Issue link: https://industrialmanagement.epubxp.com/i/285723
march/april 2014 23 Pushed by relentless cost pressures, many companies in the developed world want to use production in low-wage countries to reduce expenses. In many cases, it is just too hard to compete against products made using labor that costs significantly less. While recent news accounts of offshoring gone bad in countries such as China and Bangladesh might make them tread more carefully, the lure of low wages is hard for many companies to resist. However, as some corporations choosing to source from low-wage countries have found, there may be unexpected problems that were not factored into their decision. Under- standing these soft risks – factors that may be difficult to detect, measure and guard against but that can be frighten- ingly powerful – often helps determine success or failure of an organization's move into areas that offer low-wage production. If the risks are considered acceptable and the project gets the green light, good local assessment and community engagement can help find solutions and build a positive outcome. Understand the risks vs. the costs Choosing where to manufacture always involves trade-offs. In developed world countries, the costs may be high for inputs such as wages, pensions and benefits, regulatory compliance and real estate. Generally, these costs are lower in the developing world. However – and this point tends to get missed by many global players – the developed world also offers a more predictable environment. Tax rates are transparent and generally stable, so these costs are easy to calculate. There is rule of law, so companies can count on continuing to own what they have bought. Intellectual property rights are understood and generally respected. It may take some time to obtain regulatory approval, but the process is reliable and transparent. It all adds up to a picture of high predictability. In other words, the higher costs are balanced by lower opera- tional risk. Contrast this with many developing world environments. What company representatives often find when getting off the plane in Lagos, Nigeria, Kuala Lumpur, Malaysia, or Bogota, Colombia, is the appearance of what they're used to. Environmental regulations, tax rates, payroll taxes and other factors are stated clearly. Transport routes, water supplies and electrical substations are mapped out well. It may take some time to find out where reality does not match the picture presented. The roads could turn out to be muddy, nearly impassable tracks. The electrical power comes on only a few hours a day. And police and government officials might be more interested in supplementing their own low wages than they are in enforcing the laws. Companies that do not take the time and effort to measure and mitigate these soft risks are setting themselves up for a costly lesson. For example, consider an opportunity that we investigated in northern Haiti. The country's government was eager to grow the manufacturing capacity of that region. However, a deeper look found that there was almost no infrastructure regarding transportation networks, water or power supply. Health and safety provi- sions were low. Corruption was high. The lack of skilled labor meant a need for additional investment in capacity building. This opportunity of low wages might have looked good on the surface, but it was too risky to implement. Sometimes organizations want to examine existing operations to see why they are not performing as they should. Often, our investigation shows that the failures are related to those soft risks that are not easily measured, issues that are well outside developed world realities. Lack of respect for people at the operational site and abuse of power in the hands of local management, plus inattention to social risk, failure to reach out to local communities and labor, and little understanding in the head office of the social dynamics at the site – all of these factors could lead to slowed or stopped production. At an oil and gas production facility in South America, for example, our investi- gation revealed what was in effect a caste system – managers had access to privi- leges not given to lower rank employees. Unskilled laborers, many of them indigenous people, slept on the ground in shelters and were provided with low quality food. It was clear that there was little control by the head office, as well as limited understanding of the realities and dynamics on site. This led to abuse of power by local management. A case of sexual abuse at the site led to a protest that caught up many of the unskilled workers, who saw in this an opportunity to express their anger against the abuses of local management. The protesters burned part of the camp, stopping production. The lost production, loss of trust of local communities working there, plus the costs of rebuilding the camp and relationships with labor and commu- nities, turned into an expensive "learning opportunity." The problem might have been avoided if the company had taken steps to analyze the social situation at the camp and then set up ways to manage its managers better. Risk audits need to probe beneath the surface To be effective, analysis of a location for a new venture, such as a greenfield plant, needs to probe beneath the surface. This should start with aspects of the past that may affect the future, such as the legacy of civil war in countries such as Honduras and Nicaragua. It is also important to look at other legacies that continue into the present, such as the drug trade in Mexico and clashes between religious groups in parts of Africa. An effective risk audit examines the physical environment, such as the factors that contribute to accessible electrical power and the water supply. For example, will there be enough water to meet production needs, as well as restrooms for 2,000 employees? The audit also must consider the social environment, including local It may take some time to find out where reality does not match the picture presented. IM MarApr 2014.indd 23 3/24/14 12:13 PM