If our community needed any additional reinforcement regarding how important, and perhaps how expensive, open contract management terms and supplier relationships have become, than today’s headlines involving Starbucks and Kraft Foods should be the reminder. (Paid subscription or tiered free viewing) Yesterday an arbiter ordered Starbucks to pay Kraft’s new spinoff, Mondelez International a total of roughly $2.8 billion dollars after the early termination of a Kraft’s supply coffee agreement with Starbucks.
The coffee supply agreement dates back to 1998 when Kraft was contracted to market and distribute Starbucks branded coffee among U.S. grocery and supermarket channels. In a November 2010 Supply Chain Matters commentary, we noted reports that the deal with Kraft was designed as an indefinite arrangement subject to certain conditions and limitations. In order to terminate the supply arrangement, Starbucks accused its partner of failure to actively market the brand and not maintaining appropriate promotional campaigns. Notice was given in November 2010 for termination in March 2011. For its part, Kraft indicated that Starbucks could take over the supply arrangement but needed to compensate the supplier for the market value of the business. At the time, Wall Street analysts’ estimates were that Kraft would seek $1.5 billion in compensation. Starbucks offered $750 million to settle the arrangement. The process was submitted to arbitration in 2011 after both sides could not agree to a compensation number.
While Starbucks now indicates that it strongly disagrees with arbitrator’s ruling, it must now reportedly restate its fiscal fourth quarter financials to show an operating loss. Because Kraft’s coffee business has now split into Mondelez International, that company will receive the recovery from the arbitration award. According to a report published in the Wall Street Journal, Mondelez management indicates that any proceeds will be utilized to buy back shares of that company.
For its part, Starbucks has taken control of its own packaged coffee distribution business and has entered into a distribution agreement with Keurig single-serve brewers. A company spokesperson indicated to the Wall Street Journal that it has sold more than one billion K-cups since the suspension with Kraft. Kraft, in turn, has now entered into an agreement to distribute McCafe branded coffee from McDonalds.
In our November 2010 commentary, we opined that instead of playing “my supply chain trumps yours”, perhaps it was better to move toward a “win-win” negotiation agreement where the lawyers and egos stand in the background. Readers can make their own judgment as to whether this was hindsight or wishful thinking. Three years later, the financial implications have now come to light.
From our lens, a final observation is in order from regarding Mondelez. Instead of allocating this award totally to stock buyback, perhaps some of these monies can be invested in supply chain transformation. After all, that was the original intent.
This week, the Wall Street Journal reported that Mondelez International, the snack foods spinout of Kraft, has set expectations of a large revamp of its complex supply chain. The goal of this latest effort is to facilitate a 5 percentage point improvement in operating income margin by 2016. The effort itself has large expectations for overall savings which include $3 billion in gross productivity, $1.5 billion in net productivity and $1 billion in incremental cash over the next three years, all stemming from supply chain improvements.
At face value, this type of concentrated supply chain cost savings initiative would probably be perceived as challenging. For the supply chain related teams associated with this chocolate, biscuit and candy producer with brands such as Nabisco, Trident and Cadbury it is doubly challenging because of earlier cost-saving efforts initiated when Kraft purchased Cadbury Foods.
At the time of the Cadbury merger announcement, Kraft management had declared a target of $675 million of cost savings required by 2012, the bulk of which, $300 million, was targeted for procurement, manufacturing and logistics cost savings. An initial consolidation plan called for all backroom systems and processes to be consolidated under a single Kraft supply chain platform. Something changed, however. Activist investors aggressively pushed for a split of Kraft under the belief that the snacks businesses would provide a far higher trajectory of growth and profitability than the traditional grocery and cheese products lines. The split indeed happened, and the previous plan to consolidate supply chain activities under a single umbrella fell victim to a Wall Street focused decision. Now, both of the split companies, Mondelez and Kraft, and their respective supply chains have operating margin challenges to address.
To add more drama, one of the most activist investors, Nelson Peltz, has since publically called for PepsiCo to buy Mondelez, combine both snacks businesses, and spin off the Pepsi beverages business. But, we get ahead of ourselves in focusing on the current supply chain challenge.
Some details regarding the Mondelez supply chain cost reduction effort are beginning to see light. The September 2nd edition of Fortune features an opinion column, A Snack Maker’s Unsavory Business Practices, penned by business network CNBC anchor Becky Quick. This is the Becky Quick who can garner a three hour on-air interview with the likes of Warren Buffet. Her article observes that earlier this year, the snack producer sent a letter to its key suppliers and announced a 120 day payment policy for goods purchased. A profound quote from Ms. Quick in contrasting other consumer product good companies supplier payment policies states: “But with its planned four-month delay to pay bills, Mondelez is engaging in a stunning example of one-upmanship.” Later in the article, Quick cites an unnamed industry observer indicating that on the customer side, Mondelez tailors its account receivable terms so that customers are penalized if they do not pay for confection products within 15 days, and snack related products within 25 days. We applaud Ms. Quick for also pointing out to readers: “that in the long run, big businesses are only as healthy as their supply chains.”
Supply Chain Matters is not alone in pointing out that numerous risks and drawbacks associated with leveraging cost reduction efforts on the backs of suppliers. Even though these delayed supplier payments tend to continue, we do not believe in the long run, that they provide any longer-term benefits. Quite the contrary.
On the inbound side, confectionary and snack related supply chains are often challenged with volatile commodity costs for items such as cocoa, sugar and grains. While global purchasing scale can provide procurement leverage, Mondelez must deal with the ups and downs of the market, particularly in the current era of extraordinary weather patterns brought about by climate change. We tend to believe that paying suppliers in four months probably will not help in securing favored buyer status. Developing consumer growth markets such as China as well as mature markets place a high premium on brand and quality because of prior history of tainted or harmful products. As we have noted in repeated prior Supply Chain Matters commentaries, a glitch in a production process or a reduction in quality oversight has huge implications for consumers, as evidenced by the recent incident involving Fonterra.
On the outbound side, a confection and snacks oriented business with a presence in 160 countries presents its own set of unique challenges. This business is more focused on higher touch and complex distribution channels. There are direct to store needs of supermarkets, convenience stores and smaller retail. Snack food consumers tend toward impulse buying, with promotions, market timing and inventory strategies that require considerable sophistication and supply chain wide execution. The Mondelez supply chain must compete with that of competitors Nestle, Unilever and other who continue to invest in more sophisticated supply chain process capabilities, and who demonstrate highly collaborative actions with suppliers and customers on product and process innovation.
The latest cost reduction challenges facing the extended Mondelez supply chain are yet another manifestation of the new financial engineering that surrounds the consumer goods industry, where supply chain efficiencies and cost reduction fuel needs for heightened short-term business performance expectations by Wall Street and the broader investor community. Supply Chain Matters is of the belief that the Amazon model for sustained investment in supply chain business process and future revenue growth capability far outweighs one that has the supply chain constantly uncovering rocks to find the next iteration of cuts.
Too often, suppliers, customers, consumers and supply chain teams themselves tend to pay the price for these actions.
However, the supply chain community consistently rises above and responds to both the near-term improvement and consequent results of these efforts.
Supply Chain Matters has had a number of commentaries pointing out that supply chain risk mitigation not only includes the threat of physical supply disruption, but also matters of social responsibility and fair labor practices. The risk is fundamental, it involves the reputation of your business and your brand.
There have been a number of previous high profile past examples including Nike, who’s brand came under enormous pressures with discoveries of child labor violations involving offshore manufacturing. Then there are top of mind examples, including Gartner’s number one ranked supply chain Apple, who continues to both react to and respondto audit findings regarding labor practices at its prime contract manufacturer as well as some of its suppliers. In our prior and other subsequent commentaries, we noted that when a company like Apple is deservedly ranked number one on nearly every researcher’s top supply chain listing, the ranking comes with a high bar of expectations. We all expect such a company to set world class benchmarks in many supply chain capabilities including supplier and social responsibility. We also opined that while Apple may be feeling the heat, there are many other firms dealing with the same challenges. The “biggest dog in the pound” often gets the most visibility, scrutiny and scolding.
Today, another high profile supply chain, Nestle, is openly responding to a social responsibility finding. The Fair Labor Association, the same agency that Apple called in to audit its supply chain, discovered that child labor practices exist in the cocoa supply chain of Nestle. For all those readers who indulge in chocolate, cocoa is the prime supply ingredient. A BBC News article related to this development runs with the headline, Nestle “failing” on child labour abuse, says FLA report. It reports that Nestle commissioned the FLA report after receiving enormous pressure, and that public awareness of the problem dates back to 2001 with a U.S. Congressional investigation and subsequent agreement to end the problem. Reported abuses include both labor practices and rampant injuries. The FLA found that while Nestle insisted that primary suppliers, mostly multi-national in scope, had agreed to remediation practices, actions went no further to smaller entities and farms, where four-fifths of its cocoa supplies originate. The FLA report also notes that while 20 percent of cocoa can be traced under Nestlé’s Sustainable Farming Program, the rest comes from a “standard” supply chain which is not transparent.
The FLA report found that cocoa farms in Cote d’lvoire are utilizing child labor and subsequently made 11 recommendations to Nestle to mitigate this situation. We should also point out that the FLA report also indicates that suggestions for Nestle are applicable to other chocolate producers, among them being Mondalez International (new snacks entity from Kraft Foods) and Hershey. We also reference a published Bloomberg article that provides further details to the findings.
For its part, Nestle has communicated a number of high profile actions to respond to and mitigate this situation, including a direct quote from the company’s Executive Vice President of Operations indicating that tackling child labor is a top priority. Nestle also states that while farmers need to run profitable farms, child labor cannot be a means to this objective. Nestlé’s Cocoa Plan is described as a multi-year effort of education, training and business practice actions including cocoa sourcing targets for suppliers certified by the plan. According to Nestlé’s press release, the target this year is set at 10 percent sourcing, while the 2013 target is set at 15 percent. In our view, these numbers are either appearing too conservative or reflect a far more complex set of hurdles to overcome. To be fair, the target Ivory Coast area in question has had a long history of political and civil unrest. In any case, we trust Nestle and its cocoa supply chain team will revisit their commitment and assumptions in the coming weeks.
Judging from the length and depth of the response, including produced video, Nestle management has had some time to respond to the FLA findings, but can be noted from just two of our referenced articles, business media is taking full advantage of public concerns, especially since many consumers can relate to their love for chocolate.
As was noted in the ongoing Apple developments, while one of the biggest supply chain dominants gets the bulk of the negative spotlight, the rest of the industry had better play close attention. It may have been convenient to turn a blind eye and place social responsibility practices across the supply chain in neutral status, the issues of abuse now span multiple industries.
In August of 2011, consumer goods provider Kraft Foods made a surprising announcement that included global supply chain implications. The company announced that it would split into two independent public companies, one to be focused on a global snacks business with the other being the company’s core grocery business. The timing of this split is slated for late this year. The snacks business unit will have responsibility for $32 billion in global revenues while Kraft Foods (Grocery) will be responsible for half that amount, namely $16 billion in revenues.
At the time of this announcement, Supply Chain Matters provided a commentary with an open question, namely how will the company respond with its corresponding supply chain and distribution strategy alignment. The essential challenge is that the global snacks business is driven by fundamental different performance metrics and investment needs than grocery. The former is high touch, complex channels driven while the latter is high volume, designated channel, low margin driven.
The latest indicators related to supply chain realignment came this week when Kraft initially named the senior leadership team among both companies.
Irene Rosenfeld, current Chairmen and CEO of Kraft will be the designated Chairmen and CEO of Kraft Foods Global Snacks. Ms. Rosenfeld leadership team will essentially be the same as existed in the singular company, including EVP’s of Europe, North America, marketing, human resources, R&D and quality.
The Kraft Foods Business will have as its CEO W. Anthony (Tony) Vernon. Vernon is the current EVP and President of Kraft Foods North America. Vernon’s management team is essentially the same North America team with the exception of the CFO, who is designated as Timothy McLevish, the current CFO for all of Kraft.
Supply chain team leadership among both companies is split, but has senior management leadership designation. Daniel Myers, the former P&G executive who was recently recruited and named Chief Supply Officer of Kraft was named EVP, Integrated Supply Chain for Global Snacks. His responsibilities are noted as procurement, manufacturing, engineering, logistics and customer service. The EVP, Integrated Supply Chain slot for North America Grocery is currently noted as open. While it does appear that Kraft management recognizes that each business unit will have to be driven by different global supply chain leadership tenets, we wonder aloud if there will be some form of shared services arrangement for certain functions among both companies. More details related to supply chain strategies and resources will obviously follow in the coming months but we trust that both organizations will have the autonomy to drive distinctive strategies and deployment models for each business unit.
In the critical area of information systems, the Global Snacks business will have IT reporting under the office of the CFO. Kraft Foods (Grocery) will have IT reporting to the EVP for corporate strategies, mergers and acquisition. We can each make our own interpretations of these structures for IT, suffice to state that they are different.
A review of the newly announced management teams seems to evoke an impression that management loyalties prevailed over management cross-seeding or balance among both of the newly created entities. Then again, that may allow the grocery business team to shine with more innovative out-of-box thinking that includes supply chain capabilities. As is usually the case, only time will provide the real story.
This week, consumer goods provider Kraft made a surprising announcement that comes with global supply chain implications.
The company announced that it would split into two independent companies, one focused on the global snacks business, with the other being grocery. The announcement was reported as a reversal from Kraft’s previous bigger-is-better growth approach. The Wall Street Journal in its reporting of the story noted that just 18 months ago, CEO Irene Rosenfeld told investors that “scale is a source of great competitive advantage.”
Financial media are reporting that under the proposed split, the snacks business and confectionary business may consist of Kraft’s European business and developing markets groups, along with the North America snacks and confectionary businesses, amounting to a $32 billion annual business. Brands that could be included are Oreo cookies, Cadbury chocolates and Trident chewing gums. The grocery division is initially planned to include Kraft’s current North America grocery businesses, and include brands like Kraft Cheese, Maxwell House coffees, Oscar Mayer meats and Jell-O. Grocery would amount to a $16 billion business.
Supply Chain Matters has published multiple commentaries regarding Kraft, particularly its controversial $19 billion acquisition of European snacks and confectionary company Cadbury last year. The most detailed was in February of 2010. In that commentary we noted that Kraft’s supply chain was about to undergo a rather dramatic transition, with challenges related to new geographic distribution channels and the need for more cost synergies in merging of two supply chains. At the time of the Cadbury merger announcement, Kraft management issued a target of $675 million of cost savings required by 2012. Cadbury itself was also under considerable external pressure to increase margins prior to the acquisition and was bloated with inventory.
This week’s announcement, we believe, puts an entirely different lens and perspective for Kraft supply chain strategies moving forward. Snacks and grocery are driven from different business and distribution models. The snacks business provides rather optimistic numbers for market growth but its distribution model is more focused to the higher touch and direct to store needs of convenience stores and smaller retail. Snack food consumers are impulse buyers, with promotions, market timing and inventory strategies that require considerable sophistication and proper timing.
The grocery business provides a business model with much more conservative growth, higher margins, and more high volume focused warehousing, distribution and supply chain needs. Much of Grocery’s customer base is large supermarkets and retailers, with high dependency on either vendor managed inventory or store replenishment business process support.
The open question is how Kraft will respond with its supply chain and distribution strategies as a result of the proposed split. As noted, Kraft established a target of $675 million in potential cost savings through the combination of operations and supply chains. We presume that some of these savings may have already been garnered but then again, more may be required. We at Supply Chain Matters were a bit perplexed as to how Kraft would be able to service both types of businesses under a singular structure. Would cuts be made in the wrong areas? Did grocery really understand the unique high touch direct-store needs of snacks? How would supply chain costs be apportioned?
With this dramatic announcement of a corporate split, various other options will undoubtedly be put on the table and Supply Chain Matters speculates that the options could include independently splitting each business supply chain, creating some form of a centralized supply chain shared services model, or investigating some hybrid that includes various internal and externally sourced distribution services.
The good news is that Kraft recently recruited Daniel Myers, a former P&G executive at the company’s Beauty and Hair Care divisions, to be its new Chief Supply Chain officer. Myer reports directly to Kraft CEO Irene Rosenfield and is a member of the Kraft senior executive team. That reporting relationship will prove to be rather timely as Kraft embarks on its newest supply chain challenge, and will hopefully provide a more unbiased, outsider perspective to the challenges ahead.
The Gartner 2011 Supply Chain Top 25 supply chains ranking for 2011 pegs Kraft in the number 25 and last position and notes Kraft’s leading channel management strategy as its biggest strength. One wonders which of Kraft’s pending two companies will fare in future rankings.
Stayed tuned to our blog for more Kraft postings in the coming months. In the meantime, Supply Chain Matters welcomes commentary from readers regarding Kraft’s new supply chain structural challenges.
©Copyright 2011 The Ferrari Consulting and Research Group LLC