Supply Chain Matters provides another reader update regarding the global supply chain impacts from the devastating monsoon floods that impacted Thailand and other Southeast Asian countries in the Fall of 2011. Readers might recall that beyond the tragic loss of life, the flooding impacted over two-thirds of the country’s provinces and that seven of country’s important industrial manufacturing parks were severely flooded. While some factories have restarted operations, others continue to struggle with various issues.

In our previous general update in mid-November, we honed in on the specific impacts that both the high tech and automotive industries would potentially encounter. As we enter 2012, these impacts continue, although the picture appears to be a bit more optimistic.  On the other hand, as noted in our 2012 Predictions for Global Supply Chains, the broader and more far reaching implications concerning the Thai flooding and other 2011 disruptive events are raising significant new considerations for strategic and other product sourcing decisions in the months to come.

For high tech and consumer electronics, all eyes remained focused on hard disk drives (HDD) production.  Western Digital, initially the most impacted manufacturer, re-started some partial HDD production in its Thai Bang Pa-in facility in the first week of December, one week ahead of schedule.  That facility had been submerged under six feet of water.  Western Digital expects to ramp-up production at this facility during the March 2012 quarter. Other of the company’s production facilities in Thailand are in the process of re-starting.  The expected impacts on reduced overall HDD supply and pricing are underway.  Both EMC and HP increased large-scale storage system pricing in late December in the range of 5 to 15 percent, but supply shortages have amplified price levels even further. In Asia, there are reports that HDD pricing at the retail level has spiked as much as 50 to 100 percent. The Semiconductor Industry Association (SIA) released a statement in early January noting: “Supply chain disruptions resulting from the floods in Thailand have impacted semiconductor sales in the near term, however OEM’s are expected to recover production losses over the course of the next few months.” Industry leader Intel attributed its latest quarterly decline in revenues to the impact of supply brought about from the result of the floods.

Computer OEM’s such as Apple, HP, Lenovo and Dell remain publically silent concerning an ongoing shortage of disk drives but we are sure that internal supply planning teams have been hard at work sorting out disk allocation and various product offering scenarios.  As anticipated, most of the available supply is being allocated to higher priced, more profitable PC products.

Regarding other industry impacts, reports from Japan indicate that the country experienced a 2.6 percent month-to-month drop in factory production for November, which was worse than had been predicted. According to an AFP report, production of passenger cars and mobile phones were among the hardest hit because of the supply shortage impacts emanating from Japanese-plant sourcing in Thailand. However, Japanese automotive providers were reported to be more optimistic for December and January production output levels. Both Toyota and Honda have now acknowledged that the combination of massive supply disruption brought about from the earthquake and tsunami that impacted Japan in March, and the Thai monsoon related floods, have caused both to lose market share because of reduced vehicle output.

Other industry impacts have come to light.  PPG Industries has indicated that production of certain optical components prevented that company from satisfying supply contracts and conducting normal business.  Goodyear Tire and Rubber warned in December that impacts of the Thai flooding could result in “a potential global shortage” of aircraft tires.

Beyond the tragic loss of life, the World Bank estimates that flood damage has reached $45 billion and rebuilding efforts are estimated at about $25 billion. This loss, along with the unprecedented magnitude of loses emanating from certain areas of Asia and Australia has motivated major global insurers and re-insurance firms to reduce their exposure to certain catastrophe prone areas.  The Financial Times recently reported that exposures in Australia, Indonesia, Taiwan and Vietnam have all experienced large insurance premium rises during key early January policy renewal negotiations.  Noted were premium rate increases in the range of 10 percent to as high as 35 percent in these countries, with certain exposures in Australia rising in the range of 40-75 percent, and New Zealand 80-150 percent.

Supply Chain Matters continues to believe that these developments will motivate CFO’s and Chief Supply Chain Officer’s to revisit near and longer-term sourcing strategies that directly relate to regions deemed high risk for natural or catastrophic future incidents.  Beyond the cost of direct labor and transportation, a new, more sobering financial input has been added to the evaluation of strategic sourcing, and that should be prompting strategic sourcing teams to begin to revisit sourcing strategies.

The year 2012 has not added to the confidence of a year that was not like 2011 in terms of global supply chain disruption.  Last week, a 7.2 magnitude earthquake that struck of the coast of Indonesia prompted a brief tsunami warning.  Luckily, the tsunami did not occur and damage was reported as minimal, but nerves were definitely rattled.  The bottom-line is that the probability for global supply chain disruption prompted by natural disasters and catastrophe events remains high and manufacturers are about to actively re-examine global sourcing strategies weighting a new and financial sobering aspect of geographic exposure to regions more prone to these incidents going forward.

Bob Ferrari

©2012, The Ferrari Consulting and Research Group LLC and Supply Chain Matters blog, All rights reserved.

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

Yesterday, Nestle’s senior procurement executive declared what many consumer products and other industry supply chain and business executives are fully aware, that prices for inbound raw materials and commodities have increased at unprecedented rates.  Of more concern, this situation could continue for some time to come.

In an article published in the Wall Street Journal (paid subscription of preview account required), Kevin Petrie, the head of procurement for Nestle noted that a combination of factors attributed to financial speculation, bad weather, and the rising price of oil are dramatically impacting the cost for cocoa, coffee and other ingredients.  He added: “We see tremendous volatility and headwinds.”  That statement is significant since as the WSJ points out, Nestle is one of the biggest raw food buyers in the world with an annual spend of over $71 billion.  Mr. Petrie noted one specific example where investment funds accounted for 38 percent of the New York Arabica coffee futures market, with no intentions of taking delivery.  Political crisis in areas such as the Ivory Coast and the Middle East and the vast extremes in weather events during recent years have also added to crop failures or setbacks.

The obvious question for procurement and supply chain strategic teams is how to prepare or try to overcome these significant headwinds.  One obvious conclusion is that strategy, size and buying leverage do matter. The WSJ observed that Nestle has established commodity research teams to forecast prices six-quarters into the future, peg longer-term trends, and is itself utilizing futures contracts and hedging to lessen exposure to price swings.  That strategy is not for everyone, since some companies have experienced setbacks in the past when short-term markets collapsed, and hedging provided negative results.

Another company that practices active strategic commodity planning is Apple, which has not been shy in placing multi-year, multi-billion dollar contracts for strategic long-term supply. Just this week, a posting on EDN.com notes that in 2010, Apple became the world’s largest buyer of semiconductors, amounting to $17.5 billion of semiconductor spend.  That is leveraged buying power and comes with some significant influence. A Table listed in the article shows that among the top five global buyers, there is a 110 percent difference in buying power from number five Nokia, to number one, Apple. Another interesting observation is that the number two buyer Samsung also serves as Apple’s largest supplier.

The most significant takeaway from this commentary applies to companies who cannot garner such buying influence, or who cannot afford to invest in strategic commodity teams and hedging.  A couple of thoughts come to mind:

• Be prepared to absorb some form of price increases, or find other means to offset these increases.
• Explore buying co-operatives where multi-company needs can be pooled
• Now, more than ever, it is very important to have supply agreements spread across multiple suppliers. Supplier loyalty and continuity is a rather important strategy right now and this is not the time to be consolidating the vendor base that provides strategic raw materials.

Finally, strategic commodity planning requires the best available product demand plans and forecasts.  It is rather important that senior procurement managers be active participants in the executive level S&OP process.

What other recommendations can you share regarding the current challenges in high commodity prices?

Bob Ferrari

Henry Hwong, VP of Product Marketing and Allison Jeannotte, Director of Corporate Communications for Reardon Commerce called Supply Chain Matters attention to a recent “pulse survey” conducted among attendees at the recent Institute of Supply Management (ISM) annual conference.  The survey is rather timely, in that it uncovers the need for sourcing and procurement professionals, in light of current global supply chain developments, to possibly modify some of their current thinking. The context is for both indirect and direct procurement activities.

As noted in the press release, the survey points to where procurement will look for the next layer of cost savings:

• Nearly half (44 percent) believe more spending should be under the control of procurement and that controlling off-contract purchasing will make the biggest dent in purchasing.
• A smaller segment, 28 percent, indicated that enterprise-wide visibility into spending is the key to keeping costs down.
• A general consensus (60 percent) believed that consolidating the supply base was at the top of the procurement agenda.

Unstated and hopefully implied, is that in these current times of broadly extended global-wide supply chains, the ability for differentiating strategic, tactical and indirect material spending is more important than ever.  While procurement can’t control what it cannot see, control comes with other broader responsibilities that include the balancing of cost control with other business needs such as risk avoidance.

The recent tragic earthquake and tsunami that struck Japan has been a clear wake-up call among senior executive and supply chain communities.  Companies and suppliers, who initially thought that their supply chains would not be impacted, came to discover later that the visibility to the lowest tiers of supply were lacking, and these organizations were indeed impacted.  Companies that felt assured that key parts were not at risk because of single-sourcing discovered that their context of key parts did not extend far enough down the supply chain.  The headlines of supply disruptions involving Japan included epoxies, low-cost but required electronic components, resins, paint chips, and other components.  And as companies scrambled to find alternative sources of supply, the concept of reserving capacity for loyal and existing customers played out as usual.

In the past, procurement teams were very successful in mining cost reduction opportunities by operating on a principle that the tighter the control and oversight, the more leverage that could be gained in extracting cost savings.  That made the CFO very happy, but might have caused some business units to be a bit more innovative in rogue sourcing and hiding spend.  Today however, supply chain management is taking on a more strategic and risk-aware perspective, where agility, the ability to deal with constant variability and respond to events and opportunities in the market are the new table stakes for competitiveness.

Supply Chain Matters advises procurement teams to turn their energies towards more internally-focused collaboration among product development, sales and operations planning teams.  Strategies for direct and indirect procurement need to remain differentiated, with different sets of goals.  Every component or part that makes-up your finished products need to be analyzed for supplier coverage, capabilities and risk potential.

Rather than a broad swath of compliance and consolidation, the message of these times is keen analysis, intelligence and internal collaboration for achieving  broader business goals along with spend reduction.

Bob Ferrari

Today’s Financial Times featured a rather interesting article penned by Asia correspondent Tom Mitchell indicating some significant export trend data reported by the world’s largest apparel trade sourcing company, Li & Fung.  It indicates that the average price of Asian exports shipped by Li &Fung to its various retail customers fell by 9 percent in 2009, which was describe as unprecedented,  The company feels is a firm indicator that western retailers were trading down in their apparel sourcing decisions.  They also noted a noticeable shift in orders from relatively high cost production sites in the coastal southern region of China, to other competitive regions in Southeast Asia. A quote from William Fung, managing director notes that the prime beneficiary of this sourcing strategy shift was the country of Bangladesh. The company does note however that orders taken in last two to three months are at higher prices, which may be an early indicator of a more confident retail consumer. 

From my perspective, I would have to agree that once again Li & Fung has demonstrated its ability to adapt to a rather difficult business environment and still increase its margins.  That is a quite enviable capability to have in a traditionally low margin business environmemt.

You can view a video capsule of the article at the FT website.  (free preview account may be required)

Bob Ferrari

While searching China’s Xinhua News Agency site to secure references to my previous posting related to the after effects of the tainted milk scandal, I came across a rather interesting article that provides some indication of the changing winds of outsourcing manufacturing within China.

The article, Toy exports slump with higher costs in Southern China, notes that China’s major toy manufacturing province, Guangdong, is experiencing a slump in toy exports to Europe and the U.S. amid rising costs. 

The cost of manufacturing toys in southern China has increased an average of 25 percent, while overall export demand has remained slack due to the effects of the world economy and keen competition. Both the EU and the U.S. have adopted more stringent standards on imported toys, and that has required Chinese producers to spend 15 percent more on higher quality raw materials as well as much more time on product inspection and quality needs. Labor and transportation costs within China have also risen.

In the first ten months of 2009, exports to Europe, Hong Kong and the U.S. have dropped 10.9 percent, 12 percent, and 15.2 percent respectively, which indicates that the bulk of toy purchases have already been consummated to stock for the upcoming holiday buying season and declining export volume for 2009 is a certainty.

 Toy manufacturing represents the most margin sensitive aspect of manufacturing sourcing and in fact it was the toy industry that led the first wave of production outsourcing within China’s Guangdong province.  Since that time, the obvious need for higher quality and safety standards are driving these same brand owners to source their production in more interior regions of China, or within other evolving low-cost manufacturing regions. In essence, the trends noted should not be a total surprise.

This trending in the toy industry is however another indicator of the changing winds for global outsourcing or near shoring.  The singular notion of savings in direct labor costs can no longer justify an outsourcing decision. The added factors of market acceptance of quality, more stringent regulatory compliance, transportation and landed cost factors now play a more significant aspect to the overall sourcing decision.

The latest and most timely reminder of for increased quality and safety concerns stems from this weeks highly publicized product recall of infant cribs, the largest in U.S. history,.  Over 2.1 million drop-side infant cribs, manufactured from January 1993 to October 2009 are being recalled because of potential hardware breakage leading to infant safety concerns or potential death from suffocation.  The affected cribs were noted as being manufactured in Canada, China, and Indonesia.

The takeaway is that sourcing decisions are no longer static, and sourcing professionals need many more strategic skills and information sources to make the most intelligent and timely sourcing decisions.

 Bob Ferrari