE BEAR'S LAIR
The murder of US manufacturing
By Martin Hutchinson
GE's announcement a week ago that it would accept offers for its appliances
business marked the death-knell of yet another US manufacturing business, one
among so many in US manufacturing's long and seemingly unstoppable downtrend
since 1980.
That decline may seem an inevitable historical trend, and Wall Street's
analysts would claim that the US economy can prosper just fine without it. Yet
impartial analysts of the putrefying corpse of US manufacturing capability are
forced into an inescapable question: did it die of natural causes or was it
murdered?
For the past 30 years, Wall Street's insouciant attitude appears to
have made sense. US manufacturing has slowly declined, as operations have moved
to lower-wage centers in the Third World. Yet the US economy as a whole has
continued to thrive, as financial services doubled as a share of gross domestic
product and grew to provide 40% of the earnings on the Standard & Poor's
500 share index. Prosperity was heavily skewed towards the very rich, but the
majority of Americans continued to enjoy a general, if halting improvement in
living standards.
The collapse of the financial services bubble has, however, called into
question three of Wall Street's most cherished beliefs about manufacturing:
First, Wall Street believes that financial services and other services can take
the place of manufacturing, and that the United States can remain a prosperous
economy thereby. Second, it believes that manufacturing tangible products is an
intrinsically low-skill and uninteresting operation, so that the US would do
much better to specialize in "symbol manipulation". Third, it believes that the
decline in US manufacturing was and is inevitable, so that decline would have
happened whatever strategies management had adopted, and whatever resources and
attention it had devoted to manufacturing activities.
The inevitability of manufacturing's decline is in some ways the most
interesting question, which has not been addressed much elsewhere. Most
large-scale events of this nature appear inevitable in retrospect, yet if
examined in detail can be shown to have been triggered by a series of decisions
that could have gone the other way.
Management decision-making, like most human activities, is a slave to fashion:
whichever guru has captured the attention of business academics and the
business press at any given time is likely to have an inordinate influence on
management decisions.
In the 1920s through the 1950s, the production engineering of Frederick W
Taylor was fashionable, and the United States built the first mass-production
economy. In the 1960s, MBA-credentialed top management was thought able to run
anything, and so both conglomeration and strategy consulting came into fashion.
From the early 1980s, it became received wisdom that all organizations could
usefully be "downsized" and that the traditional corporate welfare protection
of employees was wasteful. All these theories had their virtues; the reality
however is that they cannot all be universally true since they are largely
mutually incompatible.
In the 1970s, the new and very fashionable Boston Consulting Group introduced
the "strategy matrix" under which businesses were divided into stars, cows,
dogs and question-marks, according to their growth prospects and profitability.
Stars, the businesses with the highest growth prospects and profitability, were
to be nurtured and given resources, dogs, of low profitability and low growth
were to be closed down, and question-marks, of high growth but low
profitability, were to be given modest resources to see whether they turned
into stars or dogs.
The whole operation was to be paid for by milking the "cows", those businesses
of low growth but high profitability. Cows, as their name suggests, would be
denied capital investment, since such investment should not be wasted on
low-growth situations. Instead, their cash flow would be milked to provide
capital investment for the stars and the more favored question-marks.
There were several problems with this mechanistic, clever-clever approach to
business management. One was that the businesses' typology could not be
identified accurately; which businesses were treated as "stars" was more a
matter of the business cycle and doubtless of office politics than of the
long-term underlying reality. A second, even more fundamental problem was this:
cows that are milked and not fed quickly turn into dogs. Businesses that are
treated as not part of the company's glorious growing future quickly wither on
the vine, as new opportunities in those business areas are missed. Their
profitability starts to decline and quickly the cash flow that was their
corporate raison d'etre disappears.
When examined dispassionately in the light of posterity, it appears that far
too many of these "cow" businesses were manufacturing operations milked for
cash flow that was diverted into more-fashionable businesses in the service
sector, particularly in finance. Westinghouse, for example, one of the most
important names in electric equipment until 1980, had split up and left
manufacturing altogether by 2000. To be fair, Westinghouse management had a
good excuse; one of their leading and most successful businesses had been the
construction of nuclear reactors, an activity that disappeared in the 1980s
owing to political cowardice in the face of environmentalist harassment.
General Electric, however, run from 1981 to 2001 by ultra-fashionable "Neutron"
Jack Welch, epitomized the failings of the era. It under-invested in many of
its manufacturing businesses, entered into a blizzard of divestitures designed
to boost its short-term earnings, played games with its pension accruals and
built a gigantic financial services empire of low-quality businesses in which
it could never be a leader. It also ruthlessly eliminated its middle management
and overpaid its top management, winners in the corporate office political
game. GE was a much-admired operation in Welch's later years; it is less so
now, and if the bloated global financial services business returns to a
historically normal size may finally be seen to have been a disaster.
GE Appliances, GE's home-appliance business dating back to 1907, the early
years of electrification, was long dominant in the home appliance field. GE
chairman Jeff Immelt has now put GE Appliances on the sale block so that GE can
focus on higher-margin businesses. The appliance side has attracted interest
from China's Haier Group but is expected to be less interesting to South
Korea's LG, because LG manufactures appliances of a higher price and quality. A
commoditized and fairly uninteresting business, in other words, currently worth
around US$6.3 billion to $6.5 billion, little more than 2% of GE’s $290 billion
market capital.
However, if you look back even to 1994, a medium year that was already well
into GE's Welch-inspired transformation, appliances represented 10% of GE's
sales and 8% of operating profit. In other words, the business has been
steadily starved relative to GE's other businesses, and has turned itself from
a "cow" into a "dog".
To see how this happened, think back to the 1950s. Electric appliances were the
major growth business of that decade, symbolizing the decade's new affluence.
Forecasters confidently predicted that by 2000 robot appliances would be in
every household, removing the drudgery of housework once and for all. As a
youthful reader of Isaac Asimov's Robot stories I shared that confidence
- after all, the computerization necessary for robot control systems, which had
not existed in 1940 when Asimov wrote the first of his I Robot short
stories, was already revolutionizing business management by the late 1950s.
Now it's not just 2000 but 2008. So where the hell are the robots? GE
Appliances has no such offering; if you buy a GE vacuum cleaner you will still
have do all the work yourself. Can it be that the technological optimism of the
1950s was misplaced, and that home robots will never exist, or will be invented
only in the far distant future? You'd certainly think so from looking at GE's
catalog of products.
However it turns out that GE is simply behind the curve. The iRobot Corporation
of Bedford Massachusetts, founded by keen Asimov readers from MIT in 1990,
manufactures fully robotized vacuum cleaners as well as some pretty neat
robotized mine-clearing equipment for the military. iRobot's standard model
runs around $300, less in real terms than an ordinary vacuum cleaner would have
cost you in 1980. iRobot's total sales are only $250 million, which GE would no
doubt class as a rounding error, but dammit, the company doesn't have GE's
brand name or distribution network.
Had GE had the sense and innovative skill to develop robot vacuum cleaners, can
anybody doubt that that product group's sales would today be several billion
dollars, with appropriately high margins? It is thus clear that by starving GE
Appliances of investment and, more important, of research dollars, and devoting
the company's efforts to financial services, "Neutron Jack" and his cohorts
have deprived the United States of a major new business and deprived us
overworked consumers of a major labor-saving technology (unless we are lucky
enough to find out about iRobot or its few small-company competitors).
GE has commoditized its appliance business, forcing down prices by
manufacturing in ever cheaper-labor parts of the world. Instead it should have
been enriching that business, opening up new opportunities for products that
could be sold at higher prices and higher margins and provide more value to the
consumer.
The sad story of GE Appliances is a paradigm of what has gone wrong in the US
economy since 1980. No, manufacturing did not need to leave the United States;
US manufacturing was killed by a multitude of foolish short-term-profit
motivated decisions by inept and overpaid US management.
The other questions can also be answered. Manufacturing is not intrinsically a
low-skill and uninteresting operation. It involves skills at the highest
possible level and can readily employ high-wage workers - after all LG's
workforce in South Korea are these days very far from being subsistence-level
Third World proletariat. Finally, the US cannot survive through financial
services and tech startups alone; it needs to reinvest in manufacturing or it
will find itself unable to support an advanced-economy living standard for the
mass of its population.
Yes, Virginia, you could have had both robots and the Internet. The 1950s dream
of an infinitely prosperous United States full of household robots and other
high-tech wonders was not a fantasy, it was there for the taking. Only
political and business incompetence prevented us from achieving it.
Martin Hutchinson is the author of Great Conservatives (Academica
Press, 2005) - details can be found at www.greatconservatives.com.
(Republished with permission from PrudentBear.com.
Copyright 2005-07 David W Tice & Associates.)
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