Expensive Oil, Stupid Trade Groups, and Pending Enterprise Software Growth

USA Today had an interesting article today that calls into question a few of the doomsday scenarios that have dominated US policy-makers and those for whom policy has been made over the last decade or so. And in the process America’s newspaper debunks some stupid policy issues on the subject of offshore drilling, offshore manufacturing, among others.

USA Today had an interesting article today that calls into question a few of the doomsday scenarios that have dominated US policy-makers and those for whom policy has been made over the last decade or so. And in the process America’s newspaper debunks some stupid policy issues on the subject of offshore drilling, offshore manufacturing, among others.

The gist of the article is contained in the following statement:

“Shipping a standard 40-foot container from Shanghai to the U.S. East Coast in May cost about $8,000, vs. $3,000 eight years ago, when oil was around $20 a barrel.”

This little nugget contains the essence of a potentially enormous shift in the U.S. manufacturing economy that may effectively reverse the decades-long practice of off-shoring. And in the process the article signals why enterprise software is going to do very well over the next few years, regardless of when the current recession wanes or even if there is ever a massive shift back to on-shoring that the USA Today article postulates.

The amazing thing about this almost three-fold increase in shipping costs is not that it’s happening, but that it’s coming in the context of two other factors that are tending to push manufacturing back to the US: The first is the growing inflation in less-developed manufacturing countries that has begun to push labor and other costs higher, making off-shore manufacturing less cost-effective than it was when the trend started. Simultaneously, the disastrous quality issues that emerged in the off-shore manufacture of toys (leaded, despite policies and regulations to the contrary) and drugs like heparin (contaminated, despite polices and regulations to the contrary) have spurned more than a few manufacturers to reconsider the cost of off-shoring in light of the costs of quality control and the risk of a fatal loss of customer satisfaction.

What is clear is that with shipping costs increasing, quality threatened, and manufacturing costs rising in less-developed countries, off-shoring is starting to look less like the no-brainer it seemed to be at the outset of the trend. Or as USA Today puts it:

“… the calculations that drove a doubling in global trade volume since 2000 and the establishment of far-flung supply networks might require rethinking. Orders might be placed with factories closer to home. Shuttered assembly lines could be given new life. And suddenly, the confident claims of globalization's cheerleaders that distance doesn't matter would ring hollow.”

So, what’s the impact of this. First is that U.S. manufacturing looks like it will be a major beneficiary of this change in the value equation of off-shoring. Spurred by expensive oil – and reinforced by quality and inflation problems in offshore countries – companies all over the world may look to bring manufacturing closer to the world’s largest market. This boost to U.S. manufacturing may take some time to have an impact, but, with oil prices not expected to go back to the glory days of sub $100 per barrel, time is on manufacturing’s side.

The second beneficiary will be the enterprise software vendors that build the supply chain, logistics, and ERP systems that optimize manufacturing strategies. The shift in the value of off-shoring will engender a major analytical push by manufacturers to ensure that product X is being built with the lowest possible energy – and while we’re at it, carbon – footprint. This means building more sophisticated enterprise transaction and analysis systems in order to make the strategic decisions needed to know when to offshore and when to onshore. It’s going to be a major boost for a software sector that has thus far weathered the current recession well, precisely because of its ability to assist in optimizing the use of resources in the enterprise regardless of which way the economic wind is blowing.

Meanwhile, this trend may also help get US manufacturers out from under some of the moribund policies that are being promoted by one of the top manufacturing trade groups, National Association of Manufacturers, which has been run over the years by a team that believes that carrying water for current administration policies trumps promoting good policy choices for its constituents. NAM’s position on energy policy is a good case in point: the organization has pushed hard for more oil drilling, first in the Alaskan wilderness, and now offshore, on the short-sighted premise that the only thing good for US manufacturing is cheap oil.

Meanwhile, as the USA Today article shows, there are actually some real net gains for US manufacturing from expensive oil, and that’s not counting on the growth of energy-related manufacturing that is based on mitigating the impact of higher energy prices. The growing use of photovoltaics and wind-based energy resources, new products that support more complex energy conservation processes, and all manners of green construction products are part of a growing manufacturing push that needs expensive oil in order to succeed. This trend has been happening in Denmark since the 1970s, and, as the New York Time's Tom Friedman reports, this energy-efficiency manufacturing sector generated $10.5 billion in export revenues last year in Denmark. Not too shabby, to say the least.

Indeed, one of the main beneficiaries of expensive oil may be the rebirth of the nuclear power industry in the US, which would portend a major building boom and would, in my opinion be worth the investment even considering the potential safety issues (which I believe are largely comparable to the problems associated with mining coal, which not only claims many more lives per year on the mining side than nuclear energy development in the US ever claimed, but also has a largely similar long-term environmental impact in the form of global warming and associated issues.) In all fairness, I should point out that, when it comes to nuclear, NAM and I agree.

Regardless of whether nuclear power makes a comeback or not, the fact is that rising energy prices are having potentially very positive impacts on the manufacturing sector. This is not to trivialize the problems of rising energy costs, but to emphasize that cheap energy – which isn’t coming back anyway – isn’t necessarily the panacea we need to strive for. Indeed, US manufacturers are going to find that there's a silver lining in high energy prices, and if they can, the smart ones will exploit it to their benefit.

The scenario is almost mind-boggling: if the upshot of higher energy (along with inflation and quality problems in less-developed manufacturing countries) results in increased domestic manufacturing, we'll emerge from the current recession stronger in more ways than we ever thought possible. And so will enterprise software, which will benefit from this boom regardless of the actual net increase in domestic manufacturing that results.

So, inside the wild ride we're going through with energy costs is a potential silver lining that may, in the long run, have a greater net benefit than anyone could have imagined. Will this benefit balance out the negatives? We'll have to see. But, with some sound policy management, hopefully from the manufacturing trade associations themselves, and some good strategy management, we may get to make lemonade out of this energy lemon yet. It's definitely possible, it's up to all of us to make it happen.