Supply chain procurement and operational professionals have yet another cost reduction and control challenge to address for the remainder of 2010 and 2011.  Many are probably already acutely aware that a spike of key commodity prices is now putting increased pressure on profit margins. The challenge over the coming months will be finding means to offset higher inbound material costs, and it will not be easy.

As the calender winds down the September ending earnings reporting phase, many manufacturing and consumer oriented companies are flashing warnings to Wall Street.  The latest, Procter and Gamble, experienced a 6.8% earnings decline and vowed to hold the line on increased prices by offsetting cost reductions.  P&G acknowledged that sharply higher costs for paper, pulp and plastic resins are affecting margins. Overall gross margin fell nearly a percentage point to 51.8%.  Other consumer goods manufacturers are also noted these new cost challenges.  The Hershey Company acknowledged higher inbound costs for cocoa and sugar, but indicated that it will attempt to hold the line on cost increases through offsetting cost reductions.  Kraft Foods indicated that it consider select price increases as an offset to higher supply costs.

In the industrial sector, a recent Wall Street Journal article (paid subscription may be required) noted that major industrial suppliers such as Parker Hannifin Corp. and A.O. Smith are all signaling caution relative to reduced margins, and in some cases, reduced growth. However, Illinois Tool Works, who has 800 businesses ranging from appliances to fasteners, that span many tiers of discrete manufacturing supply chains, experienced a revenue increase of 12% and a profit gain of 39% in the past quarter.  One could speculate whether such gains were a result of riding the wave of price increases.

The causes of these new cost headwinds are, in my view, twofold.  First, they reflect that the spike in inventory buildup that occurred earlier this year emboldened commodity providers or market influencers, such as hedge funds, to initiate waves of price increases to fatten-up their own margins and profitability.  One can ponder whether such increases were actually pegged to overall global demand needs.

The other relates to legitimate supply shortages brought about by natural or political events. As an example, wheat crop failures in key agricultural areas, such as Russia, have driven up the price of wheat, and other crop failures in sugar cane or cocoa also triggered natural supply vs. demand price actions. China’s recent political dispute with Japan caused a ban on shipments of rare earth minerals.

Through my lens, this evolving crisis of increased commodity prices is equivalent to gaming the system.  Legitimate interruptions in supply have caused increased pricing pressures, but also cause speculation from a new breed of market influencers or manipulators.

For supply chain procurement and operations professionals, it adds a significant additional challenge in the coming months. Many supply chains currently operate in a fragile and lean state. Supply Chain Matters has  penned multiple commentaries noting key parts shortages impacting shipment and revenue results for those industries experiencing robust growth, and our recent newsletter notes the specific impact on various industry supply chains. Additional pressures for cost reductions could risk cutting into the muscle of supply chain capabilities at a time when agility and flexibility to changing business requirements places emphasis on the ability to quickly respond to market uptakes.

The open question is whether this new challenge of inbound supply cost increases without offsetting revenue increases, placing supply chains into a more fragile state than they already are.

Has senior management raised too much of a risk for cost reduction burden on supply chain teams?  Will this result in further cross-functional team conflict, and further parts and upside capacity shortages when revenue growth is required?

Only time will tell.

What’s your view?  Has the cost reduction challenge introduced significant added risk to supply chain responsiveness?

Bob Ferrari

There was a somewhat surprising announcement this week. Accenture entered into an agreement to acquire the strategic sourcing and business process outsourcing (BPO) services assets of Ariba, Inc.  For readers not totally familiar with the history of Ariba, the acquired group is essentially the services aspects brought over from Ariba’s acquisition of FreeMarkets several years ago.

Our initial reaction is that this event should cause procurement executives as well as procurement technology selection teams to revisit existing assumptions regarding leveraged use of strategic sourcing technology and coupled services to deliver aggressive cost savings for the business. It is also another evidence point that software companies have difficulty incorporating conflicting software and services business objectives.

First, we should summarize the details of this event.  According to the press release, the terms of the agreement call for Accenture to take ownership of Ariba’s category, commodity sourcing and strategic sourcing process execution resources which amounts to approximately 160 people.  The stated purchase price is $51 million, $12 million of which is subject to escrow based on assignment and subsequent performance of certain of these assets. Ariba itself will retain its in-house Global Services software implementation resources dedicated to assisting clients in both the actual implementation of Ariba software as well as gaining additional benefits in leveraged use of the software. This deal is anticipated to close in the quarter ending in December, which is an indicator that parties want to move fast.

My observation of the procurement BPO area over the years has been that firms decide on embarking on this path either because they have determined that strategic sourcing of materials or services is a core competency that is better outsourced to experts, or that aggressive savings goals are such that an interim outsourcing arrangement affords a better opportunity in achieving this goal in a shorter period of time.  The latter strategy proved beneficial to Ariba, since it was able to offer customers both the software technology, as well as services options.  However, certain customers who increased their learning in the use of the software, or conducting of major sourcing events moved away from an external dependence.  That had some impact to Ariba’s services revenue performance over these past periods. Some customers also felt that Ariba’s business model was too tied to services revenues and chose instead to shop the market for other vendor alternatives at time of renewal.

Services customers will probably now have a clearer landscape to consider in either a software or services decision, since the overlap is about to be corrected. I do have to believe, however, that in the short-term, Ariba prospects who desire dedicated sourcing services are going to be immediately shunted over to Accenture in order to make the escrow and performance goals of the acquisition successful.

Existing commodity and strategic sourcing services customers of Ariba gain a new provider, one that has Procurement BPO as a core competency.  I have also always been impressed by the capabilities of the direct sourcing services team both in their creation at FreeMarkets and their continuation with Ariba.  Accenture will inherit a dedicated group of professionals.  The implication however is that come contract renewal time, exiting Ariba services customers may find that there will be different aspects to consider under the umbrella of Accenture.  Accenture, with this new infusion of Ariba sourcing expertise, will no doubt extend its existing BPO capabilities into deeper expertise in the sourcing of direct materials. That coupled with existing expertise in indirect materials and services sourcing, provide Accenture the opportunity to present clients with a one-stop BPO services alternative. Outsourced procurement services are a key strategic decision that impacts the business over a multiple year time window.  That decision will now become clearer in the context of Accenture or other specialized BPO providers.

The other implication for Accenture revolves around the fact that it also provides software referrals to other software providers such as Emptoris or SAP, and it will have to re-double its efforts to insure potential clients that it can still provide objectivity in the choice of software, coupled with services.

Finally, existing Ariba software customers should view this announcement as a strategic decision made by Ariba’s senior management to focus more on Ariba’s previous core competencies, that being the software side of the company’s business, either on-premise or on-demand focused. The cash infusion from the acquisition will no doubt be applied to strengthening one or both of these segments.  The open question however is whether Ariba will now turn its attention towards a broader small and medium business market penetration, leveraging its on-demand software offering for sourcing and procurement technology needs. It may also be an indication that Ariba will up its diversification into more industry verticals, as well as compete more aggressively with existing ERP and best-of-breed technology players.

More implications of this announcement will certainly unfold in the coming weeks and procurement leaders need to be observant as to whether these implications will have impact on their ongoing efforts in integrating software automation with augmented services.

Bob Ferrari

There is some healthy debate on the blogosphere being generated on the subject of whether the strategic sourcing process has seen its best days.  All of this got started with a rather interesting guest posting by Dalip Raheja on the Sourcing Innovation blog.  Dalip’s argument is that a process that is driven by a principle motivation of cost reduction should not be characterized to be a strategic process that delivers exceptional business results over the longer term horizon. I enjoyed reading the various viewpoints and perspectives to Dalip’s posting. For an entire summary of various viewpoints, you can check out the full listing of commentaries on Sourcing Innovation.

I am admittedly late to this commentary and I ask for some indulgence from readers since this topic is one that I also have some passion about.  I happen to be in the camp that advocates that a pure cost reduction driven strategy is indeed not strategic, and there is quite a bit of evidence all around us to reflect this condition.  In fact I argue that there are many supply chains right now in a very fragile state, just one major incident away from a full crisis, because of the cumulative effects of a singular focus directed at cost reduction.

We perhaps need to place some context to this debate, since at face value, today’s strategic sourcing processes driven by spend analysis, eAuctions and other advanced supplier management tools have delivered significant savings in both direct, production-oriented procurement as well as indirect procurement.  Firms would not be adopting this technology if it was not delivering value, and the various case studies speak to these results.

It is important however to place proper context.  The last five years, and especially these last two years of severe global recession have not been kind to supply chain management teams.  With top-line revenue growth evaporating in multiple industry settings, CFO’s had no choice but to take control and layout significant cost reduction goals.  For a manufacturing firm, the supply chain, both inbound and outbound, holds the key for a good majority of the components that make-up the cost of goods sold, and thus came the mandates to significantly reduce costs, as soon as possible.  A CFO having the procurement organization as a direct report in the organization, or having close association with procurement provided organizational leverage for turning to modern strategic sourcing processes as a catalyst for significant cost reduction. Justifying such investments was a safe bet, and companies saved significant amounts of money. As an example, we have commented on Supply Chain Matters how certain consumer product goods companies were able to take millions in supply chain savings as a funding source for new product development, marketing and sales initiatives directed at driving more top-line growth.  CPO’s also gained considerable organizational stature by delivering results for the business, perhaps at the expense of other supply chain teams who had to live with the consequences of the ‘lowest-cost’ provider, but in the essence of team, the goal was delivered, and teams move on to the next challenge.

Now, some argue that strategic sourcing is not only thriving, but will take on even more responsibility such as supply risk and performance management.  I’m not that confident in that argument, because such an argument stems from a purely functional perspective  Many supply chains are being called on for more expectations. They are being called on to remain agile and responsive to unpredictable and  changing needs in markets, yet product design and manufacturing are outsourced with external providers.  They are expected to continue to deliver more cost savings when most initiatives have already uncovered the bulk of savings opportunities without introducing significantly more risk. Speaking of risk, a globally extended supply chain continues to add unprecedented levels of complexity and risk exposure, both internal and external in nature.  As noted, some supply chains are so lean at this point, one major disruptive incident will create havoc.

Firms  need to  move away from cost-cutting to value and capability driven approaches. The perspective I argue is that everyone is in the same leaking boat, and everybody had better be rowing in the same direction, with the same strategic goals.  The debate should be focused on leadership, strategy, and the skills and process capabilities needed to serve customer needs.  It is not about one process, but a collection of capabilities.  It is not about one function, but a cross-organizational objective on common goals and mutual rewards.

Bob Ferrari

The following posting can also be read and commented upon in the Kinaxis Expert Supply Chain Community web site.

There has been no shortage of significant supply chain related news these past months, but I would dare state that the most troubling thus far this year broke this weekend.

A global supply manager at Apple was arrested and charged with offenses that include wire fraud, money laundering and unlawful monetary transactions involving more than one million dollars in alleged kickbacks.  According to the Wall Street Journal article, (paid subscription may be required)  “this incident underscores the pressures on companies that hope to serve as suppliers to the fast-growing Silicon Valley giant.” An indictment also names an employee of one of Apple’s suppliers as a co-conspirator.

The U.S. Internal Revenue Service and the FBI conducted the investigation uncovering an elaborate scheme involving at least three suppliers where confidential information that would allow these suppliers to negotiate on more favorable terms with Apple was shared.  The suppliers in question provided mechanical parts, tooling and fixtures related to the manufacture of Apple iPads and iPhones. Information allegedly shared by those indicted include Apple’s planned sales volumes, product specifications, competitors target prices and bids, which in essence provided overall intelligence on how to best bid for Apple’s business. Correspondence with suppliers was made through Hotmail and Gmail email accounts, payments were made in traveler’s checks and as many as 14 U.S. and overseas bank accounts were utilized in depositing the monies.

To Apple’s credit, the company reacted swiftly, filing a civil suit against the alleged conspirators charging them with fraud and violations of racketeering laws.  The company also issued a statement indicating that it has “zero tolerance for dishonest behavior inside or outside of the company.”

The fact that these incidents continue to be uncovered is troubling in itself.  As many in our community are astutely aware, Apple fosters intense secrecy about its supply chain activities both among its suppliers and its internal employees. Now that an Apple supply manager allegedly violated that policy for personal gain implies that certain individuals will take extraordinary risks for personal gain, not to mention that certain suppliers themselves felt the need to take part in such unethical and criminal behavior in order to maintain or advance their supplier business interests with the company.  Further, as has been noted in past incidents of this type of behavior, the incidents themselves occurred for many months before detection.  Apple indicated that activities related this alleged incident dated back to October of 2006.

There are real questions to ponder.  Does huge supplier contracts with potential for long-term business volume foster an environment that ‘winks’ at unsavory business practices?  The suppliers alleged to be involved in this incident stemmed from China, South Korea and Singapore.  Would North America or European-based suppliers be just as susceptible to practicing these activities?  Are certain corporate security and ethical standards not being consistently enforced?  There are so many questions ….

What’s your view?

Bob Ferrari

The following posting can also be viewed and commented upon on the Kinaxis supply chain Expert Community web site.

Every now and then, it is important to take a step back from our everyday supply chain and procurement activities and reflect on the big-picture.  Such reflection could well uncover a brewing crisis before it becomes unwieldy, or worse, before it becomes a significant setback to business.

As I analyze various trends in cross-industry supply chain and financial performance, I have been reflecting upon why this post-recession recovery transition period has been demonstrating so many conflicting trends.  Large global manufacturing firms, for the most part, have generated rather impressive profitability results in the face of unprecedented business conditions.  Many months of cost-cutting in direct labor, overhead and supply-related costs have provided a far lower threshold to profitability, but a far leaner and vulnerable supply chain.  Some firms have taken a further step to attack any fixed cost associated with their supply chains, outsourcing the bulk of activities to contract manufacturers or key suppliers.

The end result is that many of these global manufacturing firms are amassing large amounts of cash.  The most recent analysis pegs that cumulative cash balance number in excess of $8 trillion, and Wall Street analysts are salivating on the potential for an upcoming period of increased acquisitions.  Others speculate why additional hiring has not begun.  However you view this situation, there are more fundamental stakes in play, and they directly concern supply chains.

This week, the Financial Times published an article , Industrial’s success squeezes suppliers (free preview account may be required), which perhaps gets more to the big-picture, namely that while the larger firms have been practicing financial engineering, they may well have done so at the financial risk to their smaller suppliers.

During the darkest days of the recession and continuing into this current transitionary period, smaller suppliers were forced by supply chain dominants to dramatically cut back on costs and capacity. In many cases, suppliers were mandated to absorb longer payment cycles on their accounts receivable.  Some suppliers have survived the crisis, others have not.

Now, continued uncertainty relative to the longer-term direction of the global economy has caused many of the survivors to be extra cautious before investing in added resources and/or capacity.  Those suppliers who are experiencing significant increases in demand are finding it rather difficult to borrow money to fund expansion.  The Financial Times reported last month that U.S. small businesses are having to pay more relative to the Federal Reserve’s benchmark borrowing rate then at any time in the last 25 years.

In essence, large firms have placed more strategic and tactical importance on supplier capabilities, yet still demand the same upside and downside agility as if they still owned these capabilities in-house.  In the FT article, the CFO of Caterpillar notes that this year, some Caterpillar facilities have ramped from near zero to as much as 70 percent with very little notice being provided to suppliers.  Japanese manufacturing firms who had previously built “kiretsu” partnerships with suppliers that included joint-financing assistance, are now aggressively outsourcing large portions of manufacturing to contract manufacturers.  In its article, FT concludes that “big manufacturers may well take the lesson that careful stewardship of the supply chain is important at all stages of the cycle.”

Perhaps we should not call all big manufacturing firms to task for transferring the bulk of supply chain capability to smaller suppliers without some strategic assistance.  Some firms have indeed reached out, but I suspect that the numbers are small.  What is becoming clearer, however, is that dependency on suppliers, whether large or small, is the ‘new normal’ and larger firms have higher stakes in the long-term success of these suppliers.  Perhaps some of the key parts shortages being experienced in the high tech and other industries may have root cause to the current conditions.  In any case, there is, at least in my mind, some basis for the effectiveness of “kirestsu” types of supplier partnerships.  The ‘big-picture’ is that some new form of partnership model is required, one that requires the involvement of business, financial and/or other parties.

The months of severe recession and cumulative cost cutting has shifted the supply chain risk profile.  Today’s volatile and uncertain global economy requires capabilities in supply chain agility. While technology can help with agility, strategic and partnership strategies related to suppliers may be a missing component in today’s environment.

Is your organization actively addressing this situation?

Bob Ferrari

Oracle is taking advantage of the International Supply Management (ISM) Conference being held this week to showcase the availability of both Oracle Supplier Lifecycle Management and Oracle Supplier Hub. Both applications are part of the Oracle E-Business Suite Release 12.1.2, being offered as Supplier Management support.

These applications were designed to be complimentary to each other and are being offered to companies who have a large number of suppliers to support.  They were designed to support needs for improving overall supplier visibility and to overcome supplier data fragmentation.  Oracle Supplier Lifecycle Management is positioned more towards business process applications needs, supporting supplier discovery, qualification, contract compliance, scorecarding and self-service registration and applications needs.  Oracle Supplier Hub is positioned more as a master data management hub to consolidate, cleanse and share supplier data with other applications.  The application creates a blended supplier record from multiple sources and supports a cross reference to each connected application. It further supports the importing of data via multiple means, including XML or spreadsheet uploads.

Interesting enough, Patni Computer Systems partnered with Oracle to jointly develop both of these applications is an unusual occurrence for Oracle. I was informed by Nagaraj Srinivasan, Oracle’s Vice President of Supply Chain and Procurement Applications Development that Patni will be a prime, but not exclusive implementation partner. 

Oracle is targeting a broad swath of vertical industries with these applications, to include not only manufacturing and retail, but communications, financial, insurance and public sector.  The common denominators are companies that must manage and support a very large number of suppliers at any given time.

 Bob Ferrari