Localisation and building domestic manufacturing capacity


At the moment I am spending most of my time working with the more traditional manufacturing sector in South Africa. Traditional apparently means non-advanced, but it would be a mistake to think that because a particular object (like a metal casting) has been made for 8000 years that there is nothing advanced about it. For instance, in a typical foundry you find very different technical, engineering and management capacities that must be combined in order to make metal components for very demanding customers.

Localisation in South Africa (and in other places like the US) means to bring orders that have gone offshore back into the country. It often involves trying to rebuild manufacturing capacity that once existed in a country, but that originally developed under completely different economic conditions. For instance, 30 years ago many manufacturers grew in South Africa, starting very small and growing over time. About 10 years ago these manufacturers closed, or moved offshore. In the meantime global market consolidated and found low cost producers. To now try and create this capacity again is not an easy task. Firstly, you don’t have 20 years for experimentation in technologies, business models and market segments. Secondly, customers already now know what they want, and this usually includes a proven product at a competitive price. The new enterprise must hit the ground running with proven technology, management and adequate resources. This means that you have to develop both local producers and their supporting institutions, service providers and their markets at the same time. Bear in mind that their competitors overseas are benefiting from this same ecosystem developing naturally.

Localization is seen by some as the opposite of globalization and outsourcing. But buying from a local manufacturer is still outsourcing . As far as localization as the antidote to globalization is concerned, this is not correct, as localized products often enter world markets again, as does local knowledge workers that are now mobile due to their enhanced expertise. Localization is about creating local manufacturing capacity. It is about more than just helping local entrepreneurs start firms – it is often about finding or developing unique local capacity that meets very specific local requirements. It is therefore often driven by public policy- however the most successful localization is often driven by businesses wanting certain suppliers or competencies nearby.

Perhaps another way of looking at localization could be to see it as part of a natural cycle. Products are made locally at $x and a small volume supported by a limited local market. Over time standards, low cost production methods evolve, market consolidate and production concentrates in a few places able to reach scale and efficiency. Now the numbers are high – new entrants struggle to enter as existing firms ramp up efficiency. Right about then flexibility is lost, management becomes expensive, and you may be sharing production facilities with current and future competitors. In the meantime, products evolve, markets and applications differentiate, and suddenly there is a need for more specific production to meet a specific market. this is where a local producer with the right technology, people and business model could gain a foothold (if only they knew about the opportunity). The cycle might just start all over again. This is just one simple example. I acknowledge that many countries have not been able to recapture orders once they are lost to offshore competitors – partly because several economies have also progressed up the value chain. But for developing countries, evolving up a value chain is a very painful process that is often not possible.

From the demand side we have a different perspective. Multinationals or large local manufacturers wanting to localize typically have an existing production system, or they are expanding local capacity. They have advanced or well developed management systems, markets, products and supply chains. Often, buying local is not first choice as they might have invested already in capacity elsewhere, although localization is frequently a requirement of developing country procurement policies. So they first localize non-core activities, the crumbs or components where few things can go wrong. For local manufacturers, this is the toughest place to enter, as these basic components are often like commodities – they are standard, and hence competitors have already reached scale and efficiency levels that are hard to beat.

For buyers, another problem is that local manufacturing capacity is hard to identify and secure. Existing manufacturers in developing countries are either undergoing BOOM or BUST. The boomers are just to busy in markets and products they already understand, and the busters just cant be trusted. Lastly, large multinationals that tries to localize production very often draw their domestic engineering, management and other skills directly from the very limited skills pool that exists locally, attracting skills from the local manufacturing sector that is hard to replace.

So some insights:

a) firstly, don’t let your local manufacturing sector collapse, even if they are not entirely local or entirely politically correct

b) don’t assume that multinationals can easily do business with local manufacturers, don’t depend on checklists.

c) don’t assume that all that your local manufacturers need are some orders from the big firms or government – they are most likely behind in multiple areas, such as skills, working capital, engineering technology and capacity

d) it is not just about technology. Large firms giving technology to local firms is not the solution. Local firms must get a deeper understanding into the market, the drivers of change, the drivers of performance and manufacturing management methods.

e) for a local manufacturer to grow, take on new (demanding) customers, add additional shifts, manage a busier schedule, recruit and train more staff – all these things require change. Remember to assess the readiness of local entrepreneurs to change, invest and expand.

 

Lastly, localization should not be  about import substitution at all cost, because this reduces the buy local decision to a costing issue. Isolating local manufacturers from international markets will not help in the long run. Rather, the focus must be to connect local manufacturers with global markets, knowledge pools, trends and developments.

If you really want to develop your local manufacturing sector, start with the buyers and understand their needs. Understand their business risks, their cost drivers, their incentives to expand and their means to support local manufacturing. Then find out which experts they bring into their operations, what challenges they had to create and maintain their own systems – chances are that what is an inconvenience to a large firm could be a complete obstacle to a local firm. Then articulate these messages, trends and projects clearly to local producers.

I have found that the main issue for large firms wanting to localize is not price – it is reliability and flexibility of local supply. It is dedication to getting the product right at the right quality, on time. And it is also a supply chain of local engineering and management skills.

Oh, did I mention that small firms also want to localize, not just the big firms? More about that next time.

 

 

5 Responses to “Localisation and building domestic manufacturing capacity”

  1. Lucho Osorio Says:

    Dear Shawn: thanks for your blog post; I enjoyed it. However, I wanted to ask you about your insight (a): “don’t let your local manufacturing sector collapse, even if they are not entirely local or entirely politically correct”.

    Who should avoide the collapse? Presumably the government?

    If so, why should they do it? Presumably, because the political costs are too high (lost jobs = lost votes)?

    Why should we hang on to collapsing industries? Why not better heping the market actors to upgrade, innovate, build new competencies and competitive advantages through more functional and appropriate training institutions, standards, tax incentives, info flows, etc?

    I can see that there are certain industries where governments would be keen to avoid a collapse: industries that are critical for national security (e.g. military, energy; and in some cases some ag products) and “political security” (i.e. industries with high job density). But I am not sure that these are the typical industries in the contexts where we work.

    Sometimes it is better to invest scarce public resources in re-training, social protection mechanisms for workers who lose their jobs during the transition phase, subsector/sector shift and upgrading, etc. than in defending the indefensible or holding on to mediocre sectors…

    I look forward to your response.

    Like

    • Dr. Shawn Cunningham Says:

      Hi Lucho,
      Thank you for your comment. In many African countries, local industries are often not supported by governments. This is due to many reasons, ranging from too high prices, too political motives. But it is not only governments that should support local industries, local industry itself should support local producers. I am not a proponent of import substitution, and agree that in some cases paying too high prices when a foreign item is available at a lower price does not make sense at all. I am right now working on trying to secure orders for our local manufacturing sector here in South Africa. One of the reasons their prices is not competitive relates to scale of operations and volume. When volumes goes up, prices comes down. But local buyers typically place smaller volumes on local producers than when they order the same item from a foreign supplier.

      Also bear in mind that in many developing countries social security systems are weak, so when industries fail there is typically no safety net.

      Once whole industries fail they are not easily re-established due to the high investment costs and small markets.

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  2. Waldo Krugell Says:

    Shawn, thanks for the great post. You hit the nail right on the head. I’m weary of all the policy talk about support of manufacturing, localisation, IDZs and the like, when it is only about incentives. Your post shows that there are many more things to consider. At the moment I like Richard Baldwin’s ideas about the importance of joining supply chains in what he calls globalisation’s second unbundling (there is a NBER paper, I’ll look for the link and send it along). I think that you’ll enjoy it too.

    Like

    • Dr. Shawn Cunningham Says:

      Hi Waldo,
      It would great if you could send me that link to the Baldwin article.

      I am finding many South African manufacturers that are desperate to find local suppliers. Local suppliers are more flexible and responsive, even if their prices is not always the best in the world. In the current uncertainty nobody wants a string of containers stretching around the world, taking 11 weeks or more to get here.

      Best wishes,

      Shawn

      Like

  3. Counting blessings at the end of a year « Shawn Cunningham's Weblog Says:

    […] post was about there being more value to value chains than adding value to products, followed by localization and building domestic manufacturing capacity and supporting business that creates wealth and growth should be our main priority (this was also […]

    Like


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