Commoditization of Manufacturing
There is a simple explanation for the great productivity stagnation and the technology paradox.
Real labor productivity in the US manufacturing sector has stagnated for over a decade.
Germany, China, and Japan are no different.
What is wrong with manufacturing labor productivity despite all the new technologies? What happened to Industry 4.0? Is the dissemination of the technology not fast enough? Or is it about the effectiveness of adoption? Can AI bring the productivity trend back to where it was? How can we convince CxOs to buy more tech? These are the questions being asked by the intellectuals of the world of manufacturing technology.
These questions are myopic, biased, and neglectful. These questions are myopic in that they look at only within the four walls of plants, biased in that they are fixated on technology, and neglectful in that they do not discern productivity from efficiency and ignore the topline component of productivity. Also, these questions allude to what I call “corporate consumerism,” which epitomizes a person who wants to lose weight by purchasing weight loss pills, diet books, and gym memberships instead of changing his/her habits and lifestyle.
Below is the US’s real manufacturing output for all workers. It seems to have stagnated for the last 15 years.
To understand this graph correctly, we must be careful with our analysis and understand the data before worrying about which AI technology to buy.
Real sectoral productivity is about the ratio of real outputs vs. inputs. This ratio factors in several moving parts simultaneously: the pricing of goods, the amount of goods produced, the pricing of inputs, and efficiency.
Interestingly, most experts look at the chart above and conclude that labor efficiency has been stagnant. It is not. See the chart below. For the period of labor productivity stagnation, industrial production increased by 21% while industrial employment increased by 10%. This means that labor productivity stagnation is not about labor efficiency. Moreover, all those involved in manufacturing in the last two decades would know how much real operational efficiency was gained, mainly focusing on labor efficiency. At least, I do not know a factory that is only as labor-efficient as it was 15 years ago and still in business.
If labor efficiency went up but real labor productivity was stagnant, this means the labor efficiency gains were negated by something else. There is only one explanation: the real value of outputs declined so significantly that even the labor efficiency gains did not help.
Take a moment to read the below chart first. It contains 50% of the insights we need.
In the figure above, without a doubt, consumer prices (blue line) always went up and accelerated after 2020.
Question 1: Why manufacturers and commodity producers could not increase their prices at the same rate as consumer prices?
In most markets, retailers are few and big, whereas manufacturing is more fragmented with smaller players; therefore, manufacturers are subject to more competition.
Question 2: How come even the commodity prices (green line) were almost always more resilient than manufacturers’ prices?
In most markets, commodity producers are fewer and bigger than manufacturers.
Question 3: Why do manufacturers’ prices correlate more with commodity prices than consumer prices?
Most manufacturers are price takers. Their prices are led by the procurement function of their customers on a cost-plus basis.
Question 4: Why does manufacturers’ pricing power manifest cycles of “very weak” and “less weak”?
Because most manufacturers pursue economies of scale, which comes with operating leverage and causes inelastic supply, periods of relative shortage are followed by capacity expansions, eroding manufacturers’ pricing power, and trapping more and more capital into this vicious cycle.
So, the problem is not about labor efficiency. It is about the commoditization of the outputs.
As long as a manufacturer is in a competitive market, a price taker, forced to play the cost-plus game and must sustain a break-even volume, its efficiency gains can only increase its real output until the next best competitor achieves similar efficiency gains. Such efficiency improvements are often disseminated by buyers, as illustrated in the strategic sourcing and procurement practices of the aerospace, pharma, and automotive industries.
The other 50% of the answer is distributed in these articles:
Overcoming The Technology Myopia of Industry 4.0
For more actionable and contextualized insights, reach out to me on LinkedIn.
© Saip Eren Yilmaz, 2023
