Sunday, July 4, 2010

Andy Grove: How to Make an American Job Before It's Too Late

(H/T: Naked Capitalism and Bloomberg News)

When Yves Smith of Naked Capitalism suggests we read
something, I usually take notice.

Yesterday, she directed her readers to an article by Andy Grove
(one of the founders of Intel), calling for drastic changes in
American industrial policy, specifically toward startups,
innovation, scaling, and manufacturing job creation.

The piece is long, detailed, and worth reading in full, but
the central point is this: An economy that innovates
prolifically but consistently exports its jobs to lower
cost overseas locations will over time not only lose its
capacity for mass production but also its very ability
to innovate.

So compelling and important is this piece that I am
going to present it here substantially in its entirety:

Dr. Grove:

" Recently, an acquaintance at the next table at a
Palo Alto , California restaurant introduced me to
his companions: three young venture capitalists
from China. They explained, with visible excitement,
that they were touring promising companies in
Silicon Valley. I've lived in the Valley a long time,
and usually when I see that the region has become
such a draw for global investment, I feel a little proud.

" Not this time. I left the restaurant unsettled. Something
didn't add up. Bay Area unemployment is even higher
than the 9.7 per cent national average. Clearly, the great
Silicon Valley innovation machine hasn't been creating
many jobs of late - unless you count Asia, where
American technology companies have been
creating jobs like mad for years.

" The underlying problem isn't simply lower Asian costs.
It's our own misplaced faith in the power of American
startups to create U.S. jobs. Americans love the idea of
the guys in the garage inventing something that changes
the world. New York Times columnist Thomas L. Friedman
recently encapsulated this view in a piece entitled
"Startups, Not Bailouts" . His argument: Let tired old
companies that do commodity manufacturing die if
they have to. If Washington really wants to create jobs,
he wrote, it should back startups.

Mythical Moment

" Friedman is wrong. Startups are a wonderful thing, but
they cannot by themselves increase tech employment.
Equally important is what comes after that mythical
moment of creation in the garage, as technology goes
from prototype to mass production. This is the phase
where companies scale up. They work out design details,
figure out how to make things affordably, and hire
people by the thousands. Scaling is hard work but
necessary to make innovation matter.

" The scaling process is no longer happening in the U.S.
And as long as that's the case, plowing capital into young
companies that build their factories elsewhere will
continue to yield a bad return in terms of American jobs.

" Scaling used to work well in Silicon Valley. Entrepreneurs
came up with an invention. Investors gave them money to
build their business. If the founders and their investors were
lucky, the company grew and had an initial public offering,
which brought in money that financed further growth.

Intel Startup

" I am fortunate to have lived through one such example.
In 1968 two well-known inventors and their investor
friends anted up $ 3 million to start Intel Corp., making
memory chips for the computer industry. From the
beginning, we had to figure out how to make our chips
in volume. We had to build factories, hire, train, and
retain employees; establish relationships with suppliers;
and sort out a million other things before Intel could
become a billion-dollar company. Three years later it went
public and grew to become one of the biggest technology
companies in the world. By 1980, which was about ten
years after our IPO, about 13,000 people worked for
Intel in the U.S.

"Not far from Intel's headquarters in Santa Clara,
California, other companies developed. Tandem
Computers went through a similar process, then
Sun Microsystems, Inc., then Cisco Systems Inc.,
Netscape Communications Corp., and on and on.
Some companies died along the way or were absorbed
by others, but each survivor added to the complex
technological ecosystem that came to be
called Silicon Valley.

" As time passed, wages and health care costs rose in the
U.S., and China opened up. American companies
discovered that they could have their manufacturing
and even their engineering done cheaper overseas.
When they did so, margins improved. Management
was happy, and so were stockholders. Growth
continued, even more profitably. But the job machine

U.S. Versus China

" Today, manufacturing employment in the U.S. computer
industry is about 166,000 - lower than it was before the first
personal computer, the MITS Altair 2800, was assembled in
1975. Meanwhile, a very effective computer manufacturing
industry has emerged in Asia, employing about 1.5 million
workers - factory workers, engineers, and managers.

" The largest of these companies is Hon Hai Precision Industry
Co., also known as Foxconn. The company has grown at an
astounding rate, first in Taiwan and then in China. Its revenue
last year was $ 62 billion, larger than Apple Inc., Microsoft Corp.,
Dell Inc. or Intel. Foxconn employs more than 800,000 people,
more than the combined worldwide head count of Apple,
Dell, Microsoft, Hewlett-Packard, Intel and Sony Corp.

10 -to- 1 Ratio

" Until a recent spate of suicides at Foxconn's complex
in Shenzhen, China, few people had ever heard of the
company. But most know the products it makes -
computers for Dell and H-P, Nokia cellphones,
Microsoft XBox 360 consoles, Intel motherboards,
and countless other familiar gadgets. Some 250,000
Foxconn employees in Southern China produce all
of Apple's products. Apple, meanwhile, has about 25,000
employees in the U.S. - that means for every Apple worker
in the U.S. there are 10 people in China working on iPods,
iMacs, and iPhones. The same roughly 10-to-1 relationship
holds for Dell, disk-drive maker Seagate Technology,
and other U.S. tech companies.

" You could say, as many do, that shipping jobs overseas
is no big deal because the high-value work - and much
of the profits - remain in the U.S. That may well be so.
But what kind of a society are we going to have if it consists
of a few highly paid people doing high-value-added work -
and masses of unemployed?

" Since the early days of Silicon Valley, the money invested
in companies has increased dramatically, only to produce
fewer jobs. Simply put, the U.S. has become wildly inefficient
at creating American tech jobs. We may be less aware of this
growing inefficiency, however, because our history of creating
jobs over the long term - the last fifty years - has been
spectacular, masking our greater and greater spending
to create each position.

Tragic Mistake

" Should we wait and not act on the basis of early indicators?
I think that would be a tragic mistake because the only
chance we have to reverse this deterioration is if we
act early and decisively.

"Already the decline has been marked. It may be
measured by way of a simple calculation ; the employment
cost-effectiveness of a company. First, take the initial
investment plus the investment during a company's IPO.
Then, divide that by the number of employees working in
that company ten years later. For Intel, this worked out to
be about $650 per job - $3,600 adjusted for inflation.
National Semiconductor Corp., another chip company,
was even more efficient at about $2,000 per job.

" Making the same calculations for a number of
Silicon Valley companies shows that the cost creating
U.S. jobs grew from a few thousand dollars per position in
the early years to $100,000 today. The obvious reason:
companies simply hire fewer people as more and more
work is done by outside companies, usually in Asia.

Alternative Energy

" The job-machine breakdown isn't just in computers.
Consider alternative energy, an industry where there
is plenty of innovation. Photovoltaics, for example, are a
U.S. invention. Their use in home-energy applications
was also pioneered by the U.S.

" Last year, I decided to do my bit for energy conservation
and decided to equip my house with solar power. My wife
and I talked to four local solar firms. As part of our due
diligence, I checked where they get their photovoltaic panels
- the key part of the system. All of the panels they use come
from China. A Silicon Valley company sells equipment used
to make photo-active films - and they ship close to ten times
more machines to China than the U.S. - and the gap is growing.
Not surprisingly, estimated U.S. employment in the making
of photovoltaic films, panels, and the equipment to produce
them is about 10,000 - a few per cent of total worldwide

Advanced Batteries.

" There's more at stake than just exported jobs. With
some technologies, both scaling and innovation take
place overseas. Such is the case with advanced batteries.
It has taken years and many false starts, but finally we
are about to witness mass-produced electric cars and trucks.
They all rely on lithium-ion batteries. What microprocessors
are to computing, batteries are to electric vehicles.
Unlike microprocessors, the U.S. share of lithium-ion
battery production is tiny.

" That's a problem. A new industry needs an effective
ecosystem in which technology knowhow accumulates,
experience builds upon experience, and close relationships
develop between supplier, manufacturer, and customer.
The U.S. lost its lead in batteries 30 years ago when it
stopped making consumer electronic devices.
Whoever made batteries then gained the exposure and
relationships needed to learn to supply batteries for the
more demanding Laptop PC market, and after that for the
more demanding automotive market.

"U.S. companies didn't participate in the first phase and
consequently weren't in the running for all that followed.
I doubt that they will ever catch up.

Job Creation

" Scaling isn't easy. The investments required are
much higher than in the invention phase. And funds
need to be committed early, when not much is known
about the potential market. Another example from Intel:
The investment to build a silicon plant in the 1970's was a
few million dollars. By the early 1990's, the costs of the
factories that would be able to produce the new Pentium
chips in volume rose to several billion dollars. The decision
to build these plants needed to be made years before we
knew whether the Pentium chip would work or whether
the market would be interested in it.

"Lessons we learned from previous missteps helped us.
Years earlier, when Intel's business consisted of making
memory chips, we hesitated to add manufacturing capacity,
not sure of the market demand in years to come.
Our Japanese competitors didn't hesitate: they built the
plants. When the demand for memory chips exploded,
the Japanese roared into the U.S. market and Intel
began its decline as a memory-chip supplier.

Intel Experience.

" Though steeled by that experience, I remember how
afraid I was as I asked the Intel directors for authorization
to spend billions of dollars for factories to make a product
that didn't exist for a market we couldn't size.
Fortunately,they gave their OK even as they gulped.
The bet paid off.

" My point isn't that Intel was brilliant. The company
was founded at a time when it was easier to scale domestically.
For one thing, China wasn't yet open for business. More
importantly, the U.S. hadn't yet forgotten that scaling
was crucial to its economic future.

" How could the U.S. have forgotten? I believe that the
answer has to do with a general undervaluing of
manufacturing --- the idea that as long as "Knowledge Work"
stays in the U.S., it doesn't matter what happens to factory
jobs. It's not just newspaper columnists who spread this idea -
but politicians and academics as well.

Off shore Production.

" Consider this passage by Princeton economist Alan S. Blinder:

"The TV manufacturing industry really started here,
and at one point employed many workers. But as TV
sets became 'just a commodity' the production moved
offshore to locations with much lower wages. And
nowadays the number of TV sets manufactured in
the United States is zero. A Failure? No --- a success! "

" I disagree. Not only did we lose an untold number of jobs,
we broke the chain of experience that is so important in
technological evolution. As happened with batteries,
abandoning today's "commodity" manufacturing
can lock you out of tomorrow's emerging industry.

" Our fundamental economic beliefs, which we have
elevated from an observation to an unquestioned truism,
is that the free market is the best economic system - the
freer, the better. Our generation has seen the decisive
victory of free-market principles over planned economies.
So we stick with this belief, largely oblivious to emerging
evidence that while free markets beat planned economies,
there may be room for a modification that is even better.

No. 1 Objective.

" Such evidence stares at us from the performance of
several Asian economies in the past decades. These
countries seem to understand that Job Creation
(italics mine - TTN) must be the number one objective
of state economic policy. The government plays a
strategic role in setting the priorities and arraying
the forces necessary to achieve that goal.

" The rapid development of the Asian economies
provides numerous illustrations. In a thorough study
of the development of East Asia, Robert Wade of the
London School of Economics found that these
economies turned in precedent-shattering performances
in the 1970's and 1980's because of government involvement
in the targeting the growth of manufacturing industries.

"Consider the "Golden Projects" - a series of digital
initiatives in the late 1980's and 1990's. Beijing was
convinced of the importance of electronic networks - used
for transactions, communications, and co-ordination - in
enabling job creation, especially in the less developed parts
of the country. Consequently, the Golden Projects
enjoyed priority funding. In time, they contributed to
the country's rapid development of China's information
infrastructure and the country's economic growth.

Job-Centric Economy

" How do we turn such Asian experience into intelligent
action here and now? Long-term, we need a job-centric
economic theory - and job-centric political leadership -
to guide our plans and actions. In the meantime,
consider some basic thoughts from a onetime factory guy.

" Silicon Valley is a community with a strong tradition of
engineering, and engineers are a peculiar breed. They are
eager to solve whatever problems they encounter. If
profit margins are the problem, we go to work on margins,
with exquisite focus. Each company, ruggedly individualistic,
does its best to expand efficiently and improve its own
profitability. However, our pursuit of our individual
businesses, which often involves transferring a great
deal of manufacturing and engineering out of the country,
has hindered our ability bring innovations to scale here at home.

" Without scaling, we don't just lose jobs - we lose our
hold on new technologies. Losing our ability to scale
means losing our ability to innovate.

" A story goes around that an engineer was to be executed
by guillotine. The guillotine was stuck, and tradition
demanded that if the blade didn't drop, the condemned
man was set free. Before this could happen, the engineer
pointed with excitement to a rusty pulley, and told the
executioner to apply some oil there. Off went his head.

"An example: Five years ago a friend of mine joined
a large VC firm as a partner. His responsibility was to
ensure that every startup they funded had a
"China Strategy" - meaning , a plan to ship as many jobs as
they possibly could to China. He was going around with
an oil can, applying drops to the guillotine in case it
was stuck. We should put away our oil cans. Every
VC firm should have a partner in charge of every startup's
"U.S. Strategy".

Financial Incentives

" The first task is to rebuild our industrial commons.
We should develop a system of financial incentives.
Levy an extra tax on the product of offshored labor.
If the result is a trade war, treat it like any other war -
fight to win. Keep that money separate. Deposit it in
the coffers of what we might call the Scaling Bank
of the U.S. and make these sums available to companies
that will scale their American operations. Such a system
would be a daily reminder that while pursuing our company
goals, all of us in business have a responsibility to maintain
the industrial base on which we depend and the society
whose adaptability - and stability - we may have taken
for granted.

" I fled Hungary as a young man to come to the U.S. in
1956. Growing up in the Soviet bloc, I witnessed firsthand
the perils of both government overreach and a stratified
population. Most Americans aren't aware that there was a
time when tanks and cavalry were massed on Pennsylvania
Avenue to chase away the unemployed. It was 1932; thousands
of jobless veterans were demonstrating outside the White House.
Soldiers with live ammunition and fixed bayonets moved in,
herding them away from the White House. In America!

" Unemployment is corrosive. If what I'm suggesting is
protectionist, so be it. Yet the imperative for change is
real, and the choice is simple.

"If we wish to remain a leading economy, we change on
our own, or change will continue to be forced upon us. "

(Andy Grove is a senior adviser to Intel Corp. and was Intel
Chairman and CEO from 1987 to 2005)

1 comment:

  1. Brilliant article! Dr. Andy Grove is a great man who did a great service by writing this article. The left and the right should abandon support for outsourcing, shipping jobs overseas, whatever it is called. Above all else because it is unpatriotic! America has had few worse fates than outsourcing, and well-known politicians of all stripes are responsible! Fuck them! What the heck is Obama's plan for job creation? To fight outsourcing and create American jobs- pretty much the same thing- Dr. Grove should be drafted into the White House so Obama can get a clue! Dr. Grove also has experience creating jobs, much more than the pretenders in federal, state, and local races nowadays.

    Oh, and a funny little line I just thought of. Slavery in America's past is superior to today's outsourcing because at least slaves had the opportunity to work in America. Slaves were taken care of also, at least slaves had just enough to eat and drink so they would function properly. No slavemaster would throw his money away by allowing property to die off. If only today's multinational corporate CEO's had as much heart. There is always so much throwaway rabble to hire on the street, they think. But they won't, just to increase their damned balance sheet.