Friday, 5 April 2013

Micro Level Trends – Western Economic Transition – From Investor Profiteering to Continent Re-Engineering to Leverage the Global Knowledge Gap.

In Q1 of this year, a painful five years on, the major western stock market indices at long last crept towards their October 2007 highs, America's S&P now beyond.

New Futurism -

This an important watershed moment regards not only investor sentiment and outlook, but also renewed faith amongst the much disillusioned America and European populace; who saw the foundation stones of the much hyped ‘new norm’ being laid, so promising a better (and closer) tomorrow.

The new highs of the S&P, FTSE, DAX and CAC, indicate the critical transition point between heavily contrasting old and new eras.

The former built on the premis of a triple aspect demand-led economy that saw credit-fuelled exuberant spending from governments, households and corporates. That in stark juxtaposition against a present essentially reliant upon a single aspect: the corporate-orientated “supply-led” economic regeneration.

In the Hands of Corporations -

Centre-stage are the blue-chip, high-cap commercial players, sitting upon sizeable liquidity cushions gained from a mixture of retained earnings and access to QE measures and (for investment grade entities at least) low borrowing rates. Yet even in what appears this perfect-storm period for those corporate giants, holding the levers to growth, they must now balance a range of opposing forces which constitute the ingredients of the supply-side mix.

Theory and practice expectantly sees a shift from operational focus upon ‘tick-over’ maintenance budgets toward greater capital expenditure, which obviously improves productivity when well timed. Yet such heavy fixed costs in what is still a fragile environment must invariably be off-set by truly cost-efficient and critically value-adding labour; at all levels of the organisation. The scheduling of available funds for such fixed and variable cost endeavours obviously weighed against the macro and micro picture, but given today's fiscal sensitivity more than ever correlated a firm’s confirmed and prospective order book.

M&A Temptations -

Yet for many well positioned firms the temptation of avoiding the disadvantages of organic growth – primarily management time and cost - the idea of a quick-fix from ‘bolt-on’ growth achieved through M&A can be attractive. Especially so at this time when funded either from cash reserves, or from the presently compliant pool of credit sources.

M&A typically provides extended horizontal business reach through complementary product segments and/or additional regional markets, or can extended vertical reach up or down the value chain. And indeed possibly provide for ‘diagonal’ reach giving the best of both worlds, though usually as part of a major restructuring.

However, whilst typically assuring the operations of an enlarged group in the short-term, and that of a re-shaped group in the medium-term, that newly captured productivity gains, associated value-added and wealth generation will naturally be recycled internally to the company and of course distributed to shareholders.

When performed well, M&A extracts additional value from the synergies of a combined operations set , and typically sees a shrinkage of ‘back office’ functions as administration is centralised or contracted-out externally (BPO). These savings providing for expansion of outward-facing operations in sales and marketing and core operations of production and/or service provision. Therefore, whilst the firm changes shape, shedding overhead and expanding value-creation, often overall personnel numbers may ultimately remain little changed from previously.

Of course, the company is operating more efficiently, and in doing so able to grow short and medium term income, EBIT and net earnings. So operates well within its own business sphere, and offers promise to investors.

Downsides Appear -

But from the macro-economic perspective (specifically regards the central issue of GDP growth), to the chagrin of governments, it (and its sector counterparts) are still effectively treading water. The firm has yet to physically expand enough so as to take on new labour (execs, management and staff), all required to absorb meaningful portions of excess labour capacity. Those newly employed then able to become more economically proactive individuals and thereby able add to a nation’s economic growth story.

Whilst we are undoubtedly in the mid stages of western economic transition, the very process is complex and verses a normative historic re-bound perspective has proven stilted. This because the corporate and banking worlds are having to wade through far greater “after-shock debris” at micro and macro levels when seeking-out sector-specific M&A target opportunities ; whilst other finance-backed players such as holding companies, 'buy-out 'shells and hedge-funds seek – at the higher economic altitude - an optimal re-arrangement of the good, the bad and the ugly firms across the western world.

'Public Good' Growth Paths -

It is a well entrenched theme that those nations and global corporates with interests in the “post-industrial west” now seek to rediscover their manufacturing pasts and potency through eco inspired technology and methods, similarly seeking to strengthen their service sectors via the affiliated ideology of “sustainability”.

The mantras of eco-tech and sustainability complemented by the application of intelligently efficient networked systems. The whole (a post-post-modern “grand narrative”) notionally directed to humanistic ends, reducing time and cost waste. Simultaneously reducing what economists term 'externalities', since the cost of dealing with issues that affect the 'public good' can no longer be born from ever more limited governmental resources.

This simplistic description today means that an ever greater burden for economic growth and the public good is placed upon the shoulders of corporations...largely western corporations.

A Truly New Era -

The story of global industrial development obviously had its 18th and 19th century roots in Western and Eastern Europe, these innovations deployed across British and French colonies of the time, and redeployed with productive and consumptive economies of scale in North America during the 20th century. That competitive advantage in turn exercised giving the USA economic reach into Japan and S.Korea. Thereafter, the mixed-market advantages of Europe overtook the ailing Soviet system, with new the EU entrants able to effectively provide new demand and new supply participants. The 21st century has seen such productivity orientated economic expansionism re-played yet again with formerly the 'BRICs', now the 'CIVETS', with Mexico becoming ever more integrated into the NAFTA free-trade pact.

Thus the redeployment of 20th century technology across the world has been the maxim to date.

Of course when such 'old tech' previously created for smaller populaces invariably becomes adopted by an ever increasing number of companies and consumers, the associated 'externality' problems becomes increasingly apparent. Newer innovations play a part in helping to circumnavigate some problems.

An example being internet based 'apps' based mobile telephony giving even those in remote under-developed areas direct access to personal banking, so reducing their reliance upon what are often heavily polluting aged public transport vehicles.

Yet for most people in notionally advanced regions, for those in notional EM regions and those in so called under-developed regions, the dream of personal travel has long been an actuality, engrained as a basic human expectation.

Thus as those notional 'democratic freedoms' have emerged so the challenges of containing the 'externalities' created by billions of people have equally emerged. And though the internet and soft-tech solutions can undoubtedly assist (as seen) it is also recognised that a major and ongoing innovation overhaul is required if the peoples of the world are to enjoy a similar living standards.

Re-Engineering Western Capabilities for the Global Good -

It is obvious across various disciplines that Europe and North America still retains portions of technical advancement and advantage with a plethora of world-leading companies offering research, development, specialist and umbrella-span technologists and as critical strategically attuned leadership.

View the S&P, FTSE, DAX and CAC and those company names and associated brands are self-evident, from AstraZeneca to GSK to Merck to Pfizer, from BAE to Boeing to EADS to GE to Rolls-Royce to Safran, from GKN to Siemens to Bombardier.

North America, though perhaps more socially fragmented today still operates as a politically and financially unified entity, presently with positive indicators regards home-market re-growth and ASEAN orientated free-trade aspirations – such regeneration sought to heal both the domestic social fractures and try and retain its world-power status.

Importantly, the central issue of the supply-side driven economic model is being seen to take form in the US with a cumulative effect that connects its domestic shale gas and domestic deep water drilling energy policy to create affordable power to energise its light and heavy industries.

Yet Europe, today whilst far from broken even with negative conjecture, is still obviously politically and socially fractured, so affording the idea that a more centralised financial system will better support the ideals of the Euro, a 're-Europeanisation' of the region and so assist a stable future for new EU members.

Ironically, whilst the US is able to domestically merge its old-tech and new-tech industries (exemplified by Detroit conjoining matured pressed-steel manufacturing with evermore innovative consumer electronics), for the most part the wider-world may eventually need to rely upon European, Japanese (and to a lesser extent US) commercial know-how to bring forth advanced 'leap-frog' technical solutions – from lightweight hybrid cars to public service and home-help robots – and their associated manufacturing systems.

The USA will no doubt seek to commercialise a new raft of militarily developed solutions, successors to the likes of teflon materials of the 1960s space programmes to unmanned flying drones of the last decade. And seek to strengthen much of its web-related activities , building on the foundation-stones of Google, Facebook etc; if indeed able to given international privacy issues.

Here and now, very simplistically, it seems that Europe leads in advanced materials and manufacturing science, whilst the US leads in advanced cyber-space development; the former obviously providing the basis for people's future physical needs, the latter far more subtly shaping people's perceptions and behaviour today/tomorrow.

Thus it will be both 'Euro-hardware' and 'American-software' that promise to shape the world. But of course, historic western dominance is slowly shifting.

Prime EM Players “Go Long” on Eco Advantage -

The basis of European technical leadership (along with Japan) was well recognised by India's TATA conglomerate when TATA Motors bought Jaguar Land Rover, for its lightweight engineering skills as much as its legendary nameplates. Similarly China's Geely when it acquired Volvo Cars for its skill set in world-class safety engineering, and the purchase of SAAB's assets by Singapore's National Modern Energy Holdings, as it seeks to either create a reborn eco-friendly SAAB via Chinese alliances or find timely exit s from its ex-SAAB divisions .

Naturally then, as perhaps initially prompted by Lenovo's purchase of the IBM laptop division, those EM based companies with sizeable resources invariably seek-out advantageous technological solutions for their own national, regional and even global needs.

Though a Closer Horizon for Most -

Thus far such examples which marry present/future scale with accordant technology solutions appear to have been limited to these few obvious high profile deals.

As is the usual case, most EM firms hunt for acquisitions that immediately fit everyday operational business rationale, evolution rather than revolution, or indeed a far horizon 'bolt-on' by which to possible steer the company. Most EM firms, even the majority of large corporations, will be focused on the near and mid-term business template as opposed to being primary catalysts of the national economic agenda.

In the past, typically EM countries with prime activities in 'low-order' activities have firstly sought to strengthen their international presence so as to gain economies of scale, access new markets and improve margins: as seen with ArcelorMittal in steel production and various mining and oil sector expansion efforts. Latterly, to serve the national and corporate agenda such endeavours have been balanced with 'mid-order' at lower cost service efforts, as seen by the previous emergence of Asian call centres, whilst simultaneously efforts made to offer 'high-order' services from highly educated workforces, such as TATA Consulting in civil engineering and IT.

History's Influence -

Given the fact that for much of the latter half of the 20th century EM countries were effectively economically forced to retain extended use of licensed 1950s-1980s technologies - still evident in light 3-wheeler 'tuk-tuks', medium trucks and vans, though less so now with passenger cars – it is hardly surprising that the skills base of EM countries has been so slow to broadly grow, even with propelling project efforts such as Nano.

The Knowledge Gap -

Though EM nations have been replicating western solutions and processes to form ever higher value commercial services and products, and the pace of progress impressive, it still appears that a distinct knowledge-gap still exists.

That gap very much dependent upon the philosophy of the specific national agenda. Whether to protect and build a domestic industry, gaining skills as and when feasible, and invariably takes decades; or to attract FDI (foreign direct investment) so as to modernise far more quickly but see portions of new national wealth creation repatriated to foreign firms.

This well illustrated by the auto-sector development paths of India vs Brazil.

India's wish to protect the market share of its indigenous manufacturers (TATA, Mahindra) and its previous special relationship with Japan (Maruti-Suzuki, Hero Honda) means that knowledge and technology transfers have limited. The Ultra Low Cost Car idea – forged by Nano – was supposed to have opened the doors to major VMs seeking to create such small cars via Indian alliances. But initial collaboration deals publicising imminent new R and D facilities flailed. Instead those 'open doors' (eg Mahindra-Renault/Dacia and TATA-FIAT) invariably created to attract limited series CKD manufacturing deals from which the host nation could effectively extract modern vehicle design and manufacturing intelligence (ie Dacia Logan and FIAT Linea).

Indeed, the 'knowledge-gap' seen by TATA Motor's recourse to contracting Italian engineering skills when developing the concept and development work of a supposedly “home-grown” steel bodied, low parts count, Nano model. The 'Heath Robinson' appearance of Nano's initial prototype / packaging buck, though with its own cost-learning merit, seemed to highlight that knowledge-gap.

[NB Nano has been decried as a failure since it has not met its targeted launch and early stage volume forecasts, but the car seems certain to remain a core product of TATA's line-up, and could eventually attain its 1 Lakh as the company balances eventual amortised enabled price reduction relative to slowly increasing wealth amongst the motorcycling masses].

Hence, India's historical background as a national specialist in the licensing and national adoption of western manufacture – from textiles to railway rolling-stock to cars – means that whilst it has become very proficient at 'recycling' and 'life-extending' old technologies well suited to its domestic low cost needs, it would as a result always be a technology follower as opposed to leader. Hence would never allow India to become a truly powerful global leader. With this well understood at the turn of the 21st century, and with much improved corporate cash positions thanks to the Indian IT revolution, initiative were undertaken to reach the 'distant horizon'. Moreover, it was understood that such learning could not be extracted from short term foreign alliances, whilst long-term alliances demand a give-away of domestic market share. Hence the decision to fully purchase attractive entities such as JLR.

[NB investment-auto-motives believes that TATA Motors / TATA Group will seek to similarly bolster the core competences of its Truck / Bus and Defence Vehicle divisions by acquiring world-class western firms].

In contrast has been the story of Brazil's auto-sector.

Whilst Brazil has periodically enjoyed pseudo-national vehicles (adaptations of other vehicles) it has never had a truly indigenous large-scale auto industry. Since the 1920s Ford, GM and Chrysler sought market domination, but post WW2, it was the European corporations that won favour, initially VW and latterly FIAT. From the early 1990s to date, initially as an 'over-spill' market, many companies have become present, latterly the Japanese, S.Koreans and now Chinese.

As such, with the need to grow GDP and without the need to protect a self-created domestic industry, Brazil has had a true open door policy to automotive FDI.

Thanks largely to the export of commodity goods underpinning an impressive economic success story over the last 20 years, public spending programmes and private consumption created massive demand for construction equipment, agricultural equipment, HGV, MGV and LGV trucks, buses and passenger cars.

To satisfy this multi-aspect transportation need the administrators in Brazilia welcomed most if not all foreign interests, the well entrenched and newcomers. It appears to have learned what could be construed as the past mistakes of other countries (ie India) by not electing to create a large domestic auto-industry from scratch using bought-in old generation technology. Instead, it seeks to intrinsically learn by both keeping pace and mimicking the capabilities of its broad, imported foreign skills-base, from which the local population can professionally learn both directly as an employee and indirectly via industry-academia relationships.

That skills base seen to be grown with the advent of FIAT's dedicated design and engineering centre in Belo Horionte (the only one outside of Italy prior to acquiring Chrysler), producing the effectively 'home-grown' Nouvo Uno.

First signs of this approach come from the creation of the Brazilian motorcycle firm 'Brasil and Movomento' in 2000, with apparent intent to deploy where possible best practice learned from foreign makers, at lower cost to suit the national marketplace.

Also have been commercial developments form the multi-mix vehicle maker Agrale, It started with the licensed manufacture tractors, but latterly has sought to develop (like other EM countries) its own commercial and specialist vehicle ranges. This with large trucks and specialist (4x4, 4x2) utility vehicles (utility spanning military, emergency services and SVO build needs). Both are understandably styled with heavy aesthetic connotations of class leading vehicles – Euro-Trucks and for Utility a merged formula of Hummer front aspect, Jeep rear aspect and Land-Rover side aspect; typical of any newcomers engineering stance. However whilst seemingly capable, the lack off-road poise (eg axle articulation / weight distribution etc) demonstrates an absence of engineering integrity compared to more expensive western products, hence a necessary lower manufacturing cost and price point of Agrale (ie Brazilian) vehicles to service Brazilian, Latin region and other EM nations.

However, as seen with Indian 4x4s (TATA and Mahindra) dedication to decades long generational vehicle improvement does pay dividends in home grown skills and maintained and improved market share, even if ultimately still removed from world-class vehicle performance benchmarks.

Hence Brazil is then seeking to primarily extract core competence knowledge from western auto-makers, whilst also creating its own extended learning path in low volume but higher value specialist products.

India and Brazil then demonstrate two very different auto-tech growth stories, and the lessons learned is that: whilst EM countries undoubtedly seek to much improve domestic Research, Design and Engineering Development capabilities, the ability to actually properly obtain and integrate modern skills (education, IT etc) very much depends upon trade negotiation terms with the major international manufacturers.

Yes, self-creation and what may be termed delayed learning is an approach that may be deemed appropriate given specific country circumstances, (specifically the desire to micro-manage industrial expansion directly relative to population wealth expansion), but as also seen such a perspective must also be balanced by recognising the need to invest toward the far horizon, again done through complete acquisition (not alliances) of target technologies.

However, whilst an obvious and large technological (and associated commercialisation) knowledge gap exists, its appears the fact that whilst all EM countries are individually unique, the myriad of smaller non-BRIC countries will only offer lip-service regards the transformative power of 'new-tech' and 'eco-tech', and may in fact because of financial, political and cultural reasons be generally satisfied by maintaining the general status quo regards industrial development.

Whilst the BRICs and various CIVETS have the financial might to apply advanced solutions in the mid-term, across showcase buildings, general infrastructure, energy, vehicles, IT and healthcare, the vast majority of those that lie beneath the BRICs and CIVETS umbrella will in reality continue to recycle in a marginal, evolutionary manner previous generation methods from the west whilst re-deploying locally engrained traditional answers.

Timely Re-Expansion of the European Advantage -

It is now seen that the technological advantage held by the west is still apparent, yet because of the re-orientation of global trade over the last 15 years and the EM focus on national economic growth agendas, that once massive knowledge-gap is being reduced, the top-tier EM countries able to now obtain such knowledge by M&A or FDI.

Such events should raise 'alarm bells' for western firms, the marked or gradual depletion of their innate competitive advantage(s) halted and reversed through investment into what needs to be a new golden era of western research, development and manufacturing.

The spectre of global warming has been an ongoing issue throughout the 20th century, in contemporary times highlighted by the 1997 Kyoto Protocol's first and second commitment periods (2008-12 and 2013-20). Whilst various governments chose to adhere, or not, to the expectation, the fact is that the aftermath of the 2007/8 financial crisis scuppered both modest and grand scheme attempts to harness what is still by conventional standards the high costs of the idealised 'new energy economy', itself founded upon over-optimistic perceptions regards the prevalence (ubiquitousness) and associated costs of 'far reach' eco-tech.

The new norm has reset expectations, yet that Kyoto ideal could instead be resurrected in a broader manner beyond the centricism of 'new energy' to encompass a wider appreciation of the 'global public good' and the challenges of the 'externalities' to be overcome.

The west, and specifically Europe, should seek to lead this debate, but instead of putting the “horse before the cart” as seems the case with Kyoto's reliance upon immature, revolutionary technologies; European companies, consortia and associations should offer and far more convincing and constructive approach by demonstrating the very real advantages that a quickened evolution of current and 'bridge' technologies may bring.

This perspective has already been seen in the automotive sphere, with the likes of European manufacturers avidly 'down-sizing' their engine capacities and reducing vehicle mass, so as to much improve emissions measures, and now increasingly adopting Japanese initiated petrol-hybrid, diesel-hybrid and plug-in hybrid ('bridge technology') systems.

This approach, though more cautious than the pre-2007 'eco-dream' - involving a world of electric cars powered by wind and sea and solar farms – is readily understood and applicable, and critically more readily understood and convincing to the European and indeed global investment community.

Importantly, accompanying this fast-track evolutionary technology approach should be a truly concerted effort to cross-fertilise the cornucopia of technological solutions past and present, so as to attain improved ecological (and otherwise) performance standards.

Only by realistically creating a new remit for 'Advanced Europe' (and indeed the broader West to include the US, UK, Scandinavia and near Eurasia) toward a new but realistic 'global public good' forum (akin to Kyoto's principles but, but within Europe) will the most advanced nations of the West be able to positively influence the broader direction of world progress.

As the 'new order' BRIC and CIVETS* countries understandably seek to take control of their own destinies via trade pacts and ongoing summit talks (seen very recently), the west will need to demonstrate its innate technological and moral worth.

Without doing so it will become increasingly excluded as new order countries seek to maximise the exploitation of now engrained older technologies and benchmarks, and dissuaded from anything but distant era improvement.

In automotive sector terms, when China's C-NCAP safety standards (itself ultimately improved by Volvo's local input) becomes the BRIC and CIVETS 'gold standard' instead of Europe's original NCAP, much of the world will be happy to continue with decreasing western input.

The time has undoubtedly come for a European shift from investor profiteering to continent re-engineering to leverage the diminishing but still powerful Euro-Global “knowledge gap”.

To this end, the E16bn EuMaT 'materials and technology' programme and its strategic research agenda may (or may not) serve as the broad aspirations template, but necessarily altered from the 'radical change' to 'optimal change'.

Of course, efforts must be maintained to reach into the future with high-brow 'pure' research-work, but without recognising the global realities and true challenges within the 'applied' realm, the politicians, academics and 'brainiacs' in Europe and the West may be seen to be operating idealistically within its own slowly crumbling ivory tower.

Post Script -

Though formally known as the BRICS since the inclusion of South Africa (invited because of its mineral wealth), investment-auto-motives prefers to retain the distinct BRIC and CIVETS nomenclature given S.Africa's closer approximation with those notionally 2nd-tier countries.