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Reports that U.S. Volkswagen Dealers are Growing Restless Regarding the Ongoing Diesel Emissions Scandal Fixes

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The ongoing brand crisis involving Volkswagen and specifically its customers and dealers over the diesel engine emissions alteration admission continues to take on new dimensions.

Last week, The Wall Street Journal reported that VW dealers across the U.S. are fuming regarding the receipt of specific guidance  regarding the estimated 12,000 diesel powered autos that they are not allowed to sell. These unsold and currently prohibited stop-sale vehicles have been sitting in lots for over 10 months while VW and U.S. regulators traverse a legal process for determining next steps. According to this report, U.S. VW dealers are now sitting on approximately 107 days of finished goods inventory of which 12 percent represent currently non-saleable models.

Not wanting unsellable inventory to be clearly visible, many dealers have reverted to moving stop-sale inventory onto adjacent or off-site storage lots. While VW is currently compensating dealers for additional financing and needs for periodic servicing of this large amount of unsold and un-positioned inventory, dealers are not apparently making up the difference in new sales volume because of a lack of new saleable inventory. The long awaited family-sized sport-utility vehicle is not expected to be introduced in the U.S. until early 2017 while anew Alltrack small station wagon is due to be introduced in the next several months adding to dealer frustrations for more models to sell. Plans are very unclear as to whether the new family-sized SUV model will be offered with any diesel powered options as previously planned.

Last week, California regulators rejected a proposed VW fix for cars with the larger 3.0 liter diesel power plant. VW executives indicate that they have a fix related to the 2.0 liter diesel engines but regulators also need to approve this process as well.

In its report, the WSJ quotes one specific VW dealer executive as indicating that the scandal, compounded by the current glut of unsaleable inventory has soured his view of VW senior management. This executive further indicates that VW should take the unsold diesel vehicles back to Germany or some other location in the world where they can comply with emission standards.

On Friday, VW U.S. executives met with 150 Northeast U.S. dealers to review what was termed as a TDI Settlement Program, and pledged  additional compensation to dealers. While the details of such restitution still are not known it was the first time that VW indicated that the dealers themselves will receive direct compensation.

A detailed timeline was reportedly outlined regarding the proposed buyback and repair program across the U.S., one that is expected to extend through the end of 2018.  According to a subsequent report from the WSJ, a software fix would be made available for third-generation diesels by October, followed by a combination hardware and software fix for first-generation diesels beginning in January 2017, and a software update for second-generation diesel powered vehicles in February 2017. VW further indicated that it expects to have a hardware fix ready for third-generation diesels by October 2017.

This overall timeline, if approved by U.S. regulators will affect the nearly 500,000 existing diesel powered vehicles now on U.S. roads in addition to the unsold inventory of 12,000 vehicles.  Thus, it is more than likely that U.S. VW dealer service teams will be very, very busy over the coming months and years. However, VW continues to decline media outlets regarding any specifics related to overall time lines or specific restitution for its dealers. The WSJ report also indicates that for consumers electing to sell their vehicles back to VW, a “third-party settlement specialist” would be inserted to act as an intermediary and direct communicator with dealers.

There is little doubt that U.S. VW dealers face a service management crisis, one that will tax both aftermarket and pre-sales service business segments.

As noted in previous commentaries, VW continues to experience painful lessons regarding its ongoing emissions scandal. A company noted for a somewhat tops-down management style and an engineering-driven culture and among one of the two top global producers will learn some tough lessons as a result of this scandal. The most important when all the dust settles, will be more sensitivity to customer, market and dealer network needs along with implications of being afoul to governmental emission standards.

Once again, all of these challenges in the months to come demand that VW executives move decision-making beyond the halls of Wolfsburg with more emphasis on major geographic based leadership such as VW U.S. The supply chain implications alone place a major emphasis on service management and responsiveness or risk even more erosion to the brand and to customer loyalty. VW needs to think more boldly and more creatively to address fixing the current challenges with non-conforming diesel powered vehicles including the need for augmented resources.

Bob Ferrari

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


Volkswagen’s Initial Settlement with U.S. Regulators- More Challenges Remain

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Today marks the initial formal settlement by Volkswagen with U.S. based regulators regarding approximately 500,000 U.S. vehicle owners of two liter diesel engines as a result of the emissions cheating scandal. The financial settlement amounting to more than $15 billion, ranks as one of the highest ever incurred on an automotive manufacturer, a new industry milestone. It further represents what could be one of the largest vehicle buyback offers in U.S. history, one that we believe will test reverse supply chain processes.

Today’s settlement adds additional challenges for VW in its efforts to move beyond this emissions scandal. They include continued damage to brands because some consumers feel deceived and continued heartburn for existing VW dealers and retailers in selling what remains of existing gasoline powered vehicles.

Of the $15 billion total, a little over $10 billion is set aside in a civil settlement to offer vehicle buybacks and additional cash settlements to owners of existing vehicles that were implicated in the software manipulation of diesel powered emissions while $5 billion in allocated to offset excess diesel emissions and eventually boost efforts for new green energy and zero emissions vehicles by VW.

Yet remaining to be eventually settled is the issue of 85,000 4.0 liter diesel powered vehicles involving other primarily Audi and Porsche brands.

According to various published reports, existing owners of 2009-2015 affected vehicles will receive direct compensation of at least $5000 along with the estimated cash value of the impacted vehicles. Prior owners are expected to receive half the compensation of current owners while leased vehicles will also be included in some form of financial settlement. Buybacks are not expected to begin until October at the earliest, pending final judicial approvals of the settlements.

The company faces other fines involving governmental or civil settlements both in the U.S. and other countries as a result of the incident. According to Reuters, regulators will not immediately approve fixes for all three generations of polluting 2009-2015 vehicles. There are still open questions as to whether these vehicles can be economically and logistically repaired.  That opens the potential for a significant reverse supply chain challenge to move such vehicles to recycling or environmentally safe disposal channels.

As noted in our Supply Chain Matters commentary last September, Volkswagen runs the risk of losing the trust and loyalty of its U.S. and global customers if this crisis is not proactively managed. Thus far, it would seem that VW management is trying to move forward in settlements and in executive leadership changes but much more work remains. Many other ongoing supply chain and product related challenges remain as well.

One relates to the inventory of unsold diesel cars that now have had their U.S. and European sales suspended. That adds to the recycling and reverse supply chain challenges. If VW elects to repair or refit some of the diesel powered fleet, there are challenges related to who performs these services, how will compensation be administers and where the refits will be performed.

It is no secret that Volkswagen has struggled with its vehicle line-up for the U.S. market, including a market competitive and fuel efficient mid-sized SUV which was initially promised for 2016 market entry. That model availability problem has become much more complicated and may force VW to reach out to other manufacturers to fill-in holes in the model line-up.

VW continues to learn financially painful lessons regarding its ongoing emissions scandal. A company noted for a somewhat tops-down management style and an engineering-driven culture and among one of the two top global producers will learn some tough lessons as a result of this scandal. The most important when all the dust settles, will be more sensitivity to customer and market needs along with implications of being afoul to governmental emission standards. Now, more than ever in the company’s history, VW needs to take an industry leadership role in alternative powered and green energy powered vehicles.

All of these present a difficult set of challenges in the months to come, when that demands that VW executives move beyond the halls of Wolfsburg.

Bob Ferrari

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

 


Lumber Liquidators Terminates Sourcing of China Produced Laminate Flooring

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In February of 2015, Lumber Liquidators, at the time, one of the largest and fastest growing retailers of hardwood and laminate flooring in North America was involved in a supply chain expose.  Approaching 18 months later, the retailer continues to deal with the customer, brand and financial impacts of that disclosure.

In 2015, a broadcast report from CBS News’s 60 Minutes television program turned a public light on the retailer’s supply chain in terms of sourcing and product composition. That report declared that much of the retailer’s laminate flooring that was sourced and produced in China may fail to meet health and safety standards, because it contains high levels of formaldehyde, a known cancer causing chemical.

In May of 2015 the retailer announced that it is suspending all of its China sourced laminate flooring products. The retailer took further action as well. According to its web site, the retailer has systematically enhanced its compliance and sustainability practices across all of its business sectors. That included the hiring of a skilled and experienced senior executive to be the company’s Chief Compliance Officer (CCO), reporting directly to the CEO, John Presley. This CCO has led a team of professionals through an intensive evaluation of policies, processes and of the firm’s supply chain. That evaluation process included:

  • Reorganizing our company to better align processes with a commitment to quality and safety.
  • Installing a new risk assessment and evaluation process of every Lumber Liquidators supplier in every location.
  • Terminating relationships with suppliers who do not meet standards.
  • Adopting a detailed code of business conduct that, among many other requirements, mandates that each Lumber Liquidators employee be accountable for compliance in his or her area of responsibility.

Lumber Liquidators and the U.S. Consumer Product Safety Commission further agreed to a “recall to test” action, which is the term the CPSC uses to describe a testing program where the retailer agreed to initiate an in-home air quality testing program for consumers who purchased Chinese-made laminate flooring between February 2012 and May 2015. That testing program continues and consumers are offered a test kit for no-charge.

The retailer currently reports that tests involving over 1,300 floor samples have been completed without one testing above the designated CPSC’s remediation guidelines.

The latest development came last week when the retailer agreed not to resume sales of its previously sourced laminate wood flooring from supply sources in China.

According to news reports, more than 600,000 consumers bought the Chinese sourced laminate flooring over an estimated four year horizon. That would indicate that there are a lot more flooring installations that have yet to be tested thus far. After consultation with U.S. regulatory and consumer product safety agencies, the impacted consumers have been informed to not remove the flooring, because removal could cause added, more harmful exposure to formaldehyde.  Rather, regulators want consumers to work directly with Lumber Liquidators on additional testing and remediation needs. If the emission level is elevated, the retailer has agreed to work with homeowners to increase the air flow in affected homes or remove a small plank of wood flooring and conduct additional tests, free of charge.

The retailer continues to assure affected consumers that the China sourced flooring meets acceptable standards of chemical emissions.

Readers can gain any additional information and guidelines at this specific CPSC web site.

The financial, brand and other fallout from this incident continues. Shares of the company’s stock have reportedly dropped nearly a quarter this year, and the retailer reported its first annual financial loss in a least a decade. In its latest quarter, the retailer reported revenues down 10 percent with a wider loss.

Consumers directly affected by the China sourced laminate flooring obviously have their own impressions, now having to deal with guidelines that are somewhat less-specific as to remedies.

It is important to reiterate our previous takeaway to supply chain audiences regarding this ongoing incident.  It is yet another example of the needs for transparency across the global supply chain, particularly when an individual country’s or state’s product safety standards considerably differ. As business and industry media have acknowledged, there is no apparent recognized national U.S. standard for indoor formaldehyde concentrations and global wide standards vary among agencies. Interpretation of standards can tend to take on a different lens from different suppliers and thus the need for vigilant and consistent supplier monitoring and risk awareness.

Lumber Liquidators has learned an important lesson in supplier sourcing and in standards interpretation.  Affected consumers continue to learn an important lesson as-well.

Bob Ferrari


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.


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