Thoughts about the “Low Cost Country” business model

I’ve been thinking recently about the trend for companies in “High Cost Countries” (notably North American and Central European countries — you know who you are…) or HCC (er, not to be confused with the “High Cadre Children” of post-Cultural Revolution Communist China, as described in Qui Xiaolong’s novel “Death of a Red Heroine“) to source raw-materials, components, sub-assemblies and complete finished goods from “Low Cost Countries” or LCC.

In addition to being a source of goods, some of the LCCs are also widely used for outsourcing of services (e.g. telemarketing, customer service, technical support, engineering, data processing, etc — even preparation of tax returns has been off-shored) that can readily be provided via various telecommunications paths — telephone, e-mail, internet chat/IM, WANs and VPNs, etc.

Now, the conventional wisdom (ooh, there’s that phrase…) on LCCs says that They Are A Good Thing For All The Parties Involved. The reasoning, at least as I understand it (see disclaimer below), goes something like this:

  • Raw material and labour costs in LCCs are low enough to more than offset the cost of transporting and importing the goods to the HCC, so that the net cost is less than the same goods sourced within the HCC.
  • The lower costs will result in lower prices to the consumer, giving companies using LCCs a competitive advantage in the marketplace.
  • The money flowing to the LCC is A Good Thing For The People There, who would otherwise be much poorer.
  • Jobs lost locally in the HCC to the LCC will be replaced by higher paying “value added” jobs.

The supposed advantages of LCCs over HCCs, from a cost perspective are:

  • Lower labour and social program costs in “undeveloped” countries; a result of the lower standard of living and people’s expectations there.
  • Less stringent safety and ecological impact regulations; no need to spend money on improving safety or reducing pollution, with few consequences for accidents or long-term health hazards.
  • Large pool of available labour compared to work; high levels of un- or under-employment keep labour rates depressed and allow workers to be exploited (and labour laws are generally lax in comparison with the HCC’s).

OK so far (although you’ll note perhaps just a hint of cynicism in my commentaries), but let’s think about this a moment. Time’s up. Here’s the Unconventional Wisdom on LCCs:

  • Transportation costs: have you looked at the price of Dead Dinosaur Juice (a.k.a. petroleum products) lately? And it’s not going to go down, either — demand is increasing (ahem… the fastest growing consumer of oil these days? One of those LCCs… a bit ironic, no?) and supply is not growing (it’s essentially finite, people… no matter how many holes we drill or tar sands we mine it will run out). Simple economics (even the kind doled out to the likes of me in Engineering School) tells you what happens in a case like this — the price continues to rise. So at some point, probably sooner rather than later, the cost of transporting goods from LCCs to HCCs is going to reduce and then eliminate any cost advantage.
  • Security of supply: this is partly related to transportation, partly to growing economies in LCCs (with two effects from each of these). If you have to transport goods a long distance by ship (because of the location of many of the LCCs relative to the HCCs, air transportation is too costly) you have issues due to: a) severe weather leading to loss of the goods at sea; and b) timing of arrival of the goods, which can be impacted by normal weather, and may adversely affect production and delivery scheduling. The growing economies in LCCs can cause issues because: a) in some LCCs private, for-profit businesses are A Very New Thing and they haven’t quite got the hang of things yet, so a supplier may just suddenly disappear due to bankruptcy (hmm… maybe they need to figure out that you have to sell at a higher price than your costs in order to make a profit. And they will, once they get over the heady exuberance of Just Selling A Lot Of Stuff.); and b) they compete with off-shore demand for the same things, raw materials and labour. Now, if you have two customers, one who’s two doors down and can easily come looking for you and the goods you agreed to deliver; the other who’s in another country somewhere across the ocean and several time-zones away — who do you think is going to get their goods first if there’s not enough to go around? My money’s on the neighbour…
  • Now this one’s not necessarily a LCC risk, and sort of falls under security of supply too — purchasing policies being driven by economy of scale, which lead to single-sourcing of critical goods. It does often go hand in hand with the LCC strategy, along with other Purchasing Department WMDs like reverse-auctions. Single-sourcing, in my experience, can be A Very Bad Thing, unless you have absolute security of supply. Now for commodities, it may not be critical, provided there is a ready over-supply in the marketplace or at least the capability of other suppliers to rapidly increase production in response to a loss of a supply source. But if not, then you become vulnerable to cost increases (if you have no alternatives for supply and you need the product to be able to continue to sell to your customers… well, think of what a junkie will do for a fix…) and in the worst case, you suffer a total loss (you single-sourced for that economy of scale, remember?) of supply and eventually run out of finished goods to sell. And your competitors? Perhaps they didn’t put all their eggs in one basket, paying a little more for the security of multiple suppliers (can you say “Insurance Policy Premiums”? I bet you can…) and they’re now taking your customers and eating your lunch.
  • The assumption, at least in most developed Western nations, is that the people of the LCCs will remain content with their standard of living and undeveloped status. Riiiight. Very short term viewpoint (and at its roots, harks back to the colonial impulses that the developed nations seem to have never quite gotten over). The two fastest growing economies in the world, if I’ve remembered recent news reports correctly, are both LCCs — the People’s Republic of China and India. And despite some government controls on access to information in China, in neither case are they living in a vacuum. They have internet and can see The Grass Is Greener On The Other Side Of The Fence. So why would Western countries expect that they wouldn’t want a piece of the pie too? And there are a lot of smart, hard working people in the LCCs (despite some Western stereotypes to the contrary) — there’s absolutely no reason why they can’t become as developed as any Western nation; perhaps even more advanced. With comparable standards of living and corresponding costs for labour and social programs. They’re going to want similar protections too: labour laws protecting them from abuses, better environmental conditions and so on. In addition, all this new prosperity brings with it increased internal demands for goods and services. Supply and demand — we all understand their effect on price, right?

So, the Unconventional Wisdom on Low Cost Countries is: look out the front window, that may be the next LCC you’re seeing.  Don’t they say “turnabout is fair play”?  And those higher paying, “value added” jobs?  Could they end up moving to the future crop of HCCs; you know who I mean, those current LCCs once they become developed?

Disclaimer time: Your Mileage May Vary. I’m not an economist, nor do I have an MBA (I occasionally regret not having found the time over the years to go back to school and get an MBA; not because I think it would have made me any smarter but principally for the career juju it seems to impart to people…) so the above is strictly based on years of observation of How Business Gets Done and much personal thought on the subject, rather than on any specialized education in the field.

So, if you have any well-reasoned thoughts or opinions — either for or against my propositions above — on the subject that you’d like to share, please leave them in the comments.

Advertisements

3 Responses to Thoughts about the “Low Cost Country” business model

  1. […] the chickens come home to roost I’ve blogged about the “Low Cost Country” (LCC) phenomenon previously, so if you’ve read that post you — like me — will probably not be […]

  2. […] had a Walmart open up in your town, you’ll know what I mean.  Another example would be the outsourcing of work to a location with lower costs, where the standard of living is substantially lower and the company can avoid paying for things […]

  3. debate_participant_2 says:

    Interesting thoughts. However, I think we are already past the stage where we see the HCC LCC as a one-way transfer. China’s consumer demand is what keeps world economy alive and may HCC sell their high tech products to … guess what, China. Wages in LCC are rising as we speak. Economists would say: the caravan moves on. Textile industry (a classical low-cost industry) is already moving from China to e.g. Bangladesh. Remember Germany 150 years ago? The UK was fearing it for “their low-cost production at the beginning of industrialization”. The interesting question is: where will we end? Will one day the last LCC have become a HCC and we all enjoy a high living standard and social security? Probably not. The sad lesson from history seems to be that country can move in the opposite direction as well. Rome, being once the center of the antique world, was almost deserted in medieval age.

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s

%d bloggers like this: