Is This the End of Globalization?

We see nationalistic leaders getting elected in many parts of the world. These leaders are concerned about trade disparities with other nations and the impact of lower economic activities on new job creation within their borders. Can you really blame them for that?

Today, business leaders are challenged with building resilient supply chain bases, getting access to essential materials for manufacturing, and competing for a dwindling pool of scientists and engineers because of new immigration laws. When it comes to free trade and globalization, there seems to be a tug-of-war between the Western democratic countries and the centralized authoritarian rulers of some other countries. No, this is not the end of globalization, but it is the beginning of a new era for globalization.

As the pandemic subsides and the world’s political environment calms down, there will be new norms for globalization with revised policies and rules of engagement between nations. According to the World Trade Organization, the total annual volume of the world’s exports of merchandise has seen a 50 percent increase since the 2009 recession, currently estimated at $19 trillion. However, gross domestic product (GDP) figures are not evenly distributed today. Asia has 62 percent of the world’s population but generates 37 percent of the world’s GDP. North America has 8 percent of the world’s population but generates 29 percent of the world’s GDP. For the world’s economic activities to continue, countries will need to maintain trade agreements and respect the laws of the land. When the benefits of globalization become lopsided, nationalistic sentiments are bound to creep in.

In the 1960s, American manufacturing contributed to 25 percent of the country’s GDP, but today, it is less than 10 percent. Since the early 2000s, more than 5 million manufacturing jobs have been lost in the United States. Slowing globalization will affect both the developed and the developing world. While costs may rise and growth may slow down in developed markets, countries in the developing world will pay a huge price in lower economic activities with a significant slowdown in their economies. Further, developed countries are considering emerging technologies such as artificial intelligence, automation, telecommunication (5G), robotics and health sciences as national security and implementing trade barriers. Countries want to be self-reliant in certain key sectors such as pharmaceuticals. This puts CEOs’ of multinational corporations (MNCs) in a bind trying to figure out the impact of geopolitics on their businesses.

In the last two decades, MNCs invested heavily in far-flung countries to expand markets, gain economies of scale, reduce the cost of operations, and tap into a talented workforce for R&D and innovation. However, there is a major tradeoff between efficiency and the resiliency of the supply chain and manufacturing base. The pandemic has caused massive disruptions to supply chains, and several MNCs have announced re-shoring to manage production risks. Further, the rising costs in some developing countries is making it easier for companies to favor re-shoring. The Japanese government is encouraging their companies to re-shore with a $300 M incentive program. Apple is moving some of its production capacities to different parts of Asia to diversify and manage production risks. This means that consumers will end up paying more for goods and services— the cost of doing business in the new era.

So, what can business leaders do to address the current challenges?

First, it is important to get the fundamentals of global strategy right. Companies have to evaluate and reevaluate the reasons to be in far-flung markets with a wide portfolio of products, services and production facilities. For some companies, going global may not be the best use of their resources. The strategy has to be dynamic, in that it should be flexible to address ever-changing market trends and geopolitical risks.

Trends in areas such as urbanization, population growth, regulations, and infrastructure spending all point to higher growth opportunities in developing markets. Large industrial companies, who generate a third of their revenues from international markets, cannot ignore these trends. Nevertheless, companies have to be diligent in allocating their valuable resources to chase narrow slivers of the global market share. Leaders have to go beyond setting regional strategies to developing clear, country-specific or sub-regional strategies. There needs to be tight collaboration between business units and their regional teams in developing these strategies. For example, company leaders need to develop compelling product localization plans that address the unique needs and characteristics of local markets. They also need to investigate all elements of the strategy: what products/services to sell, through what channels, and at what price to clearly defined end market segments.

Second, leaders should manage the short and long-term risks associated with supply chains. McKinsey estimates that supply chain disruptions lasting a month or longer now happen every 3.7 years on average, costing more than 40 percent of a year’s profit every decade. When it comes to global sourcing, companies have to balance resiliency over efficiency. In the past, companies built an efficient global manufacturing process with LEAN programs to achieve lower inventory levels and better cost position. With disruptions, companies now have to come up with new models to achieve resiliency through a diversified mix of vendors and regionalizing manufacturing systems. In one of my previous roles, we deliberately built a balanced supply chain strategy by sourcing critical raw material from Germany (high cost, high reliability) and Southeast Asia (low cost, lower reliability). This diversified strategy allowed us to differentiate and charge premium prices in the marketplace by offering products with an industry-leading short lead time.

Third, it is important to protect the intellectual property (IP) of your offerings. Over time, IP associated with products and services gets diluted through product localization and theft of technology. Companies have to overinvest in R&D to remain on the edge of the technology curve to remain competitive. When I started my career in the nuclear industry, Western companies had the technology advantage. Over time, with technology transfer through partnership with Asian companies, they have lost the advantage, but now they are trying to catch up with the next generation of nuclear technology.

Lastly, if your company isn’t careful, channel partners can end up becoming your competitors. Developing countries have built formidable enterprises that can be great partners for you in their home markets, but do not forget, they aspire to compete on a global stage—and are capable of doing so. Companies have to go beyond drafting ironclad contracts with suppliers and partners to proactively managing IP and the business model. Product line leaders and general managers of the business should take a bigger role in how the design principles, manufacturing drawings, bills of materials, and so on are managed and disseminated both inside and outside the company.

Bottom Line

We are entering a new era of globalization. Rules will change. New policies, regulations, and trade barriers will be introduced. Countries and companies will compete for limited resources, technologies, and talent to improve their odds of winning in the global marketplace.

Despite the challenges, business leaders can’t ignore high-growth markets. The macro trends of urbanization, population growth, changing regulations, and infrastructure spending point to continued growth in these markets.

Business leaders are forced to reevaluate their global strategies, in combination with geopolitics and business risks. In the short term, it is important to manage supply chain risks to achieve resiliency over efficiency. Finally, protecting a firm’s IP and investing in R&D to remain on the edge of technology curve is critical to its long-term success.

If we want to keep globalization alive for the next generation, there is no alternative to ensuring that it works to the benefit of all.   — Christine Lagarde, Head of the IMF