Evolving Excellence

Counterintuitive Value of Mergers

By Kevin Meyer

Conventional thinking has it that when two similar organizations merge the sum is more efficient than the parts.  That's the thought behind mergers of companies, government entities, and the like.  But is it really true?  Perhaps not - at least on the government side of things - and that can give us some lessons for the mergers of other types of organizations.

Governors and lawmakers across the U.S., looking to trim the costs of local government, are prodding school districts, townships and other entities to combine into bigger jurisdictions. But a number of studies—and evidence from past consolidations—suggest such mergers rarely save money, and in many cases, they end up raising costs.

There are several reasons for this.

The logic often cited behind consolidations is saving money by shedding layers of management or having departments share equipment such as snowplows. But managers and equipment account for far less than half of local governments' expenses—most of their cost is rank-and-file labor.

Another reason: When small governments merge, they often "harmonize" services and employee benefits to the highest level among the combining units. In other words, the consolidated city finds it politically expedient to take on the more-expensive version of everything.

But since it is counterintuitive, our legislators are trying to incent the practice.

Still, when it comes to controlling local government's largest cost—labor—smaller governments generally do better. Take Illinois, where budget troubles and pension obligations have eroded the state's credit rating. There, state Sen. Terry Link proposed a bill that would lead to local governments being combined or dissolved in a bid to save money. "There are a lot of these units of local government that aren't necessary anymore," said Mr. Link, a Democrat. {wow - a Democrat saying parts of government aren't necessary?  -ed]

But a study this year for a group representing most of Illinois's 1,433 townships used state data to show that tiny townships are the state's most austere government operations. Spending by the state's townships grew 17% from 1992 to 2007, adjusted for inflation, according to the study. State expenditures over that same period grew 51%, while spending by larger municipalities grew 50%; school districts' spending rose 74%.

Now the real question is what can be extrapolated from this information.  If local government is more efficient than state government, is state government more efficient that the federal government?  Can two small companies be more efficient than one larger company?  We've actually seen that in many industries.

Agility, customized service vs. a one-size-fits-all approach, optimization of resource conversion and delivery vs. bureaucracy.

"In government, the whole idea of economies of scale is turned on its head," said Wendell Cox, who produced the report for Township Officials of Illinois, an umbrella group for the state's townships.

A few years ago Bill had a two-part series on the problems with economies of scale in manufacturing.  It's still true - and not just in manufacturing.

Kill Rats - Not Messengers

by BILL WADDELL

For $50 a month you can monitor what the social media is saying about you, your company and your product.  For nuthin' a month you can not worry about it.  More and more stories are popping up about the need to "beat down" social media, and keep it from doing "irreparable harm".  It is a sad reflection of the times.  Nothing said about confronting the truth, as painful as that often is.  No advocating root cause analysis and corrective action - just about the need to control the message.

A guy with a highly contagious disease eats at a New Jersey diner and "Within no time, parents and restaurant regulars alike had taken to the Internet, voicing their health concerns."  Yeah - and why shouldn't they?  The problem isn't the parents and customers who are concerned about it.  The problem is a guy with a highly contagious disease in the restaurant.

"When someone posted a video on YouTube of rats running around a New York City Taco Bell restaurant in February of 2007, the video spread across the web like wildfire, causing Taco Bell's (YUM, Fortune 500) stock price and sales to drop."  Seems pretty clear to me that YUM's stock price and sales should drop if there are rats running around their restaurants.  The YouTube video isn't the cause of dropping sales and stock prices - lousy management that lets rats have the run of a Taco Bell is.

If you run the business in such a way that there are no rats to be videoed, there is no need to worry about the truth coming out about the business.

The biggest hoot is reserved for the management of the pharmaceuticals (seems we can always count on them for a laugh these days).  It turns out Facebook cut a deal with the pharmers where no one could post comments to their pages.  Why Facebook would give away their integrity to these stumble bums is something of a mystery, but they did, and then came to their senses and said 'no more'.  With that, a number of the pharmers opted to cancel their Facebook pages.

"The industry 'nightmare' is processing adverse event reports (AERs), said Joe Farris, co-founder of the Digital Health Coalition, a nonprofit group focused on online marketing of health-care products. Users might write on a company’s Wall about a specific product causing an unexpected reaction or injury. That information could qualify as an AER, and it must then be filed with the Food and Drug Administration, which uses the reports to monitor product safety."

The "industry nightmare" should be people experiencing the "unexpected reaction or injury" as a result of their products - not the prospect of having to report the event to the FDA.  I would think management would want to know if people are being harmed by the product, rather than take the position that 'if you guys are gonna allow the truth to be told we want no part of it'.

The guy running Flick By Design furniture in Toronto whines that a disgruntled customer falsely claimed to have been "Flik'd over" by him, setting off a chain of unflattering comments in the social media.  Perhaps the guy who started it was unreasonable, but the Flick guy ought to be asking himself why his customer base was so willing to believe him.

Several months ago one of my kids complained about her older relatives taking her to task about something her 'friends' had posted on Facebook.  She wanted to un-Friend the old folks because they "don't understand".  My advice to her: Live your life in such a manner that ti doesn't matter how publicly desplayed it is on Facebook then you won't have to worry about it.

Same is true with business.  Keep the rats out, deal with customer compaints and problems promtly and fairly from the get go, worry about the substance of the business, then you don't have to lose a minute's sleep worrying about the truth coming out in the social media.

Errol Flynn - Eat Your Heart Out

by BILL WADDELL

I just came across this exciting video on Lean Accounting. Unknown to me, it's been out on YouTube for half a year or so.  If this riveting, keep-you-on-the-egde-of-your-seat bit of cinematography doesn't convince your execs to pursue Lean Accounting nothing will ...

 

 

Jeff - You Ain't No Charlie Wilson

by BILL WADDELL

Just about everyone has heard one version or another of GM President Charlie Wilson's response in the Senate hearings to confirm his nomination as Secretary of Defense. Senator Robert Hendrickson asked whether Wilson could make a decision that would harm GM if such a situation arose.  Wilson answered, "I cannot conceive of one, because for years I thought what was good for our country was good for General Motors and vice versa. The difference did not exist. Our company is too big. It goes with the welfare of the country."

Compare that with GE's Jeff Immelt.  "I’m a GE leader first and foremost.  At the same time . . . I work for an American company."

Immelt can set his priorities however he chooses, of course.  I have a whole lot of things higher on my 'first and foremost' list than work - my faith, my family, and, yes, I am an American long before I am a manufacturing consultant.  I am quite sure most of the blog readers have similar priority lists.  In fact, while Engine Charlie was much maligned as a result of the misquoting of his words - it went into popular wisdom as "What is good for GM is good for the country" - he was actually saying that (1) there was no conflict between the company's interests and the country's, and (2) if such a conflict ever arose there was no doubt the country came first.  That is exactly how most of us would see things.  Other than occasionally being late for dinner because a meeting ran late, the job and our personal values - faith, family, country - are not in conflict.  And like Charlie, if they come into conflict the job would be the first thing to go.

As I said, Immelt can set his priorities as he chooses - pretty pathetic for someone to make business "first and foremost" in their life but it's his empty life to live.

The big question is exactly what is the country's obligation to people and companies like Immelt and GE who take full advantage of the benefits of the United States but feel little or no obligation to give back?

The article in which the quote appeared cites P&G as having only 28% of their 128,000 employees in this country.  According to this morning's Cincinnati Enquirer they are planning to reduce that number even though 42% of their sales are here.  IBM has more employees in India than they do in the United States, but I bet they sell a whole lot more technology here than they do in India.  Apple, as we have long noted, keeps ten or more Chinese folks employed for every one American, as does Nike.  They sell their iPods and shoes here though.  More and more the business model is to take and take and take from the United States ... and give as little back as they possibly can.

Back in 1953 Wilson would have been right even if he had said what was good for GM was good for the country.  GM created wealth and jobs and the only controversy was how much of the wealth went to workers and how much went to management and stockholders, but it was American wealth for the most part regardless of how the pie was divided.  The multi-national model of 2011 is quite different.  It is to drain the accumulated wealth of the USA for their own benefit.

The fact that most of the world is safe for them to go into and manufacture and sell as a result of a century of US blood and treasure through wars, foreign aid and treaties to make it so, and they can gallavant around the world secure in the knowledge that the full might of the United States keeps the collection of communists, tin horn dictators and criminals of all sorts from reverting to form and slitting their throats and confiscating their money means nothing to them.  We are simply the underwriters of the secure legal and financial infrastructure they use to get rich, and nothing more.

The mainstream American manufacturer is taxed far too much.  He gives back to the United States far more than he takes in the form of jobs, community support and much more.  Typical American manufacturing leadership is out front in volunteering, donating and doing everything possible for the country.  But the leaders of the multi-nationals are a selfish, shameful lot and even have the gall to look for tax breaks - their taxes should be doubled - no tripled.  What exactly is in it for us to give these folks a break?

Where is the great loss if the Jeff Immelts take their companies and leave?  They won't - they are all in for sending everyone else's job to China, India and Vietnam but there is not enough money in the world to convince them to leave the friendly, safe confines of Connecticut and live in those places.  They won't reduce any jobs - they have the bare minimum here anyway, and they will still do whatever it takes to sell into the biggest economy in the world.  Would investors lose out?  Not hardly.  Let IBM, Apple and Nike move their headquarters and the paltry few jobs they provide to Shanghai.  You can invest in them through the Shanghai Stock Exchange just as easily as you can the NYSE.

We need to cut the tax rate for American companies in half, but we should stick it to the multi-nationals and their 'company first - America when it's convenient' leadership as hard as we can.  In my lean seminars I ask CEO's the question, "What is your commitment to your employees, your community, your suppliers and your customers?  And what would happen if they felt exactly the same commitment to you?"  Time for Jeff Immelt to find out.

Non-Manufacturing in America - Kindle, iPhone, and Software

By Kevin Meyer

This past week has seen a trio of articles explicitly lay out the crisis, misperception, and opportunity of manufacturing in America.  Two great articles by Steve Denning sandwiching a piece by software venture capitalist Marc Andreesen.  If you get a chance I'd suggest you read them in this order, but I'll do my best to summarize below.

1. Why Amazon Can't Make a Kindle in the USA (Steve Denning, Forbes)
2. Why Software is Eating the World (Mark Andreesen, WSJ)
3. Does it Really Matter that Amazon Can't Make a Kindle in the USA? (Steve Denning, Forbes)

So to kick it off, let's tackle the first article.  Steve Denning bluntly lays out the problem, building on a previous article of his on How Do You Explain Radical Management to a CFO.

Decades of outsourcing manufacturing have left US industry without the means to invent the next generation of high-tech products that are key to rebuilding its economy, as noted by Garry Pisano and Willy Shih in a classic article Thus in “Restoring American Competitiveness”. The US has lost or is on the verge of losing its ability to develop and manufacture a slew of high-tech products. Amazon’s Kindle 2 couldn’t be made in the US, even if Amazon wanted to.

- The flex circuit connectors are made in China because the US supplier base migrated to Asia.

- [article goes on to detail five additional key components]

Pisano and Shih continue:

“So the decline of manufacturing in a region sets of a chain reaction. Once manufacturing is outsourced, process-engineering expertise can’t be maintained, since it depends on daily interactions with manufacturing. Without process-engineering capabilities, companies find it increasingly difficult to conduct advanced research on next-generation process technologies. Without the ability to develop such new processes, they find they can no longer develop new products. In the long term, then, an economy that lacks an infrastructure for advanced process engineering and manufacturing will lose its ability to innovate.”

In the same way that cost accounting and short-term corporate profits don’t reflect the true health of corporations, the economists’ reckoning of the impact of outsourcing production overseas misses the point. Americans are left with shipping the goods, selling the goods, marketing the goods. But the country is no longer to compete in the key task of actually making the goods.

Denning goes on to list a host of industries that have already been lost - too lengthy to appropriately duplicate here.  He then details what various types of leaders and functions need to do.  Here are just a couple:

Accountants: Accountants need to get beyond the mental prison of cost accounting and embrace the thinking in throughput accounting that puts the emphasis on how companies can add new value, rather than just cutting costs.

Economists: Economists need to realize that merely adding up the numbers is not enough. They have to look at the meaning behind the numbers. When they trumpet their finding that “Chinese goods are only 1% of the U.S. economy”, it’s akin to saying “we kept the house but gave away the keys.”

Next, Marc Andreesen tries to convince us that all of this doesn't matter.  Software innovation will save the day, as software is supposedly the linchpin of everything in life.

This week, Hewlett-Packard (where I am on the board) announced that it is exploring jettisoning its struggling PC business in favor of investing more heavily in software, where it sees better potential for growth. Meanwhile, Google plans to buy up the cellphone handset maker Motorola Mobility. Both moves surprised the tech world. But both moves are also in line with a trend I've observed, one that makes me optimistic about the future growth of the American and world economies, despite the recent turmoil in the stock market.

In short, software is eating the world.  My own theory is that we are in the middle of a dramatic and broad technological and economic shift in which software companies are poised to take over large swathes of the economy.

Ok... anyone else have visions of SkyNet?

Six decades into the computer revolution, four decades since the invention of the microprocessor, and two decades into the rise of the modern Internet, all of the technology required to transform industries through software finally works and can be widely delivered at global scale.

He goes on to describe how every major industry - from book selling to music to health care to defense to even oil production - now has software as the supposed key component.

Instead of constantly questioning their valuations, let's seek to understand how the new generation of technology companies are doing what they do, what the broader consequences are for businesses and the economy and what we can collectively do to expand the number of innovative new software companies created in the U.S. and around the world.

That's the big opportunity. I know where I'm putting my money.

It's all about the software, stupid! But keep in mind Steve Denning's original article on how the receptacle of the miraculous software can't be built in the USA.  Which is why he quickly followed up his article.

Marc Andreessen’s article in the Wall Street Journal is certainly right to point out that software development is a huge part of both the present and the future economy.

But software per se is not the solution. Saying that “software is the solution” is like saying that the winning firms of the early 20^th Century were successful because of electricity. The difference wasn’t electricity. The difference was more imaginative management that took advantage of the opportunities that electricity presented.

In any event, the idea that software development is immune from the experience of being undermined by disruptive innovation from low cost producers is a comforting but dangerous illusion, particularly in fields where software and hardware development is intimately intertwined.

Similarly, the idea that the USA has a perpetual lock on software development is as solid as the idea that Detroit owns auto manufacture or that the IBM [IBM] owns the PC.

Bingo.  So what's the solution?

I agree that the idea that there is a lot of outsourcing going on is hardly news. The idea that it is irreversible and destructive of the economy’s ability to grow is less well known. Even so, it’s not exactly new news: the HBR article that I cite is two years old.

What is really new news is that (1) these fairly obvious truths haven’t yet dawned on economists at the Federal Reserve Bank of San Francisco, CEOs, accountants, politicians, among others and (2) the way to manage in a radically different way to deal with these issues is now more fully articulated than it has been before.

The issue is not hardware or software. The issue is how the firm is managed. Traditional management is killing both the firm and the economy. The statistics of the decline are well-documented.

Good work Steve.  There are a bunch of Evolving Excellence readers equally convinced that this situation needs to change - and can change.

The Old GM is the New GM is the Old GM

By Kevin Meyer

Forget for a moment all the financial convolutions the GM bailout foisted upon the taxpayers, and the accounting machinations they're going through to show a profit.  Forget that they are in effect using U.S. taxpayer dollars to invest in China - although perhaps that's a more direct route than interest on the growing U.S. debt in effect being an investment in China.

Companies succeed when they focus on creating value for the customer... which only then creates value for the shareholders and stakeholders, and only then creates value for management.  The old GM forgot that - if they ever knew it in the first place, and tried to skip those initial couple of steps.  If you forget it all begins with the customer, you crumble.

The new taxpayer-enabled GM claimed they were different.  Some pretty nice designs were created, some pretty pathetic ones discontinued.  But somehow the internal philosophy of the company apparently hasn't changed.

General Motors Co is seeking to dismiss a lawsuit over a suspension problem on more than 400,000 Chevrolet Impalas from the 2007 and 2008 model years, saying it should not be responsible for repairs because the flaw predated its bankruptcy.

The lawsuit, filed on June 29 by Donna Trusky of Blakely, Pennsylvania, contended that her Impala suffered from faulty rear spindle rods, causing her rear tires to wear out after just 6,000 miles.

"New GM's warranty obligations for vehicles sold by Old GM are limited to the express terms and conditions in the Old GM written warranties on a going-forward basis," wrote Benjamin Jeffers, a lawyer for GM. "New GM did not assume responsibility for Old GM's design choices, conduct, or alleged breaches of liability under the warranty."

Technically GM is probably correct.  But if you are a customer and see GM trying to weasel out of any commitment to quality and responsibility, how would you feel?  Is that creating value - in terms of confidence among other things?  Of course not.

Nice job GM.  Old GM.

The Value of Profiting from Poverty

By Kevin Meyer

I know that title alone is going to get a bunch of folks tied up in their undies but a story on CNN over the weekend made me think a bit.  And perhaps we do need to think a bit instead of accepting commonly-held perspectives.  Let's start with some brief background.

It started with such a simple concept: A solar light bulb that charges up during the day and lights the night when the sun sets. Inventor Steve Katsaros perfected his design in June 2010, and four days later he had a patent in hand.

He knew it was a good product, but he didn't know what to do with it. "It wasn't until after we created it that we asked ourselves, 'How do we market this,'" Katsaros says. "And we learned that the largest market was the developing world." As Katsaros began researching markets in developing countries, he began to realize that his solar light bulb could potentially make a huge impact on the 1.4 billion people around the world who don't have access to an electrical grid.

Ok now let's really get some of you twisted into a tizzy.

First, Katsaros had to answer a key question that would determine how he would have the strongest impact: should his company be nonprofit, or for-profit? Katsaros found inspiration from the 2008 book by Paul Polak, "Out of Poverty."

Polak, who has worked in developing nations for 30 years, believes that the charity model of aid used by nonprofit organizations doesn't work -- despite its good intentions.The best way to help people, according to Polak, is to treat them as consumers. If you can sell to them, he says, you can help them.

"In the beginning I was a nut case and nobody paid attention," Polak says. "The consensus was 30 years ago that this is what caused poverty, and to be involved in business was outrageous and evil."

Today, that is starting to change, he says. But that doesn't mean that nongovernmental organizations have rolled out the red carpet for Polak's ideas. "Many NGOs say it's making money on the back of the poor, but I love to make money on the back of the poor," Polak says.

The evil! The horror!  And I'll admit that last statement even made my gut turn a bit.  But I happen to have also read Polak's book a year or two ago and was equally impressed.  Sometimes a new perspective is necessary.  And here it is.

"You can feel really good about yourself giving stuff away ... but if you are going to sell things to people, you need to have respect for them because no one is going to buy something if you have contempt for them."

He says market forces will ensure that the right products get into the marketplace and ultimately lead to empowering people in developing countries to be better able to fend for themselves.

"If you have a village that's used to the dole, it's very hard to get them off of the dole," Polak says. "We have to face the fact that conventional development aid has failed. "It just doesn't work."

Now speaking of "villages on the dole" there was an interesting comment to the article:

"We have to face the fact that conventional development aid has failed." Is he talking about Detroit, Camden, Chicago, Newark, Gary, East St. Louis, North Miami Beach....?I

No kidding, but that's the subject for another day, if not another blog altogether.  Let's get back to the other perspective this article forces us to face, beginning with that concept of respect.

After interviewing more than 3,000 families who live on $3 a day or less, Polak concluded that they know best how to care for their families. They will respond to a free market that presents them with products that will fit their needs, he says.

"They are stubborn creative survival entrepreneurs," Polak says. "They make life and death decisions about how to spend their meager income. They are used to investing their money very wisely."

Compare that to just throwing a bunch of "good ideas" at a population that may not accept them.  The article goes into considerable detail about such failures - including a "merry go-round water pump" that relied on kids to play on it to pump water.  Guess what happened when the kids got bored.

So we have the technology value and selection property of the free market.  What else?

Polak markets a pump of its own, which costs about $8 to make and sells for $25. Polak says a small family farmer who buys a pump can increase his annual income by $100.

He says they have sold 1.5 million in Bangladesh alone and have created thousands of jobs in turn. "We have 3,000 (villages) dealers making an income and 3,000 well drillers making an income, and 75 workshops making the pumps making an income," Polak says.

A self-replicating supply and distribution chain that is able to get the product into far more people's hands, far more efficiently, than simply air-dropping boxes of them.

And that is one of the key tenants of the social entrepreneurship model. It helps create more jobs and a network of dealers and distributors that can then be utilized to sell more products and ultimitely build a more robust economy in developing countries.

That's a model Katsaros hopes to replicate with his solar light bulbs. "This is something I personally believe in, to create smaller entrepreneurs around the globe," he says. "It's a business model I really love and believe in."

In Kenya and Tanzania they sell what they call "business in a box kits," 144 bulbs along with displays and fliers. Would-be entrepreneurs can go village-to-village selling the bulbs and establishing a network of customers.

So a brief recap.

The goal is to get a life-enhancing product to as many desperate people as possible.  By leveraging respect for people, market-based product selection and improvement, and incentivized distribution channels the product reaches far more people, while creating far more jobs, than simply throwing free products out of planes.

Explain the evil again?  Which is more important - achieving the goal or maintaining a self-centered supposedly moral perception?

Chopsticks and iPhones

By Kevin Meyer

Cheap, low margin, low tech.  Made in America, exported to China.  It can be done, even with a product that has comparatively zero demand in America.

Enter Georgia Chopsticks. Jae Lee, a former scrap-metal exporter, saw an opportunity and began turning out chopsticks for the Chinese market late last year. He and his co-owner, David Hughes, make their chopsticks from poplar and sweet-gum trees, which have the requisite flexibility and toughness, and are abundant throughout Georgia.

In May Georgia Chopsticks moved to larger premises in Americus, a location that offered room to grow, inexpensive facilities and a willing workforce. Sumter County, of which Americus is the seat, has an unemployment rate of more than 12%. Georgia Chopsticks now employs 81 people turning out 2m chopsticks a day. By year’s end Mr Lee and Mr Hughes hope to increase their workforce to 150, and dream of building a “manufacturing incubator” to help foreign firms take advantage of Georgia’s workforce and raw materials.

If it can be done with chopsticks, why not with iPhones?  What if Apple's innovation genius was applied to manufacturing and the supply chain, not just product design?

What if?

The Fed - Dishonest or Dumb? You Decide

by BILL WADDELL

The United States woke up to a report from the San Francisco Fed picked up by just about every business news outlet announcing that the "Goods and services from China accounted for only 2.7% of U.S. personal consumption expenditures in 2010, of which less than half reflected the actual costs of Chinese imports."  Only 1.2% of your spending was for stuff from China, say the well-paid wizards.

I am not going to begin to decipher their convoluted logic.  Suffice to say:

In 2010 the average household income in the United States was about $67,000

In 2010 there were 113,146,000 households in the United States

In 2010 imports from China were $364,943,900,000 - or $3,225 per household

$3,225 to China per household is 4.8% of $67,000

Not 1.2%, but 4X that ludicrous figure.

In their math they left out things like the Chinese content in your house - apparently they don't spend a lot of time at The Home Depot - and the recent drywall debacle sailed over their heads.  They assumed that nothing from China was used in any of the hotels you visit, at any if the Disney operations, or in any medical equipment.  In fact, they went at the analysis by coming in through the back door, the side door, sneaking in through a second floor window - every way except straight on.

The analysis is simple - How much stuff did we get from China?  How many of us are there?  What does that come out to? No need to start with the retail price at Walmart and do a lot of convoluted gyrations to back into the landed China cost. 

They ought to be intellectually honest in citing other folks analyses.  They wrote, "This is partly because a large share of Chinese production costs consists of imports from other countries. Xing and Detert (2010) demonstrate this by examining the production costs of an iPhone. In 2009, it cost about $179 in China to produce an iPhone, which sold in the United States for about $500. Thus, $179 of the U.S. retail cost consisted of Chinese imported content. However, only $6.50 was actually due to assembly costs in China."  

In fact, Xing and Detert's wrote, "In this paper, the authors use the iPhone as a case to show that even high-tech products invented by United States (US) companies will not increase US exports, but on the contrary exacerbate the US trade deficit. The iPhone contributed US$1.9 billion to the US trade deficit with the People's Republic of China (PRC)."  Their data demonstrated quite the opposite of the Fed's.

So why does the Fed publish such misleading information?  Are they really that dumb?  That is hard to believe.  The alternative is that they are deliberately trying to mislead the American public.  That is a frightening thought.  For what purpose would they do so?  For that matter, why did they publish the paper at all?  What is the goal in deliberately understating the amount of money flowing to China by 75%?

In the end, however, as with the productivity data, we cannot solve our serious economic problems when the people in charge will not or cannot provide honest information.

The Economics of Lead Times

by BILL WADDELL

Retail executives from sea to shining sea are not sleeping as well as they used to as we hurtle headlong toward September.  In any other year their purchase orders would be placed, Chinese factories would be humming and the container ships would be lining up at Hong Kong, Chiwan and Shanghai.  The retail execs would be working on the details of their ad campaigns as they head into the holidays - the time that makes or breaks the retail year.

But the orders haven't even been placed yet for many of the big retailers.  The Chinese factories are still waiting, and the container ships are in no particular hurry to get anywhere.  That may be something of an overstatement - but not much of one.

The big systems with their mathematically elegant forecasts are fine, so long as there is not much downside to error - whether they will sell 10,000 or 11,000 rolls of Charmin three months out, or if the summer weather will be good, driving demand for barbecue paraphernalia up 8% over last year.  But forecasting the holidays is very high stakes poker - and they know all too well the forecasts are nothing but GIGO machines - manipulators of historical data and human assumptions; and they have nothing but garbage and irrelevant history to feed them.

Nothing is particularly hot this year.  Consumers have become value driven and uninterested in the latest artificially created demand for fashions, toys or much of anything else.  There are always a few electronic gadgets that are hot, but beyond that it gets pretty thin.

But the Chinese manufacturers need 60-90 days and that window is closing fast.  They don't know what to order, or how much, but to order nothing is to walk away from 20%+ of their annual sales and all of their profits.

And waiting is getting more expensive.  Inflation in China is running at 6 - 6.5% that they admit to.  The reality is undoubtedly much higher.  If that weren't enough, the currency rates are also working against the retailers.  This is not a coincidence - the Chinese are having to play it straighter with their currency to try to get inflation under control.

As the chart below indicates, the rate corrections add another 5%+ to the cost of everything coming out of China.

 

Between inflation and currency, the stuff the retailers buy is better than 10% more expensive than it was last year - but US consumers have not been willing to cover the increase lately, and in light of the current economy, it does not seem likely that they are going to start this Christmas.

So while the retail execs fret, the cost of goods from China is going up a percent per month or better.

And just to pour salt on the wounds, oil prices are a good 25-30% higher now than they were going into the last holiday shipping season.

Many folks don't know that, while the big retailers negotiate pretty good contracts with the shipping lines, the folks driving the big boats reserve the right to tack on a fuel surcharge ... and they are waiting for the big orders to come in so they can pounce with that unpleasant bit of news for the retailers.

 The underlying cause of much of the impending retail disaster is an utter disregard for the economic significance of lead times.  Traditional accounting doesn't know how to quantify it, so, by definition, it is not important ... or so they told themselves.  Only now those long lead times are driving retailers to make 'bet the ranch' decisions in the face of huge uncertainty.  Right about now I am sure they would give quite a bit to have a few of the American manufacturers they beat into oblivion back, with their short lead times.

The bigger issue is that the chickens are coming home to roost - as they always do.  China has been playing games with its currency to keep Chinese prices artificially low.  Naive western economists saw this as good for America as we benefited from those low prices.  Finance Minister Guido Mantega President of Brazil, however, is a litttle bit more street smart than the typical economic genius. He describes China as "predatory".  The Chinese set out to take over the world's manufacturing base, and willfully ate the cost of currency manipulation to do so.  Their accomplices in this effort are the big American retailers - unwitting to be sure, but lack of wits is not an excuse when the unwitted are paid the sort of money the execs are.  Now the string has run out.

Whether the Chinese can consolidate and hold onto their ill-gotten gains remains to be seen.  The big retailers, however, are left high and dry.  They reaped the benefits of artificially low Chinese prices for years and ignored the very important matter of lead times, and now they are paying the price.  What is certain is that retailers will measure success this year in very different terms.  The big winners will be those who survive.