September 17, 2008
By Charles Cresson Wood
The world has changed dramatically, and the traditional business models used by many firms in the United States are dangerously out-of-date. The world’s total production of oil is about to peak, is now peaking, or has very recently peaked. This means that petroleum-based fuels such as gasoline and petro-diesel will soon be markedly more expensive and much more scarce. This also means that the supply networks providing these fuels will become dramatically more unreliable. This article discusses a few business model implications of this new situation. While these implications are wide-ranging, we will restrict this discussion to: (1) minimizing internal operations to the core competencies of the organization, and (2) exploiting lower wage rates in foreign countries via offshoring. The position taken here is that these strategic business model objectives are now passé and need to be rethought in light of the new energy supply reality.
Management consultants for years have been urging clients to focus on core competencies. By this the consultants mean what a firm can do well, something that could provide a competitive advantage. Activities that are not seen as core competencies should, with this theory, be divested and outsourced to other firms, in order to free up resources that can then be invested in the improvement of core competencies.
While this approach made sense in an era where inexpensive energy (primarily petroleum) was readily available, it no longer makes sense. The core competency approach assumes that outside firms will be able to reliably deliver products and services. In an era of rapidly depleting fossil fuels, the continued viability of other businesses, particularly those that have not taken aggressive steps to accommodate the new energy reality, is in doubt. For example, the continued existence of many airlines is in great question now that fuel costs have risen so much. Thus businesses that continue to employ the core competency approach will take on unnecessary business risks, and jeopardize their own firm’s existence, when and if they rely on outside firms to provide critical activities.
Instead, organizations should be identifying the critical activities that absolutely must continue to be provided, along the lines of a classical business interruption contingency planning process. Activities that are critical should then be brought in-house so that management can directly supervise them, can reengineer them so that they will continue to be available in the future of uncertain petroleum supplies. By bringing an activity in-house, management can then convert such a critical activity (such as product delivery to customers) from a reliance on petroleum-based fuels, to a reliance on renewable energy technologies. For example, the diesel trucks owned by a delivery service could be replaced by electric trucks owned by the firm distributing these products. The electricity for these new trucks could then be generated by solar panels, wind turbines, geothermal stations, and other renewable in-house and on-site systems that are not dependent on outside organizations. If an activity is highly-critical, for example military defense of a country, then spare parts for these new energy systems, and in-house maintenance staff, can also be set-up to further lessen the dependence on outside organizations.
With the old-fashioned way of looking at things, the diversity of supply found in the free marketplace will help to ensure that a certain product or service is provided by those who have the most expertise, the lowest costs, or some other particular competitive advantage. This theory, in conjunction with plentiful and relatively low-cost petroleum, led to outsourcing of much of America’s manufacturing to foreign countries such as China (AKA offshoring). The cost of shipping raw materials to these countries, and the costs of shipping the finished products back to the United States, over the most recent decades been considerably less than the reduction in labor costs thereby achieved. But in the era of increasingly-high energy costs, distance now matters a whole lot more than it did in the recent past. Increasing wage rates in these foreign countries are also unfavorably altered the economics of offshoring.
As a result, firms with heavy or bulky products, like auto company Tesla Motors and furniture manufacturer Ikea, are repatriating their manufacturing activities due to high shipping costs. The trend toward the localization of various business activities is additionally found in the recent efforts of companies like General Electric, DuPont, Alcoa, and Proctor & Gamble. Not only does this localization reduce shipping costs, it revitalizes local economies, and also reduces carbon emissions.
Offshoring arrangements where there is considerable shipping to and from foreign countries will soon become prohibitively expensive. High petroleum-based fuel costs will tip the equation increasingly toward local provision of raw materials, local provision of labor, local manufacturing, and local distribution. Supply chains will get shorter, less complicated, and more personalized. Those firms that continue to rely on foreign business partners in these offshoring arrangements risk the sudden cut-off shipments due to fuel shortages, fuel rationing, and very high fuel prices. Future military conflicts over access to energy supplies, as well as terrorist incidents focused on the petroleum production and distribution infrastructure, both have the potential to seriously disrupt these offshoring arrangements.
Instead of exploiting the lower wage rates found in foreign countries, an increasing group of forward looking organizations will soon be placing greater priority on operational reliability, predictability, and control. By bringing these activities back to the home country, and for critical activities, bringing the activities entirely in-house, an organization will be able to engineer internal processes so that they will be buffered from the increasingly fragile petroleum-based fuel situation. For these firms, the traditional notion of a company town looks interesting as we enter the era where energy supplies will be in increasingly restricted. With this approach, local on-site workers could be provided with housing, food, clothing, entertainment, etc. so that they need never leave the company town. Energy to support the business activities taking place in this company town could be generated entirely locally, ideally entirely in-house, with technologies such as bio-methane (also called renewable natural gas). This fuel can be generated by the bacterial decomposition of organic industrial waste, organic agricultural waste, or organic municipal waste. This fuel could be used to generate electricity, to power motor vehicles, and to heat buildings.
There are many other aspects of traditional business models that must be rethought so that they will be viable in the era of declining supplies of petroleum. These include the notion of just-in-time (JIT) inventory management, where the on-hand supplies of inventory will be minimized to keep carrying costs low, but the chances of a stock-out condition will be set at an acceptably low level. With the increasingly unreliable supplies of petroleum-based fuels that we will encounter in the years ahead, shipping companies will find it much more difficult to consistently meet customer delivery schedules. Instead, progressive firms will be considering business interruption contingency plans that will allow them to successfully weather delivery firm failures, delivery system delays, in-transit product piracy, and related problems. These contingency plans will often include larger on-hand inventories than were found in the recent past.
Perhaps it is time to review the business plan at your organization to determine whether it will be cost-effective in the new energy reality? Perhaps it is time to determine whether this business plan is truly sustainable in an era that will most likely be characterized by high petroleum prices, petroleum shortages, and petroleum rationing? Perhaps it’s time to integrate renewable energy technology into this business plan so as to come to terms with these issues?
Charles Cresson Wood, MBA, MSE, is an alternative fuels management consultant with Post-Petroleum Transportation, based in Sausalito, California. His most recent book is Kicking The Gasoline & Petro-Diesel Habit: A Business Manager’s Blueprint For Action. For more information about the book, as well as his alternative fuels blog, and a mechanism to contact him, go to www.kickingthegasoline.com.