By

Thomas Schinkel

Labor Day Weekend, 2008

The 2008 Olympics over, the athletes returned to their home countries, let’s talk Globalization and the cost of fuel. The rapidly rising cost of fuel during the last few years gives us pause to reflect on numerous issues. I want to discuss the energy equation in a simplified format, recognizing that simplification the title I use two concepts that are starkly opposed to one another.

Local Direct

First of all, what does “Local Direct” mean? Well, I live here in Boston and when I want to eat fish for dinner I have two options. I can get fish sticks from a package on display in the frozen section of my supermarket, or I can get it freshly caught by a local fisherman (who anchored his boat in Gloucester harbor early that same morning. Getting it fresh from the local harbor is an example of ‘local direct’. No packaging, no freezing, no branding, no private label, just nature.

Exhibit One

Detour Economics

The frozen fish that is available to me in a package, was also caught in the very same waters that my fresh fish came from, except it had been frozen, packaged, and shipped to China. Once there, it had been processed some more, then shipped back to the U.S., where it had been wrapped in a nice colorful box, then shipped to my local supermarket, and now, after this long journey, it is available to me, the consumer. This is an example of detour economics.

As long as the total energy costs that go into the product prepared according to the rules of detour economics remain below a certain threshold, this mode of operations is satisfactory.

Milk Processing and Distribution

Before we go on, let me give you one more example. The concentration closest to where I live – in downtown Boston – of milk producing cows is in Vermont, no more than 200 miles from here. In the ‘olden days’, that Vermont milk got shipped directly to a local milk processing plant here in the city for pasteurization and bottling; an army of local distributors (a.k.a. the milkmen), would swarm around the plant everyday, take the bottled milk on their wagons and shuttle the bottles off to the end user. Alas, the days of that local processing plant are long gone. The armies of milk distributors are no more.

Today, that same Vermont milk gets sent off on a journey to Peoria or someplace else in Illinois. Once there, it gets processed, packaged, and reshipped to a warehouse somewhere on its way back to the East Coast. And only now it gets reshipped back to my local supermarket. In other words, the milk from the cows of Vermont today is off on a 1,500mile journey before it reaches me the consumer, and not the 200 miles of days past. Milk distribution has become part of an intricate value chain management system that is dominated by two or three power players who decide on price, packaging, shipping, handling and all aspects in between. As long as the price of energy is low, nobody seems to care. But let the price of energy go up, as it did during the long hot summer of 2008, and cracks in this kind of detour economics seem to pop up all over.

Now that you get my description of the difference between “Local Direct” and Detour Economics”, I am sure you can come up with examples in your own world where this dichotomy is at work. Come to think of it, “Detour Economics” seems to have wormed its way into more and more aspects of our present day lives. Increasingly, it seems that issues like globalization, off-shoring and out-sourcing have become so many different manifestations of the same theme, Detour Economics driven to the Extreme!

Detour Economics on berserk?

Let me give you two anecdotal examples of detour economics gone berserk.

• The local newspaper here in town, The Boston Globe, is in some sort of serious trouble. The internet is doing a number on it; readership is down, costs are up and layoffs are inevitable. Nothing new. It happens to newspapers all across the land. But how do they react? They outsource the jobs of their telephone receptionists! Try to call them and the first person you get on the phone is located somewhere in the Philippines! Move your first line of defense as far from the customer as you can. Detour economics gone berserk!

• Three months ago I bought a couple of shirts at my local Brooks Brothers store. A week later the phone rang. Guess what! Someone from India wanted to know whether I was happy with my purchase at Brooks Brothers. Over at Brooks Brothers, it seems, the vital task of checking back with your customer has been relegated to a trainee in a cubicle in Bangalore. What made me think that it was the local store manager’s job!

When companies resort to this kind of detour economics, I read it either as a sign of desperation or else of pure stupidity. If the store manager had called me, or better yet, the clerk who actually helped me with the purchase, it would have come across as authentic and genuine. Now it was phony. I have not been there since! And what about the Boston Globe? Frankly, who needs them if one can go to the BBC, Reuters, Bloomberg and all things social, cultural and sports on the Net! At no cost!

By the way, not all customer experiences are like this. Here is an excellent example of creating customer loyalty through ‘Local Direct’. Last year, early December, I went to my local Staples store for personalized Christmas cards. The order placed, the clerk told me I would have them within a week, enough time to send them out before Christmas. At the end of the week the phone rang. It was the clerk who had taken my order. She was remarkably direct with me: “Mr. Schinkel, there is a problem with your order; we are unable to deliver the cards on time”! She apologized profusely and offered me my money back. I thanked her for her forthright and pro-active approach, and moved on. I continue to shop there. Why? Most of the time, they get it right, even when it goes wrong. I love that.

Back to globalization! Increasingly my sense is that it is being driven to excess. Let me give you an example from my own practice:

“Earlier this year, I got a call from the CEO of a small manufacturing facility located in the heartland of the country. At $25 million dollars, their sales had been stagnant for over three years. He had a couple of issues he wanted me to help him sort out. Their largest customer – the world’s largest big box retailer – had hinted (in no uncertain terms, I might add), that they needed to move production off-shore (code word for China), or else! Now, in working with my client I soon discovered that this company had trouble getting its most basic accounting functions right, let alone the complexity of moving operations to China. They had no clue about their activity costs; they did not even know what it meant! And yet, here they are spending gobs of money they don’t have on legal fees, travel, research and moving expenses, just so that the box retailer can lower their price to their own customers by another twenty percent. What are the products? Cute little sticky wickies – Price elasticity “zero”. Lower the price twenty percent, demand goes up “zero” percent! That sort of thing”.

To me, this is yet another example of detour economics and globalization gone berserk. Don’t misunderstand me – I am not against globalization per se! And I don’t have any hidden axes to grind with big box retailers either. What I am saying is that perhaps we are overdoing it.

And the point I am making, with as much clarity as I can!, is that the rising price of energy lays bare inherent weaknesses in many “global” business models and that some of  these models may become vulnerable to competitors that operate from a mindset inspired by the notion of “local direct”.

Inspiration for New Combinations

Why is this important from a business point of view, you might ask? Well, you see, there may be opportunity in the tension between the two concepts. Opportunity is what the entrepreneur is looking for and my entire thesis with this line of reasoning is that a thorough understanding of this tension may produce ideas for new combinations – that remarkably simple term first framed in 1911, by a German economist who for many years taught at Harvard. His name was Joseph Schumpeter, and it was he who defined the job of the entrepreneur, “the person who searches for profit through the creation of New Combinations”. He couched the subject in such a beautiful manner that it not just applied to the realm of business but to social, political, and military environments as well. How clever, and how apropos to the realities of today! The more things change, the more they stay the same!

In the meantime, the last thirty years have witnessed a lot of new combinations, many in the direction of “Detour Economics”. Could the next ten years witness the reverse?

The years 2006 and 2007 saw the introduction of the world’s largest container ship and the world’s largest passenger airliner respectively. Yet, during that same time-frame, the cost of shipping a 40 ft container from Shanghai to Los Angeles went up from $3,500 to $8,000, and the price of an airline ticket between New York and Paris rose more than 30%. As capacity increases, the price increases? I thought it was supposed to be the other way around!

Remember the slogan “Think Global, Act Local”? Maybe it no longer qualifies as a viable metaphor for explaining the complexities of today’s business environment. Just recently, one of America’s hallmark companies, Anheuser Bush, got sold off to a Belgian-Brazilian conglomerate. I always thought of Anheuser Bush as the quintessential example of a business model competing on the basis of centralized production and the creation of a strong, global consumer brand.

Clever marketing – that ultimate barrier to entry – would hold their competitors at bay. The relentless drive for market share seemed at the center of this empire in its decade long quest for dominance. And yet, if this is such an effective business model, why have hundreds of micro-breweries have popped up all over, from Boston to Columbus to San Francisco, to Austin, TX and all locales in between; tiny little companies producing quirky brands and excellent, authentic taste?

When the price of energy is low, and the margins are high, the laws of detour economics make it easy to stretch the value chain. When energy goes up and margins are shrinking, the glitter of detour economics begins to fade and opportunities open up for business processes and ideas informed by the lure of “Local Direct”.

My sense is that during the next decade we will have a hybrid economy where these two opposing concepts engage one another in numerous industries, and at varying levels of intensity. As a CEO, you want to be at the center of this tension because it is up to you to determine for your company what will be the right thing to do; where you want to be five years from now. If you get it right, your company will prosper; you get it wrong, trouble follows.

If I were the CEO of Staples, or Office Depot, or Home Depot or any distribution Depot for that matter, this would give me sleepless nights than anything else in the discharge of my responsibilities. And manufacturers who sell into the complex supply chains that have been created over the last twenty years or so can derive comfort from the knowledge that there are only seven sleepless nights they can have in any single week.

From office supplies to groceries to house-wares to hardware and medical devices, manufacturers and their distribution partners have to deal with this issue. Define where you stand on the issue, or else your competitors will do it for you.

Whichever way you choose to go, everything else you do is derived from this dichotomy between local direct and detour economics. How, when and where you compete, against whom; how, when and where you cooperate, with whom; where you allocate your capital resources, what types of people you hire, you name it, it all gets reduced to this simple dichotomy.

“Grotesque oversimplification”, you might ask? Perhaps!. But then again, perhaps not! Stripping seemingly complex issues of their codifications sometimes lays bare remarkably simple truths. It is to the entrepreneur to discover these truths and to translate them into opportunity and prosperity for a new generation. In conclusion, allow me to leave you with a question to ponder over the coming Labor Day weekend:

“What is You Business Model and how do you intend to adapt that model to the changing “Energy Equation” that is upon us all? When the time comes, how do you migrate from ‘Detour Economics’ to ‘Local Direct’?

Thanks for visiting and May the spirit of common sense, sober-minded thinking and civilized discourse be with you this Labor Day!

Thomas Schinkel

Business Adviser

PS: In my next article, I will come back to the question of America becoming an “Export Nation”. I have some very interesting information to share with you; stay tuned.

Thomas Schinkel is an internationally recognized business expert who works with chief executives of large, medium- and small businesses on a broad range of issues of strategic significance to them and their stakeholders.

He does this through coaching, consulting, writing, training, meeting facilitation and through speaking engagements at conferences. Clients also include venture capital firms, trade associations and individual investors.

He is particularly passionate about three intertwined issues, namely:

• Business Opportunities resulting from International Trade,
• Growing the Business through Acquisition and
• Customer Relations Management.

He has founded and developed several companies, including Co-optics of America, a cooperative buying group for optometrists. In 1998, he created, and implemented an international strategic alliance for contract-stationers from various countries.

He has worked with clients in the office products industry, in general aviation, in the medical device industry, in the software industry, in the eye care market, and in hardware and industrial distribution environments. He works and lives in Boston, Massachusetts. He can be reached via e-mail at Thomas.schinkel@gmail.com or via telephone at 617-818-8783.