The term ‘globalization‘ refers to the increasing integration of countries in the world economy. Facets of globalization include the movement of manufacturing from high-wage countries to low-wage countries; the formation of free trade zones through the creation of entities like NAFTA; and the free movement of labor between countries.
There’s just one big problem: it’s all bullshit.
Globalization is based on the flawed economic theory of Comparative Advantage, which states that countries should produce and export things that have a lower relative price and import things that have a higher relative price. This idea was developed by David Ricardo in the 1800s.
The problem with this theory is that transaction costs can reduce or completely eliminate any benefits that may be realized by trading. Transaction costs are the costs that arise from seeking out and completing a trade. If these costs are too high, a trade may not be worth making. For example, if I have a guitar that needs $100 worth of repairs but it will cost me more than $100 to find someone to repair it, I won’t get it fixed. The cost of finding someone outweighs the benefit from having the repairs done, so they don’t get done.
And that’s the problem with the whole globalization thing. Full transaction costs are not being taken into account when companies make their decisions to move manufacturing overseas. In the last 2 years, I have spent time working for 3 large multinational firms. All three firms were experiencing significant problems due to cultural differences, as well as the long distances between the suppliers and their manufacturing facilities.
One firm outsourced their accounting function to India (just like the IRS). Now they are experiencing serious problems with their accounting and other record keeping. Non-accountants are making entries in the journals, and no one in the corporate office can make heads or tails of what they are doing or why. The Indian ‘accountants’ are also setting up the depreciation of assets wrong, which can cause income to be overstated and may eventually result in problems with the IRS. The remaining American office staff is being asked to track down and fix the problems caused by the foreign office, but no one in India is answering the phones. And they aren’t answering their emails either.
The financial analysts in another firm are spending hours in phone meetings. Many of the things discussed in these meetings could be explained in an email or two. But that won’t help, because the financial analysts are being deluged with emails every day, the majority of which have nothing to do with their jobs. One analyst I worked with had 75 emails waiting for her when she came in in the morning; the other analyst had over 270. It’s hard to do your job when you spend hours every day going through your inbox trying to figure out what needs to be done right now and what can wait or be ignored until later. These people are very competent, but they have so much to do that they never catch up. In fact, over the Christmas and New Year’s holidays, they were still spending more than 8 hours per day working from home. This includes working on Christmas and New Years Day. They gave me a weird look when I asked them if it was really worth it.
The question that such firms have to ask themselves is this: what is the total opportunity cost of doing business this way? In other words, there are implicit costs that may outweigh the explicit costs. And do these cost ‘savings’ offset the problems that they are creating for your employees?
One firm that has asked these questions is American Giant, an apparel company located in San Francisco. And the answer for American Giant is a resounding “NO!”
An increase in demand for a hoodie sweatshirt made by American Giant has prompted the CEO to ramp up production by adding sewing lines at American Giant’s four U.S. factories. American Giant has also moved its fabric sourcing operations back to the U.S. as well:
(CEO) Winthrop says he is finding it easier to manage supply logistics now that he’s sourcing fabric domestically. After solvents caused blotting on T-shirts at the Los Angeles factory recently, he was able to get his production chief in California on the phone with his fabric supplier in South Carolina. The issue was fixed in a few hours, and only about 10 yards of fabric went to waste.
Good thing they answered the phone in California and South Carolina, eh? But what if the fabric was still sourced in India?
Had the company still been sourcing fabric from India, Winthrop says, the same issue could have taken weeks to resolve, and thousands of yards of fabric could have been lost.
Lost fabric in this industry means lost profits. Communication and transport problems only add to the transaction costs of moving manufacturing out of the United States. So, multinational CEOs, do you get it yet? YOU AREN’T SAVING MONEY WHEN YOU MOVE YOUR FACTORIES OUT OF THE U.S. IN FACT, YOU ARE CAUSING YOUR PROBLEMS AND COSTS TO INCREASE!
The story continues:
“You just can’t get that kind of quality control” with overseas suppliers.
Labor costs in the U.S. are more than double what they are in, say, India, but American Giant makes up for its relatively high worker wages with a direct-to-consumer marketing strategy.
The story at Fortune.com requires a subscription in order to view the entire article. I have copied the most relevant parts here, as the article is only one column in size. If you want to read the entire article, you can either pay to read it at Fortune.com; purchase the January 13, 2014 issue of Fortune magazine; or do what I did and read it for free at your local library.
* The hoodie does cost between $59 and $79. But it is the Greatest Hoodie of All Time, and is made to last:
But there is really no comparison between American Giant’s hoodie and the competition. It looks better and feels substantially more durable—Winthrop says it will last a lifetime. When you wear this hoodie, you’ll wonder why all other clothes aren’t made this well.
First, it’s made of heavyweight cotton. Most other sweatshirts on the market today are made of some kind of blend, usually cotton and polyester. The cheaper the sweatshirt, the more polyester. (American Apparel’s hoodie, which sells for $46, is 50 percent polyester.) Not only is a polyester blend cheaper than cotton, it’s also easier to work with, allowing for faster, lower-cost production. Blended fabrics shrink more predictably than cotton, letting manufacturers get more consistent clothes without much more effort. Blends can also be made to take on a variety of textures—the soft, fluffy inside lining on a cotton/poly blend hoodie, for instance, is just as easy to achieve as the smooth outer layer. To create the same soft interior in cotton, American Giant has to send its material through machines that pick loops of thread out of the fabric. That isn’t a cheap process.
The result is a sweatshirt with several design elements you won’t find on the competition. The most obvious difference is that American Giant’s hoodie is fitted—it sits close around your chest, then gently tapers in around your stomach, resulting in a garment that doesn’t look slouchy. At great expense—and after lots of experimentation—Manoux added a “side-panel” to the hoodie, a strip of stretchy fabric that joins the back of the hoodie to the front. The side panel gives the hoodie “mobility,” Manoux explained—it allows you to raise your arm all the way up without feeling the whole coat ride up on you. It also insures the hoodie against future expansion: As your stomach grows larger, the stretchy fabric will grow along with it.
This is how a business is supposed to work. Minimal problems, a high-quality product, and happy customers who rave about your product. This is what has been forgotten: there are ways to run a profitable business that don’t require cutting costs to the bone; selling a low-quality product; and increasing the workload on your employees to the point that it adversely affects their lives.
But you sure as hell can’t do it through globalization…