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.
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.
© 2016 The Ferrari Consulting and Research Group and the Supply Chain Matters® blog. All rights reserved.
It has been two days since our Supply Chain Matters breaking news alert published on Friday on the occurrence of multiple severe earthquakes impacting southern Japan. While the major focus continues toward tending to the injured and missing, along with the assessment of the impacted region’s major infrastructure, the supply chain disruption implications are indeed evident and potentially include multi-industry dimensions.
Numerous incidents of aftershocks continue to impact the area which is hampering efforts by companies to assess damage to facilities and supply chain operations. Reports that we are monitoring indicate that Toyota will gradually halt automobile production across Japan because of a shortage of components. The Toyota Lexus production plant in Fukuoka prefecture remains in production halt for the remainder of this week. The Tustsumi plant which produces the Toyota Prius will halt production from Tuesday thru Saturday of this week.
Toyota supplier Aisin Seiki has acknowledged the discovery of broken walls, windows and assembly equipment at its facilities in the quake area but has indicated that plans are underway to shift the production of door and engine parts to other owned facilities located in other parts of Japan as well as other external plants. The open question is how much additional time will be required to implement this shifting of production.
Other automakers such as Honda and Nissan have also halted operations within factories within the impacted region. Honda has a motorcycle manufacturing plant near the city of Kumamoto.
Sony is assessing damage to its smartphone image sensor plant in Kumamoto indicating that that plant operations are unlikely to re-start soon. Sony’s camera image sensors are included in the Apple iPhone but the supplier has indicated that full operations remain at its plants in Nagasaki and Oita which also produce sensors used in smartphone cameras.
Semiconductor producer Renesas Electronics confirms it has sustained damage to equipment at its plant in Kumamoto which produces microcontroller chips for automobiles. Further assessment of damage remains to be completed before deciding when to resume production at this particular facility.
In addition, on Saturday, a more powerful magnitude 7.8 quake struck Ecuador, about 17 miles from the northwestern coastal city of Muisne, near the border with Colombia. What makes this incident so concerning is that this earthquake lies on the same geological “Ring of Fire” plates that surround the Pacific Ocean. Thus far, more than 200 deaths have been confirmed and there are reports of significant damage to the region’s infrastructure.
The top exports of Ecuador are crude petroleum, bananas, crustaceans, processed fish and cut flowers.
Such considerable natural disaster events occurring over a short period of time should cause ongoing concern for multi-industry supply chain professionals since there is a lot of strategic component, commodity and finished goods production located in various regions along the “Ring of Fire.” These incidents continue to remind all that the North America west coast region including California, Washington State and Oregon remain vulnerable to a major earthquake. As geologists constantly remind regarding the U.S. west coast region, it is not a matter of possibilities, but rather a matter of when a rather significant seismic event occurs.
Another aspect already being raised by business media has been what learning came from the 2011 major earthquake and subsequent divesting tsunami that struck northern Japan regarding supply chain disruption and business continuity planning, and how that will come into play over the coming days and weeks.
Our thoughts and prayers remain with the numerous victims of these disasters along with the impacted families. These tragic natural disaster events provide constant reminders that are planet remains fragile to devastating seismic and climate related events.
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.
Supply Chain Matters had the opportunity to attend the 2016 Crossroads Conference hosted by the Massachusetts Institute of Technology (MIT) Center for Transportation and Logistics (CTL). Crossroads is an annual event that began 12 years ago for the benefit of MIT CTL corporate sponsors, and each year the conference brings together leading-edge industry and global supply chain trends and insights developed by MIT and external academic focused research. This Editor has been fortunate to be invited to this event for many prior years, and this year was no exception.
The agenda included a presentation by Sertac Karaman, MIT Assistant Professor of Aeronautics and Astronautics on the timely topic: Autonomous Vehicles: Driving Change in Logistics Networks. In the talk, Professor Karaman traced the recent history of self-driving cars after Google developed the first autonomous vehicle. What was most interesting was his predictions for what’s next in this area, which he indicated would be broader deployment of autonomous vehicles operating in distribution and logistics centers within the next two years, and within what he described as suburban focused driving environments within the next six years. One of the remaining challenges to be addressed, according to Karaman, was urban delivery and logistics requirement. Here, he referenced efforts underway from UK based Starship Technologies directed at a specialized autonomous delivery vehicle that can navigate urban landscapes. The summary conclusion is that there has been substantial technological advancement in autonomous vehicles over the past decade and the forthcoming two-year immediate impacts in supply chain environments will be in low-speed, low complexity environments in existing distribution centers and warehouses. Beyond that, there are many other opportunities as technology advances continue.
A presentation by Matthias Winkenbach, Director of the MIT Megacity Logistics Lab at CTL addressed the topic: Big Data and the Journey to a More Efficient Last Mile. Winkenbach reminded the audience that 60 percent of future GDP growth will emanate from 600 global cities, and that the logistics industry must tackle the current huge density of retail outlets that exist in mega city landscapes through more advanced use of big data integration techniques involving geographic, delivery requirements, physical sensor and other pertinent data sources. By combining publically available data such as income demographics, density of commercial establishments, road network density and capacity, with transactional data related to orders, MIT researches have been able to plot and simulate logistics needs for the delivery of food and beverage deliveries in some of the world’s most dense mega-city complexes. The integration of this data was described as the ability to correlate customer stops with special delivery services, to optimally identify delivery person walking time needs (off-vehicle operations) along with providing drivers information on optimal parking locations or congestion points to avoid at certain times.
A rather interesting insight from the Q&A session of this presentation was actual audience polling that revealed that a lot of data is actually being collected by organizations but is not being currently leveraged because of a number of challenges related to data accuracy, understanding, size and complexity as well as technical competence.
A fascinating but very concerning presentation came from Retsef Levi, Professor of Operations Management, MIT Sloan School of Management whose topic was: Adulteration Risks in Global Food Supply Chains Emanating from China. He addressed MIT research spanning over two years which was funded by the U.S. Food and Drug Administration. Observed was that imports of food shipments into the United States have dramatically expanded to include upwards of 80 percent of seafood, 70 percent of honey and other basic food commodities. The FDA sponsored Food Safety Modernization Act signed into law in 2011 was passed to prevent food safety problems rather than regulatory agencies having to merely react and respond to growing incidents. The act clearly shifted the responsibility and accountability for food safety with the industry, including validation of the food supply chain. MIT assembled a cross-departmental research team to address how does the structure of the food supply chain impact risk? Because of the FDA sensitivities related to this research, we will refrain from sharing more of details. Suffice to note to our readers that the research identifies compelling risk drivers that include unmonitored stakeholders, overall dispersion of food supply chains, regulatory strength and the targeting of key strategic commodities that are common to many food products.
An industry focused presentation came from Joel LaFrance, Supply Chain Visibility Lead at General Mills. The day before the Crossroads conference, a group of CTL corporate members identified supply chain visibility as their most important and compelling challenge. That theme was addressed as LaFrance addressed the importance of defining supply chain visibility lexicon, as contrasted with transparency and traceability. He described the new influences impacting General Mills supply chains including unprecedented complexity and volatility as well as the convergence of physical and digital processes. The consumer goods producer started it supply chain visibility journey nearly 18 months deploying a series of use cases and initiatives directed at supporting line-of-business needs. Further shared were top four learnings that included realization that connected data is critical, that insuring end-to-end supply chain visibility changes that way work is performed, along with prioritizing end-to-end visibility needs as opposed to targeting specific functional needs.
This author had to cut-short his attendance for the full agenda, because of a previously scheduled client commitment. However, we did obtain a copy of CTL Executive Director Chris Caplice’s presentation: Transforming Professional education: An Update from the Front Line. Addressed was MIT’s ground breaking efforts in delivering an online ‘Micro-Master’s’ Program for Supply Chain Management that features open enrollment, online certification and no admissions criteria. While the program is characterized as not an MIT degree program, it does provide a faster path towards a degree. The curriculum will include courses such as Supply Chain Fundamentals, Supply Chain Analytics, Supply Chain Design and Technology. The online learning experience includes on-demand, ‘bite-sized’ video segments of 3-9 minutes coupled with quick reinforcing questions and extensive practice problems after each section. Current enrollment in this online program now exceeds 28,000 and includes student representation from 181 countries which is quite a testament to the global interest levels in acquiring supply chain management skills. This innovative program was described as helping organization’s to identify supply chain talent because MicroMasters provide a proxy for grit. It further helps to recognize and foster high-potential achievers by recognition.
This was another informative Crossroads conference one providing broader perspectives on the direction of supply chain management.
© 2016 The Ferrari Consulting and Research Group and the Supply Chain Matters® blog. All Rights Reserved.
Report That Chipotle is Stepping Back from Recently Announced Supply Chain Wide Food Safety Assurance Practices
Supply Chain Matters features an update commentary regarding Chipotle Mexican Grill, specifically ongoing efforts to address a 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.
In our 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 are re-addressed from farm to fork. We opined that the quality and safe food perception crisis remains ongoing and that Chipotle must now convince it’s once loyal customers that it serves safe food with integrity.
Current developments put a different twist to the crisis. This week, The Wall Street Journal citing informed sources, reported that the restaurant chain is considering 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 is apparently to test only certain foods, according to this report. The chain’s beef supplies are now being pre-cooked in centralized kitchen facilities to insure that E.coli is eliminated, and then packaged in vacuum-sealed bags shipped to local outlets where the product is then marinated and grilled. The firm’s website indicates that local outlet workers are to marinate beef and chicken in sealed bags after restaurants are closed to avoid possible contamination with any food prepared during the day.
Supply Chain Matters can speculate that the decision to scale back DNA testing may have been brought about by further process and supply chain focused analysis. Yet, this week, the restaurant chain further announced the hiring of a noted meat industry food safety expert to be its new director of overall food safety. We can only question whether such decisions for scaling back testing should have been made so early in the process of restoring consumer confidence. After all, this is an ongoing crisis of perceived trust in the overall safety as well as quality of food served.
On the financial front, the restaurant chain warned this week that it would likely book its first quarterly loss as a public company with sales at existing outlets dropping slightly over 26 percent last month. This sales drop came while the chain was offering a wide-scale free burrito promotion to lure customers back to Chipotle. According to business media reports, many equity analysts are now scaling back 2016 and 2017 earnings estimates for the firm, signaling a prolonged process of restoring sales and profit growth.
Another concerning development was a recent securities filing indicating that senior executive future compensation plans would be directly tied to share price performance, specifically a stock price of above $700 for 30 consecutive days in order to trigger additional stock awards. We cite a specific paragraph in the firm’s Schedule 14A SEC filing:
“In light of the challenges we faced during the second half of 2015 and the resulting decline in the price of our common stock, in February 2016 the Compensation Committee of the Board awarded performance shares to our executive officers that will be tied solely to highly challenging absolute stock price performance goals over a three-year performance period. We believe this will align executive officer compensation with restoring and further enhancing shareholder value.”
As we pen this commentary, the chain’s stock price closed slightly over $485 which implies that the stock has to rise by approximately 44 percent over the next three years to trigger executive stock awards.
Further, according to a prior WSJ report, the firm’s two co-CEO’s have already felt the implication of the incurred brand crisis with total compensation having declined by more than 50 percent with no bonuses being rewarded. However, according to the report, the base salaries of both executives increased by roughly $100,000 in 2015.
Supply Chain Matters reviewed the Compensation Plan outlined in the latest Schedule 14A security filing and could not find any specific indication of other operational metrics tied to executive compensation, other than stock performance. We noticed a response to a recurring shareholder proposal calling for additional measures related to the firm’s sustainability and food with integrity metrics with a Compensation Committee response indicating that such an effort would involve too much time and expense and a diversion of management resources.
At face value, we find the revised executive compensation plan troubling in its sole emphasis on stock performance without any indication of cited metrics related to either customer value or the firm’s food with integrity core mission. Then again, this seems to be evidence of the continued over emphasis on stock and shareholder value that is apparent in so many industry settings today, an emphasis whose impact cascades down and up respective industry supply chains.
Our belief remains that restoring consumer trust in a badly damaged brand is not a one-time marketing challenge, but rather a systemic management challenge to address quality and food safety practices among all farm to fork processes and activities. These latest developments related to early scale-back in testing efforts coupled with revised executive compensation plans tied directly to stock price performance reinforce the perception that the sole mission is one of accelerated growth.
© 2016 The Ferrari Consulting and Research Group and the Supply Chain Matters® blog. All rights reserved.