TL;DR: the short version
The investment world does not have a good roadmap for industry development, which makes it impossible to come up with a well-structured investment thesis.
Industries emerge out of agrarian economies, usually where there is a confluence of good resources, market demand, synergies, low transport costs, and an accumulation of capital. This then results in a fundamental change in the economic structure, with a different set of economic assumptions. In particular, businesses in industrial economics are built on the principle of specialisation of labour, and assume the existence of synergised industries. These do not apply in a pre-industrial economic setting – they are the fruition of the industrialisation process.
A starting point for a theory of industrial development would be to model this step-change of economic reality. One example of this model is a firm with the potential to be an industry catalyst. An industry catalyst must start by encapsulating the full value chain within itself, but with a particular focus on the critical step of value creation. This requires a generalist mindset, with a long-term focus on capacity building. As the business grows, the divisions for each component of the value chain can become more independent, making the firm resemble a synergised conglomerate. At full industrialisation, the divisions can become completely specialised, and be spun off into separate businesses.
My partners and I have spent the last seven years building the building blocks for a new aquaculture industry in Mozambique. Even though we had a rough sense of what needed to be done, those ideas didn’t come from any particular theory of industry development. In general, economists take the momentum of industry creation for granted. But how do you actually create the momentum where none yet exists?
This is such an important conversation to have, because I think it sits right at the nexus point for addressing so many of the key issues in our discourse: climate change, economic development, regulation, corruption, income inequality, international trade, protectionism, immigration, privilege.
Why Industry Development is key
Let’s start with an issue like Climate Change. We know that it’s real, and we know that it’s coming regardless of what we do at this point. A clear consequence here is a concern around food security, because extreme weather is going to disrupt it.
We can ensure the future of food in two ways.
Option 1 is to build resilience into our existing food production. We’ll find better ways to irrigate our crops (following Israel’s pioneering example), or breed more resistant strains, or other technological innovations.
Option 2 is to go back to the drawing board, and looking for new ways and places to produce food.
For example, there are areas of the world that have the potential to become the world’s future breadbaskets, because they will benefit from the effects of climate change. There are also regions with natural barriers against extreme storms, because of the topography that surrounds them. It makes sense to kickstart food production in those places. From scratch.
Another idea is to plan for a future of different food choices. Today, we eat beef and chicken. Tomorrow, it may be crickets and mealworms (that’s a reference to the European Union’s approval in January of these two insects for human consumption). A more palatable alternative might be a plant-based diet with occasional fish protein for its nutritional value.
But it doesn’t matter how sensible the approach may be, direct human intervention will be needed to get those industrialisation processes started.
We really do need a practical theory of new industry development
Because we need a general road map to go from the problem to the solution.
You see, the easy part is identifying the start and end points:
- Problem: food production threatened by Climate Change
- Solution: food production located somewhere less threatened by Climate Change
But the mechanics of moving from the problem to the solution are still a mystery. We know that it requires action. We know that it requires money. But for the most part, we hope that if you throw enough money and action at the problem, that the solution will start to perpetuate itself.
It’s like putting a well-caffeinated driver and a full tank of a fuel into a car, and assuming that if the car is just driven for long enough in a particular direction, regardless of the actual routes available, it will eventually arrive at its destination. Hopefully, before it runs out of fuel, and before the driver falls asleep at the wheel in exhaustion.
But a general sense of direction is not enough. You need a map, with an idea of what landmarks to look out for, so that you can make reasonable decisions to keep you on course.
I can think of a better analogy than driving for what it means to nurture a new industry: parenting.
New parents arrive on the scene with a rough sense of how to feed, clothe and school a child to get it to adulthood. And while each parent will figure out for themselves what works for their particular child (and their particular personality, talents, challenges and potential), there are some basic principles that we’ve learned through time. Children need love in the form of constant parental interest and appreciation. They need space to grow, but also boundaries to give focus to their growth. They need routine, and they need that routine to have periods of unstructured play. Their biological growth will happen with food and clothing; their intellectual skills will come with education; and their psychological and spiritual development will come with guidance, support and care.
And we have plenty of theories of how to parent. Some work better than others. Some approaches are outright harmful. There are books, blogs, youtube channels, therapists and obnoxious great aunts.
Unfortunately, industry development has very little of this informational support.
But nevertheless, building a new industry is like raising a child. The initial labour pangs are incredibly painful. For the first few years, your nascent industry requires you to do absolutely everything for them. They are an endless lists of expenses with nothing to show for it but dirty diapers and sleepless nights. When they’re learning to walk on their own, they fall down a lot and cry, making the other adults in the room look at you like you’re a bad parent. Schooling is a nightmare, because they’re incredibly sensitive to being bullied by bad teacher-regulators. And then once they reach adulthood, they frequently want to go and spend more money achieving “specialisation”.
And while the entire process may be incredibly rewarding, with much benefit along the way for everyone involved, the success of your industry will still be measured by its monthly paycheck.
The point is: every new industry project is a massive gamble that starts when you and your angel investor decide to get together and sign a baby term sheet.
Now, I can’t claim to be writing an academic paper on new industry development. But I have some actual experience in doing it on the ground, and I’ve had to market it in every investor pitch that I’ve ever written.
So think of me as a mommy blogger of industry development.
What we know about Industry Development already
I’m going to pull heavily here on an essay by Abhijit Banerjee, titled “Notes toward a Theory of Industrialisation in the Developing World.” Banerjee and his wife, Esther Duflo, are both Professors at MIT, have won a Nobel prize for their work, and wrote the book “Poor Economics”. I read and reviewed that book back in 2013, and it had such a strong influence on my own thinking that it’s part of the reason that I took on Mozambique’s new aquaculture industry in the first place.
A good theoretical starting point of industrial development is probably to say something about what economic historians have observed from industries in action.
In the world where markets are perfect and contractual inefficiencies are absent, economic theory tells us that the location of industry is a function of resources, synergies, transport costs and demand. …[An] equally important influence on the location of industry particularly in the developing world is the availability of either capital or that particular connectedness of communities that is sometimes described as social capital.Banerjee, A. 2000. Notes Toward a Theory of Industrialisation in the Developing World. Published in “Development, Displacement and Disparity: India in the last quarter of the 20th Century.
So let me translate that.
What economists have noticed is that you find industries developing on their own when they’re “in the right place at the right time.” What does it mean to be in the right place at the right time? Basically:
- There’s a market for a particular product (demand)
- There is the ability to grow or make it (resources)
- There are other industries nearby to supply whatever the industry is not making itself (synergies)
- It’s not so expensive to get to and from the place that it makes it infeasible (transport costs)
Banerjee argues that you need one of two other factors as well:
- Either you need the money to get the process started (capital); or
- You need the local community to be invested in the process (social capital)*
*This is really understating the argument in the essay, but I’m trying to avoid getting too lost in the technical detail
This logical list of requirements is what any industry will need in order for it to exist. Now comes the tricky part: intervening to create the requirements.
How we do Industry Development in practice
Let me tell you what I have to include in my investor decks when I go out to pitch for the farm:
- The Market – what is the demand for my product
- The Business Process – what are the resources that I’m using to grow or make the product
- The Route to Market – how am I getting my product to the market, and how much it will cost (transport costs)
- The Financing Requirements – how much capital or money do I need to get the process started
- The Competition – what the competitors are doing, and how this will be different
- The Impact Story – how we will change the local community
These questions don’t come from nowhere – this is a requirement list that comes with years of interacting with investors, and with plenty of guidance from helpful mentors.
The obvious problems:
- Not only do we miss out “Synergies” altogether, the fixation is on the “Competition”.
- The Impact Story is one-sided.
That is, we are missing two key elements:
- There are other industries nearby to supply whatever the industry is not making itself (synergies)
- You need the local community to be invested in the process (social capital)
This is a fundamental flaw in our standard Investment Thesis thinking, and we need to say something more about it.
The Agrarian – Industrialist Thinking Gap
In the Mozambican setting, I often hear a common complaint: “These Europeans and Americans just don’t understand how things work here.”
I spend a lot of time trying to teach investors to think differently. And the point that I generally come back to is: “You come from an Industrialised economy, but you are investing in a pre-Industrial economy that is essentially agrarian. You need to rebase your economic assumptions.”
For me, this is a really core issue.
When you come from an industrialised economy, you take for granted certain base economic assumptions like “the specialisation of labour”. But we must remember that Adam Smith’s work on the wealth of nations came out of the Industrial Revolution. When you are surrounded by industry (in other words, surrounded by synergies), you are operating in a board game of competition. Your competitive edge comes from specialising on what you are best at. This is an optimal deployment of economic resources.
But in a pre-industrial context, a specialisation of labour makes less sense. Consider a farm that is a half day journey from the nearest trading town. If that farmer chose to specialise in growing blueberries, then he is destined to starve. A much more sensible economic survival strategy is to diversify his farming methods. He grows a variety of fruit and vegetables, alongside summer and winter crops, that are timed to produce food (and to be stored) for consumption throughout the year. He would also raise a few kinds of livestock, to ensure that no single disease would wipe them out. Livestock itself acts like a kind of storage, taking grain in a time of plenty, and being available for consumption during the leaner winter months. He’d also have to have some skills as a builder, as a carpenter, and so on, in order to keep the farm going. His wife might be a cook, a seamstress, a a teacher, a food preserver, a cleaner, and a healer.
But even this example betrays a kind of nuclear-family thinking that is anachronistic. Rather than a single family unit, you would have communities of extended families on a successful farm. The community itself would practice some specialisation of labour – especially with a technical occupation, like a blacksmith – but it would be rare for anyone to have a single dedicated, full-time occupation.
The land would only be able to sustain a certain number of people on it, so inheritance laws and marriage would be a real societal necessity, and you would always get a certain number of folks moving off to create new farming communities, or join ones that were short of particular skillsets.
From here, you can see how industrialisation might be a next step in the evolution of community. A technological breakthrough in speed and volume of transport (eg. the steam engine), reducing the transport costs in both time and money, would allow better synergies between farming communities. This builds the critical mass in demand for specialisation of labour to take place more broadly.
But you have to get there first.
The good news here is that we can, at least, identify a road map for how industries naturally emerge over time.
A theoretical starting point
Here is a suggested basic timeline:
- People need food, and they need to produce it.
- A geographic location with good resources (arable land, water, predictable climate, etc) allows for a community to develop there.
- The community begins by being subsistent, because the cost of transport (in terms of time) is usually prohibitive.
- A beneficial change occurs (a reduction in the cost of transport, or the site proves particularly productive), leading to greater trade and greater specialisation of labour. This creates a cycle for potential savings (ie. profit or capital).
- The accumulation of capital from the beneficial change leads to general industrialisation: both in the core industry, and in the synergised industries that have emerged around it.
- Further accumulation of capital from the industrialisation allows for entrepreneurship, which leads to greater efficiencies through competition.
There are some basic principles that we can also glean from this:
- The economic model changes over time. At first, it is Agrarian, or subsistent, and it practices a generalisation of labour. It then progresses into early Industrialisation, where its factors of production are made more efficient. This is represented by the emergence of Capital, and the specialisation of Labour. It then progresses to full Industrialisation, where Entrepreneurship leads to Competition.
- Industrialisation is usually General rather than Specific. This is because any particular industry is built around a particular specialisation of labour, and they generally rely on other industries to scale alongside them to facilitate their growth.
- The growth and the accumulation of capital is not a zero-sum game. Industrialisation means harnessing natural resources more efficiently, to realise their benefits more quickly. This is a very attractive way to accumulate capital.
This brings me back to the challenge we face in trying to spark the virtuous cycle of Industrialisation.
Let’s start with the common practice, and why that is problematic.
The problem of a circular investment thesis
We start with a very basic recipe for Industrialisation: “just add Capital”.
And that’s exactly right!
If you go back to the timeline, the idea is to be “the beneficial change” in stage 4. If an investor can identify a business case where there are good resources, a product with a market and a route to market, a price point that sets the business up to accumulate capital in future, and a good entrepreneurial management team to run it, then the only thing needed in the equation is the initial investment of Capital.
This investment case thinking is the exact same formula that is used for businesses in the Industrialised World. The ultimate holders of Capital are children of Industrialisation, as are the investment fund managers and analysts doing the investment work. The risk of contextual bias is therefore high.
I have sat in meetings with donor organisations that go as follows:
- Donor: “What does your industry need?”
- Me: “It needs investment in cold chain storage.”
- Donor: “Do you know anyone doing cold chain storage?”
- Me: “Yes, there is only one business doing it at the moment. They are trying to expand their facilities. You should fund them.”
- Donor: “But that would be a market distortion if we invest in only one player.”
- Me: “But there is no one else to fund. Don’t you have to have a market first before you can distort it?”
- Donor: “I see what you are saying, but that will not be accepted by <Brussels/Washington/London/etc>. They will say that we are creating a monopoly.“
Being concerned about market distortion in a market that does not yet exist is completely disconnected from the reality of how industries develop – which is exactly why we need a common theory of it.
And I am not making this point as a moral argument.
When an Industrialist steps into an Agrarian economy, with an investment thesis that says they should just add capital to a firm within a particular industry, then that really is a high risk activity. They are taking for granted that the synergies of other industries already exist at the necessary scale. They worry about competition in a market that is still being built. In practice, the Industrialist is trying to encourage industrialisation while expecting that it has already happened.
And because this is impossible, the investment success stories tend to be outliers where luck and good fortune played a key part. Most investments will fail, because the risks and the obstacles are not adequately assessed.
It also means that we tend not to learn from the investment failures.
This is the uglier side of that economic bias. It leads us to double-down on the unspoken belief that industrial economies are naturally hard-working (or industrious), and this is the reason for their success. Meanwhile, agrarian communities which have not yet industrialised are either lazy, insufficiently educated or corrupt, and this is the reason for their failure to industrialise and be successful.
So how can we do this better?
A different kind of investment case
For the time being, the reality is that investment funds invest only in firms. No fund will support an entire industry: that is too much concentration of risk. So we must accept that constraint.
So what can be done within that constraint?
Well, I can tell you what we have done in Mozambique, and why we think the way that we do.
Our own investment case began with an observation: throughout Africa, once a fish farm is established, you will find smallscale fish-farmers farming around them. They did not exist before, but they exist afterwards.
That is nascent industry creation. The key question is why.
As a disclaimer: know that it is almost impossible to answer that question with scientific confidence. The scientific method would require you to have control groups and randomised trials. This is a perennial problem in economic theory. Most of the time, economists observe a reality, and then infer the chain of causality behind it.
But here is an answer anyway.
Any good impact investment fund will tell you that the three basic inputs that a farmer requires are “seed, feed and training”. Of course, what they really mean is: “seed, feed and training that is affordable, close by, and readily available at the right time”. The good news is that a commercial farm that is well-run and risk-mitigating will always try to operate with a small surplus of seed and feed to ensure that its value chain is not impacted by temporary shortages. And, of course, it will train all of its employees to work there. So the farm itself can offers all three of those inputs.
In short: a well-run commercial farm is an excellent industry catalyst.
But this is not enough, really. Because specialised farms are only part of an industry’s value chain.
A farm is reliant on upstream suppliers for its feed and capital equipment. A farm is reliant on synergistic industries for construction and engineering skills. A farm is reliant on transporters, distributors and marketers for its downstream sales. And that is quite separate to the advocacy and finance work that is needed.
And this is where things get complicated. Industrialised value chains are reliant on specialisation. Seeking to establish those value chains by only focusing on a particular component is expecting the synergies to already exist.
But because it takes time for synergies to develop, you should be prepared for an industry catalyst firm to contain a mini-industry within itself.
I cannot say if these rare industry catalytic firms are applicable for all industrial development – but they’re a good departure point. If only because they force you to think about growth strategies in a manner that recognises the risk of reliance on external development.
An anchoring roadmap for Industry
An industry is an ecosystem of interconnected and experienced economic actors built around a particular output. It is also a value chain of transactions.
To build an industry from the ground up, you should start with a first mover that is capable of building that value chain at a microeconomic level (ie. at the firm level). This requires them to be a strategic generalist: in that they are able to specialise in the most critical step in the value chain, while simultaneously able to fill the gaps in the value chain around it.
The anchor firm must then strategically engage in the work of capacity building.
This may sound like a tall order for a new business, but we’re talking about necessary steps that the management team should be taking anyway. Our experience is that the work of “industry-building” is almost always aligned with the long-term commercial needs for the firm’s growth. And where it is not aligned, you need to recheck your strategic thinking, and make sure that the work is really a good use of your time.
How do you build capacity?
Let’s take a process like skills development. Training people from the nearby communities may sound like a humanitarian task, but it is also a commercial necessity when you are building a new business from scratch. The skills needed are not there because there was never a reason for them to exist before. If you want your business to be sustainable, you need to invest in training people. And the same goes for a sustainable industry: it needs a pool of local talent to draw from. This is a clear example where the industry and commercial needs are synergised.
But I want to emphasise the importance of this dual-purpose thinking, and how it alters the commercial problem-solving process.
There are essentially two ways to deal with a shortage of skills:
- you can import the skills that you need; and
- you can invest in folks with aptitude to give them the skills that you need.
The temptation for an Industrialist is to look for the quickest way to solve the problem. That leads them to import skills that they can, and segregate the operations of the business to account for the fact that most of the local workforce will be unskilled.
An Agrarian outlook is subtly different. Farmers deal with organic growth cycles. Spending their days, months, seasons and years harnessing the inescapable constraint of biological time means that they account for the dimension of time in their thinking. If I was to describe that in spiritual terms, I would call it the virtue of patience. It can come across as slowness to fast-paced city-dwellers, but it is depth.
Once you account for the long-term in the skill constraint, its shape becomes much clearer. Imported skills are very costly, which is a concern for all mindsets. But more importantly, imported skills are not sustainable because they have an expiry date. Communities are the anchors around which people build their lives and livelihoods. Expatriated skills tend to repatriate back to their homes because of that pull. But equally, thanks to that pull, investment in the local community will help it to be a better anchor, and will give you the pool of talent that you need.
That investment will take a long time, but the agrarian mindset is precisely skilled in that area. And they are focused on efficiency on all fronts.
A farming-style approach to training people looks a lot like farming. For those that come to work on the farm, there is no fixed training session. Initial training is small and measured, much like the sowing of seed. Those new trainees are then nurtured with constant supervision and correction. That supervision allows you to identify particular aptitudes, that you can then build on for more focused tasks. You invest more time and guidance in those that have the potential to become the next generation of trainers.
When community training work happens, you undertake broad basic training as a kind of screening exercise to identify those with strong potential. You then devote time strategically to deeper training where it is most likely to be fruitful.
There is also a clear sense in which this is a training relationship with an ongoing dialogue, rather than a one-sided set of lectures.
These are logical and deeply strategic steps to take – once you accept that your work should always serve the purposes of both the firm (in the short term) and the industry (in the long term).
And this should also make it clear why industries emerge out of agrarian communities in the first place. Industrialists develop existing industries, but it takes a different kind of skillset to build them in the first place.
But the industrialist skillset is still fundamental.
Achieving Industrial Momentum
The shift from farming to trading is where the industrial heart beats. Long-term thinking is essential for the work of capacity building; but as Keynes said “In the long run, we are all dead.”
Traders have the industrialist mindset that appreciates the value of time as money. This is what creates the momentum in the value chain. Their demand for more output at better pricing drives the industry toward growth and efficiencies. And it drives it towards specialisation.
Let’s take a step-back to the catalyst firm, that is now engaged in multiple steps of the value chain, with its core focus on the most critical step (in this case, production).
At this point, an Industrialist might ask whether the firm is truly making best use of all its resources. Because in order to move its product, the firm has invested in a fleet of specialised trucks. It has also set up a number of sales outlets to sell its product.
Some pertinent Industrialist questions might be:
- Does it make sense to have a fleet of trucks sitting idle half the time while production is happening? Or would it be better if that fleet was making deliveries for other businesses as well?
- Does it make sense to have a shop that only sells one type of product, or would it be better to have a range of products in store?
This is where the work of capacity building has tipped over into some spare capacity. I suspect that many businesses can fail at this stage in their growth cycle by having built up a large variety of essential overheads, but then failing to deploy those overheads to their full potential.
We can say that the first true phase of industrialisation occurs when a firm’s internal divisions can benefit from being treated as standalone businesses in their own right.
This is a kind of conglomeration, where you have synergised mini-industries operating independently, but with a centralised strategic focus. It is the first step toward specialisation.
And if you want some evidence of this, we must look at successful business groups within the African context. There is an unusually high representation of conglomerates that have followed the value chain of their core businesses, and aligned them through common ownership structures.
The next step is what we’ve observed over the last few decades in the developed world. Conglomerates get unwieldy and inefficient at scale, creating the room for competition from sharp entrepreneurs. By this point, those mini-industries have hived off into their own growing industries, with increasingly efficient and more specialised offerings.
This is fully integrated Industrialisation – undoubtedly still fragile, but operating with competition and with its own momentum.
So that’s the theory
You may be wondering where my proof is for this theory. That is exactly the point: theories need to be tested, so that they can be improved.
Some of my thinking is informed by the way in which many of the Asian countries approached their own processes of industrialisation, and succeeded. Their policies for achieving industrialisation would be completely anathema to the economic consensus of the developed world. That should give us all pause for thought.
But, of course, most of this is the learnings of trying to build an industry in real time. As with any organic process, it is difficult to take credit. You may plant the seed, and fertilise it, but the sun and the soil and the climate are powers beyond our control.
What we can observe, however:
- In our local community, people have been building boundary walls around their homes. The fact is: you don’t need a wall if you have nothing to protect. The community is investing alongside us.
- Aquaculture in Mozambique has gone from a relative unknown to being a part of the legislative agenda. There are two significant new funding programs for smallscale fish farmers. Last year, Mozambique slashed the corporate tax rate for aquaculture from 32% to 10%.
- This year, there is a groundswell of political concern around the lack of feed for smallscale farmers.
When an industry has problems like a lack of feed, it is not good news for anyone in the industry.
However, in order for an industry to have a problem, it must first exist.
And that is very good news indeed.