Management Accounting

Digging In

With the economy in the pits, companies are leaving no stone unturned in their efforts to cut supply-chain costs.
Randy MyersSeptember 1, 2008

Overwhelmed by rising costs, many companies are realizing that profits don’t come easy these days. That’s true even when you’re sitting on a gold mine. Despite the massive run-up in gold prices (160 percent since August 2003), Kinross Gold Corp. has taken a pickax to a host of supply-chain costs, driving out waste wherever it can. Finance executives in many sectors can relate, as manufacturers, distributors, retailers, and others suddenly realize that with margins under pressure, ideas that once seemed unworkable are now viable.

Kinross has a supply chain that’s unusual, to say the least. Consider its Maricunga open-pit mine, located high in Chile’s Atacama Desert, nearly three miles above sea level. In the summer, winds whip in excess of 60 mph, and in winter the temperature can drop to
–20° F or more. Visitors to the mine require a physical before making the ascent and another when they arrive, and workers are checked daily by medical personnel lest altitude sickness take a toll. “When I get back to sea level, I sometimes find that my notes don’t make sense,” concedes Sean Samson, vice president of commercial development for $1.1 billion Kinross.

The Toronto-based company extracts and processes about 11 million metric tons of ore per year from Maricunga, which yields about 8 tons of gold. At Maricunga and other similarly remote sites, that activity requires vast fleets of heavy trucks, some of which consume an astounding 20 to 25 gallons of diesel fuel an hour. Kinross executives can be thankful that the soaring price of oil has coincided with an equally momentous bull market in gold. “Our revenue is growing tremendously with the rising price of gold,” Samson says. “We are in a tremendous boom — a super cycle in precious-metals mining. But we are also heavy consumers of oil, which is killing us on the cost side. That means we have to continue to bring financial discipline to our supply chain.”

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To do that, Kinross and other companies are leaving no stone unturned. Many are talking more frequently with vendors and customers to improve forecasting and better manage inventory levels. Some are deploying technology in the cause, from warehouse robots to software systems that help businesses route freight efficiently. Still others are revisiting payment and delivery terms with suppliers and customers, centralizing procurement activities to leverage economies of scale, exploring more-sophisticated commodity-hedging strategies, and scrounging for any way they can think of to minimize energy consumption. Some, like Arrow Electronics Inc., a $16 billion distributor of electronic components and computer products headquartered in Melville, New York, have even tweaked their compensation schemes to reward managers for efficient supply-chain operations.

“This economy has sensitized people to what it really costs them when they’re not doing as good a job as they can with forecasting and other aspects of managing their supply chains,” says Stephen Timme, president of supply-chain consulting firm FinListics Solutions Inc. in Atlanta. “We’ve been talking about this for years, but this slowdown has convinced people to go back and revisit the issue.”

A Closer Look at Customer Demand

Dow Chemical Co., the $54 billion producer of plastics, chemicals, hydrocarbons, and agrochemicals, is renowned for its financial-management prowess. But even finely tuned enterprises like Dow can be roughed up by turbulent markets. The Midland, Michigan-based company reported a 23 percent year-over-year gain in sales in the second quarter, but saw net income slip 24 percent compared with the same quarter last year as it wrestled with a $2.4 billion increase in feedstock and energy costs. One response has been to put even more effort into what is already a sophisticated forecasting operation in an attempt to better match inventories with customer demand.

“We’ve bought into a concept called demand-driven business operations,” says Darrell Zavitz, “which is about having good dialogue with the market and your customers and what’s going to be needed, and producing the right products and getting them to [your customers] efficiently.” As vice president of market-facing shared services, Zavitz is heavily involved in supply-chain and procurement activities. “It is about dialogue, and also respect for the urgency of certain messages,” he says. “We are getting more face time with our customers, we are on the phone with them more quickly, and we are making sure we maintain a solid line of communication between them, our suppliers, and ourselves.”

Internally, senior Dow executives are stepping up their oversight of sales and operations planning, too. “In the past we may have had routine reviews on a quarterly or a monthly basis,” Zavitz explains. “We’re increasing that frequency. For example, in some businesses we’re bringing teams together weekly to determine whether or not we have the right supply/demand balance. I’m talking about a fairly senior group of people responsible for big assets or markets.”

Arrow Electronics is following a similar strategy by sharing more inventory information among its various locations around the world. “If we don’t have enough inventory in one region,” says CFO Paul Reilly, “it may be more prudent to buy it from ourselves rather than our supplier.” The company also is making an extra effort to get aged inventory out of its distribution centers by reviewing return rights with suppliers and checking with customers to ensure they take delivery according to the delivery date.

Many companies, in fact, are finding that better forecasting requires precisely this kind of boots-on-the-ground effort. Simtek Corp., a $33 million specialty semiconductor company that farms out chip production to third-party manufacturers, is a classic build-to-forecast business; its manufacturing partners have production cycles ranging from 60 to 90 days, while its customers typically order with no more than a 30-day lead time.

Over the past few years, says Simtek CFO Brian Alleman (who is also a partner with executive services and consulting firm Tatum LLC), the Colorado Springs, Colorado-based company has been able to reduce cycle times by about two weeks by sharing more of its internal forecasting with its suppliers. Eager to shorten them even further, Simtek is driving its sales force to pry more information from customers about their 60-to-90-day outlook. “We have a new ERP system that gives us better ability to plan production,” Alleman says, “but before you can use software to improve forecasting, you have to understand demand.”

Taming Energy and Transportation

Better forecasts allow for tighter inventory levels, saving working capital. But what to do about those soaring energy bills? Some companies have seen their expenses rise so high that they see a solid rate of return behind multi-million-dollar efforts to curb them. At Kinross’s Maricunga operation, for example, 12 massive Caterpillar “haul trucks” consume more than 2.5 million gallons of diesel fuel a year. Kinross is installing mining-truck simulators at a cost of $1 million each, one benefit of which is the ability to train operators at every location how to drive so that they save fuel and reduce tire wear. The company is also replacing the haul boxes on its trucks with lighter-weight versions and is treating the box liners with chemicals that help make sure all the ore slides out each time a load is dumped.

To get better pricing on fuel and other consumables, Kinross is coordinating procurement of key commodities with the help of Quadrem International Ltd., a Dutch company that offers an E-commerce platform for buyers and suppliers. And it is seeking to become a “little more sophisticated” in the way it hedges against oil-price increases, says Sean Samson, trading customized options contracts in the over-the-counter market, for example, and exploring hedging opportunities for other commodities. While declining to discuss specific returns on these investments, Samson notes that “at $60 a barrel, a lot of these initiatives didn’t offer great payback. At $120 a barrel, they do.”

Dow Chemical, which consumes the equivalent of 850,000 barrels of oil a day in energy and hydrocarbon feedstocks, is focusing its fight against rising energy costs on conservation. Although it increased the energy efficiency of its worldwide operations by about 22 percent between 1995 and 2005, Zavitz says, it is targeting another 25 percent improvement from the 2005 baseline between now and 2015, via multiple short-, medium-, and long-term initiatives. In 2007, the company announced several joint ventures to secure more-cost-effective feedstocks and promote the development and use of renewable and alternative energy sources. For example, the company has launched an initiative in Brazil to create polyethylene from ethanol derived from renewable sugar cane.

Many companies that are not big consumers of oil and oil derivatives have nonetheless been affected by the sharp rise in fuel costs, of course, especially those in shipping-intensive industries. Avnet Inc., an $18 billion distributor of electronic components and computer products, tries to pass increased freight costs on to its customers where it can, but in the meantime is working with them to minimize the use of overnight and two-day delivery services that typically cost 40 percent or more than standard ground delivery. “By changing their ordering patterns a little, we both save money,” says Avnet senior vice president, CFO, and assistant secretary Ray Sadowski. The company also is trying to consolidate orders more effectively to minimize freight costs, he says, “without having a negative impact on our customers.” Avnet is pursuing similar initiatives with its suppliers, asking them to shun high-cost shipping services when they aren’t required to meet customer timetables.

Welch Foods Inc., a $700 million Concord, Massachusetts-based cooperative that produces fruit juices and jellies, tackled the burgeoning cost of shipping its goods by investing in transportation and logistics reporting software (from Oco Inc.). The software pulls together data from three existing software systems the company uses to create a data warehouse yielding reams of real-time information about customer orders and shipping patterns. Implemented in six weeks and brought online earlier this year, the new system has allowed the company to load and route outbound trucks more efficiently, says Bill Coyne, Welch’s director of purchasing and logistics. “We’ve probably identified several hundred thousand dollars in savings already,” he says, “and we are still gaining additional insights into our structure.”

Companies can also reduce their shipping costs, says Steve Crowther, CFO of Transplace Inc., a privately held third-party logistics provider in Plano, Texas, by negotiating lower core hauling rates with trucking companies that have seen business slow with the economic downturn, and by encouraging their own drivers to drive more conservatively. The typical long-haul driver logs about 120,000 miles a year, and by some estimates a driver could save about $100,000 over that period by going easier on the accelerator and adopting other conservative driving techniques.

Rethinking Everything

Companies need to be more creative in looking for ways to streamline supply chains, says Frank Burkitt, head of supply chain and operations service for Deloitte Consulting. For example, his firm is working with a number of companies that are developing differing tiers of service for customers based on their profitability, which can translate into holding less inventory for less-profitable customers. Other companies are rethinking their product lines, jettisoning slow-moving items that add costs not only in the form of additional inventory but also production capacity, which can negatively affect order-to-fulfillment cycles for more-profitable products.

Some companies are rethinking the conventional view that producing goods in low-wage countries is preferable to producing them in the developed markets where customers buy them. In some industries, Burkitt says, shipping costs from China now exceed the cost of the goods being shipped. Some experts believe this will give further impetus to the “reverse outsourcing” trend, in which jobs (mostly in manufacturing) return to the businesses’ home countries. In other cases, such as with automakers, companies may build factories closer to customers; witness Toyota’s recent decision to begin building Prius hybrids in the United States.

Amid all the cost-cutting activities aimed at streamlining the supply chain, companies must be careful, of course, that they don’t jeopardize their ability to deliver the goods and services customers want when they want them. The finance function can assist in that effort by helping operating personnel analyze the trade-offs that supply-chain decisions present. “That risk-management expertise is exactly where our finance function comes in, and it helps me in my operational role,” says Dow’s Zavitz. “They help me understand the longer-term risks and opportunities associated with supply-chain management.”

Alfred Lin, CFO and COO for Inc., an $840 million online retailer of shoes and other goods based in Henderson, Nevada, says CFOs and finance organizations can also help by setting targets for supply-chain improvements and by demonstrating that those targets are achievable, whether through traditional analysis or by benchmarking against best-practice competitors. Or, put another way, it’s time for CFOs to acknowledge that they are, in fact, critical links in their companies’ supply chains.

Randy Myers is a contributing editor of CFO.

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