There was a rather interesting article, On the rebound, featured in the August 15^th edition of The Economist Magazine of which supply chain strategic planners should take note.  This article points out that Asia’s emerging economies are recovering much more quickly that those in other parts of the world, but raises the question of longer term sustainability of this momentum.  I would argue that this momentum also implies an investment in more sophisticated supply chain planning and analytical decision-making tools.

What I found to be of most interest in the article was the Barclays Capital chart (Back on track) that indicates that emerging Asia’s  industrial production levels have jumped to an annualized rate of 36% growth in the second quarter, and output has regained levels achieved prior to the onslaught of the global economic crisis. The authors cite China as the prime influencer of this trend, where industrial production has risen 11% in the past twelve months.  The U.S. on the other hand, continues its decline in industrial production activity, which reinforces the premise that the emerging Asian economies, and Asian based supply chains are now leading in the overall recovery.

There was previous speculation among economic forecasters that emerging Asia economies that were highly dependent on export-driven markets such as the U.S or Europe would lag in the recovery, or at least front-end recovery in these countries such as the U.S.. The opposite has occurred thus far.

The authors make the observation that Asian firms, similar to other global firms, aggressively cut production to below the level of sales in order to shed excess costs. Different than the situation in other regions, these firms now need to reopen factories.  The authors point to industry observers that note that the current pick-up of activity simply reflects the rebuilding of inventories in anticipation of increased demand.  South Korea’s private consumption rose by an annualized 14% in the second quarter, and in China, consumer spending in urban areas is up by almost 11%, mostly driven by government stimulus incentives directly related to consumer spending.  The article notes: “…South Korea, Singapore, Malaysia, Taiwan and Thailand have all had a government boost this year of at least 4% of GDP.”  The argument is that stimulus has been more effective in these countries because Asian households were not burdened by huge debts, and that it was a lot easier for emerging economies to find worthwhile infrastructure projects.

While all of these trends are noteworthy, I would raise a couple of caution flags for supply chain planners.  First, similar to the current debate around government stimulus programs that motivated U.S. consumers to trade in their clunkers for new automotive purchases, the question of longer-term sustainability of demand is a very valid one, and pertains to Asia as well as other countries. Firms will need to continually sense for sustainability in product demand, or a structural shifting of demand.

Second, Asia has a particular problem related to over capacity in certain industry sectors that existed prior to the recession.  If Asian factories begin to crank-up demand too far ahead of real demand, that overcapacity problem will lead to price erosion and a need to find more outlets for goods, potentially leading to another condition of too much inventory and productive capacity.

On the subject of the threat of inflation, the article’s authors point out that growth in the overall labor supply as well as sustained productivity levels will need to combat future inflationary pressures across Asia. I would argue that implies Asian based supply chain organizations will need to step-up their investments in IT tools that can provide global-wide supply chain visibility, as well as timelier decision-making relative to overall inventory and production levels.

If Asia does lead the West in the global recovery it must do so with smarter supply chain business processes and supporting technology that can rapidly sense and respond to both domestic or export driven market changes.  This is not necessarily a call to large-scale IT investment, but rather investing in tools that provide more insights into the timely balancing of supply with actual demand.

 Bob Ferrari

I was traveling and vacationing last week, and I’m now catching-up with some supply chain news over these past few days. 

One of the more interesting and eye catching supply chain stories was that related to Southwest Airlines, which has again been cited by the FAA for a significant maintenance lapse.  On Saturday, August 22, a dispute between the FAA and Southwest over the use of potentially unauthorized parts forced the airline to temporarily ground 46 of its 737 aircraft, nearly 10% of its fleet, forcing significant delays in its service operations. The parts in question, an exhaust gate assembly, functions to protect movable panels on the rear of the wings from being damaged by hot engine exhaust, and according to both the FAA and Southwest, does not pose an immediate safety issue.  According to an article in the Wall Street Journal last Wednesday (subscription may be required), FAA inspectors and managers maintain that since the specific parts were never authorized for aviation use, the planes containing these parts were technically not fit to carry passengers. According to this WSJ article, an FAA inspector uncovered the parts discrepancy “during a routine inspection” and since then, Southwest “has told us that it plans to replace all of these parts on the affected planes.” Both the FAA and the airline have come up with a plan to replace the suspect parts in less than two weeks.

A follow-on article in today’s Wall Street Journal indicates that the unauthorized use of the subject parts has occurred for up to three years on 82 planes, and has now presented a vexing policy question for the FAA as to forcing airlines to ground planes even though the violations don’t pose an immediate danger to air safety. Southwest has indicated that swapping out all of the suspect parts could take up to three more months. The FAA in-turn is concerned that allowing Southwest to continue flying these suspect jets could set a precedent for other carriers to seek similar special treatment in the future.

In my view, there are much broader issues at stake here, those related to the operation and maintenance procedures of discount air carriers, as well as the issue of supply chain risk and control.  First, Southwest has been the benchmark for many of today’s discount carriers in obtaining maximum operational use of fleet aircraft.  We have all more than likely experienced the quick, less than 30 minute turnaround of flight landings and departures, as well as the maximum utilization of aircraft during any given 24 hours of flight schedules. The unstated question is whether the emphasis of low cost and cheap airfares that leads to maximum utilization of aircraft use is adequately supported by required and properly scheduled maintenance. There is an excellent exchange of commentary attached to the initial WSJ article that debates the pros and cons of cheap airfares and proper maintenance. One commenter reminds us that two previous FAA inspectors who were overseeing Southwest maintenance standards have since been transferred, alleging that there may have been a  “too comfortable” relationship regarding oversight.

The other issue relates to the contracting of maintenance to a third-party, that, in-turn, may sub-contract that maintenance to another firm. As the latest WSJ article points out, Southwest has had a history of outsourcing maintenance to a U.S. based contractor D-Velco Aviation Services, that in turn, subcontracted work on the affected systems to another company that was not authorized by the FAA to provide the particular parts.  Southwest has suspended D-Velco as a maintenance contractor.

Readers may further recall that there have been other maintenance incidents directly attributed to Southwest.  In March of 2008, 44 of its older jets were grounded to inspect for possible structural damage after it was revealed that the airline chose to keep flying 46 jets that had overdue safety inspections for fuselage damage. At that time, the FAA imposed a record $10.2 million fine on Southwest. An article in the Dallas Morning News in March of 2008 quoted Southwest CEO Gary Kelly on Southwest’s continued commitment to safety, and another Southwest spokesperson pointed to the airline’s ongoing internal investigation of its maintenance operations and compliance with required work.

It is time for both Southwest and the FAA to establish renewed efforts for what is acceptable maintenance and parts control standards for discount air carriers.  The notion and/or perception by the traveling public that discount air carriers can find means to “get-around” required maintenance and inspections in order to maintain schedules needs to be put to rest.  The traveling air passenger needs the assurance that aircraft, no matter how much utilized or how long in service, has had both required maintenance and is safe to continue flying.  Yes, reason should prevail relative to what may be deemed a threat to aircraft safety or air worthiness vs. other maintenance.  Airlines in turn have another reminder that outsourcing of maintenance, for the sake of cost, does not include the outsourcing of responsibility for adhering to required maintenance and parts specifications.  Airlines that choose to practice full conformance with maintenance and safety of aircraft should not be placed at a de-facto cost disadvantage.

We trust that Southwest, as well as other discount air carriers, and the FAA, will hopefully learn again that efficiency must not compromise on required maintenance and adherence to parts specifications. Surely, now is the time to adopt standards that can keep the airline industry solvent but at the same time, safe.

Bob Ferrari

CFO Magazine has been annually publishing its Working Capital Scorecard report, the latest of which was published in June.  This scorecard tracks the key working capital performance measures of accounts receivable, days payable and most important to the supply chain community, Days Inventory Outstanding (DIO).  As a senior supply chain marketing manager and industry analyst, I often leveraged the trends of this report to help companies to determine where supply chain improvement initiatives can best be leveraged.

Dan Gilmore, Editor of Supply Chain Digest, recently penned an article, Analysis of Inventory Numbers for 2008, referencing the specific CFO DIO trends.  Dan notes that based on the numbers, 2008 were a good year for inventory management.  That goes without saying, especially since the fourth quarter was where many businesses in many industries experienced very dramatic declines in product revenues.  The good news for global supply chains was that on an aggregate basis, inventory was ratcheted down dramatically, a phenomenon I subsequently termed as the “great inventory backflush“.

While a larger number of industries showed improvement, I believe it is very important to also consider the inventory situation thus far in 2009, about three quarters into the year.  The financial communities are winding down from many of the Q2 earnings announcements.  One clear theme I kept hearing was that most companies managed to buffer dramatic erosion in revenues and profitability by aggressive cost control measures, which included inventory.  Financial analysts who cover the retail industry have noted that overall that industry is at its leanest inventory levels in many years. The same could be stated for high tech and consumer electronics.  But much work remains, since the overall economic recovery, at least in the U.S., is still lagging, and we cannot afford to take our eye off the inventory ball.

The U.S. Census Bureau has just released its latest Manufacturing and Trade Inventory report for the end of June.  It notes that overall trade inventories are down 9.8 percent from a year ago levels, which certainly reinforces that the momentum of inventory reduction has continued   But, similar to the measurement criteria of DIO, which ties inventory to sales activity, the more important inventory to sales ratio still has a very long way to go to reach levels of 2007/2008.  The ratio stands at 1.38 vs. 1.26 a year ago.  That means that there is 38 cents of additional inventory for every dollar of sales in the U.S.

There are other concerning trends brought out in the DIO statistics by industry.  The spreads between best vs. laggards still remains extreme, indicating that the longer the recovery takes, the more problems laggards will have in drawing off inventory levels.

Another industry of note is healthcare, especially considering the current level of rancor and debate underway in the U.S. relative to healthcare reform.  Healthcare equipment and supplies companies had a median of 50 days inventory outstanding, whereas pharmaceutical companies had 35.  Now here is an area where savings can be made.

If your organization has aggressively managed inventory since the recession began, pat yourselves on the back.  But, efforts need to continue, because more work remains.

Bob Ferrari

With all of the various incidents of late concerning supply chain disruption and risk, it is somewhat important for risk-related professionals to consider the hidden timeline of risk.  What I mean by this is that a risk situation may have already occurred before mitigation teams actually get involved.  To provide some concrete examples, I did some research into the recent peanut butter and peanut products recalls that involved hundreds of different food-related supply chains.

 First, take a look at the following timeline graph provided by the U.S. Centers for Disease Control (CDC).

 You will note that the actual occurrences of reported sicknesses actually occurred as far back as October of 2008.  It wasn’t until early January of 2009 that various state and federal government officials were able to triangulate the 430 reported sicknesses and 5 deaths to peanut products being produced by the Peanut Corporation of America (PCA) facility in Georgia. On January 10, the first product recalls began, followed by numerous cascading recalls as the PCA products were traced among various other food-related supply chains.

The takeaway is that risk management groups need to consider the entire timeline of risk exposure. There was at least three to four months, if not longer, exposure of potentially contaminated product in various supply chains, before formal product recall actions were initiated.  It wasn’t until late April or early May until the number of cases of sickness began to decline, as products were removed from various supply chains.  The total timeline of this incident thus equates to roughly nine months, if not longer.

Are there ways to gain more visibility and intelligence during the hidden periods? Probably so. But the real question lies with who, how and at what cost.  

Should regulatory agencies be relied on for early-warning visibility? Can advanced technology in information retrieval and analytics play a more meaningful role?  Is there a justifiable ROI for early-warning tools?

These are all open questions that risk professionally should have on their radar screens, I’d be interested in seeing some commentary on this topic.

Share your observations or views in the Comments section of this posting.

 Bob Ferrari

The Seattle Post Intelligencer blog had a recent posting by Aubrey Cohen, titled Problems won’t reverse (Boeing) outsourcing.  This posting comments on the ongoing outsourcing challenges that Boeing has been encountering on its 787 Dreamliner program.  Readers of this blog are quite familiar with this topic, since we have featured various commentary of our own.  The latest two postings came be found here, and here.

The Seattle PI posting quotes the practice leader of PricewaterhouseCoopers LLP aerospace and defense practice as indicating that this new experiment of large scale outsourcing within the aerospace industry was bound to have some growing pains. This same consultant further states that he doesn’t see any major reversal in the trend toward large-scale outsourcing.

What really surprised me regarding this commentary was a lack of acknowledgement as to “what has the industry, and specifically Boeing learned as a result of this chapter?”  Obviously, that information will be an internal learning and guidepost for Boeing and other industry players for managing major outsourcing initiatives.

As a supply chain industry observer,  I can offer some pointers as to what should be included in such learning.

1. The notion of large-scale outsourcing involving multiple global players brings its own inherent risks.  When you add revolutionary new technology of composite materials or innovation of new supply chain processes, it just adds more to the overall aspects of risk.     Outsourcing processes need to include balanced risk.
2. Supply chain wide visibility and transparent communications are essential.  Too often, information that must traverse multiple organizational structures, program offices, functional stovepipes or teams causes that information to become pigeon holed.  Outsourcing of major components often requires cross-functionally integrated teams, empowered to make required decisions on a timely basis. Late last week, Boeing seemed surprised over leaked news that in June, an Italian supplier, Alenia Aeronautica, had to stop work on 46 of the 787 carbon fiber barrel assemblies because of wrinkles in the carbon fiber skin.  Boeing characterized the problem as “not serious” and of no impact. But the financial community reacting quite differently drove down Boeing’s stock.  Trust and consistency in information is a very big deal.
3. Suppliers who are empowered with the right collaborative tools and information streams. A supplier should be an extension of both your product management and production teams, and goaled on the same performance measures as the entire program management team. Similar to what Toyota has successfully taught, the success or failure of any individual supplier, is that of the team.  
4. A senior management structure that is highly engaged in the details, as opposed to insulated by organizational filters. When Airbus experienced its third major delay in expected deliveries of to its A380 customers, President and CEO Christian Streiff became actively involved in program leadership and stewardship.  It astounds me that with all of the current delays and setbacks around the 787 program, that there has been no visible stewardship from the very top ranks of Boeing.
5. Clear communication flow to all value-chain participants regarding delivery dates.  Global based air carriers have much at stake in the scheduling and delivery of  new aircraft.  There are implications of significant financial, route scheduling, or customer service implications.  The fact that in mid-August, Boeing has yet to definitively commit to 787 first test flight or revised delivery schedules does not

Yes, the problems encountered by the aerospace industry won’t reverse outsourcing, but those companies that excel will have addressed many of the lessons learned from current programs, especially Boeing.

Bob Ferrari