The printed edition of the Wall Street Journal will report tomorrow (paid subscription required or free metered view) that the Fair Labor Association (FLA), the designated supplier social responsibility auditor for Apple, has discovered multiple instances of average work weeks exceeding 60 hours along with other safety issues at prime contract manufacturer, Foxconn.  Also reported was that the FLA found that workers weren’t being fairly compensated for overtime, an issue that Foxconn, FLA and Apple are committed to fix.

Apple requested this audit earlier in the year in an effort to put more teeth into its social responsibility practices.

The audit was based, in part, on surveys of over 35,000 workers among Foxconn Chinese facilities located in Shenzhen and Chengdu.  The WSJ reports that the FLA found at least 50 legal or code violations. The FLA found that during some periods over the past 12 months workers worked an average of more than 60 hours per week, and there were several months in the past year where the majority of Foxconn workers exceeded China’s legal maximum of 36 overtime hours per month. The WSJ further indicates that the FLA report cited an average of 80 overtime hours worked per month.

Interestingly, FLA’s report indicates that 48 percent of worker respondents thought working hours were reasonable while 64.3 percent of workers thought their salary was not sufficient for basic needs. That certainly merits further discussion and analysis.

The report indicates that Foxconn has agreed to bring its factories in China within China’s legal limits by July 2013, and further indicates that Foxconn would need to recruit tens of thousands of extra workers to comply. In the article, FLA President and CEO Auret van Heerden is quoted as indicating that the findings were “no worse than any other factory in China”.

As Supply Chain Matters posted earlier today, Apple CEO Tim Cook has been visiting China this week and as we suspected, Mr. Cook took the time to visit and tour an iPhone assembly line at Foxconn’s Zhengzhou facility.

As a final note, we would not be surprised if Foxconn now decides to accelerate its investment and installation plans for factory automation and robotics in the wake of this latest audit development.

Bob Ferrari

These past two weeks have been rather active in terms of supply chain developments, not the least has been the announcement by UPS on its intent to acquire European based TNT Express.  The all-cash deal, valued at $6.8 billion is headlined as the biggest in UPS history, and has global shipping implications. It represents what we believe is a means to block rival FedEx and others from expanding their own ground transportation services within Europe.

In its coverage of the UPS acquisition, the Wall Street Journal characterizes the deal as allowing UPS to capitalize on further long-term economic growth in Europe while FedEx remains better positioned to take advantage of long-term growth across Asia. In essence, both global providers are making different strategic bets on future value-chain growth and global shipment volumes.

FedEx capabilities servicing Europe currently lie in air express capabilities while UPS now has the potential to leverage both air express, ground transport and rail networks. Because Europe is more compact from an overall geographic perspective, ground transportation is a viable shipping alternative in terms of time and cost.

Asia increasingly represents the focal point for today’s component and finished goods manufacturing activity.  The region represents a much wider geographic footprint traversing large bodies of water. Manufactured goods generally enter other supply chains by either ocean transport or air freight.   Ocean container carriers invested far too much in container ship capacity, causing gross overcapacity, little profit that have resulted in an erosion in transit times to Europe or the U.S.. Thus for any shipments that are time-sensitive, shippers have little choice but to bite the expense bullet and opt for air express.  That is why both FedEx and UPS have benefitted in their Asia investments in air freight capacity. FedEx’s fiscal 2011 full year earnings announced last June noted a 6 percent increase in daily international package volume driven primarily from export volume originating from Asia.  In yesterday’s announcement of Q3 results, FedEx reported a 1 percent decline in international shipment volumes and announced that it would temporarily idle some of its international freighters.  The company also reflected a rather cautious international and U.S. economic outlook for the remainder of 2012. Asia exports and imports have obviously slowed.

It is the view of Supply Chain Matters that the final commentary related to UPS’s strategic move to acquire TNT comes later as global economies and supply chain activities shift to accommodate changing sourcing patterns, value-chain footprints and commerce fulfillment models.  Both UPS and FedEx can continue to benefit or one, or the other, may feel the effects of a wrong bet.

Bob Ferrari

One important aspect to our blog which provides commentary on global supply chain management is to keep an eagle eye on developments both before, during, and sometimes considerably after a significant supply chain related event.  Our focus is to share learning or takeaways from these various incidents.

When we launched Supply Chain Matters back in 2008, one of our first series of commentaries concerned supply chain risk management, specifically the issue of the tainted pharmaceutical drug heparin that originated from Chinese based suppliers.  Readers may recall that tainted batches of the prime API compound that produces heparin, a key life-saving drug utilized as a blood thinner, were found to later contain oversulfated chondroitin, an altered version of the required chondroitin sulfate.  Instead of sourcing this active API from designated pig intestines, the tainted API apparently came from shark cartilage.  This specific incident attributed to death of 80 persons and many others became very ill.

Our 2008 commentary, Will FDA Inspectors in China Solve Product Safety Issues?, questioned whether regulatory agencies were ill equipped to keep up with the pace of global outsourcing of pharmaceutical compounds and specifically getting a handle on the increasing occurrence of counterfeit or non-conforming products. At the time, the FDA had just announced the deployment of 15 inspectors to monitor hundreds of Chinese food and drug related suppliers that were supplying U.S. destination supply chains.

It was thus with keen interest that we came upon a recent Wall Street Journal published news story titled Suppliers Linked to Impure Heparin. (paid subscription or free metered view).  The article notes that 14 Chinese suppliers are suspected of supplying contaminated raw material to make heparin, but an FDA spokesperson stresses that the agency does not have any hard evidence that these same companies are currently supplying tainted material. The 14 companies have reportedly been placed on an import alert list, with 8 other suppliers that allows FDA and other governmental inspectors to stop shipments from any of these suppliers at the U.S. border.

In our view, the takeaway is that four years after the original incidents, our 2008 commentary still resonates, namely, can the FDA or other regulatory agencies police supply chains for the existence of non-conforming or unsafe products, or is this a prime responsibility of the industry itself.  Since 2008, the FDA has managed to specify a test that can reportedly detect the existence of any heparin contaminate and is now reminding heparin manufacturers to police their supply chains.

The WSJ article quotes the same FDA spokesperson as indicating the following: “The heparin supply is safe.  It’s one of the most protected drugs out there.” Perhaps this statement is predicated on an assumption that the industry will invest in the proper processes and tools to be able to detect unsafe or non-conforming materials, and that the FDA can somehow accelerate its monitoring of foreign-based suppliers.

The final takeaway question is this: Is it really possible for regulated industries such as drugs and medicines to continue their current pace of global-based outsourcing without significant investments in counterfeit and non-conforming materials protection?

Supply Chain Matters is of the point of view that evidence of the current pace of mitigation efforts related to detecting counterfeit materials seems inadequate.  Four years is a very long time to wait for concerted action plans. Investments in global based product pedigree, track and traceability and centralized supplier intelligence could have long been implemented with an investment cost far below the current costs of liability and damaged brand identities.

Perhaps other industry participants, regulators  or service providers can share some perspectives on what exactly is the problem here?

Bob Ferrari

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

Supply Chain Matters provides our February update commentary regarding the global supply chain impacts from the devastating monsoon floods that impacted Thailand in the fall of 2011. Our last early 2012 update in January reflected on the initial quantifiable impacts across industry supply chains. As the period of end of year earnings announcements concludes, we are getting a far more quantifiable picture of the cascading global supply chain impacts as a result of the floods.

We begin with the overall financial impacts.  According to a recent Insurance Journal posting, noted rating agency AM Best indicates that the insurance losses resulting from the floods in Thailand could be considered one of the five costliest insured loss events in the past 31 years.  Thai authorities now estimate that flood damage costs could be up to $15 billion, involving more than 400 manufacturers and households. A study from Aeon Benfield indicates that the amount of structural damage is actually “four times greater than what resulted from Japan’s earthquake and tsunami in March 2011, but only half of the total insured loss due to a low rate of insurance adoption.”  The implication is that many smaller suppliers or manufacturers may have self-insured.  The more sobering news for sourcing and procurement professionals to be concerned about is an indication by Best that the Thai commercial insurance industry “will likely face sharply contracted (coverage) capacity, higher pricing and tighter terms for coverage with the Sian and Japanese reinsurance renewals in April.” The takeaway, in our point-of-view, is that existing suppliers in these regions will probably face significant higher insurance or liability costs by virtue of their location in a disaster-prone region.

From an economic standpoint, the financial impact to the overall economy of Thailand was far larger than expected. That economy contracted at the annual rate of 9 percent in the final quarter of 2011 which is quite significant. According to the National Economic and Social Development Board of Thailand, the manufacturing sector alone declined 23 percent while net exports fell at an annual rate of 6.1 percent compared to a 17.3 growth rate in the previous quarter.  Beyond Thailand, the economy of Japan contracted a worse than expected 2.3 percent in the final quarter of 2011 and government authorities pointed to a strong yen, falling overseas demand and the impacts from the Thailand floods as hampering production and exports.

The financial impact among individual companies has also come to light.  Western Digital, initially the most impacted manufacturer with 60 percent of its global hard disk drive (HDD) manufacturing sourced in Thailand, indicated that in its fiscal second-quarter, earnings fell 36 percent while overall HDD shipments dropped a substantial 45 percent. That volume drop equates to a shipping shortfall of over 52 million hard drives from the year earlier quarter.  Overall revenues were down 20 percent from the previous quarter. The news from Western Digital was generally well received by Wall Street given the dour initial news immediately after the floods. Company officials noted that while manufacturing levels are on the increase, manufacturing capacity levels will not reach pre-flood levels until at least the September quarter, and that supply chain pipeline inventories are not expected to reach normal levels until the first-half of calendar year 2013.  Meanwhile, rival Seagate Technologies Inc. who had far more limited production presence in Thailand reported better than expected earnings, margins and shipments for the quarter ending in December.  Seagate shipped almost twice the volume of Western Digital, 47 million HDD’s in comparison to the 28.5 million for Western. Seagate’s gross margins increased nearly 12 percentage points from a year earlier as limited overall supply chain supply led to higher prices. According to IHS iSuppli, the average selling price for HDD’s increased on average 28 percent in Q4 of 2011 and will only decline slightly in the current quarter. In our January update, we noted reports of pricing spiking as much as 50 to 100 percent at the retail level in Asia.

Moving up the supply chain, computer providers Dell and Hewlett Packard has released each of their latest quarterly earnings with noted admissions to the financial impact from interruption of HDD supply.  Dell’s fourth quarter 2011 results indicated that while revenues rose 2 percent, earnings fell 18 percent. Dell CFO Brian Glidden acknowledged that the flooding in Thailand financially hurt the company during the quarter.  Not only were available hard drives expensive, Dell could not fulfill its desired needs for higher capacity drives. HP announced that for the quarter ending in January, PC related profits were down 31 percent, and server related profits declined 32 percent.  Overall profits declined 31 percent, and HP’s CFO in-turn acknowledged that the HDD shortage hurt both PC and server sales, and that the impact would continue through the first half of this year.  Readers should recall that both of these companies previously downplayed any significant disruption in supply or pricing.  This again brings credence to the concept of whether in times of significant supply chain disruption, it may be better to bring forward the worst and best case impacts, setting appropriate expectations, rather than waiting for the actual results to occur.  In the case of Western Digital, prior announcements of significant impact, followed by better than expected performance, was well received by Wall Street, in spite of not so positive financial news. Apple on the other hand, most likely from its huge influence in volume buying agreements, has publically indicated little supply impact and had stellar financial results in its latest quarter.  Interesting enough, both Western Digital and Seagate are listed suppliers on Apple’s supplier responsibility report.

Moving down the supply chain, a Forbes hosted article penned by semiconductor industry analyst Jim Handy noted the effects of the HDD supply disruption on the other components of global PC and server supply chains.  Handy notes that  about 40 percent of the total semiconductor market is made up of data processing applications, and because limited supplies of HDD restricted PC build schedules, other components such as LCD screens and DRAMS went into oversupply.  He predicts that other PC components will enter oversupply this quarter which will have a negative impact on semiconductor component prices both in the current quarter and perhaps the remainder of the year.  Supply Chain Matters would add that this may also reflect a situation where longer-term volume buying contracts could not be adjusted or that supply chain planners were challenged with maintaining current build plans while hoping for the best in HDD supply.

As more quantitative and other data attributed to this one significant major supply chain disruption becomes ever more visible, the consequences for re-examined strategic sourcing, supply chain risk mitigation and other planning become more obvious in the months to come.

We can all collectively hope for a less disruptive remaining 2012, but that may be wishful thinking.

Bob Ferrari

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

To follow-on with our previous posting, we provide another important update regarding Supply Chain Matters ongoing commentaries addressing significant supply breakdowns of critical life-saving drugs within pharmaceutical and drug supply chains. When legitimate essential drugs become scarce, unscrupulous activities unfortunately take advantage.

During these past few weeks, regulatory agencies have been alerting doctors and healthcare providers that in the light of severe shortages of hundreds of drugs, there are now clear signs that unauthorized or counterfeit versions of these drugs are infiltrating global supply chains. The U.S. FDA recently alerted to the appearance of “non-FDA approved injectable cancer medications.”  These include non-authorized versions of Faslodex, Hercetin, Neupogen and Rituxan.

The most visible headlines among traditional business media regarding the appearance of counterfeit versions involve the drug Avastin, prescribed to treat brain, colon, lung and kidney cancers.  Last week Swiss drug maker Roche, and its Genetech unit, the global producers of Avastin, indicated that counterfeit versions of its top-selling cancer drug, ones without any active ingredient, were being circulated in the U.S. Patients receiving this counterfeit version would thus not received required therapy. The FDA has further alerted 19 U.S. medical centers about purchases made from suspect distributors.

What is ever more concerning to supply chain management teams is the global based chain of custody now involved in these suspect drugs, adding many more points of vulnerability.  As shortages of life-saving drugs become more acute, healthcare providers are  turning to secondary channels in hopes of securing essential supply, sometimes not knowing the reliability product sourcing of such smaller wholesalers. In the specific case of Avastin, the counterfeit version flowed through wholesalers in Switzerland, Denmark and the United Kingdom before entry into the U.S.  According to an article published in the Financial Times, the Medicines and Healthcare products Regulatory Agency (MHRA) in the U.K. is further investigating whether the source of the counterfeit drug originated from a supplier in Egypt. It was also reported that some of these wholesalers never saw nor physically inspected the drug.  In essence, the existence of a counterfeit gets passed unnoticed all along the chain until it reaches the healthcare provider pharmacy. In its reporting, the Wall Street Journal included a graphic which indicates the multiple alternative wholesaler paths that were reported for distribution of the suspect Avastin.

Since there are currently no clear signs of improvement in overcoming critical shortages of life-saving injectable drugs, the emergence of increased distribution of unapproved or counterfeit drugs will only increase.

If there were ever a time for increased ‘track and trace’ or serial number control processes to assure legitimacy of supplies, it is clearly now.  While the industry has been generally dragging its feet on these initiatives, limiting such efforts to conform to specific U.S. state or national mandate schedules, current alarming events will only force legislative regulators to mandate increased controls for authentication., or possibly accelerate implementation timetables.  The problem is global in scope, meaning that tracking processes and standards must accommodate global supply chain distribution channels.

There is little question that pharmaceutical and drug supply chains have fallen down in insuring adequate and reliable supply of life-saving injectable drugs. Obviously, there are many ongoing problems to resolve, not the least of which is too much single sourcing and lack of adequate supplier monitoring of quality and consistency.  One big problem invariably leads to others, and now, an alarming trend for increased appearance of non-conforming or counterfeit versions leads to yet another problem, insuring authenticity and reliability of supply.

The bottom line, in our view, is that all members of pharmaceutical and drug supply chains, industry and regulators, need to bring serious attention and resources to bear on processes related to sourcing, supply planning, supplier monitoring and product authenticity.

We encourage comments from readers within the industry dealing with these problems.

Bob Ferrari

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