On Friday, a significant explosion rocked the Foxconn Technology Group production facility located in Chengdu, China.  The facility manufactures Apple’s iPad tablets, among other products.  Initial news reports are indicating that two workers were killed and sixteen were injured, three seriously, as a result of the explosion.

A news report appearing on the International Business Times web site indicates that the explosion and fire, which occurred around 7pm Friday evening, was suspected to be caused by accumulation of aluminum dust in the ventilation pipe of the central air conditioning unit, which may have triggered a spark, leading to the fire and explosion. This IBTimes posting features an amateur video apparently captured by a Foxconn worker fleeing the immediate scene, and the video features clearly evident smoke billowing from the factory and worker panic directly after the incident.

At this point, it is very unclear as to whether this incident will have any immediate or short-term impact on production of Apple iPad2 or other products produced at the Chengdu facility.  According to a Wall Street Journal report, the explosion occurred in the “polishing plant”, which is a cleaning and finishing step after devices are assembled.

This incident unfortunately occurs as Apple continues to catch-up with overwhelming demand for the iPad2.

The following posting can also be viewed and commented upon on the Supply Chain Expert Community web site.

Within the Supply Chain Expert Community, Supply Chain Matters has posted previous commentary relative to Apple’s Secret Sauce- it’s relentless attention to supply chain strategy and operational capabilities.  Our previous commentary in mid-February noted how Apple was plugging strategic and tactical holes in its long-term supply strategy by placing a $7.8 billion order for key LCD, NAND memory and other electronic components from Samsung Electronics, along with back-up supply contracts with strategic vendors such as LG Display. We have also commented on the reality that Apple’s influence and buying power within the industry insures that it will receive preferred status during supply crisis such as the one unfolding as a result of the earthquake in Japan.  Apple has also maintained a strong and collaborative working relationship with its prime contract manufacturer, Foxconn International, and in some cases has help Foxconn to invest in innovative new capabilities.

This week, a blog commentary penned by John Paczkowski on Digital Daily headlines that a glance at Apple’s latest 10-Q SEC filing indicates that Apple has invested more of its available cash resources in long-term supply.  Purchase commitments rose from $7.9 billion in Q4 of 2010 to $11 billion in Q1 of this fiscal year. Paczkowski speculates that there are two reasons motivating this 39 percent increase in long-term supply commitments: the tight supply environment caused by recent calamities in Japan and the expected increases in iPad2 shipments, which is in a backlogged, supply constrained situation.  Our community, especially those residing in the high tech sector can certainly add even more insights to the supply dynamics that occurring right now.

There is however a far more important lesson for global manufacturers, that being a sensitivity and commitment by senior management for strategically investing in long-term supply chain capabilities vs. short-term gains.

I read a recent commentary appearing on the Manufacturing News Blog which makes the observation that in the depths and consequent exit from the global recession, major manufacturers such as Cisco Systems, General Electric, Hewlett Packard, Intel, Pfizer, Texas Instruments and others allocated more cash to stock buyback programs as opposed to product innovation or other strategic business investments.  Stock buybacks can accelerate the appreciation of a stock price when earnings are on the rise, as they have been for many global manufacturers. It seems that financial engineering is alive and well.

Yesterday the Wall Street Journal noted (paid subscription required) that the stock-market rebound from the depths of the financial crisis has been a boon to executives who received grants of stock options at rock bottom prices in late 2008 and early 2009.  The depressed stock prices at the time motivated corporate boards to grant larger numbers of options than usual. The WSJ notes that more than 90 percent of CEOs of companies in the Standard & Poor’s 500-stock index received stock options from October of 2008 through September of 2009, and that consequent CEO equity has risen more than $3 billion above original grant valuations.

Our community would have rather strong arguments that a good portion of the business success since 2008 came from the ability of the supply chain to successfully navigate through many numbers of supply, demand or disruption centered crisis situations.  Conversely, as certain industry sectors are discovering, a crisis such as the Japan earthquake will again reinforce the notion that a highly visible supply chain setback can have a direct negative impact on stock price performance.

A recent Tomkins Supply Chain Consortium survey noted that senior supply chain executives now have a higher level of uncertainty than they did in the past. Nearly 31 percent expect riskier conditions in the future with areas of greatest concern centered on business planning, product sourcing, customer service and transportation. While manufacturers have managed to navigate very turbulent waters by dramatically cutting back on people, costs, and perhaps certain controls, more uncertainty, complexity and risk remains.

If as a community, we accept Apple as one highly visible benchmark for excellence in global –wide supply chain capabilities, we can again note that Apple understands that investing in long-term supply, fulfillment process capabilities, and supply chain resources can result in more rewarding bottom-line results and stockholder performance.  We should at least give Steve Jobs the credit for calling out stock buybacks for what they are, the transfer of cash from one pocket to another.

Over the coming months, we will all observe more evidence of where investments in supply chain vs. investments in financial engineering have the ultimate impact on customers and shareholders.

What’s your view?

As manufacturers transition from the severe recession, do short-term perspectives and goal fulfillment remain the norm?

Are investments in strategic supply, risk mitigation and customer fulfillment capabilities now being supported in your organization?

Bob Ferrari

In the community of supply chain management, all eyes remain focused on Apple.  The reasons are fairly obvious since Apple’s supply chain capabilities inevitably show-up on everyone’s top-five ranking or benchmarking list. As an independent  industry analyst and blogger, I pay close attention  when Apple shows signs of a strategic or tactical shift, and I sense signs of a shift from Apple’s latest fourth quarter results.

First, some highlights of another blowout quarter.  In the September ended quarter, Apple reported a profit of $4.31 billion vs. $2.53 billion in the year ago quarter, coming close to doubling profits.  Business performance in the quarter generated $5.7 million in cash flow and  the cumulative cash balance now stands at $45.8 billion. Revenues were a record $20.3 billion compared to $12.2 billion a year prior.  Full results are noted in Apple’s earnings press release.

Results were clearly lifted by sales of the iPhones, with 14.1 million units shipped in the quarter, over 90 percent more than a year ago.  Even more significant, and a testament to Apple’s value-chain and product launch capabilities, the latest iPhone release became available in late June, and Apple obviously implemented a fairly effective marketing and supply chain support strategy to sustain these incredible shipment volumes for the quarter.  The company further reported that it sold 4.2 million iPads in the quarter vs. 3.3 million units shipped in the previous quarter.  Both of these shipment milestones are noteworthy because Apple was not immune to critical supply shortages during the quarter.  We commented in a previous joint Kinaxis Supply Chain Community and Supply Chain Matters commentary that shortages of LCD devices from Samsung were impacting the momentum of shipments during the quarter.  In its briefing to analysts, Apple noted that it could have sold more iPhones and iPads.

There was however other important shifts embedded in the euphoria of the results.  Apple’s gross margins dropped to 37% compared to nearly 42% in the year ago quarter.  Granted, some firms would envy a 37% margin in this economy but nonetheless there has been a shift. There were obviously business reasons that led up to this erosion, not the least of which relates to elements of Apple’s value-chain. Apple’s prime contract manufacturer Foxconn continues to deal with the aftermath of increased incidents of worker suicides and responded with across-the-board double-digit wage increases. Thus far, Foxconn publically indicates that these wage increases will be internally absorbed, but this contract manufacturer is making aggressive plans to significantly ship production to more interior regions of China where wage rates are lower. A glance at Apple’s balance sheet indicates that there has been a significant investment in inventory, close to $600 million over the past twelve months.  By my calculation, Apple’s days inventory outstanding (DIO) has climbed to 5.8 days from a average 3.87 days a year ago. While many companies would envy such inventory metrics, nonetheless they reflect a need for Apple to invest in inventory to maintain or accelerate current sales momentum.

Within traditional press and the blogosphere, there are many commentaries relating to Apple’s strategy of tight control of its operating system and platforms.  A recent New York Times article, Will Apple’s Culture Hurt the iPhone?, notes that U.S. consumers are currently buying more Android phones than iPhones.  The stakes for control of mobile computing are huge, and the battle is yet to play out.  Some contrasts are being made to the battle of Macs and PC’s 20 years ago, when Apple similarly insisted on a proprietary platform approach.  The Times article rightfully notes that Apple’s current strategy is risky and leaves little room for error. Volume and market share are the prime business target.

The same analogies concern Apple’s value-chain strategy.  Strategic supply agreements in flash memory, LCD’s and other key components have served the company well in supporting such enviable volume ramps.  Foxconn has in-turn demonstrated a remarkable ability to ramp-up and support higher production volumes in a market with faster clock-speeds of product innovation.  It also has contributed its own share of innovation in product design through vertical integration.

Apple has further recognized that supply chain strategy cannot rest on any singular cost tenet or metric, but on insuring that its supply chain has the flexibility and adaptability to support a high volume growth business model.  We noted in our Supply Chain Matters coverage of the Supply Chain Council Executive Summit- Dispatch Four, Professor Steve Melnyk’s  principles of outcome-driven supply chains. Apple’s current shifts in inventory investment are in our view, an important demonstration of these principles. As Professor Melnyk noted, the supply chain needs to be strategically coupled, value-driven, with the ability to support blended outcomes.  Apple’s shifts in inventory investment and continued supply focused vertical integration are evidence of weighting blended outcomes.  Apple’s product and business momentum are strategically linked to supply chain, and any major glitches will have impact on market share results.

Bob Ferrari

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

The fallout from the indictment and arrest of Paul Devine, a global supply manager at Apple charged with wire fraud, money laundering and unlawful monetary transactions involving more than one million dollars in alleged kickbacks, has continued since we first commented on this incident.  As I pen this entry, a Google search notes over 1200 web entries directly related to various aspects of this incident. Commentaries in the blogosphere and among academics are focusing on the implications for procurement and supply planning strategies, and we all have to ponder whether this one, highly visible incident is just another sign of the state of the times or whether this is a watershed incident leading to more focused ethical standards.

Reports in various global financial publications such as the Financial Times and The Wall Street Journal are focusing on the general reactions among specific suppliers involved, as various companies respond to protect either legal interests or reputations in the market.  According to the Financial Times, Kaedar Electronics of China, a unit of Taiwan’s Pegatron Corp. and Cresyn of South Korea admitted it benefitted from the information provided by Mr. Devine. The article notes that “Cresyn and Mr. Devine signed a “consulting services agreement” spelling out what Mr. Devine was required to leak, including Apple product roadmaps and sales forecasts, in exchange for $6,000 in monthly payments.” The Times notes that Pegatron had begun its investigation and had suspended the Kaedar manager allegedly involved. Meanwhile a Wall Street Journal article notes that a Pegatron spokesperson acknowledged that Kaedar did pay a brokerage commission to an intermediate trading company for its business with Apple, but declined to disclose the amount of money paid. Others suppliers reportedly involved are indicting that such practices are not condoned.

No doubt, the coming days and weeks will provide even more opinion and commentary on the implications of this incident, and whether it sends a wake-up call on the state of ethical procurement practices when supply chain business pressures and various business cultures collide.  While some may deflect such remedies toward the moral principles or motivations of the individuals involved, or on future hiring and selection policies, in my view, hiring policy has little to do with the underlying root cause of this episode.

Individuals respond to the business culture and the goals and organizational expectations practiced within their firms.  We all know that Apple surrounds itself with a culture of extreme secrecy to protect itself from competitors.  Suppliers want an edge on their competitors, and will sometimes go to extraordinary means to secure protected information that provides that edge.  To change all of this, all members of the value-chain need to equally share in the risks and rewards of success, and further need to know where the lines are drawn. Apple has a well articulated Supplier Code of Conduct, and to its credit, is taking very decisive action in dealing with this incident.

I come back toward the needs for insuring that proper risk and reward strategies are practiced and properly monitored among all in the value-chain, and with all professionals involved. Confidentiality and the safeguarding of key information has its place and all parties need to understand that certain behavior and practices will not be tolerated.  The anticipation of lucrative business does not warrant unscrupulous behavior.

What’s your view?

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