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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.


Major Move by Boeing to Secure Service Parts Revenue Control

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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.

Bob Ferrari


Not a Good Week and Time for Automotive Service Management Supply Chains

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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.

Bob Ferrari

 


The Need for Removing Retail Organizational Silos in Omni-Channel Fulfillment

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Before and throughout the 2015 holiday fulfillment quarter, Supply Chain Matters has highlighted industry developments related to one of the most significant challenges facing the retail industry today, namely the increasing implications of online customer fulfillment on retail supply chain business processes and organizational alignments. Indeed, included in our retail industry supply chain predictions for 2016 is our continued belief that the ongoing permanent shift among consumers towards favoring combinations of online and in-store fulfillment channels and more integrated Omni-channel fulfillment capabilities will necessitate the accelerated breakdown of organizational silos.

Already the evidence is of such implications are building. Besides announcing the closing of over 200 select locations, Walmart announced in in January that the retailer is merging all of its existing corporate IT and Silicon Valley online commerce IT groups together under a singular umbrella of leadership and direction. Walmart’s existing corporate CIO and the Chief Technology Officer of Walmart Labs now report directly to the head of the retailer’s E-Commerce division.  In its reporting of the Walmart move, Reuters quoted the head of Walmart’s E-Commerce division as indicating that customers do not think of interactions as different physical or online experiences, but rather as one experience.

Also in January, office supplies retailer Staples announced the departure of the head of North America stores and online operations in favor a revised alignment where retail store and online operations report to a North America operations chief. The CEO of Staples indicated the change was brought about to speed decision-making and drive toward more profitable growth.

And there is obviously more industry change unfolding as the realities of industry financial performance and eroding profitability continue to unfold.

Thus it was very timely that results from the third annual PWC Viewpoint 2016 executive survey were announced this week. This survey conducted on behalf of JDA Software, included 300 retail and consumer goods CEO’s and was administered in late 2015.

Last year’s survey confirmed increased challenges related to profitability because of the higher unplanned costs associated with online customer fulfillment needs and expectations. One area of challenging costs was logistics and transportation, key criteria for influential Free Shipping policies. The 2015 report revealed only 16 percent of retailers indicating that they could fulfill Omni-channel demand profitably. That reality continues to unfold.

The headline results and takeaways of the latest survey reflect a mere 18 percent of surveyed CEO’s indicating that they have eliminated operational silos that are hampering a singular Omni-channel shopping experience for customers. However, this minority of companies expressed greater confidence in future revenue and profit growth than their peers. The study further revealed considerable differences in Omni-channel maturity across various geographic countries.

Readers who review all of the survey data observations will find a lot of insightful indicators. What particularly caught the eye of Supply Chain Matters were the indications of what areas Omni-channel leaders were electing to invest within during the next 12 months vs. the next three years. This for us was an indication of priority and as noted by the survey authors, the current sense of urgency. For instance the executive summary indicates:

CEOs’ investment intentions are higher for the next 12 months than they are over the following three years, especially for the critical Omni-channel functions of extending the range of customer fulfillment options and providing seamless customer shopping experiences. The emerging markets in particular are spending heavily in these areas, as well as in understanding social media, improving supply chains and creating new in-store experiences.

The accompanying Figure outlining areas of near-term investment points primarily to initiatives that classified as either customer or supply chain centric initiatives. The categories for extending the range of customer order fulfillment options, providing a more seamless shopping experience or expanding supply chain capabilities for customer order fulfillment options each garnered high preference.

We continue to believe and advise that more integrated Omni-channel fulfillment capability will trump customer engagement Initiatives in 2016 as will the overall ability to be able synchronize and context customer fulfillment execution with network-wide inventory management with logistics and transportation cost needs.

Bob Ferrari

Disclosure: JDA Software is one of other sponsors of the Supply Chain Matters blog.


The Rush to Internet of Things Platform Dominance- General Electric Opens its Predix Technology Platform

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Supply Chain Matters has featured prior commentary regarding General Electric and its ongoing efforts to transform itself from a diversified industrial equipment manufacturer to that of both an equipment and software services provider.  GE is an ongoing case study in the leveraging of Internet of Things (IoT) technology into new business models for its customers and for GE itself. The core of GE’s Industrial Internet strategy is the Predix IoT platform tailored for operating equipment environments.

In conjunction with the Mobile World Congress trade show being held in Barcelona, GE announced today the GE Digital Alliance Program, an effort dedicated to growing its digital industrial ecosystem. This expanded alliance program is billed as connecting systems integrator’s telecommunications service providers, independent software vendors, technology providers and resellers with the technology and digital industrial expertise of GE. For the first time, GE alliance members will be able to train and certify their developers and begin building a variety of additional industrial applications with Predix.

In a prior commentary reflecting on GE’s 2015 financial performance, we noted that the new GE Digital business unit delivered a reported $5 billion in revenues in 2015. The company’s goal is to triple Digital Business revenues by 2020.

Development efforts surrounding the core Predix operating system began in 2012 as an internal effort to connect the vast amount of sensor data generated by equipment products. By 2013, GE began to analyze data among fleets of machines and equipment to discover important analytics related to operational performance and maintenance needs. Operating units began to correlate certain operating environments with performance outliers and needs for unplanned maintenance. It was then that GE executives began to view Predix as a data and analytics platform tailored for the unique and demanding requirements of many forms of equipment networks made up of aircraft engines, turbines, wind mills or sophisticated medical equipment. That includes collecting very significant volumes of real-time data and harnessing that data into more predictive analytical insights into asset up-time and reliable performance. The CTO of GE Digital is of the belief that Industrial Internet platforms will break the zettabyte barrier (1000 exabytes) in the next five years.

GE has invested upwards of $1 billion in its Industrial Internet efforts thus far, in-essence making a significant strategic bet on the Predix platform. The industrial giant holds a strategic card as well, namely current existing customer relationships with global industrial companies eager to leverage new and more recurring revenue streams. Make no mistake, the expanded Digital Alliance program is a wide swath initiative to build extensive influence and critical technology and development mass in the IoT marketspace.

With today’s announcement, GE unveiled new Digital Alliance collaborations with Intel, Capgemini, TCS, Deloitte Digital, Infosys, Genpact, Softtek and Wipro Limited. They join existing Digital Alliance partners Accenture, AT&T, Verizon and Vodafone, Softbank Corporation and Cisco. We recently brought reader attention to Cisco’s announced acquisition of Jasper Technologies to broaden that firm’s IoT platform.

Other enterprise technology providers recognize the vast potential of IoT enabled business models that link equipment performance with add-on services. Thus, as Supply Chain Matters has observed, the battle of which platform is to be most utilized in now underway, and there is a lot at-stake. Firms such as Cisco, PTC, Microsoft and Oracle are now engaged in this effort of influence among IoT development communities.

As Supply Chain Matters has previously advised, the early adopters of IoT enabled business models related to industrial and supply chain needs should exercise some caution in their early prototype development efforts. Understand that vendors are indeed positioning for dominance and to do your homework on the long-term resilience and scalability aspects of the network platform. Just like previous item level tech waves such as RFID, the perspective is far broader than any existing single technology or services provider.

Vendors with influence and large pockets will continue to positioning for platform and indeed partner and industry dominance, but that should not be deterrence to early adoption business initiatives for new business models that can leverage IoT information. . Early adopters also have a buyer’s advantage in that customer references and early success stories are critical for technology vendors and services providers vying for dominance.

A large building or business initiative requires a solid foundation built for endurance, solid architecture and partner support resources. That should remain a guiding principle.

Bob Ferrari

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

 


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