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Winning With Global Value Chains

Simple outsourcing isn’t enough. If a CEO can raise the bar on his firm’s value chain, the earnings improvement will outshine almost anything else he tries.

When CEO Andrew Liveris talks about restoring a long-term luster to Dow Chemical, he predictably ticks off objectives concerning product innovation, joint ventures and financial discipline. But in the same breath, he’ll also mention the company’s value chain-maybe his delight at Dow’s growing footprint in China, its selection to construct a world-scale new complex in Saudi Arabia, or even the company’s new project to help build a safer railroad car in the U.S.

Liveris leaves no doubt that the management of its global value chain has moved front and center for Midland, Mich.-based Dow. It’s “critical,” he says, to “proactively use the supply chain to advantage by being the best in class and setting the new standard, or the new regulation, or being the best supplier to a customer and getting a premium for that-or, at a minimum, not losing business.”

Of course, pioneers such as Dell and Wal-Mart have parlayed their value chains into market domination-fortifying, streamlining and integrating the company’s sourcing, transportation, logistics and delivery to add and extract value throughout the entire enterprise. Such value-chain leaders gain an advantage over rivals that alone amounts to a whopping 4 to 6 percent of revenues, according to Korn/Ferry International, a leading executive-recruitment firm.

For that reason, more CEOs are upgrading value-chain management from a transaction oriented afterthought to a strategic priority. Whether they call it supply-chain management, building a global value chain, or something altogether different, these CEOs are embracing the strategic imperative of extracting value from these complex networks at every step along the way and from every node and connection.

“CEOs are starting to realize that, other than a hot new product that’s first to market-like an iPod-the fastest and most effective way to improve your bottom line is to get better in the supply chain,” says Bill Fello, managing director of the global supply-chain practice for Korn/Ferry in Tucson. Global sourcing is usually the wedge that leads CEOs into a total overhaul of value-chain management. A $5 billion U.S. company spending 50 cents of every sales dollar on direct materials can garner $100 million to $200 million in annual savings by manufacturing abroad, according to Accenture, which reports that the most aggressive companies plan to double spending on low-cost-country sourcing over the next three years. Beyond manufacturing, of course, this includes outsourcing services ranging from customer-service calls to complex engineering. But even as companies increasingly rely on globalization, they’re also coping with the reality that simply outsourcing abroad brings advantages that aren’t as simple as they’d hoped-and often offsetting disadvantages.

Impact of Global Sourcing on Profitabilty

For a typical U.S. $5 billion industrial products company operating at a 10 percent EBIT margin, sourcing 40 percent of direct material spend globally at 15 percent savings will drive an additional $150 million annually to the bottom line-an EBIT increase of 30 percent.

Supply Feats and Flops

For the most successful practitioners, global sourcing is only the most elementary step in adding value throughout the management of all the links in their enterprise.

Hewlett-Packard’s growing command of its global enterprise, extending from manufacturers to customers, is regarded as the primary factor in its recent overtaking of Dell Computer as the acknowledged industry leader. Because of the attention that it has paid to building its value chain, HP gained share from Dell in many non-English- speaking economies, says Mark Margevicius, a Gartner analyst. And the quality of the customer support offered by Dell, an early adopter of outsourced call-center services in India, is declining. In fact, Dell’s struggles compelled Michael Dell to return as CEO in January and sack his longtime friend and protégé, Kevin Rollins.

Meanwhile, HP beefed up its value chain largely by religiously following a model that works well: outsourcing nearly all of its manufacturing to about 40 suppliers that constitute 90 percent of HP’s volume, and then energetically nurturing those relationships. “At this point, HP’s core competency isn’t manufacturing but the management of contract manufacturing, both capacity and the flexibility,” says Shoshanah Cohen, lead partner in worldwide supply- chain practice for Pittiglio Rabin Todd & McGrath, Mountain View, Calif. “With suppliers, it’s not a beat-them- up strategy but more a matter of forming really successful relationships- trying to set them up more as win-win than I-win-you-lose.”

HP integrates those suppliers into a value chain that is transporting $50 billion in supplies and finished goods at any one time, fulfilling more than 50 million orders a year for items ranging from a $20 inkjet cartridge to a $1 million printer. The company decentralized as many value-chain functions as possible to keep management close to operations, while still reaping economies of scale from corporate-wide procurement and logistics. It designs products partly around minimizing the components necessary to produce different models for different countries and employs mathematical algorithms to keep everything straight. Yet, HP’s value chain isn’t yet flawless. One vulnerability-especially compared with Dell and its direct-sales system-is the last link in the value chain: consumer-electronics retailers.

HP figures that consumers still find electronics retailers out of stock of any given printer 7 to 10 percent of the time because the outlets may have only one item on the shelves, a few extras in the back room and “phantom inventory” that isn’t really on the premises. Better deployment of RFID (radio frequency identification) could allow HP to recover a quarter of those lost sales, amounting to as much as hundreds of millions of dollars a year, says Didier Chenneveau, vice president of operations for the Americas. But while manufacturing in China or setting up call centers in India may save huge chunks in direct costs, it can also create major disruptions in a supply chain’s speed and quality of interaction with customers. W.H. Brady CEO Frank Jaehnert, for example, saw fiscal-2007 net income suddenly dip by more than $8 million because of hiccups in how the cell-phone and computer-part maker deployed its manufacturing in China. Despite more than doubling its locations in China over the last two years, the Milwaukee based company lost some big contracts late in 2006 because it didn’t happen to have a plant close enough to the customer’s assembly facility in China.

“In the U.S., we have predictable delivery mechanisms where this would not have been a problem with that customer,” says Rob Damron, an analyst who follows Brady for 21st Century Equity Research. “But in China, the infrastructure isn’t dependable enough.”

In light of these developments, many CEOs are confronting the possibility that, when it comes to their supply chains, “lean” isn’t necessarily optimum. “The default answer for a lot of people is to €˜lean out’ the supply chain,” says Jeff Woods, research vice president for Gartner, New York. “That’s a sufficient answer when there is a fairly high level of reliability in your supply network. But when you look at global operations, lean is not a totalizing answer. You need to be €˜chaos-tolerant’ as well.”

For a typical industrial products company, landed-cost savings from global sourcing can be substantial.

Source: Accenture

Crowding Out Chaos

The Tetley Group recently tried to strip much of the “chaos” out of its value chain in order to glean cost and speed advantages. Soon after the West London-based tea giant was acquired by India‘s Tata Group a decade ago, management made a dramatic decision to divest the company of most tea-cultivation assets and focus on optimizing the worldwide management of brands. Among other advantages, Tetley no longer is tied to tea acreage that may or may not be favored by global climate change.

Tetley also pared its seven blending plants down to just two, one in India and one in the U.K., and consolidated all supply-chain purchasing and support, including finance, IT and HR, into one worldwide operation. “There’s a very complex optimization process going on that looks at the consistency of blends, supply-chain issues, stocking the supply chain and the cost of supply from particular markets, which changes through time with climatic conditions, to optimize the supply-chain equation,” says Peter Unsworth, managing director of supply and support for the Tetley Group.

The strategy has proven effective, Unsworth says. A decade ago in the U.K., the typical price for Tetley’s standard package of 80 tea bags was £1.69. Today, that price is £1.39 to £1.59 despite the impact of 10 years of inflation on the U.K. economy. And Tetley is more profitable than it was a decade ago.

Dow, of course, has a much bigger global footprint than Tetley. With operations in 39 countries, the $46 billion chemical giant sucks up petrochemical feedstocks from all over the world and turns out polyurethane, olefins, Styrofoam and other basic and value added products that it sells in 175 nations. At the end of its value chain, Dow is delivering everything from a 20,000-gallon rail car of naphtha to a pallet of $3.99 cans of Great Stuff household foam to a Home Depot.

While global sourcing is nothing new to Dow, the company has been placing even more of its manufacturing closer to the cheapest sources of energy worldwide, such as the Middle East and Russia, and where it can most easily supply booming markets such as China. CEO Andrew Liveris also is trying to account for growing threats to Dow’s supply chain from terrorism and other externalities. “So while having a low cost to [market] is Job One,” he says, “we also must put the same focus on our €˜moving’ assets.”

This focus flows through a corporate- wide value-chain command headed by David Kepler, CIO and senior vice president of shared services and environment, health and safety. Optimizing Dow’s complex global value chain begins, he says, with integrating each business unit into a common IT platform that uses proprietary statistical-modeling tools to reconcile manufacturing operations and inventory management with customer demands. GPS, RFID and other technologies help Dow track everything in the chain. Dow also is paying more attention to supply-chain vulnerability after the concussive effects of border closings in the aftermath of 9/11, mounting threats ranging from SARS to avian flu in Asia, and a series of railroad and manufacturing accidents in the U.S. Meanwhile, entities ranging from the European Union to the municipality of Washington, D.C., are slapping more restrictions on the movement of the sort of hazardous materials that make up much of Dow’s tonnage worldwide.

Source: TBM Consulting Group

Vanquishing Vulnerability

One of Dow’s answers has been to launch an intense initiative, along with rail companies and the Federal Railroad Administration, to design a next-generation rail car more crash-and terrorist-proof than called for even by new U.S. standards that go into effect in early 2008. Among other things, Kepler says, the rail cars will be able to withstand the impact of the improvised explosive devices (IEDs) that are being used so effectively by Iraqi insurgents against American troops and equipment.

Dow’s efforts also exemplify another concern of CEOs expanding a global footprint: “sustainability.” In January, for example, Wal-Mart and Europe‘s three largest supermarket retailers endorsed a unified approach to promoting good working conditions in the supply chain. And over the last five years, the annual contract value of electronics retailers “saying that these concerns are important to us” grew from just $100 million to about $6 billion, says Bonnie Nixon-Gardiner, global program manager for HP’s supply chain in social and environmental responsibility.

“We don’t want to end up like Nike and other companies with these issues,” says Michael Fawkes, HP’s senior vice president of operations. HP banded together with competitors and with the world’s largest contract manufacturers of electronics to agree on a code governing “human rights,” ethical practices, environmental codes and the like.

Real progress has included Mexico, where the group trained managers to address complaints of labor-rights violations among contract electronics manufacturers, reducing such concerns to a trickle from a peak of 600 complaints.

Such rising complexities in managing global value chains, combined with the increasing importance of getting a handle on the pursuit, means that more CEOs are turning to UPS and other third-party logistics providers to relieve some of their headaches and to help them squeeze results.

“We’re the bridge; we’re the conduit,” says Mike Eskew, CEO of United Parcel Service. “We go global to take our customers global and manage infrastructure and networks for our customers. Our supply chain is how we can make our customers better.”

In addition to shipping packages, UPS also operates warehouses, fulfillment centers and other nodes of supply- chain management for clients at its 350 facilities. Its 2,000 supply-chain engineers consult with customers; and UPS books billions of dollars of air-transport time outside its own fleet of planes at rates far cheaper than any of its customers could.

Endo Pharmaceuticals began a decade ago as the result of a management buyout of DuPont’s drug business. The Chaddsford, Pa.-based company now distributes prescription and other drugs in the U.S. from contract manufacturers in Japan, England, Northern Ireland and Nebraska.

Federal regulations require Endo to ship many of its products from a vault with 12-inch reinforced-concrete walls, floors and ceilings and a “two man” security rule. Instead of investing $1 million to $2 million to build it, Endo partnered with UPS, which has a unit devoted to health care distribution, to construct the nation’s largest controlled-substance vault.

“I need that asset there whether we’re only using it one-third or one-half of the time right now,” says Daniel Carbery, Endo’s senior vice president of operations. “We get sub-rent, and UPS is able to accommodate other customers who can use the same services.

We want them to be experts in handling controlled substances.”

There’s a lot of missionary work yet to be done before every CEO recognizes the business-transforming power of building a global value chain. “I’d like to say that everyone is there now, but they’re not,” says Bob Stoffel, a member of the UPS Management Committee. “Some CEOs still just talk transactionally about what it takes to move one 10-pound object from one place to another in the world, independent of a strategic view.”

Going from that kind of thinking to the strategies of today’s most sophisticated value-chain builders requires a tremendous leap. But CEOs who don’t train for and make the jump could find their companies being left permanently on a lower plane by competitors whose prospects are taking off on the wings of global value chains.

About Dale Buss

Dale Buss
Dale Buss is a long-time contributor to Chief Executive, Forbes, The Wall Street Journal and other top-flight business publications. He lives in Michigan.