Wednesday, February 27, 2013

How can we move variability out of the system?

How can we move variability out of the system? By outsourcing it.

"...Needless to say, the loss of industrial jobs is a disaster for industrial workers, and for politicians whose efforts depend on large pools of organized labor (more on that later). But unless one is an industrial
worker, a trade union, or a left-wing democratic politician this is great news. Why? Because it means that the underlying economy loses most of its cyclicality. Let us explain:
• The industrial part of the production process is by far the most cyclical of the three step (design, produce, sell) process described in the first chapter.
• So as companies outsource the ‘production’ part, they effectively outsource the volatile part of the business process to someone else.
• This means that, when underlying economic activity is weaker then had been forecast, Western companies do not end up with the excess inventories, excess labor etc. It is the suppliers that have
to deal with any excesses left over by the unforeseen economic soft spot.

To illustrate this, imagine the following situation. Due to an unexpected event (9/11? Tech bust? Very cold weather?) furniture sales in North America are all of a sudden much weaker than had been anticipated
initially by IKEA. So what does IKEA do? It picks up the phone and calls its supplier in Indonesia (or Poland, Mexico etc.) and says:
Ikea: “Sorry. I know that, this time last year, we ordered 50,000 cupboards from you. But this month, we will only need 5,000.”
Supplier: “But I have already bought the wood for 50,000 cupboards?”
Ikea: “Really? Then I guess you can give me a special deal on the 5,000 cupboards that I do need. After all, you will want to get rid of your wood inventory.”
Supplier: “But how am I supposed to make my employee payrolls?”
Ikea: “Sorry my friend. There are two kinds of problem in the capitalist world in which we live: mine, and not mine. Your inventory and payroll issues are the second kind of problem.”

Because of the slowdown in the demand for furniture, the supplier in Mexico (or elsewhere) is then forced to lay off people. Meanwhile, the designers at IKEA are hard at work on finding new designs that will draw
people back into the stores, as are the IKEA marketing teams. In neither of the latter two activities do we witness many lay-offs. IKEA’s people in Sweden and the United States remain duly employed and the shock is absorbed by the Mexican economy."

From one very interesting quite old but still very relevant book Our Brave New World

Written by Anatole Kaletsky, Charles Gave, Louis-Vincent Gave
Edition: GaveKal Research

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