AI
Sunday, June 29, 2003 3:09:00 PM
warning ... this is very long, but worth the time, in my opinion.
A series from "Barron's Online" this week.
Ken Wilson
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Monday, June 23, 2003
WEEKDAY TRADER
Will U.S. Manufacturing Go to Zero?
By DIMITRA DEFOTIS
FOR A GLIMPSE OF THE FUTURE of U.S. manufacturing, look no further than the corn and wheat fields of the American heartland.
Representing half the nation's economic output before the Civil War, agricultural production still accounted for nearly 10% of gross domestic product at the end of World War II.
Fast forward to 2003, when combines with computerized fertilizing schedules do what scores of family farmers once did, and agriculture comprises less than 2% of GDP.
Could manufacturing go the same route?
Since 2000, more than two million U.S. manufacturing jobs have been eliminated or moved overseas. Manufacturing's role in the economy has dropped from nearly 30% of GDP after the war to only 14% in 2002.
How much further could it fall?
"In the case of a country like the United States, it could get to zero," states Barry Bosworth, an economist and senior fellow at the Brookings Institution in Washington, D.C.
"The long-term trend is [that] the role of manufacturing declines for high-income countries. This has been happening for a long time and will continue."
There were 14.7 million jobs in U.S. manufacturing in May, and the U.S. Department of Labor is in the process of revising (likely downward) its projection that manufacturing jobs will show weaker than average total growth of 3.1% by 2010. But some job categories, like tool and die makers or industrial engineers, could see almost no growth during that time.
With the force of a steam locomotive, technological progress and globalization are pushing the manufacturing sector and the entire U.S. economy into a new period of change perhaps unrivaled since the Industrial Revolution. Price competition, overcapacity and investors' demands for more higher profits are pressuring U.S. corporations to squeeze every last dollar of "excess" cost out of their operations.
This trend has been going on for some time -- U.S. productivity surged 38% from 1994 to 2002 -- as companies consolidated and used new technologies to increase their efficiency. But now, the liberalization of world trade and the emergence of nations like China, India and Mexico as centers of manufacturing and technology for U.S. firms is only speeding up the transition.
This week, Barron's Online departs from our usual Weekday Trader format to concentrate exclusively on this tectonic shift in the economy, which we call "The Great Shakeout." In today's installment, we examine changes in manufacturing. We'll look at services on Tuesday and technology on Wednesday, and on Thursday we'll focus on some of the economic and political implications of these changes.
To some degree, manufacturers are in the vanguard of this change: For years, they've been forced to cut costs in the face of growing commoditization of their products and chronic overcapacity. One strategy they've adopted: consolidation. In industries from chemicals to paper, merger after merger has slashed expenses while reducing competition.
"If a company can absorb others' capacity efficiently, it can expand margins," says William Dierker, a manager of the One Group Large Cap Value Fund.
For instance, tool maker Danaher (whose stock his fund owns) added $800 million in revenue through acquisitions last year, while Ingersoll-Rand, which makes construction and refrigeration equipment, has been steadily cutting costs while buying more profitable businesses.
And there is room for even more consolidation, says Holden Lewis, an analyst at BB&T Capital Markets.
In March, for example, Timken, which produces engineered bearings and alloyed steels, completed its acquisition of Torrington, a smaller maker of bearings and other components. That should help Timken increase its peak earnings power as it lowers its cost of capital, Lewis says.
Timken was part of another, sweeping movement -- outsourcing production overseas. In Timken's case, it opened ventures in Eastern Europe and China, which has become the industrialized world's workshop (or sweatshop, some critics charge).
More and more manufacturers have relocated operations to countries where labor costs are much cheaper. That's been happening for a long time in industries as diverse as semiconductors, shoes, clothing, toys and furniture. But the outflow of jobs now reaches sectors like industrial machinery and computer technology, too.
Who's next? Service jobs within manufacturing companies. According to Forrester Research, roughly a third of the 3.3 million service jobs expected to move overseas by 2015 will be in manufacturing, as back-office positions like customer service and technology help desks head to countries like India.
The dollar's recent weakness may slow that exodus somewhat, says Gerald D. Cohen, a senior economist at Merrill Lynch. But manufacturing is wide open to global competition.
And that's a good thing, he adds, because competition ultimately improves quality. He points to American competition with Japanese automakers in the 1980s that yielded better cars. Now, he says, Japanese companies manufacture some cars in the U.S. because "our workforce is more efficient and may be [even] lower paid adjusting for currencies."
U.S. companies will have to work hard to continue making cars and computers efficiently here at home -- although Cohen thinks productivity gains and a skilled labor force will keep high-end manufacturing and research and development operations here.
"We may not make the chips here, but do the R&D and make the machines that make the chips," he says.
"One hundred years ago, you measured output in tons of iron, steel or coal," says Jay Mueller, economist and director of fixed income at Strong Capital Management in Wisconsin. "The natural progression of the economy [is] goods with high intellectual content are likely to do better than those that are pretty much commodity products."
"My theory is U.S. manufacturing will continue to exist and will probably tend to migrate further up the value chain," he says.
That's why Bosworth of the Brookings Institution thinks that manufacturing jobs in fields that require high intellectual input, like supercomputing or medical technology, are the ones most likely to survive.
One possible exception: the Defense Department will probably continue supporting a large domestic manufacturing presence in the aerospace and defense industries, for national security reasons. That should benefit companies like Boeing, whose defense business is growing but whose commercial-aircraft business has been losing market share to the heavily subsidized Airbus consortium.
Meanwhile, the AFL-CIO is pushing for monetary and policy changes that will protect manufacturing jobs, which advocates say create more jobs than service industries do, thereby bolstering overall economic growth. But Bosworth thinks protecting jobs is inefficient when retrained workers can instead move to new, better-paying jobs.
"It can be painful when you throw people in their 40s and 50s out of work or you close a plant in a small town," Bosworth says. "But in the long run, our future does not lie in the increase in manufacturing jobs."
As U.S. manufacturers face a Darwinian struggle in an increasingly competitive world, they're bound by only one immutable rule: make a profit -- and investors are demanding more and more of those every year.
That, along with the natural evolution of the U.S. economy and the rapid development of other parts of the world, are pushing U.S. manufacturers to consolidate and outsource even more and, whether they want to or not, move up the value chain.
Like evolution itself, these changes have the force of natural law: They're all about survival, and for U.S. manufacturers there's just no turning back.
Tuesday: The Great Shakeout -- Will services go the way of manufacturing?_______________________________________________________________
Tuesday, June 24, 2003
WEEKDAY TRADER
Will Services Go Manufacturing's Way?
By ALLISON KRAMPF
Editor's Note: On Monday Weekday Trader examined how consolidation and outsourcing were transforming the manufacturing economy. In today's installment of our series, The Great Shakeout, we look at how they're affecting service businesses.
FOR YEARS, MANUFACTURING BORE the brunt of companies' efforts to control costs in their efforts to be competitive.
Now, it's the service sector's turn.
Amid a weak global economy and intense pressures from investors to boost shareholder returns, service businesses, too, have been merging and are shipping jobs overseas to boost profits by slashing costs even further.
These trends have been going on for some time, but as in manufacturing, they may pick up speed in what is shaping up as a major restructuring of corporate America.
In the service sector, which represents about 55% of the U.S. gross domestic product, "further consolidations are likely, to take advantage of cost [savings] and build economies of scale," says Ron Masulis, professor of finance at Vanderbilt University's Owen Graduate School of Management. He expects that trend to continue for some time.
And over the next 15 years, 3.3 million U.S. service industry jobs and as much as $136 billion in service-business wages will move offshore to countries like India, Russia, China and the Philippines, according to Forrester Research.
The economics behind it is almost a no-brainer: This kind of outsourcing can cut costs dramatically, the Forrester study says.
Any function that involves the gathering and re-keying of information can be taken offshore, where "you can get the equivalent of a Certified Public Accountant (CPA) for half the price" of an American one, says John McCarthy, Forrester's group director of research.
The information-technology industry should continue to lead the exodus, although back-office accounting, software and product development and customer service and call-center activities in health care and insurance are most likely to be shipped out to cheaper offshore locations, Forrester says.
Nowhere are these trends more evident than in financial services. Some financial services companies, such as mutual fund firms, have been longstanding users of offshore and outsourcing. But now, the rest of the group is joining the party.
"We are not aware of any major U.S. financial institution not exploring offshoring at this point," says Peter Lowes, a partner with Deloitte Consulting. HSBC and GE Capital already are implementing outsourcing programs.
Behind these moves is the lack of pricing power in financial services, where customers seem unwilling to pay up for "me-too" products that they perceive to have little added value.
"The entire financial services business is getting commoditized," says Dushyant Shahrawat, senior analyst with The Tower Group. "There is a need to cut expenses to get the profit line up."
So, it's not surprising that some 500,000 financial services jobs will be relocated offshore within the next five years, according to consulting firm A.T. Kearney. That represents 8% of the industry's U.S. workforce, and could result in $30 billion in annual cost savings for financial services companies.
In fact, the amount North American brokerages will spend on offshore contracts should triple to $1.31 billion in 2005, from $417 million last year.
Finance companies are increasingly taking advantage of the educated workforce in India, which produces about as many college graduates as the U.S. does and where talented, English-speaking labor comes cheap. (They're also looking to farm out work to other emerging markets such as South Africa, the Philippines, Costa Rica and Mexico.)
Finance specialists in areas such as equity research earn an average of $1,000 per month in India, compared with the U.S. average of $7,000 per month.
"Higher-end service-type jobs are being migrated," and that includes research and financial analytics, says Andrea Bierce, vice president at A.T. Kearney, an author of that firm's report on outsourcing in financial services.
J.P. Morgan Chase, for example, expects to hire 40 junior research analysts and 1,000 other support staffers this year in Bombay, according to Reuters. Those analysts could earn bonuses one-quarter of what their counterparts get in New York or London, the news service reported.
In fact, says Bierce, "financial institutions have had to cut so many people they are concerned with how they will quickly respond to a business pick-up." So, they are setting up their own call centers or processing venues offshore rather than outsource to third parties. The result, however, is ultimately the same: more financial services jobs overseas, fewer of them here.
Mortgage servicing, too, seems ripe for the cost savings outsourcing and consolidation yield.
"The mortgage industry is highly competitive. There are about 7,500 companies that fund mortgage loans, and any savings or efficiencies can get passed back to the consumer immediately in better pricing," says Doug Duncan, chief economist with the Mortgage Bankers Association of America.
Duncan notes that several companies could use one outsourcer, rather than having each one set up its own operations overseas. "A small company servicing 50,000 loans could have a $3.00 per-unit cost, but if one outsourcer does that for ten companies servicing 500,000 loans, the combined volume may be done for only $2.50 per call," he points out.
Meanwhile, on Wall Street, weak retail and investment banking business has sparked speculation (from people like Morgan Stanley's chief executive officer, Philip Purcell) that we could be on the verge of another round of consolidation -- driven by the need for greater economies of scale.
"There may be the temptation in investment banking to merge, since profits have not been so great," says Masulis, mentioning a couple of the usual suspects as possible targets -- Bear Stearns and Lehman Brothers, both of whose stocks have been on a tear since late last year.
Of course, that would depend on the would-be acquirers' willingness to pay steep prices for their rivals, which is why a new Wall Street merger wave could be several years away.
Traditional banking, however, remains ripe for further consolidation, since there is still too much capacity in the domestic banking system, says Jason Goldberg, bank analyst with Lehman Brothers.
"Everyone right now is focused on 'de novo' expansion.," says Goldberg. (Editor's Note: 'De novo' expansion is banking industry jargon for building new branches and facilities.)
"But clearly, with 9,000 U.S. banks, consolidation has to pick up" at some point, he adds.
The U.S. had more than 15,000 banks in 1990, and Vanderbilt's Masulis estimates that there could be only 4,500 banks left within the next five years -- driven once again by the need for cost savings and economies of scale.
Banks that have historically been acquirers, such as Wells Fargo, Fifth Third Bank and Wachovia, are likely to continue to do so.
And foreign banks, which have paid hefty premiums for U.S. firms, could again look to buy their way into the U.S. market. They could include Royal Bank of Canada, Royal Bank of Scotland and BNP Paribas, Goldberg says.
U.S. financial services companies that do outsourcing may have the advantage over their European counterparts, who would face strong union resistance if they tried to shift too many well-paying jobs from Europeans to lower-wage workers in other countries, Shahrawat says.
So, although more American workers may lose their jobs in the short run, American companies and the U.S. economy will be more competitive over the long haul.
Because it all boils down to competition and shareholders' return, and large services companies can go anywhere in the world to find skilled workers to do the job. Isn't that what globalization is supposed to be all about?
Wednesday: Will Tech Still Be a Growth Engine?
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Wednesday, June 25, 2003
WEEKDAY TRADER
Will Silicon Valley Move to Asia?
By ERIC C. FLEMING
Editor's Note: Our four-part series, The Great Shakeout, continues today with a look at how outsourcing and consolidation will affect the U.S.'s great technology machine.
THREE YEARS AGO, telecom equipment firm ANDA Networks had about 100 engineers in Silicon Valley. Now it has seven.
Where did those jobs go? Wuhan, China, a city of seven million people about 400 miles west of Shanghai. ANDA employs 65 engineers there.
In Wuhan, San Jose-based ANDA Networks pays an engineer about $17,000 per year, including benefits -- about one-seventh of what it pays his or her counterpart in Silicon Valley. No surprise, then, that privately held ANDA has slashed operating costs by 90% since 2001.
ANDA's story is becoming more and more common these days as demand for technology remains weak and investors push for stronger earnings growth, forcing tech companies to cut costs.
How? The same way other manufacturing and services companies are doing so -- through consolidation and exporting jobs overseas.
In fact, Silicon Valley may well be the epicenter of the restructuring that's transforming all of American business.
The big problem is weak demand -- especially compared with the boom years of the late 1990s.
"I don't think [technology spending at that level] will come back in my lifetime," says Sam Jadallah, general partner at venture capital firm Mohr, Davidow Ventures in Menlo Park, Calif.
Indeed, there doesn't seem to be another Y2K, Internet-related spending splurge or a robust economy around the corner to juice earnings.
"If they aren't innovating, what are customers going to buy in the future?" asks Brian Flanagan, co-manager of the AAL Technology Stock Fund.
What's more, the personal computer, computer networking and wireless technology -- responsible for much of the job growth during the tech bubble -- are maturing businesses. And tech companies have to slash costs, just like everybody else.
Increasingly, that means outsourcing jobs to China, India and elsewhere.
"Outsourcing has become a euphemism for India," said Peter Chung, general partner of venture capital firm Summit Partners, during a panel discussion at the recent Bear Stearns Technology Conference in New York.
India's allure is particularly strong for tech companies, as it is for service companies in general, because of its vast supply of well-trained, highly educated, English-speaking professionals available at bargain-basement salaries.
A product designer or engineering services worker earns salary and benefits 80% lower in India than in the U.S. or Western Europe, according to consulting firm Booz Allen Hamilton.
Not surprisingly, American tech giants like IBM, Accenture and Oracle all have operations there. About 2,800 IBM employees now work out of offices in three cities in India.
And outsourcing firm Infosys Technologies, based in Bangalore, India, takes more and more work off the hands of its 345 customers, which range from Microsoft to Lucent Technologies.
Between companies like Infosys and U.S. corporations that open their own facilities offshore, more than 3.3 million U.S. services jobs, accounting for $136 billion in wages, should migrate overseas in the next 15 years, according to market research firm Forrester Research.
Many of those jobs flying the coop will be in technology, which represents about 10% of the gross national product.
And not just to India, of course. Companies like Hewlett-Packard are also operating in low-cost countries like the Philippines, Poland and Costa Rica.
"All you need is one flare-up on the India-Pakistan border to show that you need to be in more than one place," says Joe Hogan, a vice president of marketing for HP.
By 2005, China will handle half the final assembly of the world's electronics -- double what it did in 2001 and surpassing Western Europe, according to Booz Allen.
Booz projects that semiconductor production in emerging nations like China and those in Eastern Europe will hit $8.3 billion by 2005 (from $3 billion in 2001), while general electronics assembly should grow to $14 billion by 2005, from $8 billion in 2001.
It's no longer just customer service jobs, either, that are migrating abroad, but the whitest of white-collar tech jobs such as computer chip design.
"Now they are moving engineering teams, where they had just moved production [before]," says Barry Jaruzelski, managing partner of Booz Allen.
The original outsourcing firms, contract manufacturers, are doing more and more for customers at cheaper prices overseas. Celestica has moved much of its own production from Europe to lower-cost Asia.
"Those companies have sucked the manufacturing prowess out of American industry," Michael Moritz, partner at venture-capital firm Sequoia Capital Partners in Cupertino, Calif., told attendees of the Bear Stearns conference earlier this month. "Now they're embedding the design process in their business."
So, even keeping small staffs of white-collar workers may become a memory, since "innovation is starting to happen overseas," says Jadallah.
Does that mean all tech jobs are vulnerable to export? Not likely.
"The pieces that face the customer, like marketing, as well as intellectual property, are kept in the U.S," says Charles Kenmore, ANDA's chief executive officer.
The ease with which companies can divvy up tasks around the globe at little cost stems, in part, from the spread of the Internet. E-mail is the universal language for technology companies.
But sending jobs half a world away brings up issues of oversight, quality control and delayed communications, as well as legal concerns and risks to intellectual property.
Many nations simply don't have the technical skills, resources and infrastructure that China and India offer.
Meanwhile, technology companies face an unfamiliar problem -- overcapacity. That, and the impetus to cut costs, could lead to a new wave of mergers in the sector.
The computer industry "is about as large as it's going to be," and has about 1,000 companies that need to go bankrupt, Oracle's chief executive officer Larry Ellison told The Wall Street Journal in April.
Ellison apparently is putting his money where his mouth is, as database software king Oracle launched a $6.3-billion hostile takeover bid for enterprise resource planning software firm PeopleSoft after PeopleSoft made a deal to take over J.D. Edwards & Co.
While PeopleSoft's board of directors has turned down Oracle's sweetened bid, and Oracle may up the ante further, it may be a sign of the times, as the big fish swallow the little ones in technology.
"There's a large number of small companies with no reason for being," declares Jaruzelski.
Jaruzelski sees network computing, enterprise software and broadband chipmakers as the most likely sectors to face consolidation, says Jaruzelski.
Ellison identified former hot topics like Ariba and Commerce One, as well as BEA Systems and Siebel, as potential takeover targets.
More consolidation may not be imminent, however. Mark Herskovitz, manager of the Dreyfus Premier Technology Growth Fund, says tech companies have lots of cold, hard cash that's kept them afloat while sales remain anemic -- and could buy their managements more time before they have to turn to suitors.
Still, the money so many tech companies raised in the recent explosion of convertible-debt offerings, as well as their rising stock prices, could ultimately grease the wheels of the merger machine.
Who would have thought it would come to this? Just three and a half years ago, we were in a New Economy whose growth engine was technology, where the U.S.'s competitive advantage appeared well nigh impregnable.
Now, tech companies are slashing costs any way they can, and software engineers in Palo Alto or Menlo Park are fighting for jobs with much-lower-paid counterparts in Bangalore or Wuhan.
Welcome to the Great Shakeout, Silicon Valley. It's going to be part of the way we do business for quite a while.
Thursday: How it will affect us all.
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Thursday, June 26, 2003
Globalization Meets Creative Destruction
by Howard R Gold
HERE ARE A COUPLE of straws in the wind.
A few months ago, I rented a car from Alamo Rent a Car for a trip to Florida. I had some questions, so I called the company's 800 number.
The customer service representative I reached was pleasant, polite and well spoken. Yet I detected a certain lilt in her voice that prompted me to ask if she was from India.
Yes, she replied, from Bangalore, where Alamo had set up a call center and had trained a whole team of customer service representatives to handle calls from American car renters.
Fast forward to last week, when I was having dinner with my brother, an internist in a busy medical practice in Pennsylvania.
The dozen or so physicians at Medical Associates of Monroe County used to routinely dictate their notes about patient visits, diagnoses and test reports every night and turn them over to an in-house transcriber, he told me.
But it took at least a week to get the reports back, so sometimes specialists didn't get all the information they needed about patients the internists had referred to them.
Cardiologist Dr. Vidya Ponnathpur had an idea: He contacted a company in his hometown of Bangalore that agreed to take on the work. The firm hires all the transcribers, supervises them, pays them and charges the doctors by the line.
Now, at the end of the day, the doctors of Medical Associates dictate their notes, which are then converted into voice files and transmitted to a server in Bangalore.
Since Bangalore is 9 1/2 hours ahead of East Coast time, the transcribers work through our night and send Word files of the complete reports back to the doctors by 10:30 AM the next morning -- as reliably as FedEx.
And oh., yes, it used to cost 16 cents to 17 cents a line for transcriptions; now it's nine cents a line -- a total cost savings to the practice of $60,000 to $70,000 a year.
It all comes down to the same thing. Businesses from private medical practices to large rental car chains to giant corporations like Delta Airlines and Hewlett-Packard are under enormous pressure to keep costs down.
And now, with the Internet and the opening up of the world economy called globalization, they have the means to do so.
Globalization allows corporations to scour the world for the highest returns and lets them build a truly international workforce. The Internet makes it easier for managers to monitor that workforce -- wherever they are -- and integrate them into the global networks that large companies are becoming.
Twenty years ago, it would have been inconceivable for a small private company like ANDA Networks to in effect relocate its engineering workforce from San Jose to Wuhan, China (see Weekday Trader, "Will Silicon Valley Move to Asia?1," June 25).
Why bother, when reasonably priced software engineers were abundant in Silicon Valley at the dawn of the PC revolution? The idea of managing such core creative technical people thousands of miles away would have seemed impossible, if not ludicrous.
And I doubt whether you could have found 65 qualified software engineers in Wuhan, a city of seven million, when China was just beginning to open up to the West and the free enterprise system.
The combination of events we've called "The Great Shakeout" in this week's special series in Barron's Online comes from the marriage of globalization and Internet technology. Along with the continuing trend toward consolidation in many key industries, it constitutes a fundamental restructuring of the U.S. economy that may ultimately rival the transition from an agricultural to a manufacturing economy in the 19th century.
Not surprisingly, manufacturers are the furthest along (see Weekday Trader, "Will U.S. Manufacturing Go to Zero?2," June 23). For years they've had to cut costs in the face of overcapacity and a lack of pricing power. But now the outflow of jobs we've seen in industries like clothing, toys and shoes has spread to more sophisticated sectors like industrial machinery and computer technology.
That exodus is also moving up the white-collar ladder as part of a general trend toward outsourcing in the service industry, which comprises more than half our gross domestic product -- nearly four times the percentage that manufacturing represents (see Weekday Trader: "Will Services Go the Way of Manufacturing?3," June 24).
Again, the same forces are at work: overcapacity, lack of pricing power and a push for higher profitability -- trends that can be seen most acutely in financial services. "The entire financial services business is getting commoditized," says Dushyant Shahrawat, senior analyst with The Tower Group.
So, where is this all going? Assuming that this is a structural change and not just the outgrowth of a recession and a slow recovery (which some economists argue), we can expect major dislocations in various parts of the U.S. economy over the next few years (see Weekday Trader, "Will the Great Shakeout Take Its Toll?,4" June 26).
Industries like U.S.-based call centers and the cities that support them could be hit hard. Many blue-collar workers will have to give up their dream of a steady union job and go into business for themselves or retrain as lower-paid teachers or nurses.
Older, highly compensated information technology professionals may have to take pay cuts, and some of them may never work in IT again at the level to which they're accustomed. MBAs in finance from Harvard or Wharton may not land that first Wall Street associate's job out of school, because increasingly those jobs will be filled, at much lower salaries, by graduates of Beijing University or the Indian Institute of Technology.
Who knows? Like the displaced family farmers who captured the nation's imagination in the 1980s or the haunted blue-collar antiheroes of many a Bruce Springsteen song, the alienated, proletarianized white-collar or IT worker could become a potent cultural symbol.
In all seriousness, unemployment and social dislocation have enormous costs, both direct and indirect, on the people who live through them, and their families. Anybody who downplays this is simply being naive.
But it's a necessary part of the ebb and flow of our economy, which sacrifices a false "stability" for real dynamism and growth.
Time after time in our history, critics have proclaimed the U.S. had exhausted its potential and time after time the economy has reinvented itself.
The Austrian-born economist Joseph A. Schumpeter described this as a "process of industrial mutation" that "incessantly revolutionizes the economic structure from within, incessantly destroying the old one, incessantly creating a new one."
"This process of Creative Destruction," he wrote, "is the essential fact about capitalism."
That's why I'm optimistic that though many Americans may be hurt over the next few years, the U.S, economy will emerge from the Great Shakeout more competitive than ever.
But here's another consideration. That young Indian Alamo customer service rep I spoke with seemed generally excited about what would be a dead-end job in the States but for her was a real opportunity for advancement.
"Here you would say [it's a lower-middle-class job]," Dr. Ponnathpur says of the medical transcribers in Bangalore. "There, they would probably be middle class. It's pretty good money for those guys."
For years the U.S. has trumpeted the virtues of globalization -- and rightly so.
But if we really believe that free markets offer everyone the best hope for a better life, we'll have to let nature take its course -- even if globalization begins to cut the other way.
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Howard R. Gold is editor of Barron's Online. Fighting the Tape appears twice monthly.
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also Thursday, June 26, 2003
WEEKDAY TRADER
Will The Great Shakeout Take Its Toll?
By EVELYN ELLISON TWITCHELL
Editor's note: This is the last of a four-part series on The Great Shakeout, the fundamental restructuring of U.S. industry that's going on today.
BARRON'S ONLINE HAS SPENT THIS WEEK looking at how outsourcing and consolidation are reshaping our economy. This fundamental restructuring of U.S. industry may look great from the boardroom and on Wall Street. But there's likely to be real pain lower down the food chain.
The job losses we've seen so far have created high anxiety from the factory floor to the executive suite. Longer term, restructuring and global competition could limit the wage growth of white-collar workers in the same way it did to their blue-collar counterparts when manufacturing began moving outside the U.S. a generation ago.
And some areas of the country that rely heavily on vulnerable industries like call centers and data-processing facilities may feel the pinch, too.
"This is going to be one of the biggest macroeconomic shifts in the overall U.S. economy in the next ten years, no questions asked," contends John McCarthy, Forrester Research's group director of research.
His prediction that 3.3 million U.S. services industry jobs will move offshore over the next 15 years has set off alarm bells and garnered lots of media coverage.
Gartner Research also forecasts that some 80% of U.S. corporations will have at least considered offshore outsourcing by next year.
Meanwhile, though mergers and acquisitions have dropped sharply since the stock market bubble burst in 2000, Federal Trade Commissioner Mozelle Thompson tells Barron's Online M&A activity should pick up when the economy revives.
"The big AOL/Time Warners might not come down the path, but you might see more consolidation in middle-market companies," Thompson says.
That certainly won't lower employees' stress levels.
Alexander Horniman, a specialist in organizational behavior and psychology at the University of Virginia's Darden Graduate School of Business Administration, says workers often feel a sense of loss and betrayal in the wake of job-killing mergers.
"When I began work, you expected that if you worked hard and kept your nose clean, you'd retire from that company," Horniman says. "That's all changed. It's take care of yourself first, because it's quite likely nobody is going to take care of you."
Outsourcing also is heightening workers' insecurity.
"You have to worry that you're next," says Paul Osterman, a labor economist and professor at the Massachusetts Institute of Technology's Sloan School of Management.
And that could actually drive incomes down.
"In the long term, if you can make enough workers feel insecure about their jobs, corporations [may] be able to put a pretty powerful brake on wage growth," says Josh Bivens, an international economist at the Economic Policy Institute.
Ultimately, workers will be paid the prevailing global wage, not the prevailing U.S. wage, contends Frances Karamouzis, director of research at Gartner.
How much is that? Don't ask. An information technology specialist working for an outsourcer in India earns from $20 to $30 per day; his or her in-house U.S. counterpart would get $50 to $90 per hour, Karamouzis's research shows. An entry-level programmer in China makes 30% to 50% less than one in Chicago, according to Forrester.
On the flip side, outsourcing gives companies the breathing room to charge lower prices, offsetting the pressure on disposable income. Indeed, U.S. standards of living actually have risen as a result of international trade in the past, observes William Dickens, a senior fellow in economic studies at the Brookings Institution.
"Our total income should rise when we succeed in doing things more efficiently," suggests Marvin Kosters, a labor economist at the American Enterprise Institute for Public Policy Research.
Yet, at the very least, new global competition could reverse the trend whereby white-collar employees' wage gains outstripped those of blue-collar workers.
Outsourcing of IT jobs also could reduce the allure of technology hubs, such as Silicon Valley; Austin, Texas, and Research Triangle Park, N.C.
But Middle America may bear the brunt of it. Just as the globalization of manufacturing devastated cities like Flint, Mich., the outsourcing of service jobs may hurt communities in which call centers or payroll-processing facilities are big employers.
"Appleton, Wisconsin; Fargo, North Dakota, Wilkes-Barre, Pennsylvania -- those places will be very hard hit," Gartner's Karamouzis predicts. "When you ask what the impact is, in a local place, it's huge."
Not surprisingly, there already are signs of a political backlash, as several states consider laws to keep government jobs at home.
And with jobs scarce, U.S. workers may not be so eager to let foreigners work here. There may be renewed calls for immigration control and limits on H1B visas, which allow companies to hire technical workers from abroad.
"There's a growing chorus of complaints among IT workers, in particular, that somehow the H1B workers are eliminating jobs here in the United States," observes Dan Griswold, associate director of the Cato Institute's Center for Trade Policy Studies.
Still, he contends that even if 3.3 million jobs really do move overseas in the next 15 years, as Forrester projects, that amounts to only 220,000 jobs lost per year -- a fraction of the two to three million jobs that typically disappear each year through normal changes in technology and competition, he says.
In fact, the U.S. typically creates a net one to two million additional jobs each year, Griswold says.
And as companies save money by outsourcing, they may able to reinvest more and actually create jobs here.
The Bureau of Labor Statistics projects that computer and data processing services -- an area ripe for outsourcing -- will be the fastest growing industry in the U.S. economy between 2000 and 2010, as employment grows by 86%.
"You can be hysterical about it, and that I think would be wrong," MIT's Osterman says.
Historically, the U.S. economy has found ways to move on to ever-greater prosperity.
AEI's Kosters notes that about 3% of U.S. workers today are employed in agriculture, down from around half the labor force a century ago.
"So, we lost 47% of our jobs, right?" Kosters says. "That's not the right way to think about this. The right way is: we got much more efficient and released the workforce to do more interesting things."
Indeed, for workers, the best recourse may be to acquire the skills to move to higher-end jobs that are more difficult to replace, such as upper-level management, creative jobs and those that require direct contact with customers. Certain industries, such as health care and leisure services, also may offer more opportunities as Baby Boomers retire, Kosters points out.
But who is going to pay for all the retraining? Employers? Fiscally strapped local governments? The federal government? Not likely.
At a Gartner conference on outsourcing in Los Angeles this week, Karamouzis asked 150 IT service providers how media coverage of job losses in the U.S. was affecting their decisions about overseas outsourcing.
A full 80% said it was having no impact at all, suggesting that the need to cut costs is outweighing any concern for the human toll -- or the bad publicity it might create.
That wouldn't surprise McCarthy's Forrester, who predicted in his study: "By the end of the decade, executive stature will be measured by the size of the outsourcing contracts that they manage, not the number of employees."
It's a different kind of empire building for a very different age.
A series from "Barron's Online" this week.
Ken Wilson
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Monday, June 23, 2003
WEEKDAY TRADER
Will U.S. Manufacturing Go to Zero?
By DIMITRA DEFOTIS
FOR A GLIMPSE OF THE FUTURE of U.S. manufacturing, look no further than the corn and wheat fields of the American heartland.
Representing half the nation's economic output before the Civil War, agricultural production still accounted for nearly 10% of gross domestic product at the end of World War II.
Fast forward to 2003, when combines with computerized fertilizing schedules do what scores of family farmers once did, and agriculture comprises less than 2% of GDP.
Could manufacturing go the same route?
Since 2000, more than two million U.S. manufacturing jobs have been eliminated or moved overseas. Manufacturing's role in the economy has dropped from nearly 30% of GDP after the war to only 14% in 2002.
How much further could it fall?
"In the case of a country like the United States, it could get to zero," states Barry Bosworth, an economist and senior fellow at the Brookings Institution in Washington, D.C.
"The long-term trend is [that] the role of manufacturing declines for high-income countries. This has been happening for a long time and will continue."
There were 14.7 million jobs in U.S. manufacturing in May, and the U.S. Department of Labor is in the process of revising (likely downward) its projection that manufacturing jobs will show weaker than average total growth of 3.1% by 2010. But some job categories, like tool and die makers or industrial engineers, could see almost no growth during that time.
With the force of a steam locomotive, technological progress and globalization are pushing the manufacturing sector and the entire U.S. economy into a new period of change perhaps unrivaled since the Industrial Revolution. Price competition, overcapacity and investors' demands for more higher profits are pressuring U.S. corporations to squeeze every last dollar of "excess" cost out of their operations.
This trend has been going on for some time -- U.S. productivity surged 38% from 1994 to 2002 -- as companies consolidated and used new technologies to increase their efficiency. But now, the liberalization of world trade and the emergence of nations like China, India and Mexico as centers of manufacturing and technology for U.S. firms is only speeding up the transition.
This week, Barron's Online departs from our usual Weekday Trader format to concentrate exclusively on this tectonic shift in the economy, which we call "The Great Shakeout." In today's installment, we examine changes in manufacturing. We'll look at services on Tuesday and technology on Wednesday, and on Thursday we'll focus on some of the economic and political implications of these changes.
To some degree, manufacturers are in the vanguard of this change: For years, they've been forced to cut costs in the face of growing commoditization of their products and chronic overcapacity. One strategy they've adopted: consolidation. In industries from chemicals to paper, merger after merger has slashed expenses while reducing competition.
"If a company can absorb others' capacity efficiently, it can expand margins," says William Dierker, a manager of the One Group Large Cap Value Fund.
For instance, tool maker Danaher (whose stock his fund owns) added $800 million in revenue through acquisitions last year, while Ingersoll-Rand, which makes construction and refrigeration equipment, has been steadily cutting costs while buying more profitable businesses.
And there is room for even more consolidation, says Holden Lewis, an analyst at BB&T Capital Markets.
In March, for example, Timken, which produces engineered bearings and alloyed steels, completed its acquisition of Torrington, a smaller maker of bearings and other components. That should help Timken increase its peak earnings power as it lowers its cost of capital, Lewis says.
Timken was part of another, sweeping movement -- outsourcing production overseas. In Timken's case, it opened ventures in Eastern Europe and China, which has become the industrialized world's workshop (or sweatshop, some critics charge).
More and more manufacturers have relocated operations to countries where labor costs are much cheaper. That's been happening for a long time in industries as diverse as semiconductors, shoes, clothing, toys and furniture. But the outflow of jobs now reaches sectors like industrial machinery and computer technology, too.
Who's next? Service jobs within manufacturing companies. According to Forrester Research, roughly a third of the 3.3 million service jobs expected to move overseas by 2015 will be in manufacturing, as back-office positions like customer service and technology help desks head to countries like India.
The dollar's recent weakness may slow that exodus somewhat, says Gerald D. Cohen, a senior economist at Merrill Lynch. But manufacturing is wide open to global competition.
And that's a good thing, he adds, because competition ultimately improves quality. He points to American competition with Japanese automakers in the 1980s that yielded better cars. Now, he says, Japanese companies manufacture some cars in the U.S. because "our workforce is more efficient and may be [even] lower paid adjusting for currencies."
U.S. companies will have to work hard to continue making cars and computers efficiently here at home -- although Cohen thinks productivity gains and a skilled labor force will keep high-end manufacturing and research and development operations here.
"We may not make the chips here, but do the R&D and make the machines that make the chips," he says.
"One hundred years ago, you measured output in tons of iron, steel or coal," says Jay Mueller, economist and director of fixed income at Strong Capital Management in Wisconsin. "The natural progression of the economy [is] goods with high intellectual content are likely to do better than those that are pretty much commodity products."
"My theory is U.S. manufacturing will continue to exist and will probably tend to migrate further up the value chain," he says.
That's why Bosworth of the Brookings Institution thinks that manufacturing jobs in fields that require high intellectual input, like supercomputing or medical technology, are the ones most likely to survive.
One possible exception: the Defense Department will probably continue supporting a large domestic manufacturing presence in the aerospace and defense industries, for national security reasons. That should benefit companies like Boeing, whose defense business is growing but whose commercial-aircraft business has been losing market share to the heavily subsidized Airbus consortium.
Meanwhile, the AFL-CIO is pushing for monetary and policy changes that will protect manufacturing jobs, which advocates say create more jobs than service industries do, thereby bolstering overall economic growth. But Bosworth thinks protecting jobs is inefficient when retrained workers can instead move to new, better-paying jobs.
"It can be painful when you throw people in their 40s and 50s out of work or you close a plant in a small town," Bosworth says. "But in the long run, our future does not lie in the increase in manufacturing jobs."
As U.S. manufacturers face a Darwinian struggle in an increasingly competitive world, they're bound by only one immutable rule: make a profit -- and investors are demanding more and more of those every year.
That, along with the natural evolution of the U.S. economy and the rapid development of other parts of the world, are pushing U.S. manufacturers to consolidate and outsource even more and, whether they want to or not, move up the value chain.
Like evolution itself, these changes have the force of natural law: They're all about survival, and for U.S. manufacturers there's just no turning back.
Tuesday: The Great Shakeout -- Will services go the way of manufacturing?_______________________________________________________________
Tuesday, June 24, 2003
WEEKDAY TRADER
Will Services Go Manufacturing's Way?
By ALLISON KRAMPF
Editor's Note: On Monday Weekday Trader examined how consolidation and outsourcing were transforming the manufacturing economy. In today's installment of our series, The Great Shakeout, we look at how they're affecting service businesses.
FOR YEARS, MANUFACTURING BORE the brunt of companies' efforts to control costs in their efforts to be competitive.
Now, it's the service sector's turn.
Amid a weak global economy and intense pressures from investors to boost shareholder returns, service businesses, too, have been merging and are shipping jobs overseas to boost profits by slashing costs even further.
These trends have been going on for some time, but as in manufacturing, they may pick up speed in what is shaping up as a major restructuring of corporate America.
In the service sector, which represents about 55% of the U.S. gross domestic product, "further consolidations are likely, to take advantage of cost [savings] and build economies of scale," says Ron Masulis, professor of finance at Vanderbilt University's Owen Graduate School of Management. He expects that trend to continue for some time.
And over the next 15 years, 3.3 million U.S. service industry jobs and as much as $136 billion in service-business wages will move offshore to countries like India, Russia, China and the Philippines, according to Forrester Research.
The economics behind it is almost a no-brainer: This kind of outsourcing can cut costs dramatically, the Forrester study says.
Any function that involves the gathering and re-keying of information can be taken offshore, where "you can get the equivalent of a Certified Public Accountant (CPA) for half the price" of an American one, says John McCarthy, Forrester's group director of research.
The information-technology industry should continue to lead the exodus, although back-office accounting, software and product development and customer service and call-center activities in health care and insurance are most likely to be shipped out to cheaper offshore locations, Forrester says.
Nowhere are these trends more evident than in financial services. Some financial services companies, such as mutual fund firms, have been longstanding users of offshore and outsourcing. But now, the rest of the group is joining the party.
"We are not aware of any major U.S. financial institution not exploring offshoring at this point," says Peter Lowes, a partner with Deloitte Consulting. HSBC and GE Capital already are implementing outsourcing programs.
Behind these moves is the lack of pricing power in financial services, where customers seem unwilling to pay up for "me-too" products that they perceive to have little added value.
"The entire financial services business is getting commoditized," says Dushyant Shahrawat, senior analyst with The Tower Group. "There is a need to cut expenses to get the profit line up."
So, it's not surprising that some 500,000 financial services jobs will be relocated offshore within the next five years, according to consulting firm A.T. Kearney. That represents 8% of the industry's U.S. workforce, and could result in $30 billion in annual cost savings for financial services companies.
In fact, the amount North American brokerages will spend on offshore contracts should triple to $1.31 billion in 2005, from $417 million last year.
Finance companies are increasingly taking advantage of the educated workforce in India, which produces about as many college graduates as the U.S. does and where talented, English-speaking labor comes cheap. (They're also looking to farm out work to other emerging markets such as South Africa, the Philippines, Costa Rica and Mexico.)
Finance specialists in areas such as equity research earn an average of $1,000 per month in India, compared with the U.S. average of $7,000 per month.
"Higher-end service-type jobs are being migrated," and that includes research and financial analytics, says Andrea Bierce, vice president at A.T. Kearney, an author of that firm's report on outsourcing in financial services.
J.P. Morgan Chase, for example, expects to hire 40 junior research analysts and 1,000 other support staffers this year in Bombay, according to Reuters. Those analysts could earn bonuses one-quarter of what their counterparts get in New York or London, the news service reported.
In fact, says Bierce, "financial institutions have had to cut so many people they are concerned with how they will quickly respond to a business pick-up." So, they are setting up their own call centers or processing venues offshore rather than outsource to third parties. The result, however, is ultimately the same: more financial services jobs overseas, fewer of them here.
Mortgage servicing, too, seems ripe for the cost savings outsourcing and consolidation yield.
"The mortgage industry is highly competitive. There are about 7,500 companies that fund mortgage loans, and any savings or efficiencies can get passed back to the consumer immediately in better pricing," says Doug Duncan, chief economist with the Mortgage Bankers Association of America.
Duncan notes that several companies could use one outsourcer, rather than having each one set up its own operations overseas. "A small company servicing 50,000 loans could have a $3.00 per-unit cost, but if one outsourcer does that for ten companies servicing 500,000 loans, the combined volume may be done for only $2.50 per call," he points out.
Meanwhile, on Wall Street, weak retail and investment banking business has sparked speculation (from people like Morgan Stanley's chief executive officer, Philip Purcell) that we could be on the verge of another round of consolidation -- driven by the need for greater economies of scale.
"There may be the temptation in investment banking to merge, since profits have not been so great," says Masulis, mentioning a couple of the usual suspects as possible targets -- Bear Stearns and Lehman Brothers, both of whose stocks have been on a tear since late last year.
Of course, that would depend on the would-be acquirers' willingness to pay steep prices for their rivals, which is why a new Wall Street merger wave could be several years away.
Traditional banking, however, remains ripe for further consolidation, since there is still too much capacity in the domestic banking system, says Jason Goldberg, bank analyst with Lehman Brothers.
"Everyone right now is focused on 'de novo' expansion.," says Goldberg. (Editor's Note: 'De novo' expansion is banking industry jargon for building new branches and facilities.)
"But clearly, with 9,000 U.S. banks, consolidation has to pick up" at some point, he adds.
The U.S. had more than 15,000 banks in 1990, and Vanderbilt's Masulis estimates that there could be only 4,500 banks left within the next five years -- driven once again by the need for cost savings and economies of scale.
Banks that have historically been acquirers, such as Wells Fargo, Fifth Third Bank and Wachovia, are likely to continue to do so.
And foreign banks, which have paid hefty premiums for U.S. firms, could again look to buy their way into the U.S. market. They could include Royal Bank of Canada, Royal Bank of Scotland and BNP Paribas, Goldberg says.
U.S. financial services companies that do outsourcing may have the advantage over their European counterparts, who would face strong union resistance if they tried to shift too many well-paying jobs from Europeans to lower-wage workers in other countries, Shahrawat says.
So, although more American workers may lose their jobs in the short run, American companies and the U.S. economy will be more competitive over the long haul.
Because it all boils down to competition and shareholders' return, and large services companies can go anywhere in the world to find skilled workers to do the job. Isn't that what globalization is supposed to be all about?
Wednesday: Will Tech Still Be a Growth Engine?
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Wednesday, June 25, 2003
WEEKDAY TRADER
Will Silicon Valley Move to Asia?
By ERIC C. FLEMING
Editor's Note: Our four-part series, The Great Shakeout, continues today with a look at how outsourcing and consolidation will affect the U.S.'s great technology machine.
THREE YEARS AGO, telecom equipment firm ANDA Networks had about 100 engineers in Silicon Valley. Now it has seven.
Where did those jobs go? Wuhan, China, a city of seven million people about 400 miles west of Shanghai. ANDA employs 65 engineers there.
In Wuhan, San Jose-based ANDA Networks pays an engineer about $17,000 per year, including benefits -- about one-seventh of what it pays his or her counterpart in Silicon Valley. No surprise, then, that privately held ANDA has slashed operating costs by 90% since 2001.
ANDA's story is becoming more and more common these days as demand for technology remains weak and investors push for stronger earnings growth, forcing tech companies to cut costs.
How? The same way other manufacturing and services companies are doing so -- through consolidation and exporting jobs overseas.
In fact, Silicon Valley may well be the epicenter of the restructuring that's transforming all of American business.
The big problem is weak demand -- especially compared with the boom years of the late 1990s.
"I don't think [technology spending at that level] will come back in my lifetime," says Sam Jadallah, general partner at venture capital firm Mohr, Davidow Ventures in Menlo Park, Calif.
Indeed, there doesn't seem to be another Y2K, Internet-related spending splurge or a robust economy around the corner to juice earnings.
"If they aren't innovating, what are customers going to buy in the future?" asks Brian Flanagan, co-manager of the AAL Technology Stock Fund.
What's more, the personal computer, computer networking and wireless technology -- responsible for much of the job growth during the tech bubble -- are maturing businesses. And tech companies have to slash costs, just like everybody else.
Increasingly, that means outsourcing jobs to China, India and elsewhere.
"Outsourcing has become a euphemism for India," said Peter Chung, general partner of venture capital firm Summit Partners, during a panel discussion at the recent Bear Stearns Technology Conference in New York.
India's allure is particularly strong for tech companies, as it is for service companies in general, because of its vast supply of well-trained, highly educated, English-speaking professionals available at bargain-basement salaries.
A product designer or engineering services worker earns salary and benefits 80% lower in India than in the U.S. or Western Europe, according to consulting firm Booz Allen Hamilton.
Not surprisingly, American tech giants like IBM, Accenture and Oracle all have operations there. About 2,800 IBM employees now work out of offices in three cities in India.
And outsourcing firm Infosys Technologies, based in Bangalore, India, takes more and more work off the hands of its 345 customers, which range from Microsoft to Lucent Technologies.
Between companies like Infosys and U.S. corporations that open their own facilities offshore, more than 3.3 million U.S. services jobs, accounting for $136 billion in wages, should migrate overseas in the next 15 years, according to market research firm Forrester Research.
Many of those jobs flying the coop will be in technology, which represents about 10% of the gross national product.
And not just to India, of course. Companies like Hewlett-Packard are also operating in low-cost countries like the Philippines, Poland and Costa Rica.
"All you need is one flare-up on the India-Pakistan border to show that you need to be in more than one place," says Joe Hogan, a vice president of marketing for HP.
By 2005, China will handle half the final assembly of the world's electronics -- double what it did in 2001 and surpassing Western Europe, according to Booz Allen.
Booz projects that semiconductor production in emerging nations like China and those in Eastern Europe will hit $8.3 billion by 2005 (from $3 billion in 2001), while general electronics assembly should grow to $14 billion by 2005, from $8 billion in 2001.
It's no longer just customer service jobs, either, that are migrating abroad, but the whitest of white-collar tech jobs such as computer chip design.
"Now they are moving engineering teams, where they had just moved production [before]," says Barry Jaruzelski, managing partner of Booz Allen.
The original outsourcing firms, contract manufacturers, are doing more and more for customers at cheaper prices overseas. Celestica has moved much of its own production from Europe to lower-cost Asia.
"Those companies have sucked the manufacturing prowess out of American industry," Michael Moritz, partner at venture-capital firm Sequoia Capital Partners in Cupertino, Calif., told attendees of the Bear Stearns conference earlier this month. "Now they're embedding the design process in their business."
So, even keeping small staffs of white-collar workers may become a memory, since "innovation is starting to happen overseas," says Jadallah.
Does that mean all tech jobs are vulnerable to export? Not likely.
"The pieces that face the customer, like marketing, as well as intellectual property, are kept in the U.S," says Charles Kenmore, ANDA's chief executive officer.
The ease with which companies can divvy up tasks around the globe at little cost stems, in part, from the spread of the Internet. E-mail is the universal language for technology companies.
But sending jobs half a world away brings up issues of oversight, quality control and delayed communications, as well as legal concerns and risks to intellectual property.
Many nations simply don't have the technical skills, resources and infrastructure that China and India offer.
Meanwhile, technology companies face an unfamiliar problem -- overcapacity. That, and the impetus to cut costs, could lead to a new wave of mergers in the sector.
The computer industry "is about as large as it's going to be," and has about 1,000 companies that need to go bankrupt, Oracle's chief executive officer Larry Ellison told The Wall Street Journal in April.
Ellison apparently is putting his money where his mouth is, as database software king Oracle launched a $6.3-billion hostile takeover bid for enterprise resource planning software firm PeopleSoft after PeopleSoft made a deal to take over J.D. Edwards & Co.
While PeopleSoft's board of directors has turned down Oracle's sweetened bid, and Oracle may up the ante further, it may be a sign of the times, as the big fish swallow the little ones in technology.
"There's a large number of small companies with no reason for being," declares Jaruzelski.
Jaruzelski sees network computing, enterprise software and broadband chipmakers as the most likely sectors to face consolidation, says Jaruzelski.
Ellison identified former hot topics like Ariba and Commerce One, as well as BEA Systems and Siebel, as potential takeover targets.
More consolidation may not be imminent, however. Mark Herskovitz, manager of the Dreyfus Premier Technology Growth Fund, says tech companies have lots of cold, hard cash that's kept them afloat while sales remain anemic -- and could buy their managements more time before they have to turn to suitors.
Still, the money so many tech companies raised in the recent explosion of convertible-debt offerings, as well as their rising stock prices, could ultimately grease the wheels of the merger machine.
Who would have thought it would come to this? Just three and a half years ago, we were in a New Economy whose growth engine was technology, where the U.S.'s competitive advantage appeared well nigh impregnable.
Now, tech companies are slashing costs any way they can, and software engineers in Palo Alto or Menlo Park are fighting for jobs with much-lower-paid counterparts in Bangalore or Wuhan.
Welcome to the Great Shakeout, Silicon Valley. It's going to be part of the way we do business for quite a while.
Thursday: How it will affect us all.
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Thursday, June 26, 2003
Globalization Meets Creative Destruction
by Howard R Gold
HERE ARE A COUPLE of straws in the wind.
A few months ago, I rented a car from Alamo Rent a Car for a trip to Florida. I had some questions, so I called the company's 800 number.
The customer service representative I reached was pleasant, polite and well spoken. Yet I detected a certain lilt in her voice that prompted me to ask if she was from India.
Yes, she replied, from Bangalore, where Alamo had set up a call center and had trained a whole team of customer service representatives to handle calls from American car renters.
Fast forward to last week, when I was having dinner with my brother, an internist in a busy medical practice in Pennsylvania.
The dozen or so physicians at Medical Associates of Monroe County used to routinely dictate their notes about patient visits, diagnoses and test reports every night and turn them over to an in-house transcriber, he told me.
But it took at least a week to get the reports back, so sometimes specialists didn't get all the information they needed about patients the internists had referred to them.
Cardiologist Dr. Vidya Ponnathpur had an idea: He contacted a company in his hometown of Bangalore that agreed to take on the work. The firm hires all the transcribers, supervises them, pays them and charges the doctors by the line.
Now, at the end of the day, the doctors of Medical Associates dictate their notes, which are then converted into voice files and transmitted to a server in Bangalore.
Since Bangalore is 9 1/2 hours ahead of East Coast time, the transcribers work through our night and send Word files of the complete reports back to the doctors by 10:30 AM the next morning -- as reliably as FedEx.
And oh., yes, it used to cost 16 cents to 17 cents a line for transcriptions; now it's nine cents a line -- a total cost savings to the practice of $60,000 to $70,000 a year.
It all comes down to the same thing. Businesses from private medical practices to large rental car chains to giant corporations like Delta Airlines and Hewlett-Packard are under enormous pressure to keep costs down.
And now, with the Internet and the opening up of the world economy called globalization, they have the means to do so.
Globalization allows corporations to scour the world for the highest returns and lets them build a truly international workforce. The Internet makes it easier for managers to monitor that workforce -- wherever they are -- and integrate them into the global networks that large companies are becoming.
Twenty years ago, it would have been inconceivable for a small private company like ANDA Networks to in effect relocate its engineering workforce from San Jose to Wuhan, China (see Weekday Trader, "Will Silicon Valley Move to Asia?1," June 25).
Why bother, when reasonably priced software engineers were abundant in Silicon Valley at the dawn of the PC revolution? The idea of managing such core creative technical people thousands of miles away would have seemed impossible, if not ludicrous.
And I doubt whether you could have found 65 qualified software engineers in Wuhan, a city of seven million, when China was just beginning to open up to the West and the free enterprise system.
The combination of events we've called "The Great Shakeout" in this week's special series in Barron's Online comes from the marriage of globalization and Internet technology. Along with the continuing trend toward consolidation in many key industries, it constitutes a fundamental restructuring of the U.S. economy that may ultimately rival the transition from an agricultural to a manufacturing economy in the 19th century.
Not surprisingly, manufacturers are the furthest along (see Weekday Trader, "Will U.S. Manufacturing Go to Zero?2," June 23). For years they've had to cut costs in the face of overcapacity and a lack of pricing power. But now the outflow of jobs we've seen in industries like clothing, toys and shoes has spread to more sophisticated sectors like industrial machinery and computer technology.
That exodus is also moving up the white-collar ladder as part of a general trend toward outsourcing in the service industry, which comprises more than half our gross domestic product -- nearly four times the percentage that manufacturing represents (see Weekday Trader: "Will Services Go the Way of Manufacturing?3," June 24).
Again, the same forces are at work: overcapacity, lack of pricing power and a push for higher profitability -- trends that can be seen most acutely in financial services. "The entire financial services business is getting commoditized," says Dushyant Shahrawat, senior analyst with The Tower Group.
So, where is this all going? Assuming that this is a structural change and not just the outgrowth of a recession and a slow recovery (which some economists argue), we can expect major dislocations in various parts of the U.S. economy over the next few years (see Weekday Trader, "Will the Great Shakeout Take Its Toll?,4" June 26).
Industries like U.S.-based call centers and the cities that support them could be hit hard. Many blue-collar workers will have to give up their dream of a steady union job and go into business for themselves or retrain as lower-paid teachers or nurses.
Older, highly compensated information technology professionals may have to take pay cuts, and some of them may never work in IT again at the level to which they're accustomed. MBAs in finance from Harvard or Wharton may not land that first Wall Street associate's job out of school, because increasingly those jobs will be filled, at much lower salaries, by graduates of Beijing University or the Indian Institute of Technology.
Who knows? Like the displaced family farmers who captured the nation's imagination in the 1980s or the haunted blue-collar antiheroes of many a Bruce Springsteen song, the alienated, proletarianized white-collar or IT worker could become a potent cultural symbol.
In all seriousness, unemployment and social dislocation have enormous costs, both direct and indirect, on the people who live through them, and their families. Anybody who downplays this is simply being naive.
But it's a necessary part of the ebb and flow of our economy, which sacrifices a false "stability" for real dynamism and growth.
Time after time in our history, critics have proclaimed the U.S. had exhausted its potential and time after time the economy has reinvented itself.
The Austrian-born economist Joseph A. Schumpeter described this as a "process of industrial mutation" that "incessantly revolutionizes the economic structure from within, incessantly destroying the old one, incessantly creating a new one."
"This process of Creative Destruction," he wrote, "is the essential fact about capitalism."
That's why I'm optimistic that though many Americans may be hurt over the next few years, the U.S, economy will emerge from the Great Shakeout more competitive than ever.
But here's another consideration. That young Indian Alamo customer service rep I spoke with seemed generally excited about what would be a dead-end job in the States but for her was a real opportunity for advancement.
"Here you would say [it's a lower-middle-class job]," Dr. Ponnathpur says of the medical transcribers in Bangalore. "There, they would probably be middle class. It's pretty good money for those guys."
For years the U.S. has trumpeted the virtues of globalization -- and rightly so.
But if we really believe that free markets offer everyone the best hope for a better life, we'll have to let nature take its course -- even if globalization begins to cut the other way.
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Howard R. Gold is editor of Barron's Online. Fighting the Tape appears twice monthly.
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also Thursday, June 26, 2003
WEEKDAY TRADER
Will The Great Shakeout Take Its Toll?
By EVELYN ELLISON TWITCHELL
Editor's note: This is the last of a four-part series on The Great Shakeout, the fundamental restructuring of U.S. industry that's going on today.
BARRON'S ONLINE HAS SPENT THIS WEEK looking at how outsourcing and consolidation are reshaping our economy. This fundamental restructuring of U.S. industry may look great from the boardroom and on Wall Street. But there's likely to be real pain lower down the food chain.
The job losses we've seen so far have created high anxiety from the factory floor to the executive suite. Longer term, restructuring and global competition could limit the wage growth of white-collar workers in the same way it did to their blue-collar counterparts when manufacturing began moving outside the U.S. a generation ago.
And some areas of the country that rely heavily on vulnerable industries like call centers and data-processing facilities may feel the pinch, too.
"This is going to be one of the biggest macroeconomic shifts in the overall U.S. economy in the next ten years, no questions asked," contends John McCarthy, Forrester Research's group director of research.
His prediction that 3.3 million U.S. services industry jobs will move offshore over the next 15 years has set off alarm bells and garnered lots of media coverage.
Gartner Research also forecasts that some 80% of U.S. corporations will have at least considered offshore outsourcing by next year.
Meanwhile, though mergers and acquisitions have dropped sharply since the stock market bubble burst in 2000, Federal Trade Commissioner Mozelle Thompson tells Barron's Online M&A activity should pick up when the economy revives.
"The big AOL/Time Warners might not come down the path, but you might see more consolidation in middle-market companies," Thompson says.
That certainly won't lower employees' stress levels.
Alexander Horniman, a specialist in organizational behavior and psychology at the University of Virginia's Darden Graduate School of Business Administration, says workers often feel a sense of loss and betrayal in the wake of job-killing mergers.
"When I began work, you expected that if you worked hard and kept your nose clean, you'd retire from that company," Horniman says. "That's all changed. It's take care of yourself first, because it's quite likely nobody is going to take care of you."
Outsourcing also is heightening workers' insecurity.
"You have to worry that you're next," says Paul Osterman, a labor economist and professor at the Massachusetts Institute of Technology's Sloan School of Management.
And that could actually drive incomes down.
"In the long term, if you can make enough workers feel insecure about their jobs, corporations [may] be able to put a pretty powerful brake on wage growth," says Josh Bivens, an international economist at the Economic Policy Institute.
Ultimately, workers will be paid the prevailing global wage, not the prevailing U.S. wage, contends Frances Karamouzis, director of research at Gartner.
How much is that? Don't ask. An information technology specialist working for an outsourcer in India earns from $20 to $30 per day; his or her in-house U.S. counterpart would get $50 to $90 per hour, Karamouzis's research shows. An entry-level programmer in China makes 30% to 50% less than one in Chicago, according to Forrester.
On the flip side, outsourcing gives companies the breathing room to charge lower prices, offsetting the pressure on disposable income. Indeed, U.S. standards of living actually have risen as a result of international trade in the past, observes William Dickens, a senior fellow in economic studies at the Brookings Institution.
"Our total income should rise when we succeed in doing things more efficiently," suggests Marvin Kosters, a labor economist at the American Enterprise Institute for Public Policy Research.
Yet, at the very least, new global competition could reverse the trend whereby white-collar employees' wage gains outstripped those of blue-collar workers.
Outsourcing of IT jobs also could reduce the allure of technology hubs, such as Silicon Valley; Austin, Texas, and Research Triangle Park, N.C.
But Middle America may bear the brunt of it. Just as the globalization of manufacturing devastated cities like Flint, Mich., the outsourcing of service jobs may hurt communities in which call centers or payroll-processing facilities are big employers.
"Appleton, Wisconsin; Fargo, North Dakota, Wilkes-Barre, Pennsylvania -- those places will be very hard hit," Gartner's Karamouzis predicts. "When you ask what the impact is, in a local place, it's huge."
Not surprisingly, there already are signs of a political backlash, as several states consider laws to keep government jobs at home.
And with jobs scarce, U.S. workers may not be so eager to let foreigners work here. There may be renewed calls for immigration control and limits on H1B visas, which allow companies to hire technical workers from abroad.
"There's a growing chorus of complaints among IT workers, in particular, that somehow the H1B workers are eliminating jobs here in the United States," observes Dan Griswold, associate director of the Cato Institute's Center for Trade Policy Studies.
Still, he contends that even if 3.3 million jobs really do move overseas in the next 15 years, as Forrester projects, that amounts to only 220,000 jobs lost per year -- a fraction of the two to three million jobs that typically disappear each year through normal changes in technology and competition, he says.
In fact, the U.S. typically creates a net one to two million additional jobs each year, Griswold says.
And as companies save money by outsourcing, they may able to reinvest more and actually create jobs here.
The Bureau of Labor Statistics projects that computer and data processing services -- an area ripe for outsourcing -- will be the fastest growing industry in the U.S. economy between 2000 and 2010, as employment grows by 86%.
"You can be hysterical about it, and that I think would be wrong," MIT's Osterman says.
Historically, the U.S. economy has found ways to move on to ever-greater prosperity.
AEI's Kosters notes that about 3% of U.S. workers today are employed in agriculture, down from around half the labor force a century ago.
"So, we lost 47% of our jobs, right?" Kosters says. "That's not the right way to think about this. The right way is: we got much more efficient and released the workforce to do more interesting things."
Indeed, for workers, the best recourse may be to acquire the skills to move to higher-end jobs that are more difficult to replace, such as upper-level management, creative jobs and those that require direct contact with customers. Certain industries, such as health care and leisure services, also may offer more opportunities as Baby Boomers retire, Kosters points out.
But who is going to pay for all the retraining? Employers? Fiscally strapped local governments? The federal government? Not likely.
At a Gartner conference on outsourcing in Los Angeles this week, Karamouzis asked 150 IT service providers how media coverage of job losses in the U.S. was affecting their decisions about overseas outsourcing.
A full 80% said it was having no impact at all, suggesting that the need to cut costs is outweighing any concern for the human toll -- or the bad publicity it might create.
That wouldn't surprise McCarthy's Forrester, who predicted in his study: "By the end of the decade, executive stature will be measured by the size of the outsourcing contracts that they manage, not the number of employees."
It's a different kind of empire building for a very different age.
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