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Chipotle Feels the Financial Impact of its Ongoing Food Safety Crisis

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This is a Supply Chain Matters update commentary regarding Chipotle Mexican Grill, specifically efforts to address its ongoing food-safety challenge that not only threatens the restaurant chain’s value to its brand and to its investors, but on perceived quality risks in its farm to fork supply chain.   Chipotle logo

This week, the restaurant chain posted its first quarterly financial loss as a public company amid a nearly 30 percent reduction in same store sales. Total revenues were down 23.4 percent while net income dropped by $122.6 million. Operating margin dropped to 6.8 percent from just over 28 percent a year earlier due to what was described as higher marketing, waste and food testing costs.

In a previous February commentary, we observed that the restaurant chain had entered a new critical phase, one focused in rebuilding its brand integrity along with assuring that food safety practices were re-addressed across the supply chain and within its individual restaurants. In our mid-March commentary, we highlighted reports that seemed to put a different twist to the ongoing crisis. At the time, The Wall Street Journal citing informed sources, reported that the restaurant chain considered stepping back from the food safety changes touted back in February. Rather than conduct high-resolution DNA testing on a multiple of inbound supply ingredients, the plan was apparently to test only certain foods. Further reported was that the chain’s beef supplies would be pre-cooked in centralized kitchen facilities to insure that E.coli was eliminated, and then packaged in vacuum-sealed bags and shipped to local outlets where the product could be marinated and grilled.

We speculated that the decision to scale back DNA testing may have been brought about by further process and supply chain focused analysis.  Yet, the restaurant chain later announced the hiring of a noted meat industry food safety expert to be its new director of overall food safety.  We questioned whether such decisions for scaling back testing should have been made so early in the process, without the insight or input of the chain’s newly hired food safety expert, and without allowing more time to address consumer concerns regarding uncertainty in food sourcing and handling practices.

Our stated belief was that restoring consumer trust in a badly damaged brand is not a one-time marketing or financial budgeting challenge, but rather a systemic management challenge to address quality and food safety practices among all farm to fork processes and activities.

The chain has since stepped-up training within local restaurants on food safety and food handling practices as well as the assistance of a field leadership program to assist local managers in managing and auditing food safety and handling practices.

Chipotle’s co-CEO, Steve Ells indicated to investors that rebuilding trust with customers would take some time. While we found that that admission insightful and somewhat overdue, we were taken back by a subsequent statement:

We will continue to make it our top priority to entice customers to return to Chipotle through effective promotions and marketing, and when they do return, we’re committed to providing the very best experience that we can to help ensure that they will keep coming back.”

Not a mention of testing and assuring consistent food safety practices as the top priority.

Further noted in business media reports are even further changes in food preparation and sourcing practices after apparent customer feedback indicated a decline in the quality of certain ingredients. Customers complained that produce or lettuce no longer tasted as it should. For instance, now the chain claims to have refined its washing of lettuce which will once again allow local restaurants to cut lettuce locally while still ensuring that it is safe. Similarly, bell peppers will be blanched and sliced in local restaurants rather than the previous change to do so in central kitchens.

On a positive note, customers apparently have endorsed the process for cooking organic beef in vacuum sealed bags within central kitchens because the meat is now perceived to not as dry to the taste.

As Chipotle customers may now be aware, the chain is attempting to incent customers to return by offering free burritos and other promotions. Over 5 million free burrito offers were issued followed by a direct mail promotion distributed to over 20 million households. Judging from the customer traffic statistics to-date, the chain’s most loyal consumers may not be completely convinced as of yet to return, although data seems to point to return by some not as loyal but cost conscious customers. One equity analyst has indicated that couponing is a short-term rather than a more sustainable strategy for restoring traffic.

In recent weeks, both Glass Lewis & Co. and Institutional Shareholder Services, both influential proxy advisory firms have weighed in on management. ISS is recommending a vote against re-election of certain current Chipotle board members at the upcoming annual stockholder meeting in May. The firm questions whether the ongoing food safety issues have exposed a flawed board succession process that nominated directors who have the management skill sets to keep pace with a chain’s size and complexity. Further stated was a failure of risk oversight by the firm’s Audit Committee.

Glass Lewis has reportedly taken issue with the board’s pay-for-performance model. As we noted in our March commentary, senior executive bonuses were recently changed to be pegged to increases in the firm’s stock price alone. ISS has also opined that the majority of discussion with major investors has focused on improving share price and changing executive compensation as opposed to addressing food safety.

The reality of losing the trust of loyal customers is indeed an ongoing challenge and Chipotle management must by our lens, have as its collective top priority means and methods to address food safety and quality from farm to fork. Management compensation not directly tied in some fashion to that goal, and management briefings and direction-setting that continues to lead with marketing and sales tactics are not going to convince this past Chipotle consumer that issues have been addressed and the quality and safety of food is industry-leading. Apparently we are not alone in that perception.

Bob Ferrari

© 2016 The Ferrari Consulting and Research Group and the Supply Chain Matters® blog. All rights reserved.


New Development in Sports Authority Bankruptcy Reorganization Effort

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Yesterday, there was a significant development related to the bankruptcy proceedings involving sporting goods retailer Sports Authority, one with continued supplier collaboration and management implications for the broader retail and consumer goods industry sectors.

In early March, Supply Chain Matters called attention a report that retailer Sports Authority has filed for Chapter 11 bankruptcy protection which included an intent to close or sell 140 stores and two existing distribution centers.  Characterized as one of the largest sporting-goods retailers, the chain found itself weighted down with debt from a prior leveraged buyout a decade ago. According to media reports, there was $1.1 billion in debt that included $717 million in bank loans and over $200 million in trade debt owed to suppliers. Lenders have given the retailer up to the end of April to find a buyer or another investor, or close any remaining stores.

A subsequent disturbing twist to this bankruptcy proceeding involved the categorization of existing consignment inventory.  Attorneys for the retail chain filed lawsuits with more than 160 existing suppliers challenging claims to consigned inventories. According to reports, upwards of $85 million in shoes and other gear that were currently on the shelves in retail stores were at-stake. The supplier lawsuits were apparently a means to challenge who gets the bulk of compensation when consigned goods are sold in store closings or in discounted sales. Our Supply Chain Matters view was that the move on consignment inventory had significant ramifications for supplier collaboration practices within retail as well as other consumer goods focused supply chains.

Today, business reports indicate that this week, Sports Authority has abandoned its reorganization plan and instead will count on any potential buyers to salvage parts of the retail chain. A report in today’s editions of The Wall Street Journal indicated that the chain’s lawyers indicated to a bankruptcy judge that the existing debtors will not support reorganization and are instead enforcing an outright sale. A May 16 auction date has apparently been set for the bulk of the retail chain’s operations and facilities.  According to today’s WSJ report, there are no guarantees that any of existing stores will stay in operation.

What caught our attention was the following sentence:

The financing fight is also the arena for claims from some vendors that they, rather than lenders, have the right to collect the proceeds when goods are sold”

That obviously is a reference to attempt to seize proceeds from vendor consignment inventories. One could speculate that existing suppliers elected to play hardball, given what was on the table, and given that some other sporting goods retailers are financially struggling as-well. From our lens, it was indeed protecting the integrity of consignment inventory contracts.

Reports indicate that talks remain ongoing, and although a planned reorganization is off the table, a subsequent liquidation plan will have to address how any existing debt will be paid-up.

Our takeaway from this week’s Sports Authority development is a caution to other retailers to not mess with existing key suppliers who have extended a hand to help finance inventory investments. We continue to wonder aloud whether the Sports Authority developments, regardless of final outcome, provide a longer-term setback in joint inventory management practices.

Bob Ferrari

 

 


Noteworthy Senior Supply Chain Executive Changes at J.M. Smucker

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We at Supply Chain Matters are always on the lookout for important supply chain related learning, insights and accomplishments. Thus, what caught our eye was a recent announcement related to senior supply chain leadership changes at consumer foods producer J.M. Smucker.

The company announced the pending retirement of Senior Vice President, Supply Chain Logistics and Operations, Dennis J. Armstrong following 37 years with the company.  Mr. Armstrong will retire from his corporate officer role in September.

How extraordinary is that in today’s world of ever changing job roles and continuous employers.

Noted is that Mr. Armstrong has served in a number of leadership roles that have spanned logistics, operations and purchasing during his long career.

According to the announcement, Mr. Armstrong’s supply chain leadership responsibility will be assumed by two other existing J.M. Smucker executives.

James R. Ray will assume the role of Senior Vice President of Operations. Day, with 27 years at the company, was the Vice President of Coffee Operations for the past seven years and thus assumes the new senior operations management role from a line-of-business background. For readers unfamiliar with Smucker’s coffee business, it includes the retail production and distribution of Dunkin Donuts branded coffee, among other brands. Prior operations management roles for Mr. Ray were within consumer and natural foods businesses.

Robert D. Ferguson assumes the role of Senior Vice President Supply Chain.  Mr. Ferguson is currently Vice President, Integrated Business and Program Management and came to Smucker from the 2015 acquisition of Big Heart Pet Brands. Integrated business and program management responsibilities usually connote organizational transformation leadership roles. In today’s consumer goods focused supply chain, transformation remains continuous.

Both Mr. Day and Mr. Ferguson will now report directly to Smucker’s soon to be President and Chief Executive Officer, Mark Smucker, and thus will be members of the executive leadership team. Senior leadership changes included other executives as well leading to a revised executive leadership team.

Thus, yet another example of the strategic importance that operations and supply chain has garnered in supporting and delivering expected business outcomes.

While we often write about such leadership shifts, we believe it is important for Supply Chain Matters to be able to reference actual occurrence, especially in an industry that is dealing with significant business strategy challenges affecting products and changing consumer needs.

As for Mr. Armstrong, we extend our best wishes for an enjoyable and rewarding retirement after what looks to be rewarding operations and supply chain leadership career at a single employer.

Bob Ferrari


A Good Reference for Opportunities and Risks Regarding Supply Chain Activities Within Cuba

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In the first three months of 2016, media has been abuzz with the news that the United States elected to ease its business and trade relations with Cuba. The March visit to Cuba by President Barack Obama reflected a noted sea change in US-Cuban relations. Already, there are reports of pending new airline service, the opening of expanded tourism and the potential for new opportunities in supply chain and manufacturing sourcing.

Supply Chain Matters recently received notification from Knowledge@Wharton of a newly published E-Book, The Road to Cuba, The Opportunities and Risks for US Business, Revised and Updated Edition. This Editor had the opportunity to review this E-Book publication and we are passing along a reference for those multi-industry readers who may be thinking of Cuba as a potential for added business and supply chain activities.

The Wharton School authors point out in the document Forward:

While significant political and ideological differences still separate the two governments, Obama’s historic visit, the first to Cuba by a US head of state since Calvin Coolidge traveled there in 1928, is an opportunity to widen the space for unfettered communication, trade and business between the United States and Cuba, for the mutual benefit of their citizens.

Further noted:

Whether you run a US business, are an investor, or are interested in exploring the opportunities, you need to know what now can and cannot be done in Cuba amid the complexities that surround the constantly evolving negotiations and normalization process between the two countries. If you already do business in Cuba, you need to understand the competition that is on its way.”

We specifically reviewed two pertinent chapters: Longer-Term Prospects: Manufacturing/Retail, along with Longer Term Prospects: Pharmaceuticals/Biotechnology.

From the manufacturing lens, Cuba’s close proximity to large U.S. consumer markets indeed makes this country attractive as a production and assembly center for consumer goods that are exported to the U.S. Noted is the current establishment of the Mariel Special Development Zone at Mariel port just west of the city of Havana. This development zone, initiated in 2013, offers tax breaks and duty-free concessions is already the home of food and beverage processing, light industry assembly, vehicle assembly and alternative energy ventures. The report cites Cuban authorities as indicating that more than 400 companies including US firms have expressed interest the Muriel Zone.

In January, Unilever, which has been investing in Cuba since 1994, announced an intent to build a $35 million soap and toothpaste processing facility within the Muriel Zone. The consumer goods producer established a 60-40 joint venture with the Cuban state company Intersuchel SA as a means to expand its presence. There is also mention of Nestle’s production of soft drinks and mineral waters with a Cuban partner as well as AB In-Bev, whose Cerveceria Bucanero venture distributes beer to the local market.

Another promising opportunity is that of biotechnology and pharmaceuticals and the report indicates that pharma exports are big business for the island. This sector is noted as growing with sales made to emerging market economies in Latin America, Asia and Africa. The report notes:

Fidel Castro’s government pumped billions of dollars of domestic investment into the development of Cuba’s biotechnology industry, mostly based in Western Havana but with outlying clusters in other parts of the island.

Main products thus far have been developed vaccines for combating Group B meningococcal meningitis, hepatitis B along with PPG, cholesterol –lowering product developed from sugar cane.  Further noted is ongoing development of potential vaccines to combat HIV/AIDS, cholera, leptospirosis, dengue fever, hepatitis C and cancer.

Cuba also represents a market for U.S. medical and pharmaceutical exports.

The report includes noted words of caution: “The Door has Opened, But needs to Swing Wider.”

An important insight:

However, an early boom in interest by US companies and entrepreneurs to trade and invest in Cuba has yet to be fulfilled in terms of concrete business deals and opportunities. These are still being held back, both by the persisting economic embargo, which can only be completely lifted by Congress, and by the Cuban government’s own apparent reluctance to fully embrace liberalizing reforms that would open up the state-run economy.”

We interpreted that statement as indicating that more time and patience is required in order to fully evaluate or take advantage of investment and new business opportunities for the island. It has over a year since the U.S. government announced its intention to loosen restrictions, and the actual visit by the President, and perhaps, the next phases will come sooner rather than later. The current U.S. Presidential and Legislative election cycle, currently underway, has to run its course as-well.

The overall transportation and logistics infrastructure for the island further needs modernization as witness to existing vintage delivery vehicles.

However, after our review, we certainly sense lots of long-term potential from product export and import lenses, and especially from a pharmaceutical supply chain perspective. Check it out for yourself by clicking on this web link.

Bob Ferrari

 


Further Business Media Expose Related to Product Composition

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In mid-March, Supply Chain Matters called attention to a business media expose focused on when a consumer product contains what it is supposed to. The Wall Street Journal had published a report reflecting on the importance of knowing your product, your supplier management and oversight practices along with supporting your core product marketing strategies. Today, the WSJ added another dimension to this topic, one that perhaps has more implications for regulatory oversight.

The March WSJ report focused on actress Jessica Alba’s co-founded company, the Honest Company, which has soared to a reported $1.7 billion in private valuation in less than four years. The stated core mission of this consumer goods company is to offer cleaning products that do not knowingly contain harsh chemicals found in mainstream marketed and sold products. One of the harmful compounds of question is that of sodium lauryl sulfate, referred to as SLS. The Honest Company’s claims to consumer are that its products are free of SLS.  However, in its report, the WSJ indicated that it commissioned two independent testing labs to analyze Honest’s liquid laundry detergent only to determine that it contained significant amounts of the chemical.

Today’s WSJ report (Paid subscription required) reflects on one of largest producers of natural shampoos and skin cleaners in the United States, that being Hain Celestial Group. That company is reportedly in the process of reformulating dozens of products and dropping claims that do not contain SLS. Like Honest Company, Hain had long declared that its products contained no harsh chemicals.  Instead, some products reportedly use the ingredient sodium coco sulfate (SCS), which actually contains SLS.

What adds more interest to this development is the WSJ indicating that it actually commissioned independent laboratory testing last fall on several branded consumer products containing the SCS compound. A product general manager for Hain Celestial indicated to the WSJ that it had begun to review product formulation last spring and decided in November, after being contacted by the WSJ of its findings, to remove the “no SLS” claims on products that contain SCS.

In its latest reporting, the Journal points out that there are no current regulatory guidelines for what makes household and personal-care products “natural.” Instead, producers have termed their products as natural if they are derived from natural ingredients, even they have been chemically processed. The notation that other consumer brands were tested is perhaps an indication that more revelations or revised product claim declarations may be forthcoming.

Our readers might recall that product ingredients and product specifications are increasingly under the public looking glass. Recall the Lumber Liquidators expose in 2015 forcing that company to suspend all of its China sourced laminate flooring products after 60 Minutes, an investigative news television program turned a public light on suspected high levels of formaldehyde from certain China based flooring offered by this retailer.  While not of the same severity of concern related to natural products claims, it does reflect the relationships among product management teams and suppliers. Lumber Liquidators is still dealing with both the consumer perceptual and financial implications of that prior incident.

The takeaway from these ongoing developments is that today’s traditional and social media outlets are holding consumer goods producers to a high standard of transparency as to product formulation and declaration claims. These ongoing revelations run the risk of triggering added calls for more regulatory oversight of producers as well as suppliers, one that obviously the industry wants to avoid.

Thus the importance of a rather close relationship among product design, management, marketing and supplier sourcing teams to insure that there is total transparency of product formulation and composition declarations.

 


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