Supply chains directly associated with up and coming or mid-sized businesses need to be constantly diligent to the effects of a major supply chain disruption, both overt and not so. Procurement teams of mid-sized brand owners need to be especially cognizant that labor unrest has become much more prevalent within low-cost manufacturing regions and the implications to less influential customers have greater significance. Of late, such unrest moves beyond disputes regarding wages, but also worker social responsibility policies. Once more, active use of customer segmentation strategies implies that the bigger global players can often be buffered to such disruptions, both operationally and financially.
Just this week, we have come across news reports of ongoing disruptions involving influential industry supply chain players. In the footwear and apparel sector, workers at certain facilities of shoe manufacturer Yue Yuen Industrial, located in southern China have walked off the job in a dispute over social insurance payments tied to overall wage rates, which are governed by labor law. Yue Yuen employs upwards of 40,000 employees at its facilities located in Dongguan. The Wall Street Journal reported (paid subscription) yesterday that this shoe manufacturer is a supplier for both Adidas and Nike. It quotes an Adidas spokesperson as indicating that the Chinese supplier is currently working at 50 percent of capacity but Adidas has experienced no slowdown in production volumes. A spokesperson for Nike is noted as indicating that that company is monitoring the current situation including ongoing talks between workers and factory management. The WSJ report further indicates that demands raised by the Yue Yuan workers may become an important precedent for labor policies among most workers in China’s manufacturing industry. Thus, the stakes in finding a resolution are somewhat higher.
Judging from the reported statements from both Adidas and Nike, we would venture an opinion that what production capability that is still operating is probably being allocated to the production schedule needs of the most influential customers. That is an obvious supply chain reality, namely, the most influential customers in terms of revenue and profit will in more times than not, be somewhat buffered from such disruption. Consider further that ongoing labor unrest continues for within apparel producers in Bangladesh, Cambodia and other regions as workers continue to be more active in demanding that social responsibility policies are adhered to by employers in these regions. While industry consortiums have been established to address such issues, workers have become untrusting.
Continued work stoppages and production disruption imply that the most influential customers will be somehow buffered while less influential customers may bare the bulk of the disruption or added cost burden.
Supply Chain Matters has featured a number of commentaries regarding the challenges for being selected as a key component or contract manufacturing supplier to Apple. On the one hand, the designation for being a key supplier in the Apple value chain can lead to enormous revenue potential and scale along with providing much cache for landing additional industry business. On the other hand, Apple aggressive product margin goals coupled with steep and constantly changing production volume ramp-up or ramp-down requirements can challenge any supplier organization. Apple sets high expectations and expects total responsiveness and virtual flexibility from its key suppliers, especially those residing in lower-cost manufacturing regions such as China.
The past two weeks have provided two interesting contrasts in terms of strategy and financial results among two of Apple’s key contract manufacturers.
In May of 2013, Supply Chain Matters reinforced and amplified the observation that Apple had begun to actively pursue its own supply chain risk mitigation and supply chain segmentation plan by electing to dual source some of its contract manufacturing needs with the use of Pegatron, one of Taiwan’s largest contract and original equipment manufacturers, in addition to longstanding CMS provider, Foxconn. We cited a Wall Street Journal report indicating that Pegatron was willing to accept thinner profit margins in courting Apple’s massive business.
However, Pegatron was put to the test with last year’s massive pre-holiday production ramp-ups and ramp-downs to support the changing volume production requirements of the new iPhone 5c and iPhone Mini. The market reception for iPhone 5c was not as originally planned, prompting Apple to cut-back on original pre-holiday production forecasts. The iPad Mini however, experienced high consumer acceptance. Pegatron had other challenges and there were reports indicating the alleged use of underage workers in some of this company’s factories in China, along with allegations from China Labor Watch related to excessive working hours and challenging working conditions. At the time, China Labor Watch alleged that worker conditions at Pegatron factories were worse than those of previous Foxconn conditions.
Last week Pegatron reported fiscal fourth quarter results and posted a 22 percent jump in net profits even though its overall revenues fell slightly from year ago results. Revenues derived from the manufacturing of communications products, gaming consoles, smartphones and tablet computers rose 20 percent while those associated with PC’s and consumer products including televisions, declined. In its latest reporting regarding Pegatron’s earnings, the WSJ cites a KGI Securities analyst as indicating that Apple now represents upwards of 40 percent of this company’s revenues, which is significant considering the brief history of relationship. Further cited was that initially low yield rates in producing Apple’s products have now improved. Operating margin improved to 1.9 percent from a previous 1.6 percent, but how many firms can sustain at such a low margin? Once more, without any planned launches of new Apple products in the first-half of 2014, Pegatron is forecasting that shipments of smartphones, tablets and game consoles will likely decline in a range between 15 and 20 percent in the current first quarter.
The parent of Apple’s other longstanding prime contract manufacturer Foxconn, which is Hon Hai Precision Industry, last week reported that its profits rose 13 percent, boosted by increases in iPhone and iPad sales. Total revenues increased slightly to 3.95 trillion new Taiwan dollars. It is estimated that Hon Hai garners more than 40 percent of its revenues from its various supply relationships with Apple.
However, this company continues to exercise a broader diversification strategy as revenues and margins derived from contract manufacturing continue to decline. In a Supply Chain Matters posting in July 2013, we observed that Foxconn continues in its process for diversifying by moving downstream and upstream in the consumer electronics value-stream, possibly resulting in some Foxconn branded consumer electronics devices.
Last week, Hon Hai announced investments of $90 million in various strategic manufacturing related projects with a focus toward higher value chain activities along with advanced automation. These investments include $42 million to establish a trading and manufacturing unit for China based components, $30 million in a new software development unit and $15 million in a robot manufacturing and sales unit. In early February, Supply Chain Matters commented on Foxconn’s current collaboration with Google in the area of advanced robotics.
Foxconn is once again shifting some of its manufacturing presence into lower-cost, more interior regions of China. According to a WSJ report, facilities will be built in the central and western provinces of Chengdu, Wuhan and Zhengzhou where direct labor rates are as much as two-thirds less than those in the coastal regions.
Wall Street and business media has increasingly been skeptical of Apple amid stronger competition in smartphones, tablets and other consumer electronics devices. Doubt has been raised as to whether Apple has lost its mojo in product innovation cycles. In exercising a supply diversification and segmentation strategy among its contract manufacturing supply base, other dynamics are underway. While Pegatron has pinned its fortunes on Apple to offset other areas of declining business, Hon Hai is exercising a broader diversification strategy that will likely lessen its dependence on Apple. How both fare in these different strategies will be certainly worth observing in the coming months.
©2014, The Ferrari Consulting and Research Group LLC and the Supply Chain Matters Blog. All rights reserved.
This posting is an update to our previous Supply Chain Matters posting regarding Lenovo’ intent to acquire the x-86 hardware server business from IBM.
Last week, approximately 1000 workers joined a labor stoppage at the IBM Systems and Technology production facility in Shenzhen China. Reports indicated that workers were angered over reports of severance benefits that would be offered by IBM if workers elected not to join Lenovo, as well as the potential for lower wage rates when Lenovo takes control of the facility. The latest reports are indicating that the plant reopened yesterday, nine days after the employees walked off their jobs.
Today’s Wall Street Journal reports (paid subscription or free metered view) that IBM fired 20 of the strikers for taking part in unlawful assembly that led to the shutdown of the plant. A written communication by IBM provided to the WSJ indicates that actions were within Chinese law and whether employees elect to work for Lenovo is an individual decision. Further stated is that while IBM is not required to do so, the company is ready to provide an equitable severance package to those workers who elect not to join Lenovo. The WSJ additionally reports that returning workers may have been offered a bonus payment to return to work during the period when the acquisition becomes finalized. The company indicated that growing numbers of workers are beginning to return to work.
A local Chinese labor union spokesperson is quoted as indicating that IBM’s approach has been “unyielding”, and that the workers do not understand how this situation is being handled.
For its part, Lenovo issued a position statement on its web site re-iterating that any integration of facilities will not be conducted until the acquisition is completed, and that the current work stoppage is an internal matter with IBM. Lenovo’s statement goes on to state that the intent of the acquisition is to gain the talent and experience of the existing x-86 business resources and that the company look forward to welcoming transitioning employees in several months’ time.
Obviously, this is a sensitive time of transition for both IBM and Lenovo.
Globalization brings on new dimensions of activism. As a blog commenting on global B2B/B2C and supply chain management developments, we did not expect that we would be posting commentaries on labor work stoppages or trade union elections at Amazon distribution fulfillment centers in Germany and the United States. Who can forget the incidents of worker suicides or rioting that occurred at Foxconn facilities in China, working on assembling products from Apple. Now, a work stoppage at an IBM production facility in China.
These are extraordinary times across industry supply chains.
We along with other recognized supply chain thought leaders have been raising awareness to the current talent shortages regarding areas of supply chain management, particularly individuals with experience related to linking the introduction of new products and product management with overall supply chain ramp-up and ramp-down deployment needs.
One of globe’s top-ranked supply chains, Apple, has been under considerable pressure of-late because of the perception that its product innovation cycles have slowed and industry competitors are quickly narrowing the gap in surpassing such capabilities.
A newly published report from the Wall Street Journal (paid subscription or free metered view) places a poignant perspective to Apple’s growing need. The report indicates that Apple is in the midst of hiring hundreds of new engineers and supply chain managers across China and Taiwan in its attempts to speed product development and introduce a wider range of innovative products. The report notes that current victims of this hiring blitz include the likes of HTC Corp. and other Taiwanese technology firms. According to the report: “The total number of engineers and (supply chain) operations staff in China now exceeds 600…”
The report further outlines that while core research and development will remain in Cupertino, engineering and supply chain management talent investments within China pale in comparison to those in the United States, implying an ever more expanded presence in China. Further disclosed is that Apple has added contract manufacturers Wistron Corp. and Compal Communications to help produce upcoming versions of iPhones and iPads.
Supply Chain Matters has often commented how Apple’s purchasing clout and volume scale can lock-out smaller high tech and consumer electronics OEM’s from lowest cost pricing and favored supply agreements. With this latest report regarding the current talent seeking hiring spree centered on China, the industry can probably add talent raiding and talent shortages to the impacts of Apple along with its competitors.
Talented and experienced cross-functional supply chain management professionals with experience in new product ramp-up and time-to-market, along with alleviating supply chain choke points are going to be in the catbird seat across global locations, since the talent war seems to be escalating across high-tech supply chains.
In the industry-specific section of our 2014 Predictions for the current year, (full research report available for complimentary downloading in our Research Center) we specifically addressed consumer product goods supply chains where combinations of external forces are providing unique challenges. That force includes contraction of growth rates and margins from previously expanding emerging markets, a certain group of activist investors demanding more cash value, and now, increases in key commodity costs.
Some CPG supply chains are rising to the task while many continue to deal with challenges on multiple fronts.
Global CPG giants such as Nestle and Unilever have managed to meet investor quarterly earnings expectations yet continue to report growth headwinds concerning emerging markets along with currency challenges. The CEO of Unilever recently told business network CNBC that emerging markets use to be in the range of 6 to 8 percent but now range 5 to 6 percent. Nestle’s organic growth targets of between 5 to 6 percent are currently trending at 4.6 percent. Unilever currently garners 60 percent of its revenues from China, India and other emerging consumer markets. Mondelez International reported its fiscal fourth quarter earnings this week and reported that organic sales rose declined 6.1 percent in the Asia-pacific region while revenues specifically in China declined by the mid-teens. Supply Chain Matters featured a previous commentary regarding the Kellogg Company.
Noted exceptions of late have been Procter & Gamble and Kimberly-Clark. P&G recently reported that demand for its products in emerging markets such as Brazil and China remains strong. However, P&G reported a 16 percent drop in profits largely due to unfavorable exchange rates. Kimberly-Clark reported that its emerging market business continues to grow strongly. Today, Campbell Soup indicated a solid quarterly performance including growth in certain emerging markets.
The U.S. market further presents its own challenges as economically distressed consumers continue to opt for price-sensitive products in their purchases. Today’s edition of the Wall Street Journal reports that many European based consumer goods companies had relied on sales in Brazil, China, Mexico and other Asian countries to maintain revenue and profitability momentum while developed markets remained sluggish. We would add that these same companies made significant investments in supply chain fulfillment networks in these regions as well.
On the activist investor front, PepsiCo indicated this week that it continue to focus on expanding its soft-drink product revenues instead of taking actions to split-up the company, which certain activist investors are demanding. To continue its course, the company indicated it was investing $8.7 billion in stock buybacks, increasing its cash dividends by 35 percent in the current year, and will initiate $1 billion in productivity gains, including job cuts, through 2019.
There is now the additional challenge of increased commodity costs. On the occasion of Valentine’s Day here in the United States, the Wall Street Journal featured a report that growing demand for chocolate products, particularly from emerging consumer markets, has driven commodity prices for cocoa up 9 percent this year, to levels not reached since 2011. Once more, an industry trade group boasts that demand will outstrip limited supply for the next five years, the longest shortfall since 1960. This week, U.S. cocoa futures hovered in the high $2900 a ton range, a 29 month high. The implication is that with these current signposts, chocolate makers such as Hershey Foods, Mars, Mondelez, Nestle and others will face decisions for raising prices, adding more pressure to existing product demand and profitability trends.
Indeed, consumer product goods industry supply chains have extraordinary challenges to overcome. Supporting emerging market growth objectives requires laser-focused investments in channel customer fulfillment and distribution capabilities. Companies such as P&G provide evidence that such a laser focus can provide benefits and continued growth.
Continued relentless pressures for continued productivity and cost reductions are impacting the marrow of people resources, and further require out-of-box thinking. A dependence on past efforts at continuous improvement or past industry productivity benchmarks will not help in the current environment. With added challenges for increased input materials costs for certain key commodities, the challenges become ever more dynamic.
In 2014, CPG supply chains will require bold leadership and innovative thinking. Business-as-usual has long passed, and so has continuous improvement mentalities. Integrated supply chain management, more timely and responsive decision-making and the laser-like investments in productivity and cost management loom large.
We certainly encourage our readers residing in consumer goods supply chains to share learning from the current environment in the Comments section below.
© 2014 The Ferrari Consulting and Research Group LLC and the Supply Chain Matters Blog. All rights reserved.
Disclosure: The author of this posting has a modest holding in Unilever stock.
Both the tech world and business media are abuzz this week with the back-to-back news regarding China based Lenovo’s announced acquisitions of both the IBM low-end server hardware business and this yesterday’s revelation regarding the acquisition of Google’s Motorola unit.
From our lens, both moves point to added global brand presence and further leveraging of the current scale of Lenovo’s global supply chain capabilities.
However, both deals are contingent on government scrutiny, and that may present a challenge.
Lenovo’s thrust into low-end servers where product margins have been an ongoing challenge, can complement the firms core manufacturing presence across China. This is rather significant since the server market has rapidly shifted toward commodity plug-and-play hardware options. It also provides further depth to the firm’s server based product lines, not to mention the previously installed base of existing IBM customers. By our lens, it is a parallel to the actual creation of the Lenovo global brand with the acquisition of IBM’s personal computer hardware business.
The Motorola acquisition provides a more interesting backdrop. Google acquired the Motorola unit in 2012 for $12.5 billion amid lots of market speculation as to why the search and mobile operating system giant would want to get into the smartphone hardware business. Since the acquisition, Google has incurred a reported $2 billion in additional operating losses along with creating additional friction among existing Android OS hardware brands including Samsung. With the announcement of this deal, one Silicon Valley outlet was quick to opine that Google’s prior decision to acquire Motorola was a major mistake and with the deal, Google is taking more than a $5 billion loss on its prior investment.
Reports indicate that Google insisted on holding on to a portfolio of key product patents which was more than likely the original motivation to acquire Motorola. Thus Lenovo is buying the brand, product IP licensing and platform to add to existing line-up of smartphone products. If the acquisition is approved, it would thrust Lenovo into the number three position within the global market, along with a credible presence in the U.S. and North America smartphone market.
Motorola was already attempting to transform itself into a lower-cost, higher volume smartphone hardware provider with the launch of its recent Moto X and Moto G product line-up. Lenovo has its own smartphone line-up, pursuing an aggressive strategy to compete within China’s massive but cost-conscious smartphone market It has been competing directly with Samsung, Apple, Huawei and according to one research firm, has assumed the number four position in China.
In its reporting of the deal, the Wall Street Journal astutely concluded that Lenovo’s greater worldwide supply chain scale positions the company well to be able to leverage low-cost Android devices across the global market. It would appear that Lenovo will retain all Motorola employees in the smartphone segment and thus there an incremental plus in product development and distribution.
In a September 2012 commentary, Supply Chain Matterscommented that from what we extracted from a talk given by Lenovo’s Vice President of Procurement, that its hybrid supply chain strategies were well positioned to be able to enable the company’s strategic business and product outcomes. If these two new acquisitions are approved by U.S. regulators, the Lenovo supply chain may well reap more benefits from its ongoing capability efforts.
© 2014, The Ferrari Consulting and Research Group LLC and the Supply Chain matters Blog. All rights reserved.