Category Archives: Economics

Is Your Supply Management Organization About to Move to Asia?

As per this recent article over on the McKinsey Quarterly on “Translating Innovation into US Growth: An Advanced-Industries Perspective”, the US is posed for a future in which the elements of economic leadership are moving abroad. The US might still be the global leader in R&D spending overall, but in order to maintain its competitive edge, it has to be able to devise innovations the world wants and needs and translate those into economic leadership.

Economic leadership requires more than a capital market system that encourages (and rewards) risk taking and entrepreneurship, more than simply attracting top students and teachers globally, and more than bulk spending. As per the article, it also requires cutting-edge technology, demand, talent, and entrepreneurial spirit. And, right now, the US is falling behind on each of these.

Cutting-Edge Technology
In leading industrial technologies — such as advanced batteries, high-speed rail, hybrid automobiles, solar modules, offshore wind turbines, and machine tools — the United States finds itself competing against, or even catching up, with foreign companies and engineers. Furthermore, as the article notes, the US is now relying on Japan, Russian, and Western Europe to launch its satellites — an industry it used to pretty much own globally. If the US can’t even compete in green energy, it’s in for trouble.

Demand
More than 50% of the global middle class now lives outside North America and the demand for many next-generation products is now coming from Asia, Latin Ameria, and the Middle East. These customers are creating new markets and dictating preferences. US products for the US market are no longer profitable on their own in many industries.

Talent
Scientific and engineering talent is now building up outside the US while one-third of US manufacturing companies are suffering from skills shortages. Cutting edge research is moving to India and China as well as accelerating in Japan and Germany.

Entrepreneurial Spirit
Once a mainstay of the private sector, risk aversion to new vetures is increasing across the board in the US. At the same time, the “new” India is becoming much more entrepreneurial and risk taking. It’s not a good combination.

Then, when you also consider:

Cost
Many emerging countries have labour and overall operating costs that are still only a third of labour and operational costs in North America or Europe.

Success
A number of global multinationals, including IBM, have proved that you can move global Financial, Services, and Supply Management organizations to China and India and still be a world-class organization.

it becomes impossible not to ask if your supply management organization is about to move to Asia.

Should You Manufacture That Product?

A recent article over on Industry Week that asked you to “show me the money” laid out six money questions that the author believes should be asked and answered before a manufacturing decision is made because a product that can’t be manufactured affordably shouldn’t be manufactured at all. As a supply chain professional, it’s your job to ask, and answer, these questions even if product development doesn’t, and even if the product can’t be cut, your job to figure out if it’s cheaper to build in house or outsource.

So, what are the key questions that should be answered?

  • How much will the total project cost?
  • How many products will be sold in a year? and
  • How many years will it take to get your investment back if you manufacture in house?

If the ROI will take years because an investment in new technology is needed, then, even if outsourcing adds cost, it might be the right idea.

For more insights, including the questions to asks (and calculations to do) if you’re trying to decide whether or not to manufacture a product in the first place, see the article.

Procurement Is Worth IT

So listen to the CPO Agenda when it says that Procurement Professionals should get bonuses, even though it might make this recommendation for the wrong reasons.

If Sales gets bonuses for making a sale, which brings the organization X cents to the bottom line for every dollar sold, then Procurement, which brings the organization 5X to 20X cents to the bottom line for every X dollars saved should definitely be in line for a bonus.

Plus, as the CPO Agenda suggests, if fixed costs are still a problem from a (short-sighted) organizational viewpoint, performance-based bonuses should be much less of a problem, especially if they are based on cost avoidance or savings, as a CFO can’t argue with numbers that improve the bottom-line 10X as much as the same numbers from Sales improve the bottom line.

Plus, if you want to retain talent, this is the best way to do it. Just like a hedge fund manager jumps to the investment house that will give him the biggest reward, your stars are going to jump to the organizations which give them the biggest rewards. And as much as you’d like to think that work-life balance, empowerment, and sustainability are important to your team, in general, nothing compares to a bigger paycheck which gives your star the ability to control their own work-life balance, a feeling of empowerment, and the ability to financially support their own sustainability goals.

So give your stars performance-based bonuses. They’re worth it.

Productivity Truths

The McKinsey Quarterly recently ran a great article on “five misconceptions about productivity” (registration required) that is a must read for anyone thinking about not greenlighting an investment in new supply chain technology. As per the article:

  • Productivity IS a priority
    In order for the US to sustain its average historical GDP growth of 3.3% with the projected declines in labor-force growth, productivity growth needs to increase at an annual rate of 2.3% — a rate of growth not achieved since the 1960s. And since the supply chain is the dominant driver of productivity in most organizations, supply chain needs every productivity increase it can get.
  • Productivity IS a job saver
    With a continuing lack of credit and a slow sales rebound in most sectors, your average company can not afford to hire and still has a significant need to do more with less as it first has to grow with the resources it has. Productivity increases help a company keep costs under control, which reduces the chances it will need to layoff.
  • Productivity gains ALSO come from increasing value
    If a new technology will allow the company to identify value or increase value, it’s a must. For example, an analytics system that will help pinpoint key value addes across a product line, new sustainable warehouse technologies (such as hybrid vehicles), or investments in new technologies that reduce plant energy requirements, can increase profit, brand image, and/or sales.
  • Productivity IS AS important to leaders as losers
    How do you think leaders stay leaders? They continue to make gains year after year!
  • There is NO LIMIT to Productivity Gains
    McKinsey’s research estimates that three quarters of the productivity gains required by the US can be achieved simply by applying best practices across the private sector! Imagine what new technology and methodologies could do!

Transfer Pricing – Do You Know What You Need To?

Transfer pricing, which allocates profits and losses among different parts of a multinational entity for tax and related purposes, can have a significant financial effect on your supply chain because the companies in a commonly controlled supply chain must comply with transfer pricing rules and regulations in determining what companies should recognize what amounts of income, deductions, credits, and allowances among the various tax jurisdictions.

Transfer pricing regulations, which are governed under section 482 of the tax code that authorizes the IRS to adjust the income, deductions, credits, or allowances of commonly controlled taxpayers to prevent evasion of taxes in the US, and which must follow OECD Transfer Pricing Guidelines, can be quite complex, but as this recent article in Industry Week on “what manufacturers need to know about transfer pricing”, most regulations are based on one underlying principle: the arm’s length principle.

The arm’s length principle is the condition or the fact that the parties to a transaction are independent and on an equal footing. Transactions based on the arm’s length principle are arm’s length transactions and used in contract law to arrange equitable agreements that will stand up to legal scrutiny, even though the parties may have shared interests or are too closely related to be seen as completely independent. The principle requires that the amount charged by one party to another (related) party must be the same as it would be if the parties were not related. An arm’s length price is the same price that an independent company would pay for a good or service.

This sounds pretty easy until you get into international transactions when trying to split profits and you have to figure out who bears the product liability, the risk of currency fluctuations, and so on. At this point, most multinationals will use a transfer pricing study that performs a detailed analysis of the functions performed, assets employed, and risks borne by each party in the transaction. This will provide a justification of the cost breakdown that will stand up to regulatory and legal scrutiny.

For more information on transfer pricing, see the Transfer Pricing Network in the US, the Cole & Partners Transfer Pricing Site in Canada, or the Transfer Pricing Forum in the EU. Understanding the profit breakdowns will help you understand the cost savings that Procurement directly and indirectly generates for the supply chain.