Bringing Manufacturing Back Home

Authored by Christopher Helmrath, Founder & Managing Director, SC&H Capital

Over the past few weeks, we’ve heard lots of predictions and palaver about how industry and commerce is having to re-invent itself in response to the pandemic.

But there are some drivers to that sort of rapid transformation that haven’t been discussed enough. Among them is the role played by behavioral economics – think desperate acts in desperate times – and the role that psychological behavior plays in economic decision making. It’s an element we see at the beginning of that reinvention, which is catapulting domestic manufacturing and innovation on the factory floor (from Dyson and car manufacturers making ventilators to 3D printing of PPE products).

Another new twist that innovators are discovering are the challenges of sourcing. Where you obtained your raw materials and skills a year ago, and where you are going to get them in the next week or month look very different. One more big consideration? The myriad of investment opportunities generated by the spurt of industrial nationalism we’re seeing.

The late Nobel Prize-winning economist Milton Friedman made the point in a lecture entitled “The Lesson of the Pencil,” based on Leonard Reed’s essay. Holding up a pretty typical yellow pencil, he explored exactly how such a seemingly simple product came to be. First, the pencil company needed wood, perhaps from forests in the Northwest, then woodsmen and chain saws to harvest it, and a mill to shave the wood down into little hollow sticks. The rubber for the eraser had to be imported from South America or Southeast Asia, while the brass ring holding the eraser is made from an alloy using copper and zinc, and processed in recent years mostly in places like China, India, Japan, and Korea. And the graphite for the part that does the actual scribbling? Try mines in places like China, Mexico, Canada, Brazil, and Madagascar. No one company can make a pencil, it takes many smaller companies coming together.

Of course, many of these resources were available right here in the U.S. a century ago. But we ceded control of several of those industries to other countries in the name of lowering costs and juicing up the bottom line. Another interesting example is so-called rare-earth metals, which aren’t really that rare, and are found in North America, but are expensive to mine and process. They’re needed in electronics, including weapons and satellite software, and the Pentagon has quietly worried for years about depending too much in recent years on exports from China. And they’re right to worry.

There was a sort of reverse case in point right here in Baltimore about 120 years ago, when the nation didn’t depend on other countries for natural resources or essential products.

In the interest of lowering crew costs and speeding cargo deliveries, the shipbuilding industry, which was a big deal in Baltimore, was forced in just a few years to switch gears. What started as building wooden sailing ships, shifted to building steam-powered ships, then to steel-hulled steamers (the builders didn’t totally trust the new technology in the mid-1800s: The first steamers were built with both boiler-driven propellers and masts with sails).

The folks who founded Loane Bros., a 160-year-old company here that now makes tents and awnings, know this story: Right before that transition happened, they were founded to make canvas sails. (Fun timeline trivia: The 22-gun sloop U.S.S. Constellation in the Inner Harbor was commissioned in 1855, the last all-sail warship in the U.S. Navy).

But the industry change happened pretty fast because all the commodities and resources needed were local: Lumber from the East Coast, steel from Baltimore and Pennsylvania, coal from the Mid-Atlantic, and the propulsion machinery from Baltimore blacksmiths-turned-boiler makers. Some weird little iron part was needed in small lots to make the boiler work. They could go to “job shops” as an example, smaller blacksmith operations right here who specialized in producing smaller amounts of customized parts.

And during today’s economic crisis caused by the pandemic, people are starting to sense that how things worked a century ago is a sourcing model we need to return to, and quickly.

Sure, some of the supply-line nationalism is driven by either being cut off from imports we foolishly came to rely too heavily upon, or by the famously poor quality products from a certain second-largest economy that is not our friend and would be happy to see the U.S. end up in the dustbin of history. But some of the nationalism is driven by anger, pride, and fear, too—we know now we have to provide for ourselves for a while, at a minimum. And, yes, firing up industries that we abandoned to imports a century ago is going to raise costs on some products, but behavioral economics will drive the change that’s needed.

For instance, what would you pay for a COVID-19 vaccine? Or toilet paper? Or rubbing alcohol and bleach? The answer is, more than you paid last year at Costco. It’s going to be a whole new set of values and priorities based only on what is critical to us, which may mean, for a while, discarding the shallow trappings of an affluent society. And that money saved on some luxury items and “nice to haves” is what’s going to pay for the things that cost more, but which we really need.

We’ve all gotten some encouragement from seeing everything from face masks and ventilators to hand sanitizer being made by companies that used to manufacture autos or distill liquor.

The most inspiring examples are the small, agile manufacturing outfits that are re-inventing themselves to meet new needs, such as when LifeBridge Health partnered with Under Armour to make 100,000 face masks in two weeks.

That’s just one example of building an onshore supply line where we once relied on imports. Now think of everything that is currently produced in China, Malaysia, or India, and how much of this will now be moved back to the U.S. The list will be so much more than health care supplies, albeit this area will be a focus for the next 12-18 months, at a minimum.

But it’s no longer going to be about one big player in each industry, but a bunch of smaller, regional players coming together to pivot and meet a need by rebuilding our manufacturing capability.

And because it’ll be about teams of these smaller players, you don’t need to buy General Motors or Amazon to make money on the transition. This is why investors of all sorts will be looking at all the options for acquiring local-level manufacturing operations. It’s that same industrial nationalism that’s motivating the business world while it’s trying to address structural inefficiencies—but inefficiencies that offer endless opportunity, especially for the private equity markets that my company advises. Imagine, for instance, buying up a few blacksmith shops 150 years ago that could make boilers?

Joel Mokyr, an economic historian at Northwestern University, shared in a Wall Street Journal article: National crises such as wars and pandemics historically generate a hive of entrepreneurial innovation, from the late 18th-century search in England for a treatment for smallpox to a German drive in the run-up to World War I to use atmospheric nitrogen for explosives.

“We have this huge reservoir of creative energy spread around the economy. When you have an event like this all of a sudden, everyone says, ‘Oh, wow, let’s look at this problem—let’s see what I can do to solve it.’”

I’d argue that it’s not how everyone will react:

There will be some that see the problems and try to solve them as a practical matter, and others who will want to sit and wait.

But my money is on those who look for opportunities and will act.