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The Implications of Brexit Grow Near but So Far for Industry Supply Chains

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In a published Supply Chain Matters commentary in late June of last year, we explored our initial perspectives of the new term in geopolitical events, that of Brexit. By voting to exit the European Union, the British electorate set off a series of events that many continue to describe as unprecedented.  The most cited analogy remains- “unchartered waters and political events.” Such uncertainly not only surrounds the direct impact on the United Kingdom, but on the EU alliance itself if other select countries take a similar course.

On Monday, Britain’s ambassador to the European Union informed European Council President Donald Tusk that his country would trigger Article 50 of the Lisbon Treaty, the formal mechanism seeking withdrawal, on March 29, a week from today. That starts the clock in a rather complex, two-year window of negotiations between Britain and the 27 other EU member nations and the European Parliament leading to the actual exit. Tusk has asked EU leaders, minus the UK, to meet on April 29 to begin discussions relative to the guidelines for Britain’s exit. In a statement, Mr. Tusk indicated that the main priority for the upcoming negotiations is to create as much certainty and clarity as possible for all citizens, countries, and member states. Supply Chain Matters could certainly suggest adding clarity to industry supply chains to Mr. Tusk’s statement.

Business and broad media all point to the start of some of the most complex negotiations either side has undertaken, with many issues to resolve over the next two years. They include trade and tariff, border security and the movement of goods.

Since the announcement of the results of the referendum, the pound sterling has had a somewhat steady decline in relation to its value with the Euro and the U.S. Dollar. As a rather positive consequence has been increased attraction of British goods among domestic and global markets.  Broad supply chain activity, as reflected by the CIPS UK Manufacturing Index, reached a significantly high value of 56.1 at the end of December, with the report noting that rates of growth in production and new orders were among the best observed over the past two-and-one-half years. Since December, this index has moderated slightly to 55.9 in January, and 54.6 in February, both reflecting healthy activity. Thus, in the short-term, the UK has garnered supply chain economic benefit related to Brexit.

The open question is course, the longer-term picture.

Entering the triggering of Article 50, British Prime Minister Theresa May has advocated for a “clean” break from the EU. She has threatened to walk away from negotiations if Britain did not get the trade deals it was seeking or if the EU tried to impose punitive measures.  She has further indicated that the UK could cut corporate taxes, loosen regulations, and could have a free trade deal with the EU that would include tariff-free access. British media including the Financial Times have interpreted such a stance as to indicate that Britain could transform itself into the low-tax Singapore of the west.  Such declarations appear to not set well with established EU countries.

Thus, a lot will transpire over the coming months and industry supply chain strategies will have find ways to navigate such a geopolitical environment. Most observers tend to believe that new trade agreements between both parties cannot be realistically negotiated and ratified by over 30 various parliaments in two years’ time. In fact, Mrs. May has indicated that the entire body of EU laws will be copied onto British statutes, and then over time modified by negotiation events and outcomes. The Economist noted in its editorials that it has recently taken nearly seven years to secure Canada’s free-trade deal with the EU.

As noted in our original commentary, two major industries dominating UK based manufacturing are automotive and the aerospace industry, the latter being focused primarily in commercial aircraft component manufacturing. Two of the most dominant stakeholder brands of autos are Volkswagen and Tata Motors, followed by Nissan and Toyota. According to Wikipedia, the aerospace industry within the U.K. is the second- or third-largest national aerospace industry in the world, depending upon the method of measurement. The industry employs around 113,000 people directly and around 276,000 indirectly and has an annual turnover of around £25 billion. Domestic companies with a large presence include BAE Systems (the world’s third-largest defense contractor), Britten-Norman, Cobham, GKN, Meggitt, QinetiQ, Rolls-Royce (the world’s second-largest aircraft engine maker), and Ultra Electronics. External companies with a major presence include Boeing, Bombardier, Airbus, Finmeccanica, General Electric, Lockheed Martin, Safran and Thales Group. As indicated in our 2017 predictions, the aerospace industry itself is believed to be reaching a 15-20 year inflection point, one that will be quite different from the past boom years of upwards of 10 year customer order backlogs.

No doubt, the invoking of Article 50 begins a period of discernable uncertainty among specific industry supply chains, related to access to key markets, financial goal performance, engineering, manufacturing, and overall talent capability.

A lot can and undoubtedly will occur, since in today’s clock speed of global business, two years can be a rather long-time, perhaps reflecting a new wave of geopolitical and technology change.

So goes this global environment of uncertainty, implications that seem near but yet so far.

Bob Ferrari

© Copyright 2017. The Ferrari Consulting and Research Group and the Supply Chain Matters® blog. All rights reserved.

 


Reinforcement of Messages for a Year of Certain Strategic and Tactical Supply Chain Planning

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In a prior Supply Chain Matters blog posting earlier this week, A Persistent Team- Be Prepared for a Year of Continual Analysis, we again urged readers and clients to be prepared for a year of continual analysis of the potential supply chain impacts of what could well be significant changing tax and trade policies involving the United States. We cautioned teams against do-nothing tendencies under a notion that political debates need to run their course.

Since we published our commentary, we have come across more reinforcing information.

On Tuesday, global strategy and consulting firm KPMG invited us to view an online seminar from the corporate and policy advisory unit titled: Will New Policies from Washington Disrupt Your Strategy?  The session featured a Principal in C-Suite/Board level strategy, a Partner in Tax strategies and a Principal in procurement and operations value management. Also included to represent a manufacturing focused client perspective was the head of financial supply chain design for global contract manufacturing services provider Flex.

The primary message delivered by KPMG presenters was that given the current scope of pending U.S. changes in corporate tax and trade policies, it is imperative that companies reevaluate existing global footprints, supply chain, and business strategies. The dimensions of potential change were contexed as involving geopolitical, regulatory, and company-specific dimensions. There is also opportunity, in the ability to capitalize early on new policies to gain first-mover advantage.

The presenters presented sample scenarios of the potential net income impacts could be for a U.S. based manufacturer whose supply chain is externally sourced under potential tax reform scenarios, some of which were rather significant in bottom-line impact. What also caught this author’s eye was the potential impact of corporate strategies under current debt vs. equity allocation under a revised policy of potentially non-deductible interest expense. In essence, the weighted cost of capital could tip a lot higher for firms with current high debt loads.

The KPMG team provided some guidance on impacts and timing which, depending on specific area, could be as soon as now, or a year from now in cases of changed trade agreements or U.S. corporate tax policies. Online seminar participants were urged to not silo strategy discussions in finance alone, since the implications involve a revisit of existing and future business operating models. The primary message delivered: “Be agile enough to be able to adapt to changes.”

As we noted in our prior blog commentary, the KPMG presenters posed also the question of being cognizant of industry competitors, especially if new sources of qualified supply are required from U.S. based sources, where existing product value chain capabilities may be limited.  The process of search and qualification should be underway.

A separate development to add reinforcement to the above message was today’s published report by The Wall Street Journal indicating that Samsung is now exploring the feasibility of expanded investment in U.S. manufacturing related to its home appliance product lines.  Initially being planned is the shifting of oven range production from Mexico to the U.S., with potentially added capabilities for refrigerators, washers, dryers, and other home appliances. Samsung directly indicated to the WSJ: “However, this is a complex process that, like all strategic business decisions, will not be made final until it is determined through proper due diligence and planning, that is the best option for Samsung.”

Getting back to the webinar, Brant Miller of Flex indicated that many of their customers are already posing the question of what should our supply chain look like in the U.S., and what level of industry supply chain capabilities currently exist.  An emphasis for increased investment in U.S. manufacturing comes with a strong emphasis on manufacturing automation to offset expected increased costs, and reinforcing perceptions for being a brand-conscious company. Miller reinforced the latter to include a brand that is vested both in sustainable business practices and in U.S. manufacturing to support domestic market needs.

Certainly, not all companies are suited to change major supply chain sourcing strategy.  There are factors of product margins, cost of goods sold (COGS), overall product lifecycles, capital intensity, along with avoidance of higher transportation and inventory investment costs.  The one clear message delivered by Miller was that planning is essential.

We urge readers, if they can, view the replay of the referenced KPMG online webcast. While we do not have a web link at this time, we will post one well available in the Comments section below.

Bob Ferrari

© Copyright 2017. The Ferrari Consulting and Research Group and the Supply Chain Matters® blog. All rights reserved.


An Update Concerning Foxconn

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We wanted to provide our readers an update from a recent Supply Chain Matters posting citing a report indicating that a Sharp Foxconn U.S. plant announcement was imminentFoxconn

This week, The Wall Street Journal reported that while Foxconn was still interested in building a large-scale flat-panel U.S. manufacturing facility, its iconic Chairmen is challenging U.S. business and sense-of-urgency norms.

This latest WSJ update (Paid subscription required or metered view) indicates that Foxconn Chairman Terry Gau is drawing contrasts among China’s Guangdong Province officials who eagerly supported efforts to move ahead with the siting and building of an $8.8 billion flat-panel factory while U.S. talks have stretched on for years. Cited are officials noting that it took literally just 50 days for Guangdong officials to negotiate a deal with Foxconn.

Supply Chain Matters would quickly add, however, that business norms among these countries are quite different, for very important reasons.

In this week’s report, Mr. Gau indicated to the WSJ that he had just visited Washington D.C. but declined to elaborate further. He further indicated that to compete with China government officials, the U.S. must offer tax breaks and develop worker-training programs, along with studying how things are done in China. Gau indicated to the WSJ that he has urged U.S. state representatives to visit China: “To see how in such a short span of time, we can get so many things done here.”

We strongly suspect that Mr. Gau may be trying to cater to the current pro-business agenda of the new Trump Administration, especially in the notions of reduced regulations and in the reported thwarting of government agencies such as the U.S. Environmental Protection Agency (EPA). Perhaps Mr. Gau may not be sensitive to the current political backdrop of a U.S. state granting fairly large incentives to a China based manufacturer as contrasted to a U.S. resident manufacturer.

Beyond the political optics, there is, from our lens, a far broader consideration.

In the acquisition of Sharp, Foxconn is embarking on a mission to foster a globally branded company. Brands represent certain perception and values for consumers which not only include features, pricing, and technology of products, but other values as well. They include commitment to sustainability and the environment along with social responsibilities in the treatment of workers and suppliers. Do not misconstrue, any company has the right to be a tough bargainer and foster its business goals, but a set of values must be recognized as well.

An important reinforcement to the above is the WSJ reporting of Foxconn’s confirmation that it is bidding to also acquire the flash-memory business of Toshiba Corp.

With the current U.S., political debate leaning toward corporate tax reform and a potential import tax, Foxconn may find itself needing a U.S. presence, not only in support of its own brands, but in supporting its own contract manufacturing customers. The other card that Foxconn has in its favor is its current investments in manufacturing assembly automation utilizing robots, along with access to other U.S. manufacturing centers of excellence.

Foxconn could well re-discover that negotiating is a give and take exercise, with the latter having equal value.

Bob Ferrari

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


Tesla Reports Q4 and 2016 Financial Performance with Most Eyes Affixed on the Model 3 Supply Chain

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Electric-automobile and solar power producer Tesla reported fourth quarter and full year 2016 results this week but it seemed that most eyes are focused on the ramp-up of the new Model 3 volume ramp-up production and supporting supply chain strategies. Tesla_Flag

On the financial front, the company reported mixed results. Q4 automotive revenues were reported down by 7 percent on a quarter on quarter basis while total year revenues increased 69 percent from the year-earlier period. Q4 gross margin in automotive nearly doubled from the year-earlier quarter while full year gross profit for automotive increased 74 percent.

Equity analysts remained concerned about Tesla’s current and anticipated cash-burn rate, particularly since the new Model 3’s ramp-up will require added capital spending. The Wall Street Journal today observed that total liabilities now stand at nearly $18 billion, compared with $7 billion a year ago. Total cash on-hand amounts to $3.4 billion with speculation that the company must raise additional capital. A further development is the pending departure in April of the firm’s current CFO Jason Wheeler who will be replaced by Deepak Ahuya, Tesla’s initial CFO for more than 7 years.

In this week’s letter to stockholders, Elon Musk, Chairman and CEO indicated that in the past quarter, combined net orders for the Model S and Model X increased 49 percent compared to the same period in 2015.  Vehicle production increased by 77 percent over the year-earlier period. I

In January, Tesla reported that it produced a total of 83,922 vehicles which was at the low-end of its mid-year forecast for producing between 80,000-90,000 vehicles in 2016. During the final quarter, the auto maker produced 24,882 vehicles, many of which were delayed until December because of a what have been described as short-term production challenges starting in late October and extending to early December. Like the rest of the auto industry, Tesla remains challenged by a gap of finished goods produced vs. vehicles actually delivered and signed for by customers. In the final quarter, the gap between vehicles produced and vehicles delivered was 2682 vehicles, which will be counted in the new fiscal year as revenue.

Yet, the company still has a long way to go to meet its milestone of producing upwards of 500,000 vehicles on an annual basis by 2018.

We previously alerted our readers to a published report that Tesla began pilot production of the new Model 3 vehicle earlier this month, to coincide with this week’s report to shareholders. In this week’s letter to shareholders, Musk declares that Model 3 product development, supply chain and manufacturing are on-track to support volume deliveries in the second-half of this year, while installation of manufacturing equipment is underway at both the Fremont California and the Nevada based Gigafactory. The company expects to invest somewhere between $2 billion and $2.5 billion in capital expenditures ahead of the start of Model 3 production and by our lens, there is little tolerance for missteps in engineering and process design.

Upwards of 400,000 paid deposit reservations are believed to have been made so that prospective Tesla customers can be assured of a Model 3 delivery slot. Tesla executives however refuse to cite any number related to Model 3 deposits.

Musk previously informed shareholders of plans to begin Model 3 volume production by July of this year but cautioned that the company could miss that date if suppliers do not meet deadlines. In this latest letter to shareholders, there is a statement indicating that all Model 3-related sourcing is on plan to support the start of production in July.

During the Q&A phase of management’s briefing to equity analysts regarding the latest financial results, there were multiple questions related to further background for the Model 3 ramp-up. Musk re-iterated that the goal for the Model 3 is to have production rates of 5000 per week by the end of this calendar year and that current supplier parts orders begin to ramp to increased volume cadence from July through September. He reiterated that the auto maker has refocused most of Tesla’s engineering, including design engineering into designing the factory. “I think in the future, the factory will be a more important product than the car itself.” Also stated: “I’ve said this before, but our goal is to be the best manufacturer on Earth. This is our real goal. I don’t know if we will succeed, but I think we’re making good progress in that direction.”

Responding to a question on the difference in the Model 3’s design, executives indicated that the amount of complexities in the overall design and vehicle complexities to assemble the newer, lower priced but higher volume model have been dramatically reduced, while the amount of operations that involve more judgment from production operators have been dramatically reduced, or almost eliminated. The Model 3 was described as designed for manufacturability.

A further acknowledgement was learning from the previous Model X production ramp-up where complex design changes hampered ramp-up, bottleneck and cost efficiency milestones, which we have pointed out in prior blog postings related to Tesla.

Another difference noted by Musk is that in earlier models, it was rather difficult to recruit established automotive tier-one suppliers for long-term supply contracts because Tesla was viewed as a start-up with financial risks. For the Model 3, component and subsystem supply contracts have been established with some tier-one suppliers and there is now renewed confidence in supplier capabilities to meet design, quality, and volume commitments.

Supply Chain Matters has previously praised Tesla’s vision, innovative thinking and its can-do perspectives concerning supply chain and distribution. Many eyes are now focused on Tesla’s next critical milestone, that being the ability to operate as a high volume, disciplined manufacturer of industry-leading and technology-laden innovate automobiles.  As many of our readers are well aware, Tesla is now embarking on a full-blown supply chain segmentation strategy, one that differentiates capabilities of full-featured, higher-priced vehicles from that of the high-volume, lower-priced Model 3.

The year 2017 will be the crucial test.

Bob Ferrari

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


Report Indicating Tesla Model 3 Pilot Build About to Begin

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After Founder and CEO Elon Musk declared last May an intent to revolutionize Tesla Motors production activities to coincide with the availability of the new dramatically lower cost Model 3, a report now indicates that the electric auto maker is planning to start pilot production this month at its Fremont California production facility.

The Reuters report syndicated by global business network CNBC, cites sources as indicating that Tesla has informed suppliers that test build of the new Model 3 sedans will initiate on February 20.  While the sources did not know of how many sedans were planned for this initial pilot build, it would likely be a small number to test the new assembly and test needs.

The February date happens to precede by two days, Tesla’s scheduled shareholders meeting. Speculation is that the initiation of test build would provide added optics for reservation customers as well as shareholders.

Upwards of 375,000 paid deposit reservations have been already made by prospective Tesla customers. Musk previously informed shareholders of plans to begin Model 3 volume production by July of this year but cautioned that the company could miss that date if suppliers do not meet deadlines.

According to the report, sources indicate that the Model 3 timeline is indeed considered to be extremely aggressive, especially since engineers are still making last-minute design changes to the vehicle. This has been a common pattern for Tesla, one in the mold of Apple under the leadership of Steve Jobs, where last-minute design changes drove suppliers and contract manufacturers crazy in periods of critical production volume ramp-up.  Tesla suffered some effects of this process with the prior Model X, whose revolutionary gull-wing doors and seating designs had to be re-visited because of volume production yield challenges.

At last year’s annual meeting of shareholders, Founder and CEO Elon Musk indicated that Tesla will “completely re-think the factory process.” Musk repeatedly raised the notions of “physics-first principles” and made the point that his team now realizes that where the greatest potential lies is in designing and building the factory.  He challenged Tesla engineering teams to the principles of “you build the machines that build the machine.” In other words, the context is in thinking that the factory is the product, and that you design a factory with similar principles as in designing an advanced computer with many interlinking operating needs. Further acknowledged was that the Model X design was over complicated, perhaps too much to accommodate production volume needs. Going forward with the development of the new Model 3, Musk indicated that a tighter integration loop among product design and manufacturing would be fostered.

This latest report raises the question of whether Musk can fulfill his promise for producing 500,000 cars annual by 2018. That currently represents 4-5 times 2016 production levels, which missed their annual goal as well.

From our lens, the other open question is whether Tesla’s unique new vehicle distribution and customer delivery model can also ramp-up to such levels. Increasingly, at the close of each quarter, Tesla reports thousands of vehicles still in-transit to awaiting customers.

Readers may well have their own views but it would seem to this blog that Tesla’s better efforts should be directed at taking the time to get all production and distribution processes highly synchronized in high volume dimensions across the entire supply chain. Rather than communicate whether suppliers can meet deadlines, communicate the readiness of the entire supply chain machine to meet production and distribution milestones.

The optics can come later.

Bob Ferrari

© Copyright 2017. The Ferrari Consulting and Research Group and the Supply Chain Matters® blog. All rights reserved.

 


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