What is the Urgency to Automate Today?

Most SMEs are still not approaching automation with a sense of urgency, especially in countries that have historically benefited from relatively low labor wages, like Taiwan. However, we think that this complacency could result in growth headwinds in the next 10 years because of a variety of macroeconomic and demographic factors. SMEs today should accelerate their push towards automation and digitization before it becomes too late.

Oct 24, 2023

Background

East Asia has historically been a low wage region. Many East Asian countries developed rapidly starting in the 1970s as they started industrializing and focusing on export-led growth. These countries were able to take advantage of their relatively low labor costs (relative to developed Europe and the US), skilled and relatively well-educated workforce, to compete effectively with competitors in the developed economies. The trend towards globalization in the post-World War 2 era also facilitated this trend.

The first to takeoff was Japan, followed by the Four Dragons (Singapore, Hong Kong, Taiwan, South Korea). Economic growth then started diffusing to the other South-East Asian countries like Indonesia, Malaysia, Thailand and the Philippines. Finally, China took off in a massive way, followed by Vietnam. Today, countries like Singapore, Hong Kong and South Korea no longer have any significant labor cost advantage. Taiwan still has some, but that is also rapidly eroding. It is only natural for economic growth to lift wages and reduce the importance of cheap labor as a source of competitive advantage.

Furthermore, at some point, the high labor costs in countries like Singapore will become competitive disadvantage. The only solution to retain competitiveness is to increase labor productivity by increasing the capital-labor ratio and improving the margin productivity of labor.

Macroeconomic Headwinds

Inflation has become a global problem since the pandemic, and the problem will likely continue in the near future. One of the biggest risks to global economic growth is a resumption of the wage-price spiral that wrecked developed economies in the 1970s. A wage-price spiral will continuously push wages up. Companies that lack pricing power may be unable to raise prices of their products and services sufficiently to offset the wage cost increase.

There will also be upwards pressure on other input prices, ranging from commodities like oil and copper, to manufactured inputs like semiconductor chips.

With such cost inflation, companies with weaker pricing power will suffer a contraction in profit margins, thereby reducing cash flow and raising the risk that such companies will either go bankrupt or lack the capital to continue to invest in the business.

In general, SMEs will be face greater impact from the negative macroeconomic trends than large companies.

Negative Demographic Trends

East Asia in the post-World War 2 period benefited from the post-War baby boom. This ensured a steady and increasing stream of cheap labor for the industrializing economies. Today, that demographic boom has disappeared in many countries like Singapore, South Korea, China, Hong Kong and Taiwan. In fact, the replacement ratio is so low that we can well expect a big shortage of workers in the next 10-20 years. The consequences are:

The cost of labor will rise rapidly due to the demand-supply imbalance. Upwards wage pressures in many East Asian economies will be a major source of problems from many companies.
The quantity of new labor entering the labor force will decline, resulting in labor being a supply bottleneck. If average labor productivity does not increase, the total amount of good and services produced will decline.

The interesting thing about demographic trends are:

This information is widely-disseminated. It is not a secret.
The consequences are easily understood and will be obvious 10-20 years later. Nothing can change this.

Furthermore, SMEs will be more adversely affected than large companies because:

Everything else being equal, most young people prefer to work at large companies than SMEs. SMEs already start out at a disadvantage in the competition for scarce labor.
Most SMEs have low margins and lack the deep financial pockets to compete with large companies for labor using higher wages.

Clearly, in an environment where labor is scarce, SMEs will be in a much weaker position than large companies.

Why the Lack of Urgency in SMEs?

Obviously, there are many reasons why any particular SME is uninterested in pursuing automation. The common reasons cited are a range of financial and operational considerations:

Lack of money to spend on automation - there is an initial outlay required for implementing automation projects.
Lack of staff with the necessary skills to use the automation tools.
Belief that the operation is unsuitable for automation.

Some of these reasons may truly be unsurmountable or reduce the effectiveness of automation, but often these are just excuses because the business owner simply does not see the importance or value of automation. This is especially true for successful SMEs that had started in the preceding decades where the supply and cost of labor was not an issue. Many SME owners still stick to the belief that manual operational methods had worked in the past and will continue to work in the future.

Consequences

It may be argued that the inflationary pressures could be transitory and eventually disappear, as did the inflationary problems of the 1970s and early 1980s. The risk is that this becomes a drawn-out problem that takes many years to resolve and we are only right at the start of that period. By the time the current inflationary problems runs its course, many SMEs may no longer be around.

However, the long-term demographic problem is a very different problem. It will not be reversed in the next 10-20 years because the workers entering the workforce in the next 10-20 years are the babies that were perhaps 5-15 years ago, when the demographic trend was already bad.

The likely consequence is that the next 10 years will see a shakeout in the SMEs in many countries in East Asia. Those SMEs that automate and start transitioning to a data-driven model today will most probably thrive and grow and take market share from those SMEs that are sitting back today and not doing anything. By the time these latter SMEs start to see the urgency, the writing will probably be already on the wall.