Supply chain: Making and breaking the business

Supply chain: Making and breaking the business

Boeing's troubles show the pitfalls of outsourcing

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Few corporate supply chain issues have garnered quite the global notoriety of Boeing's trouble with the 787 Dreamliner. Its huge new commercial product, derided in some circles as the "seven-late-seven", is the victim of a system overwhelmed by ambitious aircraft design innovations that had to share the spotlight, over a period of years, with a supply chain management revolution.

"The cumulative impact of the 787 schedule revisions has put pressure on program profitability," Boeing CFO James Bell acknowledged in his recent conference call with Wall Street analysts, held just after the Dreamliner was tagged with its seventh delivery delay in three years. Just one of a cascade of negative items, the aerospace giant also guided investors to expect a dip of 10 to 15% in 2011 profits, a year already coming off a lower revenue 2010.


But fortunately for American industry, Boeing doesn't represent the typical face of 21st-Century supply chain management. In fact, candidates for that role include companies like global polymer materials maker PolyOne Corp. A few days after Boeing vented its problems, PolyOne reported a surge in fourth-quarter profit that beat Wall Street estimates for the sixth straight quarter, on higher revenues across all of its segments, hitting $2.6 billion for the year, up 27% from 2009.

It ended the year with $378 million in cash and $506 million of liquidity and said it expects double digit earnings growth in 2011, on top of a 252% gain in 2010, excluding special items and tax adjustments.

The link between chains and excellence

Their differing industries have little to do with the stark contrast in 2011 outlook between PolyOne and Boeing, as both manufacturers are navigating the turbulent aftermath of the worst global recession in a generation.

The divergence of fortunes goes back three years, and has its roots deep within their respective supply chains. If for Boeing the story was one of supply-chain missteps increasingly creating financial woe, for PolyOne supply chain improvements drove a turnaround.

The world's leading companies have been wringing inefficiencies from their global supply chains for years, shrinking excess inventories and speeding order fulfillment, thus utilising cash more efficiently and better matching supply of components and manufactured goods with customer needs. Yet even supply chain champions like Toyota, which famously employed lean manufacturing and just-in-time inventory management to become the world's largest auto maker, can stumble, as 12 million vehicles recalls worldwide since 2009 and a 39% slide in its most recent quarterly profits demonstrate.

"We see more and more companies acknowledging the importance and impact of supply chain excellence on overall financial performance in their financial statements and discussions with Wall Street," notes Debra Hofman, a vice president at market research firm Gartner. "High tech and consumer products came more quickly to this understanding, but the heavy industrial sectors are now catching up fast, [including] PolyOne."

In fact, the ongoing round of year-end earnings calls with Wall Street is replete with examples of supply chain competence going directly to the bottom line: both positively and negatively. Take global consumer goods powerhouse Unilever, which produces household name brands from Hellmann's mayonnaise to Dove soap to Ben & Jerry's ice cream, attributing €1.4 billion in savings to its supply chain and overhead cost containment efforts, helping it achieve a 26% increase in net profit in 2010.

"We saw strong delivery from our savings programme both in supply chain as well as in our indirect overhead cost base," Unilever CFO Jean-Marc Huet told analysts earlier this month. "Total savings for 2010 were €1.4 billion, well ahead of the €1 billion we were targeting at the start of the year. This comes after savings of a further €1.4 billion in 2009, nearly €3 billion taken out of our cost base over the last two years."

Hardly a cosmetic problem

Another consumer goods maker, the Estee Lauder Companies, lacked the necessary visibility along its supply chain to adequately map demand to production, acknowledged Richard Kunes, the company's CFO, citing a climb in inventory days to 168 at year-end, compared with 150 days at the end of December 2009.

"Given our long supply chain, it has been challenging to accurately forecast the pace of recovery and demand, as well as the rapidly changing product mix," he told analysts. "Also, as suppliers ramp up to meet the more robust industry demand, we are experiencing delays in deliveries of some materials."

Few supply chain hiccups have been as prolonged and public as those at Boeing, which designed its 787 Dreamliner with wings and a fuselage made of lightweight carbon composites rather than aluminum, and a sophisticated electrical system designed to consume up to 35% less power from the engines than traditional pneumatic systems.

While the company innovated with the design, it also "reinvented" its supply chain into a collaborative system in which major portions of the new plane were to be built by suppliers around the globe and shipped to Boeing for final assembly. Together, the reinventions were a recipe for disaster.

"When Boeing outsourced things like engineering and manufacturing, one had to wonder, 'If they are outsourcing that, then what are Boeing's core areas of business?'" says Brett Booen, editor of supplychaindigital. "If you do, you run the risk of becoming fully reliant on your suppliers. That's what Boeing did, and now they are paying for it dearly."

Boeing's net income dropped precipitously from the more than $4 billion it earned in 2007, to nearly $2.7 billion in 2008 and $1.3 billion in 2009, before partially recovering to $3.3 billion in 2010. Its stock price peaked at nearly $105 in late August 2007, but hasn't traded above $76 in the past 52 weeks. Shares of PolyOne, in contrast, are trading at or near all-time highs above $14, after dipping under $2 in January 2009.

An Apple for the chain managers

The correlation between supply chain performance and financial/equity returns is no coincidence, according to Gartner, which in 2009 acquired AMR Research, publisher of its annual Supply Chain Top 25 rankings since 2004. Shares in companies named to the list for supply chain excellence have consistently outperformed the major stock indices, and it's no surprise that Wall Street juggernaut Apple has topped the rankings for three years running.

"Evidence of the link between supply chain activities and financial results continues to build," wrote Gartner's Hofman and Kevin O'Marah, who has led AMR's Global Supply Chain research since 2000, in the 2010 Supply Chain Top 25 report. Hofman and O'Marah cite a study by Dr. Alex Ellinger and a team at the University of Alabama and Texas A&M who found that the the Supply Chain Top 25 companies are more financially successful than their competitors.

"We in the supply chain business intuitively believe that being good at supply chain management has a positive impact on bottom-line financial performance," they wrote, "but there have been few objective, large scale studies that support that belief."

Ellinger's research used the Altman Z-score, a measure of financial success developed in 1968 to predict bankruptcy, but now widely used tool for assessing overall financial health. The average Z-score, calculated from a weighted average of five key balance sheet ratios, for a group of Supply Chain Top 25 companies was 4.439, compared to 3.043 for competitors, or just above the 2.99 bankruptcy predictor. Ellinger's team also found the Top 25 companies had lower inventories, cost of goods sold, and accounts receivable than their close competitors.

Note: Altman Z-score components are liquidity (working capital/total assets), leverage (retained earnings/total assets), profitability or operating efficiency (Ebit/total assets), solvency (market value of equity/total liabilities) and activity (net sales/total assets.)

The link between supply chain management and financial performance is clearly evident in the current parade of earnings announcements on Wall Street, Hofman notes, citing how Raytheon's CEO specifically attributed its positive numbers to disciplined supply chain management, "a connection which might be helped along by Boeing's very public challenges.

"Boeing attempted a major innovation in its product development supply chain with mixed results, providing itself and the rest of the industry with some important lessons going forward."

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  • anonymous Boeing was always conservative with their new airplane programs in the past and made small increments from program to program because they risk a tremendous amount of money on each airplane The 767 which was certified in 1982 only had composite ailerons and rudder The 777 designed in the 90s only had a composite vertical tail For some reason Boeing leapt to an all composite design and a huge increase in outsourcing The outsourcing was based on the assumption that if the suppliers were risk sharing partners Boeing executives could put them on the honor system to keep their work on schedule That assumption failed
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