More Inflation Cautions

The Institute of Supply Management’s Purchasing Managers Index (PMI) for October that was reported today made its biggest jump since 2006. — from 52.6 in September to 55.7 last month. (See the news release.) That’s good news for the economy as a whole, but it bolsters our cautions that pressures on prices are likely to increase faster than the pace of economic recovery over the next few months.

The PMI is considered a leading indicator of economic business conditions. Purchasing managers are already reporting price increases in 11 commodity categories. Furthermore, inventories have been contracting for 42 consecutive months. Those facts suggest that price pressure is likely to go up.

Suppliers may be trying to recover from their losses over the last year and perhaps betting that shortages might drive prices higher quickly. It’s also possible that tight credit is still limiting manufacturers to add production capacity. Whatever the reason, buyers must remain diligent in their efforts to contain cost.  As companies recover and work to improve their bottom line, cost containment will be the core focus in managing suppliers in 2010. It will be necessary for buyers to review their tools for containing costs and develop new methods for dealing with price escalation.

In southeast Michigan we see the same kind of pressures on prices, but there was also a drop in the local PMI, released by the Institute of Supply Management – Southeast Michigan.  The ISM-SEM reported that its October purchasing managers index was 51.3, a drop of more than 10 points, but still in the range that demonstrates some modest improvement in economic conditions. The three-month trend of the index also remains positive.

We likely had an uptick in September as a trailing result of the ‘Cash for Clunkers’ automotive incentives. The October composite figure shows a slight cooling off, but looking deeper we see local purchasing managers reporting higher prices in a number of categories. That suggests there is finally demand building that can drive new growth.

The drop in the southeast Michigan index might suggest a note of caution about the national figure, too, because Michigan’s PMI often leads the index for the rest of the country. October’s big jump in the national PMI might be followed by a lower index next month, matching Michigan’s pattern. With so many uncertainties, we shouldn’t be surprised if the recovery has some fits and starts. Overall the outlook is still positive.”

Still at risk …

The economy may be topsy-turvy, but issues such as risk management are timeless.

I was reminded of that when Jan Husdal recently reviewed an article our consultants Jim Kiser and George Cantrell wrote in 2006 for Supply Chain Management Review.  It lays out six steps necessary to manage risks in the supply chain. Here’s the link:

http://www.scmr.com/article/CA6329866.html

One of the messages we often forget is to look beyond direct suppliers right through the supply chain. As we were saying on the PI Window on Business Blogradio program recently purchasers are prone to focus on what’s immediately in front of them. I like to use the term “supply management” or “sourcing” rather than “purchasing” because they both imply a deeper approach to the profession.

Chemicals

I recently had a good conversation with Richard Weissman at Purchasing Magazine about buying chemicals. I can tell you a few things I told him — or you can read the whole article (with good comments also by Tom Brossart, the director of global logistics and trade and compliance at W.R. Grace in Columbia, Md.).

http://www.purchasing.com/article/CA6635527.html?q=bill+michels

1. Nothing really replaces an in-person supplier visit. Travel budgets are tight, but risks from low-cost country sources are significant.

2. An example of an area of risk is environmental practices. You can no longer “export” pollution to countries that have less stringent laws than the U.S. Organizations are monitoring practices around the globe, and consumers hold companies here accountable for what their suppliers do abroad. Sustainability and the environment are critical issues that reach through the whole chemical supply chain.

3. The chemical supply chain is suffering from the same effects of the credit crunch as other products. Buyers are extending terms. Suppliers are squeezed and risks of disruptions are increasing. We work with clients to run simulations that gives us clues where the stress is greatest, so we know where we ought to line up standby sources.

It is easy to think of chemicals as commodities that need to be evaluated almost exclusively on price, but when you add considerations of risk — environmental, logistical or financial — procurement strategies have to more carefully constructed to accommodate them.

Riding the economic Tsunami

Darwin probably said it best – the fittest will survive. That’s also the assessment of my colleague in the UK, Robin Jackson, CEO of ADR International. If you haven’t seen ADR’s newsletter, this is what he had to say:

“The business environment has changed fundamentally and we will have to look back to the great depression of the 1930s, the collapse of South American economies in the 1970s and 1980s and Japan’s “lost decade” of the 1990s to draw lessons.

In this radically changed environment it is vital for the survival of businesses for procurement leaders to consider new ways of handling these challenges and develop new offensive and defensive sourcing strategies.

Remember this is a once-in-a-century readjustment of prices. Only if you are bold and act speedily will your business survive. Your competitors will be doing it and to survive you will need to do it too.

It’s time to call in the favours – if ever there was a time for strategic co-operation with key suppliers, this is it. If they don’t live up to their part of the strategic partnership billing, move swiftly to find alternative partners. Leverage your strategic supplier relationships. Be demanding and move rapidly.

Conserve your cash. Even if your business can borrow it is more expensive to do so now. So extend payment terms to the maximum without damaging the viability of your suppliers.

If you receive a price increase request then the supplier must be having a joke. With basic commodities falling in price by 40 per cent or more (a barrel of oil is down 70 per cent) how can any supplier claim their input costs are increasing? Any increases caused by the fall in the value of currency will be more than offset by the collapse in input prices.

Your defensive strategy should include preparing now for possible disruption of your supply chain. Disruption can result from suppliers going bankrupt, economic meltdown in countries, significant currency fluctuations and political unrest, so plan carefully how your business will manage it by developing detailed countermeasures.

In China the number of bankruptcies has increased significantly and this has led to an increase in social instability – imagine the chaos if a new political regime closed China’s borders to the West again, or Russia switched off the gas.

We need more than ever to be aware of currency movements and take them into account in all our procurement decisions. Given the volatility now inherent in the world economy, today’s low-cost destination of choice could be tomorrow’s high-cost country to avoid.

In this climate, it almost certainly makes sense to shorten your supply chain to reduce risk and vulnerability, so local sourcing could become the new must-do procurement strategy to replace the obsession with low-cost country sourcing of recent years.


These are unprecedented times. So our strategy for 2009 should be: be bold, be brave, act swiftly and be ruthless. Develop new offensive and defensive ideas and ways of working. Only then will you and your business have a chance to survive this economic tsunami.”

Thanks, Robin. We should all bookmark this. Post it on our desktops and build it into our work plan every day for 2009.

Find more articles by Robin and others at our ADI International web site. 

 

Damage Control = Cost Control

We were thinking here about how Wal-Mart wants to eliminate all returns from its suppliers over the next 2-3 years and it reminded us that even though you expect the carrier or supplier to cover the cost of damaged products — it still makes sense for buyers to take an active role.

Here’s what our consultant Fred Parkinson had to say on the matter.

When products or merchandise that arrive at your loading dock damaged – what do you do? Could the damage have been prevented? What are the actual costs, both direct and indirect, of managing product that has to be returned or discarded?

Prevention 

OK, you can’t control weather or sloppy package handlers, but you can write packaging specifications into your product orders. Purchasing should call on other departments within the company to help develop specifications and shipping requirements that will insure the integrity of the product when it arrives from the supplier. 

Your supplier should also be used as a resource to develop the packaging and shipping requirements because they likely have dealt with damage returns in the past.

Your parts supplier may guide you to its corrugated supplier, who will likely have a packaging engineer or designer whose services would be available to you free of charge. 

The transportation carrier should also be able to provide or recommend shipping solutions that will get the product to your dock without being damaged. Maintaining good supplier relations will help you in times like these when you need to draw on their expertise.

Costs

The hidden costs associated with returning damaged product may include:

·      Warehouse labor costs, both at your facility and at the suppliers plant, that result from handling the damaged goods three or four times.

·      Administrative labor costs of notifying the supplier of the problem, submitting claim forms with the carrier, arranging for pick ups and expediting a replacement shipment.

·      Inventory costs associated with carrying a larger safety stock if the problem is a reoccurring one.  If the product is being imported the pipeline will be substantially longer, which will also have a big impact on how much safety stock has to be carried.

·      Accounting labor costs to process and handle multipliable invoices and credit vouchers.

·      Cash flow issues while claims are being settled or waiting for credit.

·      Lost sales revenue from being out of stock and customer dissatisfaction which may result in loss of business long term.

All good suppliers and carriers will cover the obvious expenses, but when you calculate these hidden costs – you can see why it’s in the interest of buyers to take active steps to prevent damaged goods from arriving at their plants.

 

Roller coaster diesel prices may be masking a new carrier pricing cycle

They took off like a rocket and fell like a stone. The spike and subsequent plunge in diesel prices over the last six months has quieted many analysts who are normally quick to give you a prediction of fuel costs. Roll in the unknown effects of a global credit freeze, a stock market free-fall and you have a shipping environment unlike anything we have seen in the past.
David McClimon, who has spent over 28 years in the transportation industry and most recently ran Con-way Freight, is now advising some of our clients on their transportation and logistics issues. I asked him to contribute to this blog, and here’s what he had to say….
——
Before the spike, carriers had been chasing a declining level of tonnage, keeping rates low. During the price spiral, fuel surcharges swung the price pendulum emphatically the other direction. As fuel prices came down, common wisdom would expect the pressure to keep rates down would exert itself again. This seems especially true as shipments in core industries such as auto have dropped dramatically. In short, any company that is still shipping should be in the driver’s seat on prices.
Before we all celebrate too much, though, there are warning signs ahead. The surge in diesel fuel prices put many marginal carriers right out of business. According to America’s Commercial Transportation research group, more than 45,000 vehicles, or 3% of the tractor fleet, have disappeared from the industry since last year. Carriers with at least five trucks are going out of business at an accelerated pace. The American Trucking Association reports that in the first quarter of 2008, 935 operations shut down. This is up from 385 in the first quarter of 2007 and is the highest quarterly failure rate since the 2001 recession.
Don’t expect the contraction to end quickly, either. There are analysts projecting truck capacity in the U.S. to drop at a rate of 2% per quarter, or 6% by mid-2009. Add that to the number already gone and we might have a total capacity loss of more than 10% over an 18-month period.
When the economy turns, capacity is not likely to come back as quickly as demand, and prices may rise accordingly. Of course, no one is ready to predict the timing or the pace of a turnaround, so there is considerable uncertainty in the market.
Whenever uncertainty is high, risk is also preeminent. Here are some ways to mitigate risks if your business expects to survive this recession and capitalize on a recovery:
1.    Be sure your fuel surcharges are current – based on latest, falling prices. With barrel prices collapsing a week’s change could be a big change.
2.    Assess the financial health of your most important carriers. Do they have the resources to deliver right through a recession? Failure of a strategic supplier could disrupt your supply chain during a downturn. Weigh the benefits of leveraging now with the risk of losing the low-bid carrier to bankruptcy and the cost of lining up new carriers when the capacity is scarcer and carriers have the upper hand.
3.    If you see an opportunity to take advantage of current overcapacity, do so carefully. Evaluate each situation individually. You might be able to lock in long-term base rates that make you look very good in 18-months, but only if your carrier is still in operation. There is no good reason to leverage your current advantage into a supplier failure.
In summary, look through the wild swings of fuel surcharges to the fundamentals that are still at work in logistics. Don’t get caught up in driving prices down unless you have carefully assessed your supplier.
Establish relationships, because if you plan on being in business 18 months from now, you want your primary carriers to be in business as well. Those shippers that have been able to develop long lasting relationship with their carriers, vs. taking advantage of short term pricing pressure opportunities will be in the best position when the power of the pricing pendulum swings in favor of the carrier.

China Smog

We’ve been helping our clients source from China for years, but recent developments leave some uncertainties surrounding China as a first choice for sourcing manufactured goods.

The obvious first issue that has us reworking calculations for our clients is fuel prices. They are a significant part of shipping costs – regardless of the mode of transportation. Longer routes are clearly more susceptible to significant price increases. Transportation costs in some cases must be factored in twice – once for moving raw material to the factory and a second time for shipping the manufactured product to your loading dock or customer. When we advise clients about strategic purchasing decisions we ask them to look all the way back through their supply chain, just so they can assess factors such as that.

A second issue coming from Chinese sourcing is risk – not just from the longer travel times or distances from China — but the potential for disruptions coming from disclosures of unsafe goods or manufacturing practices. Major companies that should have done better due diligence have been burned.

Even with these cautions, China still has a tremendous attraction for buyers. The difference in the cost of labor is still striking, and in many kinds of manufacturing Chinese technology is state-of-the-art. But like good investors who review their portfolios every quarter, purchasers ought to review their cost and risk calculations whenever there are significant changes in their supply chain. That is certainly the case right now.

If your firm is considering sourcing in China, it is essential that you look for a partner with resources on the ground in Asia and the United States to help manage the relationships and risks. The cost of a trusted representative in China is likely to have a quick payoff in several key areas:

·      Understanding the protocols of Chinese business

·      Inspecting manufacturing sites

·      Ensuring that your supplier meets your social responsibility and ethics compliance requirements

·      Providing technical and logistics support to assure that your specifications are understood, met and delivered to your location without incident

·      Monitoring market conditions to make sure changes such as those we are seeing now continued to be factored into your sourcing decisions.

Many businesses rely on trading companies to represent them overseas, however, considering what’s at stake, a sourcing agent with a broad reach and on-the-ground resources looking after your interests is generally a better bet.  The cost of bringing in a qualified partner may offset some savings in year one, but it’s money well spent to deliver long term results.

Flip the switch to Cost Containment

We enjoyed a supply managers’ market for over a decade where cost improvement and value improvement was a way of life. But record commodity prices, like $100 per barrel of oil, record wheat and soaring precious metal prices, has not only penetrated many of our supply chains, it has had a profound impact on the U.S. and global economies.
Supply managers are kidding themselves if they are not planning for cost increases in steel, aluminum, plastics, chemicals, freight, fuel, capital equipment and travel resulting from the dynamics of oil and energy markets. Many suppliers, working on already thin margins, will be aggressively pushing through price increases in 2008. Before they hit, here are three things to do to prepare for them.

1. Forecast your exposure. How much do you know about your suppliers’ cost structures? How much is actually tied up in commodity materials that are rising rapidly in price? If you can’t realistically do a full cost analysis, you can do a price analysis of your suppliers’ materials inputs. Knowing that could help create a negotiation environment where costs become transparent and the discussion turns to cost containment solutions for you and your supplier both.  For instance, there may be alternative designs or materials worth considering.

2. Condition against increases. Your expectation should be that over time your suppliers should be continuously improving — creating efficiencies that bring more value for your purchases, or lower your costs. Make it clear that price increases run against the grain of those principles. They should be hard to accept and suppliers should know that. Requesting an increase should be “difficult,” requiring the sales representative to work hard. Demand three months notice, in writing, of all increase requests and insist that they are accompanied by a detailed statement of the actions the supplier has taken to reduce or eliminate the need for an increase. A rigorous internal approval system will deter supply managers from recommending increases they might otherwise waive through because of time pressure or the desire for a quiet life.

 3. Preempt the increase. If you haven’t already, this is a good time to investigate other suppliers, prepare RFQs or RFPs and distribute them before you receive requests for higher prices. Find out what changes your suppliers have made. A new plant might have brought productivity improvements that would justify a price reduction. The same might be argued about higher volume sales covering the same overhead. Working ahead of your supplier could change the whole structure of the negotiation in your favor.

All these actions can prepare you for the inevitable.

The best way to find your weakest link is NOT by hammering on every one.

Chrysler’s production hiccup this week is a great lesson in how and why. How NOT to treat a strategic supplier and why risk management is a worthwhile investment. They are both related, because let’s face it, if you leverage your suppliers for cost reductions to the point of bankruptcy, you’d darn well better be watching them verrrrry carefully for signs of distress, and be prepared when you leverage them right into bankruptcy court.

Do we really think that Toyota or Honda would let a critical supplier slip into bankruptcy without sending in a few troops to help sort things out? Not that they would be inclined to push a supplier into that position in the first place, but if the price of petroleum is creating a crisis with a supplier, either one of them would be working with their supplier to find solutions.

Supply chains are only as strong as their weakest links – that’s an easy truth. Finding where the weak links are and taking steps to mitigate risks before they turn into losses – that’s harder. You can’t plan during a crisis, you can only plan ahead of a crisis.

Here are some tips that I have presented and published before, but seem particularly relevant today.

One way to start is by creating a two dimensional grid. Across the top, identify the “disruptors”:

• Weather
• Disasters – natural or manmade
• Political instability
• War
• Terrorism
• Economic or Business changes

Working down, identify each link in your supply chain and all critical categories of supplies. Consider indirect spending categories as well as tracing sources for what your company might manufacture or distribute. A few examples to start a list:

• Outsourced components
• Raw materials – for your company and its suppliers
• Energy or fuel
• Transportation and logistics
• IT and communication

To really benefit from this kind of analysis you will need a comprehensive understanding of the supply chain for all critical ingredients and packaging materials your company requires. This means tracing your suppliers’ raw materials to their source with the assistance of your purchasing organization.

If your list is comprehensive and your information good you can simply consider each box in the grid to highlight your most vulnerable links. Using the grid systematically might unearth weaknesses in unexpected areas, as well.

Develop a Supply Chain Risk Management Plan

The best way to anticipate disruptions is to create a cross- functional team comprised of purchasing, manufacturing, research and development, marketing and quality personnel to create options for dealing with the vulnerabilities. If you realize that alternative materials or designs might have to be put in place, a testing program will likely be required to ensure that the integrity of the final product is not compromised. This team will have to buy the alternate supply sources and specifications you’ve designed.

This emergency action plan includes the following:

• Comprehensive documentation of the supply market including potential suppliers, their capacities and their capacity utilization
• An analysis of the supply chain down to the basic raw materials to understand vulnerabilities
• Critical review of specifications to understand how changes may be incorporated
• A detailed implementation plan

Interestingly, the thought process associated with building an emergency action plan may have some serendipitous beneficial consequences. By reviewing supplier relationships, you will gain in-depth knowledge of these companies, their capabilities and their relationship with their own suppliers. You will also acquire a more complete understanding of your specifications and how you can achieve the desired finished product.

Chrysler and Plastech — a preventable fiasco

Better supply chain risk management would have prevented a shutdown of Chrysler LLC factories this week caused by a dispute with Plastech Engineered Products, Inc.

It is unfortunate that many companies assess the vulnerability and risk in their supply chain after a catastrophic event occurs. The best practice in supply chain management is to have a detailed risk management plan, which would have anticipated scenarios such as a bankrupt supplier and set up contingency procedures.

For example, a set of duplicate tooling for critical plastic components might have been cheap insurance for Chrysler. It’s easy to see that in retrospect, but it’s also possible in many cases to assess risks in time to mitigate them. Tools are available to identify potential trouble spots by analyzing key supply chain risk factors. Those predictive models can spot troubled suppliers or other potential problems that can disrupt supplies.

Chrysler’s dilemma also points out the dangers when big companies use too much leverage to try to force down prices from their suppliers. It is unfortunate, but as the economy continues to worsen and prices for basic commodities soar, suppliers that have been leveraged by their customers are bound to fail.

Here are some early warning signals of suppliers who are in trouble.
• Constant price increases, early payment, accelerated payment terms or direct financing
• Consistently using your technical support
• Failure to support sales
• Failure to meet on time in full deliveries
• Requests for pre-payment
• Lack of investment
• Failure to appropriately cut costs during economic downturns
• Delinquent paying taxes
• Deteriorating accounts receivable and payable
• Employment of business turnaround specialists
• Introduction of many consultants – especially business turnaround specialists
• Lack of maintenance
• Negative variances from projections
• Payments on insider debt
• Use of third parties and factoring companies
• Loss of business or market share
• Recent rapid growth in sales volume
• Lack of focus by management or response to requests

Even before you spot those warning signs, here’s a few techniques for managing supplier relations and avoiding troubled suppliers.
• Conduct proper due diligence on the front end
• Periodically audit suppliers
• Create a program to effectively select and manage the supply base
• Conduct internal training for purchasing agents, accounts payable, quality control and plant managers so they can recognize potentially troubled suppliers
• Create a proactive Supply Chain Risk Management strategy