In an earlier Supply Chain Matters posting, we noted that this week, Apple provided a huge thud across Silicon Valley and global equity markets. The globe’s richest and most profitable company delivered a huge financial disappointment resulting in the first quarterly sales drop in 13 years. Executives pointed to macroeconomic headwinds and a far more competitive and challenging smartphone market. Yesterday, the Dow Jones Industrial Average suffered its biggest drop since February, fueled by the recent financial performance news from Apple, along with sharp declines provided by IBM and Cisco Systems.
However, this is a global world of industry competition and it is important to reflect on other players and other product, market, pricing and supply chain trends in similar industries and markets.
This week Samsung Electronics reported what was billed as the fastest profit growth in its core mobile business in nearly three years, attributed to strong initial sales for its Samsung Galaxy S7 model smartphones. Overall revenue rose 5.7 percent. The company’s mobile business operating profit for the March ending quarter rose 42 percent from the year-earlier period, noted as the largest year-over-year improvement in mobile profits since the second quarter of 2014.
Business media reports cite analyst’s estimates that Samsung shipped 10-12 million units of the new Galaxy S7 series phones in the past quarter. Keep in mind that Samsung elected to push-up the scheduled launch of this new S7 models to Q1, which may have led to the improvement in financial performance. Once more, Samsung’s guidance to investors reflected a continued optimistic sales growth forecast for S7 devices in the current operating quarter. In its reporting, global business network broadcaster CNBC quoted market research firm TrendForce as forecasting that S7 unit shipments will reach 52 million by year-end, surpassing a previous record of 47 million for the Galaxy S4 model. While that number does not equate to iPhone sales in a single quarter, keep in mind that Samsung offers abroad variety of other smartphone models in various competitive price ranges. One estimate indicates over 79 million total Samsung produced smartphones sold in Q1.
Thus, while the overall global smartphone market may be shrinking or turning toward a replacement cycle, there are pockets of provider growth. Among the current rankings of top five global producers of smartphones, besides Samsung and Apple, three are China based, offering price competitive models, especially for larger China and Asia based markets.
Operating margins for Samsung are noted to have risen to 14.1 percent from 10.6 percent from a year ago amid a streamlining of product line offerings and reductions in manufacturing costs. Keep that number in perspective and recall that Apple’s current operating margin was noted as close to 28 percent in its most recent quarter, twice that of Samsung. That may be an indicator of price performance and sensitivity reflected in today’s global smartphone markets. It also counters Apple’s claim of macroeconomic headwinds in current regions, since Samsung competes in similar geographies.
Readers should recall that Samsung is both a competitor as well as a major supplier to Apple in the form of proprietary processor chips as well as general memory chips produced by Samsung’s semiconductor operations. In the latest quarter, this chip business recorded its first year-over-year decline in more than three years, due to what was termed as a supply glut and cooling demand for processor and memory chips.
We have previously noted the importance of Samsung’s vertical supply chain integration strategy reflected by its chips business as both an internal and external industry supplier. From an advanced technology perspective, Samsung gains the benefit for first mover advantage in leveraging the most advanced chip based technologies. From a broader key strategic industry component supplier perspective, the risk is that when supply chain dominants such as Apple financially sneeze, the implication flows down to the component supplier, even large key suppliers. These reverberations will likely continue over the coming months.
Thus there are different sides to any coin and it is important for high tech and consumer electronics supply chain S&OP teams to focus on the core sales, pricing and product trends reflected in the overall market, not just certain players. Another key takeaway is the ongoing critical importance of responsive and timely product design and new product introduction.
This week marked a rather significant milestone and a rather huge thump within Silicon Valley and global equity markets. The globe’s richest and most profitable company along with the most highly recognized supply chain delivered a huge if not somewhat expected disappointment. Note your calendars for reference, as this week; Apple did indeed report the company’s first quarterly sales drop in 13 years.
The growth streak has temporarily paused and the question is now what comes next.
The financial numbers are somewhat ugly by Apple standards- second fiscal quarter revenues declined 13 percent while profitability fell over 22 percent. Then again, how many companies would envy a quarter that resulted in over $50 billion in sales and over 10 billion in net income?
Revenues across global regions were consistently down- a 10 percent reduction for Americas; a 5 percent reduction in Europe; a 26 percent reduction in the all-important Greater China region. Once more, Apple has issued lower sales forecasts for the current quarter. The impact of a strong U.S. dollar was somewhat a factor in global revenues with Apple indicating that revenue declines would have narrowed by 4 percentage points without such an impact.
For the past year, Apple’s shares have declined 20 percent and according to a commentary by The Wall Street Journal: “The decline erased more than $46 billion of the company’s market capitalization, more than the total value of Caterpillar Inc. or Netflix Inc.”
The unit volume picture was concerning- All important iPhone sales volume was reported as 51.2 million, down 16 percent from year earlier period. The firm’s iPad sales volumes declined 19 percent, continuing in a two-year long sales slump despite efforts to boost sales and a strategic alliance with IBM for more iPad focused business applications. Supply Chain Matters highlighted a number of ongoing published reports emanating from supplier information leaks indicating that Apple’s S&OP team has been consistently reducing iPhone production volumes since the beginning of the year. While inventories did increase, the situation would have likely been a lot worse since Apple had plans at one time to support an 80 million iPhone sales rate. Apple CEO Tim Cook indicated that the company plans to reduce inventories by $2 billion because of what he describes as the current challenging global economy. Gross margin for the current quarter is forecasted to be in a range of 37.5 to 38 percent, again below margin rates in the 40 percent range in prior years.
One bright spot was the introduction of the lower cost Apple iPhone SE that started shipping at the end of March. Apple CEO Tim Cook described current demand for this model as exceeding current supply, but too late to make any difference in second quarter performance.
The obvious question that reverberates across financial networks is when Apple, if ever will, return to growth. Some would point to the need for an acquisition, some point to the need for the next “cool” product, perhaps electric cars or televisions.
Within the supply chain umbrella, one can anticipate a number of ongoing challenges.
Apple’s product design and product management teams are now under enormous pressure to develop the next successful groundbreaking product. The all-important design completion milestone date is mid-summer, since the global supply chain needs time to build supply and production to meet the traditional September new product announcement period and the critical October-December holiday sales period. Apple’s product design culture has always shown a tendency to push design changes to the very last minute.
Another reality is how long Apple can continue to support a premium price and margin point given an overall slump in global smartphone sales. Emerging consumer regions where sales growth continues to exist are battlegrounds for price vs. performance, with lower price winning the majority of the time. If the iPhone SE turns out to be a sales volume success, it will have to be supported by a lower-cost supply chain channel.
Apple’s global direct materials procurement teams must continue to practice active supplier management since many of Apple’s suppliers have pinned their own financial performance outcomes on the large output volumes expected from Apple. When Apple sneezes, suppliers tend to catch pneumonia. Challenges will manifest themselves at annual supply contract reviews when volume expectations are clarified. With Apple practicing active segmentation, dual sourcing and key commodity risk mitigation, the role of supplier sourcing management should be very active.
Finally, Apple S&OP team must continue to be the arbitrator between sales and marketing teams who live in a hyped atmosphere of ever optimistic sales growth, a financial community now razor focused on margins and profitability goals, and supply chain operational teams that has not previously found themselves under an overt cost control looking glass.
A final open question is what if Apple elects to execute a large or complex acquisition. Perhaps an existing electric car or up and coming consumer electronics company?
There’s been an evitable thud in Cupertino, and the coming months will indicate whether this is indeed a temporary setback, or another turnaround milestone for the legacy and history of Apple.
© 2016. The Ferrari Consulting and Research Group and the Supply Chain Matters® blog. All rights reserved.
Equipment and capital goods manufacturers have increasingly re-discovered new and growing revenue opportunities that reside in added services and service parts sectors related to in-service equipment. Such opportunities are especially pertinent across commercial or defense focused aircraft which have operational service that spans many years of service. However, when an industry dominant such as Boeing decides that it wants to take more control as well as revenue cut of all service parts, the financial implications and subsequent impacts will reverberate among all key suppliers.
Today’s edition of The Wall Street Journal reports such an implication as Boeing elects to secure a new source of revenue beyond building aircraft. (Paid subscription required) The report indicates that whereas in the past, Boeing’s largest suppliers such as Spirit AeroSystems or Rockwell Collins could sell respective manufactured parts directly to airline and aircraft operators for in-service service replacement needs, the OEM elected in late February to prohibit suppliers from directly selling proprietary service parts, along with suspending licenses to suppliers to sell any such proprietary parts to its customers. The WSJ characterizes this development:
“It is the most aggressive move to-date in Boeing’s year-long effort to assert control over distribution-and the resulting revenue- of parts.”
According to the report, Boeing is looking to nearly triple revenues associated with commercial and defense aviation parts and services business by 2025.
Supply chain teams in these sectors know all too well that margins on service parts can far exceed those for original equipment production needs. According to the WSJ, it can be upwards of 4X more than what Boeing pays for the part to support initial production. Suppliers will often forego margins on supply contracts to a customer such as Boeing with the expectation that multi-year margins can be garnered in service parts needs over the operating life of an aircraft model.
In a highly regulated industry such as commercial or defense focused aircraft, certain structural or key operating parts have designated service-life provisions which must be adhered to, thus assuring ongoing component stocking and service part demand needs.
The WSJ report further links these moves to Boeing’s ongoing Partnering for Success initiative addressing added cost control opportunities among existing suppliers. According to the report:
“Boeing also prohibited some suppliers from being given new work or withheld regulatory approvals for parts until revised (supply) contracts were complete.”
The report cites a Credit Suisse aerospace industry analyst as indicating:
“The economics of being a Boeing supplier could be facing their greatest challenge yet.”
While airlines themselves have become increasingly concerned by the rising prices of service parts charged by suppliers, by our Supply Chain Matters lens, this revised strategy by Boeing does not necessarily address nor mitigate that trend. It obviously takes away profitability opportunities for suppliers while adding yet another intermediary in the service parts supply chain.
One of the most promising service management opportunities related to commercial and defense focused aircraft resides in the leveraging of Internet of Things (IoT) focused technologies that would allow operating equipment the ability to communicate service and replacement needs based on operating environmental conditions. Rather that static, fixed maintenance schedules, the opportunity is for the equipment itself to self-diagnose its parts replacement needs.
Many original equipment manufacturers are thus positioning to take advantage of such technologies in new service focused business models. That includes aircraft engine producers such as General Electric and CFM International. With this latest move by Boeing, a new participant is added to the overall business model, a participant that must share the same technology tenets being promoted in automated performance monitoring and service dispatch. Add the notion of IoT platform providers positing for their portion of the overall business model via platform adoption and subsequent dominance, and the picture begins to turn to one we have witnessed before with breakthrough technology. Every participant attempting to position for leveraged control of a promising new business model while target customers have to determine what all of this implies for added efficiencies or cost savings.
The dilemma of commercial aircraft supply chains that presented multi-year order backlogs and insatiable demand for more fuel-efficient technology-laden new aircraft has met the reality of more educated and aggressive airline customers, coupled with rapidly changing economic times. These forces are inserting their influence on aircraft pricing, delivery expectations and operating service needs.
Boeing is now responding to these needs by aggressive supply chain cost and headcount reductions, and now, demanding its proportional cut of service parts revenues. In essence, like too many supply chain dominants, the picture is again moving the need of cost reduction or added revenue needs down the supply chain.
More and more, the notion of we are all in this to share industry growth opportunities together reverts back to the supply chain dominant as the ultimate long-term benefactor.
Respective suppliers will obviously have to determine their own response strategies. Larger suppliers will be able to find means to remain resilient to such changes while smaller suppliers may feel the bulk of the pain. In the long-run, the party that ultimately controls the customer relationship along with product and process design ends up to be the eventual winner.
Nikkei Asian Review, citing component supplier based sources, reports that Apple will continue to reduce production levels of iPhones for the April-June time period. The latest adjustment comes after forecast volumes were lowered in the January-March quarter.
According to the report, the continued slowdown stems from slowing sales of the iPhone 6s and iPhone 6s Plus models, while the recently announced iPhone SE does not have enough demand volume to offset volume declines of the former two models.
The implication will obviously be an impact on component suppliers of LCD displays, memory chips and image sensors who rely on the iPhone’s huge volumes for their own revenue and profitability expectations. The Nikkei report comes after an EBN report published in in early February indicating earlier cutbacks.
From our Supply Chain Matters lens, this news has broader implications. Other product areas such as the iPad continue to experience declining demand, while Apple has been very reluctant to disclose any volume numbers related to its Apple Watch products, which can be interpreted to mean either exceeding or declining expectations.
For the globe’s most admired product development and supply chain organization, the pressure for coming-up the next big market disruptive product has to enormous. It’s no secret that the iPhone product lineup is the soul of Apple’s ongoing healthy levels of profitability, and thus the beast needs to be fed a constant high-calorie diet. Thus as we enter mid-year, we can expect that something had better be churning on the product front since suppliers are obviously jittery.
Perhaps the speculation that Apple will enter the electric car business may be closer than we think, else, something else may be brewing on the acquisition screen.
For service facing and aftermarket automotive related supply chains, news developments this week have undoubtedly bordered on the surreal or even bizarre.
The ongoing product recall crisis involving airbag inflators’ producer by Takata took on even broader dimensions. The National Highway Traffic Safety Administration (NHTSA) indicated this week that as many as 85 million potentially defective airbag inflators are still inside cars and trucks now being driven across the United States. That number is supposedly in addition to the nearly 29 million inflators that have already been designated for replacement in the ongoing massive product recall campaign. Reports indicate that thus far, at least 11 people have died and over 400 have been injured by defective airbag inflators.
There are many facets compounding this overall logistical challenge. NHTSA itself indicates that because of inadequate reporting information from automotive producers, the agency does not exactly know how many vehicles are exposed to potentially defective airbag inflators that were produced by Takata. There are also multiple inflators installed in every vehicle. Add to this, that previous replaced inflators were not properly designed, causing a second recall.
As Supply Chain Matters has noted in our previous commentaries regarding this industry recall challenge, the problem of premature explosion of the inflators has been linked to long-term exposure to high humidity. Thus the failure profile can be linked to specific U.S. states whose climate matches such humidity, such as Florida and the U.S. Gulf Coast states. One potential fix to the problem has been the addition of dessicant drying agent material to the inflator to lessen the moisture caused by high humidity. That obviously implies a separate part identity.
The far broader problem is the sheer scope of the potential campaign. The government is not even sure it has the authority to mandate a recall of such volume and with such monetary implications. With a potential of over 100 million inflators having to be eventually replaced, the recall campaign would obviously exceed current capacity for producing replacement parts, implying multiple years of effort. The sheer volume is of the magnitude of supporting the redesign of multiple new models of automobiles and trucks and would have to involve many more airbag inflator suppliers. As Supply Chain Matters noted earlier week, suppliers such as Autoliv have already benefited from the crisis, and with such massive numbers, other suppliers will benefit as well. And then there is the biggest question of all, who will pay for all of the replacement parts and installation costs.
The Donald Trump analogy of: “This is a HUGE problem” is an appropriate descriptor.
This saga and its implications will obviously test the limits of automotive service supply chains and dealers for many months to come.
Then the industry has the diesel engine emissions crisis involving certain Volkswagen produced models. Since our prior commentaries in late 2015, we have refrained from other updates because of the sheer kaleidoscope of bizarre actions by Volkswagen. First there was the sacking of senior corporate product design and quality executives. Then came the sacking of the top U.S. executive Michael Horn, who was revered by U.S. dealers, after Horn supposedly proposed monetary gestures to affected vehicle owners.
While the global auto maker has initiated a product recall plan for affected vehicles in Europe, the deadline for a plan to address polluting vehicles in the U.S. has come and gone and remains somewhat a work-in-progress. According to industry reports, VW continues to face upwards of $20 billion in potential fines as well as class-action lawsuits, not to mention a rather tense ongoing relationships with U.S. regulators and legislative bodies as well as its U.S. dealers.
Meanwhile VW senior executives had the shear nerve to position themselves for management bonuses. That had drawn the ire of executives of the IG Metall trade union who are influential members of the company’s Supervisory Board. The news this week is that executive bonuses have now been squashed by that board. Details related to future actions that VW will take related to a recall plan for the U.S. are not expected until VW’s board of directors meets later this month to review various investigative reports related to the U.S. emissions scandal.
The VW service management supply chain remains with lots of pending challenges and unknowns. Thousands of in-service diesel-powered vehicles may be subject to costly vehicle hardware and software fixes that potentially will involve significant labor hours per vehicle. Unsold diesel-powered vehicles remain in dealer lots awaiting a disposition as well. If a vehicle recall is initiated, individual owners are likely to very intolerant to repair times that extend over many, many months. Then again, what-if VW elects to buy-back certain models? That’s a reverse supply chain challenge in the making.
Overall, automotive service management supply chains remain stressed and face unprecedented process and execution challenges in the coming months and years. There is obvious learning that will come from this ongoing multi-brand crisis, involving product-design, supplier quality and supplier management dimensions. Many consumers will be impacted and will get first-hand knowledge of the effects.