Enterra Insights

Shipping Industry Update: Going Big and Going Green

Because part of Enterra Solutions' business involves port and harbor operations and security and because shipping is an integral part of the supply chain, I watch what is going on in the shipping industry. Last year, as the global recession started to wane, I noted that the shipping industry, which had been hard hit during the recession, was starting to recover (see Stormy Seas Seem to Be Calming for Shipping Lines, Shipping News Keeps Getting Better, and Maritime Shipping Forecasts Remain Positive Despite Slowing Growth). The news has been especially bright for lines specializing in container shipping. At least one shipping line, Maersk, believes the future looks bright. It has ordered ten of the world's largest ships to be built with the first one expected to be delivered in 2013 ["The Triple-E Maersk container ship will be the world's largest ship and the most efficient," by Jack Martin, Gizmag, 21 February 2011]. Martin reports:

"Korea's Daewoo is to build the world's largest ship for Mærsk line. The US$190 million, 400 metre 'Triple-E' class bohemoths will carry 18,000 TEU containers, 2500 more than the current largest, Emma Mærsk. Superior economies of scale will enable the new monsters to surpass the industry record for both fuel efficiency and (20% better) CO2 emissions per container moved. In a move set to impact global shipping transport costs and efficiencies, ten Triple-E ships will go into service between 2013 and 2015 with a further 20 ships optioned. If the same number of containers were loaded on a train, it would be 110 km long. If they were stacked on top of one another, they'd reach beyond the stratosphere (47 km)."

Admit it -- you're impressed. That is one big ship. The Financial Times published a terrific video about the Triple-E. It takes about 4 minutes to watch. Maersk is apparently not alone in its desire to have bigger ships. "These days, Choe Yong Seok of Daewoo Shipbuilding & Marine Engineering in Seoul has been getting calls and e-mails from clients asking whether the company can build ships that can carry 20,000 20-foot containers, more than double the capacity of today's most common vessels." ["A Trade Rebound Launches Bigger Boats," by Kyhunghee Park, Bloomberg BusinessWeek, 9 December 2010]. Bigger ships mean better efficiency -- if they can be filled to capacity -- and companies believe big ships are more environmentally friendly. Many analysts believe that more and more companies are going to try and reduce their carbon footprint for both PR and profitability reasons. Maersk must certainly believe that to be true since it is advertising the carbon reducing features of its new class of ship. As Martin puts it, "The vessel's enormous capacity will enable Maersk Line to move the greatest number of containers possible for its customers in the most energy efficient way and with the smallest CO2 footprint." The image below indicates how some of these efficiencies are being made (click to enlarge).

Martin reports that "the Triple-E isn't just the largest vessel of any kind in operation today: it is actually the longest and widest container vessel possible based on port restrictions." Although the Triple-E will be able to carry 16 percent more TEUs than the Emma Mærsk (the company's E-class ship), it will only be four meters longer and three meters wider than that ship. Martin continues:

"The Triple-E's enormity is actually in its bulk. Through feats of engineering, the Triple-E's vastly expanded inside cavity gives it a capacity 16 percent greater than Emma (equivalent to 2,500 containers), despite relatively little change in the length and width. Unlike Emma Mærsk's more typical V-shaped hull which limits container capacity towards the bottom of the 'V' in the cargo holds, the hull of the Triple-E is more like a U-shape. An additional row of containers was added to the Triple-E as well, giving it 23 rows across its width, compared to Emma's 22. The more spacious hull and extra row provides additional capacity for 1,500 containers. Additional container space has been created in the vessel by moving the navigation bridge and accommodation 5 bays forward and the engine room and chimney 6 bays back in what is called a 'two-island' design. With the more forward navigation bridge, containers can be stacked higher in front of the bridge (approximately 250 more) without losing visibility. And approximately 750 more containers fill the space behind the bridge above deck and below deck using the space created by the engine room's position further to the back of the vessel."

As noted above, with a length of over four football fields (400 meters), Triple-E ships will be the longest vessels plying the seas. For purposes of comparison, Martin notes that the Emma Mærsk class vessels are 396 meters long, the super tanker Berge Emperor is 380 meters long, the cruise ship Allure of the Seas is 361 meters long, and the carrier USS Enterprise is 341 meters long. He reports that "the largest ship ever built was the super tanker Knock Nevis which was 458 metres long but is no longer in service and is being scrapped." Whereas the USS Enterprise operates with a nominal crew of 3200 (plus an additional 2480 personnel when the air wing is aboard), Triple-E ships can only accommodate 34 persons and will be operated with a standard crew of a crew of 19 seafarers (although it can be operated with as few as 13 people).

Triple-E ships will be capable of traveling at 23-knots, but they will be purpose-built to travel more slowly. As the graphic below indicates, the ships will be able to reduce their CO2 emissions significantly by traveling 8 knots slower than their top speed.

Traveling at reduced speeds has been a standard industry practice since the price of a barrel of oil shot up several years ago. With oil prices currently predicted to stabilize around $100/barrel, the practice of slow steaming probably won't change in the future. When it comes to maritime shipping, Elisabeth Rosenthal insists, "Slow is better." ["Slow Trip Across Sea Aids Profit and Environment," New York Times, 16 February 2010]. She writes:

"By halving its top cruising speed over the last two years, Maersk cut fuel consumption on major routes by as much as 30 percent, greatly reducing costs. But the company also achieved an equal cut in the ships' emissions of greenhouse gases. 'The previous focus has been on "What will it cost?" and "Get it to me as fast as possible,"' said Soren Stig Nielsen, Maersk's director of environmental sustainability, who noted that the practice began in 2008, when oil prices jumped to $145 a barrel. 'But now there is a third dimension,' he said. 'What's the CO2 footprint?' Traveling more slowly, he added, is 'a great opportunity' to lower emissions 'without a quantum leap in innovation.'"

Not everyone is totally pleased with slow steaming strategies, "Federal Maritime Commission Chairman Richard A. Lidinsky Jr. says ... that the agency should assess the economic effects of slow-steaming to ensure the practice is not causing 'unreasonable constraints' on the international supply chain." ["FMC wants to look at Impact of Slow Steaming on the Supply Chain, as for More Disclosure from Carrier Alliance Meetings," Supply Chain Digest, 13 January 2011] Lidinsky's concerns seem to focus on "'extra slow steaming,' in which speeds are cut to 12-16 knots, which research company Alphaliner estimates is used on half the Pacific to West Coast routes and an astounding 9% of Asia to Europe lanes." The article concludes:

"While the practice does reduce CO2 emissions and other pollutants, the real driver of the approach was the collapse in ocean shipping rates and much excess capacity in the industry. Slow steaming allowed carriers to save significantly on expensive bunker fuel consumption (by as much as 60%), and the longer voyages due to the slower speeds had the effect of reducing industry capacity. In the terrible economic climate, shippers and importers were willing to incur longer shipping cycles and more inventory risk to reduce logistics costs. ... [The Transpacific Stabilization Agreement (TSA), a consortium of carriers serving the Asia to US market,] now wants to an OK from the FMC to look at increased use of alternative fuels, 'cold-ironing' (powering a ship from shore when it is at berth in port), and the use of other technologies to reduce air emissions. 'While these practices hold promise for reducing vessels' emissions, the Commission will closely monitor slow-steaming arrangements to ensure that they do not cause unreasonable constraints now that international shipping demand has recovered,' Lidinsky said."

Although shipping lines are primarily concerned about costs, they are increasingly combining cost and carbon emission reduction efforts. For example, the Transpacific Stabilization Agreement consortium was given permission by the Federal Maritime Commission to talk collectively about slow steaming practices under the guise of environmentalism. There is good reason for the industry to concern itself about carbon emissions, "The industry accounts for some 3 per cent of world carbon dioxide emissions – about the same as aviation – and it has come under considerable pressure to reduce them." ["All energy savings on deck," by Robert Wright, Financial Times, 24 November 2009]. Wright reports:

"The industry is convinced that modern, efficient ships have a role to play in cutting carbon dioxide emissions for each tonne of goods moved. The International Chamber of Shipping, a confederation of shipowners' organisations, says the sector has cut emissions per tonne shipped by about a quarter since the 1970s. That could be cut by a further 15 to 20 per cent over the next five to 15 years, they believe. ... Overall energy saving on modern ships comes from a package of measures ranging from using more energy-efficient light bulbs to improving hull design, says [Bo Cerup-Simonsen, head of Maersk maritime technology]."

Among some of the technologies being explored include engines, alternate energy sources, propellers, paint, and air lubrication. "The marine industry is gearing up for the biggest revolution since World War II," says Lee Sokje, an analyst at Mirae Asset Securities in Seoul. ["Big Ships Go Green," by Kyunghee Park, Bloomberg BusinessWeek, 17 May 2010]. Park reports:

"Nippon Yusen, owner of the world’s second-largest fleet, is sinking $743 million into emissions control over five years. Among other things, the Tokyo-based company has been testing what it calls an 'air lubrication' system that reduces CO2 by approximately 10 percent and is considering putting it to work on new ships. ... In time, Nippon Yusen hopes to combine an air lubrication system with others that harness solar and wind power to achieve carbon reductions of as much as 69 percent. ... Rivals, meanwhile, are exploring other routes to fuel efficiency. China Cosco Holdings is considering bringing back nuclear-powered cargo ships, introduced in the early 1960s. 'We're not only looking into nuclear but also wind energy and solar energy,' says Zhang Liang, president of China Cosco."

I wouldn't look for any alternative energy powered ships anytime in the near future. "Analysts warn that the cost of deploying some alternative energy technologies are prohibitive. 'Ship prices are going to go through the roof if any of these ships using renewable energy are built,' says Mirae's Lee." Since current maritime diesel engines are already pretty efficient, slow steaming strategies, improved hull designs, and drag reducing technologies are likely to provide the biggest reductions in carbon emissions. Port operators, of course, are watching this trend towards super-sizing because the Triple-E will push the limits of current super port capacity. Tomorrow, I'll discuss the shipping industries future from the port operator rather than the shipping line perspective.

Supply Chain Risk Management and Disaster Mitigation: Part 4

This is the final post in a four-part series on supply chain risk management. In this post, I'd like to discuss some hedging strategies and techniques offered by Bill McBeath from ChainLink Research. He notes that "global dynamics ensure that commodity prices will remain volatile, with huge price spikes, for decades to come. Good hedging strategies are increasingly critical." ["Managing Supply Risk Part Three - Hedging Strategies: Cross-Functional Teams," ChainLink Research, 16 November 2010]. For businesses, there are few greater challenges than dealing with supply chain disruptions. One challenge that approaches the level of concern created by disruption is volatile commodity prices. McBeath believes that cross-functional teams can help address this challenge. Long-time readers of this post know that I'm a fan of such teams. In numerous past posts on the subject of innovation and creativity, I have noted how assembling cross-functional teams can foster an environment for solving problems. McBeath writes, "Cross-functional teams are a great way to accomplish smarter hedging." He continues:

"The meteoric growth of emerging economies, in particular China, has had a dramatic impact on the price of raw materials and energy. With infrastructure construction in China continuing at breakneck pace, the world's supplies of steel, concrete, copper, and other commodities are diverted and prices have risen dramatically as a result. China will almost certainly continue its spectacular building spree for many years (probably decades) to come, and is being joined by India, South East Asia, and other fast growing regions. ... As much as commodity prices have risen in the past few years, they could rise to new unheard of heights. But not in a straight line; they will likely remain highly volatile for many years, if not decades, to come."

All supply chains eventually lead back to raw materials. For now, most of those raw materials continue to be extracted from the earth. In the centuries ahead, more raw materials are likely to come from recycled goods than from extraction -- but let's not get ahead of ourselves. McBeath notes that "price volatility does not apply just to raw materials." He explains:

"In many cases intermediate materials (e.g. titanium sponge or tantalum powder) or components (e.g. memory chips) can be constrained by the production capacity, which can be overwhelmed during periods of high demand. For these industries, it can take a year or two to bring significant new capacity online. When these shortages occur, prices skyrocket. All too often it seems that just as demand cools off, the suppliers have just managed to create significant new capacity which now far exceeds demand, and the prices drop like a rock. The bottom line is that sourcing personnel will have to learn to deal with commodity price volatility for many decades. That is why good hedging strategies are becoming an increasingly important element in the sourcing professional's arsenal of methods and skills."

McBeath discusses the importance of commodity price hedging strategies and I recommend that you read his article if it is a subject that affects your company. He points out that the problem with hedging strategies is that they are like insurance policies and there are bound to be corporate executives who whine if they are never used. He writes, "That is a little like complaining about the expense of buying insurance because you haven't had any fires or hurricanes to make those insurance costs worthwhile." Hedging strategies, of course, can be useful in more situations than just dealing with volatile commodity prices. Although McBeath's discussion about cross-functional teams focuses on the challenge of commodity prices, I think you will see how such teams could be useful for discussing other potential disruptions to the supply chain as well. He writes:

"One of the firms that we interviewed uses cross-functional teams to create and manage their hedging strategies, leveraging a complementary mix of knowledge and skills. This seems to be a very smart approach. Their team consisted of people from the following functions:

"Sourcing/Commodity Manager—Understands dynamics of supply markets, such as pricing trends, sources of supply, capacity constraints, risks (political, geologic/weather, etc.), overall consumption, etc. Knowledgeable commodity managers have a good handle on the overall capacity and the current and projected levels of capacity utilization (i.e. degree of supply constraint) for the industry supplying the commodity.

"Treasury—Expertise in financial and risk analysis, hedging instruments, accounting and regulatory requirements, tax and other consequences

"Engineering—Knowledge of emerging technologies and new designs that may dramatically impact the quantities of particular materials and components needed in each product being manufactured. The need for some materials may be dramatically reduced or eliminated altogether, and at the same time new ones arise. ...

"Product Management—Knows the product mix/roadmap, and forecasted volumes, all of which impact the firm’s expected levels of consumption of commodities. Also should know the overall industry growth rate, which can be used to estimate industry-wide consumption of commodities.

"Economist—Knowledge of the broader global conditions and long-term outlooks, which could impact both demand and supply."

That, of course, is not an exhaustive list of potential members of a cross-functional team. The make-up of the team should be determined by the kinds of challenges that confront the flow of supplies -- from natural disasters to weather to politics. In the final segment of his series on this subject, McBeath describes how one consumer packaged goods company uses hedging strategies to protect its business ["Managing Supply Risk Part Four - Hedging Strategies: Approaches," ChainLink Research, 30 November 2010]. To conclude my post, however, I would like to examine the research of one McBeath's colleagues, Michael J. Corby, who offers his thoughts on what constitutes a good business continuity plan ["12 Attributes of a Successful Business Continuity Plan," ChainLink Research, 13 April 2010]. Corby writes:

"Business Continuity Planning is the one of the four commonly linked components of an organization's risk management strategy. The distinction and relationship among the four components are commonly misunderstood. Often one component is confused with the other three. Frequently all four are combined into an overall process, which is good, but then handed off to a single person, or a small team of people who are charged with trying to satisfy the basic requirements of all of them in one fell swoop. This has generally proven to be an impossible task. All are important and each one has a specific critical role to play in resolving serious disruptions, but each one is a complex process and can require more effort than a single person or small group of people can accomplish. In Business Continuity Planning, shortcomings are like mistakes made in parachute packing. Neither one is recognized until it's too late, with very poor results."

In other words, risk management is a corporate responsibility and it requires broad support and participation. Corby obviously supports McBeath's assertion that the risk management process will be more successful if cross-functional teams are involved. Corby refers to "four commonly linked components of an organization's risk management strategy" which he depicts in the graphic below (click to enlarge).

Although each of the four components is important, Corby's article deals only with business continuity. He continues:

"Over many years of Business Continuity Plan development, I've come to recognize twelve telltale signs that often foretell the fate of the business continuity planning effort. Let's look at the role of Business Continuity Planning within risk management and these twelve indicators of success. Business Continuity Planning joins with Emergency Response, Crisis Management and Disaster Recovery Planning to create a comprehensive process for recovering from unexpected events that threaten stability or even the future existence of an organization. Business Continuity is often the most crucial element in determining whether an organization can survive a major disruption over the long run. While the other three are certainly important factors in reducing damage, saving lives and re-establishing a reliable snapshot of the organization's technology infrastructure, databases and transactions, all are rendered ineffective without a sound Business Continuity Plan (BCP)."

Before discussing his "12 attributes" of a successful BCP, Corby reminds us that all plans need to be tested -- a point I stressed in the last part of this series. He also provides the caveat that his 12 attributes "do not necessarily mean the plan will be a success, nor do they indicate that failing to demonstrate them foretells failure." Corby provides excellent discussions of each of his attributes and I recommend that you read his entire article. I'll only be providing the abridged version.

"1. Critical Business Functions Have Been Identified and Prioritized -- The root of a sound business continuity plan lies in the ability to quickly and accurately determine the most important business functions. To be effective, the inventory of all critical business functions (both manual and automated) must be created in advance and be accurate. This inventory needs to include factors that can change an item's priority, such as a cash management application that is extra important just before scheduled large payments like payroll or acquired inventory payments are processed."

Corby notes that "determining the truly critical applications can be a challenge." Sometimes the challenge comes because executives don't really know what their most critical assets and processes are and sometimes the challenge comes before they deem everything critical. As I noted in an earlier post, Enterra Solutions uses its proprietary Enterprise Resilience Management Methodology™ to help companies identify its core assets and processes. ERMM™ offers a strategic approach to analyzing an organization’s core infrastructure and assessing enterprise risk. It helps clients understand the connections between tactical decisions and enterprise strategy, with regards to critical practices, processes, and rules governing the enterprise. Corby continues:

"2. Recovery Time Objectives Have Been Determined for Critical Assets -- The impact of a loss or delay in completing a business function typically changes over time. Usually we find that most business functions do not result in a significant brand image or product creation immediately, even though the effect on product quality, regulatory compliance or direct revenue can be immediate. A temporary workaround can often be used for some period of time before the effect is actually felt, but in almost all business functions, that temporary fix can only be continued for a short time before it becomes cumbersome at best and totally ineffective. That point in time when the process must be restored is called the Recovery Time Objective (RTO). When connected to the revenue streams the RTO represents the maximum time that the facility, person, process or technology is unavailable or delayed until revenue is seriously impacted."

This is one of the areas that a business really needs to test. Guessing about your RTO could prove disastrous. For example, if your business suffered a fire that resulted in both loss of infrastructure and life, does your RTO account for the fact that critical employees might not be available to get back in operation? Corby continues:

"3. Recovery Point Objectives Have Been Established for Critical Applications -- Recovery Point Objectives (RPOs) are similar to Recovery Time Objectives except that they represent the tolerance for lost data once the process has been recovered or restored. For most computer applications that require data entry, archiving the source documents for re-entry will support full data recovery however the source documents may be lost or destroyed along with the computer files. Effective file and document archive procedures can help prevent losing these critical transaction records entirely."

In the case of the World Trade Center disaster, companies like Cantor Fitzgerald had moved their data bases offsite following the 1993 attack on the buildings. As a result, those businesses managed to restart operations remarkably soon considering the nature of the catastrophe.

"4. A Comprehensive Risk Assessment Has Been Conducted On Critical Facilities -- The risk of loss of critical facilities can be mitigated, but generally at very high costs. Successful Risk Management methods strive to achieve a risk mitigation strategy that it proportionate to the potential for loss. There have been numerous attempts at detailing the steps required for a thorough risk assessment strategy. As in many other processes, perfection is the enemy of the good. I've seen organizations get so mired in the details that the objective can never be met. If risk management efforts start at the lowest level of detail, chances are pretty good that before all the details have been tallied, the cost factors will have changed. Then what do you do? Too frequently the answer is to start all over. ... It is much easier to look at the four key elements of People, Process, Plan and Technology and to ignore the event that can cause a disruption, but instead look at the effect on those elements in only two categories: Total Loss and Significant Reduction in functionality. That transforms the target of the risk assessment from an infinite by infinite matrix by a much simpler four by two matrix. Only eight possibilities for each critical business function. By my calculation this is a much more attainable result."

I think what Corby is trying to drive home is that a little common sense can go a long way. Thinking about "black swans" is important and can help executives fine tune their instincts; but, cutting to heart the matter as recommended by Corby, executives can put in a place a "good enough" system that can serve as a foundation on which they can rebuild.

"5. Succession Plans Exist for Key Employees or Consultants -- One of the most overlooked aspects of successful Business Continuity Planning is the potential loss of key decision makers during the response and recovery time when their abilities are most crucial. If you want to see the impact of key decision makers in a Business Continuity Plan, try running a recovery test without certain key roles. Often the head of Corporate Communications, the Data Center Manager, the I/T Network specialist or the authentication server administrator has knowledge that eluded the recovery documents."

The point is that investments in a good training program and a robust internal communications plan that fosters lots of shared information could pay off big during a disaster. I agree with Corby that too often plans concentrate on things rather than people. The most valuable asset a company has is its people.

"6. A Technology Backup Strategy Exists and Is Tested Regularly -- Several years ago, an interesting I/T disaster Recovery approach was developed. Called the 'No-Plan Plan,' it prescribed that every day should be a Disaster Recovery exercise. ... Too often however, I/T Disaster Recovery Planning is confused with full Business Continuity Planning, but in reality it only represents part of the enterprises risk management strategy. I/T recovery can be fruitless if there are no available people or facilities to use the restored computer applications. Creating and testing is an effective element in Business Continuity, but it cannot become the sole activity."

Corby points out that testing an IT recovery plan without having to really disrupt operations can be tricky and time consuming. He concludes, "One philosophy I've used over the years is 'Don't create a disaster trying to test the recovery from one.'" In the last post, Daniel Stengel recommended using simulations to test your plans. Simulations allow you to push the system to its breaking point without actually disrupting operations. Corby continues:

"7. Multiple Sources Are Available for Critical Supplies and Processes -- Product quality and information privacy regulations make the task of identifying alternate suppliers more challenging. You cannot relinquish your need for proper controls over your alternate sources."

In my previous post, I discussed the importance of maintaining supplier risk profiles and supplier ratings to help address the point being made by Corby. Such tools need to be used for alternate suppliers as well as primary suppliers.

"8. People (an often overlooked critical business resource) Are Included in Business Continuity -- Recently, pandemic response planning has taken its place in Business Continuity Planning, both from an employee absence perspective and one that represents a dramatic alteration in public behavior (e.g. restaurants, public transportation, hospital care)."

Earlier Corby stressed the importance of continuity of leadership. His point here is that a pandemic can affect the regular work force as well as leadership. At what point would absences caused by a pandemic constitute a crisis for your company? It's worth thinking about. I know that there is some preliminary work being done to see how social networks could be used to help understand how a "dramatic alteration in public behavior" unfolds during a crisis. It is an area that deserves a lot more study.

"9. Tools and Training Are In Place to Provide Advanced Warning of Incidents -- The best Business Continuity Plans are ones that can be initiated very early before the interruption has progressed to the point of a crisis. Well-trained and practiced employees are the first line of defense in identifying situations that could become serious. Part of the plan is to teach employees to recognize the signs of an impending disruption in normal activity. Many computer incidents such as failing components, hacking attempts or infection by computer viruses can be recognized by intrusion detection and operations management tools. These components are often included in technology operations strategies, but they must be run and monitored to be effective."

Corby once again underscores the importance of training and exercising. Plans that sit on shelves gathering dust until they are needed are plans that are going to go terribly wrong at the worst possible time.

"10. All Projects Include a Disaster Recovery Component -- For complex I/T applications, experience has shown that developing Disaster Recovery (DR) elements after the application has been completed costs much more than anticipating DR needs during the design stage. Operational sync-points and offline versions of key data files can more easily be accommodated at the onset of the project. Many effective techniques exist for building a resilient facility that can provide risk remediation, especially for computer and communications capabilities. This capacity is often cost prohibitive in existing facilities, but over time, as plants are expanded, upgraded or acquired, these modifications can be made with minimal increased cost."

The old carpenters' adage "measure twice and cut once" should be applied to the planning of any facility. In other words, make sure you know what you are doing before proceeding. Corby is correct that the challenges of trying to bring old infrastructure up to snuff can be cost prohibitive -- just ensure that the alternative (failing to modernize) doesn't risk putting the company out of business if disaster does strike.

"11. Technology Domains Are Defined to Include Business Continuity and Security -- Technology can be used to effectively create a domain structure that enhances the ability to consolidate resources with similar requirements for Confidentiality, Integrity and Availability. Technical infrastructure and advanced processes can be applied at the domain group level, saving considerable costs and substantially reducing complexity. Most business units cannot justify the expense associated with providing a continuous availability strategy, rigorous monitoring or enabling strong authentication techniques. When several business units share the benefits and costs however, the expense can be more easily justified."

Like with so many other aspects of running a company, a business case has to be made for implementation of risk management procedures and systems. Cross-functional teams can help ensure that a good case is made when they are being designed. Corby concludes his list of attributes:

"12. Capacity Planning Includes Strategy for Increased Demand -- Business Continuity Planning is not exclusively for the restoration of processes after a disaster or disruptive event. Successfully executing an effective plan can also provide considerable benefits including increased market share. Like the old joke about the two guys in the jungle trying to outrun the tiger, Business Continuity Planning is the ability to respond more quickly and more successfully than competitors to gain a competitive advantage."

That's a lot information to take in; and, as I noted earlier, Corby provides even more information in his full article. Hopefully, this series of posts have given you some grist to think about.

Supply Chain Risk Management and Disaster Mitigation: Part 3

This is Part 3 of a 4-part series on supply chain risk management. In Part 1 of the series, I discussed the fact that many companies are overconfident in their ability to handle supply chain disruptions or seem to be in denial that disruptions could affect their business. In Part 2, I noted that experts believe that supply chain risk management remains in its infancy (which could help explain why so few companies have truly robust business continuity/disaster recovery (BC/DR) plans in place. In this post, I want to relay some expert advice about how to establish and test risk management plans. Before I examine what the experts are saying, however, I want to remind you that supply chain risk management is much more complex than simply dealing with "inside the chain" risks that could affect internal processes, suppliers, and customers. A truly robust supply chain risk management system looks outside the supply chain at weather, politics, demographics, etc. The more factors that a company takes into account in preparing its plan, the better prepared it will be for whatever eventuality occurs. Bill McBeath notes, "Early warning gives companies a much broader range of options to deal with potential problems in a systematic way" ["Managing Supply Risk Part One - Quantifying and Predicting Supplier Risk," ChainLink Research, 2 November 2010]. In his superb four-part series on this subject, McBeath begins by discussing "how companies [can] ensure continuous affordable supply by measuring supplier risk and anticipating potential supplier problems." He writes:

"Sourcing professionals are expected to predict and mitigate the constellation of risks that have arisen from increasingly globalized sources and supply chain complexities, involving orders of magnitude more players. But we shouldn't complain too much because risks = opportunities. Those who can handle this complexity, who create the agility needed to deal with supply disruptions, and who preemptively alleviate supplier problems, become valuable players within the organization. Managing supplier risks (non-performance, bankruptcy, etc.) as well as supply risk (industry capacity constraints, disruption of supply, allocation, etc.) has always been a core function of sourcing. However, with globalization and outsourcing, there are so many more things that can go wrong. The management of risk has taken on new dimensions of complexity and criticality, demanding new approaches and methods for mitigating risks."

As noted in previous discussions, gathering data is not simple because knowing exactly what should be gathered, how to interpret it once it is obtained, and when to act on the knowledge gained is as much art as science. In an ideal world, data would be gathered on as many subjects as possible, all of that data would be integrated, and a combination of artificial and human intelligence would help make sense of it all. In the real world, however, somebody generally makes an assessment of what risks could have the most impact on a business and most of the company's intelligence resources are focused on them. On the front end of this assessment, nothing is more important than reliable suppliers. McBeath continues:

"It is common sense, but not necessarily common practice to quantify the risks for each of your key suppliers. The approach taken by one major high tech manufacturer we talked to provides a good template for managing supplier risk. They group their suppliers into A, B, and C tiers, based on strategic importance, volume, and a few other factors. It is mandatory for their buyers to maintain a risk profile for every 'A' tier supplier. The risk profile incorporates elements such as financial health, political stability, infrastructure risks, and natural disaster risks of the regions in which the supplier operates. For example, some cities in China have frequent power outages, which can last days, which is disastrous for PCB (printed circuit board) manufacturing. The suppliers are ranked into risk categories—the lower the rating, the riskier the supplier. These are used in supplier selection and negotiations. Category 1 (highest risk) suppliers are never used. Use of category 2 suppliers (second highest risk) depends on the availability of alternatives. If there really are only one or two suppliers of a specific item or material worldwide, then this company may still do business even with a category 2 firm. If the supplier is important, the buyer will work with them to find ways to lower risks, but that is not always possible (you can't necessarily ask your supplier to build a new factory in a different geographic region). So, the sourcing group sometimes will go back to the design engineering group, to explore if there is a way to redesign the product to allow selection of a lower risk supplier."

Another method of mitigating a higher risk of disruption from a lower-rated supplier is maintaining a higher level of inventory from that supplier. Certainly that is not an ideal situation, but it is better than the alternative -- having no supplies at a critical time. Risk profiles and supplier ratings, however, are great tools to help make more informed procurement decisions. McBeath continues:

"The key lesson here is that supplier risk should be methodically measured for key suppliers and systematically used in the selection process. Exceptions (selection of high risk suppliers) must go through a justification process and trigger risk mitigation planning activities and actions. No more eyes half shut to supplier risks, just because we've always used them or know someone there!"

Having just emerged from "the so-called year of the catastrophe" and a global recession, companies should now be operating with their eyes wide open to supplier risks. As the global middle class continues to emerge, they will bring with them social upheavals and new opportunities that should not be overlooked. McBeath goes on to note that risk profiles and supplier ratings can be bolstered by actual supplier performance data. In many ways, the past is prelude to the future. He notes that one "large diversified industrial manufacturer ... found that having all their supplier performance data centralized proved to be very useful in helping them proactively manage supplier risk." Using this centralized data, the manufacturer has "been able to automate predictive supplier risk management." The manufacturer combines three sources of information, which are:

• "Publicly available data—such as credit worthiness, how quickly the suppliers pay bills, lawsuits, court actions, earnings, number of people on payroll, etc., all of which can be bought from companies like D&B and mined from publications and the web by bots (software agents for data mining and monitoring).
• "Qualitative supplier performance data—feedback and evaluation of suppliers by the people within the buyers’ organization: buyers, engineers, users, manufacturing, quality personnel, etc. Gather direct intelligence on how the supplier is performing relative to their peers from the individuals who are interacting with the suppliers.
• "Quantitative supplier performance data—their centralized database pulls actual performance data (e.g. on-time delivery, quality, etc.) from the companies' various execution systems."

McBeath reports that this data is used to analyze "patterns to predict in advance the risk of supplier failure. For example, if quality and delivery are faltering, the firm’s financial performance is shaky, and/or qualitative ratings are declining, then a red flag is raised." He goes on to note that some indicators (like deterioration in quality) "often precede financial declines." The most important point he makes is that "integrating these different sources of information creates a better predictive tool than viewing the data points in isolation." I couldn't agree more. One of the things we specialize in at Enterra Solutions is aggregating data in order to make sense of it. McBeath concludes:

"The ability to spot trouble ahead of time is extremely valuable. It allows [manufacturers to implement] mitigation strategies before there is a crisis. This gives them a broader range of choices in action and the time to act calmly and deliberately, avoiding expensive, sub-optimal, hasty reactions and possibly a very expensive, high-profile supply failure. By quantifying supplier risk and proactively monitoring and predicting potential trouble, firms can greatly increase the chances of ensuring uninterrupted supply at a price that they can afford."

To set the stage for the second part of his series, McBeath asks: "Do your key suppliers have a working disaster recovery/business continuity plan if one of their plants or critical IT systems goes down?" He then states, "If you don't know, you are inviting disaster." ["Managing Supply Risk Part Two - Supplier Business Continuity," ChainLink Research, 9 November 2010]. In parts 1 and 2 of this series of posts, I discussed the need for your company to have business continuity and disaster recovery plans. McBeath is suggesting that you should insist on your suppliers having them as well. He writes:

"As part of your overall risk strategy, it is important to ensure that your suppliers have good disaster recovery/business continuity plans in place. This should be a requirement embedded in your contracts with key contract manufacturers and suppliers. It is particularly important during seasonal or end-of-quarter loaded timeframes when the majority of a company's products are shipped and profits made. If disaster happens during that window of opportunity, it is vital to rapidly recover the critical processes and infrastructure or risk losing huge amounts of revenue, profit, and shareholder value."

McBeath goes on to describe how one company uses "several useful elements to [implement] their supplier disaster recovery strategy." Based on those elements, he believes that companies should:

• "Audit and qualify ... facilities owned by ... contract manufacturers as possible backup manufacturing sites. This allows [companies] to know ahead of time what they are working with, and pre-plan the necessary migration steps with their suppliers.
• "Use inventory management to minimize the impact. ...
• Have a very complete and up-to-date list of product-specific tooling – test fixtures, board fixtures. If disaster strikes, they won't have to spend days trying to recreate that information, hoping their suppliers might have it. Instead, [companies know] exactly what they need in order to recreate the entire setup. ...
• [Build] priority clauses ... into their contracts. [Negotiate] 'go to the front of line' clauses with key suppliers. ... This provides valuable insurance, well worth the small added cost. A buyer with large volumes may be able to negotiate this type of priority clause without a price increase.
• Audit the supplier's business continuity plans and testing. Checking that suppliers' plans have all the attributes of successful business continuity planning and that suppliers are conducting tests of their disaster recovery and continuity plans on a regular basis (e.g. every 6 months). A recovery plan that has not been tested recently is often nearly worthless."

McBeath raises a great point about testing continuity plans on a regular basis. What he doesn't tell you is how to test the plan. Daniel Stengel, a risk management expert, reports, "There is limited literature on using simulation to evaluate supply chains under stress ["Case Study: Stress Testing Supply Chains," Supply Chain Risk Management, 7 February 2011]. But he does claim that "stress tests are an acknowledged method to test systems under extreme conditions." Stengel's post refers to a case study that did test a supply chain under stress using a simulation. He concludes:

"In this case stress testing helped the company: to gain a better understanding of their supply chain and to improve supply chain operations. It also helped the customer to gain confidence in the capabilities of its supplier. I find it an interesting thought, that proven reliability, in this case based on a transparent simulation model, can support a company to gain new customers. But also other companies, which have a strong emphasis on supply chain risk management, are using stress testing for their supply chains, one example would be Dow Chemical. The complete article can be downloaded here free of charge."

If your company and its most critical suppliers can conduct simultaneous tests of your risk management systems, it might save both time and money and provide a better test of overall capabilities. I can promise you that if your testing procedures don't stress the system to the point of breaking, you are doing yourself no favors. McBeath concludes:

"Of course the level of effort you put into ensuring supplier continuity will depend on the criticality of the supplier and the availability of alternate sources. For really critical suppliers, you will want to actively audit them. For the next tier of suppliers, it may be good enough to survey them about their capabilities (self scoring). Your supplier continuity program should be an integrated part of your broader supplier risk and supply chain risk program, which would consider things like whether you have too many resources across your entire supply chain concentrated in one geographic area. It takes time and effort to implement a decent supplier disaster recovery strategy. But the do-nothing-and-hope-for-the-best alternative is inviting a real disaster for your company ... and for your career!"

In the final part of this series, I'll discuss the importance of hedging strategies and examine attributes of a good business continuity plan.

Supply Chain Risk Management and Disaster Mitigation: Part 2

In Part 1 of this series on supply chain risk management, I discussed the fact that a number of supply chain analysts believe that the business sector doesn't walk the talk when it comes to business continuity and disaster recovery (BC/DR) planning and implementation. Blogger Daniel Stengel, a risk management expert, believes that business continuity and disaster recovery are "more narrow disciplines" of Supply Chain Risk Management -- with "Business Continuity on the one end and Supply Chain Crisis Management on the other." ["Supply Chain Crisis Management," Supply Chain Risk Management, 25 October 2010]. Stengel's discussion starts at the latter end of spectrum. He asks, "So how do crises fit into the Supply Chain Risk Management landscape?" To help answer that question, he refers to a study entitled "Managing supply chains in times of crisis: a review of literature and insights," by Malini Natarajarathinam, Ismail Capar, and Arunachalam Narayanan. According the study's abstract: "This paper will serve as a guide to supply chain managers who would like to know how crises, disasters, and disruptions in supply chains have been handled in existing academic literature." Commenting on the study, Stengel writes:

"The authors cite Merriam-Webster on crisis, where it is defined as: 'an unstable or crucial time or state of affairs in which a decisive change is impending; especially: one with the distinct possibility of a highly undesirable outcome.' So in a supply chain context, a crisis is comparable to a disruption where the flow of goods, information or money is interrupted."

Stengel reports that the authors searched "peer-reviewed articles as a basis for their work. For their sample they were using keywords like 'crisis', 'risks', 'disaster', 'uncertainty' and more. This search resulted in 118 relevant articles published between ... 1990 and 2008." More than half of the relevant articles (64) were written in or after 2005 -- demonstrating that the topic of supply chain risk management has taken on a new urgency in recent years. Apparently the authors found "gaps in the literature that can provide ideas for future research in this area." Stengel concluded that the study was clearly written, but he believed "the discussion of the term 'Crisis Management' could have been more elaborate." The fact that relatively little research has been concluded in this area might be one reason that so few companies have adequate business continuity and disaster recovery plans in place. So what can they do? The first thing that Stengel recommends is that business executives should understand how reducing uncertainties across business processes can make a significantly greater difference than reducing uncertainties in a few selected sectors.

Stengel reaches this conclusion from a study that examines "The Supply Chain Uncertainty Circle," [Supply Chain Risk Management, 27 October 2010]. "What," you ask, "is the supply chain uncertainty circle?" Authors of the study, Rachel Mason-Jones and Denis R. Towill, explain that the circle represents the total uncertainty in the product delivery process contained in four "fundamental constituent segments due to manufacturing," namely: demand side, supply side, control systems, and the manufacturing process (Figure 1 -- click to enlarge). ["Shrinking the Supply Chain Uncertainty Circle," by Rachel Mason-Jones and Denis R. Towill, Control, September 1998]

Figure 1

An Uncertainty Circle with equal uncertainty in each segment would then look like this:

Stengel then writes: "With the Uncertainty Circle it is now possible to visualize [the] effect of shrinking one of the risks without the other: Overall risk is only reduced by a (comparatively) small amount. [Figure 2] This furthermore implies the goal for supply chain risk managers: Reduction of risk on all frontiers!"

Figure 2

Stengel concludes:

"This of course does not have to happen at the same time. Companies usually start with improvements in their own manufacturing processes and establish lean thinking to improve lead times and quality. As a next step this concept may be enlarged to the companies' suppliers as well to reduce supply side risks. The authors then argue that much potential is left untouched on the reduction of demand side uncertainties and control systems. Demand side risks can be reduced by improving the information flow from the end-customer throughout the supply chain and companies can tackle control risks by improving their ability to act on this new information with a adequate Decision Support System."

What Stengel is implying is that supply chains need to become demand driven. On that point, he agrees with a number of other supply chain analysts (to learn more, read my post entitled Demand Driven Supply Chains). He concludes, "Even though the article [was] published twelve years ago the concept of the Uncertainty Circle can still be used as a framework to reduce risks within a supply chain." Supply chain analyst Bob Ferrari seems to agree with Stengel that a framework is needed to perform and implement business continuity and disaster recovery successfully ["Supply Chain Matters Business Briefing Series- Supply Chain Risk Management and Mitigation," Supply Chain Matters, 17 January 2011]. He writes:

"Supply chain risk management includes a systemic process to identify, evaluate, monitor, control and/or respond to perceived risk conditions. It refers to uncertain and/or unpredictable events affecting one or more organizations, companies or supply networks which have costly results to a business or to a brand. There are many perceived reasons for these occurrences which can stem from operational, individual product, natural disaster or political and regulatory risk factors. In many cases the companies, organizations or teams impacted may have felt that they had adequate plans in place to either avoid or mitigate these occurrences. Then again, firms may be in an unprecedented era of many so-called 'black swan' events and subsequent impacts."

What I most appreciated about Ferrari's post was that he offered a series of questions that companies can use to help develop their risk management systems. Those questions include:

• "What are the various aspects of risk and where in the organization does the accountability for value chain risk reside?
• "What are the most important components to a risk mitigation plan?
• "How should organizations respond to a risk incident, and what roles do various supply chain functional teams play in a response and mitigation plan?
• "How will social-media based communications impact a risk response strategy?
• "What role can technology play in identifying and mitigating supply and value-chain risk?"

The good news, according to Steve Banker, is that the field of supply chain risk management is advancing at a rapid rate ["The Advancing Field of Supply Chain Risk Management," Logistics Viewpoints, 8 November 2010]. That supports the finding of the study with which I began this column that showed that activity in this field started to increase around five years ago. Banker writes:

"The Supply Chain Risk Leadership Council (SCRLC) ... has developed a very nice way of categorizing supply chain risk management (SCRM). They view it as being composed of five distinct disciplines:

• "Preparedness, Continuity, and Recovery Planning;
• "Regulatory & Security;
• "Supply Chain Resiliency;
• "Risk Assessment and Monitoring;
• "Supply Chain Incident Detection and Crisis Management."

I'm always in favor of frameworks that offer improved ways of looking at complex challenges. In this case, I'm pleased that the SCRLC includes resiliency among their categories. Banker indicates that the Council is "compiling a 'lexicon' of terms." He writes:

"I found the definitions interesting because they show how deeply the organization is thinking about this topic. Here are a couple of examples. SCRLC prefers the term 'risk management' to 'crisis management' because the latter implies an after-the-fact response to a crisis, while risk management is more proactive. The term 'Risk Appetite,' however, is more difficult and elusive to define. 'It's a concept you can resonate to at fifty thousand feet, but when you try to implement it on the ground as a practical application, it's very tough,' says John Brown, Director, Risk Management, Supply Chain Development, Coca-Cola Company, and a member of the track. 'It's important to have a measure so individuals within a company don't take more down-side uncertainty than a company can reasonably bear or less than is optimal for a company to tolerate. But with the exception of financial services, it's very cutting edge to develop a metric that puts numbers on risk appetite. There are so many functions within a company, how can you say concisely what is acceptable risk? Most risk levels at the enterprise level are more qualitative than quantitative.' 'Risk Tolerance' is equally difficult to define. As Brown notes in the newsletter, 'ISO defines it as an organization's readiness to bear risk, which can be interpreted as an absolute boundary that the company can accept and still survive. But some companies would say just the opposite—that Appetite is the total picture and Tolerance falls within that.'"

What I gather from Banker's comments is that supply chain risk management is still in its infancy, but quickly maturing. That should make it an exciting field in which to work over the next few decades. Banker says some companies, like Cisco, are more mature than others. When he was briefed a couple of years ago by Cisco on its approach to SCRM" he "was blown away." He concludes:

"I was fascinated by the council's list of resources, websites that could provide very useful information to a SCRM team. These resources include CNN; the Emergency Email and Wireless Network (breaking news and emergency email notifications of natural disasters or other emergencies in a particular locale); the World Health Organization; Centers for Disease Control (tracking of pandemics and acute disease outbreaks); the World Metrologic Organization; the US Geological Survey/Earthquake Information (earthquakes, hurricanes, cyclones, and severe weather); and Maplecroft Maps (portfolio of risk indices displayed in interactive maps; I plan to get briefed by them soon). In conclusion, although the field of supply chain risk management is advancing, it is still in its infancy, and most companies still only focus on business continuity and recovery planning and not the broader approach to SCRM put forward by this council."

I agree with Banker that the more comprehensive a company's approach to risk management the better off it is going to be. The fact that the Supply Chain Risk Leadership Council has provided some resources for companies to use is a good step forward. It helps companies understand just how complex the field of risk management really is. In the next post of this series, I'll look at some recommendations that have been offered by risk management experts.

Supply Chain Risk Management and Disaster Mitigation: Part 1

Today's earthquake in New Zealand reminds us that bad things can happen quickly and unexpectedly. Cyclones in Southeast Asia, unrest in Egypt, and volcanic eruptions in Iceland have all made news over the past year as have automobile recalls, embargoes of rare earth minerals, and flaws in microchip manufacturing. What these events have in common is that each of them affects the supply chain in one way or another. As a result, there have been a number of articles about the importance of having a business continuity/disaster recovery (BC/DR) plan and system in place. Curt Barry, president of F. Curtis Barry & Co., a multichannel operations and fulfillment consultancy, claims that many businesses believe they have a BC/DR plan in place, "but it's often not the case." ["Develop a master disaster plan," Multichannel Merchant, 1 February 2011]. He writes:

"Natural or man-made, disruptions and disasters that could pose threats to the well-being of our employees, physical plants and business viability are more common than we think — and it's human nature to be overconfident about our preparedness. ... Concerns about costs, as well as the 'it can't happen to us' mindset, prevent many companies from addressing these crucial issues."

Barry is correct that overconfidence and denial can prove disastrous for a company. This past year should have convinced most companies that "it can happen here." Julian Evans writes:

"In a world where almost every company relies on global supply chains and an international network of outsourced activities, a freak event many thousands of miles away can have a potentially devastating impact on business at home. In this environment, it is critical that companies have a firm strategy in place to deal with the unexpected and a thorough knowledge of the insurance industry. Never was this shown to be more important than in 2010 - the so-called year of the catastrophe. It had everything: Devastating earthquakes in Haiti, Chile, China and Iran, severe flooding in Pakistan, forest fires and suffocating smog in Russia, a major oil spill off the coast of the U.S., an extremely cold winter that caused travel chaos, and even a volcanic eruption that left the skies empty of planes. Not to mention the banking system." ["Weathering the Storm," Wall Street Journal, 7 February 2011].

There are a number of things that must be considered when one thinks about supply chain risk management (see my post entitled Defining Supply Chain Risk). Evans reports that the consequences of natural disasters last year were devastating, both financially and emotionally. He writes:

"The insurance company Swiss Re estimates that worldwide economic losses from natural catastrophes and man-made disasters reached $222 billion last year - more than triple the losses in 2009. Moreover, the number of deaths due to catastrophe reached 260,000 in 2010, which is the highest figure since 1976, and more than the total killed through terrorism over the last 40 years."

Supply chain professionals look at natural disasters in terms of the disruptions they are likely to cause. Evans notes that "the impact [of natural disasters on the supply chain] is exacerbated by the interdependence of global society." He continues:

"Globalization has ... exposed companies to greater catastrophe or crisis risk, because their supply chains are now stretched across the world, and they may have outsourced many parts of their business to suppliers or service companies thousands of miles away. If one link in the supply chain goes wrong, it can have a huge impact. Look, for example, at Toyota, the world's biggest car company, which outsourced the manufacture of many of its parts, only to see its profit and reputation take a huge hit this year when it had to recall over 10 million vehicles for safety reasons. David Noble, chief executive of the Chartered Institute of Purchasing and Supply, says: 'There's certainly a risk that comes with outsourcing. We hear from CEOs of major multinationals that analysts are increasingly quizzing them about how well they're managing their supply risk.'"

Evans then rhetorically asks, "So what can businesses do to expect the unexpected and control the uncontrollable?" His answer: "They can, at least, put together a business continuity plan." That leads us back to Barry's assertion that many companies overrate the plans they have in place. Evans continues:

"Vincent West, head of UK business continuity practice at risk manager Aon, says: 'If companies create a business continuity plan, then they have a framework for response to catastrophes. They have identified in advance those activities that are absolutely essential to the running of the business - the people, the premises, the infrastructure - then they can plan how to protect these parts of the business if, for example, 40% of the workforce falls ill with swine flu. They can learn how to deploy resources to keep the core business up and running.'"

Enterra Solutions uses its proprietary Enterprise Resilience Management Methodology™ to help companies identify its core assets and processes. ERMM™ offers a strategic approach to analyzing an organization’s core infrastructure and assessing enterprise risk. It helps clients understand the connections between tactical decisions and enterprise strategy, with regards to critical practices, processes, and rules governing the enterprise. Of course, identifying core assets and processes is only the beginning of creating and implementing a BC/DR plan. Evans continues:

"Companies also need to address which parts of their supply chain are essential, and which parts are particularly vulnerable. 'Companies are keen to ensure their supply chain is secure,' says Mr. West, 'because if they don't, there's a danger they will import disaster.' An important part of any company's response to freak conditions is their communication strategy. [James Crask, senior manager in consultancy PricewaterhouseCoopers' risk and business continuity team] says: 'A company needs to bear in mind how they'll be perceived. If you lose the confidence of your customers during a crisis, it can be very hard to win back.' Take the reputation of BAA, the operator of the U.K.'s Heathrow Airport, which was widely criticized for closing two runways for three days in the run-up to Christmas, after one day of snow, which made thousands of travelers unable to reach their destinations for Christmas. BAA made a bad situation worse by giving stranded passengers hardly any information about why it was taking so long to clear the snow or when the situation might improve."

Evans concludes his article by noting that companies can always cover losses by buying catastrophe insurance; but such insurance doesn't buy back lost good will from customers. The editorial staff at Supply Chain Digest agrees with Barry that there is some denial being experienced among businesses. It writes that there is a big difference between how important companies say risk management is versus what they are really doing about it. ["Key Drivers of Successful Supplier Risk Management," 18 August 2010]. The article continues:

"The global recession proved perhaps the most challenging period ever, or at least since the Great Depression, in terms of managing supplier risk, as companies had to find new ways to both assess that risk and enact mitigation strategies as suppliers struggled to stay solvent. While the worst may be over, in these dynamic times supplier risk management will stay high on the procurement priority list, and companies need a formal process for managing that process. Research shows that on average large companies encounter a major supply chain disruption every 4-5 years. Just this year, for example, network equipment and other high tech companies have battled shortages on very basic electronic components, leading such as Ericsson, Nokia, Alcatel-Lucent and other firms to report pretty significant hits to revenue in Q2 and falling stock prices because they simply couldn’t deliver the goods to customers."

The article notes that the Boston Consulting Group (BGC) "defines supplier risk management as 'the use of processes and procedures to offset any risk factors that could interrupt a supplier's ability to provide an organization with needed raw materials, components, or other inputs or services." The article continues:

"[Boston Consulting] says typical risk factors include: financial risks that could affect a supplier's solvency; operational risks that could affect quality, logistics or pricing; market risks related to regulatory and geopolitical events, or changes in commodity prices; major catastrophes and natural disasters; and anything that would compromise a company's brand, intellectual property or proprietary processes."

For an even more extensive list of risk factors, click on the link to my post mentioned above. BGC consultants Robert Tevelson, Petros Paranikas, and Byron Paul claim that "the majority of companies that do have [supplier risk management] practices tend to focus only on direct, supplier-driven risks, ignoring those related to market changes, geopolitical issues and other potentially disruptive, external events." In other words, the focus of most BC/DR plans is too narrow. In a globalized world that is not a good thing. The Supply Chain Digest articles concludes with "Five Levers for Supplier Risk Management Success" identified by BCG. The first "lever" starts at the top:

"Engage Top-level Management: This means both that senior procurement leaders must actively show their support for SRM within their organizations, and then also communicate that need to the CEO and executive peers. Yet, BGC's research showed only 45% of respondents discuss SRM with the organization's executive team on a quarterly basis; 20% never discuss SRM with senior management. Best-in-class companies, BGC says, set up regular SRM reviews that follow a standard format and offer clear escalation procedures when potential problems are flagged. The authors make the strong point that SRM cannot be only the province of the procurement group – the trade-offs and level of risk tolerance must be approached cross-functionally."

It is hard to imagine that events that could "compromise a company's brand, intellectual property or proprietary processes" would not be routine topics discussed at the highest levels of corporate management. The second "lever" identified by Boston Consulting is segmenting suppliers.

"Segment Suppliers Based on Relative Risk: No company can manage detailed risk assessment and mitigation strategies across thousands or even hundreds of suppliers. So, procurement organizations must pick the most important suppliers to focus on, but too often this is done by 'gut feel' rather than a formal categorization process. 'Best-in-class companies take a more formal approach, dividing suppliers into different risk categories based on predetermined criteria such as financial health, supply of critical components, supplier value-add, supplier power, time to switch and industry outlook,' BGC says. 'These risk assessments are refreshed at least annually, and, in some instances, every quarter. High-risk suppliers are reviewed more often, so that issues are identified early and quick action can be taken.' Not surprisingly, the authors say, more frequent risk assessment is linked to more successful risk identification."

More and more companies are beginning to score their suppliers so that they have a better understanding of which ones perform best. I believe this is a trend that will continue to grow. The third BCG lever involves measuring and managing.

"Rigorously Measure and Manage Risk: Even though it has become well understood that companies need to assess both the probability of a supply disruption and the level of financial impact the disruption might cause, BGC's research found only 40% of respondents were satisfied that their companies could effectively quantify the likelihood and impact of key risks. BGC says companies need to add more 'rigor' to the risk assessment process, and do a better job collecting cross-functional data that might help identify an emerging supplier problem earlier (for example, are key personnel leaving the supplier?)."

Obviously, some important data (like departing personnel) may be difficult to obtain in timely manner. I agree that collecting "cross-functional data" is important, but collecting data and understanding it are two different challenges. That is why I like systems that sense, think, and respond. The fourth "lever" deals with collaboration.

"Collaborate with Key Suppliers: Complex, global supply chains require higher levels of collaboration. So do very 'lean' supply chains (and who doesn't have one of those these days?), where disruptions can quickly lead to operational and financial problems. The key point: 'Companies such as these must understand the risks of the entire supply chain, not just of individual suppliers. Yet few can single-handedly take on the substantial cost of managing risk across the board. Collaboration is critical,' the BGC consultants say. The research found few companies say that their companies actively collaborate with suppliers to manage risk."

Long-time readers of this post (or posts like those written by supply chain analyst Lora Cecere) understand that collaboration is going to play an increasingly important role in supply chain management. Collaboration is important for more effective functioning of supply chain during normal operations as well as preparing for disruptions. Look for a future post on this subject. The final "lever" identified by BCG involves giving supply chain personnel the right tools and training to help them be successful.

"Give Category Managers Tools and Training: As with many things, most companies agree that supplier risk management is essential, yet the survey showed few companies effectively educate their senior leaders and category managers on how to do it well. The research showed two-thirds of respondents reported that their companies failed to provide even one full day of risk management training, and most expressed dissatisfaction with current programs company training programs on the subject. Technology support tools are equally lacking, though BGC says a few companies have complex tools that can track the potential impact of a single event in one location — such as a tornado in Kansas — on all aspects of the supply chain. 'SRM is challenging and requires a proactive, customized approach to get it right,' the BGC authors conclude. 'Understanding your company's model, based on your source of competitive advantage and degree of supply chain complexity, reveals critical best practices. These, combined with the five levers for success, can help your company stay ahead of potential supplier problems.'"

We will continue this discussion in Parts 2 through 4 of this series. Part 2 discusses some recommended approaches to supply chain risk management. Part 3 discusses establishing and testing risk management plans. Finally, Part 4 discusses hedging strategies.

Small Businesses and Globalization

During his State of the Union address, President Barack Obama stated, "To help businesses sell more products abroad, we set a goal of doubling our exports by 2014 -– because the more we export, the more jobs we create here at home." Such broad-brush statements are easy to make. As the old saying goes, "The devil is in the details." In order to increase exports, you have produce something that people around the world need or want. In a post entitled Entrepreneurs, Medium-Sized Companies, and the Global Supply Chain, I discussed how mid-sized German companies (called Mittelstand) represent "80% of the world's medium-sized market leaders" and have made Germany "the world’s largest goods exporter after China despite high labour costs and a strongish euro." Perhaps the President has noticed the German model and hopes to replicate it in the United States. Although he didn't single out small- and medium-sized businesses in his address, the President is apparently going to send "top U.S. trade officials ... across the country this year to recruit small-business owners in the administration's effort to double exports by 2015." ["Government to Urge Small Businesses to Export," by Tom Barkley, Wall Street Journal, 28 January 2011]. Barkley reports:

"A year after President Barack Obama announced the export initiative to help tackle stubbornly high unemployment, the administration is trying to reach out to the group of business owners that account for nearly two-thirds of job creation but less than a third of total goods sold abroad. 'For America to win the future, more small and medium-size businesses must export, because the more small businesses export, the more they produce; the more they produce, the more workers they need, and that means good-paying jobs here at home,' U.S. Commerce Secretary Gary Locke said in a statement announcing the outreach program."

Barkley notes that "out of the nearly 30 million small and medium-size firms in the country, only 1% market their goods abroad." U.S. Trade Representative Ron Kirk "wants to double that number." He told Barkley, "We know that firms that export grow faster, add jobs more quickly and pay better wages than those that don't." He believes that doubling the number of small- and medium-sized businesses that export their products is realistic because he sees a number of companies that represent "low-hanging fruit" that, with a little help, could start exporting overseas in the near future. Barkley continues:

"A senior Commerce official said the outreach effort has made some headway so far, with small and medium-size businesses accounting for over 85% of the 5,500 companies that the commercial service division helped to increase exports last year. Still, 58% of such companies export to only one country, so Commerce has set a goal of increasing by half the number that export to more than one market."

Barkley notes that the passage of trade deals that began during the Bush administration would help the Obama administration achieve its goal but additional help is also required. An official from the Commerce Department told Barkley, "The National Export Initiative takes a comprehensive, multi-pronged approach, because while trade agreements are important—especially to small businesses, which often lack the resources to deal with barriers and tariffs—they will not by themselves allow the U.S. to reach the goal of doubling exports by 2015." In support of this initiative, the U.S. Export-Import Bank announced that it hopes "to spur exports by increasing small-business loans to $6 billion this year and $9 billion a year by 2015." ["Export-Import Bank to Increase Small-Business Loans," by Jamila Trindle, Wall Street Journal, 18 January 2011]. Trindle continues:

"Ex-Im Bank officials said the goal is to bring 5,000 new small businesses into the bank's lending program by 2015. The bank lent $5 billion to small businesses in 2010. 'We can't grow our economy without growing export sales and we can't grow our export sales without small businesses,' said Ex-Im Bank Chairman and President Fred Hochberg. Big companies are concerned with competing internationally, but small businesses need access to capital and expertise, Mr. Hochberg said. According to Ex-Im Bank statistics, small-business exports have grown by 80% since 2003 to $500 billion in annual sales, but still only make up 30% of total U.S. export revenue."

Some of the businesses that will help the administration reach its export goal may not even exist today. Elsewhere in his State of the Union address, the President declared:

"We know what it takes to compete for the jobs and industries of our time. We need to out-innovate, out-educate, and out-build the rest of the world. We have to make America the best place on Earth to do business. We need to take responsibility for our deficit and reform our government. That's how our people will prosper. That's how we'll win the future. And tonight, I'd like to talk about how we get there. The first step in winning the future is encouraging American innovation. None of us can predict with certainty what the next big industry will be or where the new jobs will come from. Thirty years ago, we couldn’t know that something called the Internet would lead to an economic revolution. What we can do -- what America does better than anyone else -- is spark the creativity and imagination of our people. We're the nation that put cars in driveways and computers in offices; the nation of Edison and the Wright brothers; of Google and Facebook. In America, innovation doesn’t just change our lives. It is how we make our living. Our free enterprise system is what drives innovation. But because it's not always profitable for companies to invest in basic research, throughout our history, our government has provided cutting-edge scientists and inventors with the support that they need. That's what planted the seeds for the Internet. That's what helped make possible things like computer chips and GPS. Just think of all the good jobs -- from manufacturing to retail -- that have come from these breakthroughs."

Although it is clear that the President is most interested in getting manufacturers to sell their products abroad, opportunities also exist for all sorts of U.S. companies to set up business overseas ["For Small Businesses, Big World Beckons," by Justin Lahart, Wall Street Journal, 28 January 2011]. Lahart begins his article describing a wide array of companies that plan to or are expanding their operations internationally. He writes:

"Husband-and-wife business partners Matt and Rene Greff are on track to open the first out-of-state branch of their Michigan brewpub later this year—in Bangalore, India. At Peter Frykman's Palo Alto, Calif., irrigation-equipment company, seven of the 20 employees are located outside the U.S., in China and India, while Gangesh Ganesan's communications-chip firm, in San Jose, has about a quarter of its staffers in Istanbul, and others in Tokyo and Taipei. While big companies have been the trailblazers of globalization, a growing number of relatively small businesses are following in their footsteps. Like their larger counterparts, they are drawn by new markets that are often growing much faster than those at home."

Although U.S. workers have lost their manufacturing jobs to overseas workers, employees in that global workforce may yet prove to be customers for goods produced in the United States -- thus helping to bring manufacturing jobs back to America. I'll talk more about the emerging global middle class in a future post. Most people believe that globalization has helped developing countries more than developed countries; but some developed world companies are learning that globalization is also a boon for them. Lahart continues:

"Forays abroad [by small U.S. companies] are made possible by technologies like file sharing and video conferencing, which allow managers to communicate easily across continents. Though these technologies aren't new, their price has fallen sharply over the past decade, putting them within reach of more companies."

For company owners, expanding abroad provides both opportunities and challenges. Lahart explains:

"Crossing borders doesn't come easily. Advances in technology haven't done away with the need for small-business owners to spend face time with employees and clients in other countries. PharmaSecure Inc., for example, is based in Lebanon, N.H., but Chief Executive and co-founder Nathan Sigworth says he has been spending more time in India, his primary market, than at home. Venturing abroad also requires small companies to put a lot of care into choosing the employees or local partners who will represent their interests overseas. The task often requires bridging cultural differences and navigating complex and unfamiliar bureaucracies."

I have some experience in this area and I can tell you that Lahart is right on target. Hiring the right local employees can make all difference. Lahart continues his article with the back story behind the Greffs' plan to open a brewpub in Bangalore. He writes:

"The Greffs, in Ann Arbor, Mich., were skeptical when Gaurav Sikka, a former University of Michigan student, approached them last year about opening a brewpub in Bangalore. Mr. Sikka, a native of India, was a regular at the couple's 200-seat Arbor Brewing Co. The couple had recently opened a small brewery in nearby Ypsilanti, and worried about stretching themselves too thin. 'We said no, we don't have any time or money,' recalls Mr. Greff. 'He said: "Don't rule it out of hand."' The Greffs traveled to India, where they came to believe Mr. Sikka's idea was feasible. They found that southern India had a beer-drinking culture, as well as lots of U.S.-educated professionals, including plenty of University of Michigan grads. Moreover, it was an untapped market for traditionally crafted microbrews like the ones the Greffs serve in Michigan. Now, a group of local investors, led by Mr. Sikka, is supervising arrangements for the Bangalore opening. The Greffs will have a stake in the new brewpub, and will receive consulting and licensing fees."

Lahart reaffirms the statistics noted above (i.e., "according to the Census Bureau just 2% of U.S. companies with fewer than 100 employees sell their goods in overseas markets) but notes that "there are no hard figures available [for] the number of small businesses that have invested directly in overseas operations." Although I'm sure the administration won't object if small companies invest abroad, it is much more interested in companies exporting goods produced in the United States. Lahart notes that investing abroad "typically requires a bigger financial commitment than exporting." I suspect that a growing number of small- and medium-sized U.S. companies will adopt a hybrid business strategy that includes both increasing exports and setting up business abroad. Lahart continues his article with the back stories of the companies mentioned earlier in his article. He begins with the story of Driptech:

"Mr. Frykman, the irrigation-gear executive, was part of a group of Stanford University graduate students who in 2008 came up with a method for making drip irrigation systems inexpensively. After testing them in Ethiopia, 'we saw that this could help farmers across the world,' he says. He put his plan to get an engineering Ph.D. on hold and formed Driptech Inc. A pilot project in India went well and caught the eye of Chinese officials. In 2009, the company made its first sales, in India and China, and began to seek angel investors. Last spring it raised $900,000 in funding. Seven of Driptech's employees are now working in its offices in Beijing and outside of Mumbai, and Mr. Frykman expects that within a few months half of its workers will be overseas. Having offices in three countries is a challenge, he says, but thanks to the revolution in communications technology he is able to hand off work in the evening to his co-workers in Asia, and pick it back up in the morning. 'If you get the rhythm right, you can really be working around the clock as an organization,' he says."

I first wrote about Driptech in December 2009 in a post entitled Start-Ups that are Expected to Do Well Despite the Recession. Apparently the prognosticators were right about the company. It is doing well despite the recession. The next company discussed by Lahart is a small pharmaceutical firm -- PharmaSecure.

"PharmaSecure got its start in 2007 when [Chief Executive and co-founder Nathan] Sigworth and his friend Taylor Thomson came up with a low-cost way to combat counterfeit drugs, a big problem in the developing world. PharmaSecure's system, which combines mobile-software apps and databases, allows customers to send text messages containing the codes printed on drug packages and get a reply indicating whether the code is legitimate. After a year of traveling, the partners decided that India, the source of much of the developing world's drug supply, was the best place to begin. Now, most of the company's 15 employees work out of New Delhi. Mr. Sigworth says the ability to communicate cheaply has been crucial. 'We use [Internet telephone service] Skype a lot; we use email a ton,' he says, but he adds that just as important has been the company's ease and comfort working across cultures. Born in Germany, Mr. Sigworth grew up in Connecticut, and spent summer breaks from high school working in Botswana. Many of the company's Indian employees went to U.S. universities or have worked for major U.S. multinationals."

To learn more about the problem of fake drugs, read my post entitled Drug Safety and the Supply Chain. The final company discussed by Lahart is in the information technology sector.

"Ubicom Inc., which produces chips for products such as wireless routers, made its first international foray three years ago when it tapped a Turkish employee to start an office in Istanbul. Now about 20 of its 85 employees work there. Ubicom also has offices in Taipei and, as of this month, Tokyo, as well as a group of engineers in the U.K. To videoconference, chat and work together on projects, Ubicom's offices use technology that would have been too costly for the company a decade ago, says Mr. Ganesan, the CEO. He adds that he doesn't think a company like his can do without an overseas presence.'Even though we're a small company, our customer base is truly global,' he says."

The bottom line of this post is that small- and medium-sized companies hold the to key to future prosperity. At least that is the opinion of a number of business and government analysts. As I noted in the conclusion of my post on medium-sized companies mentioned earlier, William Shakespeare reminded us centuries ago, "All the world's a stage, and all the men and women merely players." If you don't see the world as your stage, you may not be a player in the future.

Entrepreneurs: The Importance of Minding Your Money

According to entrepreneur Mike Southon, "The main reason for a company failure is running out of cash, and every financial expert I have met bemoans entrepreneurs' reluctance to address the problem earlier in the process." ["Sometimes cash flow is king," Financial Times, 18 October 2010]. In past posts, I have discussed how difficult and time-consuming raising working capital can be [see, for example, my posts entitled Through the Looking Glass: Two Sides of Start-Up Financing, Part 1 and Part 2]. Raising money, however, is only half the battle. Once you have the money you need to mind it carefully. Southon insists that there are "simple steps [that] can be taken to avoid later catastrophe." The best step, he explains, is to hire someone who is good at handling money. He writes:

"Just as many successful entrepreneurs are dyslexics, many also have a similar blind spot with regard to money. ... If you want to scale your business, hire someone who has an in-built understanding of cash flow. They might be a qualified bookkeeper or accountant, or simply someone who has no personal debt other than a modest mortgage and whose wallet contains debit, rather than credit cards. These people are comfortable in recessions as they always have cash rather than debt. A good finance person is worth their weight in gold, and will use spreadsheets and other instruments of torture for the average entrepreneur to make sure that the great idea also makes money over time."

Entrepreneur and venture capitalist Luke Johnson agrees with Southon that hiring the right person to handle your finances is critical if you want your business to grow ["Custodians of finance make the difference," Financial Times, 18 January 2011]. Hiring the wrong person, however, can be disastrous. He writes, "The weak link in many failed companies is the finance director. Better custody of borrowed or invested money by them would so often have prevented disaster." Johnson goes on to discuss what he calls "classic" Financial Director (FD) or Chief Financial Officer (CFO) "lines" that should sound alarms when spoken. He acknowledges that he is "indebted to John Dewhirst of Vincere, the turnaround specialists, for collecting" the lines.

"● 'I don’t do cash forecasts. I've never found them useful.' A lack of focus on cash is perhaps the greatest sin. A finance professional who does not prepare reasonably accurate projections of liquidity on a rolling basis is guilty of a dereliction of duty. Often FDs drop such nitty-gritty as they ascend the ranks, while some have historically enjoyed a cash cushion and never felt the pressure. They are the ones exposed when conditions deteriorate."

On that point, Southon and Johnson are in complete agreement. Johnson continues:

"● 'Sure we’ve made some losses but look how much we've grown turnover.' Finance directors should not be sales directors. Their role is to think about risks and funding. Of course they must possess an all-round understanding of operations, but their core task is to be the numbers expert. They are the conscience of the company, worrying about the financial statements, not the latest brochure, showroom or advert. They are the ones who should argue against taking on unprofitable business, or working with customers who might not pay."

Your FD or CFO is charged with minding the money not growing the business. He or she should be the conservative voice in your head that reminds you that money matters and that your future depends on being able to turn a profit. That thought segues into Johnson's next warning line.

"● 'I don’t know whether this customer account is profitable. What I do know is that we can’t supply them enough. They love us!' A finance director who doesn't understand the margins of a business byproduct and customer is falling down on the job. I have seen a number of companies go bust being busy fools, adding volume by discounting. The one person in the organisation who should stand up to such madness is the FD. If she or he cannot do the analysis and provide the data to counter such folly they should be replaced."

I'm reminded of the two would-be entrepreneurs who decided to go into the watermelon business. They bought a truck, drove it to the fields, and paid farmers a dollar per watermelon. They then drove back to the city and sold their watermelons for a dollar a piece. They soon realized that they weren't making any money. At that point, one of them said, "I don't get it. We're selling all of our watermelons and should be getting rich. Maybe we need a bigger truck!" When your CFO recommends getting a bigger truck, put him on the old one and wave goodbye. Johnson continues:

"● 'You just don’t understand our business. We've always done it this way.' Complacency and laziness are enemies of a strong finance function. Every industry I have ever come across considers itself unique. But cash behaves the same no matter which sector. The best FDs understand about lifelong learning and are open to sharing ideas and new methods to discover best practice. The objective must be to improve their competence and the way a business runs. Poor FDs are secretive and deliberately obfuscate to hide ignorance or idleness."

Although I'm from the conservative school when it comes to handling money, Johnson has a point about being open-minded to new ideas. Mike Michalowicz is certainly in favor of breaking old financial habits. In fact, he insists that Generally Accepted Accounting Principles (GAAP) are wrong ["How Entrepreneurs Can Fill the 'GAAP'," Wall Street Journal, 12 December 2010]. He writes:

"Replacing GAAP to track spending, enhance cash-flow management and assess the health of your company makes you a Galileo since you're going against what 'everyone knows.' Just because something appears to be true and 'everyone' goes along with it, doesn't mean it makes sense—and it doesn't make it true."

Michalowicz recommends something he calls Profit First Accounting. He explains:

"I propose a new type of accounting: Profit First Accounting (PFA). The difference between GAAP and PFA is simple: Deduct profit first, from the top down. On a PFA income statement, the first line item is revenue, followed by a profit deduction, then your salary, followed by cost of goods and all other expenses."

I'm not convinced that PFA is an accounting principle that will lead to success; but Michalowicz insists that "there are many benefits to PFA, such as the ability to track growth in a consistent, proven pattern, which will appeal to investors and potential buyers should you decide to sell." He concludes:

"But the best part is you will be in control of your costs from the get-go. Since your revenue will first go toward profit and then your salary, there will be less to spend on expenses. Many small-business owners determine how much they can spend based on the cash they have in the bank. The PFA method automatically forces frugality, since your profit is deducted every time cash comes in the doors."

Michalowicz insists he has used the method for years with great success. Regardless of whether or not an FD uses Generally Accepted Accounting Principles (which I recommend), he or she must be intimately familiar with financial statements. Johnson continues with FD lines that should worry CEOs. He writes:

"● 'I don’t actually prepare the management accounts.' FDs who have risen to such grand heights that they are only interested in sexy things like mergers and acquisitions or investor relations are missing the point. They must take full ownership of the financial statements, and know them backwards. Their job is about detail and precision. Only by having such an intimate grasp of the information can they provide answers to the difficult questions."

Having a good set of books is also important if you are trying to raise cash. Hiring an outside auditing firm can help you assure investors that the company is worth risking their capital on ["Audits Add Shine to Firms," by Angus Loten, Wall Street Journal, 13 January 2011]. Loten reports:

"Small businesses whose books are audited—by a hired certified public accountant, not the Internal Revenue Service—improve their chances of getting a loan, and at far better terms, than businesses with less scrutinized financial statements, a new study shows."

Loten admits that audits don't come cheap; but, he insists, "the benefits might outweigh the costs." He explains:

"Based on data from more than 10,000 closely held companies—about half of which have less than 500 employees—a study by the University of Chicago Booth School of Business found audited businesses save an average of $6,900 for every $1 million in outstanding debt every year as a result of lower interest rates, which were more than half a percentage point below rates paid by nonaudited businesses. For a loan of $3.3 million, the average size of loans analyzed in the study, the savings was about $23,000. ... Similarly, a joint study last year by Michigan State University and Indiana University found small businesses with audited financial statements were 'significantly less likely' to be denied credit from banks."

The most surprising thing that Loten reports was that "audited or not, less than a quarter of businesses with fewer than 500 employees keep financial statements of any kind, according to the Federal Reserve Board's National Survey of Small Business Finances." You simply can't mind the money without good financial statements. Financial Directors and CFOs have critical roles to play. When they abandon those roles, a company can falter. No one likes to be the bearer of bad news, but a good CFO speaks plainly and factually about money matters. That leads to Johnson's final FD line that should cause concern.

"● 'The chief executive doesn't like to talk about things like that.' An FD needs sufficient strength of character to stand up to assertive individuals like founders. They must possess independence of mind and command enough respect within an organisation that their views are heeded. They also need the confidence to listen to challenges themselves. In one company I part-owned, it was the financial controller who drew the board's attention to a significant cash shortfall – the FD was in denial and had attempted to silence the whistleblower. Unsurprisingly, the FC assumed his boss's job shortly thereafter."

Johnson's conclusion that "a great FD is a tremendous asset, but a bad one is a dangerous liability who can kill even a sound business" shouldn't surprise anybody. But as Loten reported, in far too many small businesses nobody is minding the money. If that is the situation in your company, change it. Find a good accountant (full- or part-time) and start putting your enterprise on a firmer financial foundation.

Wages at the End of the Supply Chain

When people head to large national retail stores to buy products, their main concerns are quality and price. They seldom stop to think about where the products come from or whose hands produced them. That's understandable. It's not that people are insensitive; they believe that governments have an obligation to hold corporations responsible for the fair treatment of their employees. Additionally, it is not easy for someone in the developed world to know what "fair treatment" is in another location and in different circumstances. Having run across some articles dealing with wages at the end of the supply chain, I decided that a post on the subject would help readers remember just how connected the world has become. The first article is a blog post by a senior IBM consultant entitled The Living Wage. The IBMer writes:

"What is the connection between a Living Wage and the supply chain? Take a look at this report for instance: Why is Wal-Mart blocking 35 cents an hour for Bangladeshi workers? From that article,

'Senior sewers are paid 1.7 cents for each pair of Wal-Mart jeans they sew. (Each worker must sew 10 pairs of jeans per hour, or one pair every six minutes—which is 10 percent of an hour. Ten percent of their 17-cent-an-hour wage amounts to 1.7 cents.)'

"That's an hourly wage of US$ 0.17 for experienced sewers and the current demand is to raise the wage to US$0.35 (and up to US$ 0.51 by some accounts that I have researched). The obvious question is: Is an hourly wage of US$0.17 a living wage? Is an hourly wage of US$0.35 or US$0.51 a living wage? If you think that US$0.17 is an absurdly small number, what do you make of US$0.35 or US$0.51? If you're mortified by the idea that the designer jeans that you're donning tonight was sewn together in misery, will you be gratified by the notion that they will be paid double that wage if you just bully the capitalist/retailer to forgo that marginal hit to his profits?"

Of course, you can't compare wages in the United States to wages in Bangladesh -- that is why most people use Purchasing Power Parity (PPP) as the relative measure of well-being between populations. Investopedia explains PPP this way:

"[PPP is] an economic theory that estimates the amount of adjustment needed on the exchange rate between countries in order for the exchange to be equivalent to each currency's purchasing power. The relative version of PPP is calculated as:

Where: 'S' represents exchange rate of currency 1 to currency 2; 'P_1' represents the cost of good 'x' in currency 1; and 'P_2' represents the cost of good 'x' in currency 2. In other words, the exchange rate adjusts so that an identical good in two different countries has the same price when expressed in the same currency. For example, a chocolate bar that sells for C$1.50 in a Canadian city should cost US$1.00 in a U.S. city when the exchange rate between Canada and the U.S. is 1.50 USD/CDN. (Both chocolate bars cost US$1.00.)"

By any measure, however, Bangladesh is a poor country. Its GDP is equivalent to the GDP of the state of Mississippi. Besides being poor, the country suffers from terrible flooding during most monsoon seasons. Frankly, I don't know what a living wage would be in Bangladesh. I do know that Bangladeshis who are fortunate enough to have jobs work hard for the money they make. The fact that Bangladeshis are paid low wages does have one up side -- those wages are starting to attract new businesses ["Bangladesh, With Low Pay, Moves In on China," by Vikas Bajaj, New York Times, 16 July 2010]. Bajaj reports:

"[Gazipur, Bangladesh] is no mere rural backwater. It is the sort of place to which foreign manufacturers may increasingly turn, if the rising wage demands of factory workers in China prompt companies to seek new pools of cheap labor elsewhere. Already, in factories behind steel gates and tall concrete walls, tens of thousands of workers, most of them women, spend their days stitching T-shirts, pants and sweaters for Wal-Mart, H&M, Zara and other Western retailers and brands. One of the Bangladeshi companies here, the DBL Group, employs 9,000 people making T-shirts and other knitwear. Business has been so good that the company is finishing a new 10-story building with open floors the size of soccer fields, planted with row after row of sewing machines."

A job, even a low-paying one, is generally better than having no job at all. If Japan, South Korea, and China can serve as examples, the lot of workers in low cost countries will eventually improve along with wages. But wages can't increase if jobs don't exist. Bajaj continues:

"As costs have risen in China, long the world's shop floor, it is slowly losing work to countries like Bangladesh, Vietnam and Cambodia — at least for cheaper, labor-intensive goods like casual clothes, toys and simple electronics that do not necessarily require literate workers and can tolerate unreliable transportation systems and electrical grids."

It is these low paying jobs that will eventually allow workers' children to go to school. As factories grow, companies will demand better infrastructure and more reliable electrical power. These improvements will help low-cost countries attract even more investment. It's a virtuous circle but it's not an excuse for keeping wages unrealistically low. The IBM consultant notes that developing countries are not the only nations that fail to offer living wages. He points to a Penn State University site "that enables you to work out what constitutes a living wage in America, by state, by county – Living Wage Calculator." The IBMer, however, believes that such calculations are artificial -- as are the notions of minimum or living wages. He continues:

"[Calculating living wages] will do nothing to lift those Bangladeshi garment workers out of poverty and neither will it change the lives of those living stateside. ... The poor will still be poor. ... If you don’t believe what I say, take the hypothetical Bangladeshi worker who, through all the unrest in Bangladesh, doubles (from 17 cents to 35 cents an hour) or triples (from 17 cents to 51 cents an hour) his/her hourly wage. When that dramatic increase in wage happens, what I'd like you to do is tell me what happens to his/her life?

"1. Wage – we know this already because it is a given, doubled or tripled.
"2. Rent Cost – ?
"3. Transportation Cost – ?
"4. Food cost – ?
"5. Medical cost –?
"6. Taxes – ?
"7. Entertainment costs – ?
"8. Other costs – ?

"Do you think items, 2 through 7, increase, decrease or remain the same?"

I'm not quite as cynical as the IBMer. The facts show that millions of people have escaped poverty and joined the global middle class because they have had jobs -- most of which were low paying. I have stated before that companies need to be careful about keeping wages artificially low. If they do, the inevitable result is worker unrest which could lead to violence. Recent events in the Arab world should convince even the most hardened skeptic that the average person is more empowered today than ever. Generating wealth is not a zero-sum game and workers deserve to benefit from their labors. The IBMer fears, however, that the corporate desire for profits is too strong to be tempered by the need for fairness. Bajaj reports that unrest is already growing among Bangladesh's workers. He writes:

"While workers in Bangladesh and other developing countries are demanding higher pay, too — [there have already been clashes] between police and protesters ... in a garment hub outside Dhaka — they still earn much less than Chinese factory workers. Bangladesh, for instance, has the lowest garment wages in the world, according to labor rights advocates. ... Despite its handicaps, Bangladesh nearly doubled garment exports from 2004 to 2009. And the industry now employs about three million people, more than any other industrial segment in this largely agrarian country of 160 million. From June through November last year, garment exports accounted for more than 80 percent of the country's total exports of $7.1 billion. Among developing countries, Bangladesh is the third-biggest exporter of clothing after mainland China, which exported $120 billion in 2008, and Turkey, a distant No. 2, according to the World Trade Organization. And with nearly 70 million people of working age, Bangladesh could probably absorb many more of China's 20 million garment industry jobs."

Jobs are a big deal -- no matter where you live. If you recall, the riots in Tunisia that unleashed a wave of turmoil across the Maghreb mentioned above began because people didn't have jobs. There will always be tensions between management and labor, but doing the right thing generally benefits both sides. Although the IBM consultant singled out Walmart as a bad guy in his blog, large retail chains that buy garments from Bangladesh have indicated that they are willing to increase wages. Not everyone in Bangladesh is happy about that. Bajaj reports:

"In January [2010], H&M, Wal-Mart, Gap, Tesco and other Western clothing buyers asked the Bangladeshi government to raise the minimum wage and reset it every year, although the group did not specify what the wage should be. A spokeswoman for H&M, Malin Bjorne, said the company was willing to pay more for clothing to help support higher wages. It is unclear whether other companies would do the same. But factory owners here argue that a big increase in wages would make them uncompetitive against Vietnam and other big producers, which have higher labor costs but also have better infrastructure and are more efficient producers. If that happened, Bangladesh's China opportunity could prove all too fleeting, they say."

Obviously there are no silver bullet solutions to the problem. I do believe, however, that management and labor must work together to find solutions or they will be left with only lose-lose outcomes. The second article on this subject that caught my eye was a review written by Andrew Stark, a professor of strategic management at the University of Toronto, about a book entitled The Fair Trade Revolution. ["The Price of Moral Purity," Wall Street Journal, 4 February 2011]. He writes:

"On the opening page of 'The Fair Trade Revolution,' editor John Bowes relates an anecdote about Kuapa Kokoo, a Ghanaian cooperative where some of the world's best cocoa originates. In 2000, a visiting BBC crew gave a chocolate bar to a local mother and daughter, filming their rapturous reaction on tasting it. Though the woman had worked all her life in the cocoa fields, she had never before eaten chocolate. She had no idea, Mr. Bowes writes, 'of what it was about chocolate that made it so ... appealing to people living thousands of miles away.' It's an affecting story. And certainly one of the results of the fair trade 'revolution'—chronicled in Mr. Bowes' book by several of its major figures—has been to help those at the far end of the supply chain, all over the developing world, gain a greater awareness of the developed-world consumers for whom they're producing. But as the rest of the book makes clear, fair trade is actually much more about the opposite: prodding developed-world consumers to gain a greater awareness of those on the far end of the supply chain, in the remote villages, mountainsides and farms of the developing world."

Stark asserts that the central premise of the fair trade movement is simple: "A certain type of consumer in North America and Europe will pay above-market prices for commodities such as coffee, bananas and chocolate, if he knows that this premium will be spent on higher wages for those who did the planting, picking and packing." I'm glad he wrote "a certain type of consumer" will pay more because most consumers have time and again proven that prices trump idealism. Stark continues:

"Accordingly, a number of groups—members of the Fairtrade Labelling Organization International—fan out annually to visit tea plantations in Malawi, mango groves in Peru and a lot of places in between. Where the workers are reasonably paid, and as a result are schooling their children or moving up the supply chain into processing, the organization certifies their end products with official fair-trade labels. True, there are other groups in the labeling business, including environmental groups that dislike fair trade because it involves (think of the carbon emissions) transporting commodities over long distances. But over time the Fairtrade Labelling Organization International has succeeded in placing goods with large companies like Cadbury's and even Starbucks, 1% of whose coffee, Mr. Bowes says, is now 'fair trade.'"

Stark underscores what I wrote earlier, pay workers fairly and good things happen: children go to school; infrastructure is improved; and investment capital becomes more readily available. The fact that countries that promote fair wages are "moving up the supply chain" is another good indicator that win-win scenarios are possible. Stark, however, raises the question: "Is there anything wrong with using the market to promote social change in this way?" Stark continues:

"It turns out that fair trade attracts critics on either end of the spectrum. People on the right worry that whenever commodities are sold at above-market prices, consumers must be sacrificing utility and producers wasting resources. On the left, many slam fair traders for compromising their moral purity by working with large corporations. Free marketers, for their part, have little cause for concern. Fair trade's above-market prices are not enacted by government; rather, they resemble other kinds of market-pricing arrangements. At any given time, some consumers will value a product—an airline seat, a hotel room—more than others do. Sophisticated algorithms allow airlines and hotels to figure out who they are and charge them more. In much the same way the fair-trade consumer thinks that a pound of coffee is worth more than other consumers do; he happens to place a higher value on the sweat and toil that went into it. And so he voluntarily pays more. As contributors Joe Human and Bruce Crowther note, he could get the same brew elsewhere for less. It's his personal choice to pay a higher price, not a market requirement."

Everyone who has ever bought a name-brand product over a generic brand of the same product has engaged in this type of behavior. "The fair-trade retailer, too, sells the same commodity at a higher price. He simply does so, as contributor Harriet Lamb notes, by linking his product with factual information about the conditions of the producers, not churning up subjective feelings in the minds of buyers." Stark continues:

"The matter of business sincerity has always been a problem for social-responsibility activists. What usually steams them are companies that channel profits away from shareholders and toward social causes, knowing that—thanks to the warm and fuzzy public relations that result—they'll actually boost profits in the long run. These firms don't care about doing good, the rap goes, they care only about doing well."

I've pointed out in previous posts that not everyone believes in corporate social responsibility (see, for example, my post entitled Dissing Corporate Social Responsibility). For another interesting take on this subject, read "Companies aren't charities," The Economist, 21 October 2010]. That article insists, "In poor countries the problem is not that businesses are unethical but that there are too few of them." Stark concludes:

"Whatever the merits of such a critique, it doesn't apply to fair trade. A fair-trade retailer isn't cutting profits for easy publicity now only to cash in later from an improved image. It's hiking the costs it incurs for labor and passing them on to consumers. Even if retailers wanted to, most couldn't prove that they genuinely care about fair trade—care about it for reasons that have nothing to do with their bottom line—because ultimately it's the consumer's bottom line that takes the hit. If fair traders want to expand their movement, they'll have to focus on winning over new consumers, one by one."

As I noted above, winning new consumers won't be easy. After all, Walmart didn't become the world's largest retailer by offering higher prices for the products it sells. That doesn't mean that the fair trade movement should stop trying; it just means they must work harder to get their message across. I suspect that fair trade goods will never grab too big of a market share; but, a fortunate few at the end of the supply chain will benefit from the efforts of the fair trade movement.

Supply Chain Analytics

In a post entitled Trends in Supply Chain Software, I cited a blog post by Lora Cecere in which she identified a number of trends she is going to watch this year ["Ring in the New Year ..." Supply Chain Shaman, 22 January 2011]. One of those trends was "New Forms of Supply Chain Intelligence." I was pleased Lora that mentioned Enterra Solutions in relation to that trend. This is what she wrote:

"One of my favorite trends that I am following is the changing world of supply chain intelligence. New capabilities are evolving that can deepen our abilities to design, sense and respond value networks. Historically, supply chain intelligence has been limited to simple work rules, optimization and simulation. The use of Software as a Service (SaaS) changes the game for optimization. The use of SaaS enables parallel processing, expert tuning, data cleansing, and benchmarking opening up new horizons. I am also following the use of artificial intelligence to map “multiple ifs” to “multiple then” conditions, advanced pattern recognition to drive listening and sensing platforms and the use of optimization in combination with simulation to model the feasibility of solutions to drive the best answer. Technologies to watch include Enterra Solutions, Predictix, Revionics, SAS, Sockeye Solutions, Solvoyo, and Terra Technology. This is a great trend to watch in 2011."

Lora isn't the only analyst watching the business intelligence sector. Jeremy Friedler from the Maxiom Group suspects that supply chain analytics is going to be "the next big thing" in business intelligence ["Is Supply Chain Analytics The Next Big Thing In Business Intelligence?," Maxiom Group Blog, 18 January 2011]. Friedler writes:

"I want to focus on [an] emerging supply chain trend that seems to be gaining significant traction by allowing companies to increase operational responsiveness and flexibility. This area, known as supply chain analytics, hopes to allow for supply chains to quantitatively segment multiple data points to make fact based predictive decisions as a means [to]become 'data driven' and improve operational performance. Supply chain analytics, a somewhat nascent yet growing business intelligence platform, led by companies such as Teradata, is proving to be a powerful force. While most companies across industry verticals measure supply chain performance based on what has occurred solely in the past through metrics, this approach will no longer be sustainable in the future. By contrast, analytics ties future and predictive performance together by analyzing trends based on millions of data points gathered from operational transactions in real time throughout the globe."

As business analytic systems get "smarter," they approach something like the sense-think-act paradigm that prompts human behavior. In fact, "sense-think-act" supply chains and "demand-driven" supply chains are probably the same thing identified by different names. In another post, Lora describes some characteristics shared by companies that approach having a demand-driven supply chain ["What happened to the concept of demand driven?" Supply Chain Shaman, 12 January 2011]. She writes that "demand-driven companies have by definition, five characteristics":

• "Demand sensing: The early definition of demand-driven value networks was a network of trading partners that can sense and respond to demand fluctuations with near zero latency. The concept of demand sensing with near zero demand latency is the first step in becoming demand driven. A good example of this is how supply chains can be transformed by moving from a push to a pull-based signal using Wal-Mart Retail Link.


• "Active demand shaping: However, as companies mature and learn demand-driven concepts, they quickly learn that it is not sufficient to just sense demand, but that it is critical to also actively shape demand through demand orchestration. The process of demand orchestration is horizontal. It spans functional silos of sell, deliver, make and source to and enable market-to-market corrections (from the outside in) to stimulate, or deaccelerate demand. There are multiple demand shaping levers – new product launch, marketing programs, sales/channel incentives, price management, trade promotion management, service programs/after-market support, and the sale of Slow and Obsolete products (commonly referred to as SLOB) at the highest margin – that can be leveraged to speed-up or slow down demand. The key of being demand-driven is to actively shape demand to maximize profitability ensuring alignment of all functions to deliver against the opportunity. All too often, in supply-driven organizations, demand is shaped in isolation. (E.g. a promoted product that is not in stock or a price decrease for a product when a commodity market is tightening.) Samsung does this well.


• "Design of value networks for demand. A characteristic of demand-driven value networks is that they are designed, not inherited. The company also recognizes that they have multiple value networks with each having unique characteristics for response time, cycle times, and flows. The design of these value networks for demand-driven leaders recognizes the characteristics of demand flows and incorporates demand variability into the overall design. The goal of the supply chain shifts with demand variability. Networks with low demand variability (e.g. low MAPE) can be push-based supply chains based on efficiency goals of lowest cost per unit. Networks with high variability and high volumes (seasonal products) need to be designed to be responsive. These value networks sacrifice the lowest cost to have the most responsive value network. Networks with high variability and low volumes need to be designed for agility. In these networks, companies design for the same quality, cost and customer service given the level of demand fluctuations. They know what is possible and become active modelers to understand the trade-offs. Intel’s supply chain mastery program allowed the company to redesign the value network quickly to launch the Atom chip.


• "Agility through demand translation. In the management of demand networks, demand is orchestrated—sensed and actively shaped to maximize margin—through the use of an agile supply network. In this agile network, manufacturing and distribution flexs to maximize value. (E.g. Manufacturing load is shifted from plant to plant, and shipping modes are changed to maximize value in the value network.) This orchestration of demand—sensed, shaped and translated to maximize profitability – is usually coordinated through a series of horizontal processes designed from the outside-in (from market facing processes to supplier processes) of revenue management, Sales and Operations Planning (S&OP), and New Product Launch Commercialization.


• "Focus on outcomes. As companies implement demand-driven value networks, the focus shifts from selling into the channel to selling through the channel. It can also shift from a product-based focus to a value-based outcome focus that combines product and service (E.g. An example of value-based outcomes is the shift that is happening in healthcare. It is no longer sufficient to just sell insulin to diabetes' patients, they want devices for monitoring and direct linkage to their physicians.) This may seem like a subtle shift; but the change management issues loom large for an organization implementing the strategy."

Lora's first two characteristics (i.e., demand sensing and active demand shaping) obviously focus on the "sense" portion of "sense, think, and act." They also serve as part of the feedback loop. Since companies actively try to encourage customers to buy their products (through active demand shaping), the returning demand signal helps them measure how well their efforts work. The final characteristic (i.e., focus on outcomes) deals more with the "act" portion. Sensing demand is obviously meaningless if you can't do anything about it. The middle and next to last characteristics (i.e., design of value networks for demand and agility through demand translation) provide the "thinking" connection between sensing and acting. Those two areas are where business analytics can fulfill their most vital roles. Friedler continues:

"The idea of analytics utilized within supply chain management becomes even more important as companies look towards cost containment and freeing up working capital, risk management, sustainability, and increased visibility within their supply chains. Therefore, automating the entire supply chain through advanced modeling and predictive performance is not only here for today, but very well may be the way of the future. The promise of supply chain analytics allows for 'intelligent systems' to learn and adapt to how a particular supply chain is run and then make adjustments accordingly through advanced simulation and complex algorithms. For example, this avant-garde system allows for predictive buying and selling patterns (i.e. what is the supply chain impact of a particular promotional event or seasonal trends) to coincide with the proper level of production, inventory, and distribution to more effectively align costs with revenues. In addition, some companies are even using supply chain analytics software as a competitive advantage, to adjust their supply chains based on market conditions, weather patterns, or customer segments. This ultimately provides the correct level of 'end to end visibility' of the performance of each specific node within the supply chain in order to improve responsiveness, contain costs, and improve customer service. Sophisticated modeling and analytics software may also allow companies to uncover data that may be overlooked within traditional ERP and CRM systems."

One often reads about sense and respond systems -- but little mention is made of the analysis or "thinking" that must take place between the sensing and the responding. This missing piece of the puzzle is what good analytic programs provide. Because analysts like Cecere and Friedler believe that business analytics will play an important role in the future, it should come as no surprise that workers skilled in such analytics are predicted to be in demand ["Analytics, Storage and Cloud Skills Will Be in Demand," by Jennifer LeClaire, NewsFactor.com, 17 January 2011]. LeClaire writes:

"Experts say there is plenty of action across the board for technologists with specialized skill sets. IBM is betting on business analytics. Tim Powers, a spokesperson for Big Blue's business-analytics division, said businesses and governments alike are grappling with the challenge of making sense of this data deluge to turn it into new opportunities, increased performance, and faster, better decision-making. Gartner reports business analytics is a top 10 priority for companies in 2011. 'The power of business analytics is transforming this information into a strategic asset. Although having the best, most complete and up-to-date information is useless if you can't make sense of it,' Powers said. 'Data unanalyzed is data wasted. Therefore, businesses and governments need two very important things to make this happen: The right technology, and employees with the right expertise and skill sets.'"

Clearly the need for supply chain analytics is on the rise. To remain competitive in a globalized world, costs need to be controlled and efficiencies need to be implemented. As I have pointed out in numerous posts, cost reductions and lean processes create tensions in supply chains that also require increased agility. Supply chain analytics can help companies discover the sweet spot that keeps a supply chain cost effective and efficient yet still maintains the agility it needs to succeed in a rapidly changing world.

Inventory: A Jekyll and Hyde Story

Supply chain analyst Bob Ferrari asserts that company executives are of mixed minds when it comes to the subject of inventory ["Inventory- Evil or Good?," Supply Chain Matters, 18 November 2010]. He writes:

"Most senior financial managers and some CEO's believe that too much inventory is a detriment to working capital performance. It is just plain, evil. Marketing and sales executives view inventory as an ultimate enabler, and having inventory of a hot selling product is tantamount to 'candy' to a child, or exclaims, 'Give me more!'"

If inventory is evil, it is certainly a necessary evil. "Too much inventory" is certainly not a good thing -- perhaps not evil, but certainly not good. But getting inventory "just right" is not an easy matter. Ferrari continues:

"Our community knows all too well that having the right balance and composition of inventory is the real test in the ability to satisfy all stakeholders. A previous mentor of mine, Larry Lapide would often evoke the cholesterol analogy regarding inventory in his presentations to clients. There is good and there is bad cholesterol in our bodies, and the challenge is to optimize good and minimize the bad as much as possible."

Ferrari goes on to discuss a paradox that was confronted by Walmart. At the end of last year, Walmart "experienced the sixth straight quarter of declining growth in existing U.S. outlets" yet managed to post "a 9 percent increase in profitability." Some of that profitability came from outside the U.S. (Ferrari reports that "nearly a fourth of overall sales now originate from non-U.S. retail outlets"), but he believes that some of the profitability also resulted from how Walmart dealt with inventory. He explains:

"For those readers unfamiliar with the Wal-Mart situation, there is some history to reflect upon. Wal-Mart suppliers are acutely aware of the relentless focus on supply chain cost, which includes inventory, payables and process efficiencies. The latest initiative is a program directed at purchasing more goods directly from select global suppliers, bypassing intermediaries. Wal-Mart believed that it could gain even more efficiency through direct purchases of standard items. In late 2009, Wal-Mart embarked on an aggressive store re-vamp and inventory reduction program. The intent was to stock only high volume, high demand items while creating a more streamlined, uncluttered look and feel to a Wal-Mart U.S. store. The premise was value at traditional low prices. Gone were the days of stocked pallets placed in main shopping aisles giving the appearance of a cluttered warehouse atmosphere. The new merchandising plan was designed to help customers navigate easier and locate expensive or impulse items in select high-traffic areas."

That sounds like a good plan. How did it work? Apparently not so well since Walmart "reversed course" at mid-year and "re-assigned certain U.S. management" (the implication being that those individuals who were reassigned were the ones who decided on the new inventory scheme in the first place). The reversal of the decision means that Walmart "is now adding more merchandise variety to stores." Ferrari continues:

"The Wall Street Journal noted that inventory has grown 7.7 percent compared to a year earlier. By my calculation, in the most recent quarter, days sales of inventory is up to its highest level ever, no doubt in anticipation of an aggressive holiday buying season. [Remember that this was written back in November 2009]"

As I recall, Walmart discovered that even though bargains brought shoppers into their stores they started complaining when they could no longer buy products they were used to buying -- even if less expensive alternatives to those items were available. Variety, as the old saying goes, is the spice of life. Ferrari concludes:

"Technology and business process methodologies have come a long way in the ability to optimize merchandising, plan shelf space, analyze and optimize inventory investments based on consumer needs and revenue targets. Management behavior or intuition it seems, has not made the same rate of progress."

Based on the Walmart experience, it is clear that getting inventory "just right" is no easy matter. How then should one think about "just right" inventory? The challenge, of course, is different depending on whether you are a manufacturer, a distributor, or a retailer. The editorial staff at Supply Chain Digest suggests that for manufacturers, "production scheduling optimization may have bigger impact than improving forecast accuracy." ["Looking to Reduce Inventories?" 2 November 2010]. It explains:

"The pressure to reduce inventories continues apace, even after the worst of the recession is well behind most companies. Many companies look to improving their forecast accuracy as a key driver of inventory reduction, from the common sense view that better predicting what customers are going to buy will enable companies to better match planned inventories with actual demand. But that might not always represent the lowest hanging inventory fruit for many manufacturers, according to Filippo Focacci, a product manager at IBM ILOG. According to Focacci, there are three main areas in the supply chain that can have a significant impact on overall inventory levels:

• "Forecast accuracy
• "Where and at what levels inventory is positioned within a multi-echelon supply chain network
• "Production planning and scheduling decisions

"... Focacci said that many companies think about factory planning and scheduling in terms of production costs, but often do not fully understand the significant impact manufacturing optimization can have on inventory levels as well - often delivering greater reductions in inventory than might come from improving forecast accuracy can. (To view the full Videocast, go to: Agility in Consumer Goods Demand Driven Manufacturing.)"

The article goes on to explain how Focacci reached his conclusions and provides a case study to examine. "The key is doing production planning and inventory optimization together," Focacci said. "You need less safety stock because you are doing better production planning." The article concludes:

"The challenge, of course, is how to quantify the likely impact of any or all of the three inventory drivers (forecast accuracy, inventory positioning, improved factory planning). It is not obvious at first to many companies that forecast error may not actually be the best target for inventory reduction."

Both of the articles cited above were written at the end of last year, but the problem has persisted into 2011 ["Adjusting Inventories Get Harder," by John Shipman and Paul Vigna, Wall Street Journal, 27 January 2011]. Shipman and Vigna report that "the choppy U.S. economic recovery is testing companies' skill at finding just the right inventory levels to maximize their profits." They continue:

"Business inventories, slashed during the recession, had been climbing since June on a year over year basis, according to U.S. Department of Commerce figures. But, amid December's strong auto and retail sales, the build-up of finished goods may have cooled off when the month's figures are disclosed, some economists say. The rebound in demand so far has been uneven, and combined with a rapid rise in commodity costs since the third quarter, it's becoming trickier for manufacturers to balance their production with sales. The stakes are high—produce too much and if demand falls, be forced to pare overstock at margin-killing prices; play it too safe with lean inventories and potentially miss out on additional sales."

Shipman and Vigna report that Kimberly-Clark cut production too deeply and the company estimates that it lost an estimated "$20 million in profits." Shipman and Vigna continue:

"The Johnson Redbook Index of retail sales showed January's sales so far are up 2.5% from a year ago, slightly below the research firm's estimate of a 2.6% gain. 'Some retailers said consumers are back in a penny-pinching mood,' the firm reported this week."

According to Shipman and Vigna, another company that reduced production too much was Harley-Davidson. Even though its revenues increased by 20% during the fourth quarter of 2010, its dealerships find themselves with "the lowest level of dealer inventory in many years." Shipman and Vigna continue:

"'I think customers are being very careful before taking on a load of inventory,' said John Koraleski, executive vice president of sales and marketing at Union-Pacific Corp. 'They want to make sure they see that the economic recovery is sustainable and improving, but I still think we do have upside.' Meanwhile, 3M Co. is building inventories in expectations of a strong first quarter. Inventories were up 19%, CFO Patrick Campbell said on a conference call, and he expects inventory levels to remain high as 3M exports more merchandise overseas."

Shipman and Vigna report that other companies increasing inventories include Coach Inc. and Monro Muffler Brake Inc. The fact that manufacturers producing everything from handbags to auto parts are increasing inventories should be taken a good signal that the economy is producing. Still increasing inventory can be risky. Business executive and author Michael Hugos reminds us that "inventory" is one of the five essential areas involved in supply chain management (the others being production, location, transportation, and information). [Essentials of Supply Chain Management] He recommends that supply chain managers ask the following questions when making decisions about inventory:

"What inventory should be stocked at each stage in a supply chain? How much inventory should be held as raw materials, semifinished, or finished goods? The primary purpose of inventory is to act as a buffer against uncertainty in the supply chain. However, holding inventory can be expensive, so what are the optimal inventory levels and reorder points?"

Every company will have different answers to those questions. There is no "one size fits all" solution to optimizing inventory. Inventory not only buffers against uncertainty it affects responsiveness as well. Hugos puts it this way:

"If a company's strategy is to serve a mass market and compete on the basis of price, it had better have a supply chain that is optimized for low cost. If a company's strategy is to serve a market segment and compete on the basis of customer service and convenience, it had better have a supply chain optimized for responsiveness."

To state the obvious: Large inventories can improve responsiveness but they also increase costs. Small inventories can reduce costs but risk reducing responsiveness. Best Buy, which ranks 24th on Gartner's 2010 Supply Chain Top 25, learned back in the late 1990s that "you don't buy inventory just in case -- you buy it just in time." They learned that lesson one Christmas season when they stocked on up on computers only to see PC sales plummet. David Blanchard, in his book entitled Supply Chain Management: Best Practices, writes of interview he had with Eric Morley, Best Buy's director of transportation. As a result of this bad experience, Morley indicates that Best Buy focused on inventory optimization. Blanchard writes:

"According to Morley, Best Buy has established four guiding [principles] for supply chain management:

• "Focus on where the most money is spent or where the most network disruptions occur.
• "People are the most important asset, so assign the right people to the right tasks.
• "Implement performance measures because 'what gets measured gets done.'
• "Balance overall company objectives against individual functions and activities.

"As a result of it supply chain programs, Best Buy now has high-level collaboration with selected vendors. The company recruits a key vendor in each retail department ... to undertake collaborative initiatives designed to deliver breakthrough results."

Frankly, Best Buy's "collaborative initiatives" probably have a more profound effect on the company's inventory optimization than its four guiding principles, which appear to have little to do with inventory optimization. No stakeholder in the supply chain wants to get inventory wrong. As a result, they should be willing to collaborate to get it right. Unfortunately, goals are easier to express than results are to achieve. That is why companies continue to struggle with inventory and see both the good and the evil it entails.