Supply Chain Pressure

The New York Times has an article about the lack of safety monitoring for some heart-related health care products. But this isn't an isolated problem. From the New Jersey importer that had to recall 450,000 light truck tires to some of the recent toy recalls, companies are starting to learn the difficulties of managing an extended supply chain or design chain. The concept says that companies have an interconnecting chain of suppliers and distributors and sellers that all affect product manufacturing, inventory, and distribution.

As companies have taken the standard business advice and focused on their "core competencies," they've extended these chains, having more come from outside sources. But rarely to the companies have any control over their partners. For them it's like going to a big mall and getting this from here, that from there. However, such a hands-off approach isn't going to continue to work. Particularly in an industry that directly affects people's well-being and safety, someone has to be able to guarantee the integrity of what the purchaser gets. That generally comes down to the name on the label.

It may be that many companies are going to have to take a leaf out of Wal-Mart's playbook and get more involved with their partners. As most businesses don't have the big box retailer's resources, it seems that there is a market opportunity here: consultancies that can take the specifications of clients and travel to their business partners, checking on the components they produce. It would probably have to be an organization with global scope, because manufacturing is geographically diverse. But a large management or technology consulting firm might consider this as a useful type of service offering, and one that is bound to get more popular as the number of recalls because of bad ingredients or components rise.

Lots of Labor That's Cheap - So Far

No matter what industries you find interesting, if you are remotely connected to manufacturing - professionally, economically, or politically - you should read this article at ExtremeTech.com. Mark Hachman opens his piece as follows:

About ten years ago, I was given a tour of a Visioneer scanner factory in San Jose. Even though I knew that only global companies like Toyota could essentially afford to build a car through an almost entirely automated process, I was nevertheless amazed at how many people were required to actually assemble a scanner. And I'm not talking about management, but hands-on "put this widget there" assembly.

That's the intellectual setting. The physical location, though, is Gigabyte Technology, one of the big Taiwanese manufacturers of motherboards, a key component in PCs. Although there is enormous room for consolidation in the industry, the company claims about 10 percent market share, with $1.41 billion revenue and 1,249 patent applications on file. It also builds PC power supplies (a fiercely competitive market), complete computer systems, and cell phones. And it does a whole lot of work by hand, as you can see in the pictures that Hachman took.

What makes this so important for business is that manufacturing, on which all of business ultimately rests, for years has seen a tug of war between automation and cheap labor to keep expenses down. Either a company would use computers and robotic approaches to building and assembly, or they'd try to find ways to drop the cost of having people do tasks. In the U.S., automation has, I think, been the predominant force because it's difficult to get people to work ever more cheaply. But in Asia, in one of the most high-tech endeavors you could possible imagine, at one of the globally key companies making a foundation product from PCs, the work is often manual. In other words, the slight savings (because labor, at least in high tech, is typically 5 percent of the total cost of goods) that companies see relies on incredibly low costs of labor. Not slightly lower, but monumentally so.

What happens when people get tired of having their hours subsidize corporations, particularly when they're making the very products that are symbols of economic success? China is already seeing an increase in the visibility of organized labor - look at this BusinessWeek interview with China's 80-year-old All-China Federation of Trade Unions with 137 million members that wants to unionize ... Wal-Mart.

If groups in China can start pushing like this, it could happen elsewhere in Asia. Add the increasing pressure for Beijing to allow it's currency to trade at more realistic values (an increase up ward of 40 percent), and there could be problems for companies outsourcing their manufacturing.

With so much actual work done by hand - and I've heard from a number of sources that China in particular lags by far in factory technology - then that dependence might balloon the impact of increased labor costs. That's already happending with qualified IT help (as I learned in a Computerworld article about two minutes after posting this piece). Finding people is extraordinarily tough and salaries there are climbing 20 percent to 30 percent a year with high turnover. That means you can add additional amounts for recruiting and training that go right out the window with the departing employees.

Companies have jumped on the outsourcing bandwagon without considering the true costs of doing so: inescapable dependency on others for fundamental business processes, increased inventory costs when goods take 50 to 70 days to arrive by boat, affect of leaping fuel prices on shipping expenses, and now extensive sensitivity to labor prices.

I get a sense that there is a disaster in the making that has been building for years, and companies will only become aware of their vulnerabilities when they feel themselves beaten up.

Dell to Sell in Wal-Mart - Future Profit Hell?

Dell is going to start selling two sub-$700 model multimedia computers through Wal-Mart. According to the New York Times story, and other analysis I've seen, this is the first step to Dell reforming its sales strategy so that it's not entirely dependent on direct sales.

I think it's also the beginning of the end for the theory that Dell can do no wrong. The PC business has extremely tight margins. Dell has been able to keep it's profits about three times that of its competitors. According to electronics market analysts I've spoken with, it has done so by beating up on its suppliers. From what I've heard - and I've tried talking to Dell about this in the past, but they wanted no part of the story I was writing at the time - the company pushes prices down so far that the vendors essentially have no profit, and then says that the manufacturing volume will give the vendors the economies of scale to make bigger profits from their other customers. In other words, the manufacturers are supposed to have other customers essentially subsidize Dell's business.

Some have pushed back. When Dell was coming out with its first PDA, for example, there were three firms bidding. Then Dell said what it wanted to pay and allegedly two of the Asian manufacturers walked away from the business because it didn't make any sense to take it. In an industry used to margins of just a few percent, that would have had to be a low number, indeed. Also, some of Dell's suppliers have been hearing from their other clients who have said, "Don't expect us to fund your work with Dell."

There is probably little to no room to move on the price of components. So, from where is the margin for Wal-Mart going to come? It will have to be Dell's margins. Now consider the volume of business the retailer does. This is going to change the overall margin that Dell sees, and that's even before the additional sales support demands that will drive Dell's already over-burdened and under-performing technical support function to needing life support itself.

Eventually companies come across the realization that growth isn't infinite and that high industry margins may not be sustainable. Hopefully for Dell its investors will be understanding, but that's even less likely.

Michael Dell Says Changes Are Necessary

According to a Financial Times article on April 28, 2007 (sorry, no free link), a leaked memo from Dell has the company's founder and current CEO stating that the company is “a defining moment in its history and in [its] relationships with customers.” Dell replaced his former hand-picked replacement, Kevin Rollins, in January because of disappointing results. The memo suggests some pretty significant changes in direction:

He said their plans were to simplify IT for business and the consumer and to innovate beyond its traditional hardware business. They would also work to fix
their core direct-selling business. “The direct model has been a revolution, but
is not a religion,” he said n the e-mail. “We will continue to improve our
business model, and go beyond it, to give our customers what they need.”

The company apparently wants to "radically simplify IT' for corporate customers and go beyond its direct sales model for consumers, which has done well but that is a limiting factor in growth.

I'd like to suggest that these changes are not what the company needs. Consumers aren't moving to HP because of store sales. Dell has developed a recipe for atrocious customer service. (Disclaimer, I once got so frustrated in trying to get a PC from the company on a timely basis that I cancelled the order.) Trying to chase expanding sales before management really fixes this problem is setting up the conditions for business calamity, because customer service that functions poorly now is only going to get worse with greater demands. And the idea that the company will change IT for companies is a level of arrogance that smart corporations won't tolerate - because they don't have the time, money, or inclination.

Then the Dell memo discussed how the company would "take our supply chain and manufacturing to the next level of efficiency." I've done some pieces on Dell's supply chain in the past and have heard from analysts who closely follow electronic manufacturing that Dell is already pushing so hard on its vendors that some are walking away from doing business with the company.

The amount of efficiency increases in the past could not explain the company's profit level growth compared to the rest of the industry. What seemed far more likely, according to the experts I've interviewed, is that it was beating up suppliers and pulling out every last penny of increased profit it can and telling suppliers to use the increased economies of scale that Dell can offer to make more money off their other clients. But those clients are reportedly starting to balk, because essentially they pay for Dell's ability to make more money.

The short prediction: within the next three to five years, major business magazines will be running "What Ever Happened to Dell?" stories, because you can only push your clients and vendors for so long, and then, as the poet W.B. Yeats noted, things fall appart.