What are the results of the GCC's plan to localise manufacturing?
As national transformation schemes pick up steam, AT Kearney's Douglas Pickles explores the progress that has been made so far
Two of the GCC's largest economies, Saudi Arabia and the UAE, are making steady investments in the growth of their respective localisation programmes, named Saudisation and Emiratisation. These, and similar initiatives, come as the region focuses on nation-building efforts to secure the future growth of its youth. A key area of focus is also the localisation of manufacturing, which is expected to boost the economies of the Gulf in the long-term. A director within AT Kearney Middle East’s supply management practice, Douglas Pickles, discusses the progress that is being made in the region.
In recent years, many of the GCC countries have launched national industrial strategies embedded within larger transformation programmes designed to expand the scope – and increase the urgency – of localising manufacturing within their respective countries. These programmes have now entered the implementation phases, prompting a need to reflect and to ask whether localisation of manufacturing is working.
Early results show limited progress and, in some cases, a deterioration in target indicators. In Saudi Arabia, overall gross domestic product (GDP) growth is set to slow, with average annual growth of 2% forecast by Saudi Arabian Monetary Authority (Sama) for the five years from 2018 to 2022.
The picture for the UAE is a little better, with the World Bank anticipating growth of slightly more than 3% in 2019 and 2020, up from 2.5% in 2018.
Modest growth will be less attractive for foreign direct investment (FDI), and in Saudi Arabia, the US-headquartered International Monetary Fund (IMF) is expecting only a third of the level investment received over the past five years during the next five years. The UAE has reacted to stagnating FDI by approving an FDI law that is expected to boost FDI flows by up to 20% in 2019.
Companies are no longer susceptible only to institutional pressure to perform. Social media, activist investors, and the global media are all driving increased awareness of corporate and government policies and behaviour.
The slowdown in foreign investment may be due to the fact that both countries have slipped in terms of global competitiveness. In 2013, Saudi Arabia was ranked at number 18 in the World Economic Forum index; in 2018, it had dropped to number 30. The UAE has dropped from number 19 to number 27 during the same period.
In addition, unemployment has remained stubborn. The UAE Ministry of Economy was able to report a marginal 0.1% improvement between 2013 and 2016. Saudi Arabia has fared little better, and unemployment among Saudi nationals reached 12.9% in the first quarter of 2018, according to the government’s own statistics agency.
PRESSURE TO LOCALISE
This comes at a time when pressures to localise have increased significantly. A recent AT Kearney study identified five localisation pressures impacting the global economy. The first is increasing political populism, which is driving changes in policy, most notably in trade. Since 2009, the world’s 60 largest economies have put in place more than 6,000 trade barriers.
The second is a shift in consumer preferences, with increased demand for both localised and personalised products. Although reasons for this vary by country, they commonly trace back to nationalist sentiment to support local manufacturers, concerns about the environmental impact of non-local products, the ability to personalise and localise through “frictionless” e-commerce, or a lack of consumer trust in multinational brands.
The third pressure is the most relevant to the GCC and is delivered through the national industrial policies. It is worth noting that GCC countries are not the only ones seeking to localise manufacturing production. The UN Conference on Trade and Development recently reported that a total of 84 countries have implemented industrial policies in recent years.
The fourth pressure on localisation relates to changes in technology, whereby Fourth Industrial Revolution (4IR) advances are disrupting traditional, low-cost manufacturing centres by thinning out the level of labour arbitrage. This presents an opportunity for GCC economies to target investment in robotics, additive manufacturing, and other 4IR technologies to attract FDI.
For example, in March 2017, the UAE announced a partnership with GE that would allow it to become the first country outside the US to host a 3D-printing micro-factory. However, the corresponding challenge with new technologies is that they tend to replace more jobs than they create, an important consideration given that a key goal for GCC governments is job creation.
Localisation pressures are likely to intensify competition among countries to attract and retain value-adding manufacturing firms.
The fifth and final localisation pressure identified by AT Kearney is increased scrutiny of corporate and governmental ethics. Companies are no longer susceptible only to institutional pressure to perform.
Social media, activist investors, and the global media are all driving increased awareness of corporate and government policies and behaviour. The result is that governments and businesses are more sensitive to local markets and the social licence needed to operate.
In response, AT Kearney believes a focus on four areas can boost localisation efforts and increase the attractiveness of the GCC manufacturing sector as an investment destination. Localisation efforts have often focused on attracting international firms based on the import of their technology, expertise, and capital to stimulate the manufacturing industry. It can be a time-consuming and high-cost process to identify and secure the right partner. Local supplier development offers an alternative route to encourage manufacturing firms to seize available opportunities.
Effective supplier development can take several forms, and often requires a shift in mind-set from a traditional buyer-seller relationship. For example, collaborative cost reduction is an approach that involves both parties working together to reduce costs along the value chain. This could entail working on new standards or specifications that lower manufacturing costs, or improving demand planning capabilities to increase productivity.
A supplier fitness programme is another approach that encourages the seller and buyer to work together to increase the competitiveness of the seller. This approach requires the joint investment of resources such as time, people, and money, so it is often limited to a small number of strategic suppliers that are expected to become future leaders in their respective markets.
Both approaches also require the buyer to become more forward-thinking and collaborative in order to develop their suppliers, even working with other buyers to develop suppliers for mutual benefit. Further approaches could extend to revenue- or profit-sharing schemes on either a project basis, or within a defined scope of work.
SECRETS TO SUCCESS
Successful manufacturing relies on an interconnected supply chain working together for mutual benefit. GCC countries are increasingly using local content scoring to drive the localisation of supply chains by using investment vehicles and procurement spend as levers.
In the UAE, investments by Mubadala have led to progress in the prioritised aerospace sector, establishing joint ventures and local supply agreements with companies such as Lockheed Martin, Airbus, Rolls-Royce, and Boeing. The latter is described as a collaboration to “enhance the skills of Emiratis”. However, other priority sectors for the UAE, such as medical equipment and machinery, may be harder to incentivise, particularly as both these sectors are also areas of priority for localisation for Riyadh.
Localisation in the GCC has historically focused on opportunities to close gaps in existing manufacturing value chains.
In Saudi Arabia, Saudi Aramco’s In-Kingdom Total Value Add (Iktva) programme is using procurement spending as a localisation lever, while the guidelines laid out by the Local Content and Private Sector Development Unit (Namaa) are being implemented at other national industrial champions.
However, manufacturing supply chains are complex and interconnected. The result is that local content scores can reach a “glass ceiling” when, for example, the supplier’s supplier is not incentivised to localise.
For example, mechanical seals are components within at least 10 different major equipment items manufactured by 10 different suppliers. As a result, a single equipment manufacturer may not be able to incentivise the mechanical seal manufacturer to localise without involvement from the other nine manufacturers.
Accelerating the implementation of local content scoring in the GCC will encourage more buyers to promote localisation opportunities in more components, creating a comprehensive system for localisation across manufacturing supply chains. Acceleration requires providing procurement departments, which are typically tasked with implementing local content scoring, with more resources and scope to adopt scoring mechanisms and accept new ways of working.
Acceleration also requires increased focus on market intelligence to understand local supplier capabilities and their local content scores. A league table or central register of suppliers would benefit a range of industries and promote an interconnected local market.
Localisation in the GCC has historically focused on opportunities to close gaps in existing manufacturing value chains. Common equipment items, such as valves, pumps, transformers, and heat exchangers are important, but these markets are typically well served by established original equipment manufacturers with global manufacturing footprints. This makes attracting investment to the GCC more challenging.
New technologies such as robotics, 3D printing, and augmented reality are disrupting traditional marketplaces, and efforts should increase focus on related new and emerging manufacturing opportunities. Although potentially higher risk, these opportunities offer more scope for incremental growth and have the additional benefit of positioning the GCC as a new centre for advanced manufacturing.
A local 3D-printing industry is beginning to emerge, specifically Dubai. The UAE government has announced an ambitious target of becoming a leading hub for 3D-printing technology by 2030.
Further opportunities exist to explore the value chains associated with technologies such as sensors, robotics, augmented reality, cyber security, and drones.
Localisation pressures are likely to intensify competition among countries to attract and retain value-adding manufacturing firms. With more than 80 countries implementing industrial trade policies, and both Saudi Arabia and the UAE slipping in the global competitiveness index, there is renewed impetus to focus on increasing competitiveness. On the surface, this should be an easy problem to fix, as most GCC countries have highly centralised governments.
In the UAE, investments by Mubadala have led to progress in the prioritised aerospace sector, establishing joint ventures and local supply agreements with companies such as Lockheed Martin, Airbus, Rolls-Royce, and Boeing.
The underlying issues within Saudi Arabia and the UAE are similar, but not the same. In Saudi Arabia, the latest rankings have been impacted by a lack of business dynamism – for example, starting a business has become more difficult – and by poor labour market indicators, specifically related to having the necessary level of incentives for a more meritocratic labour force.
These various factors point to a doubling-down on investment in local people while continually seeking to introduce reforms that balance the long-term need to create jobs for locals with the short-term requirement for the right skills, in the right place, at the right time.
A BRIGHT OUTLOOK
The GCC remains well placed to achieve its ambitious economic targets thanks to the region’s young and energetic population and depth of financial resources. However, it must heed the early warning signals and address implementation challenges associated with localisation before the window of opportunity closes.