Chapter 2 – Macro-level analysis – world economy and industries

Contents:

  • Crisis
    • Small-scale electricity generation and supply
  • Concentration of supply
  • Over-capacity. The case of container shipping
  • Scenarios
  • Fashion, fast or otherwise
  • Indicative answers to end-of-chapter questions

Crisis

We might ask how might the Five-Forces model works in a crisis? Covid-19 is just such a crisis. In the UK during the first wave of infection, there were some essentials in very short supply. The British Government, for example, looked to engineering firms rapidly to design, test and manufacture medical-standard ventilators. There were incumbents in this niche industry. Because of the nature of the industry, the incumbents may have struggled to scale up production as demand was not anticipated. The call from government coupled with the potential profit opportunity drew in new entrants; notably Dyson, GKN and Airbus.

Here is an audio clip from BBC Radio 4’s Today programme on 26 March 2020 that illustrates the opportunity and threat (to incumbents).

Electricity supply in Eeklo, Belgium

Business and corporate strategy generally assumes profit maximisation and competitive markets. When we apply models such as Michael Porter’s 5-Forces framework, it tells us much about industry structure in certain parts of the world and the nature of supply into predictable markets. When it comes to electricity generation and supply, the industry assumes large and capital-intensive generation and monopoly supply (if not suppliers). This seems to be a legacy of the post-war approach to Western growth: centrally-planned, owned and controlled generation and supply that, subject to the mores of the 1980s (c/f the Friedman Doctrine) wilfully transferred to the private sector on the grounds of resource efficiency and access to investment.

The crises that we now face (climate and supply of fossil fuels) provide an opportunity to reconfigure business models in the electricity generation and supply industries. Take the case of a co-operatively-owned electricity generation and supply operation in the small town of Eeklo (pop 10000) in Belgium. Now the story may well be subject to poetic licence, but it has a number of characteristics that are worth considering:

  • a social entrepreneur/deputy mayor leads with a passion and drive to enact policy to facilitate small-scale renewable energy projects
  • the need to demonstrate that wind turbines are not noisy and do not destroy the view from residents’ windows, and respond to other common NIMBY concerns
  • every roof is possible source of electrical energy through photovoltaics (residents invest directly or hire out their roofs)
  • that when stakeholders have a share in the technology, its deployment, management and development, change can be quick, collegiate and sustainable (the company is a co-operative with 60000 members)
  • small scale and appropriate technologies can lead to lower costs and hence lower prices for stakeholders (in this case, residents are paying up to 40 per cent less for electricity than what they pay directly from the grid).

This is one tangible form of stakeholder and sustainable capitalism. It is a challenge for existing analytical frameworks reliant, as they are, on globalization as an ongoing force for supplying into local markets.

Concentration of supply

The power of suppliers in an industry is often difficult to judge and measure. However, in some industries, the power is all too obvious. One of the most powerful suppliers in any industry is TSMC (Taiwan Semi-Conductor Manufacturing Company, a near monopoly supplier of microchips, not only for consumer electronics but, crucially, for the motor industry. There is an added dimension to TSMC, it is Taiwanese and is the source of tension between China and Taiwan. Taiwan asserts its independence. This is rejected by China, hence the tension. A firm like TSMC is itself strategic to the countries themselves, not just for buyers of the products.

The motor industry increasingly uses microchips in its products – they are integrated into the mechanics, they run the electronics such as navigation systems, dashboard indicators, fault diagnosis, etc. At the start of the pandemic in Europe and North America in 2020, the motor industry’s output collapsed; however, it has recovered faster than the industry anticipated leaving assemblers such as VW, GM. Toyota and Jaguar Land Rover, reported the Guardian newspaper (19 May 2021), failed to anticipate the upswing and ordered insufficient chips to make the vehicles to meet the need. Ford reported that it was only able to produce half the number needed up to June 2021. This shortage has, as expected, pushed the price up and lead to a 10 per cent increase in vehicle prices in the US from March to April 2021.

The Economist added to the insights (22 May, 2021). The chip industry is what analysts call, a “pork cycle” businesses; i.e. one that swings between under- and over-supply. The name comes from a pork markets in 1920s USA. The chip industry is not one that can quickly increase production – in this case made worse by by a fire at a factory owned by Renesas, a key Japanese supplier.

The case illustrates the dangers of a concentration in supply of a strategic product and component in so many capital and consumer products. The danger is not only one economics; it is also geopolitical. The global economy and the globalisation of production is not immune to both political effects (in this case in relations between China and Taiwan and China and the USA), but also natural phenomena such as earthquakes and droughts. There are three potential solutions:

  • Governments can invest and promote new producers located domestically (or regionally).
  • Strategic producers, in this case TSMC, can be invited to open production facilities abroad. There are plans for a factory in Arizona, in the USA, and Nanjing.
  • Better coordination across value chains.

Over-capacity. The case of container shipping

Porter’s Five Forces model tells analysts how attractive an industry is and guides policy-makers (executives) in deciding whether (a) to enter an industry, (b) stay in an industry, (c) reposition within an industry, or (d) exit an industry.

Over-capacity is one element of an unattractive industry. It is particularly acute where there are high fixed costs. This is and was the case with the global container shipping industry. Marc Levinson’s history of the industry graphically illustrates the effects of over-capacity in an industry dependent on international trade, over which the container shipping firms have little control.

The original containers ships were war-time vessels repurposed for the US coastal distribution; the international trade really took off in the 1960s during the Vietnam War and by the entrepreneurialism of a number of people, the most famous of whom was Malcolm McLean, founder and long-time boss of Sea Land.

The container shipping business model is relatively simple – though fiendishly difficult and expensive to manage. Very early on, the barriers to entry were high. Not only the capital costs, but routes and rates were controlled through so-called conferences. These were cartels. Those outside were subject to unfair competition when charges were lowered below cost in order to see off new entrants.

Over time the ships got bigger to reduced the cost per container. The closure of the Suez Canal in 2021 by one of these enormous purpose-built vessels, the Ever Given, brought into sharp focus not only how many containers are carried, but also how disruptive can be a hold-up for supply chains and consumption.

In the early days of the industry – the start-up phases – the capital costs were small. Repurposing ships is a much less costly option than buying new. In the 1960s, however, Asian shipyards – notably in Korea – started building the ships paid for by borrowing. The loans still had to be payed off even when trade declined and the ships had fewer customers, as it did in the 1970s. It was not possible just to tie up the ships and wait for better times.

Containers on rail in the UK, 5 July 2021

Larger ships meant more capacity. Incumbent firms had to respond. The options were for firms to reposition themselves, liquidate, or exit. For example, many firms merged with one another to generate cost savings. In the UK, Ben Line and Ellerman Line merged; in Gemany, Hapag-Lloyd was formed from a merger between Hamburg-Amerikanische Packetfahrt-Aktien-Gesellschaft and Norddeutscher Lloyd which then created an Asian alliance – TRIO – with two British and two Japanese shippers. Dutch NedLloyd created an alliance with Swedish operators in Asia (ScanDutch). In the USA, Matson “surrendered” (repositioned) its international business with two other major players merging: Grace Line and Prudential lines. The American Export Isbrandtsen Line had its shares on the NY Stock Exchange suspended (liquidate). But even those companies responsible for the increased capacity, notably Sea Land, experienced sharp declines in profits. Much of this was also underpinned by Governments.

This consolidation was successful – trade improved, capacity was utilised and profits returned, but then in 1973 there was another – unexpected – shock to global trade. In strategic analysis, PESTEL guides us to investigate some of the external factors affecting an industry. These shipping companies should have been aware that the economics of global shipping depended on cheap oil. When OPEC – the organisation of Oil Exporting Countries – raised the price of oil almost overnight, the ships became uneconomic. Fuel oil prices quadrupled and freight rates increased. If that were not bad enough, the price of oil also caused many economies to go into recession. The world’s economies needed less. Less in the way of commodities, fewer products. Not only were the ships now unable to meet economic load factors, their design, in McLean’s case, also became redundant. McLean had banked on speed giving him competitive advantage. Speed takes fuel and fuel suddenly became a major cost.

Another PESTEL factor for shipping companies was the P – politics. Speed had become important because of the closure of the Suez Canal in 1967 during the Arab-Israeli war. Ships had to go around the Cape of Good Hope instead. The ships were designed to go faster to compensate for the extended journey. The Canal reopened in 1975, earlier than anticipated, leaving shipping companies with fuel-hungry ships at a time of high oil prices.

Scenarios

Scenarios are not forecasts, though they may utilize forecasting data. Scenarios are plausible futures, narratives constructed from variables that might affect the future and if responded to can fundamentally alter the trajectory of the firm and, indeed, an industry.

In this context, the oil industry lends itself well to scenario analysis. Royal Dutch Shell is the pre-eminent composer of scenarios and they have used scenarios to shape the industry because it is they that have the resources to do so. Oil majors are so large that they have their own massive GDP. So, keeping any eye on scenarios designed by Shell should not be ignored.

Shell is not shy when in comes to publicising not only their scenarios, but also their scenario process and dedicated team. They explain the essence of scenarios in this short video. Scenarios are stories that can be assimilated by policy makers and acted upon in a way dry facts rarely achieve.

Shell’s scenarios for 2050 are illustrative of how scenarios are presented. For 2050 the scenario team offered policy makers two options, Scramble and Blueprint. The names should say what to expect. A blueprint is a perfect reliable guide, a future to aspire to. A scramble is uncertain and dangerous. The accompanying video has all of the necessary ingredients:

  • an authoritative voiceover and an urgency-generating score/music
  • assumptions: increasing energy use, difficulties in meeting demand and climate stress caused by the emissions of greenhouse gases.
  • two scenarios for selection (often four)

My own work on using scenarios was undertaken in the early 2000s when I was part of a consortium called MobiCom looking into to commercial opportunities for 3G technologies then being rolled out. The consortium composed 4 scenarios to 2006 (still pre-iPhone):

  • Business as usual: slow growth in search of business models (the trend scenario). By 2006 there has been a sloppy growth of mobile commerce, and the market constellation resembles the situation of today. The economic downturn and aftermath of the UMTS-licensing rounds have stagnated the anticipated growth.
  • Consensus of institutions for controlled growth. According to our experts this the most likely scenario. The big players have taken control over the development of infrastructure, standards, and services for mobile commerce. Thanks to the consensus things are under control, with little problems in technology, privacy, IPRs, etc., Some antagonists are seeing welfare losses as a consequence of operators holding back service integrators innovations and common market competition.
  • Telecom is backing off. Telecom operators agreed upon seamless roaming of mobile services all over Europe, as they see it in their interests to boost traffic on mobile networks. Competitively priced services on other technical platforms are pushing operators back to their traditional positions specialising in data transmission and keeping up the infrastructure. This has opened up possibilities for new entrants on the service market. As a consequence consumers face a growing number of options for getting access to the Internet, shopping, paying, hence proprietary networks are losing ground. Simultaneously IPR-regulation is struggling for effectiveness – technical development seems to be constantly one step beyond.
  • Deregulated, liberalistic markets. The regulators were very active in creating and implementing a liberal mobile commerce policy, in order to boost competition on the common market. IPR-regulation is effective, and seamless services are provided over various networks. Last mile competition, portable subscriber addressing, transparent pricing of services has been introduced. The severe competition has boosted the innovation of services, however, few of them survive. This is causing problems in terms of using private and commercial data.

The most concise account of the project is: Mylonopoulos, Nikolaos A. and Georgios I. Doukidis (2003). “Introduction to the Special Issue: Mobile Business: Technological Pluralism, Social Assimilation, and Growth.” International Journal of Electronic Commerce 8(1): 5-22.

Fashion, fast or otherwise – 5-Forces

The text invites readers to be critical of the 5-Forces model. Like most economic theories, it is a construct. It is not real. It is an organising mechanism. Though strategists tend to take it as an accurate representation of industries. It is a representation of industries as seen by a classical economist who strips out any human needs or inputs. To analyse industries by its application is to reproduce the structures that have delivered the climate crisis.

Take the fashion industry as currently understood. It has sectors within it: designer, fast, sports, etc. It is a highly globalised industry employing – often on below subsistence wages – 300 million people. Those at the top of the pyramid are billionaires. Those at the bottom work in unsafe conditions on unreliable “contracts”.

However, this industry is not entirely what it seems. Especially in times of climate crisis, it is changing. The industry is the second largest contributor to GHG emissions globally. It is resource intensive – water, agricultural cotton, plastics. It is hugely unsustainable. However, this changing industry sees an increase in sharing, trading, renting, self making and donating. There is a waste economy – scenes of dumped clothes in the Chilean Atacama Desert are contrasted with the one-time thriving secondhand market in Kenya.

There are many contrasting views and challenges. A few include:

  • poverty and fashion waste are inextricably linked
  • consumers need to think about carbon when purchasing, especially online if that involves returning goods
  • consumers should never hoard clothes – unwanted clothes should be sold, donated, repurposed
  • fast-fashion is not inherently bad; some FF brands are working hard to limit their impacts (though consumers should make informed choices – if the companies’ websites are not talking about their sustainability initiatives, then they are unlikely to be taking sustainability seriously
  • designer brands are often more likely to burn returned or unsold clothes than cheaper brands (as they seek to retain the exclusivity of the product)

For an insight into the changing nature of the fashion industry and how the structure of the industry is being challenged by a sustainability imperative, a 2022 edition of the Bunker Podcast featuring Dana Thomas, European Sustainability Editor at British Vogue and Dr Mark Sumner, Lecturer in Sustainable Fashion at the University of Leeds.

Indicative answers to end-of-chapter questions