Help – the industry I am working with is uncompetitive and many do not care

In most strategic management textbooks 4 generic factors are identified that can be used to build competitive advantage: efficiency, quality, innovation and customer responsiveness. These four factors are highly interrelated, as an improvement in customer responsiveness for instance could result in improved quality and better efficiencies. By addressing these four factors a business can reduce its costs and can create a differentiated position in a market. Let me briefly expand on the four factors.

Generic competitive advantage

  • Superior efficiency: a manufacturer converts inputs into outputs. Inputs are basic elements such as land, capital, labor,raw materials or knowledge. Firms that manage this conversion by constantly trying to find better ways to reduce costs, improve throughput and reduce wastage tend to be able to be more price competitive.
  • Superior quality: means that products are reliable and that they can do the job that they were designed for, meeting the specifications and performance requirements of customers. In most cases it is difficult to ensure consistent and reliable products without a system in place to control quality
  • Superior innovation: This is about the novelty of the products, process or services of the firm. It is not just about the great design of the product, but about the total offering and how customers can interact with the firm. Thus it includes how the company thinks about its own structures, internal systems, relations with markets and customers, use of technology and product development.
  • Superior responsiveness to customers: A firm that is highly responsive to its customer not only meets their requirements, it strives to anticipate and exceed those requirements. Although this could be about flexibility to respond to customers demand, in most cases it is not. It could simply be to find a way to respond the needs of customers in a creative way.

Enough of the strategy lesson. Back to the real world where we are all trying to use our own limited resources to promote particular industries or regions.

Here are the questions that keeps me awake about this project:

What if the industry that I am working with do not seem very eager to develop any real advantage around any of these four factors?

What must I do to improve the competitiveness of the region if the firms do not seem to even care about their own competitiveness?

For the last few weeks I have been wondering about these questions as I visit a range of manufacturers as part of a process to stimulate a regional innovation system in an industrial area. By visiting many firms in this region I noticed a big gap between those that are  are differentiated or excellent and the rest. The gap is so big that I sometimes wonder if it ever would be possible to move or support firms to cross over the empty space between those that can be described as “excellent” versus the “average”. Knowing that I only have a limited time, and the organization that I am supporting (An University) only has limited resources, I started worrying about helping all the firms. But this is not possible nor is it desirable.

All the average firms can offer many arguments for their current state. They lay the blame at policy uncertainty, high costs of borrowing, crime, political interference, expensive employees, low skills and many more. Many would say that they are component manufacturers that depend on the strategies and innovations of their customers (we just make what they want how they want it). Very few firms ever acknowledge that their current state is a reflection of past strategic choices taken deliberately or that played out to the current status because of not making decisions.

Yet, almost each of the excellent firms that we come across in our fieldwork focused on getting some basic principles. Many started monitoring their costs and wastage to try and improve their efficiencies. They focused on equipping their staff to understand the business, the products and the process, resulting in lower failures and higher quality. They spoke to their customers to find out how they can offer better services and products, even when they were just manufacturers of components used in someone else product. They focused on the quality of their products by looking at the quality of their process, their equipment, their systems and their management.

Those that are excellent are not necessarily better educated, better off financially, or better engineers. They just took charge despite being in the same economy, the same reason and even the same sector, with all the same environmental factors that the average firms use as a reason to do nothing. Sometimes the firms that are now excellent where started by disgruntled employees quitting the average firms. Or in other cases, the excellent firms were started by people from outside the sector moving in with a different perspective and approach.

What bothers me is the way the public sector responds to the manufacturing sector with their funding, support interventions and incentives. The strange thing is that most public sector interventions are aimed at the average or below average performers. It is almost as if the logic is that they are weaker and therefore they need protection and special care. Well, if economics is the study of how humans allocate scarce resources, then we should be very worried about directing too much of our scarce resources to firms that cannot use the resources the society endow them with (capital, labour, land and knowledge). Of course there are exceptions, but the problem is finding a fair way of deciding when it is justified to protect a firm and when it is best to let a struggling firm fold in so that the resources can be redeployed to other people that are able to use these same resources in a better way.

So what can we do when we are faced with this situation? Here are some of the ideas that we are working on now.

Lets say, of the 50 manufacturers we want to work with, 5 stand out as trying harder than the others. Perhaps another 5 or so are ambitious but they just don’t seem to know where to start, who to work with or where to go. We argued that we start with the first 5 (already good) and the 2nd five (the almost there). Then we invited any of the willing from the rest of the group (3 more stepped to the front). Now we have a core group to work with. Now we are trying to find ways to better connect them with each other, trying to get them to identify their own and their common competencies and opportunities. We have arranged a few pilots to support some of these firms to try and improve their own performance, and we have arranged some events with experts to discuss common issues.

But we have to remind ourselves that we cannot create competitive firms if they do not at least work on the four generic advantages outlined earlier. We cannot improve the competitiveness of the region without being able to show firms that are excellent. Trying to get these generic factors under their control is a minimum requirement. We should never use public resources to support firms that are not serious about improving their overall performance. Furthermore, everything that we do should become public knowledge in this industry and perhaps in the downstream customers, perhaps one of the other firms or even a customer decides to step up and form part of our initiative.

  • Have you also had an experience like this? The firms you are expected to work with just don’t seem bothered by their current status or improving their game?
  • Hey, what else should I do?
  • How do we use the principles of innovation systems and good development practice to get firms in a region to work together to improve their competitive performance in order to improve the economics of the region?

Supporting business that creates wealth and growth should be our main priority

I see that in the USA there is a similar debate as here in South Africa about whether government should support small firms or growing firms.
Andrew Hargadon wrote a brilliant post on the debate that was brought to my attention by Tim Kastelle. Hargadon argues that hindsight is often mistaken for foresight. He explains that many small firms stay small for many years before they grow, and that it is hard to predict which will grow, which will just survive and which would fail. From my own business and consulting experience I support his view and have seen on many occasions that it sometimes takes a change of ownership or management to get a small enterprise onto a growth path. But sometimes we are so obsessed with the romantic idea of an entrepreneur fighting an honorable fight against market forces and the onerous framework conditions that we miss the bigger picture. Some people are good at starting enterprises, others are good at growing enterprises, other good at maintaining an enterprises. Some will just never be able to do it no matter how much support you provide (or waste). Most people will make better employees than entrepreneurs.

The myth that small enterprises drives growth and employment is an old one, one that is firmly in the rooted in minds of policy makers and development practitioners here in RSA and in our region. There seems to be a confusion between correlation and causation. Even if statistics shows that 60% of people in RSA are employed in small enterprises (thus a correlation seem to exist between small firms and employment) it does not tell us anything about causation (does small firms create employment, or does more employment lead to more small firms being created). Research by many reputable scholars have shown that small enterprises hardly drives growth, but that it often responds to growth; it is more likely that larger better resourced companies will drive growth and efficiency in the economy, with ecosystems of small firms emerging around them providing specialized and also some general services.

For instance, the reputable scholar Thorsten Beck argues that the dynamism of enterprises is more important than the size of small firms in the total economy. I first came across Becks work while doing my PhD research (he has since moved from the Worlbank to Tilburg University). Beck has done many cross-country micro economic studies and argues that:“Policy efforts targeted at SMEs have often been justified with arguments that

(1) SMEs are an engine of innovation and growth and

(2) they help reduce poverty because they are labor-intensive and thus stimulate job growth, but

(3) they are constrained by institutional and market failures.

Cross-country, country-level, and microeconomic studies, however, do not support these claims. One study shows that, although faster-growing economies have a higher share of SME employment in their manufacturing sectors, it is not the size of this segment that drives growth“.

The full report can be found here

Here in South Africa development practitioners have the challenge that we have to pursue objectives that are in conflict.
Everyone seems to agree that we should create more employment, as the waste of human capital in our country is just socially not sustainable nor justifiable. Yet, we are constrained in that we cannot always support those firms that are more likely to create employment because of the race of the owners, or for other demographic criteria or preconditions. Sadly, many entrepreneurs that can help us absorb the unemployed have left, or have shifted into industries where they don’t have to rely so much on low skilled workers. Many have simply taken up jobs in the corporate or service sectors (people like me and many others I know). The current legislative environment just does not make it easy or attractive enough for people to start new firms or expand existing ones. In fact, many people that have the capacity to start medium sized firms are investing their money elsewhere. Now don’t get me wrong, I am not against the principle of equity enshrined in our constitution, I strongly support this. I also believe that labor should be paid fairly in a just relationship. The current labour and BEE environment just does not make for an environment where people will start firms or spin-offs that will address our primary problem of unemployment.

I believe that having a job goes a long way to equipping (black or white, male or female, young or not-so-young) employees to start a business at some point when they have gained sufficient technical AND market experience. Employment experienced and education will still do much more for sustainable black economic empowerment than any other measure. Furthermore, a focus on employment (no matter what the profile of the employer is) will also increase our tax base so that we can do more to develop our country. I will not get into my feelings about too few taxpayers supporting a too big social spend and government here.

Whether big or small, I put my money behind family owned businesses (Yes, I have a small bias). They somehow have the ability to consider both short term but also long term priorities at the same time. Even if they don’t make decisions fast, or if they sometimes appear to be conservative, I found family owned businesses are more likely to continuously invest in better equipment, in developing capacity, and in securing new markets. Family owned businesses makes for more stable employment, and generally they are more aware of the social needs of their employees. But these are also the kind of firms that are least likely to give up shares and management positions if it does not make long term business sense, thus Black Economic Empowerment policies and many conditional support incentives actually undermines this (often unrecognized) backbone of our economy.

What most people choose to ignore is that 3 drivers of costs of business are escalating very rapidly. These are:

  1. cost of raw materials. We buy smaller volumes and pay more compared to other international markets, with many countries even subsidizing access to raw materials.
  2. cost of energy. Our energy cost has increased faster than firms could upgrade, so we are far from efficient and thus at disadvantage. Municipalities further charge double and triple digit margins on top of the official electricity rates. Lastly, those that want to expand often cannot secure or afford access to electricity due to more than a decade of underinvestment in the grid at municipal level
  3. cost of labour. Many other factors are making wages too low for workers to live on (like the cost of transport), while raising the cost component of labour in business without increasing productivity resulting in South African enterprises being uncompetitive. Most employers when they do agree to wage increases simply reduce their staff, because other types of productivity improvement simply takes too long to yield results.

There is only one way that I know of to overcome these 3 cost drivers, and that is innovation at all levels of the enterprise (product, process and business model innovation). We also need social innovation, especially with regards to finding better ways at training, re-training or current workforce and the unemployed.

I can see in many sectors that those entrepreneurs that can create businesses that mainly employes skilled or educated employees are able to compete domestically and internationally. Those enterprises that depend on low skilled workers will simply struggle to compete, their costs are just to high and more and more of them are failing. Larger firms with access to capital and debt are more likely to be able to balance the investments in capital and labour that is required to be profitable in our economy, while smaller firms are struggling to balance this while raising capital and exploring new markets at the same time. The transaction costs for smaller firms to experiment until the find a workable business model in many instances is just to high. This is visible in the popularity of franchises where an entrepreneur buys into a proven business model and where the costs of experimenting with the business model is shared by many franchisees. (I wish we had something similar in manufacturing).

From my research over the last 3 years into innovation in industries I can say with confidence that our smaller manufacturers are hardly investing in Research and Development, mainly because they are under such strong cost and competitive pressure. Those smaller firms that do innovate formally often do this on contract, meaning they are paid by larger firms to do so. Larger firms that are active internationally are more likely to pay for R & D in order to drive down costs while creating new markets and new products. In doing so they support a wide range of smaller firms that provide experts services, specialized components or other intermediary inputs needed by the larger firms.

In the end, we have to direct our funds to those that can create employment, create wealth, create new markets and create new kinds of jobs. We should assess which firms we support by looking at the multiplier effects and the spillovers. We should support those firms that optimally and responsibly use existing resources, whether it be financial, natural or human resources. We must try to support the areas where dynamism already exist to start with, and then we have to try and support dynamism elsewhere. But we should not assume that our large and established smaller enterprises are able to develop all by themselves. The current focus is too much on small and not enough on multipliers and dynamism in the whole economy.

For me all other priorities come second to the objectives of growth and wealth creation, as we cannot achieve all of our countries many priorities at the same time. Growth will absorb more people, will attract more investment, will create new markets, new skills and new opportunities. Wealth creation is as important for employees as it is for investors, entrepreneurs, managers and also the government.

We have to send a strong message to ALL entrepreneurs that we value their investment, their energy and their attempts to create new markets. But we cannot help all of them, and by assisting some of them based on social criteria will not take us toward our countries biggest crises, the unemployed youth, nor will it allow us to optimally leverage the wisdom and experience of our older generation of technicians, engineers, managers and academics no matter what their demographic profile.

Supporting business that creates wealth and responsible growth should be our main priority.

Stimulating the formation of manufacturing business in South Africa

My international readers must please forgive my focus on my beloved home country in this post. But this is a topic that is close to my heart that we have to resolve in South Africa to secure the wealth and prosperity that our nation so desire. But perhaps you have faced the same challenges wherever you work.

I receive many requests to assist with the ‘creation of industrial businesses’ in South Africa. As this is a topic that is close to my heart I usually respond very enthusiastically to these requests. But in the last year or two the reality of the difficulty of establishing these kinds of businesses have dawned on me. Let me take you through my thinking.

Lets look at what it takes to start a manufacturing business. Firstly, you need an entrepreneur. This person must take the lead and mobilize and marshal the right resources, people and processes to take advantage of some opportunity. I think you would all agree with this statement. But if you unpack this sentence then you find three potential bottlenecks:

a)      you need an entrepreneur;

b)      this person must take the lead and mobilize the right resources, people and processes

c)       you need an viable opportunity

Point a) is a challenge. To start a manufacturing business the entrepreneur stands a far better change if the individual has technical or scientific competency or experience in the industry. With the current incentive environment many black or female candidates with the required competencies are better of in the corporate world, where large salaries and other perks are available. With the shortage of experienced or highly qualified advisors, most white candidates that meet this requirement have incentives to rather provide consulting services to government or large business. Many development programmes try to work around this problem by taking young inexperienced people, or even worse, vulnerable unemployed people, and try to establish them as entrepreneurs despite the fact that they would prefer employment rather than being a business person. I can go on for pages about this issue, but let me stop here.

Point b) is a second challenge. The role of an entrepreneurs goes beyond having a bold vision or being able to spot a great opportunity. The entrepreneur must mobilize resources and recruit sufficiently experienced or qualified people to work towards exploiting the opportunity. It doesn’t end here, as the most important role of the entrepreneur is to use their leadership skills to organize their mobilized resources and people into business and manufacturing processes. The latter is really difficult if the entrepreneur does not have management or manufacturing experience. Of course, we can all think of examples of individuals who have built viable businesses without management or technical skills. These cases are rare for many reasons, and it often depends on the character of the individual and the tolerance of their customers to pay for the steep learning curve that small under-resourced or under-managed enterprises have to go through. Say for instance, an entrepreneur can secure enough capital to start a manufacturing business, but they do not have any manufacturing experience. Unless they are able to recruit and trust a suitable qualified and experienced person that can take the responsibility on the technical side of the business, their investment is doomed. The inverse is also true. When a person that is technically competent starts a business, they might have trouble with the management of the administration and business processes of the enterprise unless they are able to recruit staff with sufficient experience to reduce the risks on that side of the business.

The third point is around the opportunity, and the ability of small enterprises to pursue them. One of the huge business process innovations of the last decades is the emergence of franchises. In a franchise, a proven and tested business system is replicated throughout a market. Think of a car-rental business. If you wanted to start a car rental business 15 years ago, you would need finance for several cars, staff at your outlet, technical staff, and cleaning staff. Now the likes of AVIS and others have mastered their business and technical systems to the point where a franchise in a small town can use tried and tested methods to run an office. The person managing the branch or franchise earns far less than you would be satisfied with, and plugs into a national (or even global) administrative system that manages salaries, vehicles, insurance and logistics. It would take a very brave business person to try and compete with such a hugely refined and efficient business system. And if you think of it carefully, then some of the basic rules of economies is that these kinds of system makes a society wealthier, as the productivity of each person working in that franchise branch is much higher than it would have been in your independent outfit. To compete against these business innovations (the innovation of a decentralized management and administrative system backup up by a highly efficient logistical system) you would need to have a highly differentiated business with many innovations. I am not saying it is impossible, I am simply saying it will not be easy.

OK, that is a service business example. For an entrepreneur to pursue the manufacturing of almost any product, they need suppliers, service providers, process information, marketing channels. The days where a single business making a completely integrated product are over, as these opportunities are often only profitable in a large scale. Manufacturing now takes place in ‘value networks’. So if I wanted to manufacture speakers, I have to establish myself within these networks. Despite the fact that almost an electronic student knows how to create a set of speakers, without knowledge of these networks and industrial systems it would be very difficult to establish a profitable and competitive speaker manufacturing business. So unless my product is completely unique or differentiated, I have to depend on existing systems to build my business.

Why are there so few serious entrepreneurs pursuing detergent mixing, or candle making or many of the other business formats that are often promoted by small enterprise promotion agencies? I think the main reason, is that the opportunity to build a business where a viable return on investment can be secured is limited. This means that vulnerable people are being helped to establish businesses where most sensible investors would not even venture into. If anyone can copy your business model even without acquiring the right skills or technical competencies, then how would you secure your investment?

We need to rephrase the objective of small enterprise development in South Africa. What we need to promote in South Africa is that experienced and technically competent people working in large corporates must have incentives to quit their secure jobs in order to pursue higher risk business opportunities. We need people with management skills, or with scarce technical skills, to start tinkering and designing new businesses, new products, new management systems in order to gain an advantage or an ability to secure a return on investment. Let these people create the jobs for the people that are lacking entrepreneurial skills or technical skills.

Let me know what you think!

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