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CHAPTER 1
THE CHANGING GLOBAL LANDSCAPE
To say that the search for new sources of competitive advantage is a relentless challenge grossly understates the reality of today's competitive world. Whether we are talking about marketing, finance, operations, logistics, or supply management, the need to do something better, faster, and cheaper is never ending. And nowhere is the need to show year-after-year progress greater than within the supply group.
The need to show constant improvements, particularly cost reductions, has resulted in a search for lower-cost sources of supply that has become a central part of most supply strategies. Sometimes, however, the best of intentions results in some less-than-desirable outcomes, creating a newfound awareness and appreciation of supply chain risk. Consider the following example.
In an effort to remain competitive across its product line, a U.S. producer of power tools outsourced its lower-end tools to a contract manufacturer in Asia. The plan was to allow the U.S. producer to focus on higher-margin products while still offering customers a full range of tools. Unfortunately, a seemingly sound business strategy did not lead to the best of results. The Asian supplier not only sold the excess tools it produced to other companies across Asia, but the contract manufacturer also shared the product's design among a close circle of friends. Before long the U.S. producer found itself competing in the marketplace against its own products! How could a supply strategy that was designed to help create a competitive advantage go so wrong? How could a plan that was supposed to reduce risk actually increase risk?
This chapter begins our journey through the world of international purchasing, global risk, and global supply management. It starts at a very high level by looking at the phenomenal growth in international trade. The second section examines some macroeconomic topics and discusses how they affect supply managers at the micro level. The third and fourth sections discuss the growth in international purchasing and explore the reasons behind this growth. We next present a model that underlies the framework that supports this book's progression and introduces a best-practice supply organization. The chapter concludes by introducing the important concept of global risk.
THE GROWTH IN INTERNATIONAL TRADE
Any discussion of international purchasing or global supply management would be incomplete without first stepping back and taking a look at the broader picture. The growth in worldwide commerce over the last 30 years, which includes buying and selling across borders, has been nothing short of astounding. Since the late 1980s, the level of international trade has accelerated rapidly, and the U.S. has played a major role in this growth. Starting with a discussion of the growth in worldwide trade, a broad starting point by any standard, will help lay the foundation for where we want to proceed within this book.
International trade is made up of the goods and services that enter (imports) and exit (exports) a country. For reporting purposes, the U.S. government divides imports and exports into six primary categories — foods, feeds, and beverages; industrial supplies, including petroleum and petroleum-based products; capital goods; automotive vehicles and related items; consumer goods; and other goods. Other countries also segment their trade statistics in some logical manner.
To give some idea of the magnitude of just a portion of these categories, when oil is $140 a barrel, the U.S. imports about a $1 billion a day just in petroleum. The U.S also imports several hundred billion dollars a year in automotive vehicles and parts. So it's not hard to see what makes up a major part of the U.S. trade deficit.
We hear a great deal about the trade deficit that the U.S. maintains with the rest of the world, and this roughly $700 billion annual deficit is not trivial. Often overlooked, however, is the dramatic increase in exports over the last several decades (although the economic downturn of 2008 and beyond quickly curtailed exports and import figures). Table 1.1 shows the increase in imports and exports since 1980 for goods and services. Table 1.1 also provides yearly U.S. trade balances for goods and services. Since 1980 the total value of goods exported from the U.S. has increased over 475% (from $224 billion in 1980 to almost $1.3 trillion in 2008). The value of services exported from the U.S. for this same period increased over 1000% (from $47.5 billion in 1980 to almost $552 billion in 2008). Although manufacturing is still a major part of the U.S. economy, the growth in services supports the contention that the U.S. is becoming a services- and knowledge-based economy.
Is it not possible that these figures have increased simply because prices have also increased? After all, higher prices will inflate the value of the goods and services that move across borders. While inflation explains some of the changes in these trade figures, the consumer price index (CPI) in 1980 averaged 82.4 and the index averaged 215.3 in 2008,representing an increase of 161%. The producer price index (PPI) also showed similar restraint over this period. Factors besides price increases were clearly responsible for the dramatic export and import growth.
What other reasons might explain this phenomenal growth? Perhaps first and foremost is the overall growth in the world economy. In 1980, the U.S. gross domestic product, which represents the total value of goods and services produced in the country, was $2.8 trillion. By 2008 this figure climbed to $14.3 trillion, or an increase of over 410%. The percentage growth in GDP coincided with the percentage growth in imports and exports. In fact, faster economic growth in the U.S. compared with other industrialized countries, particularly during the latter 1990s and early 2000s, combined with a strong dollar that made imports relatively cheap, were largely responsible for the widening gap between exports and imports. Imports and exports grew as the economy grew.
Other factors affect the amount and pattern of global trade. The end of the Cold War resulted in increased trade in emerging markets in Eastern Europe and Russia (although a sometimes tenuous relationship with Russia could cause a reversal of this trend). And of course, the formerly closed country known as China became receptive to international commerce and the money that came along with it. The 1990s also witnessed a growth in trade agreements that lessened import and export restrictions. World Trade Organization (WTO) rules, the General Agreement on Tariffs and Trade (GATT), and the North American Free Trade Agreement (NAFTA) all promoted a dramatic increase in worldwide trade. Various other free-trade agreements between countries, too numerous to review here, also helped to reduce trade restrictions.
The last 20 years clearly favored the dismantling of trade barriers between countries, although some will argue this dismantling was not always equitable. Interestingly, we appear to be entering a period in which free trade is not as welcomed as it was during the 1990s. The bottom line is that the world has generally become a more open place for business, at least for now.
Something that most observers probably do not realize is that a large part of international trade consists of transactions between subsidiaries or units of the same company. The U.S government calls this "related-party trade," which includes trade by U.S. companies with their subsidiaries abroad as well as trade by U.S. subsidiaries of foreign companies with their parent companies. Although related-party trade fluctuates year to year, it accounts for almost 50% of imports and almost 30% of exports. Related-party trade currently comprises around 40% of the dollar value of all exports and imports in the U.S., a percentage that has remained fairly consistent over the years. As companies become more global in their operations, we should expect to see an increase in international trade in the form of related-party trade.
THE MICRO EFFECTS FROM MACRO EVENTS
It would be easy for supply managers to look at macro economic data and events, including trade data, shrug their shoulders, and wonder what this means to supply chain risk and global supply management. After all, aren't we all just little cogs in this global economic machine that seems to have a mind of its own? How much do we really control? Although the global economic system does seem to have a mind of its own, astute managers must do their best to understand this thing called the "bigger picture."
We should not even debate that what goes on at the macro or worldwide level affects supply conditions at the micro or company level, particularly because we witnessed the great financial meltdown of 2008. Furthermore, the effects of fluctuating exchange rates; surging demand in emerging countries; new trade agreements or restrictions; geographic conflict and terrorist activities; nationalization of companies (think of Venezuela); the free flow of capital as it seeks its highest return; government budget deficits; and global supply and demand that determines the price of commodities and services are all areas that impact supply managers. Let's look at some macroeconomic examples to illustrate how global changes, a constant that will always be present, affect virtually all companies.
Trade Imbalances
Economists will tell us that it is not healthy over the longer term for trade to be predominantly one way or unbalanced. World trade works best when there is some semblance of equilibrium between trading partners. We know this equilibrium is not always present because imports and exports between countries are often widely divergent in terms of volume and value. Trade imbalances such as the one between the U.S. and China, and to a lesser extent between European countries and China, have effects that may not be obvious at first glance.
One tangible area that showed the effect of trade imbalances during the last several years involved returnable shipping containers. It may be hard to believe, but in the U.S. during 2008 there was actually a widespread shortage of shipping containers for exports. With all the freight that arrives in containers from Chinaand other parts of the world, one would think that getting a container for exporting goods would be easy. In this case that would be wrong. And trade imbalances are the reason.
It was not that shipping containers did not exist. It was the placement of the containers that created the dilemma. Incoming containers brought tons of consumer goods to the U.S., such as electronics and clothing, largely to the U.S. west coast from Asia, where many of the containers were also unpacked. Not nearly enough goods, however, went back to those countries in the form of U.S. exports. The result: thousands and thousands of containers sat idly in California enjoying the sunny weather.
Another issue was that the exporters that needed the containers, particularly in the Midwest, were far from where the containers were being unpacked. And the places where U.S. exporters wanted to send these containers were not necessarily the Asian countries where the containers had originated (remember the trade imbalance?). As a result, the containers did not flow back and forth fully loaded or to the places that were responsible for the most U.S. exports. Compounding the problem was a shortage of chassis (the truck wheels and frames that a container sits on as it moves over the road). This shortage made it difficult to get empty containers to the places where they were needed. Additionally some big shipping lines had shifted container capacity away from the U.S. to support other worldwide trade routes just when the containers were needed the most. All these things resulted in delays, lost orders, and at times crops rotting in the fields because they had nowhere to go.
In a dramatic change of events, the great economic meltdown of 2008 rapidly changed the demand for containers as imports and exports declined rapidly throughout the world. Suddenly the major container shipping carriers were talking about taking entire ships out of service because the world was awash with unused shipping capacity. To the average exporter this situation might be painful, but it emphasizes that the connection between trade balances, the pattern of trade (what goods are going where), and supply chain infrastructure is very real.
Changing Supply and Demand Markets
Commodity markets such as rubber, corn, gold, copper, and oil are a real source of concern for many supply organizations. A primary characteristic of most commodity markets is that no single industrial buyer affects or controls prices within these markets, although cartels of producers might attempt to manipulate world markets. Many commodities operate in markets that economists call pure competition. This means prices are dictated by the market forces of supply and demand, although some will argue that speculators have skewed the behavior of some markets. An increase in copper demand in China means higher prices for copper buyers in Des Moines, Iowa. At the other extreme is the situation in which commodity markets, such as oil and cocoa, are controlled by cartels that affect prices through their coordinated (and some would call coercive) actions. For industrial buyers neither scenario is much fun.
Consider an example that shows how shifting commodity markets can affect innocent bystanders. For years automakers used platinum in catalytic converters for emission control. However, in anticipation of tougher rules by the U.S. government, automotive engineers designed palladium into pollution control equipment, suddenly comprising over half of the world's demand for this previously minor element. Besides being more effective at cleaning vehicle exhaust, palladium was also less expensive (at the time) than platinum, the previous element of choice for catalytic converters.
At the end of the Cold War, there was a large stockpile of inexpensive palladium, particularly in Russia. Yet as engineers created designs that replaced platinum with palladium, the worldwide price of palladium became very volatile. As demand skyrocketed, palladium peaked at almost $1000 an ounce with each vehicle requiring almost an ounce of palladium. At this point, higher prices should have encouraged suppliers to provide more output, moving supply and demand closer to equilibrium — something that did not happen for two reasons. First, the two primary supply sources of palladium, Russia and Africa, were not known for supply stability. In Russia, the size of the palladium stockpile left over from the Cold War was treated as a state secret (and we know what happens to those in Russia who divulge state secrets). The Russian government also showed a willingness to "delay" releases from its stockpile, thereby creating major supply and price disruptions. Second, palladium was mined with platinum in Russia and with nickel in Africa, and the amount of palladium present was less, proportionally, than platinum or nickel. A producer would have to increase the production of platinum and nickel to increase the output of palladium. That would drive down the price of nickel and platinum as new supply flooded the market with no change in demand. Switching to palladium in pollution control equipment was a classic example in which the desire to pursue an improvement resulted in some serious unintended consequences.
Interestingly, palladium was also widely used in dental implants. Palladium had become the material of choice for some dental implant producers because it was cheaper than gold, another material used in implants. Now, put yourself in the shoes of an implant producer as he watched helplessly as automotive producers consumed most of the world's palladium, driving prices to levels that would become his worst nightmare. Fortunately, the implant producer was able to switch back to gold, which at the time was cheaper than palladium! Of course, in 2009 gold had increased to nearly $1000 per troy ounce. The dental implant producer probably looked to the heavens and asked, "Why me?"
As expected, the implosion of global industry has since brought most commodity prices back to earth, but what about the costs of moving these commodities and goods around the globe? International shipping rates that had soared during the boom times were suddenly looking much more "down to earth." In fact, a glut of shipping capacity resulting from the launch of massive new container ships had reduced shipping costs on some routes to a tenth of their previous level. Some carriers even offered to ship loaded containers for free if the shipper would cover fuel and transit fees of around $500.
(Continues…)
Excerpted from "Managing Global Supply and Risk"
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Copyright © 2010 Robert J. Trent and Llewellyn R. Roberts.
Excerpted by permission of J. Ross Publishing, Inc..
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