We won’t take this lying down!

The International Monetary Fund (IMF) has been in the news over the last couple of days. Unfortunately, for reasons that have nothing to do with the IMF. This post has nothing to do with that but more importantly for a forecast they released back in April. On April 25^th the IMF released the first meaningful forecast or prediction of when the United States would fall from being the leading economic power in the world.  The prediction which came from this was a bit of surprise in how soon they believed this might happen.

It does not take any sophisticated prognostication to reveal that China would be the country most likely to take this number one position from the United States.  First off, they are the most populous country in the world.  They have 1.4 billion people.  India is second with 1.2 billion and the United States is number three with 310 million.  The population of China is 4.5 greater than that of the United States.  If the consumption and productivity per capital in China were to be 25% of their American counterparts, China would be ahead of the US in these categories.  

Secondly, we have been hearing the “giant sucking sound” that H. Ross Perot talked about when he was speaking out against NAFTA in his 1992 run for President.  Perot was wrong in stating all industry jobs would be going to Mexico.  Instead they all went to China in a relatively short order.  This “giant sucking sound” was not just heard in the US, it was heard in Europe and Japan as well.  

The figure to the right, from the IMF, shows the ranking of GDPs of the top ten countries in the world in millions of USDs in 2010.  China is number two, having edged out Japan for that position recently.  China is only poised to grow.  The US having lost so much of our manufacturing base will wane in our opinion. We see it already in the shrinking middle class and changes in the distribution of wealth here.  

The surprising part of the IMF prediction is how soon they see China taking over the number one position.  They are predicting that this could happen as early as 2016!  When we read this story, we expected a much bigger reaction from the government and citizens.  There did not seem to be much furor over this at all.  The lack of reaction concerns us even more than the IMF prediction.  

Sure, the US economy will continue to be strong and there have been some movement of manufacturing coming back to the United States (on-shoring). But, as we have commented in other blog pieces, change happens faster and faster in our times.  Change occurs faster than we can react to.  If the 2016 prognosis is correct, it is practically an inevitability given we are mid-year 2011.

This does not mean, we should take this lying down.  Not at all.  Not one little bit.  Cadent Resources, Inc. is a small company but we believe in and are committed to US manufacturing and distribution.  We want to see a strong and vibrant industrial base in the US not simply because it would be good for our business.  We believe it would be good for the entire country.   

We call on all segments of our society to take advantage of our excellent universities to encourage our young people to major in and become the best in world in:  

• Engineering & Sciences


• Mathematics & Computer Sciences

We encourage our government, universities, and corporations to not only encourage such educational initiatives but to develop real workable programs geared to grow manufacturing and manufacturing jobs in this country.

It will not be easy, but we believe strongly that we need to do this.  This forecast from the IMF should be the rallying cry for our nation.

Practical Guide to Contingency Planning

We recently posted a blog, “The Crisis in Japan & the need for Contingency Plans”, and have had a few inquiries for more information on contingency plans. Allow us to expound a bit on our view of contingency planning.

There are many definitions for Contingency Planning and Contingency Plans. A representative and comprehensive definition of Contingency Plan comes from The APICS Dictionary, 12th Edition 2008:

contingency planning—A process for creating a document that specifies alternative plans to facilitate project success if certain risk events occur.

While we have great respect for and are members of APICS, the definition exemplifies the problem most of us have experienced with Contingency Plans and Contingency planning. The definition clearly and bluntly outlines the issue.  Most companies view Contingency Planning as a “process to create a document…” When the process is put in place to create a document, that is exactly what the process will yield especially when demanded such by the management team.

The Y2K effort, the mother of all contingency planning exercises, was a document creation effort. Do we have Contingency Plans i.e. do we have documents called Contingency Plans that we can show anyone who asks about them? Yes, we do. Good. Check the box.  Done.

No not done. More like a waste of time and effort.

The purpose of Contingency Planning is, or rather should, be to have a documented plan for business continuation should a high impact low probability of occurrence event happen. The events include but are not limited to fire, earthquakes, civil unrest, or devastating storms that cut off our ability to produce and fulfill orders. The disruption could effect one of our facilities directly or indirectly in that the disruption could have occurred at the facility of a key supplier.

Here is another definition from The APICS Dictionary:

Business continuation plan (BCP)—A contingency plan for sustained operations during periods of high risk, such as during labor unrest.

A Contingency Plan does need to be a documented. It needs to be a document that is focused on ensuring Business Continuation in case of a high impact low probability of occurrence event that disrupts our business.

Another more detailed definition comes from PC Magazine albeit it is focusing more on IT systems:

A plan involving suitable backups, immediate actions and longer term measures for responding to computer emergencies such as attacks or accidental disasters. Contingency plans are part of business resumption planning.

The process of developing such a plan involves convening a team representing all sectors of the organization, identifying critical resources and functions and establishing a plan for recovery based on how long the enterprise can function without specific functions. The plan must be documented and tested until it works effectively. Also called a “disaster plan,” a contingency plan must be updated continuously. 

What was that last sentence? “The plan must be documented and tested until it works effectively.” This is most interesting… the plan should actually be useful i.e. the plan should have a high probability of actually working.

Contingency Plans need to be:

1. Realistic in scope


2. Economic to Implement before the disruption


3. Readily Implementable upon disruption

Realistic in Scope:  First and foremost, the parameters must be well defined. This was a problem in Y2K. Different levels of management would define and re-define the level of disaster that had to be planned for.   

• Is the interruption catastrophic?  Does it cripple all commerce in a region or continent?


• Or, is the interruption localized to just our factory/warehouse or that of a primary supplier or customer


• Are we planning for a specific set of events or anything and everything that might happen?  

These questions will help use decide if we need to spend time working on a contingency plan or not. Here are two examples.

We own and operate a unionized factory or warehouse. The labor contract is to be re-negotiated in Q3 of this year. There is a good chance that the union could strike or management might lock them out. This will cause a potential business disruption. In this case, it makes good sense to have a contingency plan worked out and ready to implement. Such plans often include building up another month or two of inventory and flexing the non-union workforce to operate. In the case of the NFL, for example, the owners original contingency plan was to secure a television contract that allowed them to get paid even if a lockout cancels games in 2011.

Let us consider another extreme. What if a meteor were to fall out of the sky at 10 am on a work day and completely destroy our corporate headquarters and killing everyone inside. Though some might suggest, facetiously, that the business might actually run more smoothly, this will cause a disruption in the business. Is this kind of thing we should spend any time planning for?  In terms of scope is this even something that can be planned for or around? Probably not, so why waste the time and effort just to have “a document.”

In between, these two extremes is an area of grey.  Management teams should discuss and decide various scenarios and determine for which scenarios Contingency Plans should be developed.

Economic to Implement Before the Disruption:  Most plans include some aspect of redundancy that one ensures is in place well before a disruption occurs.  This involves having parallel or back-up capacity or sources in place.  This method is well known and often practiced in our daily lives.  Redundancy is good practice when it is economical and practical.  

Here is an everyday example that illustrates the point exactly.  We carry spare tires in our cars in case we get a flat tire.  The cost-risk benefit analysis usually justifies this redundancy.   Yet, most of us do not keep an extra car, just in case ours does not start one morning.  This spare tire is not expensive nor does it take up much space.  The extra car is a huge expense, takes up a lot of space, and requires maintenance.  The cost-risk benefit analysis here does not justify the redundancy.

Every business carries spare light bulbs but not every business invests in back-up generators should the power go down.  In the US and Europe, back up generation are only used in the most critical operations such as hospitals.  In Latin America where the power grids are less reliable, many more factories and warehouses have back up generation.

Again scope plays a role here.  In terms of back-up generation, the planning is often done for outages lasting hours rather than months.

Readily Implementable Upon Disruption:  If and when a disruption occurs, can the plan be activated and executed or will everyone look at it and mutter, “this thing is useless.”  It makes no sense to invest time and effort into developing a plan that will never ever work.  The PC Magazine definition resonates very well in this regard.  Any contingency plan must be viable and work.  This does not necessarily mean the plan is easy to implement

When possible, and economical, the plan should be tested.  We have fire drills for a reason.  We do not want to test the plan for the first time in the heat of battle or the chaos of a disruption. This does not necessarily mean the plan is easy to implement.  The plan may require lots of manpower operating in a well coordinated way.  Think about salaried personnel operating a plant or warehouse during a strike.  It will not be easy. The factory will not operate at the same efficiency and with the same throughput.  But, it will operate.

Final Thoughts:  Is it ever OK not to have a plan and to admit to not having a plan?  It is better for everyone to know there is not a good viable plan than to simply a document simply to check a box. Consider these to scenarios that are very realistic in today’s supply chains:

• A factory operates 24/7 and is 80% utilized, it will be very difficult to replace some or all of that capacity if the need should ever arise.


• A supplier that is the sole global source of critical material will also be very difficult to replace.


• How much effort does the management team want to invest for some in cases like this to have excess capacity or to develop excess capacity?  Or is it more prudent to take a calculated risk.

To summarize, Contingency Planning is an effective tool when the above mentioned guidelines are acknowledged and used to determine:

• Contingency Planning Scenarios


• Defining the extent and duration of disruptions


• Looking at the economics of redundancy making any preparations well before a disruption


• Testing the plan whenever possible


• Reviewing and updating Contingency Plans on an annual basis

The Crisis in Japan & the need for Contingency Plans

On the morning drive yesterday, NPR had a report on supply chain challenges posed by the earthquake, tsunami, and nuclear crisis in Japan.  The report centered on one company Ford Motor Company. They are having trouble sourcing certain paint colors because the pigments are sourced from Japan:

Ford has halted new orders for trucks, SUVs and cars that come in tuxedo black. Ford told dealers that it will continue making the models, but it’s cut back on production of cars and trucks in that color. Production of certain red vehicles will also be reduced.

Luckily, its only paint. They can still make cars and trucks but will only have to limit the offerings of certain colors until alternative sources can be developed.  Perhaps, if the sourcing of the particular Tuxedo Black materials cannot be secured, the automaker may have to settle for a different shade of black.

What if the component was more unique and applied to every vehicle in a particular nameplate?  What if it were something that could not be easily resourced without either moving production or necessitating new tools? What if it were something like fuel injectors or engines? What would you do?

Waiting until a crisis hits and then scurrying around like crazy trying to solve serious disruptions is what statisticians and forecasters call random shocks. Japan has certainly experienced not one but three chatostrophic random shocks in succession.

Though we all know that we should have contingency plans just for such circumstances, the probabilities of these events happening are extremely low. Thus it is hard to get teams motivated to take time from their busy schedules to develop contingency plans.

The worse part is that it is not easy to make meaningful and actionable contingency plans. Most companies have spent lots of time and energy making their supply chains lean and as efficient as possible. Part of being lean and efficient is the concept of sole sourcing. It is more efficient to have one solid supplier with which all of ones volume can be leveraged. Any good contingency plan would involve having alternate qualified sources for goods and materials. If you have a plant, a good contingency plan would have to address bringing production up quickly should the plant be disabled.

With supply from Japan being severely distrupted, contingency planning is on the minds of many business leaders. What should  be done? Should we go through a futile Y2K like exercises? Certainly not. The likelihood of those plans being effective were as low as a catastrophe occurring that would necessitate dusting off such plans.

We recommend the following:

• Management teams should discuss and determine their materials and suppliers critical to the business


• Purchasing and manufacturing teams should then assign risks High, Medium, and Low, similar to the classification done in a Failure Mode & Effects Analysis, to these materials and suppliers in terms of:
  
  
  
  • Importance to the business
  
  
  • Risk of disruption
  
  
  
  


• They should discuss what they would and could do should the source of the High-High materials be disrupted or if the High-High suppliers were to go out of business or not be able to produce.
  
  
  
  • What actions, at what costs, can be taken immediately?
  
  
  • What is the cost-effectiveness of qualifying a second source now?  
  
  
  • Are there design alternatives to employ less critical components such as stock items or commodities?
  
  
  • What actions should be put in place at time of a random shock? Note: Organizing a team to scurry around like crazy trying to solve the disruptions in the event of a random shock may sometimes be the only viable plan
  
  
  
  


• The results should be reviewed with the management team.

This exercise should be done at least once a year.  The objective is to make realistic assessments and actionable plans.  If no viable actions can be established, at least everyone knows the risk.

Does your company have contingency plans in place?  Are the plans viable or just plans in place to check the box? Let us know your thoughts.

Variation and Inventory

No one wants to hold inventory. It is necessary because of variation: variation in demand, variation in lead times, variation in raw and finished good quantity, variation in yield (production line reliability), variation in transit times, and of course random shocks from weather to other factors that effect raw and finished good availability. Let’s call this normal or Systemic Variation. Good supply chain managers will work to reduce this kind of variation to improve costs and over all supply chain reliability. This kind of variation is primarily in the hands of the Supply Chain. It is on us, the Supply Chain Team, to constantly be working to reducing the variations in these variables. When done right, with a sound system of management, the result is that inventory is optimized and constantly improved upon.

This is another source of variation. Let’s call this Variation Due to Internal Errors. This kind of variation is a killer. Let us call this V-DIE. This variation is due to self-inflicted wounds that cause us to carry more inventory. V-DIE causes us to make faulty assumptions when it comes to planning: Demand Planning, Production Planning, Inventory Planning. The communication of those plans to suppliers just passes and amplifies the variation . Inventory inaccuracy is also attributed to V-DIE. The kind of errors can create spikes in inventory that could take months to draw down especially if they are over forecasts which result in over procurement of raw materials, or over production of finished goods.

When inventory gets out of control because of errors,because of V-DIE, the levels of inventory will not decrease and will probably continue nudging up until these kinds of errors are fixed. V-DIE should be dealt with equal vigor as the Systemic Variation can be addressed. V-DIE can and will bias the analysis of Systemic Variation. For sure, V-DIE limits the improvement that a company can achieve in terms inventory. We will go far to say that in our experience that for a company mired in V-DIE, the culture is corrupted as well. Strong leadership is required to set the tone to eliminate this kind of variation.

What do we mean when we say that V-DIE limits the improvement a company can achieve in inventory management? Many companies task the supply chain management with reducing working capital. The supply chain team works diligently to reduce supplier lead times, implementing pull systems, working on lean manufacturing in general, and implementing new KPIs if needed. The team drives changes and takes the slack out of everything they can control. Here lies the rub or the limitation. There is only so much the supply chain management can do.

There are three major areas where the supply chain cannot drive improvement by themselves:

1. Forecast accuracy


2. Reducing Excess and Obsolete (E&O) inventory


3. Month and quarter end peaking

We have written about each of these in this blog and will touch on them again briefly.

[1] Forecast accuracy is based on two things: The forecast itself and the execution against the forecast i.e. sales. In both cases, the supply chain must work with sales and marketing to determine the forecast. Then it is up to sales to deliver sales to the forecast and the supply chain to make sure the right products are available in the right quantities to fulfill orders should the forecast be realized.

[2] If inventory is “out of whack,” there will undoubtedly be too much E&O in the system. Poor decisions in the past will have invariably led to having the wrong quantities or the wrong mix of products in the wrong places at the wrong time. This leads to inventory accumulation mostly in goods that are not selling. The stocks of these products build and become excess and invariably obsolete. Then… the inventory just sits there. The supply chain is beaten up for not reducing it. Without sales trying to sell the E&O and finance agreeing to write-off and scrap some of the excess, the E&O will not go down and, worse, will continue to grow.

[3] Many companies have a sales cycle that results in a large percentage of their monthly or quarterly sales taking place in the last few days of the month or quarter. These spikes can be as high as 50-60% of the period sales. No matter how lean a supply chain is or how well a pull system is designed and run, peaking of this magnitude requires advanced planning and building inventory based on forecast. In short, it requires operating in a push based system. Many companies that claim to be lean and operating in a pull environment only do 80% of the time. When this happens demand variation is a large factor in inventory planning. The supply chain cannot reduce this. Only sales can.

Optimal inventory can be calculated but unless V-DIE is addressed at the same time as Systemic Variation inventory will never achieve optimal results. V-DIE will flare-up and cause inventory to go up. Senior management will react and pressure those responsible for inventory in the supply chain to improve. But, because the V-DIE issues are not entirely in control of the supply chain, improvements are harder to come by. If all the slack has been taken out the Systemic Variation parameters, further gains in inventory reduction can only come from V-DIE parameters.

At Cadent Resources, we advocate our concept of Supply Chain Physics. In brief, at any given times, there are Laws of Physics that govern the behavior of our Supply Chains. The laws are:

1. The law of interdependency


2. The law of constraints


3. The law of information

V-Die squarely impacts the first two. V-DIE is a good measure of cross-functional cooperation within a company. When this kind of variation is present and dominant, it is a measure of the lack of coordination between functions. The Law of Interdependency is at work. Forecast accuracy at every level requires the cooperation of the supply chain, sales, marketing, and finance functions. Reducing E&O inventory again requires the cooperation of the supply chain, sales, and finance. In fact, measures to not increase E&O starts with improved forecasts and the even harder part: execution against the forecast. Lastly, breaking of the month and quarter end sales peaking pattern is dependent on sales, finance, and general management working hard to change the well established sales patterns which are ingrained in the minds of customers. Assigning these objectives only to the supply chain does not acknowledge the interdependency at work here and thus limits the improvements that can be made. The limits set are a constant source of frustration in the organization and reinforces the walls of the silos that already exist. It is that simple and that complex.

As a result, constraints are established. It is the constraints that set the level of improvement.

• Forecast accuracy is < 60% is repsonsible for X-amount of inventory that will always be in the system


• E&O > $Y Million truly means that you will always have at least $Y Million of inventory in the the system


• 50% of your sales in the last week of the quarter means you have to order and build to forecast, which means you end up with Z (on top of the aforementioned) X amount of inventory because of the chaos in the operations caused by such a sales spike.

Hammering, tasking, and incentivizing just the supply chain will not change the physics of the situation.

Variation is indeed the enemy. Reduction of variation is the goal. It is the goal in quality improvement. It is the goal in lean manufacturing. It is the goal in inventory management. The tools and skills needed to address variation reduction are the same. They exist in most companies. In the case of inventory management, V-DIE is the enemy. If your V-DIE is low or non-existent, we will guess that you are probably already managing your inventory quite well. If you have no clue, you are probably not happy with your inventory management. In this case, measure and begin to look at the three major V-DIE components: Forecast Accuracy, E&O, and Sales Peaking.

Supply Chain Resolution 2011

As we did last year, we would like to share our business perspective for the coming year and what it means from a supply chain standpoint.

From a macro-economic standpoint, we see the slow steady growth experienced in 2010 to continue. Our demand plans should not be overly risky or overly conservative.  It is a good time to be moderate. We are keeping an eye on the following potential issues that could minimally dampen the pace of recovery or, in the worst case, cause another recession:

Unemployment in the US is still high at around 9%.  There are indications that it has flattened out. Reports from month to month show decreases and increases.  Things are slowly getting better. Unemployment seems chronic for older workers and it is also tough for recent college graduates. Business is still tough for search firms.

Foreclosures are quite high.  This is the second shoe of the recession that many have been expecting to fall for the past three years.  It just has not happened.  These high rate are due to a combination of the mortgage crisis and the subsequent high unemployment levels.  There are too many properties where owners have negative equity and payments they cannot afford.  They default on their mortgages or their taxes.  The inventory of foreclosed properties is so high they are depressing the entire housing market and related industries.  If your business is housing related, your already depressed business could become even more dismal.  You need to pay special attention to developments in this arena.

Governmental problems may be the nastiest of the lot.  The problems of countries in the EU like Greece and Ireland have been prominent in the news.  The problem of states and municipalities in the US is less well publicized but equally risky.  There are serious concerns about large states like Illinois and California.  Will they be able to pay their bills?  Will they be able to honor the pensions of their employees and retirees?  There are municipalities that are in equally dire straits. 

Oil Prices have been creeping up in the past year.  The growth has been slow and steady unlike the bubble experienced in 2008.  We believe this trend will continue through 2011 and needs to be factored into budgets and budget revisions. 

All of the above lead us to believe that we have recovered but at a new level that is somewhat lesser economically from the go-go years of earlier this century.   This has become to be known as the New Normal.   There can be all kinds of debates if this is really true and whether the US will return to 2006 levels or if have become more like a European country like the UK or France.  No matter how this matter is debated, businesses have already adapted to the New Normal whether they admit to it explicitly or not.  This is precisely why business results and stock prices have returned.  Businesses have adapted to the New Normal and not staffed back to the pre-recession levels.

Businesses will only add jobs are they need too.  Employees, while perhaps weary of added tasks and longer hours, are still happy to be employed and will continue to work hard especially as there is nowhere else to go.

We also believe in this New Normal.  We have exported too many manufacturing jobs.  Our economy is now adjusting to that reality.  We most likely will not return to the levels of consumption and low prices that we had pre-recession.

So, what is the prognosis for 2011.  Our call, much the same as last year, is for cautious optimism.  In January of 2010, we had claimed stabilization and looked for modest growth.   The economy did modestly grow.  This year, we expect that modest growth to continue.   The aforementioned issues will, at best, continue to hamper growth and recovery… at worst, these issues could bring about another recession.

A few questions for consideration:

• How do you see 2011 from the perspective of your business?  Is the glass half-full or half-empty?


• What is your greatest hope?


• What is your biggest fear?


• Do you agree with the four issues (Unemployment, Foreclosures, Insolvent Governments, and Oil Prices)?  Is there anything we missed?

Your input will be appreciated.