Posted on 04/17/2007 8:14:33 PM PDT by dirkdavies68
As citizens of the industrial age, most of us were taught to believe that manufacturing is the source of all wealth. Until very recently, the United States was both the world’s wealthiest nation, and world’s manufacturing powerhouse leading economists to believe that there was a correlation between the two. This is why the “hollowing out” of American manufacturing was viewed with such dire alarm throughout the 1980’s and 90’s. Remember Ross Perot sounding the alarm bell during the 1992 election over NAFTA and the loss of American jobs?
Perhaps this was just an overreaction, a misunderstanding. If it is indeed true that we are moving into an “information age” or a “knowledge economy,” as the experts tell us we are, the new source of wealth becomes something intangible: Knowledge. This is demonstrated by Stan Shih’s smile curve:
More on this graph in a moment, but first a brief introduction to the guy who thought it up. Perhaps you’ve never heard of Stan Shih, but in Asia, he is a rock star capitalist –the founder of Acer Computer, a genius business theorist and now a hotshot VC.
Shih’s “Smile Curve” comes from his observations as a contract manufacturer of PCs for US brand name manufacturers. Remember back in the mid-80’s when PC clones first caught fire? There were hundreds of PC clone brands, but most of them were made by OEMs (original equipment manufacturers) – like Stan Shih’s Acer - in Taiwan.
What Shih noticed was that while companies like his did all the manufacturing work, it was the name brands – the IBM’s, the Compaq’s and the Digital’s – that got all the glory and the profits. The big American firms with the concept, the R&D, the brands and the distribution channels could outsource the lowly manufacturing work to the lowest bidder. This resulted in a bidding war to the bottom in Taiwan, driving down the cost of producing PCs.
Let’s take a look at the curve again:
The y-axis represents value added activity. Higher value activities are higher on the graph. The x-axis represents the required steps along the value chain as a linear progression through time.
To explain this using a more modern example and in concrete terms, lets use the example of the Apple iPod. Apple recently announced that has sold 100 million iPods, and the product has been a cash cow for Apple. But where was the value created? Not in the manufacturing. Apple doesn’t make the iPods, they contract the manufacturing out to a Taiwanese manufacturing giant you’ve probably never heard of called Inventec.
In fact, “manufacturing” is rather a misnomer. Assembly is more like it. An iPod’s chips come from a variety of high-value suppliers (Texas Instruments among them), the hard drives from others (Hitachi), and the hundreds of other electronics components from other suppliers. Inventec is really just a very organized assembler of parts from different companies all over the world. And the assembler’s margins are woefully slim. Inventec doesn’t just make iPods, it also makes notebook computers, phones, personal digital assistants, calculators and the like for companies much more famous than it is.
The real “value creation” in the iPod came in the knowledge required to conceptualize, create, market, brand and position the player, as well as the ability to leverage that knowledge into a hefty profit. The iPod certainly wasn’t the first mp3 player, but it is by far the most popular, thanks to the unique conceptualization, sleek branding, and superior design and engineering. In short, the value came from knowledge and through leveraging that knowledge.
Apple is able to capture huge margins on sales of the iPod. Say each iPod costs $5 -10 to make, but Apple sells them anywhere from $150 - $250 because it controls the distribution network and can therefore set the price. Because it is a unique item, there are no bidding wars with other mp3-player makers. Let others sell mp3 players as cheap as they like – few people want them.
Apple also sells “aftercare” – a payment of X dollars as insurance in the event your iPod breaks down over the next year. This intangible “knowledge product” (Apple knows how long an iPod should last, and how many will break down within the warranty period) results in extremely high profit margins.
From this example, manufacturing does indeed appear to be the lowest value input. This is why, the capitalists say, the world has evolved to the point that it has. “We think, they sweat,” they say. We of course, are the Americans and they are the sweating Asians.
Clever, isn’t it? But I have a nagging feeling there is something wrong with the theory, though I’m not exactly sure what. Perhaps I’m too rooted in the old economy, unable yet to adjust to the idea of the “knowledge economy.” But I have a feeling there is something more.
If anyone has any insights into the matter, I would certainly appreciate them. Are we keeping ahead, or just hopelessly deluding ourselves?
Ping.
If you are manufacturing commodities like raw steel, you are at the bottom.
but if you are manufacturing custom made stuff, you are at the top end.
manufacturing composites for the boeing dreamliner or components for the stealth raptor or manufacturing invisalign inserts, or custom artificial limbs etc, that is very high value stuff.
The graph is true.
Unfortunately, if you have to churn out airplanes and missiles and ships and tanks, and all of their component parts, in order to defend yourself and your allies from other people who are churning them out, all those R/D, advertising and sales and marketing guys won’t do anything for you. It’s the low point on the curve: the factories where those things are manufactured, and the factories where all the component parts of those things, from the steel and aluminum to the rubber and electronics and composites, are manufactured are closing down and moving to China, because American manufacturing cannot compete with the China price.
So, certain people in America make lots of money, money which buys consumer goods (made in China), but money which cannot, in a pinch, but oodles of new tanks and planes and missiles, because key components to those tanks and planes and missiles are not manufactured in America anymore. They’re manufactured at that “low point” in the smile curve, in some faraway place.
Of course, one low point in that smile curve is China...China which has the manufacturing plants, and great gobs of money to throw at them. In a pinch, they CAN churn out lots and lots of tanks, airplanes and missiles, and their capacity grows while ours shrinks. They don’t have to import key manufactured parts. We do.
Faced with this, the best way to keep those smiley points of that curve nice and bright will be to capitulate to China on everything, because within twenty years, in a head-on collision with China, WE will be in the position of Germany in World War II, and THEY will be in the position of America: the greatest industrial power in the world, able to outproduce us in raw metal.
But the age of mass warfare is past. I heard it all the time from Rumsfeld et al. So it must be true. Therefore, there is nothing to worry about. Ship the whole industrial base to China. It’s more efficient that way.
Hmm
If you look at the Stan Shih Smile Curve, you'll notice that the areas to both sides (before and after) of manufacturing are the high-value segments of the product development process.
This explains why a country like China is pretty much consigned to permanent dysfunction no matter how much of our manufacturing is outsourced to it. Because China has no solid legal system that can be relied upon to secure intellectual property rights and guard against patent theft, there is almost no "pre-manufacturing" value-added work done there. And because China's primary function is to serve as a source of cheap labor to manufacture things for export to wealthier markets, there is also very little marketing, sales, and post-sales service work being done there, either.
You raise good points there. I’m not sure if the age of mass warfare is over, but I suspect a major paradigm shift has occurred since World War II — not because of the atomic age in weaponry, but because space age technology has given a huge advantage to a nation that can dominate the earth’s orbit over a nation that can dominate the earth’s surface.
Yes, but the way you describe China is exactly where Taiwan was 25 years ago. Stan Shih & Acer got their start - get this - making knockoff clones of the Apple II. Completely illegal. Over time they shifted to legal manufacturing, and now Taiwan protects IP. You can’t buy pirate stuff there the way you could 25 years ago or the way you can in China.
The point is - everyone wants to move up the curve. Taiwan was at the bottom 25 years ago when China wasn’t anywhere near the curve. Now Taiwan designs a lot of stuff (for Dell, Compaq, even Apple) and they outsource the production to China. The US role is only for distribution any more, and of course, for the huge market.
But China will work its way up the curve...
Ummm...In case you haven’t heard, China and Russia are planning a trip to Mars:
http://www.physorg.com/news94297843.html
The US is toast. Sayonara. It was great while it lasted.
http://www.economyincrisis.org/articles/show/1060
I remember people ranting and raving over IBM selling it’s laptop business to the Chinese. The truth of the matter is that IBM got an outrageously high price for a division which was fast becoming just another assembler of PC-clones.
Keep in mind that even as everyone seems to be awed by China's incredible economic growth over the last decade, the reality is that the place is ranked something like 85th in the world in per-capita GDP -- down there with countries like Algeria, Gabon, and Venezuela. What is it about China that's going to set it apart from those others over the next ten years?
We can buy the IBM clones with our fiat paper money as long as the world continues to take it, but then what? The truth is that the US is sliding towards bankruptcy.
Yes, but all that IBM got was money. Little bits of paper with green ink on them. What the Chinese got was knowledge, knowhow, intellectual property. Like the Japanese before them, they can take these plans and build things now, and build more and different things later.
And in a conflict, will all of those bits of paper with green ink on them convert to combat power? Only if there are heavy factories for machines and light factories for component parts, within the USA, churning those things out. Right now, in 2007 (forget the future) American defense is dependent on foreign sources for key components in every major weapons system.
So, if the Asians are afraid of China and stop selling the microchips and other components, the US doesn’t put new planes in the sky for a couple of years, while we frantically try to rebuild an industrial sector. Meanwhile, China churns out the airplanes. Being on the good end of the manufacturing curve vis a vis the rest of the world is what made America a superpower. Losing the edge is what made France and Britain second rate powers and victims.
Those green pieces of paper won’t do us any good if we cannot convert them to combat power in a pinch.
The Chinese are much more dependant on us than we are on them. No US market, no Chinese manufacturing economy. On top of that, the Chinese are fully dependant on US innovations to propel the growth of their manufacturing sector.
Manufacturing is not only the lowest value added, it is also the most likely to be rendered obsolete by the next generation of robotics advancement.
It is increasingly possible to retain manufacturing potential without actually employing significant labor in industry.
I have been to China and ridden the fastest mag-lev train in the world, and stayed at a 6-star hotel. With the amount of money they’re amassing (1.2 Trillion in reserves), they’ll be able to catch up pretty quickly. Taiwan did it in about 25 years - it should take less time for China.
What will set them apart from Gabon, etc? Probably the fact that they’re the #1 destination for foreign direct investment in the world. They surpassed the US in 2002 or 2003 and have never looked back. China doesn’t want to lose that - they’ll clean up their act in terms of IP, etc.
I was really shaking in my boots until I read that article in more detail . . .
A small Chinese satellite will take off on a Russian rocket, according to the agreement signed Monday between the China National Space Administration and the Russian Federal Space Agency, the Chinese space body said.
Good heavens -- a satellite on a Russian rocket? NASA launched the first terrestrial mission to Mars 31 years ago.
What's next -- is China going to develop a fax machine in 2009, too?
The second article you've linked there is one of the most ridiculous things I've ever read. The biggest problem this country faces right now is a serious shortage of workers who have even the most rudimentary work skills (i.e., people who can think rationally, can read/write/speak English coherently, and can show up for work dressed like a normal human being). The second-biggest problem we face is a serious shortage of semi-skilled (or even unskilled) labor.
The value of the 'knowledge, knowhow and intellectual property' Lenovo acquired through purchase of the IBM laptop business is fast approaching zero. This stuff is basically in the public domain. Remember that we are not talking about the design or fabrication of the actual microprocessors, harddisks or other critical components of a laptop computer but what was essentially a laptop assembly business slapping these componets together. This is the reason IBM gladly sold it away.
Ummm. That’s great, but it takes a manufacturing industry to make robots. The last time I checked, Japan leads the world in the robotics industry. The US makes those little iRobot vacuum cleaners - you know, the little red toy like ones, that don’t even work?
How many aircraft carries, planes, ships, ICBMs, and other various weapons do we have on hand at the moment?
What good would it do for a country to cut off our supply and declare war on us when we already have everything we need to crush them?
You’re right about one thing.. it will be nothing like WW2. We are way more prepared this time in terms of what we have immediately available.
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