Category Archives: Finance

Economic Damnation 07: The 1%

“The 1%” was coined in 2011 to refer to the US income and wealth inequality where the concentration of wealth among the top 1% is significantly above the national average. On average, the 1% earn well over a million dollars each year (and the bottom 99% all make less than 350K) and control over one third of the country’s wealth, meaning that, on average, their financial influence is 33 times that of an average person. In addition, the roughly 536 Billionaires in the US have a net worth that is over 10,000 times that of the average household net worth in the US (and in a couple of cases, almost 100,000 times).

And the US is not the only country with such a disparate income and net worth inequality. China has 213 Billionaires in US dollars, and the top one percent in China also controls over one third of the country’s wealth. The wealth inequality has widened significantly over the last 20 years.

And similar situations appear to be arising in other developed countries around the world. A recent article in the Guardian called the growing wealth inequality in the UK a ticking time bomb, the Broadbent institute recently published a report that found Canadians vastly underestimate the wealth gap in Canada, and even the Australian Institute is finding that the inequality between those with the most and the least is rising in what was once universally thought of as an egalitarian country.

This is bad, because it’s at the point where a select view individuals can not only single-handedly make life a living hell for a large number of Procurement professionals in a number of disparate companies across the globe (as Extreme Activist Investors, Damnation 64), but can individually cause a number of economic, infrastructural, environmental, regulatory, societal, organizational, and technological headaches all on their own. If a small group of these individuals buys a Fortune 3000 and decides it’s manpower heavy, they can cause 10,000 people to be laid off in a day in a small town and cause a major shift in the local, and even regional, unemployment rate (and the market who can afford the product being built). They can start new airlines to increase competition (and logistics headaches), or buy a competitor just to decrease competition. They can create new sustainability initiatives overnight, or turn the fracking dial up to 11! They can fund entire lobby groups to get their standards and requirements in place. They can single-handedly make your supply chains safer or lobby against worker’s rights to keep costs down. They can replace your entire Sales and Marketing teams overnight. And they can dictate your ERP for years to come.

The reality is that, in today’s world, Money Talks, and when you can buy and sell 99% of the world’s companies with your pocket change, their money talks the loudest. It’s another damnation we’d rather not know exists, but it does, so we need to be as prepared as we can (and always expect that even the best laid plans can be set awry by the whims of one wealthy individual).

Technological Damnation #77 e-Currency

We started out our series with the Economic Damnation of Currency Strength, which, thanks to the recent unexpected fluctuations in certain global currencies, probably has you shaking in your boots. But if you think trying to manage real currency exchange is bad, just wait until you have to start using non-country based e-Currency, like Bitcoin.

Bitcoin, a peer-to-peer payment system released as open source software in 2009, allows users to transact without using an intermediary using a decentralized virtual currency (or crypto currency) which has a value defined by the global market based on the fact that it’s limited and once all of it has been “mined”, there are no more units. Because of its structure, new units cannot be issued on a whim (whereas a country can print as much money as it wants, at the risk of hyperinflation), and, as a result, it’s value can, and has, skyrocket(ed) over night.

For example, up until late 2013, Bitcoin’s value was negligible, at which point it skyrocketed to a value of over one hundred. It stayed there for almost a year until early 2014 when it skyrocketed up to a value of almost 1200, before, over the last year, crashing back down to about 200 (in US dollars). On January 18, 2013 it’s value was 15.70. On April 9, 2013 it was $230. On April 16, 2013 it was 68.36. On May 4, 2013 it stabilized around 112.90. It stayed there until around October 15 when it began to skyrocket to 1,147.25 on December 4, 2013 then it crashed back to 522.23 on December 18, 2013 returned to 940.10 on January 5, 2014 and since then has been on a downward fall until January 18, 2015 when it was 199.56.

As virtual / crypto currency is still in its infancy, shocks like this can be expected and can be much more devastating than the recent drop in the Ruble. And, even worse, now that many vendors are starting to accept crypto currency as payment from global consumers that trust the currency, they will be expecting to pay with the currency as well. And your organization will have to hedge against new crypto currencies, which might also include Litecoin and Darkcoin (as well as a dozen others), as well as existing currencies. The fun is just beginning.

Regulatory Damnation #34: Tariffs

While taxes alone are not damning, as taxes, like death, are one of the only two certainties in life, tariffs, on the other hand, are one of the ongoing nightmares of the Procurement world. Tariffs make the complete personal income tax code of the United States look like a kindergarten book.

For example, the current HTS (Harmonized Tariff Schedule) of the United States is 3,536 pages. And that’s just the US HTS code. The 2007 LIGIE for Mexico is 684 pages, and there have been hundreds of pages of amendments since then.

With 196 countries in the world today, extrapolating, that’s over 200,000 pages of HTS / HS (Harmonized System Code) classifications that an organization needs to be on top off to determine international import and export duty rates. But that’s just the tip of the iceberg. It’s not just keeping track of rates, it’s figuring out the rates that apply. For example, let’s say you want gloves, is it:

    4007.11.70 Leather - full grains   - glove and garment
    4017.12.70 Leather - split grain   - glove and garment
    4107.19.70 Leather - whole hide    - glove and garment 
    4017.91.70 Leather - other         - glove and garment
      ..
    4023.10.40 Apparel - articles      - gloves, mittens and mitts
    4203.29.XX Apparel - cowhide       - gloves
      ..
    6116.10.08 Gloves  - coated        - other
      ..
    6116.92.08 Gloves  - cotton        - other
      ..
    6116.93.08 Gloves  - synthetic     - other
      .. 
    6116.99.35 Gloves  - other textile - other
      ..
    6216.00.08 Gloves  - impregnated   - other
      ..

there are so many (dozens upon dozens of) classification of gloves, that it’s hard to find the right one – and if you pick the wrong one, and especially if you pick the wrong one with a lower tariff rate, then your organization is at risk of significant fines and penalties.

So how do you deal with this? There’s only one way — get a trade market intelligence solution which is kept up to date by people around the globe as classification updates and rate changes come up and easily searchable by the average Procurement professional who is not an expert in H(T)S code structures. There aren’t a lot of options, but SI recently covered one company, Integration Point, that has been building such a solution for almost 10 years. Why do you need a third party? Integration Point, which maintains a global content team, made over 2 Million updates to their global H(T)S code database in 2014 in an attempt to keep up with the never ending string of updates that are regularly released by countries around the globe. (Some countries release updates on a weekly basis. For example, Brazil once updated its HS code 80 times in one year.)

Economic Damnation #05: Currency Strength

As indicated in the prologue to this series, there are dozens upon dozens of challenges being thrown at you as a Procurement professional on a daily basis. Causing you nothing but grief and agony, these damnations collectively do nothing but divert your attention from critical strategic planning, (should-cost) modelling, and supply assurance.

Today we are going to discuss damnation #05, currency strength — one of the ten economic damnations that we will cover before this series is over. This damnation is particularly relevant with the recent volatility in the Ruble, Renminbi (Yuan), and the petro-dollar — which might be used as a hedging strategy in some organizations.

Currency fluctuations can quickly destroy the best laid sourcing plans when sourcing internationally from countries that use a different currency, even if the contract is being executed in the currency used by the buyer.

In the situation where the contract is being executed in the currency used by the buyer, if that currency devalues against the currency being used by the supplier, then the supplier may not be able to afford to honour the contract without risking bankruptcy (as the supplier’s costs would exceed their sales). In this case, the supplier may simply cease to honour the contract.

In the situation where the contract is being executed in the currency used by the supplier, and if that currency increases significantly in value compared to the buyer’s currency, then the buyer may not be able to afford to buy from the supplier (as the buyer’s costs would exceed what the customers are willing to pay) and may be forced to break the contract (and risk the ramifications).

In either situation, there is a disruption in supply and the potential for significant financial and legal ramifications down the road. And this is one damnation that is never going away as currencies never remain stable. And while it will forever damn us, it is not always impossible to predict when currencies are likely to fluctuate.

How? Through the use of Purchasing Power Parity (PPP), we can determine when a currency is undervalued and when it is likely to rise in the future or when a currency is overvalued and when it is likely to fall in the future. It’s not perfect, but it’s better than flying blind. (For a good definition of PPP rate, review Dick Locke’s classic post on Undervalued Currencies, Part I).

So how do you determine PPP? One way is to simply look them up on the World Bank site. And how do you determine if a currency is over or under valued? You compare the official exchange rate to the PPP rate. If the PPP is (significantly) greater than the exchange rate, then the currency is undervalued. But if the PPP is (significantly) less than the exchange rate, then the currency is overvalued. How much? Divide the rates to get a percentage.

So how do you put this to use? Since floating currencies don’t always settle near the PPP rate, which some analysts are prone to believe, you look at historical variations and see where the trend over time is. If the currency is undervalued by 30% but the historical trend is that the currency is only undervalued by 20%, then it is likely that the currency is going to rise and that should be taken account in one’s projections. But if the currency is undervalued by 15% and is historically undervalued by 25%, then it is likely that the currency is going to fall. (For a more detailed explanation and example calculations, see Dick Locke’s classic post on Undervalued Currencies, Part II.)

Now, this won’t account for the situations where one country, like the US, is intentionally lowering the value of a major market resource or currency basket, like the petro-dollar, in the hopes of decreasing the value of another market resource or currency, like the Ruble, in the hopes of weakening an economy, like Russia, as these situations can only be detected by geopolitical (trade) monitoring (which will be discussed when we cover damnation #25, among others), but it will give you a much better understanding of relative currency strength and how the currency value is likely to change over time based on historical trends.

Procurement Trend #07. Supplier Pre-Payment

Four anti-trends remain. We can count them on one-hand’s worth of fingers, but like LOLCat, we feel more compelled to provide examples of how far beyond retro the futurists really are when they provide us examples of trends that anyone who bothered to poke their head over their cubicle wall thirty years ago (or outside the yurt three thousand years ago) would have noticed. However, we’ll leave their bitter humiliation for LOLCat, who is obviously received very little enjoyment from this series, but still found the time to point out how LOLCats have been sustainable at least since the first corrugated cardboard box was created and instead focus on dispelling the myths the futurists continue to propagate.

So why do these Rip van Winkles keep pushing upon us trends from yesteryear? Besides the fact that some of them obviously spent the best part of last decade napping, probably because they look around, see the laggard organizations still caught in the muck, and assume they can still sell last decade’s leftover snake oil in today’s marketplace. Why do they think Supplier Prepayment is today’s cure?

  • suppliers in emerging and even recently emerged countries may not have easy access to short-term financing
    which may mean that payday loans or family* loans may be required and as a result
  • interest rates vary and suppliers’ interest rates may be much higher than yours
    and costing the supplier, and thus you, 3% or 4% a month, not per annum
  • early payment can be the difference between blood red and black
    because with 36% APR loans, they double every 24 months a borrower doesn’t make a payment

So what does this mean?

Know the True Cost of DPO

How much is 30 day, 60 day, 90 day and 180 day DPO, from the time the supplier starts producing your order, really costing the supplier and, hence, since that costs needs to be built into their price, costing you?

Know the True Return on DPO extension

If the only reason to extend DPO is to get 2% annual interest in a short-term cash deposit, and this extension of DPO costs your supplier 24% annual interest, are you really making money off of this? If, however, you have the 1 in 100,000 situation where paying on time requires a loan from your bank at 12% and your supplier is on-shore, being government funded, and getting development capital at 6%, then in this case it actually makes sense to extend DPO until you are in a better position as it only increase the supply chain cost 6% instead of 12%. But this is probably a 1 in 100,000 situation.

Know what alternative investments net

Decreasing DPO might decrease supply chain cost, but if that investment requires smaller LTL (Less Than Truckload) orders and faster inventory turnover, this could cost more in the long run as FTL (Full TruckLoad) is cheaper and stock-outs cost revenue. Throw all the numbers, good and bad, into an optimization model and figure out what the best choice really is. Sometimes it will be early payment, or even pre-payment, of the supply base, and sometimes it won’t.

* Not their family, the family, capiche?