Supply Chain Matters provides our fourth update concerning the series of strong earthquakes that impacted the Emilia Romagna region of Northern Italy in late May. Sadly, twenty-three persons lost their lives and an estimated €4 billion euros in damage was incurred by a series of severe earthquakes.

In our previous update penned in early June, we highlighted that the impacted region included a biomedical production supplies district in Medolla and in nearby Mirandola where 90 factories that produce disposable medical items along with equipment for transfusions and dialysis. Reports indicated that the majority of these facilities suffered some form of damage.

Published reports in both the Financial Times and London Telegraph indicate that Baxter Healthcare has warned hospitals and healthcare providers that potential supply disruptions stemming from the earthquake will limit some supplies of the sterile plastic tubes utilized in that company’s intensive dialysis treatment machines. The shortage will affect hospitals worldwide that use Baxter specific dialysis machines, as they can only accommodate Baxter designed tubing. While Baxter is warning healthcare providers of a potential supply disruption in early October, as opposed to declaring a total supply disruption presently, hospitals in the UK and elsewhere are increasingly concerned about reliable ongoing supply. Hospitals within the National Health System in Great Britain are beginning to feel the effects of this shortage. According to these reports, Baxter is rationing supplies to prevent panic buying. Shortage fears have prompted some UK hospitals to raise the threshold at which patients are provided certain dialysis treatments. Some hospitals have discovered that existing inventories will only last a week.  The looming shortage has created particular alarm in London where some hospitals are dealing with increased healthcare service needs as a result of the currently underway 2012 Olympics. For its part, the NHS will attempt to manage through this situation by re-allocating existing inventory within its healthcare network.

In the discrete manufacturing sector, UK based Titan Europe, a provider of wheels and undercarriages for mining, construction and agricultural vehicles has recently warned that it could not rule out a short-term volume loss from its Finale Emilia business which was impacted by the earthquakes.

The impacted area is also a prime agricultural and production area for premium cheeses including our favorite Parmigiano-Reggiano and Grana-Padano varieties. Initial reports indicated that as much as a million wheels of both varieties were reported damaged with revised damage estimated to be upwards of $150 million euros. The current Eurozone financial crisis has special meaning for agricultural interests in this region since cheese that is aged has to be financed, and that is becoming more expensive for producers as the Italian banking sector deals with higher borrowing costs. Higher costs for premium cheeses from this region will eventually make their way into global markets.

In the category of opportunity taken from supply chain disruption, NBC News Europe featured a news story of The Brazzale family, a family firm of seven generations and some 200 years that is the top producer of butter in Italy and among the biggest producers of Grana Padano cheese. In 2000, Brazzale elected to invest in a cheese production facility located in the Czech Republic. This dairy located in Litovel in the traditional farming region of Moravia was chosen because of the quality of its cattle and cheese products. The cheese in this region is made using identical methods within Italy and aged for 9-24 months. Brazzale exports up to 70 percent of its Czech Republic output and has the potential to make Gran Moravia an alternative for food producers and consumers of premium hard grainy cheeses.

Our coverage of major supply chain disruption incidents consistently indicates that the real effect of the disruptions comes several weeks and months after the initial incident, as various industry supply chains wait for the effects.  A proactive supply chain mitigation and subsequent response plan helps to buffer the direct impacts to the business. In the case of the Northern Italy incident, the effects to industry supply chains are ongoing and could well continue to present implications in the coming weeks and months.

We encourage our readers to let us know about what impacts your business is encountering a result of the implications of this incident.

Bob Ferrari

The following commentary is the author’s weekly guest blog appearing on the Supply Chain Expert Community web site.

Experienced senior executives should know that given today’s more dynamic clock speed of business, the fortunes of any business and the consequent effects on that company’s supply chain can change rather unexpectedly. Thus are the current challenges facing Ford Motor whose stock closed yesterday at a level last seen two years ago.

This proud, family legacy, automotive OEM was the only U.S. big-three automotive manufacturer avoiding bankruptcy and bailout in 2008-2009, and consequently was viewed as the success story of the U.S. automotive industry. Ford now finds itself dealing with some increasing high profile challenges in both business and product dimensions.

Last week on the product front, Ford had to recall about 11,500 of its brand new 2013 Ford Escape SUV vehicles equipped with the 1.6 liter engine because of a serious potential for a fuel leak.  This recall is significant for two important reasons.  The first is the severity of the problem which motivated Ford to take the unusual measure of instructing owners to stop driving their vehicles altogether and make arrangements to have their recalled vehicles transported to local dealers for repair. Owners are offered a loaner vehicle while their vehicle is being repaired. According to a Reuters published report, the defect is determined to be a manufacturing flaw in fuel lines supplied by parts supplier T1 Automotive.  Reuters reports: “Some of the fuel lines were “mechanically scored” at TI Automotive’s plant in Ashley, Indiana, according to documents Ford filed Friday with the National Highway Traffic Safety Administration.”

In April, Supply Chain Matters featured commentary related to a major fire that occurred at an Evonik Industries AG manufacturing plant in Marl, Germany that had cascading impacts related to the overall global supply of nylon-12, a rare resin that is utilized in the manufacturing of fuel tanks, brake and fuel lines. Nylon-12 has been extensively used because of its superior capabilities to be highly resistant to the corrosive effects of gasoline and brake fluid.  Evonik represented over 25 percent of the global supply of the building block specialty resin that eventually makes-up nylon-12, and was also a supplier to another nylon-12 producer, Arkema SA. Eight separate auto producers and 50 parts suppliers took the unusual step to meet in Detroit for purposes of drafting an alternative specification and sourcing plan in order to seek an interim replacement for nylon-12. Whether the Ford Escape fuel line issue was a consequence of this industry problem remains to be seen.

In addition to its 2013 model, Ford also recalled about 485,000 of the older 2001-2004 Escape model years to check for a damaged cruise-control cable that could cause the throttle to stick open.  That recall involves Escape vehicles sold in both in North America and Europe, where this vehicle has the Maverick nameplate. The recalled vehicles are equipped with the 3.0-liter V6 engine and cruise control.

This week, Ford issued an additional recall concerning 8,266 redesigned 2013 Escape SUVs in the U.S. to fix carpet padding that could hinder proper braking. Ford indicated that wrongly positioned carpet padding could reduce space around the pedals and cause drivers to hit the side of the brake pedal when switching from the accelerator.

The 2013 Ford Escape was totally redesigned for 2013 to leverage Ford’s global single platform strategy, and represented one of the two critical product launches planned for 2012.  This market introduction strategy now appears to be botched given the building amount of negative oriented news concerning the Escape nameplate.

This author has some first-hand consumer experience related to the 2013 Escape product launch since I was actively in the market shopping for a new SUV vehicle in the spring.  I read of the new features of the redesigned Escape on Ford’s web site and registered myself for alerts to product availability at dealer showrooms, which was communicated by Ford in February to be “early spring, 2012”.  Receiving no web updates for weeks, I made the effort to visit a number of local Ford dealers in late May in hopes of securing a test drive. No Ford dealer in my vicinity had inventory of this new model for consumers to physically view or test drive.  It was evident that a good number of the former 2012 Ford Escape models were still sitting unsold on these same dealer lots.  Did Ford hold back the availability of the new model from dealers to sell the former model inventory?  Many of the Ford current TV commercials in the U.S. still feature the 2012 Escape model.  Now, as the volume pipeline of the new model Escape is finally making its way to U.S. showrooms, this unfortunate timing of embarrassing product recalls adds a reason for pause among North American consumers.

On the global business side of Ford, the worsening economic crisis in Europe compounded by slowdowns in other economies such as China and Latin America are further impacting Ford’s bottom line. The company reported a 57 percent drop in its latest second-quarter earnings.  Many automotive manufacturers operating across Europe have reported heavy discounts and pricing pressures within the market. According to a recent published article of The Wall Street Journal, Europe represents 30 percent of Ford’s global volume coupled with a presence of five final assembly plants. Ford now anticipates losses of $1 billion as a result of eroding sales and excess capacity issues in its European operations.

In the midst of an ongoing aggressive investment in manufacturing presence in China, that market is slowing as well.  Operations in Latin America have been impacted because of efforts to undo free trade agreements with Mexico where Ford has pinned its export strategy for this region.

One of my favorite Don Henley tunes is titled “In a New York Minute”.  It laments how quickly everything can change.  For Ford, the headline of being the U.S. automotive success story now changes to once again dealing with difficult challenges in product, business and supply chain dimensions.

The learning for our supply chain management community is that the best tenet of agility- a resilient supply chain, is its ability to deal with both growth as well as business setbacks.

Bob Ferrari

Potential supply chain related problems associated with the Boeing 787 Dreamliner production program gained much higher visibility today with the announcement of two separate incidents involving this aircraft’s powered engines, provided by two different engine suppliers.

Today’s headline is that Boeing and U.S. safety officials are investigating an incident of an inflight engine failure on Saturday of a 787 being final tested for Air India. The incident sparked a subsequent grass fire at the Charleston International Airport which is adjacent to Boeing’s North Charleston final assembly facility. The engines of this aircraft were supplied by General Electric.  According to a published report in The Wall Street Journal (paid subscription or free metered view), the focus of scrutiny is on the rear components of the GEnx engine’s turbine sections. A GE spokesperson confirmed that debris exited the rear of the engine and was contained by the casing that surrounds the engine’s hot core. The damaged engine is in process of being shipped to a GE facility for teardown analysis.

According to GE’s web site describing the GEnx, this new engine utilizes the latest generation materials and design processes to reduce weight, improve performance and lower maintenance. The rear turbine blades section is described as featuring: “unique powdered metal rotors, specialized coatings, enhancing cooling techniques and new blade materials — delivering a turbine with the right balance of performance and extended life.” Three weeks ago, The Wall Street Journal featured an article profiling how GE Aircraft was working on successfully overcoming production challenges related to working with new composite materials within engines such as the GEnx.

This latest incident came less than a week after ANA (All Nippon Airways) had to temporarily ground part of its operating 787 fleet after unusual corrosion was found in the gearbox components of the Rolls Royce Trent 1000 engine. ANA, the original launch customer for the 787, indicated that the action stemmed from a flawed process that could leave a certain parts of the Trent 1000 engines vulnerable to early corrosion. According to a report posted by The Sydney Morning Herald, the Trent 1000 engine problem involves a gearbox supplied by Hamilton Sundstrand, part of U.S. conglomerate United Technologies, but for now is contained to one batch. “Two people familiar with the matter said concerns over corrosion came to light during endurance testing in the UK on one of the Trent 1000 engines designed by Rolls-Royce. During the ground test, corrosion was discovered on part of the gearbox used to drive ancillary systems. Investigators traced this to a new manufacturing process that was immediately reversed, the people said, asking not to be named.” The SMH further reported:  “A total of 17 engines contain gear boxes from the same suspect batch as the one used in the endurance test, eight of which have been delivered to ANA, industry sources said.”

From a 787 supply chain lens, the obvious question is whether these two separate engine incidents will have any further impact to the already highly stressed 787 production ramp-up program. According to the SMH article, of the total 859 Dreamliners currently ordered, 370 are to include the GEnx engine while 287 are to include the Trent 1000. While it is fairly obvious that Boeing, GE and Rolls Royce will take aggressive actions to determine root cause and remedy any design, production or associated supplier problems related to each engine, government safety agencies and designated 787 customer airlines will now have an added voice in any impacts to the delivery schedule. Customer Air India has already publically demonstrated its displeasure with delays associated with its 27 ordered Dreamliners.

The very last thing that Boeing needs right now is further delays in the program.  We suspect that Boeing customers are hoping that these latest engine related incidents will be overcome in an expedient manner without another significant delay to the 787 delivery program.

Bob Ferrari

In a Supply Chain Matters commentary posted about a month ago, we again pointed to both UPS and FedEx business predictions as good indicators of what we can anticipate in global supply chain activity in the coming months.  Both have staffed themselves with very talented economists and forecasters of business and supply chain activity with lots of reliable data gathered over the years.

In June, FedEx CEO Fred Smith predicted that a fundamental change in global freight business is underway and could well change assumptions regarding transportation lead times and service levels.  In essence FedEx indicated that the airport-to-airport transport model is in decline, that suppliers, manufacturers and retailers are opting for less costly methods of transportation for movement of components and finished goods. Meanwhile, the explosion of online commerce is driving increased B2C activity for carriers.

Earlier this week, UPS formally reported its fiscal second quarter earnings and UPS CEO Scott Davis essentially confirmed the same trends. Davis indicated that UPS Q2 earnings were primarily driven by its Domestic Express business unit but that the company’s international business, especially exports from Asia to the U.S., continue to decline. International domestic daily volume declined 3.2 percent and supply chain and freight revenue was down 1.6 percent. Revenue per package declined 2.4 percent for the international segment. UPS acknowledged that many international shipping customers have been electing deferred delivery options over premium delivery services. The company is now planning an additional 10 percent reduction in Asian air capacity to Europe and the U.S., on top of a similar cutback that occurred last quarter.

In spite of these trends, UPS delivered an overall operating profit gain of 4.4 percent along with a 1.2 percent total revenue gain. Operating margin increased to 13.4 percent from 13.2 percent. Also on the positive side, UPS garnered a 3.5 percent gain in U.S. domestic package volume driven almost entirely by B2C online commerce activity. However, UPS elected to cut its profit forecast for the full year but further indicated that it does not anticipate another U.S. recession. Readers may have also noticed that in the U.S., one tends to observe UPS delivery vans operating well into the nighttime hours because of the pressures of more residential deliveries and the effect of a cumulative cutback in drivers since the last global recession.

In essence, both UPS and FedEx concur that volume and shipment activity across global supply chains has turned toward less costly alternatives, and the global economy will remain highly uncertain in the months to come.  Notice also that both global providers have been quick to respond in reduction of overall transport capacity in effected shipping lanes, while trying to maintain a consistency in delivery contracts.  That contrasts with ocean container carriers, who continue to slow down ships to save on fuel costs, while continuing to raise rates.

Supply Chain Matters believes that international shippers will face added challenges for the remainder of 2012 and into 2013 as these structural changes continue to take hold.  We again advise supply chain teams to plan accordingly.

Finally, the last thing that global supply chains need right now is higher increases in fuel prices and fuel surcharges.

Bob Ferrari

If you are a close follower of Apple, or even if you are not, one cannot avoid this week’s large-scale coverage related to the announcement of the company’s latest fiscal June ending quarterly earnings. The business media bylines are numerous:

“Only the second time in 39 quarters the company reported results that missed analyst’s profit and revenue expectations”- The Wall Street Journal

“Apple is the world’s most valuable company, and the earnings miss was only the second time in 10 years.”- The Associated Press

“Today’s Apple Earnings are All About the iPhone” – Bloomberg Businessweek

Beneath the many bylines are results that many a company will envy these days, but unfortunately contrasted to previous spectacular results:

• Over a 22 percent increase in total quarterly revenues to $35 billion, with 62 percent originating from international sales. (down 59 percent from previous quarter)
• Profits up over 20 percent to $8.8 billion (down 94 percent from previous quarter)
• Gross margin increased to 42.8 percent from previous 41.7 percent

Much of these financial results, in many respects, is not at all dire, but portends warning signs.  One of the most significant warning signs is increasing competition in the markets where Apple competes.

We will leave readers to search out all the various financial implications in business media and instead will focus this Supply Chain Matters commentary to a supply chain lens view of what these latest Apple results might indicate.

Our first byline is: Apple’s latest results provide some breathing space for Apple’s supply chain.

The past months and weeks have provided many published information leaks emanating from various supply chain sources indicating difficulties in supporting order volumes for the newly released iPad, labor shortages and production ramp-up issues associated with the assembly of the new Mac computers, and ramp-ups of the new iPhone and iPad models. Consider the fact that Apple shipped 26 million iPhones, 17 million iPads, 4 million Mac computers, 6.8 million iPods and 1.3 million Apple TV devices. At the same time, suppliers are working on production ramp-up of the anticipated new iPhone and iPad models along with who knows what else.  Reports indicate that certain suppliers are aggressively investing in expanded capacity, including added component production in the U.S.

Last, but not at all least is the fact that Apple has chosen to pick an intellectual property battle with one of its highest profile component suppliers, Samsung, which supplies a custom ARM processor and according to data estimates from IHS iSuppli, over 12 percent of the iPhone’s bill of materials, not to mention other products including LCD displays. Signs point to Apple’s procurement teams beginning to add alternative sources of supply to buffer any impacts related to Samsung.

That is a lot of stress to place on any global supply chain, with little margin for error, and a slowdown in activity should, in our view, provide some needed breathing room.

Another obvious need for breathing room is fixing ongoing remedial actions as a result of the recent audits related to labor and worker safety practices at supplier facilities in Asia, being overseen by the Fair Labor Standards Association.

On the topic of information leaks: Apple’s supply chain information leaks have backfired

The Apple senior management and consensus Wall Street view appears to be that the company missed expectations because consumers are holding out for the new version of the iPhone due later this year. Yet, at the same time, Apple’s social-media juggernaut has been hyping all sorts of information leaks speculating on what features and components to look for in the new version. Is it any wonder that consumers are holding back?

However, the other reality is that arch rival Samsung has already scooped Apple in its new market release of the Galaxy phone which now has a time-to-market advantage.  Two months after market release are reports of over 10 million new Galaxy phones sold and component shortages limiting order fulfillment needs. Our speculation is that Apple’s PR and marketing wizards are encouraging information leaks related to the new iPhone model to blunt Samsung’s current market momentum.

Apple suppliers will unfortunately find themselves as the scapegoat of information leaks while the marketing gods leverage leaks to blunt the market.

To continue its rate of growth, Apple has to modify its product and supporting global supply chain strategy on-the-fly

There are two important factors brought out in the latest results.  The first is that Apple’s revenues are weighted heavily on international markets. The second is that the rising value of the U.S. dollar, compounded by the slowing of the economies of Europe and China, are having a discernible impact on Apple current revenue growth momentum.

We have previously penned commentaries providing our view that Apple is developing lower-cost versions of its popular devices because the company must target a more cost-sensitive consumer who cannot currently afford the high price tags of Apple’s products. Not everyone in the world can afford a $200- 300 subsidized iPhone or $500 iPad. Once more, Apple’s real goal is securing the largest volume of installed base devices upon which it can sell more profitable electronic content. Reuters just released information from a recent unsealed statement from an Apple expert witness filed in the current patent law suite against Samsung indicting that between October 2010 and March 2012, Apple encountered gross margins of 49 to 58 percent for the iPhone. An entry version of either the iPhone or iPad targeted to income challenged consumers implies different product structure, selling channels, and supply chain design. Apple is facing the challenge of having to segment its supply chains to support both existing high margin, and soon, high-volume, very low-margin products, all while adhering to a looking glass of high social responsibility and labor practice standards.  Do not be surprised that some of Apple’s huge cash balance is being tapped for increased production robotics and supply chain automation.

The bottom line is that Apple’s supply chain capabilities have in many tests, provided the agility and resiliency to enable explosive business growth. The third fiscal 2012 quarter for Apple is the turning point for even more challenges for its supply chain ecosystem.

A final postscript as we post this commentary to the web.  Samsung just announced that its fiscal second-quarter profit set another company record by rising 48 percent.  The company attributed much of that profit growth to increased sales to the recent launch of the new Galaxy smartphone.

Bob Ferrari

©2012 The Ferrari Consulting and Research Group LLC and the Supply Chain Matters Blog. All rights reserved.