Management Accounting

Supply Chains and Demand

As consumers scale back, supply chains are hurting from end to end. Finance can ease the pain.
Russ BanhamSeptember 1, 2009

The metaphor of the global supply chain, meant to convey strength through interconnectedness, has lately come to symbolize the opposite: companies dragging each other down as one fails to gauge demand while another struggles to meet it, or to manage the cash flow needed to remain a viable part of it.

As proof of the various pressures that supply chains are under, consider what happened earlier this year to Best Buy and Mattel. Best Buy noted in March that it could have sold more electronics equipment in the previous three months had its suppliers not reduced their volumes in anticipation of slowing demand. Mattel, meanwhile, saw its net income plummet, from $600 million in 2007 to $379.6 million in 2008, as customer orders shrank and 1,000 Chinese toy exporters went out of business. “These are tough times for our partners on both sides of the supply chain — the vendors that supply us are facing financial difficulties and so are our retail customers,” Mattel CEO Robert Eckert says. “We’re scrambling to make sure we can get the parts we need to make our products.”

“With weak consumer demand, the entire supply-demand equilibrium is out of whack,” says Frank Burkitt, national supply-chain and operations practice leader at Deloitte Consulting. “Many suppliers have trouble funding their operations because they can’t access working capital or a significant line of credit, and are failing as a result.” On the front end, forecasting demand is more difficult than ever.

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This puts companies’ balance sheets in peril. According to a 2009 survey by commercial-property insurer FM Global, more than 40% of senior finance executives, representing the largest companies in the United States, say they have experienced an unexpected disruption in their supply chains that has “negatively affected” their financial performance. Deloitte’s own data indicates the same. “The financial risk of the supply chain is the biggest threat out there,” Burkitt asserts.

Yet amid these many pressures, companies are not about to scale back their ever-expanding supply chains. “No one is going retro,” says Blythe J. McGarvie, author of the book Shaking the Globe: Courageous Decision-Making in a Changing World. The FM Global study backs her up, noting that 62% of respondents expect their global sourcing activities to increase over the next three years.

Today’s global supply chains comprise many more links than previously, which makes it very difficult to gauge the potential impact of trouble far down the line. But companies now realize that they must make that effort. “In the past, the ‘enterprise’ in ‘enterprise risk management’ was thought to be the company itself,” says consultant James Lam, president of James Lam & Associates. “But the global economic crisis has made it plain that ‘enterprise’ refers to the total business environment — your suppliers, their suppliers, your customers, distributors, and even your bankers.”

Add to that the impact of rising commodity prices. At Sara Lee Corp., rising fuel and animal-feed costs sent its commodity bill soaring, even as the consumer-products maker of Hillshire Farm, Jimmy Dean, Pickwick, and other well-known brands confronted a shift in consumer demand, away from restaurant meals and toward eating at home. “That’s a plus and a minus for us, given our two lines of business, in food service and retail,” explains Sara Lee chief supply chain officer George Chappelle. “It caused us to really think about how we schedule our plants to adjust to that kind of shift.”

One major change involved merging what had been essentially two separate supply chains. “This provided a 10% savings in administrative costs and made us more efficient in terms of how we deploy capital,” Chappelle says.

The company also intensified its focus on Lean manufacturing and Six Sigma efforts and exited some product lines. Mattel is also paring its catalog; it plans to eliminate the bottom 20% of products that, as CEO Eckert says, “don’t contribute much to our success or our customers’ success.”

Enter Finance

One aspect of supply-chain management that is likely to become a legacy of the recession is a much more careful assessment of the financial viability of suppliers and customers. “The credit and stability of our vendor base has certainly elevated itself in the supply-chain risk-management category,” says Michael Kramer, CEO of Kellwood Co., a St. Louis–based apparel manufacturer, with sales of $1 billion annually from labels like XOXO, Vince, and Baby Phat. “We’ve extended our due diligence further into their operations to get a better read on their financial stability. We also talk to the suppliers’ suppliers. We’ll ask them flat out, ‘Are you getting paid?’ If they’re not, it could be an indication that their customer — our supplier — has financial problems.”

Paul Reilly, CFO of Arrow Electronics, a $17 billion distributor of electronic components and enterprise computing gear, has a similar perspective. “We have increased our due diligence to ensure suppliers have the financial strength to withstand stress in their businesses,” Reilly says. “Our customers, incidentally, are requesting the same things from us.”

At Corning, assessing the financial condition of suppliers has become so strategic that the procurement group has turned to the finance group for credit analysis expertise. “The global economic crisis catalyzed the need for us to be more deliberate and rigorous around examining the financial security of our suppliers; consequently, finance has taken on the task,” says Mark Rogus, senior vice president and treasurer of the $5.6 billion maker of specialty glass and ceramics.

Corning now employs the same processes used to diagnose its customers’ financial health to diagnose its suppliers’ financial health. “The underwriting rigor we use on the accounts-receivables side has been ported over to the accounts-payables side,” Rogus says. “We’re analyzing key financial metrics like ratios for working capital, investment performance, return on invested capital, return on equity, and others on a historical basis, and then doing our own projections of what the future might hold using market-driven data. We also try to find information on a supplier’s access to available capital, determining whether they are borrowing from banks or have committed credit facilities, and the terms thereof, including the credit spreads on existing debt.”

If Corning can’t get this information from public sources, someone picks up the phone to contact the supplier. “Once we have what we need, we make short-term projections of the supplier’s financial health, since our typical supply contracts extend out only 12 months,” Rogus says. Armed with this data, Corning’s procurement organization prioritizes the suppliers based on their financial condition and other key performance indicators, like product and raw-material quality, data transparency, and reliability of supply. It then compares the supplier’s financial condition with Corning’s exposure. “The more we spend with a supplier the higher the potential risk, particularly if it’s a sole-source supplier,” Rogus says. “This is all about business continuity.”

Continuity, of course, may require a mix of ruthlessness and flexibility. Kellwood has also engineered relationships with domestic suppliers in case demand suddenly perks up.

“We often source the initial orders in China to take advantage of the low-cost labor,” explains Michael Saunders, Kellwood’s chief operating officer. “When we saw where the economy was going we got nervous and reduced the inventory, but that created the risk that we wouldn’t be able to meet an upsurge in demand. So we’ve struck deals with domestic suppliers to replenish inventory at the last minute. It costs us 10% to 20% more, but it’s a solid backup if and when demand spikes.”

“If” and “when,” of course, remain the two big questions that will shape supply-chain operations for some time to come.

Russ Banham is a contributing editor of CFO.

Sensing: An Opportunity?

As companies grapple with substantial uncertainty regarding consumer demand, some are turning to “demand sensing” technologies to gain insights. One goal is to avoid the high costs of carrying too much inventory, which, as Doug Sloan, director of supply-chain operations at Unilever USA, says, “leads to business waste because we may need to move the product at a lower price or potentially write it off.” His company has implemented demand-sensing software from Terra Technology to “quickly see the shifts in consumer preferences so we can fine-tune what to produce and how much supply we need to meet the demand.” The pilot stage of the implementation indicated a 25% improvement in forecast accuracy, Sloan says.

Older forecasting tools tended to leverage historical data, like last year’s sales, to predict next year’s. That doesn’t fly in today’s topsy-turvy economic climate. “Our software squeezes information out of current customer data to effect better sales predictions,” says Robert Byrne, CEO and president of Terra Technology. Powering this squeeze is pattern-recognition mathematics that deciphers daily streams of data to predict demand. “We’ll look at the company’s existing forecast to see if its predicted sales and orders are jibing with what is happening in the business right now,” Byrne adds.

SKF USA Inc., a manufacturer of bearings, actuators, and seals used in power transmission equipment and automobiles, is using software sold by Demand Management Inc., called Demand Solutions, to match anticipated demand to a more precise volume of materials and equipment. “If we’re better at forecasting how many bearings we’ll need in a particular geography, then procurement can be better at buying what we’ll need to make them,” says Jeff Carlisle, director of forecasting and market research at SKF. “You don’t want to overstock inventory and simply hope the customer wants it.”

Demand Solutions analyzes both historic sales data stored in the enterprise-resource-planning system and current sales data from the field, says president Bill Harrison. “Our software can run on laptops and smart phones, so that data from a salesperson who strikes a deal in China or South America or Cleveland goes through a series of statistical analyses and statistical models immediately, which results in a more accurate forecast of needed supplies.”

Companies are realistic about just what demand-sensing technologies can do. “Accuracy is a relative word,” Carlisle says. “You try to do better than natural variations in demand based on historical data. The tool gets us close to 25% plus or minus, which is actually quite good for a forecast.” — R.B.

How Finance Can Help

A Supply-Chain Action Plan for CFOs

Speaking to a finance audience at CFO’s Core Concerns conference this past June, Sara Lee Corp. chief supply-chain officer George Chappelle offered some detailed advice on just how the finance function can help propel supply-chain activities to new levels of efficiency and profitability. Among his recommendations:

Consolidate. Use scenario modeling, G&A cost management, and a focus on achievement-to-plan in order to simplify the chain where it makes sense.

Intensify Lean and Six Sigma efforts. Be the “steward of savings” by extending Lean concepts into non-supply-chain areas as one way to drive more cost savings. Help the company gauge supply-chain performance based on cash flow, not P&L.

Rationalize SKUs. Transform typical one-time efforts into a continuous process, structure data more formally, and collaborate with operations and sales.

Focus on marketing/advertising. Bring stronger ROI measures to bear, work toward repeatable capability for successful initiatives, and serve as a clearinghouse for future MAP (marketing/advertising/promotions) investments.

Support innovation. Develop a repeatable mechanism to gauge lifecycle profitability, conduct new-product margin analysis, and provide discipline on “when-to-exit” decisions.