The following posting can be viewed and commented upon on the Kinaxis Supply Chain Expert Community web site.

During the past few months, in the Kinaxis expert community and on the Supply Chain Matters Blog, I have been sharing commentaries regarding the evolving new era of aircraft manufacturing which has had such a strong dependence on an outsourced supply chain of suppliers and partners, a dependence model that still exhibits needs for improved coordination in product innovation and material flows. The time has come to comment on a third potential player, one that presents a threat from a different perspective of the supply chain.

Most everyone is aware of the continuous setbacks that have occurred with Boeing and its 787 Dreamliner program.  The latest setback occurred just a few weeks ago with an unfortunate in-flight electrical fire causing one of the test aircraft to make an emergency landing.  The Dreamliner’s scheduled first customer ship scheduled for Q1-2011 remains in jeopardy, and is now over two years late. We also commented on Bombardier’s C-Series program, a single aisle aircraft that is the cornerstone of that company’s plan to compete head-on with likes of Boeing and Airbus.  The C-Series also has a high dependence on a globally outsourced supply chain including major component assemblies sourced in China, Ireland, Italy and Germany.

Both of these programs are a high-stakes gamble for competitiveness and attraction among global based airline customers, especially those in the emerging markets.  Success is keyed on who can best coordinate and integrate the most breakthrough innovative technology with the most cost-efficient, global-based supply chain. Is the case of aerospace, sourcing equates to innovation, cost, and access to a potential growth market that has political dimensions of presence.

The third player, Commercial Aircraft Corporation (COMAC), is now coming into broader visibility.  COMAC is a China based, state-owned aerospace manufacturer who has embarked on its own program of innovation and cost.  The C919 (not to be confused with Bombardier C-Series) is a single-aisle aircraft being designed to carry up to 150 passengers. It is also being designed to be an alternative to the Boeing 737 or Airbus A320.

A recent Bloomberg Businessweek article notes that some key suppliers that supply both Boeing and Airbus, such as General Electric and United Technologies, are also working with COMAC.  They are hitching their wagons to all major aerospace players in the overall game of global competitiveness and who will become ultimate winners.  The reasons are fairly obvious; suppliers want to insure access to China’s and other very large aircraft markets that will unfold in the coming years.  Bloomberg points out that China alone accounts for 22 percent of Airbus’s 2010 orders and 15 percent of Boeing’s.   Thus far, COMAC has received orders from three Chinese airlines and two leasing companies, all state-owned, for a total of 90 C919’s, even though the maiden flight is not scheduled until 2014.   That situation alone provides one key advantage that the company has in terms of China’s airline market, its influence as being China owned and resident.

Much has been written of late about China’s high speed rail market, and how quickly China’s state-owned railway was able to master world-class technology in such a short period of time.  China’s railway is now competing for large-scale rail projects not only within China proper, but in other global regions, including the United States.  The major high speed rail OEM’s from Japan, Germany and France were all compelled to form joint-partnership arrangements in China in order to assure market access.  Now, some of these providers believe that their technology may have been compromised.

There is no doubt that in the coming months and years, product design, innovation, reliability and supply chain sourcing will all be primary factors as to which aircraft ultimately succeeds as favored by global carriers.  The Bloomberg article summarizes the bottom line of its article as noting that China’s commercial aircraft industry is getting help from Western aerospace companies who wish to branch out beyond today’s major industry players. By being resident in China, CMOC may already have a cost advantage, but has a strong reliance on product innovation and engineering.  It will be interesting for all of us to observe how a low-cost producer can overcome innovation and intellectual property barriers.

The stakes are even higher and a lot can be learned from the current episodes in high-speed rail. We could possibly read business case studies ten years from today that outline the circular trend in commercial aircraft component sourcing, moving from a past one nation, one contiguous resident supply chain, to multiple nation component supply chains, and back again to one predominant resident supply chain, which could include China.

In any case, don’t be terribly surprised if in the next five years, you find yourself traveling on a Chinese commercial aircraft, especially if you are traveling between Chinese cities.

Bob Ferrari

If your organization currently has sourcing of lower-cost finished goods or parts components residing in China, I highly recommend you read a recent Financial Times editorial commentary penned by David Pilling.  This November 17 commentary which is titled, How Foxconn signaled a new China price, (free preview account or paid subscription may be required) makes a rather insightful argument that global supply chains may have crossed a rather new threshold: before and after Foxconn’s recent wage concessions.  It notes that the foremost contract manufacturer in the world, which now employs 800,000 Chinese workers, and has granted a 30 percent wage increase to its workers, has managed to ease negative publicity on the likes of its high profile customers like Apple, Dell and HP.  It also led to a wave of further wage increases among other industries.

Victor Fung, Chairman of Li & Fung, one of the world’s largest sourcing companies in clothing apparel is quoted as indicating that the controversy concerning Foxconn has become an epoch-making event.  He is quoted: “One can talk about a world pre- and post- Foxconn.  Foxconn is as important as that.”

Post Foxconn trends are noted as a greater tolerance by Chinese officials for labor unions, increased worker rights, and a potential period of more sustained wage inflation.  Pilling argues that factories making more sophisticated electronics or automobile parts are likely to stay near Guangdong province, while production of lower-end goods will continue to move to more interior or other regions. Mr. Fung also is noted as observing that Chinese companies themselves are inquiring about sourcing garment or footwear production outside of China.  Another secondary consequence is a spillover of higher wages into countries neighboring China, with signs that this is already underway in Bangladesh.

The most important post-Foxconn effect penned by Pilling is the most profound.  If wages in China, and elsewhere in Asia continue to rise, so will the general prices of finished goods, and some traders are predicting that 10-20 percent cost increases in China could come as soon as next year, setting the stage for the re-balancing that all other global economies have been seeking, regardless of higher exchange rates.

It is a compelling editorial that readers should be read and placed in context.  It is also another strong argument for having a flexible global outsourcing or in-sourcing strategy, especially if your firm has high direct labor cost dependencies.

Bob Ferrari

In case you have not noticed, an interesting customer and supply chain distributor confrontation is underway, and it involves two highly visible players.  Kraft Foods signed a distribution agreement with Starbucks Coffee Company back in 1998, where Kraft provides global distribution of Starbucks coffee among retail outlets.  According to a company press release, Kraft notes that has grown this business from less than $50 million, to approximately $500 million in annual revenues, and Starbucks has recognized and acknowledged Kraft’s role in building this retail presence, leveraging its own supply chain capabilities.

Starbucks, however, now wants out of the deal.  According to today’s Wall Street Journal opinion commentary, Starbucks May Spill Kraft’s Coffee, (paid subscription may be required) this java experience provider has reached a challenge in growth.  While overseas expansion of outlets has gone well in some countries, other countries have presented more competitive challenges.  Starbucks is perhaps viewing the packaged-food business as a bigger growth opportunity for the future, and apparently wants more direct control.

The problem is that the deal with Kraft was designed as an indefinite arrangement, subject to certain conditions and limitations.  Starbucks has embarked on the inadequate performance route. It accused its partner of failure to properly market the brand, for example, not maintaining appropriate promotional displays inside grocery stores. According to the WSJ commentary, Starbucks sent a second letter on November 5^th indicating that its partner had failed to remedy the contract breaches and that the deal would end in March of 2011.

Kraft’s public statement makes note that Starbucks could take over the retail distribution business, but needs to compensate Kraft for the fair market value of the business, plus allow sufficient time for an orderly transition. Kraft hints at interest in a premium of up to 35 percent of sales value.  The Journal commentary quotes a Wall Street analyst best guess that a Starbucks buyout could amount to $1.5 billion.  Starbucks would have to incrementally invest in its own global retail physical distribution, transportation and process capabilities or find another partner with more favorable terms.

Whenever lawyers get directly involved in supplier and customer deals, events can get ugly and relationships can, in-turn, be severely strained.  Rather than risk an acknowledged positive relationship among two well-known companies, it would seem that a more rational approach should be explored.  Arbitration, in our view, is an acknowledgement that neither side is willing to make movement.

Starbucks, for its part, has to recognize the value that Kraft has provided in leveraging its supply and distribution expertise, along with its supply chain process capabilities in sales and operations planning. It must internalize what it would reasonably take in time and money to re-create these capabilities internally. Competitor Dunkin Donuts has elected to have a third party maintain retail distribution, and many other service retailers opt more for leveraging someone else’s supply and distribution network, for instance Amazon or others, vs. investing in singular capability.  It really comes down to that key question, how strategic is supply chain physical or process capability to long-term growth needs.

Kraft, in-turn, should recognize the importance of key customer needs, including the desire of the customer to gain more financial benefit from an existing relationship.  Kraft is already under the looking glass regarding its recent acquisition of Cadbury, and consequent need to drive considerable incremental savings in overall supply chain costs among both companies.  One would speculate that a loss of Starbucks’ profitable retail business makes the challenge even more difficult, or the potential moving of Starbucks to another consumer goods competitor’s supply chain distribution network does not bode well for Kraft’s reputation either.

Perhaps it’s time to stop playing ‘my supply chain trumps yours’ and move toward a ‘win-win’ negotiation arrangement where the lawyers and the egos stand in the background.

Bob Ferrari

Disclosure: The author of the above commentary is an owner of the common stock of Kraft Foods.

With the U.S. Thanksgiving holiday, Black Friday weekend and general holiday season fast approaching, it is rather timely for all of us as consumers and supply chain management professionals to ponder the implications of an ever more sophisticated and information advantaged consumer, and how the 2010 holiday buying season will place ever more emphasis on retailer based multi-channel operations, and consequent stronger needs for collaboration with key suppliers.

On the Infosys Supply Chain Management Blog, I had the opportunity to provide a guest commentary on how the upcoming holiday buying season will test multi-channel operations and supply chain synchronization.

You are welcomed to add your own observations to the commentary.

Bob Ferrari

The following posting can also be viewed and commented upon on the Kinaxis Supply Chain Expert Community web site.

There has been a lot of articles and commentary of late addressing brewing conflicts among global economies concerning the valuation or volatility of certain currencies and the implication to manufacturing and supply chain outsourcing is already unfolding

The most significant movement concerns Japan, where a fifteen year high, on a nominal basis, on the value of yen, has led to more and more Japanese manufacturers moving to increasing outsourcing of manufacturing to other lower-cost regions.  In previous commentaries, we noted decisions by consumer electronics providers Panasonic and Sony Electronics to aggressively move previous home country manufacturing operations to contract manufacturers in other Asian regions. The latest significant tremor involves Toyota and Nissan.

In early November, Toyota, who already sources over 50% of production outside Japan, threatened to move significantly more production out of Japan.  A Financial Times article at the time noted that Akio Toyoda, Toyota’s President called the surge in the value of the yen a “big problem” that threatened all of Japanese industry. Toyota executives note that the company is quickly losing competitiveness, especially as sales in other emerging regions are diluted by home currency issues.  The FT article contrasted Toyota to Toshiba, who since 2009, moved more supply and final production outside of Japan, and was able to profit from the yen’s rise in the first half of September. Today’s Financial Times has a front page article (free preview account may be required) noting that Nissan is planning to shift the balance of its production and support functions towards dollar-linked economies, including China and the U.S., in order to protect itself against currency volatility. CEO Carlos Ghosn is also noted as indicating that Nissan wanted to correct a “big imbalance’ in costs and revenues caused by producing cars in Japan to sell in the U.S. and other dollar-linked economies.

The November 20-26 edition of The Economist also features an article, Leaving Home, indicating Japanese firms currently do 30% of their production overseas, twice as much as the early 1990’s, and that that figure is sure to rise with current trends. Three different factors are cited as accelerating this shift and include the rising nominal value of the yen, closer access to faster-growing economies, and the burden of corporate taxes and tariffs. The Economist article also astutely points out that as major production shifts from Japan or other countries, local suppliers atrophy from lack of skills and innovation.  Also noted was that a previous belief that keeping “mother factories’ in Japan to refine production processes and retain skills is also losing favor, since in 2008, three quarters of Japanese-owned were at the same technical level as Japanese domestic plants.

Manufacturing outsourcing continues to be a delicate balance of multiple factors. Access to growing consumer-based economies, shifting and volatile currencies, higher transportation and quality control costs, and concern for intellectual property protection all interplay in the dynamics of outsourcing.

From our perspective, two conclusions stand forth.  First, outsourcing decisions will continue to involve dynamic factors, and the degree of flexibility and agility of manufacturing and supply chain networks will continue to be a key consideration in supporting outsourcing needs.  That also implies the ability to analyze and assess all the various factors. Second, no country can claim to have an economic growth plan without consideration to the global competitiveness of its manufacturing and supply chain infrastructure, as Japan is unfortunately beginning to understand.  Other countries may follow, and none are immune.

Bob Ferrari