Offshoring jobs to lower-cost countries remains a hugely sensitive political issue in the West. But for Canadian-born academic-turned-consultant Michael Treacy, it is just a natural – and unstoppable – facet of economic globalisation. He has no time for what he regards as the “populist claptrap” championed by CNN presenter Lou Dobbs, who accuses US companies of “selling out” America, arguing that in the coming years more and more of us will be competing for our jobs on a global basis.
Treacy, a popular conference speaker who has presented at Aberdeen Group’s CPO Summit in Boston for the past two years, also believes that procurement leaders are driving this trend in many industries and that they are generally doing the right things for their companies, even though they may not fully comprehend the long-term consequences of their actions.
A professor of management at MIT’s Sloan School of Management in the 1980s, Treacy moved into consultancy and wrote two business books, The Discipline of Market Leaders and Double Digit Growth. In 1999, he co-founded GEN3 Partners, a product innovation consulting firm that has worked with companies such as Alcoa, General Mills, Gillette, Honda, Procter & Gamble, Siemens and Xerox. The firm, of which he is chief strategy officer, has a scientific research hub in St Petersburg, Russia, so when it comes to offshoring he practises what he preaches.
Earlier this month, CPO Agenda talked to Treacy about the likely effects of globalisation and procurement’s role in transforming the way business is conducted. What follows is an edited transcript.
In the context of changes taking place in the global economy, how significant is the outsourcing and offshoring of work – whether products, services or R&D – to suppliers in lower-cost countries?
I think it’s very significant and perhaps the single biggest change that we are going to see to business over the next two decades. We’re moving from national economies to a truly global economy.
Globalisation, for a while, really meant multiple domestic operations in different countries, but companies really didn’t integrate across countries very much, except in a few industries. That is changing now and migrating to more and more industries. You’re seeing simultaneous launches of products, products being designed in one country for production in another. So far this has largely been the domain of big global firms that could build very sophisticated capabilities. Now what we’re seeing is that it’s moving down market to less and less sophisticated firms, because it’s getting easier to tap into the resources of other companies and countries.
It’s a huge issue because for the first time globalisation is bringing domestic capabilities of all sorts into direct competition with capabilities in other countries, and all over the world. If you look at a company, ask yourself how many of its people compete for their jobs on a global basis. Very few people in an organisation today actually compete for their jobs. Companies don’t typically look all over the world for the best people, they hire people within the local market because it is assumed that the job must be performed locally. Today, I would say that less than 2 per cent of the various roles in firms are directly affected by global competition. When that gets to 20 per cent, it starts to become a very fundamental change.
How long do you think that shift will take? A couple of decades?
Yes, I think so, because there are a number of thorny problems that have yet to be worked out. One of them – and this is perhaps more of an outsourcing issue than an offshoring one – is that you are introducing a great deal of complexity into your organisation with respect to control. It’s one thing to create control inside one organisation under a steady state condition, but as we know the needs of organisations are evolving pretty rapidly. If you’ve outsourced and/or offshored and your needs change, how do you evolve the relationships with your partners quickly so that you can adjust to the different needs of the marketplace? We haven’t yet built up enough experience in order to do that effectively. It will come, but that’s why it’s going to take a couple of decades.
Are cases of US or European companies trying outsourcing and offshoring and then bringing the work back in house simply blips then?
Yes, we are going to stumble along the way, because we are taking on things where we don’t fully understand all the challenges. They come and bite us and then we have to work out how to fix the problem. We see examples of offshoring of activities to Chinese suppliers that don’t comply with our standards, whether it’s lead paint in children’s toys or ingredients in pharmaceutical products. That’s an indication that we’ve offshored some complicated work to other people and they don’t have the same ethical standards, the same business and work standards, as we do. It’s going to take some time to work all that through. We’re all on a learning curve, but the reason we’re not going to back away from it is simply that there is too much value to be gained for customers and shareholders.
How do you view the role of CPOs and procurement functions in major US and European companies in this evolution?
Procurement is the “pointy end” of the stick here, in that it is driving a lot of globalisation. I don’t think procurement people fully understand the role they are playing in the evolution of the global economy, but then I don’t think it’s necessary that they understand that. Each of us is an actor in the economy; all we can do is act in ways that are locally optimised. The grand scheme evolves out of that. Each of these procurement offices is doing what is best for their corporation. They are picking all the low-hanging fruit first – buying commoditised and standardised items and finding ways to source those at lower cost in other parts of the world. Eventually they will take on some of the more complex problems, like how do we buy things that aren’t so commoditised? How do we buy services on a global basis? But right now there is still so much low-hanging fruit, that’s their most immediate focus.
In which industries do you think procurement is the main driving force?
I would say industrial production is the biggest one. If you look at companies making run-of-the-mill industrial products or consumer durables – things that don’t require high sophistication to fabricate, whether it’s an automobile or a washing machine – it really is procurement leading the drive, because they think about their product in component terms and once you do that it’s pretty easy to find people who can deliver to you at lower cost.
In other industries, economies of scale, rather than procurement, have been the main driver. Take integrated circuits, processors and memory chips – that’s a business where the economies of scale are so steep that companies centralised production on a global basis a long time ago. When they looked at where to locate production capabilities, they picked countries like Singapore and South Korea that had sophisticated education systems but also low costs. In the case of pharmaceuticals, the economies of scale are in research rather than production. This has created global firms from a product innovation point of view, but they are still local firms from a distribution and sales point of view, because local market regulations are so different.
So it varies by industry, but I would say the chief procurement officer has led the drive in about half of all industries.
Do you expect any industries to buck the outsourcing and offshoring trend?
Some will buck the trend, not because they are stuck in the mud but because they won’t be able to solve the control issue. Companies like Procter & Gamble and Coca-Cola are really focused on brand protection and it isn’t clear to me how far they are going to go down this path. For many consumer products, the price has only a little bit to do with the cost and a great deal to do with the brand. It’s surprising really because it’s almost irrelevant how the product is made, except from a risk mitigation perspective. And that’s the one reason that they continue to hang on to production at all, because there is so much riding on the brand.
Where we are going to see the biggest shift in the next 10 years is in the media industry. There’s no reason that magazine publishers, for example – especially trade ones – will need all the writers they have in all the expensive countries that they are based in. The insurance industry is another: there’s no reason that claims processing should be located in high-cost countries. We’re also going to see branches of medicine offshored and outsourced; already we are seeing certain centres of excellence develop for elective procedures, such as cosmetic surgery. I expect that we will see more and more specialisation in medicine, with destination locations for certain kinds of treatment.
What are the likely economic and social consequences of this shift?
Well, just imagine what happened over a 100-year period when the British economy shifted from a local economy to a national one. There was devastation. The main street in every village changed, the pattern of where production occurred changed, the pattern of where people shopped changed. That’s what we are going to see, just on a more compressed time schedule. It will be a little rough in places, but we’ll manage it. A 3 per cent a year change in the structure of the economy is something that most economies can absorb.
One of the questions I don’t have an answer for is what we do with all of our least skilled citizens – those that are either not well educated and/or not very intelligent. Historically, those people did production jobs where you could train them up in one thing and make it last for a long period of time. What if those jobs aren’t around anymore? Do you have enough local service jobs to provide employment for all those people? You are already seeing in America the emergence of a bi-modal economy; there are a set of people who have really figured out how to become a part of the information economy and are doing quite well for themselves, and then there are a lot of people who have been left behind. That’s a consequence of people at all levels in society beginning to have to compete for their jobs on a global basis.
The second consequence is that it’s going to be much tougher for kids out of college to enter the economy. A lot of entry-level jobs are fairly routine and standardised, because that’s all those kids can handle for the first two, three, four years of their career. Those are the kind of jobs that can be done more cost-effectively somewhere else. Look at investment banking. They take kids out of college and get them doing all kinds of spreadsheet models for companies they might be interested in. Well, that kind of work requires a grasp of mathematics, but I assure you I can get it done in China or India at a dramatically lower cost. So what happens if Wall Street and the City of London turn to foreign financial analysts, because they can get the work done quicker and at half the cost? How will our college kids enter investment banking without that stepping stone? Ultimately, that shift of the basic work could see the migration of the whole industry offshore.
Should CPOs be concerned about these consequences? Do they have any responsibilities to their local economies and their traditional suppliers?
Their responsibilities are to their companies, not to the economy in general. If you start trying to factor in the economic consequences of what you are doing, you get in way over your head. National policy is best left to the politicians. CPOs have plenty of problems just at the company level, because of the issue of control that I mentioned.
Some traditional suppliers have been complacent for too many years and felt that the good times would last forever. They didn’t hold up their end of the bargain, help their clients be competitive. So I think companies are doing exactly the right thing.
What’s happening in the US and Europe is that manufacturing as a function is disappearing. And it should. In 1900, 52 per cent of all Americans worked in agriculture. In 2000, less than 2 per cent did. It’s not that agriculture went away; what happened is that it became extraordinarily productive, it globalised, moved to specialisation. That’s what going to happen in manufacturing. People are going to figure out how to be radically more productive in how they manufacture things. Unless there are some extreme governmental policies around protection, the majority of what we think of as manufacturing jobs today simply aren’t going to be in the developed economies.
Are the labour cost advantages that developing countries currently have sustainable in your view?
Well, nothing is sustainable in the long run. What will happen is that their economies will develop and eventually their wages will rise to the point where their wage rate productivity is the same as ours. Prevailing wage rate divided by labour productivity is the key measure of competitive success because you have to look not only at wage rates but also at labour productivity. Chinese production workers are dramatically less productive than European production workers by a factor of three or four to one, because the Chinese haven’t invested as much in automation. But on a wage rate productivity basis, they blow us away. What is important to watch in China and India today is that their labour productivity rates are rising as fast as their wage rates. Therefore, at least for now, they are maintaining their competitive advantages. Over a 20 or 30-year period their wage rates are probably going to start rising faster than labour productivity and they will lose some, but not all, of their advantages. Just look at the evolution of Singapore under Lee Kuan Yew. When he took over that economy was driven by unskilled, low-productivity labour making cheap goods. By the time he left, the country had exported virtually all of its manufacturing capacity other than high-tech and it was primarily a services and information economy. The revolution in wage rates and standard of living was driven by an even stronger revolution in labour productivity.
You mentioned brand reputation earlier. Do you think companies are adequately factoring in the risks of outsourcing and offshoring?
There’s no question about that. One of the industries that was earliest to outsource virtually all of its production was athletic wear and shoes – companies like Adidas and Nike. They don’t really make any of their products; it’s all outsourced to the Far East, because that’s how the textile and shoe industries have moved for a long time. What happened to those guys, of course, is that they were slapped in the face by child labour practices among a few of their suppliers. It damaged their brands and forced them to realise that you will be held responsible for your suppliers’ practices and therefore need to have control over standards of supplier conduct. So they introduced all sorts of initiatives around child labour that they police vigorously.
The same thing is going to evolve with respect to quality, green and environmental issues, and safety. In not too many years, the European and American standards are simply going to become global standards. And it will be the large firms that want to outsource and offshore and feel that their reputation is at risk that will drive those standards. The auditing and policing of those standards and relationships is going to become a good-sized industry.
Do you think big companies can reconcile pressures to be environmentally friendly and good (local) corporate citizens on the one hand with ever more global supply chains on the other?
Yes. I no longer see companies prepared to admit, as they would have in the past, that they are making trade-offs between cost and the environment. They may secretly still be doing that, but eventually that will also go away.
Environmentalists see the increasing use of China as a sourcing location as an environmental disaster, because China’s environmental standards are so low. In the short term they are 100 per cent correct. But what’s going to raise China’s environmental standards, its safety standards and its working conditions in the longer term – and by that I mean the next 5-10 years – is not the United Nations or anybody else lecturing China about what it should do. Instead, it will be when the marketplace rebukes it and says “Look, if you don’t put in these standards, we don’t want this product, we can’t sell it”. There’s going to be too much of a backlash and we’re not prepared to do that. That will get them to change their standards in a heartbeat.
You’re seeing this taking place already, because the Chinese are quite sensitive to the damage that’s been done to their economy by the manufacturing disasters they’ve had during the past year. These things are getting widespread attention now in the West and it’s affecting Chinese companies’ ability to contract for new services. So in the longer term the European and American standards for safety and the environment will become the Chinese standards. I’ve no doubt about that. But interestingly, only for that part of their economy that exports. Their domestic economy, where they don’t feel the pressure of global standards, may still produce in the same old way.
Many companies fear the loss of intellectual property. How do you assess that risk?
This is a much more serious issue, because it’s not one where market pressure can as easily be brought to bear. It has to do with whether intellectual property is respected or not. You have a serious problem in China and in Russia. I don’t think it’s a serious problem in India, because the rule of law is stronger and they are relatively respectful of this. But it’s a significant reason why a number of firms aren’t going into China with all of the things that they might otherwise go with. I doubt that in 50 years from now it will be a problem, but at the moment it’s one where there doesn’t seem to be an easy answer.
On top of these issues, there are risks inherent in extending the length and complexity of your supply chains globally, aren’t there?
Absolutely. In the auto industry here in the US, for example, because of the pressure they are under companies have eliminated slack in the system. What happens is that a tiny plant in Brazil has a strike and it can shut down a US assembly line. So a lot of thinking needs to be done about how we create robust systems with appropriate levels of redundancy, so that we have something that can withstand these shocks to the system. This is a very sophisticated analytical space. There are lots of different ways that you can protect yourself against risk in a large and complex system. You can buffer things at multiple different levels, not only in terms of spare inventory sitting in place, but also through insurance policies. This whole area is in its infancy right now, but it’s another area where we are going to see lots of really interesting companies grow up providing all kinds of services.
To conclude, what’s your message to CPOs about globalisation?
Well, I think the number one heads-up to those people is that they are fighting the right fight and a good fight, and if it wasn’t them somebody else would be doing it. This is an inevitability, it’s Economics 101. Collectively what they are achieving is a thing of beauty – it’s a remarkably complex enterprise.
The second thing is that you have to go beyond really simple procurement contracts on commodity-like products where you can easily verify that you’re getting what you contracted for. And if you want to do that, you need more sophisticated control systems. You are going to have to consider all of the dimensions of quality, safety and the environment, as well as the issue of cost.
Right now, CPOs’ reach is greater than their appetite. Some of them are going to get themselves into trouble. I wouldn’t want to be the guy who has to recall all his toys because there’s lead in the paint. You need a system of control that is equal to the task.
Interview by Geraint John
