Supply Chain

Riding That Chain

Disillusioned about your supply-chain management system? There may be relief on the way, in the form of smaller, nimbler third-party service provid...
Arthur ClennamAugust 7, 2003

Here’s something that Liam Casey knows about logistics in China that you probably don’t. The People’s Republic is the only country in the world where customs officials want to know precisely the quantity of raw materials used in that component you are trying to export. Manufacturers on the mainland beware. If there’s a discrepancy in inputs versus outputs — that is, the amount of raw material bought by the company versus the amount of goods estimated to be made from that same amount — then customs agents will halt the shipment of the finished goods until the discrepancy is cleared up.

The purpose is to stanch the flow of goods transferred out of China to avoid tax and royalties. While this is a perfectly reasonable activity for a government, it’s hell on the supply chain if you’re a just-in-time manufacturer.

Suppose you’re Taiwanese designer who’s using a factory in Dongguan province to meet an order for components to be delivered to your largest European client, and suppose there’s a discrepancy in that factory’s records. The result is that your shipment will languish for days. Meanwhile, your nail-biting customer in Prague is in danger of missing his on-sale date.

That hold-up is what’s known in the supply-chain management business as a “pain point.” And that’s where Casey comes in. His company, PCH, eases aches that naturally emerge when goods move through a synchronized pipeline from one manufacturer to another, and, eventually, to market. PCH is small, earning US$2.8 million in profits on revenues of US$30 million. What’s interesting about Casey and his crew is that PCH is offering value-added services that go beyond logistics, mimicing companies 50 times its size. PCH’s service package includes sourcing, software tracking, and even risk management. Giants like UPS and Exel are trying to provide this end-to-end type of service as well. The difference is they’re struggling with massive cost pressures plus new PCH-style competitors.

“The tools of globalization,” says Casey, “such as real-time Internet tracking systems, discount air travel, and mobile phone technology are just as available to a small, low-cost provider as they are to giant organizations.” Casey and his operatives keep costs down by flying economy class, keeping an office in Shenzhen rather than pricey Hong Kong, and traveling with a battery of mobile phones — one for each market — in order to avoid steep roaming charges. He projects a 9 percent profit margin this year.

“In China, the only way to compete is to promise no surprises,” he says. He adds: “That’s a promise not easily delivered, but we can anticipate problems and undo the knots as well as anyone.”.

Pain on the Chain

There’s been a lot of talk about supply-chain knots lately, as evidenced by two studies released in May. One, by Booz Allen Hamilton, the New York research firm, found that despite a $19 billion worldwide market for supply-chain system “solutions” — a buzzword meaning software investments — 45 percent of the respondents were dissatisfied with the level of performance of their investments against expectations. The study polled senior executives who make the spending decisions — CFOs, CIOs, and commodity supply officers — at companies that sold more than US$1 billion annually and had operations on a global scale. The respondents said that the most common reason for disappointment was an inability to forecast effectively (56 percent). Other reasons include implementation issues and delays (48 percent), and unrealistic expectations about the impact of technology (44 percent).

Another technology research group, International Data Corp (IDC), based in Massachusetts, released a study with complementary findings last month. This study says that buyers of supply-chain management services had increased by 9.5 percent in 2002, but that buyers were less receptive to large-scale supply-chain management investments that required complex and lengthy implementations and internal change. Instead, the market demonstrated a clear preference for smaller-scale projects that addressed the immediate “pain points” with up-front return-on-investment and some clear “show-me” milestones.

The underlying theme, to be sure, is squeezing dollar value out of supply-chain systems that, not too long ago, were predicted by consultants to be cost savers themselves on a massive scale. Harry Lee, the managing director of Hong Kong-based TAL Apparel, is an example of an Asian executive looking hard for those “show-me” milestones cited by IDC. TAL is midway through installing a new ERP supply-chain management system using software by Intentia, the U.S.-based company software solutions company. TAL makes men’s dress shirts for manufacturers such as Calvin Klein and Brooks Brothers, with annual sales of US$500 million, and needs the system to better monitor the progress of orders through the supply chain.

The cost for the software and for consultants to help TAL connect it to warehouses and shipping facilities and customer databases, was initially priced at US$5 million. Lee, with palpable frustration, says it will “come in well over US$10 million.” The doubled price tag is due to the extensive nature of the integration needed at TAL, which already had an antiquated system that ran on an IBM mainframe and was developed 20 years ago.

“The old system was not much worse than what we’re installing now,” says Lee. “But the trouble is that when you want to get anything done, you have to pull data from all over the place. We’ve grown too big to run the operation this way.” So he and his board decided it was time to invest in “comprehensive integration that would allow more adaptability.” One of the elements of this adaptability is that the Intentia system can be Web-based, and incorporate such add-ons as TradeCard, which allows for electronic transactions that take the place of traditional letter-of-credit instruments, speeding up payments and the flow of goods.

While Lee has money to spend, many CFOs are desperate to smooth the supply chain without adding cost. Jake Vigoda, the finance chief of KR Precision, a US$45 million business in Bangkok that makes computer components, began overhauling his supply-chain management system in 2001 during a period when the company was losing money rapidly. For Vigoda, clearing up the problems in the company’s supply-chain management system was crucial. KR Precision had been hit by a downswing in computer sales and exports and needed to squeeze costs in order to return to profitability. Vigoda says. “I wanted significant improvement in working capital, and greater flexibility to meet changing demand, and improving the supply-chain process was the best place to do it.” He adds, “And I didn’t want to spend any more money.”

Vigoda says that KR Precision installed an ERP system in 1997, but that the really aggressive efforts to improve supply-chain management came when the company set up a just-in-time (JIT) hub systems 18 months ago. “We give our suppliers stock level targets,” says Vigoda, “based on our forecasting of customer’s needs. We look each day at the inventory levels, and have a tight control of the flow of what we produce and ship into our JIT hub.” The success factor? “Instead of having to keep three to five days of finished goods as a backup for changes in customer demands, we’ve been able, without any failure rate, to eliminate one whole level of buffer stock.”

Vigoda is keeping his fingers crossed. Revenues grew 50 percent year-over-year in 2002 from 2001. He’s predicting that KR Precision will return to profitability this year — if the newly fine-tuned JIT hub is able to deliver lower costs despite the growth in sales volume.

The Third-Party Option

CFOs of bigger companies have more leverage to squeeze cost out of the supply chain, particularly if they’ve opted for a complete outsourcing solution. Yet when they do so, they can put pressure on their logistics provider — and the supply chain itself.

Take, for example, Singapore-based National Semiconductor, a company which has always struggled to optimize supply-chain management. Like the much smaller KR Precision, National Semiconductor has been hit hard by the decline in technology exports from Southeast Asia. So, in 1999, in an effort to bring down distribution costs and packing and shipping time, it opted to outsource its whole operation to a global distribution center in Singapore and switched contracts from Federal Express to UPS.

To get the business, UPS took on the overheads of the center itself and the staff, estimating, according to Ong Jun Tak, the UPS country operations manager, that the volume shipped from the semiconductor maker would make it a profitable investment. But the collaboration has taken years of work — and considerable sweat. First off, National Semiconductor and UPS decided to invest in a warehouse management system dubbed PKMS, developed by Manhattan Associates based in Atlanta. Ong would not disclose the cost of the implementation but its goal was to take cost out of the process by keeping better track of inventory. In warehouse operations, Ong explains, there’s a lot of duplication of actions like double packing — once at the warehouse and once again at the airport. The Singapore facility handles about 90 percent of National Semiconductor’s inventory flow around the world, processing more than 400,000 semiconductor orders per year.

The facility receives chips from National’s final assembly plants, separates them into individual orders, and vacuum packs the orders for customer shipment, usually within 24 to 48 hours. From receiving goods to shoving them out the door under the old system, it took 20 steps, requiring a 24-hour shift to supervise the process. Now automation has whittled down the number of steps to 12, says Ong, allowing UPS to eliminate one whole shift, but still ship the same volume. That, and a multi-tier pricing system, allowed National Semiconductor to cut back on supply-chain costs by 15 percent, says Ong.

But the implementation was not without its bumps. In order to save costs from the outset, UPS decided to set its server in Atlanta, the idea being that the Atlanta server already had a tech staff who knew the system. Why duplicate it in Singapore? But, Ong admits: “It felt very insecure at first having the server so far away — and there were problems.” First off, they didn’t supply enough bandwidth to handle the data traffic between Singapore and Atlanta and the fancy PKMS database had trouble running. It took them about a year to work through the glitches.

The model is working at last, and now National Semiconductor has floated a request for proposal for third-party outsourcing of its new manufacturing facility outside Shanghai. While UPS is not exactly a shoo-in for the new business, it is in the running. Competition in China is stiff these days. The Logistics Institute-Asia Pacific, a think tank funded by the Singapore government, released a 2002 “China Logistics Provider Study” in January. The study found that revenue growth had averaged 40 percent for a group of the 29 largest logistics providers in China over the past three years. Growth is estimated to level out at about 50 percent for the next three years.

In order to succeed in China’s market, UPS will have to compete at a lower cost. A look at the company’s financials shows that this won’t be easy. UPS’s total revenues for 2002 were US$31.3 billion, while it’s operating expense amounted to US$27.2 billion, or 87 percent of sales. Following taxes and extraordinary items, net income amounted US$3.2 billion, up 33 percent over the previous year. That looks good on paper, but while net income has increased owing to the odd windfall, such as a tax reassessment and investment income, net income as a percent of revenue has been eroding — to 7.7 percent in 2002 from 8 percent in 2001 and 9.5 percent in 2000.

Operating expense is up 21 percent since 2000, outpacing revenue growth. Companies like UPS have hit a cost barrier. They need to produce growth to stay alive and stay in the business, and yet still cut down on costs dramatically. Their clients, like National Semiconductor, have cash-flow problems, too, and will bargain hard on price.

Casey at the Bat

So where does Liam Casey stand amid all this? His PCH is small, able to underbid the competition, and he’s not going away. At the moment, he’s a niche player, offering a complete supply-chain management solution between Taiwan customers, 50 factories in China who make goods for them, and, ultimately, the customers in Europe, the United States, and Mexico that install these components into their finished products. But it won’t be long before Lee in Hong Kong, Vigoda in Thailand, and maybe even National Semiconductor in China start saying yes to his pitches.

What’s interesting about his business is the range of service he’s supplying, despite the relatively small size of his business. PCH does more than just schlep goods. It buys the freight when its in transit, underwrites the risk of the shipment, earning a fee for managing the risk. Casey has invested in the design of a propriety software supply-chain tracking program — available online — that mimics sophisticated programs but looks alarmingly simple. And he hops on a plane himself to clear up those points of pain that, inevitably, threaten to clog supply chains in Asia. The fact that a small company can gain a foothold in this business quickly — Casey started out cold eight years ago with a US$20,000 bank loan and billed US$30 million in revenues last year — shows just how up-for-grabs this business can be.

Casey’s home is in Ireland, although it’s hard to tell whether he really lives there. Check out where he’s been over the last two months: Shenzhen, Taipei, Shanghai, San Jose, Seattle, Houston, Austin, Guadalajara, Tampa, Nashville, Dublin, Edinburgh, Vienna, Budapest, Prague, and Shenzhen. Ask him what color his apartment is painted, and he probably won’t know. But he knows how to move components from point A to point B, and he’s about to give the biggest logistics players a run for their money.

The KPIs in That Shirt You’re Wearing

The largest third-party logistics providers can rely on sheer mass to offer flexibility to customers. C.K. Lee, the regional CEO for the Asia/pacific operations of Exel, the U.K. logistics giant, says that Exel now operates facilities in 90 locations throughout Asia comprising 6 million square feet of floor space. All but one of those facilities is leased by Exel on what Lee says are flexible terms, allowing the provider to move quickly to another location to suit the needs of a customer’s changing market. For CFOs, the obvious attraction is not having to own the facilities. Explains Lee: “If you run your own distribution facility designed to move 1 million units a month, then you’re constrained by those terms. But if you outsource, you can pay as you go. Because we have many facilities, we can move people around, adapting to the change in inventory turnover.”

This is what Marks and Spencer, the British clothing retailer, opted to do with its Hong Kong supply-chain management, which it outsourced to Exel in 1994. John Cheston, managing director of Marks and Spencer in Hong Kong, reckons that one of the reasons the retailer was able to survive the lean days following the Asian crisis was the lower costs associated with the outsourcing. Marks and Spencer migrated 75 employees over to the Exel logistics facility. The company has also given Exel performance criteria to reduce excess inventory through just-in-time methods. These key performance indicators (KPIs) — such as on-time delivery and limited number of returns to the warehouse — are driven by a “cost-per-single” estimate on a piece of merchandise forecast by Marks and Spencer’s finance team. “Outsourcing has allowed us to focus the resources of the management team on the customer,” says Cheston, “rather than on logistics.”

Exel reported US$332 million in profits in 2002 on US$7.7 billion in sales. Profits were up 10 percent, partly because Exel had sheared costs from its operations. Analysts say that profits at third-party logistics providers such as Exel, CAT Logistics, and UPS Logistics have been eroded by underpricing of value-added services.