From the October 2011 issue of Treasury & Risk magazine

So Long, Just-in-Time Inventory

In an interconnected world, companies aim to collect more data on where risks lie, use new tools and put programs in place to better ensure supply-chain resilience.

Large corporations, especially manufacturers, have sought since the 1990s to lower their working capital costs by reducing inventories to the bare minimum, requiring suppliers to deliver parts just in time, with little room for error. Consequently, they’ve outsourced production of parts to long chains of suppliers stretched around the globe. So while 10 years ago inflation in China and Brazil or the tsunami in Japan were important news, today companies are so tightly interwoven that distant events can quickly halt production, battering their bottom lines.  The danger to supply chains has been compounded recently by skyrocketing prices in commodities ranging from oil to metals to cotton.

But perhaps the biggest wake-up call was the financial crisis, which sent stock markets crashing from the fall of 2008 into 2009 and caused a drop in economic activity not seen since the Great Depression.

Indeed, supply-chain resilience has reportedly become the topic du jour at company board meetings. “I’ve heard this four times in the last week from potential clients … that the board of directors is very concerned about supply chains,” says Michael Chagares, executive director of risk management at Accenture. “They’re concerned the company will not be able to get its product to market in a timely fashion, and they want to know what the company is doing about it.”

Another recent trend complicating matters is that corporate buyers want a greater variety of parts from suppliers. That’s especially true in the auto industry, where manufacturers are changing models more frequently, says John McGill, chief procurement officer at BorgWarner, a manufacturer of powertrain technology for car companies with $5.7 billion in 2010 revenue. “More assortment means smaller orders and therefore less economies of scale.”

And since BorgWarner relies heavily on its own bevy of suppliers, often buying completed castings and other parts instead of producing them itself, that means a more complicated supply chain, and more risk. “The buying decision has become incredibly complex, partly because of the globality of the purchase and the amount of transportation required, but also rising commodity prices and products change much faster than ever before,” McGill says.

Although multinationals have always sought to manage supply-chain and other risks, the recent spate of natural and man-made catastrophes highlighted the need to take a deeper look. Identifying, measuring and mitigating risks have become a corporate mission.

BorgWarner, along with other companies, saw many of those risks spotlighted by the financial crisis, when suppliers’ access to financing all but dried up and revenues plummeted. “Purchasing people in 2009 spent as much of their time managing risk and understanding and determining alternative sourcing scenarios as we spent on cost-reduction efforts,” McGill says.

In 2010, under the direction of the company’s board and treasury department and taking into consideration recommendations by Aon Global Risk Management, BorgWarner established more than 20 cross-functional teams to examine different risk categories. Each team was charged with defining the risk, measuring it and devising steps to mitigate or reduce it.

One major area of supply-chain concern is interruptions, such as a supplier shutting down its assembly plant even for a short time, a situation that could cost the company millions of dollars, McGill says. Another is exposure to commodities, where prices became much more volatile after 2003, he says. “When China’s market began gaining momentum and its need for raw materials spanned the globe, we saw dramatic increases in the prices of commodities.”

Greg Tayler, senior vice president in the global manufacturing and supply chain group at $21.6 billion Xerox Corp., says the company’s main supply-chain activities and strategies have been reviewed at the board level for a number of years. Today, Xerox’s broader risk management activities, including business continuity plans, are under board scrutiny, with supply chain playing an important role within that. “My sense is that boards are extending greater oversight in these areas across corporations,” Tayler says.

Because supply chains that stretch around the world can be affected by a wide variety of events, whether a localized natural disaster or a global financial panic, early warning systems have grown in importance. “We’ve seen good work done around weather and understanding which suppliers are exposed to certain weather conditions and when those conditions are moving their way,” says Laurie Champion, managing director of Aon Global Risk Consulting’s enterprise risk management practice. “If a buyer sees a big storm that’s three or four days out, it could ask a supplier [in its path] to accelerate production.”

But there’s no warning for some devastating events. Tayler says Japan’s tsunami was catastrophic for the Japanese people. Xerox was also affected. It reported that second-quarter revenue from technology, representing the sale of document systems, supplies, technical service and financing of products, was down as much as 4%, primarily as a result of supply constraints stemming from the natural disaster. Fortunately, Xerox worked closely with its partner, Fuji Xerox, to share raw materials in short supply and find alternative supply sources when necessary.

“It was disruptive, but we were able to manage through,” Tayler says.

It helped that Xerox has been building a globally integrated platform to manage its supply chain for the last eight years. The company quantifies the risk of its primary suppliers annually, and it already works with many of their suppliers to understand the risks they pose. To make its supply chain even more resilient, Xerox is building visibility tools within its supply chain system and pushing those tools out to its primary suppliers and their suppliers.

The tools will ultimately allow Xerox to track the underlying components of its products not only as they move from supplier to supplier, but also as suppliers are building them. “The ideal state of resilience is to provide a predictable degree of supply, and tracking that is the most important part,” Tayler says.

The “critical piece” is linking suppliers’ system requirements to Xerox’s core systems requirements, he says. That’s partly a matter of compatible software and systems but also ensuring that suppliers have the proper data management and structure in place. Tayler adds that Xerox is at least one or two years away from such detailed tracking of its sub-tier suppliers—the hardest part—but says that as the project progresses, the company’s understanding of where risks lie in its supply chain continually improves.

That understanding is crucial, of course, since a disruption several links down the supply chain can create dire situations for manufacturers. Getting past that first layer of suppliers, however, can be a challenge.

“Buyers must have very close relationships with the first tier of suppliers to talk to them and understand who their suppliers are,” says Eric Jones, an assistant vice president at FM Global and manager of its business risk consulting group, adding that property risk is often a “blind spot” for companies. “They tend to focus on issues such as quality, costs and margin pressures.”

McGill says the financial crisis taught BorgWarner that it must have multiple data points regarding suppliers, which “collaboratively paint a picture of a supplier’s risk.” The company hires consultants with which private-company suppliers are more likely to share financial data, since such consultancies typically translate the information into ratings or other indicators that don’t reveal proprietary details. And BorgWarner executives visiting suppliers now report back clues, such as parking lots with fewer cars or the firing of a plant manager.

“Those are all things that go in our database that didn’t before,” McGill says. “And we pay a lot more attention to what suppliers tell us about other suppliers. Maybe people who sell tools to one of our direct material suppliers say they haven’t been paid in a while, and we’ll start to get nervous about that supplier.”

Once shaky links in the supply chain have been identified and their risks measured so they can be prioritized, companies seek ways to reduce or eliminate those risks.

Jim Lawton, president of Dun & Bradstreet’s supply management solutions division, says the first strategy for manufacturers is to make sure they have more than one source for each part. However, that may be uneconomical, or it may be complicated by the proprietary nature of the part. In that case, Lawton says, the part can be redesigned to remove its custom features and make it more standardized, or to replace a component whose price has jumped.

And contrary to the just-in-time mantra of the past decade, some companies are selectively building their inventory of critical parts. “Instead of having a day’s worth for a safety stock, a company could have a month’s worth,” Lawton says. “So the company can ship for the next month while it deals with the issue.”

Tayler at Xerox says the just-in-time inventory concept came into vogue when interest rates were much higher, making the working capital to support that inventory costlier. Today’s historically low interest rates make carrying inventory less of a burden.

Recent events have also prompted Xerox to err on the side of caution, he says. “Since the crisis in Japan, we have made selective investments in inventory to increase stocks of crucial components.”

Ensuring an adequate inventory of goods is a major part of the value proposition of technology distributors such as Tech Data and Ingram Micro, which supply resellers with products from many manufacturers.

Robert Gifford, executive vice president of global logistics at Ingram Micro, notes that the company operates 100 distribution centers worldwide and says events over the past few years have not prompted it to increase inventory levels. Providing “buffer inventory” is part of its business, so the retail stores that are its customers never run out of stock. Ingram Micro’s million-square-foot distribution center in Jonestown, Pa., was inaccessible for three days after Hurricane Irene in August, Gifford says, but similar facilities in Toronto, Chicago, Dallas and Millington, Tenn., enabled the company, with $34.6 billion in 2010 revenue, to never “miss a beat” in supplying customers who needed goods.

Their role as distributors in the dynamic technology industry, where new products and models are constantly being launched, has prompted Ingram Micro and Tech Data to develop highly sophisticated supply-chain networks and systems. Executives at both companies say that expertise has been especially attractive to manufacturers buffeted by many other concerns.

“We’re seeing an increase in business from manufacturers who historically thought they could operate in a one-tier environment, where they make the products and sell them,” says Charles Dannewitz, treasurer and senior vice president at Tech Data, which had $24.4 billion in 2010 revenue. Logistics have become too complex for companies to do that efficiently, he says, and distributors such as Tech Data offer a variable-fee model that’s attractive in difficult economic times.

In fact, Ingram Micro and Tech Data now offer logistical services that run large portions of customers’ supply chains. “We started this business seven years ago, but it’s really taken off in the last couple of years,” Gifford says.

Since neither Tech Data nor Ingram Micro manufactures products, and their suppliers tend to be large, often cash-rich technology companies, they rarely confront the issue of how to deal with a single-source supplier. Not so manufacturers.

BorgWarner is always looking at whether it should have one or more suppliers for a product, McGill says. Keeping an inventory of important parts from single-source suppliers can make sense, he says, although at BorgWarner, any inventory increases tend to be balanced by more effective parts management elsewhere.

The rise in commodity prices led BorgWarner to redesign some products. Because of nickel’s soaring price, for example, the company has reduced the amount of the metal to the lower end of the specification range in some products, McGill says. “You may put nickel in a casting because it’s very stable at high temperatures, but some products may be over-engineered and simply don’t need as much nickel.”

And some commodities may be replaced by less costly ones. “When the price of magnesium gets low enough, it can be a substitute for aluminum in castings,” McGill says, adding that BorgWarner has long taken supply-chain precautions, such as locating production facilities close to customers and limiting its exposure to any one supplier.

“We also try to look for suppliers that are not in the auto industry,” McGill says, noting that if most of a supplier’s revenue comes from a major automobile manufacturer and that buyer pulls the program, it could put the supplier in dire straits. “Plus, if any of the Big Three have a big position [at the supplier], then we’re second, third or fourth in line,” McGill says.

HanesBrands, an apparel manufacturer, produces 70% of its products in-house and outsources the rest, and it has no single-source suppliers. “We don’t have any suppliers who are the only people in the world who can do it,” says Rick Moss, the $4 billion company’s treasurer.

HanesBrands spreads its risk geographically, Moss says. Nevertheless, its suppliers can face challenges funding their operations in these tough economic times. And following its 2006 spin-off from Sara Lee, heavily leveraged HanesBrands pushed suppliers to accept 55-day terms instead of 30-day, another potential financial thorn in their sides.

“A buyer can put more risk into its supply chain, because suppliers have to finance longer tenors and they can be stretched,” says Michael McDonough, supply chain product director at J.P. Morgan Treasury Services.

Adoption of the 55-day-term initiative has been successful, Moss says, but in response suppliers often seek higher prices. To prevent that and also help its suppliers stay financially sound, HanesBrands is working with its banks to launch a supply-chain finance program early next year, mainly for non-U.S. suppliers.

Such programs are another way to build supply-chain resiliency. Banks and vendors such as PrimeRevenue and Ariba offer supply-chain finance programs that give buyers and suppliers greater visibility into supply flows. Suppliers gain more certainty as to when and how they will be paid; in some programs they can get paid earlier if they are willing to accept a discount

Once HanesBrands’ banks receive an approved invoice from the company, they will fill a supplier’s payable sooner than 55 days, if the supplier is willing to take a discount. Since HanesBrands pays the full amount at the end of the term, the bank is taking on the apparel manufacturer’s risk. Moss says the program will enable HanesBrands to ease its own financial obligations by extending its 55-day-term initiative to more suppliers.

“Now it’s at 70% to 75% of suppliers,” Moss says, adding that following implementation of the supply-chain finance program, “We’re hoping we’ll get closer to 100% compliance with the 55-day term.”

 

For a look at the factors involved in quantifying supply-chain risks, see Property Risk Blind Spot. And amid the increasing focus on supply-chain risks, a recruiter says top-level supply chain executives are hard to find.

For a look at the Japanese disasters earlier this year and how they affected supply chains, see Crisis Mode in Japan.  And Sweet Notes on Supply Chain Finance looks at how Big Lots treasurer Jared Poff provided financing options for suppliers.

 

 

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