How resilient will international supply chains prove in 2010

Companies that can take advantage of such fast-evolving supply opportunities wherever they may arise hold a valuable competitive weapon, but require a well-managed modern supply chain wi

How resilient will international supply chains

prove in 2010?

RBS Foreword 4

Contents

RBS Foreword

That’s why we’ve commissioned the Economist Intelligence Unit to produce this independent report which provides insight into the general health of supply chains within a sample of 250 UK-based corporates.

The results show that over half the companies surveyed were confident that they would increase their revenues in 2010

Interestingly, even for larger companies, the report shows that China is not the obvious choice it once was If the financial markets are to be believed, the competitive advantage that China’s undervalued currency brings may not be available for much longer Buyers will therefore extend their supply chains to other areas of the globe in search of cheaper or better sources But of course, a supply chain is only as strong as its weakest link As globalisation on both the supply and market side increases, the complexity of supply chains also increases, leading to a closer, more co-dependent relationship with suppliers This, as we know, can often be a delicate balance What is certain, however, is that supply chains are gradually playing a more prominent part in the fortunes of companies, and the effective management of these chains is becoming a critical determinant of competitiveness.

That’s where RBS can help Although this report suggests progress is definitely being made in managing the risks inherent in extended supply chains, there is still much work to be done We have years of experience when it comes to supporting our customers’ international operations And our extensive international network in over 35 countries means we can really help your business make the most of the opportunities out there

I’d like to take this opportunity to thank you for your interest in the Economist Intelligence Unit survey and report I hope you find it of use.

John Lyons Head of Global Transaction Services UK The Royal Bank of Scotland plc

Please note that the report contained in this paper is sponsored by The Royal Bank of Scotland Group plc (RBS), although the findings expressed

do not necessarily reflect our views No representation or warranty, express or implied, is or will be made and no responsibility or liability is or will

be accepted by RBS or any of our officers or employees in relation to the accuracy or completeness of this report and any such liability is expressly disclaimed.

There’s no doubt that the economic challenges of the last year have changed the face of commerce in the UK But as companies look to diversify and take advantage of the potential profits international markets can offer, they must also balance the risks and supply costs involved

This means that the importance of maintaining healthy and cost‑effective supply chains has never been greater

Executive summary

A key strategy for increasing revenues and preserving margins is cutting costs with suppliers Some 63% of respondents negotiated lower prices in the past year, and 41% hoped to do so in 2010 A fifth had switched the countries in which suppliers are located, a third had reduced the number of suppliers and half reported that their relationships with their remaining suppliers were, indeed, more cooperative than before the recession.

Modern supply chain management (SCM), however, extends well beyond price cutting The term SCM recognises that when some 80% of a product’s content is bought in, as is now common practice, the producing company relies heavily on its selection of suppliers, and close cooperation with them Survey respondents listed specialist expertise as the second most important consideration when choosing a supplier, after cost

In spite of the fragile state of the global economy, the financial stability of suppliers is just the third most important consideration when selecting a supplier Only 36% of respondents selected financial stability as a consideration when choosing an overseas supplier

However, after a supplier is selected, financial accounts are the top area for ongoing monitoring, chosen by 64% of respondents

Insolvency of a supplier is a major threat to the supply chains of a significant minority of respondents 29% of respondents have experienced an insolvency

in the past year and a quarter see insolvency of a supplier as one of the biggest threats to the resilience of their supply chains over the next year

Respondents are also looking to take advantage of opportunities created by the recession The top three opportunities spotted were greater availability of talented workers in the labour market, lower interest rates (which makes financing of debt less expensive) and better prospects for mergers and acquisitions A quarter will use the impetus of the recession to review and/or rationalise

The financial crisis has put the spotlight on companies’ supply chains as management struggles to realise the benefits of

outsourcing and reduce risks The results of this survey suggest that their efforts have paid off: well over half the companies were confident of increasing their revenues in

2010, retaining their customer base and preserving their margins Other major findings include:

Introduction

At the same time, the number of foreign subsidiaries has massively increased over the past 20 years – tripling, according to estimates from McKinsey Of the most talked about hotspots, China recovered from the financial crisis well enough in the last quarter of 2009 to notch up 10.7%

annualised growth, and growth is forecast to continue at least 8% for the next few years And India is not far behind, producing hundreds of thousands of trained engineers every year, and growing economically at a pace just slightly slower than China’s

Companies that can take advantage of such fast-evolving supply opportunities wherever they may arise hold a valuable competitive weapon, but require a well-managed modern supply chain with the ability to cope with rapid change and volatility This type of supply chain requires a standard of management several degrees higher than that usually encountered in the traditional purchasing role.

The supply chain model is now more of a network, with suppliers assuming the role of partners and frequently carrying some of the risk The recent recession and the credit crisis have tested such supply chains and relationships as never before, and many suppliers have gone out of business – 29% of respondents to this survey reported such instances in the past year Companies that have adopted lean production techniques, such as just-in-time inventory and reduced numbers of suppliers, have had to be especially vigilant

‘Companies don’t compete: supply chains compete’ is an old adage that is becoming more compelling as the years go by In the days when companies manufactured, refined

or processed everything themselves, their fate was largely in their own hands Now, approximately 80% of the material value

of a complex product, whether an Airbus passenger jet or a Stannah stairlift, is likely

to have been bought in, whether on the grounds of price for a simple plastic moulding or expertise for an electronic control system.

It is not surprising, therefore, that at this stage of the economic cycle, risk is still at the forefront of everyone’s minds The moment of truth for a hard-pressed company can be the point at which sales start to increase again after a recession, but when the cash requirements finally exceed resources That perhaps explains why in this survey all but a few of the larger companies (those with annual revenues in excess of $1bn) apparently attach high priority to the risks lurking in their supply chains, and are aware that they need to be constantly alert to possible problems Extending the supply chain concept from supplier

to customer is not uncommon (if not always effective) in the consumer industries (see the case study on PJ Cussons), but elsewhere it is still a rare concept The arguments in its favour are universal but, in many companies, departmental boundaries may prove insuperable.

Overall, however, the results suggest that by managing their supply chains effectively, respondents have come through the financial crisis in pretty good shape Of course, the survey does not cover the failures, only the survivors, but well over half the respondents to this survey

of 282 UK companies, conducted in January 2010, were confident of preserving their margins over the next 12 months, increasing their revenues and retaining their existing customer base.

Still, many had reduced both the number of suppliers and their supply chain staff, but claimed they now monitor the remaining suppliers more closely Collaboration and their systems have improved, and (perhaps as a result) their demand forecasting and continuity planning are more accurate

The implication is that communication within the company

is now generally smoother than in the past, especially between the supply chain managers and the sales and marketing teams But some believe it is still not good enough, specifically in their liaison with the far end of the chain (i.e their customers)

Effective liaison assumes greater importance given the increasing volatility in both the target markets and the suppliers’ markets The chief supply chain officer (if one is appointed) acts as piggy-in-the-middle, who has the added responsibility, whatever the financial pressures, of keeping inventories at a safe minimum and unit costs at a level that satisfies the finance director, while leaving the supplier with enough incentive to provide a reliable service

As a company’s national and international operations develop, the complexity in the supply chain increases exponentially, with different markets, different products and different manufacturing and distribution centres Yet still, the survey shows that frequently the supply chain has no single head, or is decentralised It is difficult to see how a process of optimisation could be achieved in such circumstances

Many companies, it seems, have yet to wake up to the scale of possibilities that a well-managed supply chain can offer, not just in terms of operational efficiency, but as an indispensable weapon in the modern competitive world.

“Don’t waste a good crisis”, as White House chief of staff Rahm Emanuel told financial regulators last year Far‑sighted managers can seize the opportunity to initiate

a long‑desired radical change at a time when nervous colleagues and other stakeholders are more receptive to change The supply chain, involving as it does practically every department in the company, as well as a long list of suppliers, sometimes needs a crisis before all parties will fall into line

For example, Toyota, facing a $2bn loss in the 2009/10 financial year as a result of the recession, even before the devastating eight million car product recall programme, announced in December 2009 that, among other changes,

it was merging three purchasing divisions into two and imposing a 30% cut in prices to suppliers for a range of components for its 2013 models

Despite its recent problems Toyota is still considered a world leader in managing its supply chain, having demonstrated

in the Toyota Production System how to work with suppliers

to reduce costs on both sides and improve productivity

Its ‘obeya’ process brings all parties together to discuss ideas and projects, and break down functional silos

The evidence from this survey is that on a smaller scale, many respondents are faced with similar problems to Toyota and appear to be following the car firm’s lead:

56% said they were taking steps to improve collaboration and 48% went further by introducing systems to connect and align interests more closely with supply partners

Their primary objective, as always, was to find ways to cut costs by negotiating lower prices – 63% said they had done so in the past year and 41% hoped to in the coming year Perhaps to focus their relationships, 33% had reduced the number of suppliers they used and, possibly for that reason, 35% had cut their own supply chain staff Whatever the results of their efforts, 50% agreed that suppliers were more cooperative as a result of the recession.

Pushing through change

Source: Economist Intelligence Unit

Which of the following steps has your organisation taken in the past 12 months as a result

of the current downturn?

Negotiated lower prices from suppliersReduced headcount in supply chain function

Reduced number of suppliersImplemented a sustainability strategy

Diversified supply chainIncreased payment terms to suppliersInvested in supply chain management technology

Reduced capacity levelsMoved production to lower-cost countries

Increased output volumesNone of the above

Source: Economist Intelligence Unit

Which of the following steps do you expect to take in the next 12 months?

The number of suppliers tends to grow of its own accord, and a periodic weeding process is probably desirable, whatever the conclusions Three years ago, for example, an embarrassed Airbus, struggling to assemble the A380 superjumbo as well as the A400M transport, announced a gradual plan to cut its list of suppliers from 3,000 to less than 1,000 The number now stands at 1,500, and would probably be nearer its target but for the political pressures on management not

to be the cause of redundancies at its suppliers and the need to limit the effect of the strong euro by buying more components in dollars

Whatever the difficulties, there is an unmistakable note

of optimism in companies replying to questions about the current atmosphere They are, of course, the survivors, but 51% were confident of growing their revenues over the next year, with only 22% not confident As to profit margins, 39% were confident of an increase, with 29% not confident There is less confidence at the C-level: 30%

were not confident about growing revenues and 33%

feared they would not be able to increase their margins

Negotiate lower prices from suppliers

Increase output volumesDiversify supply chainReduce number of suppliersInvest in supply chain management technology

Implement a sustainability strategyReduce headcount in supply chain functionIncrease payment terms to suppliersMove production to lower-cost countries

Reduce capacity levelsNone of the above

Compared to this time 12 months ago, what degree of confidence do you have in your company’s ability to achieve the following, over the next 12 months?

Source: Economist Intelligence Unit

Figures have been rounded to the nearest %.

At the smaller end of the scale, the up-market pram and child car seat manufacturer Silver Cross has sales of

£20m, but chief executive Nick Paxton admits to having had “tough times over the past year with some of our major customers demanding extended payment terms”.

Over several years, Paxton has carefully built up a close relationship with a small group of suppliers, mostly in China, and explains “I don’t believe in spreading our custom You’re dealing nowadays with a well-educated set of managers with a good understanding of our overall requirements and the profit that we have to make, as well

as their own business

We have an office in Shanghai, and offices in each of four primary suppliers We have more secondary suppliers, but

I take time to nurture relationships For instance, we use video-conferencing for one of the factories because e-mail

is so easily misinterpreted Our Chinese suppliers have actually suffered labour shortages, so we share our troubles and our relationships with them have grown stronger.”

Preserve existing profit marginsRetain existing customer base

Grow revenuesIncrease profit marginsExpand into new markets or customer segments

Maintain control over supply chainAccess capital at acceptable cost

Change for the sake of change?

Even among larger companies, China is not quite the obvious choice that it once was Some 47% of larger companies, with over £1bn in revenues, source some

of their supplies there, compared to only 19% of firms with less than £500m But if the financial markets are

to believed, the competitive advantage that China has because of its undervalued currency may not be available for much longer Output continues to rise in China, but so

do wages, therefore cheaper cost of labour is not a guarantee either.

Perhaps in consequence, while 47% of the largest firms currently source from China, just 42% say they are enthusiastic about sourcing opportunities there over the next three years, with slightly more (43%) now favouring India Oddly, smaller firms have moved in the opposite direction, with just 19% currently sourcing from China but, 27% say they expect to source from there next year and for it to offer the greatest sourcing opportunities over the next three years Equally surprising, while 41% of companies currently source some of their purchases in North America, just 28% expect to over the next year, and just 14% say it will offer the best opportunities over the next three years.

What Paxton and bosses in a similar position disapprove of is switching suppliers, even countries, for a relatively small cost advantage Among all survey respondents, 19% reported moving their production to lower cost countries Significantly, the proportion was 12% in companies with below £500m turnover but 26% in those above £1bn The critics say that however big the saving, it is likely to be temporary

Meanwhile, the quality and reliability of the supplies over a period will be untested, and the advantages of close cooperation in design, marketing and finance will have to

be built anew

From which of the following regions and countries do you currently source products or services?

Which of the following regions and countries do you expect to offer the greatest sourcing opportunities for your organisation over the next three years?

Companies with global Companies with global Companies with global annual revenues annual revenues annual revenues Total of £25m-£500m of £500m-£1bn of >£1bn