Monthly Archives: November 2012

If America is Going to Be Number One Oil Producer By 2020, Will Canada Be Number Two?

According to this recent Economist Article on Energy to Spare, America is on track to produce all the energy it needs at home. Considering that Americans burn three and a half times as much energy as the average Chinese person, and hasn’t been able to meet its energy needs in over half a century, this seems like a tall order. Especially since, demand has more than doubled since America was last able to satisfy its energy needs from domestic sources.

However, the International Energy Agency is forecasting that America could become the world’s largest oil producer by 2020, when it could be churning out 11.1 Million barrels a day, and be energy self-sufficient by 2035. Coupled with the fact that demand is waning due to increased fuel efficiency, the prediction is that rising production and falling demand will equal out in 2035.

It’s an interesting prediction, but so is the prediction about the Athabasca Oil Sands north of the American border. Right now, production is about 1.3M barrels per day, but estimates are that production can get to 5.1M barrels per day. As per this article in the Economist, on The Sands of Grime, Canada’s oil sands contain over 170 Billion Barrels of oil that can be recovered economically with today’s technology. With the third largest proven oil reserves in the world, it’s quite likely that production can ramp up to make Canada at least fourth in oil production by 2020, with third place a strong possibility. Right now, Venezuelan production for 2020 is estimated at 6.5M barrels per day (Source) and Saudi Arabia, at close to 10M barrels per day, expects it can get to 11 M barrels per day (Source). With the difference between Canadian production estimates and Venezuelan production estimates for 2020 less than 30%, it would only take a 15% increase in Canadian production and a 15% decrease in Venezuelan production for Canada to edge in third.

Unless Saudi Arabian reserves are less than estimated, or Canadian production ramps up exponentially beyond expectations, we probably won’t make number two, but number three is a strong possibility.

Is the California High Speed Rail Authority Saving a Dime and Losing a Dollar?

A recent article in the Economist on California High-Speed Rail (HSR), touted Cheaper, Slower as if it was a good thing. Quoting the “Fresno Bee”, The CEO of the HSR Authority has decided to extend the first phase of the project, which was due to complete in 2017, until September 18.

As a result of this extension, which is expected to result in less weekend and overtime work, the California HSR Authority is expecting to save $150 Million of taxpayers’ money. This is being promoted as a good thing. I’m not sure I agree.

You see, for Taxpayers to benefit, the State as a whole has to be financially sound. This means that Revenues Minus Expenditures has to be at least zero, if not positive, and anything that increases revenue or decreases expenditures is generally good, unless the State is running a deficit, in which case the State needs to look at each action and see what the costs of the action are.

In this case, the cost of delaying the project is delaying revenues another year. If you look at the revenue projections for the project, available at this link on the California HSR site, you will see that they are massive. Over 2 Billion annually. Now while it’s true that this is just one piece, from Bakersfield to Fresno / Madera, due to the lack of travel options in the area and the fact that it is a vital part of the corridor between LA and San Jose, the revenue projections for this piece alone appear to be over 25% of the total projections. In other words, to save this 150 Million, the State is delaying at least 500 Million of Revenue by at least a year. Now, HSR does have a high operating cost, we don’t know what the profit margins are, and the HSR might actually be projected to lose money early on, but I’d like to see a full cost benefit analysis of what it is costing in the long run to achieve a projected savings of $150 Million. Until someone does this, we have no idea what the projected savings really are, and even less of an idea as to what the savings will even be as they might not even materialize when you consider expected labour increases, expected material cost increases (given the fact that inflationary times are back), and the fact that a whole slew of things could go wrong to cause delays that need to be made up with overtime.

I’m a little disappointed the Economist took the Fresno Bee at their word. An analysis really is needed here.

Do We Have to Send CPOs to Disney for Training?

According to Steve Hall of Procurement Leaders, who was busy blogging while most people were off on summer vacation, the CPO’s challenge is to re-imagine supply chains. Traditional transformation is just not enough – you have to come up with radically different designs. You have to do for supply chains what Walt Disney Imagineering does for Disney – blending imagination and engineering in a unique way to create unique experiences with their creations.

It seems that according to Steve, rapidly escalating issues such as material shortages, commodity price volatility, increasing government regulation, and financial risk in the supply base cannot be tackled by current supply chains unless they are suitably re-imagined. I’m not sure I entirely agree.

It’s not that I disagree that CPOs will need more imagination, and more engineering skills, in the future, but we must remember that:

  • material shortages happen all the time as a result of natural disasters, unexpected spikes in demand, etc.
  • commodity prices go up and down as a result of shortages, or expected shortages, or expected surpluses
  • government regulations are never-ending – going back decades
  • financial risk has always been there – it’s just at a high-point now due to global economic instability

In short, these risks are not new. They’ve been around since trade began, we’ve had, and developed, methods to deal with them since trade began, and we’ve survived. The only difference now is that all four risk categories have simultaneously hit (near) all-time highs — and the situation is only expected to get worse. Plus, whereas shortages always disappeared in the past when production ramped up, in some categories, either due to space restrictions, climate issues, or production issues, the shortages are not going to go away any time soon. In some areas, there is only so much suitable farmland; in others, the climate is no cooperating, and others still, we can’t mine the materials as fast as we need to concern them. So, in these cases, we are going to have to engineer products to use less of these materials, or alternate materials, but this is as much of an engineering challenge as a supply chain challenge (and proof that Supply Management needs to be involved earlier in product development and closely collaborate with the rest of the organization).

In short, CPOs will need to use their imaginations more often and be more creative in their solutions when backed into tough corners, but it’s not time to throw away the time-honoured supply management toolkit just yet. We’ve faced many of these problems before (even if it has been a decade or two), and many of the solutions are still relevant.

Is Your Supply Chain OCF? Part II

In Part I, we asked if your supply chain was OCF, and by OCF we meant Operating Cash Flow and not Obsessive Compulsive Finance, although you have to be the latter in order to achieve the former. We explained that, at least from a working capital management viewpoint, it is a better measure of financial health than other financial measures. We finished with a question – How Do You Impact It?

First, let’s look at one detailed formula:

  1. revenue as reported
  2. – (increase in) operating trade receivables
  3. – investment income
  4. – other income that is non cash and/or non sales related
  5. – costs of sales
  6. – all other expenses
  7. + (increase in) operating trade payables
  8. + non cash expense items
  9. + financing expenses

Based on this formula, supply chain can impact:

  • 1. Revenue as Reported
    by creating new value-added services, creating enhanced versions of a product that can be sold at a premium, etc.
  • 2. Receivables
    by creating agreements that allow for faster collection, by factoring, etc.
  • 5. Cost of Sales
    by reducing product and service costs, reducing inventory costs, reducing transport costs, etc.
  • 6. All Other Expenses
    by reducing indirect costs, SG&A overheads, etc.
  • 7. Payables
    by taking advantage of early payment discounting, by reducing amounts owed through reciprocal trade agreement, etc.
  • 9. Finance Expenses
    by taking advantage of market knowledge to obtain best rates, by selecting appropriate currencies (to hedge against), etc.

And the impact can be measured as follows:

Supply Chain Contribution to OCF / OCF

where Supply Chain Contribution is, technically (where all projections are without Supply Chain Contribution):

  • Actual Revenue – Projected Revenue +
  • Projected Receivables – Actual Receivables +
  • Projected Cost of Sales – Actual Cost of Sales +
  • Projected Other Expenses – Actual Other Expenses +
  • Actual Payables – Projected Payables** +
  • Projected Finance Expenses – Actual Finance Expenses

** while this is technically correct from a Finance view who want the organization to hold onto cash longer, from a Supply Chain view it’s usually stupid, as SI has argued for years, because your cost of capital is often lower than that of a supplier and the goal is to lower overall supply chain costs. In other words, the improvement in payables is probably coming at a cost of a greater improvement in cost of sales.

In other words, if Supply Chain Contribution to OCF was 400K and the OCF was 2M, then supply chain contributed 20% and that’s proof in the pudding that supply chain has value.

Is Your Supply Chain OCF? Part I

Is it? Well, if it’s any good, it’s probably Obsessive Compulsive about Finance, but that’s not what I’m referring to. By OCF, I’m referring to the Operating Cash Flow Metric that some are claiming is the right way to measure supply chain contributions to the organization, and, as such, the measure that should be used in place of EBITDA (Earnings Before Interest Taxes Depreciation and Amortization), ROI (Return On Investment), or ROIC (Return On Invested Capital).

Operating Cash Flow refers to the amount of cash a company generates from the revenues it brings in, excluding costs associated with long-term investment on capital items or investments in securities. The IFRS (International Financial Reporting Standards) defines operation cash flow as cash generated from operations less taxation and interest plus investment income received less dividends. The calculation of cash generated involves determining cash collected from customers and subtracting cash paid to suppliers.

The push for OCF contribution, specifically, the measure of how much additional cash was generated or how much cash payment was avoided, as a measure of supply chain success by a few pundits (including David Schneider) is due to the fact that it is a more accurate measure of how much cash a company has generated (or used) than traditional measures of profitability such as net income or EBIT. (Wikipedia)

The rationale is that other measures are (much) more easily manipulated. For example, a company with numerous fixed assets (factories, equipment, etc.) would have decreased net income due to depreciation, but since depreciation is a non-cash expense, the net income amount is not a true measure of the cash position of the company. In addition, since a company can choose to recognize receivables before the cash is received, traditional balance sheets and resulting EBIT(DA) are also not accurate measurements of the true cash picture. And since companies need cash to run (as pesky people want to be paid), cash flow is often the true measure of company vitality.

OCF allows a company to get a much better grip on its working capital than other measures, and since Supply Chain revolves around working capital, the metric makes sense. So how do you impact it?

Stay Tuned for Part II.