The goal of this three-part series has been to assess trends and determine how major supply chain participants, including downstream, upstream and transportation  are currently experiencing and viewing 2010 business levels, and how the general post recessionary recovery is manifesting itself among industry supply chains.

In Supply Chain Matters Q2 Global Supply Chain Snapshot-Part One, we observed lower-tier downstream industries and select companies that supply various other upstream supply chains. Supply Chain Matters Q2 Global Supply Chain Snapshot- Part Two reviewed selective sampling of global based manufacturers who tend to be the engines of global supply chain activities. In this Part Three posting, we will focus on sampling of major transportation segments to ascertain both Q2 and first-half of 2010 trends.

As in our previous two commentaries, a selective snapshot across the major transportation segments that support all levels of supply chain activities continue to reflect a positive upswings in Q2 transportation activities, but cautionary signs also prevail regarding a potential slowdown in momentum for the remainder of the year.  Ocean transport continues in crisis due to reduced demand and excess existing and new capacity.  U.S. railroads are well on their way to banner years, but idle capacity remains in that segment. Air transportation continues to grow, fueled by activity in Asia and critical parts shortages in electronics sectors. Previous severe cutbacks in overhead and labor costs continue bearing fruit in impressive profitability increases among the major air and surface carriers. Major global carriers continue to handsomely benefit from increased production and commerce activities within emerging regions such as Asia, particularly China.

Concerns for tepid consumer driven markets, the overhang of excess or reduced capacity in certain segments, uncertainty on fuel costs, and uneasiness brought on by increased air and ocean disruption events continue to be evident.  Earnings and shipment volumes for DHL, FedEx and UPS all continued benefit from their international shipping services from the Far East to European and North American destinations.

A snapshot of key transportation segments indicates the following:

International Air and Surface Freight

The International Air Transport Association (IATA) noted that shipper confidence rose to very high levels in April, with the key semiconductor industry sector expanding air shipments at a healthy 50 percent increased rate.  The Association, however, cautions that the potential end of the business inventory cycle will put a brake on air freight growth in the second half of the year. While international air freight volumes were down 0.5% in April as a result of European airspace closures brought on by the Icelandic volcanic ash plume, April’s volume was over 20 percent higher than a year earlier.  Domestic air freight volumes also expanded, but at half the rate of international.

DHL

• Q2 revenues up 15.6 percent (year-over-year); First-half revenues up 9.9 percent
• Q2 consolidated net profit up 95.7 percent; First-half profits quadrupled
• First-half consolidated revenues by region: Americas up 20 percent; Asia-Pacific up 39 percent; Europe up 5.6 percent
• Air Express first-half revenues up 14.1 percent: Americas up 26.3 percent; Asia-Pacific up 33.9 percent; Europe and Middle East up 13.2 percent
• Sharp year-on-year increases in daily shipment volumes for Time Definite International services
• Global freight forwarding up 24.4 percent
• Supply chain services up 5 percent
• Increased guidance on earnings for 2010 year-end

FedEx

• Fiscal Q4 revenues up 20 percent
• Fiscal Q4 operating income of $696 million vs. $849 million loss a year earlier; Fiscal year operating income increased 168 percent ($2 billion vs. $747 million last fiscal year)
• Operating margin increased to 7.4 percent, up from negative 10.8 percent year earlier
• FedEx Express Segment: Revenues up 23 percent; Average daily volume of packages up 23 percent, led by exports from Asia
• FedEx Ground Segment: Revenues up 15 percent; Average daily package volume grew 7 percent year-over-year, driven primarily by B2B markets and FedEx Home Delivery; Operating margin increased almost 5 points to 16.3 percent
• FedEx Freight Segment: Revenues up 30 percent; Narrowed operating loss to $36 million; LTL average daily shipments increased 34 percent but yield declined 6 percent due to effects of discounted pricing
• Expects continued improvement in both revenues and earnings for upcoming fiscal year

UPS

• Q2 total revenue up 13 percent (year-over-year) coupled with 7 percent increase reported in Q1
• Q2 operating profit up 57 percent, coupled with 39 percent reported in Q1
• In the first-half, generated more than 42.5 billion in free cash flow from operations
• Operating margin increased to 11.5 percent vs. 8.3 percent a year earlier
• Average daily shipment volumes up 3.4 percent in the quarter
• US Domestic Package: Revenues up 7 percent; Operating profit up 57 percent;  Daily volume up 1.2 percent; Revenue per piece improved 6 percent primarily through higher fuel surcharges and increases in base pricing
• International Package: Revenues up 23 percent; Profits up 78 percent; Average daily volume up 20 percent; Export volume increased 15 percent with Asia up 40 percent
• Supply Chain and Freight: Revues up 21 percent; Operating profit up slightly
• Raised full-year guidance for earnings and profit growth

J.B Hunt Transport Services

• Q2 revenues up 22 percent (year-over-year) coupled with 17 percent increase in Q1
• Q2 profitability more than doubled
• Operating margin increased to 9.7 percent from 6.1 percent a year earlier
• Noted that demand for transportation services has increased fairly dramatically
• Intermodal revenues up 24 percent on 19 percent volume increase
• Decreased size of tractor fleet

U.S. Railroads

The Association of American Railroads noted that in the second quarter of 2010 carloads were up 13.8 percent over year earlier levels. Carloads in June 2010 were 10.6 percent higher than June 2009, but the weekly average of carloads in June was down almost 4 percent from weekly volumes experienced in April, indicating a slowdown in shipment activity during Q2. However, the weekly average of intermodal trailers and containers in June was the highest volume since October of 2008. For the six months of 2010, carloads are up 7.8 percent over the comparable period in 2009.

An overview of commodity categories that were shipped by rail in Q2 indicates trending that shipments are decreasing for coal, agricultural and food products, along with chemicals and petroleum. Shipments increased in the quarter for metallic ores and metals and motor vehicles.  Commodities with the largest carloads gains in June 2010 over June 2009 include steel and other primary metal products, motor vehicles, and metallic ores.

Burlington Northern Sante Fe LLC

Now a part of Berskshire Hathaway and no longer publically reports detailed quarterly activity

CSX

• Q2 total revenues up 22 percent (year-over-year) coupled with 11 percent increase in Q1
• Operating profit up 36 percent coupled with 24 percent increase noted in Q1
• Volume gains in most freight markets
• Noted 7 percent increase in coal shipments reversing 13 percent decline in Q1
• 2010 outlook remains positive

Norfolk Southern Corp.

• Q2 revenues up 31 percent (year-over-year)
• Profits rose 59 percent on surging volume growth
• Volume up 22 percent
• Revenues from coal shipments increased 36 percent; General merchandise volumes up 31 percent; intermodal shipments up 23 percent

RailAmerica, Inc.

• Q2 total revenue up 18 percent (year-over-year)
• Operating income essentially the same as year ago
• Carloads up 11 percent in the quarter coupled with 8.7 percent increase in Q1
• First half carload shipments  trending higher for agricultural products, chemicals, metallic ores, food and forest products

Union Pacific Corporation

• Q2 total revenues up 27 percent (year-over-year), coupled with 16 increase noted in Q1
• Operating income up 71 percent, coupled with  47 percent increase noted in Q1
• Business volumes up 18% compared to a year ago
• Double-digit increased shipping activity; Automobiles up 105 percent; Intermodal up 35 percent; Industrial products up 30 percent; Chemicals up 19 percent; Energy up 17 percent; Agricultural up 13 percent

Ocean Shipping

The ocean shipping business continued in crisis in Q2 as shipping rates remained under intense erosion and lots of ships either remained idle in ports or decreased overall transit times to lower operating and breakeven costs.

The Baltic Dry Index, the well recognized measure of cost to transport bulk material by sea, demonstrated a steady growth increase in the first two months of Q2, peaking around the end of May.  The index then plunged dramatically during June, from a high of 4000 to 2400 by the end of June. That decline continued into July, closing the month at a reading of 1942.  A posting on CommodityOnline noted that the combination of lower iron ore imports into China, slower coal activity, easing port congestion and heavy fleet delivery schedule pushed dry freight rates lower, according to an analysis by Bank of America-Merrill Lynch. This decline was described as the longest consecutive decline since 1995. “While short-term fundamentals are poor, ships can barely break even at the current rates and we expect a high slippage rate for 2011.” The commentary further notes that the remainder of 2010 will be highly dependent on the growth in emerging markets or whether a “double-dip” slowdown occurs.

Traffic at China’s top ten container ports fell 1.9 percent in June to 9.92 million TEU’s from 10.11 million TEU’s reported in May, according to consultancy Alphaliner. Although June volume was the second highest on record, signs of weakness occurred as Guangzhou and Shanghai reported sharp declines.  This may also be a reflection of a shifting of shipping volume to China’s internal ports.

According to the Pacific Maritime Association, container volumes at U.S. West Coast ports increased 15 percent in the first six months of 2010.  Containerized imports increased 17 percent while exports were up 11 percent.  Warehouses located near California ports were jammed with inventories by the end of June awaiting transit to retailers for back-to-school and pre-holiday buying seasons.

The world’s largest freight and ocean container line, A.P. Moller Maersk AS reported its first ever financial loss in the company’s history, a somber testimony to the collapse of global trade in 2009, and carrier attempts to foster higher shipping rates in the wake of large excess capacity. The company has since announced that it expects to be profitable in 2010 based on improvements in the container business and that that the profit for 2010 will exceed the profit for 2008.

This concludes our Q2 snapshot series.  Overall, cautious optimism prevails across major levels of global supply chains as definite signs of first-half momentum slowdowns come to the surface. Continued growth in emerging regions and export markets remain the key to increased momentum for the second-half.  The American consumer remains cautious, allocating spending to basic or personal reward needs.

Momentum could change even more if any further economic setback occurs, and supply chain strategists would be wise to pay close attention to sudden demand or inventory changes occurring over the coming months.

Bob Ferrari

As we did in Q1, Supply Chain Matters once again takes a quarterly snapshot of the downstream, upstream and transportation component areas of global supply chains. The goal of this three-part series has been to assess trends and determine how major supply chain participants are currently experiencing and viewing 2010 business levels, and how the general post recessionary recovery is manifesting itself among industry supply chains.

In Supply Chain Matters Q2 Global Supply Chain Snapshot-Part One, we commented on Q2 results of some of the lower-tier downstream industries and bellwether companies that supply various other upstream supply chains. In this Part Two posting, we will focus on some bellwether global based and diversified manufacturers to ascertain Q2 trends. As noted in our initial posting, we certainly do not pretend to be trained economists, and please do not view these postings as a basis to plan for the remainder of the year. It is, however, interesting to put information points into a context from the first half of 2010, and begin a commentary on what lies in store for the remainder of 2010.

Similar to our observations of downstream companies, major globally focused manufacturing companies continued to demonstrate impressive results in revenue and profitability growth.  However, beyond the financial numbers, indices of manufacturing and order activity at mid-year are reflecting a noticeable slowdown as the second-half begins.   The Wall Street Journal noted, with 70 percent of companies in the S&P 500 having reported, Q2 earnings were averaging 42% higher than a year ago, even though revenues were up only 9 percent on average. Clearly, a continued focus on aggressive cost cutting and productivity continue to payoff for global based manufacturers.  Sales volumes generated outside of the U.S. clearly were the fuel for continued revenue growth, as export related markets continue to be robust. A prime example to these trends are the contrasting Q2 business results reported by General Electric as opposed to more export-driven Siemens.

As we enter the second half, consumer confidence remains down, and any products directly associated with direct consumer purchases, with the exception of food, fuel, or the latest high-tech goods such as Apple’s iPad or iPhone, remain tepid at best.

In Q2, manufacturing growth in China and much of the rest of Asia slowed for a second straight month in June, with PMI indexes for Australia, China, India, South Korea and Taiwan all reflecting slower growth.  While growth in these regions is slowing, these declines are modest thus far.  As we pen this commentary, The JPMorgan Global Manufacturing Purchasing Managers’ Index for July posted a 54.3 reading, its lowest reading in eight months. While raising a cautious note, it is still consistent with a solid rate of expansion. Also in July, China’s PMI dropped for the first time in over a year to 51.2, coming closest to the reading of 50 that determines contraction or expansion.

In U.S. related activity, the Institute for Supply Management July PMI was recorded as 55.5, down 0.7 from the 56.2 reading in June, and somewhat down from the 60.4 reading recorded at the end of Q1.  The new orders index dropped almost 5 points from June to July, and basically level with the level reported in April.

Our quarterly snapshot of key global based diversified manufacturers indicates the following:

Caterpillar

• Q2 revenues up 31 percent (year-over-year) compared to drop of 11 percent in Q1
• Q2 profits up 91 percent
• Manufacturing costs improved by $316 million; continue aggressively managing costs and driving better cash flow
• Agreed to acquire Electro-Motive-Diesel for $820 million
• Bulk of sales and profitability growth occurred outside the U.S.
• Noted a 400 percent increase in excavator production capacity within China
• Machinery sales up 55 percent; engine sales up 3 percent
• Again raised full year outlook for revenue and profitability expectations

Cummins

• Q2 revenues up 32 percent (year-over-year), much higher performance than in Q1
• Profit quadrupled after surging to $149 million in Q1; Q2 had highest quarterly earnings as a percentage of sales in more than 25 years
• Significant productivity gains in manufacturing
• Gross margin slightly declined to 23.5 % from 24.3% recorded in Q1, but remains higher than 18.3% noted in Q4-2009
• More than half of Q2 revenues (64 percent) generated from markets outside of the U.S.
• Engine and Components businesses each recorded 45 percent sales increases; Power Generation segment sales increased 16 percent
• Again increased revenue and profitability guidance upward for remainder of 2010

General Electric

• Q2 revenues down 4.3 percent
• Profits rose 16 percent (year-over-year)
• Orders rose 7.3 percent from year earlier
• Sales in equipment, services for aviation, rail transport and wind segments all reported as weak
• Order backlogs flat for second straight quarter
• Noted that troubles in the supply chain for electronic components cost the company $50 million in Q2 sales

Hyundai Heavy Industries

• Q2 revenue up 0.1 percent from a year ago. 0.9 percent higher than Q1
• Q2 operating profit up 44% (year-over-year)
• Revenue from offshore projects and construction offset decreases in shipbuilding
• Noted significant increased construction equipment sales generated from China
• New orders increased 197.8 percent from year earlier
• Cost of sales reduced 7.8 percent from year earlier levels

3M

• Q2 revenues up 18 percent coupled with 25 percent growth recorded in Q1
• Profit increased 43 percent coupled with 79 percent increase noted in Q1
• Sales improvements noted in all businesses and geographic regions with strongest noted as emerging markets, up 32 percent vs. 47 percent growth in Q1
• Operating margins of 23.7 percent
• Industrial and Transportation business segment up 23 percent in Q2, with previous 29.2 percent growth cited in Q1
• Display and Graphics segment up 30 percent in Q2, with 42.4 percent growth noted in Q1
• Electronic and Communication segment up 32 percent in Q2, with 38.6 percent growth noted in Q1
• Again increased revenue and profitability financial guidance upward for remainder of 2010

Samsung

• Q2 revenues up 17 percent (year-over-year) coupled with 21 percent increase noted in Q1; Q2 revenues were 4 percent higher than Q1
• Q2 profits up 83 percent, 9 percent higher than Q1
• Consumer product divisions (mobile phones, TV’s) recorded declines due to price competition and increased marketing expenses
• Semiconductor segment up 55 percent in Q2 coupled with 57 percent increase noted in Q1; division noted a 30.8 percent profit margin
• Memory segment up 74 percent coupled with 76 percent increase noted in Q1
• LCD segment up15-20 percent in Q2 coupled with 40 percent increase noted in Q1; unit sales price increase were up 3 percent in Q2 and operating margin increased to 11.3 percent from 4.2 percent noted a year ago
• Again revised upward its full-year operating profit forecast

Siemens

• Fiscal Q3 revenues up 4 percent (year-over-year) vs. decrease of 3.8% recoded in Q1
• Profits up 40 percent, couple with 32 percent profit increase noted in Q1; all three major business segments showed profit gains
• Orders and revenue both benefitted from positive currency effects
• All product segments reported double-digit growth; Energy up 18 percent; Healthcare up 10 percent; Industry up 7 percent
• Order volumes up 22 percent in the quarter vs. decline of 15% noted in Q1; 35 percent increase in new orders from China. 51 percent increase in orders from the U.S.
• Highest order backlog in the company’s history
• Still profiting from a significantly improved cost structure
• Slightly increased year-end 2010 financial guidance

Whirlpool

• Q2 revenues up 8.7 percent vs.20 percent increase noted in Q1; First-half revenues up 13.8 percent
• Profits up 146.9 percent in Q2; year-to-date profits up 91 percent
• Gross margin up 3.5 points to 16.8 percent
• Geographic breakdown: Asia up 42.5 percent in Q2 vs. 60 percent in Q1; Latin America up 23.7 percent in Q2 vs.65% in Q1; North America up 5.7 percent in Q2 vs.7 percent in Q1;  Europe down 6 percent in Q2 vs. 6 percent increase in Q1, but profitability increased due to cost reduction
• Noted 63% volume growth in Q2 and 11.6 percent increase in volume growth year-to-date
• Cited continual favorable impacts from cost reduction and profitability initiatives
• Expects industry-wide shipments of appliances in North America to increase 3.5% this year
• Key priorities in 2010 remain cost, balanced market execution and increased product innovation
• Increased financial guidance upward for remainder of 2010.

Our capsule snapshot of global manufacturers in Q1 noted an overall tone of positive resurgence but cautionary notes.  That seems to have continued with this capsule snapshot of Q2. Global manufacturers however now sense a more decreased level of momentum in the second half of 2010.  There does not seem to be high concern for a “double-dip” recession this year, but more of a tone of slow but steady growth

Demand for manufactured products was fueled by a noticeable inventory replenishment and economic stimulus cycle in the first-half, and there are open questions as to whether end-consumer and general business demand will sustain itself for the remainder of 2010.  Clearly, global manufacturers that have established a presence in the developing regions have handsomely benefitted in revenue growth thus far, and large cost reduction and productivity investments also continue paying impressive results in profitability growth.  Spot shortages of select, but critical supply components are occurring as noted by the GE admission, as some suppliers have not been able to keep-up with spot demand increases. The global supply chain pipeline remains active, order rates remain positive, but warning signs are evident in overall inventory management for the remainder of the year.

As in Q1, we did not include major high tech and consumer electronics manufacturers such as Apple, Cisco, HP, LG and others since it is clearly evident that these companies are experiencing their own very positive recovery in most geographic regions, and they would tend to bias our overall outlook. We will however take a separate look in the coming weeks as to whether there are significant other supply chain trends occurring in this sector.

In our third posting, we will focus on a snapshot of the major transportation carriers that service and support all of the various tiers of global supply chains.

In the meantime, feel free to add your own observations in the comments section noted below this posting.

Bob Ferrari

The following posting can also be viewed in the Kinaxis Supply Chain Expert Community.

While the intent is noble, the ranking of corporate supply chains can be a risky proposition and a slippery slope.  A lot has to do with ranking methodology, screening criteria and qualitative weighting factors.  An industry analyst can sometimes dread the final rankings since certain firms can take exception as to why they were not included or even considered in such rankings.

The AMR Research/Gartner Top 25 supply chains ranking seems to be that which captures the most interest among our supply chain community.  AMR’s noted criteria for ranking its Top 25 includes 50% weighting for financial performance (ROA, inventory turns, revenue and profit growth) and 50% qualitative, meaning individual analyst and peer industry nominations. Much dialogue and discussion can be made regarding who made or was not included in the ranking, and this commentary is not about such. In the end, I suppose we should be able to agree that the most important criteria in evaluating any firm’s supply chain is whether these capabilities helped that firm to be the best performing company in its industry.

I was  reading Bloomberg BusinessWeek magazine and noted its June 21 cover article, the Annual Ranking of the 50 Best-Performing Companies. BW’s overall ranking has a context of delivering maximum stockholder value, which happens to be a rather important measure attributed to supply chain capabilities.  The ranking is further noted to be firms that have the top performance in the Standard and Poors 500 stock index over the previous five years. BW notes: “In a period of tremendous economic turbulence, these stocks returned an aggregate 222.3 percent to shareholders, including reinvested dividends.” We often communicate to senior management that the true benefits of supply chain capability do not necessarily come in any one year, but are a result of many months of building process competency and customer intimacy. Thus a five year horizon can be a meaningful benchmark measure.

In the interest of getting some constructive dialogue started, let’s contrast the top five firms listed on the BW ranking with the AMR ranking.  If one screens out non-manufacturing or supply chain centric firms, only two companies stand out: Intuitive Surgical (#2), and Apple (#4).  Apple ranks #1 within the AMR/Gartner ranking, while Intuitive Surgical revenues failed to make the threshold for the AMR/Gartner revenue screening criteria. Apple is no surprise to appearing on both rankings.

Now look at the 6 through 25 ranked firms, and the following manufacturing, retail, or supply chain related firms are noted in BW’s ranking:

Flowserve- (#7)

FMC Technologies- (#8)

Cliffs Natural Resources- (#9)

Amazon.com- (#10)

Titanium Metals- (#11)

Cummins- (#12)

Celgene-  (#13)

Precision Castparts-  (#15)

Western Digital-  (#18)

Big Lots- (#19)

Cameron International- (#20)

Airgas- (#21)

CSX- (#23)

Occidental Petroleum- (#25)

Within this BW grouping, the AMR/Gartner ranking only noted Amazon.com, concurring as #10.  Select names on the AMR/Gartner ranking such as Hewlett-Packard (AMR #15, BW #28) or McDonalds (AMR #11, BW #31) did not make the top twenty- five BW cut.

Are there some observations contrasting these two rankings?    I can note some.

Company size certainly stands out as a difference.  Is supply chain capability contributing to bottom-line performance just as pertinent to smaller vs. multi-billion dollar firms? Are smaller firms characteristically more agile in their ability to take advantage of market opportunities?  Should differentiating based on company size be considered in ranking of supply chains?

Specific industry needs and profile is another obvious consideration.  In times of global recession, certain industries fare better than others.  Companies that grew during the recession could invest in supply chain, while those that declined or were flat, most likely had to reduce costs or capabilities in supply chain.

What other observations or pointers do you observe from contrasting these two rankings?

Bob Ferrari

This posting continues our Supply Chain Matters series of noting where specific supply chain initiatives have been cited as adding significant value for businesses.  ConAgra Foods is a consumer goods food manufacturer providing many recognized food brands including Healthy Choice, Chef Boyardee, Hebrew National, Hunt’s, among others.  The company also has a significant presence in providing commercial food products.

I find that the current outline of supply chain activity within ConAgra is a rather typical scenario of supply chain teams being called on to deliver significant cost-cutting initiatives for the needs of the overall business, especially through these extraordinary times of economic downturn.  Cost-savings derived from supply chain activities are often re-invested in other business priorities, or flow directly to the bottom line to insure continued profitability. 

During ConAgra’s fiscal second quarter of 2010 conference call, senior executives positively cited the contribution of supply chain teams within that company’s consumer foods supply chain.  In the quarter, consumer food sales increased 3% and volume increase 2%. Operating profit increased by a significant 31%, and this was the fourth consecutive quarter of profit growth for this operating segment.

The consumer goods supply chain team was specifically cited by ConAgra’s CFO for its long runway of cost reduction.  In the second quarter alone, approximately $90 million in savings was delivered.  The current estimate is that this team is on track to deliver up to $300 million in savings for the full fiscal year. 

The savings garnered from supply chain have allowed funding for other business priorities.  In ConAgra’s specific case, advertising and product promotional expenses increased by 25% or $24 million in the second quarter.  Savings also offset other potential product price increases.

Initiatives cited were a complete set of working capital savings initiatives including consolidation of inventory.  The company has an ongoing effort for SKU management and rationalization which was noted as working extremely well.  Longer production runs were cited as delivering higher efficiency gains.. Other cost savings initiatives include smarter sourcing strategies for commodities, such as wheat and potatoes. A net deflation in other inbound commodity costs has also contributed positively to cost savings.

Significant supply chain related cost cutting at ConAgra dates back to 2006 with far reaching plans to consolidate its network of manufacturing facilities. Of late, the company has also invested in advanced supply chain technology, including demand sensing and multi-echelon inventory optimization software.

The ConAgra supply chain team will continue in its efforts to sustain its efficiency and cost-saving initiatives. Supply Chain Matters extends a “thumbs-up” to this supply chain team for its impressive efforts.

 The open question however often remains as to whether the cumulative impacts of these cost cuts take their toll in supply chain agility and responsiveness, when the business demands that capability. Time will have the tell this story and we will certainly be observing.

How do you view ConAgra’s efforts?  Are they typical for your industry?

Bob Ferrari

Over these past weeks, Supply Chain Matters has been providing specific commentary noting that recent corporate profitability has been attributed directly to specific cost savings initiatives in and across supply chain areas.  The latest of these notations were our posts reflecting on recent profitability results for Wal-Mart and The Hershey Company.

In today’s Wall Street Journal, a rather insightful Abreast of the Market article by Tom Lauricella, Earning Are Strong, Sales Are Another Story (subscription required), validates the notion that a record number of U.S. companies have indeed beat earnings expectations in the third quarter,  and a big portion of these profits have come from cost-cutting vs. any substantial revenue growth. Thus far, revenues are on track to fall 10% overall, and without an upturn in U.S. sales, cost-cutting can only boost profits for so long.  A further notion from Wall Street is that companies are running so lean that should revenue growth pick-up in the coming months, operating margins would likely surge, giving an ever higher boost to profits.

Another key observation came from a Goldman Sachs analyst noting that most revenue surprises were heavily concentrated among health-care and technology companies, and more broadly among “intermediary” companies that make products such as semiconductors, rather than companies that sell finished goods.  If I paraphrase that statement, any revenue growth thus far has been concentrated in the lower tiers of value-chains, where inventory re-stocking has driven the bulk of incremental business activity vs. end-customers. An UBS analyst takes the opposite view, noting that a 3.8 percent rise in revenues measured against the second quarter is positive: “People have been unduly negative about the profit picture“.

I would caution certain Wall Street players not to be so optimistic about the potential for surging operating margins when sales do increase. All the evidence that I see leads me to believe that overall, supply and value-chains are at a very critical point in terms of their ability to support any rapid ramp-ups in revenue growth.  Similar to our commentary last Friday about the current warning signs in high-tech supply chains, many companies in manufacturing industries may have cut back too much in headcount and resources, and it make take months for dormant factories or fragile suppliers to be able to ramp-up and support any sustained sales growth. Instead of financial headlines praising increased margins and profitability, there may well be those that point to a breaking point in the ability of supply and value chains ability to support revenue growth.  Certainly there will be individual exception, but I suspect that on the whole, there have been too many cutbacks among industry supply chains to be able to quickly respond to a sudden upturn in revenues.

What’s the situation in your environment?

Have cutbacks in supply chain activities gone too far and cut too deep?

Please share your specific observations in the Comments section below this post, or participate in an interactive survey regarding 2010 supply chain budgets.

 Bob Ferrari