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Overstocks of U.S. Retail Inventories Spell Challenges for the Remainder of the Year

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After many prominent retailers have formally reported their financial results for the first quarter, business and industry media have been quick to note that for the most part, U.S. retailers are facing a glut of existing unsold inventory.  The exception is certain online retailers such as Amazon who have managed to post continued sales gains and leverage the existing popularity of online shopping especially in categories such as apparel. However, retailers with a large physical retail store presence and who suffered significant revenue declines in Q1 are expected to deeply discount and promote the sales of excess inventories over the coming weeks.

While this is certainly some good news for avid shoppers, this quandary will have implications for the remainder of the year. A published report from Reuters quotes a retail industry equity analyst at Edward Jones as indicating that retailers are now in the process of cutting back inventory purchases for both the third, and the all-important fourth quarter of this year.

The stated risk is that without very comprehensive and purposeful inventory planning and supplier management, retailers run the risk of jeopardizing revenues and profits in the crucial holiday buying quarter that comes towards the end of this year.  Those retailers who have invested in more advanced inventory optimization and management applications that integrate with item-level point-of-sale sales data may well get the benefit of successfully navigating through some difficult upcoming quarters.

The other obvious implication will be on global ocean container transportation, which continues to slog through its own crisis of too many ships chasing declining shipping volumes. With many traditional retailers cutting back on second-half inventory purchases, shipping volumes may well decline even further. That will bring added revenue and profitability pressures to some existing ocean container shipping, port operations and inter-modal railroad lines.

The current environment of global economic uncertainty and rapidly shifting shopper buying preferences continues, and retail focused supply chains, as always, are in the cross-hairs of scrutiny and required performance. Retail supply chains and their associated sales and operations planning teams will continue to learn lessons in responsive merchandising and more proactive inventory management while continuing to discover the increased costs of online fulfillment.


Parcel Shipping Dynamics are Moving Far More Quickly- Stay Informed and Seek Added Intelligence

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For the past 6 months, Supply Chain Matters has advised our readers that structural disruption is underway regarding online and B2B small parcel transportation and logistics, and supply chain and procurement teams, particularly those residing in retail or in small to medium sized businesses need to be prepared for the implications.

Succinct signs of these forces became visible prior to the 2015 holiday fulfillment quarter, as the major parcel carriers FedEx and UPS significantly raised rates and surcharges despite historically low fuel costs, to reap additional revenues and profitability. In an October commentary we reflected on whether the duopoly would together inch closer toward upsetting the “golden goose” of their current growth strategies, that being their ongoing participation in the boom in online B2B/B2C fulfillment. In a January commentary, we called attention to higher shipping charges impacting smaller online as well as B2B businesses.

In just a few short months, events are moving more quickly and the signs have become much more obvious.

This week, adding more arrogance, both FedEx and UPS simultaneously issued announcements indicating that effective June 1st, additional handling surcharges of $10.50 would apply to packages with dimensional measures greater than 48 inches but equal to or less than 108 inches along the longest side. The previous measure to trigger the dimensional surcharge was greater than 60 inches but equal to or less than 108 inches. Both carriers attributed the surcharge increases to increased handling and larger package volume costs.

Such larger-sized packages would generally be routed to LTL (less than truckload) carriers, and indeed, such carriers have experienced a marked increase in online B2C fulfillment package volumes. But alas, as The Wall Street Journal recently reported, such carriers are not really prepared for the impact for sending tractor-trailer rigs within multiple urban and residential neighborhoods to deliver single packages. Operational costs are increasing with driver times eaten up by longer delivery time needs as well as the need for more specialized delivery vehicles. These carriers will have little choice but to increase rates to accommodate added online orders and the fallout will impact general business transport needs.

We along with business media have noted that one of the biggest beneficiaries of the FedEx and UPS rates increases was the United States Postal Service (USPS) as more online fulfillment and B2B package needs are routed through the postal system. The USPS just reported that its revenues rose once again, rising 4.7 percent in the March ending quarter thanks to stronger shipping volume and prior rate increases.  Overall volumes rose 1.4 percent fueled by a reported 11 percent increase in first quarter package volumes, which is usually a slower period of retail activity. However, the USPS has its own good news, not so good news challenges.  Increasingly becoming the parcel carrier of choice has driven up operational expenses by 7.4 percent. While controllable income rose to $576 million from $313 million a year earlier, overall the USPS reported a loss of just over $2 billion when long-term pension liabilities are factored-in.

The reality, by our lens, is that the USPS is currently not equipped with the same inherent efficiencies and owned transportation assets as either FedEx or UPS. In fact, the service contracts with FedEx for air transport needs. The implication is that continued volume increases will drive-up more USPS operating expenses without additional rate increases or added investments in more efficient transportation assets.

We then turn our attention to the largest online retailers.

Amazon’s strategy for directly controlling more transportation assets continued to unfold with the announced of a second major announcement relative to leasing dedicated air-freight capacity. The online retailer will partner with Atlas Air Worldwide to lease 20 Boeing 767 freighters, an addition to the 20 air freighters leased from ATSG in March. Reports further speculate that Amazon is shopping for its own airport facilities in certain geographies.  With an air fleet of upwards of 40 planes, coupled to multiple customer fulfillment and logistics pre-sorting facilities, and a fleet of leased tractor-trailer units, the unfolding strategy is one of Amazon controlling its own logistics and transportation capabilities for Amazon Prime and Fulfilled By Amazon fulfillment needs.

The Wall Street Journal recently reported that Wal-Mart is about to open four additional online customer fulfillment centers, in addition to four existing centers, each spanning a size of than one million square feet housing upwards of 30,000-50,000 items. Today the WSJ amplified that Wal-Mart has begun a new Shipping Pass service, where members get free two-day shipping for $49 per year. The publication cites informed sources as indicating that in February, the retailer invited a number of regional parcel delivery companies to an Atlanta conference to outline a vision for contracting a network of regional delivery firms to support its new shipping service. Wal-Mart is reportedly wooing carriers with promises of predictable shipping volumes and strategic partnerships, and the implication, according to the WSJ report, is a shift away from FedEx which currently handles the bulk of the retailer’s current parcel delivery needs.

Events are indeed moving quickly, and the implications need to be closely monitored. Those shippers locked into longer-term contracts may or may not be impacted whereas shippers who rely on current parcel transportation rate market dynamics are bound to be impacted if they do not pay close attention to the implications of these events. While the large parcel carriers continue to play out a power game of rate increases, alternative options maybe short-lived as market dynamics and opportunistic moves by remaining carriers and by Amazon and Wal-Mart continue to unfold.

Best to seek out technology providers who can provide market intelligence and transportation market knowledge as to which carriers and which modes will provide best short and longer-term cost options.

Bob Ferrari

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


One Year Later- Lumber Liquidators Struggles Continue

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In February of 2015, Lumber Liquidators, one of the largest and fastest growing retailers of hardwood and laminate flooring in North America at the time, was involved in a supply chain expose.  Over a year later, the retailer continues to struggle with the customer and financial impacts of that disclosure.

A broadcast report from CBS News’s 60 Minutes program turned a public light on the retailer’s supply chain in terms of sourcing and product composition. The 60 Minutes report indicated that:

“Much of its (Lumber Liquidator’s) laminate flooring is made in China, and as we discovered during our investigation, may fail to meet health and safety standards, because it contains high levels of formaldehyde, a known cancer causing chemical.”

During its investigation, the news networks placed hidden cameras and conducted interviews of the company’s flooring suppliers. Employees of three Chinese mills indicated they were using core boards with higher levels of formaldehyde to save the retailer up to 15 percent on price. Three mills further admitted on camera to falsely labeling products as CARB 2–compliant.

By May, the flooring retailer announced that it had suspended all of its China sourced laminate flooring products The retailer further disclosed that a Special Committee composed of independent directors, with the assistance of third party advisors, had been conducting an ongoing review of allegations regarding laminate flooring sourced from China. That body engaged a former FBI director and his firm to review the retailer’s product sourcing practices and to serve as an independent compliance advisor. In its public update, the retailer indicated:

“From early March through May 1, 2015, BHC sent approximately 26,000 testing kits to nearly 15,000 Lumber Liquidators customers and approximately 11,000 of those testing kits were returned. As of May 1, 2015, over 3,400 testing kits from approximately 2,600 households with laminate flooring sourced from China had been reviewed and analyzed. Of those households, over 97% had indicated indoor air concentrations of formaldehyde that were within the guidelines set by the World Health Organization as protective against sensory irritation and long-term health effects.”

However, those actions, although relatively swift in nature, were not enough to convince consumers, and since that time, amid continued fallout, several top executives have departed including the CEO at the time of the incident.

For the quarter ending in March, the flooring retailer reported its fifth straight quarter of revenue declines and much deeper loses than expected. Same store sales declined nearly 14 percent in the recent quarter. The Q1 loss was reported as $32.4 million compared to a year-earlier loss $7.8 million. Expenses climbed 20 percent due to a $16 million charge related to a securities class action and a $13.5 million increase in in legal and professional fees.

The company shares have not lost more than half of their value over the past 12 months.

Once again, there is a need to focus on some takeaways. In its apparent zeal to reduce its lumber costs allegedly by 15 percent, the retailer appears to have paid a far higher price in customer loyalty, in subsequent added expenses and in shareholder value. With no recognized U.S. or global wide standards for indoor formaldehyde concentrations, the retailer was subject to varying consumer perceptions as to the overall safety and standards related to certain lines of flooring.

One year later, Lumber Liquidators remains under the looking glass, providing yet another example of how a supply chain focused disruption or snafu can have much more lingering effects


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

 

 


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