In Conversation with Hau Lee: On The Future of Global Value Chains

Q: With all changes that you are seeing today, do you think that the flying geese model will remain relevant in the coming decades?

I think to some degree we will see a continuation; companies will continue to move to coastal China, from there they will go to western China, and then to Vietnam. When Vietnam gets pricey and labor costs rise, these factories will move to Myanmar and Bangladesh. There is a continous chase for low cost labor. But this comes with a lot of negative problems. With instability comes nervousness and disruptions that are triggered by moving continually, so you will – and do – see factories which are running well, until they have to move.

But I don’t think we will continue to see this movement happen in the way it did, because I think there are a lot of manufacturing activites that can be carried out using information alone. I talked about steps that used to need labor – these steps can now be replaced with information. If I can create a new way of doing things, eliminate steps and carry out dematerialization, which is a term that some companies use, then my labor content is reduced by 30 per cent. I don’t have to keep moving. I can still stay in the same place.

The second reason why all this moving forward and around is not really necessary, is because I think that consumers are now more demanding. When they ask for products today, they no longer look for the bottom of the pyramid, which in today’s case could be items that are made in Africa. The consumers are waking up; they just don’t want the most basic versions of a product, which translates into the simplest and lowest quality items. They are asking for personalization, customization, additional features—and these all represent added value. So if I have a good factory, instead of moving and chasing labor costs, I can improve my factory, train my workers so they can handle these value-added activities. Then I’ll be able to run that factory and make more profit without having to move to another low-cost country. So I think this kind of chasing low costs will not continue in the same pace and the same magnitude as before.

Q: So what happens to these countries which have relied on this low-cost manufacturing activity to pull themselves up the ladder to prosperity?

Stanford (Graduate School of Business) has a center in Ghana where we work with entrepreneurs in Ghana, Sierra Leone and Ivory Coast. We are trying to help those entrepreneurs by telling them not to market themselves as low-cost labor, because the world is flat. Information and the internet have enabled these entrepreneurs to master know-how, skill and expertise quickly. So these companies should not just rely on pure manual labor, doing the same things as before, in the most mundane and trivial way, as a way of pulling themselves up. They can accelerate their learning curve.

(Based on this experience), I think that the growth model of these countries will be different from the era before, where you mostly see companies saying “give me the things you don’t want to do, and I execute at half the cost.” Now its about doing things that you don’t want to do, and then modifying the content, and adding what I see as value on top of it. So in a sense, everyone is better off – there is a new growth model.

Q: China has built its success on buidling up the low-cost model… where does China now fit into all this?

China will be at the center of this movement, because most manufacturers recognize the “smiley curve,” and they no longer want to be at the bottom of the value curve. Factories no longer want to produce the most basic version of their goods. They want innovation, design, their own brands. They want to master distribution. I do think all of these manufacturers are already on this journey, and China is going to be on a higher value-added path than it was before. And because China is a big market now, companies will learn to serve their market by coming up with their own designs that will serve their customers. This is the value add, because they are adding design, and they are adding customization that will fit the market needs of its geography.

Companies in China are also recognizing that a product serves a purpose, so the product itself is not something a customer values, the customer values a product because of what it can do for them. So as an example – if a farmer buys irrigation equipment, he doesn’t buy this equipment because it makes him happy, he buys it because the equipment has a purpose. If the manufacturer can not only produce the irrigation equipment, he can also irrigate and do the job better than the farmer can, then the farmer is happy to purchase this equipment.

This illustrates the transition of a company from one that is product-based to one that is product-plus service, which usually delivers higher value and margin for the manufacturer, creates more loyal customers along with a level of intimacy. So I think China is going down this path; it will graduate from what is started as a product-based economy to one that is product-with-higher-value and finally product-plus-service.

Q: Chinese companies appear to be reversing the value chain by moving to U.S. states like South Carolina to produce raw material and then sending the material back to China for processing. Do you see this happening more?

I think that this movement still involves a small number of isolated incidents. My view is that as manufacturing becomes potentially more dis-integrated, meaning that a single country or company does not have to do the whole thing in a single location, products can become fragmented, with different pieces done in different parts of the world. The more we can do that, the more we see this kind of reverse flows. In the past, when manufacturing was integral and all the manufacturing was forced to be done in one area, you had to decide whether or not to move, and if there was a move, then that move needed to be done 100 per cent. Today I think the world is migrating and changing, and things will move in pieces because it makes sense. I think that in this kind of migration to a more complex global value chain, we are leveraging to do the best we can to make a complete product.

Q: Will regional trade pacts help or hinder the development of a global chain?

I think when the trade pacts are developed they are meant to reduce trade barriers. So when trade barriers are reduced, that is meant to be good because then we can leverage the global value chain in a more efficient manner, so the less friction that you have when you cross the border, the better it will be for everyone. But the problem is that when you look at the signing of any regional pact, individual countries usually panic, they have their own ideas and they sign bilateral agreements to try and undercut regional agreements. The proliferation of these side deals creates frictions. I just have to say that regional pacts are there to make life easier for everyone, as long as we don’t also have a proliferation of these bilateral agreements.