Shorter is better for Toyota's supply chain

Automaker aims to localize production and supply base.
By David Hannon -- Purchasing, 8/14/2008

When Japanese carmaker Toyota first began selling cars in the U.S. 50 years ago, it was importing completed vehicles from Japan, which were made entirely from Japanese parts. Today, while many other U.S. manufacturers look overseas for low-cost manufacturing and supply, the Toyotas sold in the U.S. are manufactured at North American plants and the majority of the $30 billion in parts bought to make those vehicles are sourced from North American suppliers.

"We've had an overriding philosophy in place that we want to produce our vehicles where the customers are and we want to buy the parts near where we produce the vehicles," says Chris Nielsen, vice president of purchasing at Toyota Motor Engineering & Manufacturing North America (left) in a recent interview.

And that philosophy is becoming more entrenched as Toyota increases its production in North America, with new plants coming online in Canada later this year and in Mississippi in 2010. "In both those cases we'll be localizing vehicle production so most of the parts and materials used in those vehicles will come from local suppliers," Nielsen tells Purchasing. "As we continue to localize our production, our supply base will continue to localize as well."
Locally grown

As an example of that strategy at work, Nielsen says the new version of Toyota's Tundra truck launched last year went from 60% locally sourced parts to 90% local parts. (The majority of the remaining 10% comes from Japan).

Toyota is not a big proponent of supplier-hopping due primarily to the lifecycle of its product. Toyota buyers may be required to source parts up to three years prior to production for a vehicle that could stay in production up to seven years. "It's very difficult to forecast supplier-facing issues that far in advance," Nielsen says. "So we find a simpler model of supplier evaluation that focuses on the things we can control such as supplier productivity makes good sense."

The company looks at a variety of metrics to measure a supplier's productivity including: labor rates, manpower allocation, production time and scrap rates. Nielsen is quick to point out that the philosophy does not mean Toyota ignores lower cost suppliers in overseas markets, but says that when a total cost analysis is completed, most often the local suppliers prove to be the most cost-effective.

"We don't get swayed by short-term changes—you can get too wrapped up in what country has the lowest wage rate this year or which country provides the best exchange rate today. That can cause a lot of disruption and impact quality."

Toyota's total cost analysis typically includes a deep-dive on the supplier's manufacturing costs. "For example, the wage rate in China will usually be much lower than in the U.S., but productivity rates may be vastly different—likely better in the U.S. which adds to their competitiveness. And when you factor in transportation costs, productivity and the level of technology that's used to make the parts, North American suppliers are usually more productive."

But the strategy doesn't work unless those North American suppliers are constantly challenged to find new ways of increasing their value vs. their overseas competitors. That deep analysis of a supplier's manufacturing processes and costs allows Toyota's purchasing staffers to identify exactly where a local supplier may be able to improve its cost-competitiveness.

Toyota recently kicked off a value analysis campaign with its North American suppliers in an effort to further reduce costs. While value analysis is an ongoing priority at Toyota, according to Nielsen, the latest emphasis focuses on finding ways to reduce costs in both supplier products and processes, which can then be shared at its various manufacturing locations around the world.
Learning to obeya

To better facilitate the cross-functional meetings required for true value analysis work, Toyota employs a Japanese concept called obeya: while the literal translation is "big room" the true meaning focuses on bringing members of various organizations together to discuss ideas and projects.

While the obeya concept started at Toyota with purchasing and engineering coming together to discuss supplier-facing value analysis projects, today obeya has been so institutionalized at Toyota that there is an obeya phase of every project after the concept design is completed but before the final design.

"There are also obeya teams between sales and production and within organizations," says Nielsen. "We're using it to break down functional silos that often exist."
Minimizing risk

To put it simply, Nielsen says: "Shorter is better than longer in your supply chain. That is a simplified way of looking at it, but those simple philosophies provide direction and guidance to our organization in the long-term."

Nielsen says extending supply chains around the world can mean logistics rates, energy costs, labor issues and leadtimes are unpredictable at best. And where there's unpredictability, there is risk. "Ocean freight rates have fluctuated a lot recently and those are hard to forecast," he says. "Exchange rates can also change quickly, so those things add a little bit of extra unknown in the suppliers' overall costs. That's why we like our basic model of buying locally as much as possible. It reduces risks."

Toyota is so focused on reducing risk in its supply base that two years ago it created a six-person risk management team within its purchasing organization. That team had two primary goals: First monitor the financial health of Toyota's supply base and secondly, build tools to streamline that supplier risk assessment process. Last year, the team rolled out its proprietary supplier assessment tool that uses a variety of metrics to assign all suppliers—public or private—a risk score. This year, Toyota pushed the tool out to its tier one suppliers so they could, in turn, use it to assess the status of their own supply base. While it's still too early to get any real feedback from the tier ones, Nielsen says the idea has a lot of support internally at Toyota.

"While our risk management team has a pretty good handle on the tier one supply base, the tier two and beyond supply base is more of an unknown for us," Nielsen says. "That's where we're focusing this year. Some of the tier ones had good assessment practices already, but this will drive a common standard across the entire supply base."

Focus on the Process Industries: Pharmaceuticals: Reworking the Pharma Supply Chain As multiple forces challenge the pharmaceutical industry, SCM

By Jill Jusko

Dec. 1, 2008 -- If ever an industry were undergoing explosive change, it's the pharmaceutical industry. One could even call the change "unprecedented," says Paul Papas, partner and Americas Life Sciences leader, IBM Global Business Services. High levels of patent expiration among pharmaceutical companies are impacting their top-line growth, which is then driving a whole series of additional events, he points out. Among them: more mergers and acquisitions to augment the product pipeline, changes to fundamental operating models, increasing globalization and a growing emphasis on partnering. Additionally, "if the top line isn't growing, it makes sense to try to rationalize your cost basis to deliver your bottom line," Papas points out.

Add to that changing compliance demands in sales and marketing, manufacturing, and research and development, as well as a shifting client base, and really, pharmaceutical manufacturers -- and the supply chains in which they operate -- have little choice except to change and adapt to the volatile environment in which they operate. Indeed, Papas says these forces impacting pharmaceutical manufacturers are consistent with findings from IBM's most recent global CEO study. Some 79% of life sciences CEOs in that survey anticipate significant change over the next three years.

That change is already happening. For example, at pharmaceutical giant Pfizer, Anthony J. Maddaluna is overseeing a massive overhaul of the company's manufacturing and supply network worldwide. Just how large? Maddaluna, who is vice president of Pfizer Global Manufacturing (PGM) Strategy and Supply Network Transformation, points out that PGM supplies more than 500 products and 22,000 stock-keeping units (SKUs) for the New York-based global giant. Like Papas, he describes the changes in the pharmaceutical industry as unprecedented in his 34 years of experience working in the industry. Until a few years ago there wasn't the globalization of competition that exists today, he says. And during his lengthy industry tenure, Maddaluna has watched manufacturing and delivery processes change and grow more sophisticated. He doesn't expect that to change.

"It yields a different end product and may also necessitate the development of technologies we don't even have now in our manufacturing plants," Maddaluna states.

Meeting Change with Change

Pfizer is meeting those changes with changes of its own. For example, where it once was geographically segmented, PGM is now moving to segmentation by customer type. Integrating lean thinking and actions throughout its manufacturing facilities, as well as revamping business processes, is on PGM's plate. On a more public stage, the pharmaceutical firm is whittling down its internal network of manufacturing sites and increasing its outsourcing options. PGM's target by the end of 2009 is to have an internal network of 43 plants operating from a one-time internal network of 100 plants. Some facilities have closed entirely; others have been sold outright or sold to a partner with trailing supply agreements.

The goal of the transformation? "For the longest time -- and I think it's been the model for most pharmaceutical companies -- it was always ‘you sell what you make, you make what you sell,'" Maddaluna says. "What we're doing now is an active transformation to become a globally competitive supply network. So, even though our name [PGM] says ‘manufacturing,' it's sort of a vestige of our name. We're really a supply organization. We'll be a very competitive ‘make or buy' network. Our mission is to provide Pfizer with an innovative and powerful competitive advantage. That is the end goal."

Pfizer Manufacturing Deutschland GmbH, located in Illertissen, Germany, is a strategic plant in the Pfizer Global Manufacturing network. As shown, processing stages are controlled from a separate control room to prevent operator contact with material during a production run.
That means increased outsourcing where and when it makes sense, and manufacturing internally when that makes sense. And it's not all about cost, Maddaluna emphasizes. "It's all about the whole value proposition for our customers. It's about cost; it's about quality; it's about supplier reliability. They're not mutually exclusive," he says. Additional factors that help drive outsourcing decisions are product development considerations (off-patent or on-patent, for example), as well as who can more quickly bring a product to market, where speed is a factor.

By the same token, the right business mix for Pfizer means that key plants remain part of PGM's internal network. Among the factors that influence whether a plant remains an internal facility is whether it's involved in the co-development and launch of new products. It's also important that PGM retains its expertise in process capabilities and the expertise to improve those processes. "That's an important reason to have plants," Maddaluna says.

He points out that relatively recent large mergers (with Warner-Lambert in 2000 and Pharmacia in 2003) had the added effect of immediately adding a wealth of manufacturing facilities to the Pfizer name. "It's the issue of putting together three different, major pharmaceutical companies that all had very good independent strategies, but when you put them together, it doesn't quite mix. So you have to look at this now as the new company and what makes sense from a supply standpoint," he says.

For Pfizer, from a supply standpoint, appropriate outsourcing makes sense. "One of the biggest things that outsourcing does is give you supply chain flexibility," Maddaluna explains. "If you have a network of internal plants that are configured for a certain product type and you can't fully load those plants to the right capacity, then you're going to have an internal cost disadvantage. And somebody has to pay for those plants, whether they're running one unit or they're running a million units. So what we're trying to look at is the [right] mix for our business."

In fact, many pharmaceutical firms are taking that same approach, according to Global Industry Analysts. The market research firm estimates that the global market for pharmaceutical contract manufacturing, estimated at $20.4 billion for 2008, will exceed $31 billion by 2012. Furthermore, the United States is the single largest market for pharmaceutical contract manufacturing, with projected revenues of $12.8 billion in 2012.

Increased partnering along the supply chain adds a level of complexity to that chain. Pfizer, which is no stranger to contract manufacturing, is very stringent when looking at partnering arrangements, Maddaluna says. "We don't partner with just anybody," he says. "We take the right steps with our partners to make sure they are aligned with what we do. And we take a hands-on approach; we're in there with our partners, we look at them every which way, including the quality aspects, science, finances, environmental health and safety, and work practices. All of that is important to us and we expect our partners to meet our standards."

What he also expects is the continued dynamism of the industry, which means that what constitutes the right mix of internal plants and external partners also remains dynamic. Even if PGM reaches what it believes is a manageable level of internal plants and a "core" supply network, "there's always going to be inputs," Maddaluna says. "Pfizer's business may change. We may do an acquisition. We may acquire a product that requires special manufacturing. This is also the plus of having an agile network that's flexible. And when you have internal plants you tend to be less flexible than when you're partnering with external partners. So having that right mix actually helps us as the environment changes around us."

Improving Supply Chain Integrity

Among the many challenges facing the pharmaceutical supply chain is that of supply chain security. "It's probably the biggest single issue in our industry today," says Jorge Rodriguez, vice president of operations and compliance officer at pharmaceutical distributor Novis Pharmaceuticals. While a safe, secure supply chain has always been important, "it wasn't necessarily on the forefront three or four years ago," Rodriguez says. How times change.

While security may be paramount now, there exists no uniform national regulation. Instead, differing state regulations mean pharmaceutical firms aren't necessarily all in agreement about what constitutes the right approach to take in securing their supply chains. "We [Novis] came to a conclusion and moved forward in that direction," Rodriguez says.

Novis Pharmaceuticals is bolstering its own efforts to improve security and patient safety with the introduction in December of a prototype version of RxID, an inventory tracking system to enhance drug product traceability and extend that protection to its customers. It's one component of Novis Pharmaceuticals' general patient safety initiative, Rodriguez says. Integral to that is an e-pedigree solution from SupplyScape coupled with an internal serialization solution, all integrated within the company's SAP ERP solution. "We're always looking for ways to improve patient safety," he notes.

The introduction of the fully functional prototype will be followed by a pilot program with selected customers. The testing phase is projected to last about six months or so, Rodriguez estimates, with a full rollout of the system slated for June or July 2009 as an option for Novis Pharmaceutical customers. The SupplyScape e-pedigree solution will allow participating customers to check the pedigree of their products via a Web portal.

Continuous Improvement -- Engaging the Hearts and Minds of Your Employees The most successful leaders openly respect their staffs and care about their

By Ralph Keller

Dec. 1, 2008 -- At the recent AME conference this past October, the same message was heard over and over again: the need to engage everyone in your organization in order to achieve a sustainable continuous improvement program in your enterprise. Failure to win over the hearts and minds of all of your people will result in less-than-desired results, and will not achieve the sustainable continuous improvement efforts that conditions today demand in order for companies to succeed.

There are countless examples of lean transformations and continuous improvement programs where the gains achieved are not sustained because the hearts and minds of the people in the organization were not captured and engaged in the effort. At the conference, Captain Michael Abrashoff, the author of It's Your Ship, talked about his grass roots leadership that took the USS Benfold from the worst ship in the U.S. Navy's Pacific fleet to the best in two years. How did he accomplish that? He demonstrated every day to the 380-plus sailors and officers of the ship that he cared about them and valued their ideas on the journey to continuously improve the operation of their ship. He found, as have many others, that you can't accomplish this by sitting in your office and issuing orders. He did it using the tried and tested technique of MBWA (Management by Walking About) and engaging everyone on the ship so he knew each one of them personally and demonstrated to them that he cared about them and valued their input.

It takes time and a lot of hard work to win over people who have not been engaged, especially when previous leaders have not respected them, but Captain Abrashoff persevered every day with the same message until everyone on board bought into his program. That's when the improvements were made and sustained.

Office furniture manufacturer Herman Miller Inc. is transforming manufacturing by focusing on two things: the safety of each and every employee by making their jobs less strenuous, and getting everyone involved in satisfying the needs of the customer. As Ken Goodson, executive vice president of operations, explains, the employees come first and what's more, Herman Miller told everyone -- including its customers -- that the people of Herman Miller came first.

Herman Miller has a formal system where it measures every job and rates them on a scale of zero to 10 (with 10 being the most strenuous); the goal is to have every job in the operation a zero. So far, according to Goodson, the company has modified all of the highly strenuous jobs to the point that today nothing is rated higher than a 5, and efforts are ongoing to make these jobs even easier for people to perform. By following this formula, Herman Miller has found that the continuous improvement goals of improved quality, shorter lead times, less inventory, smaller footprint, less capital and higher productivity are all achieved, and the performance numbers of the operations reflect that, both in the factory and in the office.

This focus on engaging the people in an organization by having the top leadership demonstrate every day that they respect everyone and care about their ideas and well being is a recurring theme in successful, sustainable continuous improvement efforts. We have all seen the results of tools-based programs where people are directed, but not engaged, and the lack of sustainability that results. The gains that are made are not captured and quickly erode as people return to their old way of doing things.

Put succinctly, leadership matters, and it's the leaders who demonstrate every day that they respect, value and care about everyone in the organization who are able to achieve sustainable results in their continuous improvement efforts. What kind of leader are you, and will you be able to win in this competitive and difficult global business environment we operate in?

Book Review: The Customer Rules: The 14 Indispensable, Irrefutable and Indisputable Qualities of the Greatest Service Companies in the World

By C. Britt Beemer and Robert L. Shook, McGraw-Hill Companies, 2008, 332 pages,
By John Teresko

Dec. 1, 2008 -- It's a simple, logical premise: "Everyone should be constantly thinking about the customer -- the CEO, the people in the accounting department, the people in the warehouse -- everyone," says author C. Britt Beemer. It's a simple premise, but few admit to it, says Beemer and co-author Robert L. Shook. Confirmation comes from a survey involving more than 9,000 interviews conducted by Beemer's America's Research Group. (He's ARG's founder and CEO).

ARG's survey asked: "Have you ever considered the notion that everyone has a job in your company that involves the customer?" Beemer reports that four out of 10 working Americans report that neither they nor their coworkers' jobs have anything to do with customers. Second question: "Does your supervisor talk to you about how your personal efforts affect the customer?" Beemer reports 51.5% of the respondents answered "no."

Motivated by those negative findings, the authors have based their book on providing insights on how 14 companies have committed to solutions. Each company organized programs that successfully focus the entire organization on creating and supporting the customer. Through a description of the 14 companies and their practices, the authors offer advice for companies wanting to strengthen brands and market share.

The best practices range from Johnson & Johnson's carefully crafted credo specifying employee/customer behavior to Harrah's hotel rooms each being equipped with two bathrooms for married couples. ARG notes that 40% of American workers do not have a written job description. That written description would be the perfect place to mention job responsibilities to customers, ARG notes.

The authors include the following recommendations:

* Instill the importance of customer service in every employee.

* Use a "small-town" approach to meeting customers' needs no matter how big your company is.

* Develop a unique identity your customers will seek out.

* Maintain a focus on the customer before, during and after the sale.

Paccar's Hybrids: Building a Heavy-Duty Supply Chain: Special Report: Anatomy of a Product

U.S. truck maker leverages close supply chain relationships to bring innovative products to the market on time. By Jonathan Katz

Dec. 1, 2008 -- Detroit was abuzz this past September when General Motors Corp. unveiled at its headquarters the product design for its Chevy Volt plug-in electric car. Critics have referred to the Volt as the car that could "save Detroit." While the Volt isn't scheduled to arrive in showrooms until 2010, U.S. automakers of another sort have already begun producing hybrid vehicles. These technologically advanced machines are produced by the commercial trucking industry, a line of business that doesn't garner nearly the amount of mainstream media attention for its environmental efforts as advancements in consumer auto production. One U.S. manufacturer that's been at the forefront of hybrid long-haul truck production is Bellevue, Wash.-based Paccar Inc. The company began commercial production of hybrid medium-duty trucks through its Kenworth and Peterbilt divisions in September. Pilot programs have been underway for more than a year, most notably at Coca-Cola Enterprises Inc., which purchased 120 Kenworth hybrids for its fleet in February 2008. Paccar also has produced hybrid trucks in Europe through its Dutch subsidiary Daf Trucks NV. Over the years, Paccar's efforts to develop fuel-efficient vehicles has earned the company praise. In 2006, President Bush presented the National Medal of Technology to Mark Pigott, chairman and CEO, for Paccar's development of lightweight, aerodynamic commercial vehicles. In 2007, Paccar received the Environmental Protection Agency's SmartWay designation for designing reduced-emissions trucks. A worker at Paccar's Ste. Therese, Quebec, Canada, plant installs a transmission into a Paccar PX-6 engine for a Kenworth T-370 hybrid truck. The company's history of ingenuity and forward thinking has paid dividends. In 2007, Paccar recorded its 69th consecutive year of profitability, though net earnings dropped 18% to $1.2 billion from the previous year. Revenue reached $15.2 billion in 2007, compared with $16.4 billion in 2006. In an October 2008 earnings call, Pigott attributed a slight drop in third-quarter profit to the cyclical trucking industry, which he says typically endures downswings every five years. Hybrid vehicles likely won't boost Paccar's profit and revenue in the immediate future because they sell for about $40,000 more than traditional diesels, and the technology is new. But if gas prices continue to siphon profits from truck drivers and logistics providers, Paccar may have positioned itself for a major growth opportunity. That's because Paccar estimates its hybrid trucks can cut fuel costs between 25% and 50%, depending on the application. If the company's hybrid initiative is a success, its history of supply chain best practices along with lean manufacturing processes will play a significant role. Getting Ramped Up One of Paccar's closest supply chain partners is Eaton Corp., a Cleveland-based diversified industrial manufacturer. The two companies have worked together for more than 50 years, according to Chris Konkel, Eaton's account director for Paccar. So it was only natural that when Eaton established its hybrid systems business unit in 2000, Paccar quickly jumped on board. In March 2006, Paccar launched a hybrid vehicle program in conjunction with Eaton with the goal of improving fuel efficiency 30% for select medium-duty trucks by 2013. Workers at the Ste. Therese plant set the cab for the T-370. Eaton's hybrid system combines an automated transmission and clutch with a lithium ion battery pack, a motor/generator and computer logic and controls to manage the interaction between the internal combustion power and electrical power. The challenge for Paccar was integrating the technology with customized trucks. "If you're developing a Prius or an Escape, you get the same configuration all the time, and with the medium-duty and heavy-duty truck industry, since the customers' needs are so varied, you end up with a broad array of configurations, and that takes some planning and development," says Preston Feight, chief engineer for the Kenworth Truck Co. Paccar builds to customer orders, meaning one truck might be assembled with aerial capabilities for utility-line applications, while another truck could be designed for pick-up and delivery functions. On the plant floor in Ste.Therese, Quebec, Canada, where Paccar produces its Kenworth and Peterbilt hybrids, adding these unique features to a new power source required some additional training for operations workers. Initially, engineers supported operations by working with them during the assembly process to bring the line workers up to speed, says Marilyn Santangelo, Kenworth's assistant general manager of operations. "The engineers fly up there (Ste. Therese), and we have quite a bit of back and forth on how tools work or don't work given a certain location, and in the end we get the best solution," Santangelo relates. Another potential issue was validation of the components to make sure there were no electrical voids, says Feight. Paccar conducted the validation tests at Eaton's technology center, its own and independent facilities, according to Feight. Once Paccar's hybrids are operating in the field, the company monitors them closely to ensure the trucks are working properly, says Bill Kozek, Kenworth general manager and Paccar vice president. The company assigns engineers to each account to address any issues with the hybrid trucks, Kozek explains, adding that he receives a field report each Friday evening. Top of the Supply Chain When Paccar unveiled its hybrid truck initiative in 2006, Jim Cardillo, now the company's president, said the plan was to put hybrid trucks on the road by 2008. The company met that goal thanks in part to its highly efficient supply chain. The partnership between Paccar and Eaton is part of a supply chain that's been rated among the best in the nation by analyst firm AMR Research Inc. Paccar employees set the engine and transmission onto the T-370's frame. Jane Barrett, AMR research director, points to Paccar's ability to intersect operations excellence with innovation. "They have operations excellence in many areas -- from working with dealers downstream to their ability to configure a truck to exactly what a fleet or individual wants, and they work very closely with their suppliers." Paccar depends on supplier cooperation to facilitate its build-to-order production model. AMR's Kevin O'Marah recounts how Paccar coordinated customized orders at the company's operations near Seattle during a visit to the plant. "Metalsa (a Mexican supplier) gets CAD drawings direct from Paccar and cuts each set of holes, bends and notches specially into its steel frames before they show up sequenced correctly at the gate in Renton. This heavy, unyielding stuff then winds its way through the plant, out to the buyer, and onto the highways of America without ever losing its connection back to the manufacturer," O'Marah explains. Paccar works similarly close with its suppliers on its hybrid lines. "It's a lot about us knowing our suppliers and our suppliers knowing us, and for many years now the suppliers we work with are familiar with our requirements -- forecasting four weeks or three weeks out -- that we're going to transmit orders, even as closely as two weeks out, to the very specific requirements we need on the very specific day that we need them," Santangelo says. "Even nuts and bolts come in on a very programmed, sequenced manner, and it takes the knowledge of our materials management folks and our purchasing folks to work through this." In Eaton's case, the supplier works with Paccar even after the product is completed. Eaton assists educating Paccar's dealer base about repair and service issues, says Konkel. Eaton also helps Paccar inform its customers about tax credits available for hybrid truck purchases, which can get complicated with local, state and federal monies involved. The Road Ahead So far, customer reviews from two of Paccar's initial hybrid customers are thumbs up. Coca-Cola Enterprises, the largest Coca-Cola bottler, has realized a 32% improvement on fuel efficiency, a 30% to 35% reduction in emissions, and reduced maintenance costs from the Kenworth T370 Class 7 hybrids the company purchased in 2007, according to company spokesman Fred Roselli. The company expects a return on investment in three to four years. At a Glance: Paccar Inc. Founded in 1905 as the Seattle Car Manufacturing Co. Renamed Paccar in 1972 after 55 years as the Pacific Car and Foundry Co. CEO: Mark Pigott Employees: over 20,000 worldwide 2007 Revenues: $15.2 billion 2007 Net Income: $1.2 billion 2006: Partners with Eaton Corp. to build medium-duty hybrid trucks 2007: Announces plans to build heavy-duty hybrid trucks 2007: R&D investment reaches more than $1 billion Coca-Cola Enterprises was already experimenting with hybrid trucks before purchasing the 120 Kenworth hybrids, but chose the Paccar-owned brand because of the company's ability to customize the vehicles and overall quality, says Roselli. The hybrids are part of Coca-Cola Enterprises' long-term plan to add fuel-efficient trucks to its fleet, and the company expects to purchase heavy-duty hybrids, with a gross vehicle weight of 33,000 pounds, in the future when they become available. Eaton and Paccar said in August 2007 the companies are developing heavy-duty hybrids. Dunn Lumber Co. in Seattle also reports positive results, with gas mileage doubling to nearly 10 miles per gallon, says Mark Geyer, the company's manager of fleet and crane operations. Dunn Lumber purchased one pilot hybrid in March 2007 for $90,000. The company received a $12,000 tax credit and a discount from Paccar, since the truck is a prototype. Geyer says additional hybrid purchases are in the company's future, particularly since the trucks have been dependable. "The key thing for me as a fleet manager is that when the driver gets in there, contractors and homeowners expect their load in the morning, and we haven't had one problem with that truck," Geyer says. Those signs are encouraging for Paccar, but whether the company expands production of its hybrids in the future will depend on several factors. "We don't know where oil is going to go. We don't know how the technology in the batteries is going to develop," Feight says. "If oil goes up, lithium ion batteries become more prevalent and their cost goes down and economies of scale start to work, maybe this is a wide-ranging application." International Truck and Engine Corp. and Freightliner Trucks are among several Paccar competitors that have partnered with Eaton on hybrid initiatives. But according to Konkel, Paccar has established itself as one of the leaders. "We have this technology available with our other customers," he says. "The key thing with Paccar is they've taken the approach to be much more aggressive with the hybrid technology."

Sum of the Parts - Supply Chain in crisis over credit crunch

By Richard Milne

Published: November 16 2008 19:58 | Last updated: November 16 2008 19:58

Down the line: a Volkswagen is assembled in Puebla, Mexico. The German carmaker has set up a team to prevent collapses among suppliers

The idea of a “crisis cell” might suggest counterterrorism more than it does corporate risk management. But at Safran, the French aerospace and defence company, it is the name of a team charged with responding to the ever-increasing pressure on its global supply chain.

Safran’s crisis cell monitors the group’s 4,000 suppliers, which receive €5.3bn ($6.7bn, £4.5bn) in total a year in return for products and equipment. Xavier Dessemond, Safran’s purchasing director, says the aim is to deal with the problem in “a preventative manner”.

He adds that while no supplier has yet experienced great difficulties, “We know there is a crisis and we know our industry will be probably affected”.

It is a growing concern for manufacturers worldwide. Companies’ supply chains have become far more global in the past decade, with the consequence that stress from the financial crisis is spreading quickly to suppliers large and small. It is testing the global supply chain to an extent rarely seen and spurring companies in industries from aerospace to retailing to take extraordinary measures.

VT Group, a leading British defence group, is a good example. The former Vosper Thornycroft has a solid business, as many of its orders come from the UK government. But in the past two weeks it summoned its leading 100 suppliers – which account for about 70 per cent of its £500m ($740m, €580m) annual supply budget – to a meeting.

The message from Paul Lester, chief executive, was stark: “If you get into financial difficulties, don’t delay but come and talk to us. You are probably better talking to us than banks, because banks aren’t really doing their jobs right now and we can help.”

Possibilities for help include paying suppliers in cash earlier, giving them longer orders or even lending them workers, says Mr Lester. At Safran, Mr Dessemond says his company could put capital into its suppliers, help them obtain aid from government agencies or change payment terms – but all only in “exceptional cases”.

Mr Lester says simply: “We want a bloody good supply base. And we are just nervous that, particularly among SMEs [small and mid-sized enterprises], somebody will get into difficulties.”

A small software supplier to VT did go bust recently – the latest in a number of European supplier collapses, from Stankiewicz, the German car parts supplier, to several manufacturers that serve UK retailers.

WHEN SUPPLIERS FAIL:

Limited options for Land Rover

The troubles faced by Land Rover’s Discovery four-wheel-drive vehicle shows how much havoc can be wreaked by a problem in the supply chain. In 2002 Land Rover, then owned by Ford, said it might have to stop production of the Discovery because the only supplier of its chassis – UPF-Thompson – had gone bankrupt.

The carmaker estimated it would have taken six to nine months to find an alternative supplier, putting 11,000 jobs at risk at Land Rover and its suppliers. The cost of having dual suppliers would have doubled the £12m ($18m, €14m) investment needed for the chassis, the company said at the time.

The end result was messy. KPMG, the receivers for UPF, demanded about £60m from Land Rover to maintain supplies of the chassis. Land Rover accused
KPMG of holding it to ransom and the matter ended up in court. Under a settlement, Land Rover paid an estimated £15m to take on UPF’s debt.

Land Rover said the case underlined the need to reform bankruptcy law. But, in an illustration of the complexity of such issues, UK ministers were unsympathetic as they believed the carmaker had negotiated an original price on the chassis that left UPF making a loss on every component.

Below: Credit insurers are well-placed – and unpopular

All this marks a huge shift for many large industrial groups. During the summer, much of the talk focused on whether their suppliers had the capacity to keep up with demand. “It is amazing how the conversation has changed in the last few months,” says Aaron Davis, the marketing director of Schneider Electric, the French energy management company.

Now, many suppliers are more likely to be calling to ask for bail-outs. The culprit is obvious, according to manufacturers: it is the banks. VDA, the German carmakers’ association, accuses some banks of “making credit lines more expensive, withdrawing them or making credit due in the short term”. Ratings agencies such as Moody’s and Fitch point to the increased difficulties small and medium-sized companies face in securing credit from banks.

But the big companies may also be partly to blame. Many have squeezed suppliers mercilessly for years. The car industry is renowned for manufacturers suddenly imposing demands for 10 per cent across-the-board cuts in component prices. Likewise, UK retailers led by Tesco have succeeded in pushing payment terms with suppliers increasingly in their favour. Tesco has increased the time it takes to pay for some goods from 30 to 60 days.

Bart Becht, chief executive of Reckitt Benckiser, the consumer goods group, last month criticised such moves as making no sense. According to an industry insider, meanwhile, suppliers have complained in recent days that another large supermarket group has just asked for 15 per cent price cuts.

Julie Metelko, a business improvement specialist at PA Consulting, says that approach risks backfiring on large companies: “If suppliers aren’t getting cash, then you risk taking them out.”

That is why companies such as Daimler, the German luxury carmaker, and some of its rivals are looking at giving cash straight to suppliers in difficulties. “Three hundred thousand jobs are at risk in this industry – due to a crisis that was not caused by small and mid-sized companies but [which] is making them suffer massively,” says Dieter Zetsche, Daimler’s chief executive. Volkswagen, Europe’s largest carmaker, has set up a special team to stop suppliers from collapsing.

Counterparty risk is well-known in the financial world, where it refers to the chance one side of an agreement will default. As it becomes a concept to be reckoned with in the real economy, manufacturers are checking their exposure. “We have got to look at risk in the supply chain much more closely. Is your Chinese supplier financially sound? Are they capable of maintaining your supply?” asks Tim Lawrence, a supply chain expert at PA Consulting.

Many counter that they have double or triple sourcing, with suppliers for the same part spread across the world. “In tough times like these, you need as much as possible to keep two suppliers. Globalisation helps here,” says Pierre-Jean Sivignon, chief financial officer at Philips, the Dutch electronics group. Don Gogel, chief executive of Clayton, Dubilier & Rice, the US private equity firm, says: “Globalisation is a big positive, as it has led to multiple suppliers around the world.”

But doubts remain. One is over how quickly a supplier can respond to take over the capacity if one of its rivals collapses. Another is the fact that some components are so complex they are manufactured only by one supplier. Additionally, companies such as carmakers often use one supplier for each model or project, meaning changing component makers could take months.

Just-in-time delivery – long the mantra of many manufacturers worldwide – is also turning into a possible weakness in the supply chain. A problem with just one supplier can throw the entire system into chaos, as can shipping difficulties. Manufacturing experts say that for those and other reasons they are starting to see western companies bring back operations or suppliers from far-off countries in Asia to closer to home: eastern Europe or Mexico.

“We are hearing about it more and more – that companies that went to China and elsewhere in Asia for the low costs are facing rising energy and labour costs. So they are bringing production back closer to home either to the UK or more likely to eastern Europe,” says Jane Lodge, head of the manufacturing industry team at Deloitte in London.

Reports suggest 67,000 factories in China closed in the first half of this year because of the slowdown in exports. Richard Meddings, chief financial officer at Standard Chartered, says the Asian-focused bank is looking much more closely at what is happening to small and mid-sized companies as well as exporters. But he says Asia is still holding up well: “It is coping quite well but the world is obviously slowing. The order chains are still working.”

Once-booming countries such as Russia are suffering more. Yann Vincent, chief operating officer of Avtovaz, the country’s largest carmaker, says: “We have suppliers that are crying. They say, ‘If you don’t pay us x million roubles, we won’t be producing – because we don’t have credit’.”

Other big risks remain in the supply chain. One is the reduction of inventory levels – known as destocking – that is taking place across many industries. “There is a huge effect of massive destocking in all supply pipelines. Lots of people are waiting to buy things as they believe raw materials will only become cheaper. It is a vicious spiral,” says Feike Sijbesma, chief executive of DSM, the Dutch life sciences company. Destocking has also occurred in retail supply chains in a big way despite Christmas being so close.

One factor driving the cuts in stock is the approach of the end of the year for accounting. Many companies are keen to have as much cash on their balance sheets as possible by year-end. Ms Metelko says: “Everybody is being much more aggressive this year, especially as they’re looking at weaker demand.”

Daniel Corsten, a professor at the IE Business School at Madrid, says these are desperate times for some otherwise solid suppliers: “Supply chains are generally in good shape ... But what we see now is very worrying. Previously robust suppliers in terms of quality and reliability cannot finance their production cycle any more. Shrinking demand means that customers pay late, less, or default, and as a consequence suppliers receive theirs less and late. Counterparty risk has reached the real economy.”

CREDIT INSURERS ARE WELL-PLACED ... AND UNPOPULAR

When a piece of big machinery breaks, it is often due to the failure of a minute, previously unnoticed component. Supply lines are no different, writes Kiran Stacey

Credit insurers have operated quietly and unobtrusively, helping facilitate national and international trade for decades, but only now that they are withdrawing from the market has anyone apart from those closely involved noticed what they do.

Credit insurance is, in the words of Luke Johnson, entrepreneur, chairman of Channel 4 and Financial Times columnist, the “lubricant vital for everyday transactions”.

Supply lines start with small companies manufacturing small components. When they supply goods to their larger, more profitable counterparts, those buyers will often use their relative might to demand that suppliers hand over goods on credit.

It can then take months before the buyers pay their bills. In that time, there is a risk, however marginal, that a company undertaking the purchase will fail and so be unable to settle its account.

For small suppliers, the failure of one of their bigger customers can be terminal. So they take out insurance for a small premium, usually with a 10 per cent excess for which they themselves remain liable. If the buyer collapses, at least the insurance company will settle some of their debt.

Times of crisis should therefore be ideal for credit insurers. As big companies come closer to failure, suppliers are hammering at the doors of the big three credit insurers, Atradius, Euler Hermes and Coface, to demand protection for their supply lines. Fabrice Desnos (right), chief executive of Euler Hermes UK, says bullishly: “This is a great time to be in the business.”

But even the credit insurers realise there is a danger of flying too close to the sun. The worst scenario for them would be to be left facing claims from thousands of suppliers as a result of a big buyer going bust. So these companies have to manage a balance between attracting business and making sure they do not take on excessive risk.

It is understandable, therefore, that these insurers refuse to cover suppliers to particularly risky businesses. But when they start withdrawing cover on historically blue-chip companies such as General Motors and Ford, as happened last week, it is a sure sign the financial crisis is reaching parts of the economy few people ever thought it would touch.

The withdrawal of such cover leaves the buyers with three scenarios: they can hope their suppliers will continue to supply without credit insurance; they can start paying cash up-front; or they will simply have to face not receiving the supplies on which they have relied.

Each of these scenarios only helps bring an already troubled company closer to failure, as both the UK’s ScS Upholstery and Fopp music chain found when their suppliers were not able to take out credit cover. Their demise followed soon thereafter.

But even if supply lines keep moving, the withdrawal of credit cover gives an important signal to the market on the perceived health of a company. Credit insurers have regular conversations with buyers and are privy to information to which the market is not, so when they make a judgment call on the risk of a company failing, the market listens.

It is not surprising, therefore, that at times of crisis, credit insurers can find themselves suddenly unpopular. Solvent companies and suppliers complain these insurers are panicking and pulling the rug from under them.

To an extent, they have a point. Credit insurers have withdrawn cover before on big companies only to see them recover and dominate the market once more. This happened to Apple of the US during its low period in the 1990s.

But insurers point out that taking a risk-averse position is only prudent. Already the insurers are facing mounting losses. Atradius, the UK’s biggest credit insurer, saw its losses increase to account for more than 70 per cent of revenues, up from a norm of 50-60 per cent. Things in the business are likely to get worse. In the words of one credit insurance broker: “It’s bloody tough out there.” As the insurers retreat, the grinding of unlubricated supply chains can be heard round the world.