Is the global open trade regime collapsing into regional blocs?

Richard Baldwin, President of the Centre for Economic Policy Research, has argued that “regional trade liberalisation [is sweeping] the globe like wildfire”. Preferential trade agreements (PTAs) have increased from 20 in 1990 to close to 300 today. This has become a key feature of the international trade policy landscape. The data show that Mr. Baldwin was

Every country in the world is party to at least one PTA, with Mongolia the last to join the pack when it signed a deal with Japan in 2016. But Brexit, the U.S. withdrawal from the Trans-Pacific Partnership (TPP), and the renegotiation of the North American Free Trade.

Agreement (NAFTA) have all been disruptive for the world trade system. These PTAs are pursued by governments in hopes they will increase productivity and benefit consumers, promote economic policy reform, underpin supply chains, and benefit regional peace and security. By boosting trade among members (at the expense of non-members) they can have positive effects on growth. But they complicate trading operations, since they add an additional overlay on top of existing trade regimes.

Back in 2016, negotiations on the TPP, encompassing the U.S., Japan and 10 other countries in the Americas and the Asia Pacific region, and on the Trade and Investment Trans-Atlantic Partnership (TTIP) between the U.S. and the European Union, was all over the headlines. These agreements covered a significant percentage of total global trade.

By 2018, the situation had dramatically changed. The U.S. withdrew from TPP, suspended TTIP negotiations, launched the renegotiation of NAFTA and initiated the revision of some specific commitments of the Korea-U.S. PTA. Meanwhile, the TPP moved on — but without the U.S., dramatically shrinking its scope.

The UK post-Brexit repositioning requires undoing a very deep trade integration scheme with the EU and agreeing on new rules of engagement for a future economic partnership, while replicating or renegotiating some 40-odd PTAs that came with EU membership – not a small task. The UK is likely to deepen trade ties with the U.S. as a hedge.

As PTAs and regional agreements overtake globe-spanning trade regimes (the WTO), companies with multinational operations must begin to build into their operations more robustness to changing trade regimes.

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The Month of March for Trade Relations

Uncertainty about the future of the global economy has roiled stock markets in recent weeks (not to mention the operations of global companies), but what’s scheduled to hit in March could be worse than anything we’ve seen so far.

To start, a last minute reprieve just extended what was supposed to be a March 1 deadline in the trade war between the U.S. and China.  If negotiations falter, the U.S. is planning to raise tariffs on $200 billion in Chinese imports to 25% from 10%, and China is expected to retaliate.  U.S. administration officials have specified targets to be addressed, including fixing broad, longstanding problems with the Chinese economy, like its dependence on intellectual-property theft and government subsidies.  As we saw with Kim Jong Un in Vietnam, the U.S. is prepared to walk away from negotiations which are not proceeding satisfactorily.

Also in March, the United Kingdom will be lurching towards the March 29 deadline to officially exit the European Union. It’s unsure whether members of parliament will approve the proposed terms, and if not, a “no deal” Brexit will be extremely disruptive. Uncertainty over the mechanisms by which the deadline might be extended will force many companies to plan for a hard Brexit.

In a worst case scenario, “markets will likely fall substantially, corporations could lay off workers and cease investing in expansion, and consumers may end up paying for both of these,” says Sam Natapoff, a former official with the U.S. Department of Commerce and New York state trade advisor.

Overall, U.S., China, and the EU are the largest economies by gross domestic product in the world; any hit to trade in any of them is going to have global repercussions.

Is “industry benchmarking” even possible?

Is “industry benchmarking” even possible?

Companies often want to know how they compare to their peers, especially when they suspect they are leading or lagging.  For example, perhaps you want to know how your performance metrics compare to others’ in the industry — if yours are better than the industry norm, then you might infer you are doing things better; if worse, you might use that as internal motivation for improvement.

As an example, consider margins.  Margins are a function of price paid by the customer (after all adjustments, rebates, discounts, etc. are taken into account), and the cost to produce (including overheads and cost of capital / depreciation).  There are some challenges to building a set of margin data to compare to, beginning with estimating margins in the first place:

  • Actual price paid is surprisingly difficult to estimate, even for many companies themselves (especially those which rely on “back end money” for sales incentives) — and estimating realized prices for other companies is virtually impossible.
  • Actual cost to produce is also difficult to estimate for other companies (although relative costs can be estimated, with enough effort).
  • Margin estimates are further complicated by who pays shipping and duties — and this often varies by customer and market.

Consequently, most industry margin estimates delivered by analysts, academics or consultants are developed from aggregate financial data (as reported by public companies, at least) for companies “in the same industry.”  That way, one needn’t know anything about companies’ pricing cascades, just how it all nets out.  Yet SIC classes are known to be notoriously unreliable for grouping like-with-like, casting into doubt whether most groupings are actually representative of the industry in question; and there are considerable challenges in using aggregate financial data:

  • If you use total operating margins (for example), you have abstracted away from needing to understand competitors’ price cascades; but you don’t know what is “in” the reported operating margin.  Companies report very differently (even in compliance with GAAP), and they often have good reasons to bias their reported metrics in one way or another (bonus metrics, for example).
  • Not only must different companies’ reporting be harmonized (usually by the reporting service, and in ways you may not agree with or even discover), but that aggregate number rolls up:
    • Customer types and sizes — yet customer mix varies between companies, even those in the same industry.
    • Product types — different types of products carry different margins, and product mix generally varies across companies in the same space.
    • Business models — some companies price the hardware for less, then make their margins on services and/or parts; if you look at operating margins for products only, you may be misled; yet if you look at margins in total, you may be including unrelated businesses, because…
    • Lines of business — firms (especially larger ones) rarely operate in the same set of businesses as all their peers — and many companies do not break out detailed metrics by line of business.

Controlling for all these factors is very difficult (if not impossible) across the broad range of companies which would be required to establish benchmarks for an “industry norm.”  And the more narrowly one defines the industry, the less likely metrics are available.

So, what can you do?  Pick a small number of key competitors and develop estimates for them based on a combination of their reported financials and targeted research into their particular margin drivers (product mix, customer mix, business models, etc.).  This won’t be an industry benchmark (because you haven’t surveyed the industry) but it will tell you what you really need to know — which is how you might differ from key competitors.  Developing this information will require some work and informed business judgment; it won’t be available in someone’s database.

Most important, if you are comparing your performance metrics to others’, you need to understand — and adjust for — how the drivers of those metrics differ between your business and theirs.  Only then can you infer (for example) that your operations or pricing are better or worse than others’.

In US-China Trade War, Is India the Winner?

In US-China Trade War, Is India the Winner?

US-China trade tensions are mounting, with fears of a trade war roiling markets.  Yet so far, tariffs have mostly been threatened but not yet imposed, except for some US steel, aluminum, and solar panel tariffs.  It’s reminiscent of the “Phoney War” of the late 1930s, when things quieted down for awhile after the Nazi invasion of Poland.

Just as the “Phoney War” presaged major action, the current US-China trade posturing is likely to end in real and significant changes in the US-China trade relationship.  In particular, US imports of Chinese industrial goods and finished products are likely to be affected — perhaps by “voluntary” export restraints similar to those the Reagan Administration negotiated with Japan.  In addition, restrictions are likely to affect Chinese investment in American companies working in sensitive technologies such as AI, robotics, aircraft design, etc.

Overall, the effect will be to somewhat constrain American sourcing from Chinese companies — regardless of where they are located.

In combination with China’s eroding cost advantages, this means American companies currently sourcing from China and/or Chinese companies may need to diversify their supply bases with additional sources of cost-advantaged production.  One promising option is India.  Already a global source for IT services, India is rapidly building manufacturing capability.  Chinese companies themselves, as they lose their cost advantages to higher labor costs, are themselves outsourcing to India, as well as Southeast Asian countries.  Yet among the “MITI-V” (Malaysia, India, Thailand, Indonesia, and Vietnam), India may be the most promising candidate to be the next “factory for the world.”  India has five relative advantages in the MITI-V group:  massive scale; an English-speaking workforce; a proven ability to work with non-domestic customers; improving infrastructure; and a government enthusiastically pursuing industrial development (just as China’s did).

Forward-thinking leaders should be exploring supply base diversification, and considering India.

Four Keys to an Optimized R&D Portfolio

Four Keys to an Optimized R&D Portfolio

Is your R&D portfolio producing the right balance of incremental improvements and innovative projects necessary to stay ahead of the competition?  Are you funding too many incremental improvements over potential breakthrough innovations?  Is focusing on ROI providing you the right portfolio mix?

These are the types of questions that many of our clients are facing as they strive to outpace the competition.  This competition is advancing from all sides, including traditional competitors as well as upstarts coming seemingly out of “left field.”  In order to win in the marketplace, product development and manufacturing companies need a robust R&D portfolio, one that provides a well-rounded pipeline of future products.

Companies typically don’t lack for interesting potential projects or programs vying to be included in the portfolio — they lack the appropriate mechanisms and strategic rigor to determine what projects should “make the cut” (and receive the needed funding and personnel).  What can be done to address this?  Our experience points to 4 key elements:

Align Strategically — specify whether and how a project explicitly furthers strategic goals.  Many companies fund projects in the portfolio by focusing primarily on what we call “value to the company”, such as ROI.  Including value to the company is necessary, but not sufficient in portfolio optimization — overreliance on it results in an unbalanced portfolio.  Strategic alignment focuses on how well the candidate project advances strategic goals, ideally by market segment.  The prerequisite here is clarity regarding the competitive goals of the company (by product line) in each segment and geography, as well as a clear understanding of “how you’ll win” in each.

Tie to Value to the Customer — identify the specific value that the project brings to the customer.  This value is defined by the factors that are most important to the customer.  This is not easily determined, but is critical to an optimized portfolio and provides the added benefit of focusing on a deeper understanding of customer needs and how your products are used by customers to create value.  For one customer, we created a graphic representation — based on analytics established by Marketing & Engineering — that clearly depicts this value across a few key criteria versus both the competitive product and the closest internal product.

Categorize – another key to attaining (and maintaining) an appropriately balanced product portfolio is to assess and categorize types of projects flowing into R&D — are they breakthroughs, differentiators, followers?  When we did this at one of our large manufacturing clients, they realized that their R&D portfolio was too heavily weighted toward incremental improvement (“me too”) projects and not enough truly innovative potential “game changers.”  A rigorous set of criteria and assessment to determine the category in which a project resides enables proper allocation and encourages development teams to focus on the ways to create value that matter most to customers.

Simplify – new product proposals/justifications typically rely on lengthy documents, spreadsheets, presentations, etc. in an effort to display rigor and provide proposal gravitas.  Yet the executive team making R&D portfolio decisions can rarely read (much less digest) all this documentation.  If the elements outlined above are rigorously and consistently developed, then it’s possible to concisely pull all of the information together into a short (even single page!) document highlighting the key elements required for decision-makers to make an informed R&D portfolio decision, or inquire more deeply into the issues that really matter.

Incorporating these keys into your company’s process for shaping the R&D portfolio will not only focus your decision-making, but it will result in a strategically optimized product portfolio to stave off (and gain market share) from competitors.

Blockchain and Business Models

Blockchain and Business Models

Blockchain is entering the business mainstream (it’s not just for BitCoin), and technology vendors are racing to establish position in hopes of becoming major platforms (just search “business applications of blockchain” to get a taste).

Blockchain is the technology underlying cryptocurrencies like Bitcoin — but its utility goes far beyond cryptocurrencies.  At core, blockchain is a secure, peer-to-peer (distributed) database — a ledger of transactions.  Because it is shared, encrypted, and auditable, it is extremely difficult to forge or cheat; each block (transaction) is dependent on those that surround it.  It can be permissioned, so only validated participants can view or transact in it.  And “smart contracts” (automated transactions which execute only when certain conditions are met) can be embedded within Ethereum blockchain, enabling secure, frictionless transacting on a massive scale.  (Indeed, Ethereum can be thought of as a publicly-accessible yet secure distributed computing platform.)

The secure, distributed ledger obviates the need to reconcile the different ledgers of all the participants in a chain of transactions, and supplies a common, secure, transparent “source of truth” for all the participants.  This makes blockchain particularly useful for processes where transactions occur among many participants; trust is required; and being able to verify the legitimacy and identity (even if anonymized) of participants is critical, such as:  healthcare records; voting; supply chains; and especially financial services such as banking and insurance.  Being able to process transactions with greater “efficiency, security, privacy, reliability, and speed” could revolutionize many business processes.  (

The reduction in transactional friction enabled by blockchain will have broad-based benefits, but the more far-reaching effects may be in the enablement of new business models.

A business model describes how value is created, harvested, and distributed.  One familiar example is the “razors and blades” model, wherein the razor is sold at relatively low margin to lock the buyer into using proprietary blades — which are then sold at a high margin.  (Consumer printers are predominantly sold with this model as well.)  The participants in this model are the individual consumer; distributors and retailers; and the manufacturer of the products.  The value is whatever the consumer will pay to get a shave; the powerful part of this model is that most of this value is harvested by the manufacturer over time via the sale of consumables (blades, or toner cartridges in the case of printers); and shared by the vendor and the sales channel.

Now, consider the conventional business model for insurance:  the participants are the buyer (either individual or an entity); the underwriter (insurance company); and the sales channel.  Value is created in two ways:  in the first (underwriting), risk is pooled by the insurer (across time and space), and priced to each customer as a fraction of that pool.  This works because what is a one-time risk for the insured, when pooled with many other similar risks over time and geographies, becomes a predictably probabilistic risk for the underwriter.  The second way value is created is by the insurer earning returns on the invested capital covering all the risks.  Insurers generally make most of their money on the latter (not underwriting) — especially because the administrative costs of quoting, underwriting, issuing contracts (policies), collecting premiums, claims service, etc. are substantial.

Blockchain’s first impact on the insurance business model is in reducing these administrative costs and enabling new capabilities within the current business model, such as on-demand insurance:

“Insurers are riddled with inefficient processes in every part of the value chain, which creates a plethora of opportunities to leverage a technology like blockchain.  Fundamentally, blockchain technology is a series of distributed ledgers that allows for trusted interactions to occur with immutable audit trails. The concept of a “Smart Contract” in a blockchain, associated with an event or an object, would allow for on-demand risk assessment with just-in-time underwriting based on simultaneous access to a single set of trusted facts, shorter duration, event-based personalized, insurance products and dynamic claims events without first notice of loss (FNOL), all without a customer trigger or fraud. As a result, this will dramatically lower transaction costs and risks, lower premiums, revolutionize the customer experience and expand the insurance customer base” (

But beyond that, blockchain could enable new insurance business models, such as broadly crowd-funded or peer-to-peer insurance.  (  In crowd-funded insurance, the underwriter focuses on risk assessment and pricing, and moves away from asset management (which dramatically reduces capital intensity for the insurer).  Instead, the insurer posts expected returns, and interested investors bid for the contracts (or portions).  Up to this point, this model looks like Lloyd’s, or peer-to-peer lending markets.  But blockchain smart contracts make the execution processes transparent and automated, even guaranteeing payments (with no need of a bank), and without the insurance company managing a large pool of capital.  Instead, a much broader pool of investors can participate, still holding the capital themselves (unlike a syndicate such as Lloyd’s, which has a limited number of “names”).

In this model, insurance could be less costly to customers, and it might be easier to insure very specific risks.

Of course, such a model is much more attractive to new entrants than to incumbents in the business, who already have accumulated capital assets to manage for their own benefit (and pay claims when necessary).

Blockchain may have implications for your business — it may even empower new competitors you can barely imagine.  And it’s coming fast.