Supply Chain Matters provides a brief follow-up to our recent posting, The Price of Oil: Saudi Arabia Officials Understand Principles of Supply and Demand.  One development that has certainly captured keen interest among procurement and supply chain executives is the current rising cost of oil and its implication to both commodity and service costs.  The Saudis, the world’s largest producer of crude, are reportedly very concerned that the current trend of rapidly rising energy prices will derail any global economic momentum or cause a repeat of the 2008 price run-up that not only precipitated the previous global recession, but caused transportation costs to skyrocket. The Saudi’s also understand all too well, the cornerstone principles of supply and demand, and we described how a plan is underway for the Saudis to debunk any notions that the current price run-up is about any fear of a supply shortage.

Today’s Financial Times features a column (paid subscription required or free metered view) authored by Ali Naimi, Minister of Petroleum and Mineral Resources for Saudi Arabia.  In his column, Mr. Naimi emphatically declares that high oil prices are bad news for the international economy and bad for oil-producing nations. He further states that while the Saudis do not control international prices, the bottom line is that Saudis would like to see a lower price, and are prepared to call the bluff of supply and demand economics.

According to Mr. Naimi: “There is no demand which cannot be met.” He further points to the Saudi current capacity to pump up to 12.5 million barrels per day, way beyond current demand levels, along with at least 57 days of ‘safety stock’ supply in storage to handle any supply disruption.  Inventories in Saudi Arabia and in storage facilities positioned across global regions are full.

The Saudis have been clear.  They fear a setback in world economies, particularly Europe, will seriously derail any global economic momentum.

Supply Chain Matters again reiterate that procurement and transportation management teams should read between the lines, since the Saudis are flatly stating that there will be no lack of supply to cover current global demand. They are, in essence, calling the bluff of market speculators who game the system for short-term gains.  Our advice is not to focus on the current headlines echoing high oil and energy prices but rather focus on the near-term supply and demand dynamics of energy markets. This should include negotiations with carriers and suppliers over fuel surcharges.

Bob Ferrari

Supply chain risk continues to exist, especially within international food supply chains.

Last week, the Taiwan High Court sentenced the owner of a food additive manufacturing firm to a jail term of 13 years for adding toxic plasticizers to clouding agents and selling these products to food and beverage producers.  His spouse was also sentenced on the same charges.  More disturbing, the incidents were reported to occur between August of 2005 to May 2011, a period of almost six years.  This incident is being described as the largest food contamination incident in Taiwan history.

Clouding agents are typically used in the products such as fruit jelly, yogurt powder, juices and other drinks.  This incident resulted in the recall of hundreds of products and was described by the Taipei Times as “bludgeoning the confidence of Taiwanese consumers and tarnishing the country’s reputation abroad.”

Sourcing and procurement teams need to insure that proper quality measures always exist up and down the supply chain. In this Taiwan incident, the existence of non-conforming product existed far too long without detection or investigation of consumer feedback. In the case of globally extended supply, producers, distributors and retailers must further have a keen eye to specific oversight and regulatory measures.

As Supply Chain Matters has often pointed out, brands can be destroyed with a single large-scale incident.

Bob Ferrari

In June 0f last year, Supply Chain Matters provided commentary related to announcements made at the annual meeting of Hon Hai Precision Industry Co., the parent of global contract manufacturer Foxconn International Holdings Ltd.  At the time, Hon Hai Chairmen Terry Gau declared that the company would be a high-tech manufacturer, as opposed to a contract manufacturer.  He further indicated that the company’s long-term direction was to continue to develop more prowess in advanced technology, including strategic opportunities to partner with Japan based technology providers.

Today, the Wall Street Journal is reporting (paid subscription required or free metered view) that Sharp Corp. will sell nearly a 10 percent equity stake to Hon Hai in order to: “… shake up its core-but loss making –liquid crystal display panel operations.” The deal calls for Hon Hai to take a 46.5 percent  stake in Sharp’s LCD production facility in Sakai, western Japan. The Sakai plant is expected to supply displays to Hon Hai and Foxconn later this year. This deal, valued at over $800 million is being reported as the biggest investment ever involving a Taiwan based company in a Japanese technology provider.

Hon Hai already had ownership interest in own LCD unit, Chi Mei Innolux, but the is reported to be saddled with financial losses and technological weakness. As our readers are aware, Hon Hai and Foxconn are the primary contract manufacturing providers to Apple.  Chi Mei is not involved as an LCD supplier to Apple but the WSJ speculates that this equity deal may position Sharp as more of a volume supplier to Apple’s small LCD display needs.  Sharp competes with LCD industry leader Samsung Electronics for LCD displays.

This move can also be viewed a counter to recent LCD supplier agreements involving Japanese producers. In August of 2011, Supply Chain Matters made mention of the formation of Japan Display, a merging of the LCD operations of Sony, Toshiba and Hitachi. That venture was reported to be backed by a $2.6 billion funding from a government backed agency, The Innovation Network Corp. of Japan.  The August announcement was noted to be a response to competitors Sharp, Au Optronics and Samsung who were garnering a healthy share of longer-term supply contracts.

It now appears that Hon Hai and Sharp are positioning for a more strategic supply relationship with Apple and other customers.  In the view of Supply Chain Matters, this deal may also represent another attempt by Hon Hai to vertically integrate high tech and consumer electronics production, including more influence over long-term supply contracts. We also view this deal as another sign of a changing contract manufacturing model as providers move to garner more value-added margin opportunities.

The open question is how Apple and other high volume consumer electronics providers will respond to this latest announcement from Hon Hai and Sharp.

Bob Ferrari

Readers of this blog may note that like other supply chain industry analysts and consultants, there are some supply chain trends that tend to trigger our ire.  One specific area has been the ocean container carrier industry, whose arrogance toward customers and management missteps just keep on coming. Ocean container carriers still do not seem to have a clue on how to balance internal profitability objectives with delivering required customer service. Instead, decisions motivated by internal objectives are eroding customer and overall service levels.

In previous Supply Chain Matters commentaries we called attention to the dynamics of consolidation and industry restructuring and noted that just when we presumed that international ocean container carriers were finally paying more attention to customer cost and service needs they again disappointed.  Our latest commentary observed the industry again turning to price increases and targeting U.S. bound shipments for carrier profitability targets.

In mid-February, after fighting a market-share battle with its competitors, industry leader Maersk Line announced that it would cut Asia to Europe vessel capacity by 9 percent. In a Financial Times article, Maersk’s finance director indicated that the carrier will use all of its tools to return to profitability, including further pricing charges and capacity cuts beyond those already announced.  Maersk raised rates on the Asia – North Europe route by $100 per 20 foot container on February 1, and another $50 on March 1.

In late-February, AP Moeller Maersk, the parent company, announced that its profits had dropped 33 percent to $3.38 billion. Profits for Maersk Line, the ocean container group, came in at a net loss of $537 million.  Ocean container losses were fortunately offset by a 24 percent increase in oil and gas activities.  The carrier’s CEO, Soren Skou, who assumed leadership in mid-January, arrogantly declared that Maersk Line had captured enough market share to fill excess capacity. In a separate FT article, Mr. Skou declared that industry margins have come in at 2 per cent over the last seven years while 12 percent was a more acceptable range.  Later he declared that unless industry returns do not reach 8 or 9 percent, the industry is destroying shareholder value.  During this same period, container lines collectively decided to order way too much excess new capacity with over 250 vessels currently being idled.  While the industry might have viewed bigger and more efficient ships as the answer to increased profitability, too many of these ships have exceeded any conceivable notion of container shipment growth.

As a contrast for our readers, UPS currently has a pre-tax operating margin of 10.86 percent, and a net margin of 7.15 percent.  FedEx has a pre-tax margin of 5.7 percent, and a net margin of 3.7 percent. Both FedEx and UPS have proactively idled excess capacity since the global recession of 2008 without incurring significant service level erosion for customers, while continuing to exceed profitability expectations. Each has balanced investment in new, more efficient capacity with corresponding investments in process control and productivity tools directed at servicing shippers.

Today, ocean container carriers continue to run at the slowest speeds, Maersk is quoting transit times from Shanghai to Northern Europe at 34 days, up from the mid-twenty days in prior months.  That has an impact on customer needs for faster transit times and less safety stock. Last week Maersk had to declare that it was suspending bookings on the North Europe to Asia reverse route because a current backlog of shipment containers has caused European ports to be at full physical capacity. European shippers have obviously stepped-up some export volumes while empty containers needing to be sent back to origins compound the problem. The carrier indicates that it may take until May to clear port backlogs.

A failure to view an operating problem from both the internal profit and external customer service lens compounds even further.  Ocean container carriers have withdrawn capacity, and continue to slow transit speeds in order to raise profitability. Slower transit times are causing ports to become ever more congested as empty containers cannot be cycled to other ports. Shippers continue to plan for far more excess inventory to compensate for slower transit times from the key manufacturing regions in Asia. Now, as choke points continue to compound themselves, carriers decide to suspend services rather than recall an idled ship and operating crew.

I’m sure we need not continue this commentary since the bulk of our readers get the picture. While the industry may boast that it serves as the lifeblood of global commerce, management missteps and a general arrogance to shipper and customer needs have resulted in a mess. Where is the balance?

In the view of Supply Chain Matters, what this industry really needs is either a healthy dose of oversight, or a general thinning of the carrier herd with the survivors being those who demonstrate a clear focus on investing in customer and shipper needs.

Bob Ferrari

If our readers have not guessed thus far, Supply Chain Matters maintains subscriptions to two different mainstream business publications, namely the Wall Street Journal and the Financial Times.  We do so not only because both are widely read by supply chain and other business executives, but also because each publication can provide a different lens to a story.

One development that has certainly captured keen interest among procurement and supply chain executives is the current rising cost of oil and its implication to both commodity and service costs.  While the WSJ provides coverage of this development from the lens of Wall Street interests, we turned to FT and detailed articles published yesterday and today related to what actions Saudi Arabia officials have now undertaken to respond to this concerning trend, a trend which our readers should be aware.

The Saudi’s are reportedly very concerned that the current trend of rapidly rising energy prices will derail any global economic momentum or cause a repeat of the 2008 price run-up that not only precipitated the previous global recession, but caused transportation costs to skyrocket. The Saudi’s also understand all too well, the cornerstone principles of supply and demand. Increased multi-government sanctions imposed against the government of Iran, scheduled to increase even more in the coming months, have provided concerns about additional global supply reductions or the sudden closing of the Strait of Hormuz, a major shipping lane for crude supply.  In the middle of all this lies the financial market speculators who attempt to make money on perceived supply and demand imbalances.

Christine Lagarde, managing director of the International Monetary Fund (IMF) further indicated that that rising energy prices have overtaken Europe’s debt crisis as a concern for the world economy.  The same issue is often brought forward by U.S. Republication presidential candidates hoping to unseat President Barack Obama. As of this writing, oil prices are hovering at $124 per barrel.

Today’s FT article reports that Ali Naimi, Saudi Arabia oil minister has publically acknowledged that that current high oil prices are unjustified given the existing numbers of supply and demand.  Mr. Naimi views current global supply exceeding demand by 1 million to 2 million barrels per day, a situation that many in our community would view as excess supply.  Once more, according to the Saudis, customers are not requesting nor seeking more crude.  The summer months are fast approaching and global markets generally require an additional 3 million barrels per day to support seasonal consumption.

To respond to any concerns relative to near and longer-term supply, a separate FT headline article, Saudis deluge US with oil to curb price, reported that Saudi Arabia has recently contracted the largest number of super tankers in years, 11 in all, each capable of hauling 2 million barrels of crude. These tankers will be replenished by the largest increase in Saudi pumping capacity in the last 30 years. According to the FT, over the next few months: “…they will deliver a wall of oil with a single aim: to bring prices down.” The destination of these tankers is the U.S. Gulf coast. Saudi Arabia is also increasing its own supplies of crude within storage tanks located in Rotterdam, Egypt and Okinawa.

These moves are reported to be part of a longer-term Saudi strategy to maintain a very large buffer of spare crude capacity available to support global markets.  In the parlance of supplier management, the largest supplier is responding with a significant upside capacity response.

How successful this Saudi response is in driving down the current high prices of crude remains to be seen, but this effort deserves mention and praise.  The Saudis have a belief that $100 crude is a reasonable level to support world markets, and with an experienced knowledge of supply and demand principles are about to call the bluff of market speculators.  The rest is up to refiners and associated retail markets who will, without any further unexpected supply disruption, find themselves with lots of crude inventory.

In our view, commodity and procurement professionals need to stay informed and up-to-date on this latest development and on the forthcoming dynamics of oil markets. Transportation and distribution teams should be asking their commodity teams for more frequent updates in the coming months, particularly before major 3PL and transportation contracts are renewed.

Market dynamics concerning oil and energy supplies are going to be interesting to say the least.

It would be interesting for readers to share their perceptions as well.  Are you planning for higher or lower energy prices for the remainder of 2012?

Bob Ferrari

The following also appears as a published guest commentary on the Supply Chain Expert Community web site.

The one year anniversary of the tragic earthquake and tsunami that impacted northern Japan was by many accounts a game changing event for global supply chains. In a recent Supply Chain Expert Community blog posting, blogger Jim Fulcher makes mention of recent research findings from the Business Continuity Institute indicating that one year after, 82 percent of companies that reported supply chain disruption have confirmed some changes to their supply chain strategy, with 12 percent indicating significant changes implement.

The notion that no company is immune to such risks, even one that has incredible influence and buying power was brought forward last week in conjunction  with the announcement from Apple of its latest generation iPad tablet computer. The Wall Street Journal featured an article that extracted from two individual teardown analysis of the new iPad performed by firms UBM TechInsights and IHS iSuppli. The UBM analysis “found components with the same functions made by at least three manufacturers in different tablets.” Specifically, Apple has multiple tablet production sources for device memory and high-resolution display. NAND flash memory came from Micron Technology, Hynix Semiconductor along with Toshiba Corporation, a previous high volume supplier of memory for Apple iPhones. The new highly touted iPad high resolution displays were determined to be sourced from Samsung Electronics, LG Display and another company not conclusively identified.

While the strategy may not be a surprise for those who may know of Apple’s internal supply chain practices, the fact that a diversified sourcing strategy is expanding is another indication of the new importance of active supply chain mitigation has become. UBM and the WSJ both noted that the breath of suppliers is one of the most notable elements of the recent teardown of the next generation iPad and further speculate that the reason may be a sign that Apple is more actively practicing supply risk mitigation because of the past Japan and other disruptive incidents.  A glance at the suppliers of mention also triggers the thought that each supplier’s main operations are located in different geographic regions.

On Supply Chain Matters we recently dwelled on the one year anniversary and noted specific actions that automotive manufacturers Toyota and Nissan have implemented as a result of learning from the recent quake. Toyota alone discovered that approximately 300 production locations could be at risk and has now asked these specific suppliers to implement risk mitigation measures. Last week, community blogger and Kinaxis executive John Westerveld added his commentary that it is shame that if often takes a significant event to make all of the organization sensitized to the importance of assessing supply chain risk and developing risk mitigation strategies.  Jim also argues that supply chain risk management should be integrated under the umbrella of the Sales and Operations (S&OP) planning process because of its current scope, process frequency and data utilized to make decisions.   This author happens to agree with Jim and encourages our community to have a dialogue of its own regarding this important topic.

What we are now beginning to understand is that even Apple, the largest global supply chain influencer, who managed to come through the Japan tsunami and later Thailand floods incidents relatively unscathed, has implemented discernable supply chain risk mitigation.  The takeaway for all others is that like other areas of supply chain capability, the gap among leaders and laggards continues to widen, and supply chain risk mitigation is another critical capability within this gap.

Once again, are you educating and influencing your senior management to the need for more active risk management identification and mitigation strategies?

Do you believe that this responsibility falls under the umbrella of supply chain management, as opposed to finance or enterprise risk management?

Do you view the S&OP process as a natural extension to inclusion of supply chain risk mitigation?

One year is a long time in the current dynamic clock speed of business.

Bob Ferrari