Global trade has historically been driven by cheap labour and low-cost manufacturing. There are two parts to this, the cost of manufacturing the product – consisting of labour, machinery and other inputs – and that product’s delivery.
Manufacturing and delivery have often worked in different directions. Cheap labour has typically been found a long way from where the majority of the consumers have resided. It has therefore been a trade-off: is the manufacturing cost low enough when considering delivery? Typically, the answer has been yes.
However, the rise of automation is changing this. The major proportion of cost is now going to come from machinery rather than people. The location of the manufacturing plant is becoming less important – which means the geographic advantages we have witnessed over a number of decades will continue to flatten out.
The relative cost advantage will become more about how cheap it is to actually get the product to the customer. For a long time corporates have looked around the world – mainly in emerging markets – for the lowest-cost manufacturing. However, companies can now buy the machinery and put it down wherever makes most sense to reach its customers.
In addition to this, the machinery needed to construct many goods is primarily coming from the regions where the main bulk of consumers are residing – in the high-tech markets of the US, Japan and Europe. This is a major shift in how global trade has generally operated.
The impact on China
What does this mean for China, which has historically relied on major textile and other low-cost manufacturing? It is important to remember most cheap garments are no longer coming from China. Textiles have been one area of manufacturing that has kept rolling to the lowest cost area – which is now in places such as Bangladesh and Pakistan.
China has sought to move up the value chain into many other areas. A move towards automation is a natural progression for China, which is seeking to transition to a consumer-led economy. What China logically wants to do is make all the goods it consumes with robots. Instead of low-cost labour, well-educated people will operate and maintain the machines.
Many investors talk about trying to exploit the transitioning Chinese economy, but it is unclear how Western companies can make much money from selling products into this market. There is more and more evidence of it becoming increasingly difficult for overseas companies to operate in China.
If investors are optimistic about China’s ability to continue growing faster than the rest of the world and its transition into a consumer-led economy, the opportunities to play this theme are seemingly quite limited. Perhaps the answer lies in automation – an area in which China still requires Western expertise.
The rise of semiconductors
The rise of machine automation has been helped by big improvements in many industries, not least in semiconductor technology. The fast-growing semiconductor space has been a risky proposition for many companies over a long period of time, due to the reliance on a few specific types of product – think computers and mobile phones. Many semiconductor groups in this space were essentially like early-stage biotech companies – with a heavy reliance on one new drug or therapy.
However, after many boom and busts, many chip firms now have shifted focus to building safer, stronger, less risky businesses. There has been a wave of consolidation, creating larger, broader-based businesses. Further, new markets have opened up as chips become imbedded in more equipment, from lights to cars. While there are still a few commodity-like chipmakers around, the industry is typified more by large diversified companies, making a plethora of specialist chips for a widening array of niche applications.
Behind them, strong, robust companies have emerged, making the machinery required to make chips. We have exposure to a number of these names – such as Applied Materials, LAM Research and Teradyne. Software companies that assist in the production process are also interesting, like Synopsys. These groups have also indulged in a wave of consolidation, strengthening positions in particular niches in the production chain. The result is that profitability has gone up and risk has gone down throughout most of the chip production chain.
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