Last week’s financial and equity market headlines featured the news that global investors and speculators are bailing-out on commodities amid mounting worries about the slower pace of global manufacturing growth. If you have been following our global tracking of select PMI indices featured in our Quarterly Newsletter, you will have visually noticed this slower overall trend as depicted in the visual attached to this commentary.
Likewise, the precipitous plunge across China’s key stock market also continues, having a potential further impact on China’s major manufacturing sectors as consumers financially stung by severe financial loses retrench in domestic spending.
Commodities such as copper, gold, silver and oil are at their lowest points in years. Global mining firms such as Anglo American, BHP Billiton and Rio Tinto are quickly addressing cost savings by restructuring their commodity businesses that relied on the manufacturing growth and commodity speculation that has occurred in China. Multiple state-owned steel companies across China continue with optimistic output levels despite the evidence of a global surplus and overcapacity condition in steel. Anglo American alone has indicated it would slash upwards of 50,000 jobs over the next several years, amounting to a 35 percent reduction in its current workforce.
Likewise, energy companies are planning additional cost-cutting moves in the light of the sudden drop of oil prices, increased glut of supply and declining trends in global demand for oil.
For the majority of multi-industry supply chain teams, this is ironically good news since lower commodity prices equate to lower input, logistics and cost of goods sold (COGS).
In our Supply Chain Matters 2015 Predictions for Industry and Global Supply Chains (available for complimentary download in our Research Center), we highlighted a continued overall moderation trend for the cost of commodities in 2015 with certain industry specific exceptions. We predicted that dramatically lower oil prices would be the dominating headline driving commodity and pricing trends in 2015, and just past the half-year point, the trend is holding true. Purchasing and commodity teams can therefore anticipate inbound cost savings in the coming year with the usual exceptions related to unforeseen global weather or risk events such as the bird flu outbreak affecting turkey and poultry flocks in the U.S. Midwest and West regions.
However, teams cannot rest easy since the rising value of the U.S. dollar and resulting foreign currency shifts are providing rather significant headwinds to existing financial results for U.S. based manufacturers or those dealing in U.S. dollar dominated revenue flows. In some cases, such headwinds are having as much as a 10 percent or greater negative impact on overall revenues.
While lower commodity related inbound costs will help to offset some of the cost erosion, it may not be enough. Those manufacturers that had significant revenue and profitability expectations by tapping into China’s emerging consumer consumption could soon feel the effect of continuing concern. To provide added evidence, The Wall Street Journal reported today that the Chartered Institute of Procurement and Supply is raising its global risk index to its highest level since 2013. The heightened risk has a lot to do with certain key suppliers in China that may be impacted by the sharp decline in equity and consequent credit markets.
These are the not so good news messages.
Sourcing, procurement and supply chain leadership teams must therefore remain diligent to further opportunities to reduce inbound or supply chain services related costs for at least, the remainder of this year.
The following commentary is a Supply Chain Matters guest posting authored by Jim Barnes, Services Managing Director, Institute for Supply Management (ISM).
One of the biggest challenges in our industry is gaining recognition of the value procurement and supply chain management brings to the corporate bottom line. We know supply management increases shareholder value by making business more competitive and more profitable, yet it’s hard to tell the story. The perception is we’re not very strategic but are overly tactical: processing paper, comparing one price against another and policing what other departments order.
To change this perception many in supply management are exploring the option of automating some functions to move away from tactical processing and focus more on strategic interactions with suppliers. Generally speaking, automation can help reduce the number of people doing tactical work; reduce the amount of money needed to do that work; and provide supply management professionals with more time to develop better relationships with suppliers.
There are several factors to keep in mind when considering the option of automation:
- Know which processes can be automated and which cannot;
- Recognize your human resources may not be interchangeable; and
- Realize if you automate a bad process, you’ll just get bad stuff quicker.
Most transaction processes lend themselves well to automation, and there are tools to automate the bidding and RFP processes, too. However, it’s very hard to automate the human interactions in supplier relationships like strategic sourcing and negotiating.
As you automate processes and free up supply management professionals, don’t assume everyone has the ability to move into a more strategic, interactive role with suppliers. At ISM Services, we offer clients the opportunity to survey their supply management professionals to determine if they tend to be more tactical or more strategic. Then we put them through a negotiation exercise where they can learn the difference between the skill sets, the value of both and determine where their strengths lie. Participants learn that many times it makes sense to negotiate as a team with the best combination of negotiating styles to suit the objective.
It’s important to remember that automation on its own is not the answer; you still need to have a good process in place. One of our clients had a highly manual, time consuming process for receiving goods and verifying documentation. When they first automated the process they merely replicated their manual process, and it yielded the same result, a very high exception rate. After spending significant effort to re-engineer the process, they learned to rework and reset the rules to get much better results from the process.
Another problem can arise when departments are automated and outsourced at the same time, or at a later date. For example, supply management professionals who automate their accounts payable and outsource it can run into problems because the new people managing it don’t have the important knowledge of the inner workings of the company. The result, according to an experienced practitioner-friend of mine, is “your mess for less.”
So how do you decide which automation strategy is best for your company and avoid some of the pitfalls? First, determine what you want to accomplish in which departments and then establish the metrics to measure your progress and accomplishments. For example, do you want to take work out of a process? Do you want to eliminate onerous authorizations or unnecessary three-way match requirements? In the end you want to eliminate work of lesser value to the company and instill more strategic practices with your suppliers.
Second, take time to explore your options because there are quite a few available. Talk to your peers to find out what is working for them. Attend conferences and visit the vendors there and try their tools. ISM Services does not recommend nor endorse automation software but we are available to help you evaluate it against your goals.
When managed well, automation can be a game changer in the supply management industry. It can result in more efficient and cost-effective processes and give supply management professionals more time to collaborate and innovate with suppliers. It can shift the perception of procurement and supply chain management from tactical order processor to strategic partner in the C-suite.
In 2012, The Economist described the dawn of the Third Industrial Revolution, an era that would feature the digitization of manufacturing and the use of new, stronger and more innovative composite materials. And indeed, that trend continues at a rapid pace. Competing in this new era requires manufacturers to invest in new technologies that can provide both product as well as process innovation. General Electric, through its GE Reports series, recently highlighted its billion dollar bet on ceramic super material as a basis of product innovation.
Ceramics has been utilized for many years for certain power and electrical based applications mostly used in kitchen appliances. A visionary GE engineer however, believed that ceramics, which can withstand higher heat than even the most advanced alloys, could be the perfect material for jet engines and other machines that burn fuel and must handle enormous temperatures. Nearly 30 years later, along with nearly $1billion in research investment, components made from ceramic matrix composites (CMC’s) are being incorporated in the next generation of aircraft engines such as CFM International’s LEAP model that will power the upcoming Airbus A320 neo (new engine option) aircraft. The concept of a new and highly more fuel efficient upgrade of the A320, with a shorter new product development time, was prompted by these newer innovations in aircraft engine technologies.
According to the GE report, unlike other alloys, CMC components weigh one-third the weight of metal and do not need to be air-cooled. A GE Research leader indicates: “CMC’s allow for revolutionary change in jet engine design.” This was a tremendous bet on innovation. Now, aerospace, military and industrial customers may soon experience aircraft, helicopters and industrial turbines made from more CMC material based components providing lighter weight higher performance and operational savings.
However, not all suppliers have the deep pockets of global-based manufacturer such as GE. Suppliers that currently exist in commercial aerospace supply chains experience constant cost-control pressures from respective aerospace producers seeking to improve product margins or overcome prior expensive aircraft program delays. Even now, as both Airbus and Boeing are planning for significant production volume ramp-up, there still remains the perspective of who pays for innovation, and who reaps the overall benefit.
So what is the key difference for GE and its joint partners, Italian based Turbocoating, France based Snecma. That difference is that airlines negotiate and contract for aircraft engines directly with engine manufacturers. These manufacturers can translate investments in innovation to bottom line financial outcomes. CFM International has thus far booked orders for 9550 LEAP engines valued at $134 billion at list prices. The margins achieved from this amount of orders are under the direct control of the aircraft engine manufacturers themselves, a benefit that the majority of other aerospace suppliers do not have.
From our lens, the takeaway is twofold. Manufacturers ultimately own the responsibility for overall product design innovation. It is not a task delegated to key suppliers without joint compensation. Several years ago, the industry embarked on a strategy of de-centralized innovation and cost-sharing, one that required key component suppliers to innovate in product and process dimensions but not necessarily harvest the benefits from longer-term production volumes. Principle aircraft manufacturers are investing heavily in final assembly process and test automation, yet seek to offset program costs within other areas of the supply chain.
Much continues to be written on the lessons learned by that strategy, particularly those related to design and cost implications. Now, as the industry faces its toughest test in terms of supply chain ramp-up, suppliers seek due compensation for their innovation efforts. Suppliers must also answer to investors who have a shorter-term horizon.
The Third Industrial Revolution will continue to lead to breakthroughs in many dimensions, and to a new breed of more agile, market responsive manufacturers. The notions of who owns and who is rewarded for innovation will be front and center in this race to the top and will lead to a return to vertical integration supply based strategies.
The manufacturing leaders of tomorrow will be those that master the risk and reward dimensions of product and process innovation.
The Wall Street Journal, citing informed supplier-based sources, reports that Apple is planning for a larger initial production run of the next iteration of iPhones. According to the report, Apple is requesting suppliers to support between 85 million and 95 million iPhones for the all-important end-of-year holiday buying season that ends at the end of December, despite expected modest hardware changes.
Last year, Apple planned its supply chain output for a range of 70-80 million phones, and actually shipped 74.5 million smartphones during the holiday quarter. That was a 45 percent increase from the year ago holiday surge quarter. The iPhone6 incurred its own set of production ramp-up challenges including a last-minute design change involving its larger screen displays. There was the usual production yield challenges associated with the fingerprint scanner and with the LCD displays. During its most recent fiscal quarter, Apple shipped 61.2 iPhones, fueled primarily by emerging market demand primarily from China, Hong Kong and Taiwan.
The WSJ indicates that hardware changes are expected to be less noticeable and that Apple is in-essence betting that consumers will flock to upgrade their existing iPhones. Display sizes and screen resolution are expected to be unchanged.
Further reported is that contract manufacturer Hon Hai Precision (Foxconn) is in the process of hiring additional workers for its Zhengzhou China facility, in anticipation of beginning volume production starting in August.
The report confirms that a third contract manufacturer, Taiwan based Wistron Corp. will supplement production needs this year. In an April Supply Chain Matters commentary, we echoed a published report from Taiwan based Digitimes indicating that Apple was expected to adjust its lower-tier supplier Q3 order volumes for both the iPhone 6 and the newly released Apple Watch to minimize the risk of too much volume dependency on any one single supplier, as well as to meet or maintain targeted gross-margin goals. Noted was that Apple had invited both Compal Electronics and Wistron, noted contract manufacturers in laptops and other consumer electronics, to join its supply chain as augmented suppliers. The report further indicated that Apple’s two major PCB partners, Zhen Ding Tech and Flexium would have their order rates adjusted while suppliers Largan Precision and Advanced Semiconductor Engineering, which reportedly have advantages in advanced technology, will benefit from increased orders.
As noted in many of our past commentaries, the ability of the Apple supply chain to support steep new product introduction ramp-ups is predicated on active supplier risk management coupled with supply chain segmentation strategies focused on product margin and profitability goals.
The next test comes in the next five months.
In our prior Supply Chain Matters commentary concerning Sharp Corporation, we reiterated the two sides of supplier based relationships involving the most recognized supply chain, that being Apple. On the one hand, being chosen as an Apple supplier can provide enormous scale, global reach and financial rewards. However, Apple is a demanding customer with unique and exacting processes that can test any supplier.
Apple further practices very active supplier risk mitigation, insuring that this global consumer electronics provider has at least two or more supplier agreements in-place for key components.
In a May commentary, Supply Chain Matters highlighted a report indicating that one of the key technology components within the Apple Watch had experienced reliability issues. The taptic engine component, which controls the sensation of tapping the watch while transmitting heart-rate data, was sourced among two key suppliers. Citing people familiar with the matter, The Wall Street Journal reported at the time that reliability testing has discovered that the taptic engines supplied by a China based supplier demonstrated reliability problems, with Apple electing to scrap some completed watches. Engines produced by Japan based Nidec Corp., the backup supplier, reportedly had not experienced the same problem. Apple subsequently moved all remaining sourcing of this component to Nidec.
Today’s WSJ report regarding Sharp also makes mention of the Apple Watch component issue in the context of how manufacturers can discard faulty products when design issues or production snafus are evident. The report again noted how Apple subsequently turned to Nidec for nearly all of its taptic engine production needs, but it took time for this other supplier to ramp-up its own production processes to be able to accommodate Apple’s overall production volumes. Thus, for our readers who were wondering what was causing the delay in the delivery of their new Apple Watch, now you know.
The obvious takeaway is that active supply risk mitigation is essential for key technological components, as well as the ability to lend a helping hand to suppliers in time of product or business crisis. Such risk mitigation is especially critical in new product ramp-up stages as volume production processes are tested for volume scale.
There are two-sides to supplier loyalty and management, and how they are practiced goes a long way in the determination of overall supply chain agility and responsiveness.
In November of last year, the WSJ stated in a report related specifically to Apple’s supply chain: “If you cut a deal with Apple, you better know what you’re getting into.” That statement continues to sum it all.
Supply Chain Matters has featured several prior commentaries specifically related to Sharp Corporation, one of three current liquid crystal display (LCD) screen suppliers in Apple’s supply chain.
Sharp has a track record of innovation in LCD technology but a rather rocky financial history as well. Our last commentary in early April, Perils of an Apple Supplier- Sharp Corporation, highlighted continuing reports of severe financial crisis surrounding Sharp. The Wall Street Journal reported at the time that various restructuring options were being considered but no final decision had been made. One reported option was that this supplier was moving to spin-off a portion of its LCD panel business unit with intent to seek a new capital injection from Innovation Network Corp. of Japan, a governmental entity overseen by Japan’s Ministry of Economic Trade and Industry. One of the tenets of Japan’s high tech industry is to rely on government funded agencies to bridge times of financial crisis. Since our April commentary, Sharp’s bankers agreed to provide an additional $1 billion plus lifeline, the second in three years, in exchange for restructuring measures that included a 10 percent workforce reduction. Also since that time, the market prices for LCD panels remain in significant decline as other suppliers turn more to China based smartphone manufacturers for revenue needs. The WSJ cites data stemming from market research firm IHS indicating that 5 inch HD smartphone panel components prices have dropped nearly 60 percent from Q1 2013 through the current quarter.
Today, the WSJ featured a report (paid subscription required) indicating that Sharp has warned that its survival could be at-stake, and that it is now pushing suppliers for deeper price cuts and that it further considering sourcing of display components from new China based suppliers rather than its former Japan based suppliers. At its annual meeting for shareholders held this week, sales directly attributed to Apple accounted for 20 percent of Sharp’s fiscal year revenues.
For the fiscal year that ended in March, Sharp racked up a loss reported to be $1.8 billion, due to write-downs of its LCD operations. Yet, this supplier maintains a public confidence that it can implement steps to maintain its ongoing viability, despite its share price haven fallen upwards of half over the past year.
LCD screens are highly strategic for Apple, and the consumer electronics juggernaut has elected to initiate strategic supply agreement among three different suppliers to insure both leading-edge technologies as well as the ability to scale to Apple’s flexible volume requirements.
All of which leads back to the perils of being an Apple supplier. In a recent Spend Matters sponsored webinar (no relation to this blog), chief research officer Pierre Mitchell observed that Apple imposes very strict contract terms among its supplier base, shifting considerable risk on the backs of suppliers while preserving major rights to product based intellectual rights. So much so that GT Advanced Technologies recently elected to seek voluntary bankruptcy in order to gain leverage with Apple over what was described as onerous contract terms.
The conundrum for Sharp and other Japan based high tech component suppliers is that bankruptcy is culturally looked upon as a major failure and embarrassment of senior management. So much so that the most optimistic financial forecasts are stubbornly held to up to just prior to the formal reporting of the bad news. On the other hand, firms such as Apple that practice active supply risk mitigation for key components will often have contingency options to buffer the shortfalls or stumbles of any one key supplier.
The financial challenges involving Sharp will most likely linger and through its ongoing re-structuring efforts, this supplier could introduce even more risk into its ability to deliver to customer needs.
The takeaway for the broader high-tech supplier community is to insure you understand all the terms and risk implications of your supply and technology agreements.