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2011

 

Last week, I commented on what is turning out to be one of the most troublesome supply chain challenges in 2011, namely the challenge of exploding inbound material costs. This challenge often points to the need for companies to either raise product prices, which could jeopardize momentum of product demand, or undertake further cost reductions to offset material costs increases.  Recent polls of supply chain professionals indicate that volatility of demand and rapidly changing business demand patterns are also a dominant challenge.  If reports of Q4 earnings are an indicator, both challenges are occurring simultaneously in multiple industry sectors, and the proper balancing of both will be the differentiator for those companies that succeed in this ‘new normal’ of business in 2011.

 

The challenge of rising input costs was specifically noted in both B2C and B2B industry sectors.  Procter and Gamble indicated that higher inbound costs will lower its annual earnings by about $1 billion, noting that commodity prices were 20 percent higher than a year ago.  As a result, P&G initiated a new round of internal cost cutting including the elimination of some manufacturing lines, and has not ruled out selective price increases for certain products.  Kimberly Clark, under pressure in rising commodity costs and also competition from private brands,  plans to sell, close or streamline six manufacturing facilities. Yet, the company admitted it may have cut production too deeply in Q4, giving up an estimated $20 million in profits. Industrials maker 3M is actually building inventories in expectation of continued booming export demand and a robust Q1.

 

The CFO of Ford Motor Company noted that the company expected to see additional pressure on commodity costs in 2011.  Ford reported that its average profit margin on each of its cars and trucks produced in North America was $1730, while profit margin per vehicle in Asia was a mere $97 on roughly 40% of North America’s output volume.  The implication is that while Asia demand is booming, in a market of high price sensitivity, the challenge to increase margins in the midst of such challenges will be a prime concern.  Meanwhile Volkswagen warned that a shortage of certain electronic components within its engines will force the company to halt production at two German factories this week.  German automakers have experienced extraordinary order rates primarily driven by demand in emerging markets.  The CEO of Daimler noted that suppliers are under quite a strain to keep up with demand, and everyone is struggling.  In December, the Vice President of Procurement for BMW North America noted that some of BMW’s suppliers cut too deeply during the recession, and now cannot keep pace with current demand.  Corning who had slashed inventories during the recession, struggled in 2010 to keep-up with auto maker demands for emission control filters, having to ship parts by air to China factories.

 

Caterpillar experienced a blowout Q4 due in part to the fact that exploding commodity costs have fueled mining companies to invest in additional equipment, while the increased boom in building and construction in emerging markets fuels the need for additional equipment.  While acknowledging that higher prices for metals and other materials were evident, the company did not see them as a significant challenge in 2011, primarily because of the increased efficiency of its internal manufacturing plants and external suppliers.  Last year, Caterpillar’s internal plants boosted shipments at the fastest rate in more than three decades. However the company has been shifting the sourcing of complex parts away from more costly regions, such as Japan, into China.

 

While Apple has done an extraordinary job in being able to respond to and sustain explosive shipping volumes for iPhones and iPads, other consumer electronics providers continue to struggle with the combined challenges of select component shortages brought about by explosive demand, and now, the threat of increased material and component costs impacting margins.

 

These combined challenges have not gone unnoticed, and the financial media and Wall Street have taken notice to both challenges, but in our view, haven’t connected the dots as yet.  Rising raw material and component costs prompt fears for maintaining rather healthy margins and healthy balance sheets.  Wall Street enjoys the benefits of exploding productivity as companies continue to get more done with less.  On the other hand, the visibility to the constraints of today’s extraordinarily lean supply chains continued to be noted. Unplanned or exception events, can cause either a lost opportunity on securing new business, or pay a penalty in increased costs to satisfy demands.  

 

The real victims in 2011 may well be smaller suppliers who are caught in the vise of larger customers demanding additional cost and productivity concessions, or increased agility to respond to exploding growth opportunities in the emerging markets.  These same suppliers are squeezed by challenges to access additional capital financing and to invest in the business process and advanced technology tools that can provide broader supply chain visibility and responsiveness.

 

The two significant supply chain management challenges in 2011 of offsetting exploding material costs, while insuring the ability to be agile and responsive to more explosive demand coming from certain geographic regions, will no doubt cause some firms additional setbacks.  Cutting more costs internally while demanding a more agile and faster responding supply chain are mutually exclusive and conflicting goals.  This does not bode well for either North American based supply chains or smaller suppliers caught in the current squeeze. 

 

Tough decisions are in store for the remainder of 2011.  Organizations that most need to invest in value-chain agility and responsiveness may find themselves prohibited from doing so by cost pressures.  The need for closer communication and coordinated strategy among procurement and broader supply chain management teams will be a fundamental challenge in 2011.

 

How is your organization addressing these two challenges?

 

 

Bob Ferrari

 

 

© Copyright 2011 The Ferrari Consulting and Research Group LLC

 

A Monday can sometimes be a slow day for business and financial news, but yesterday, on the eve of the meeting of the World Economic Forum in Davos, it seemed that a common headline for print and video outlets revolved around the challenge of exploding inbound material costs and mounting concerns of inflation. In economic circles, these trends will often point to the need for companies to eventually raise product prices, which fuels the fears of inflation or, perhaps, another slowdown in consumer spending.  There is, however, even more at stake in terms of supply chain capabilities.

 

The latest poll displayed on the Supply Chain Expert Community web site seeks an opinion as to what will be the biggest supply chain challenge in 2001. Thus far, the majority of respondents have responded that demand volatility and collaboration with customers and suppliers seems to be the prevailing opinion.  It may well turn out that the current trend of explosively rising inbound material costs will present the most difficult supply chain related organizational challenges for 2011.

 

The trend of exploding inbound material costs should be of little surprise to the community of supply chain management professionals.  This trend started months ago and the pace is now accelerating.  The statistics are troublesome.  In food commodities, the price of corn has already risen by 84 percent, , wheat 61 percent, soybeans 48 percent, and sugar 18%.  Within industrial and discrete sectors, the price of steel is expected to double sometime this year.  We have all read of the exploding prices in precious metals and rare earth materials, and the price of oil and associated energy related products is again on the rise.

 

One of our Supply Chain Matters Top Ten Predictions for Global Supply Chains in 2011, addressed this specific challenge.  Prediction Two noted that in the year 2011, supply chain cost reduction pressures will run into a stone wall as rising inbound material costs provide difficult roadblocks for supply chain teams in their ability to deliver any offsetting aggressive cost reduction objectives. We noted how the CEO of global auto parts supplier Bosch had indicated that this rebound in commodity prices would put intense strain on industrial companies, as well as their suppliers, and there could well be more supplier casualties.   The dilemma is that the previous toll of multiple years of cost reduction efforts evokes a concern that any current increased reductions risk cutting into ‘the bone’ of supply chain performance capabilities. 

 

The counter argument is that by raising prices for products, companies will be able to offset rising inbound material costs.  In fact, the wave of announcements may be about to begin.  Other long-time industry observers, however, are quick to caution that companies remain under pressure to keep delivering healthy levels of margins, profitability and cash.

 

It seems to me that now, more than ever, is the time for supply chain management teams to step-up their communication and education to senior management regarding the specific trade-offs of cost reduction objectives.  The risks are rather high, along with the consequences.  Leaning too much toward further offsetting supply chain cost reduction may well harm the ability for agility and responsiveness in these very uncertain business times.  Passing this cost reduction burden on to suppliers also risks more disruption and harm. 

 

Conversely, aggressive price increases could negatively impact demand for products, and if a wave of companies join the stampede, the risks of another economic slowdown seem to me to be very real.

 

While supply chain management teams may not have the final say, now is the time to insure that open and unfiltered communication exists with senior management, and that supply chain cross-functional teams come to some consensus on the impacts of various cost reduction or supply chain restructuring options. Planning and mitigation now can avert a potentially serious business impact later.

 

How is your organization viewing the current challenge of  exploding input costs?

 

Bob Ferrari

 

These past few days have brought some euphoric news in the high tech and consumer electronics sector, but I could not help but ponder lessons of the past.  Times of euphoria are a time to celebrate the fruits of long hours and hard work, but after the celebrations, there needs to be some reflection on the complex supply chain challenges that lie ahead.

 

Two specific timely stories of note are Intel and Apple. 

 

Intel just reported its best financial year ever, recording a 24 percent increase in 2010 revenue and a whopping 167 percent increase in profits from a year earlier.  In reporting background on these results, Intel executives noted growing corporate and consumer demand for personal computers, business demand for server, and robust demand for other Intel products.  Since Intel products represent the lower echelon of high tech value-chains, a speculator year for Intel could portend another great year for the industry. CEO Paul Otellini noted that results can get even better in 2011 as the economy improves and Intel brings new products to market.

 

However, market analysts have been noting that sales of personal computers are being quickly overtaken by the explosion of sales in smartphones and other mobile devices, and Intel needs to be better positioned to take advantage of this new wave.  Semiconductor technology innovation cycles remain constant, and Intel has again allocated billions for new plant and equipment to support the next generation of chip technology. There are also different channels of distribution and demand fulfillment in mobile consumer devices, and Intel will continue to adjust its product demand forecasting and management processes to accommodate a more dynamic demand signals.

 

Speaking of this sector, yesterday, Apple continued its unprecedented momentum, reporting enviable fiscal 2011 first quarter results which involved this past holiday buying season.  Apple revenues increased 70% and profits increased 78% from year ago. The company produced $6 billion in profits while generating $9.8 billion in cash flow from operations. Volume shipments were impressive, and included an 86 percent increase in iPhone, and a 23 percent increase in Mac shipments.  However, iPod shipments declined 7 percent from a year ago.

 

A commentary penned by John Boudreau of the San Jose Mercury Times noted: “Apple’s current performance would be spectacular even for a startup a fraction of its size.” Another Wall Street analyst notes that other similarly sized industry players such as Hewlett Packard or IBM while also growing, are not growing at the 60 percent annual pace that Apple has right now.  Steve Jobs himself noted: “We are firing on all cylinders and we’ve got some exciting some exciting things in the pipeline for this year including iPhone 4 on Verizon, which customers can’t wait to get their hands on.” 

 

 

However industry watchers have raised cautionary tones regarding the announcement of another undetermined medical leave for Steve Jobs, as well as the ongoing strategic race for market dominance between Apple’s iPhone and the Google’s Android operating systems. Nokia, and Research In Motion are each embroiled in this race for who will prevail in platform dominance. It should be no secret that Apple’s supply chain capabilities, while the envy of the industry, remains constantly being challenged with balancing explosive demand with the realities of constrained supply and constant product innovation cycles.

 

Members of this community may also have a different lens to what occurred behind the scenes in 2010.  In the midst of the gloom and after effects of two years of severe global recession, high unemployment and generally negative news, consumers determined that having the latest PC, smartphone or tablet computer was a priority.  That caught certain semiconductor, OEM’s and key component suppliers off guard, since capacity and inventory had been cutback and many suppliers were not prepared for the sudden upticks in demand.  Throughout 2010, supply chain teams had to manage numerous component shortage situations and longer lead times, seeking either alternative sourcing, temporary design changes or sheer willpower to insure that customer fulfillment was accomplished. 

 

It was truly a year of ‘rapid response’ and agility.

 

For 2011 and beyond, the challenges continue, and more caution signs remain.  How long will current consumer demand for the latest gadgets continue when continued high unemployment levels persist?  Commodity costs are rising across the board, and certain rare earth materials have become a bargaining chip in geo-political affairs. High unemployment levels in the U.S. and looming uncertainties of more financial crisis in Europe loom as a dampening effect to consumer demand. Will supply chain teams once again succumb to the ‘bullwhip effect’ of redundant orders and inventory?  New product and innovation cycles continue on an intense, non-stop basis.  One significant glitch or miscalculation and the results can be somewhat disastrous.

 

Perhaps at this point, readers may be presuming- why is this Ferrari guy being such a curmudgeon? After all, look at all the great things that have happened.

 

My point in this commentary is to provide some wisdom. 

 

Results and hard work should indeed be a cause for celebration and reward.  But, it is precisely in the times of euphoria that there may be the tendency for leaders to take their eye away from certain longer-term signs.  Perhaps names such as Digital Equipment, Apollo Systems, Wang Systems, RCA or others come to mind.  Each had times of euphoria and perhaps ignored the signs of caution and diligence in always keeping a keen eye out for overcoming constant value-chain challenges. After all, the people, processes and systems that are the fabric of any value-chain are the key facilitators of outstanding performance, and are often the lookout of what is to come.

 

Bob Ferrari

 

An important mission of the Supply Chain Matters blog, one that we continually focus upon, is to point out specific developments where supply chain capability has either enhanced or detracted from business or financial performance of an enterprise.

 

One company that we have been monitoring from time to time is the Kellogg Company.  In 2009, its Eggo© Waffle product line was involved in a product recall that turned out to be an embarrassing situation of social media backfire.  The occurrence of factory flooding conditions and prior suspected listeria contamination were attempted to be hidden by a social-media campaign directed at consumers that lamenting the shortage of Eggo’s. A Huffington Post commentary at the time noted that news of the shortage spread quickly on Twitter as shoppers reported not being able to find their favorite breakfast food, and were also lamenting the scarcity on Facebook as well.  It was until ABC News reported the contamination story that consumers discovered the real story. Since that time, Kellogg was involved in another product recall involving 28 million boxes of cereals after consumers complained of a waxy smell and flavor coming from certain items.

 

Today’s Wall Street Journal features an article related to Kellogg which provides clearer evidence of the true impact of a troubled supply chain capability.   The article’s takeaway is that a newly appointed CEO is addressing multiple challenges of both increasing inbound commodity costs as well as a troubled supply chain. In fact, the actual article quote notes: “But problems stemming from two product recalls and a flooded Eggo waffle facility in the last couple of years will require that Kellogg put some time and effort into restoring investor confidence in its supply chain.”

 

 

Further into the article, an analyst from Telsey Advisory Group is noted as indicating that Kellogg faces too big of a challenge in restoring its supply chain for that particular analyst to get bullish on Kellogg stock.  That alone provides additional evidence of the importance that Wall Street places on negative supply chain news. 

 

In terms of some quantifiable impact, the Journal notes that Kellogg’s fiscal second quarter net income was down 15 percent immediately after the recent cereal recall.  Fiscal Q3 earnings further declined by 6 percent.  Combining lost opportunity of both quarters equates to nearly $60 million. Kellogg stock is also down approximately 4.5 percent from year ago levels.

 

Also noted is that the Eggo© brand itself lost ground to both private label and smaller brands of waffles when supply was disrupted.  Some shoppers have yet to resume normal buying patterns.

 

John A. Bryant, the new CEO of Kellogg is most likely fully aware of the supply chain challenges facing his company, and like Boeing, Johnson and Johnson, and Toyota, a keen emphasis will be placed on proactive corrective action.

 

As we continue to note, supply chain capability and proactive management of potential supply risks do matter to bottom line results.

 

Bob Ferrari