There has been a surge in articles recently about the risks associated with sourcing from China.  With Beijing hosting the Olympic Games, China is the center of attention across the world.   As a result, every aspect of the economy, culture, history and political framework is being scrutinized by opinion leaders around the world.  With China’s massive export industry, it is not surprising that the manufacturing and distribution industry is being examined with a higher level of scrutiny as well.  Yesterday I did an interview with a reporter to discuss the supply chain impacts of the Olympics, which forced me to collect my thoughts on China’s growth and challenges.  So I thought I would take a few minutes to offer my perspective on the situation.

The Past Twelve Months

A series of unfortunate events over the past twelve months have raised attention to the potential risks of supply chains sourcing goods from China:

• Product Safety – Unsafe levels of lead were discovered in toys manufactured in the fall of 2007.  Buyers such as Mattel and Toys R Us initiated massive recalls, which led to factory shutdowns across the country.  The incident, while quickly contained, has left a lasting impression in the minds of foreign consumers who express widespread skepticism about the safety of products manufactured in China.
• Holiday Calendar – The May holiday season was reduced from its historical length of seven days to only three.  News of the change in schedule was not received by some of the buyers who export from China.  Consequently, inventory levels and ordering schedules were not synchronized between foreign buyers and Chinese manufacturers.
• Snowstorm – Heavy snowstorms in Northern and Central China during the late January months led to power outages across the country.  Shortages of coal were cited as the root cause for the brown outs that affected half of the 31 provinces.  Disruptions to ground and air transportation were after effects of the inclement weather and energy shortages.
• US West Coast Port Shutdown – Negotiations between the Pacific Maritime Association, which operates most of the West Coast Ports in the US, and the International Longshoreman and Warehouse Union, which represents the dockworkers, failed to meet their contract renewal deadline of July 1^st.  Mutually agreeable terms were reached shortly thereafter.  However, for several weeks there loomed the threat of a major disruption to goods flowing into US ports from Asia, particularly China.
• Olympic Shutdowns – To reduce pollution in the greater Beijing area during the Olympic Games, Chinese officials have placed temporary restrictions on the operating hours of nearby power plants and manufacturing facilities.  Transportation capacity has been limited in the city of Beijing to minimize congestion and smog.  Exporters purchasing from Beijing and surrounding provinces are concerned that the shutdowns may result in supply chain disruptions.

Massive Snowstorm Hits China

Source: Reuters - Sheng Li

Macroeconomic Changes

The specific incidents outlined above have been compounded by a larger set of macroeconomic changes occurring in the global economy.  These changes are not unique to China, but have a disproportionate effect on the People’s Republic due to its heavy concentration of exports to the US and Europe.

• Rising Transportation Costs – Energy prices have reached all time highs in 2008 with oil peaking at over $150 a barrel earlier this year.  Higher energy prices, of course, translate into higher jet fuel prices for air cargo and higher ocean carrier rates for marine freight.  For instance, the cost of sending a 40 foot container of goods from China to the US has increased by 150% since 2000. 
• Currency Devaluation – The US has proactively devalued its currency relative to the other major world currencies such as Euro and the Yen.  Historically, the Chinese government has tied the valuation of the Yuan to the US dollar.  However, in recent months China has allowed its currency to appreciate relative to the dollar having the overall effect of raising the relative cost of exports.
• Raw Materials Costs – The demand for raw materials, ranging from grain and rice to produce food to steel and aluminum needed for construction, has been rising steadily in recent years.   Many attribute the peaks in demand to the increased consumption of China and India.  Regardless of the cause, the effect is an overall increase in costs to produce finished goods.

Policy Changes

• Tax Policy – China desires to shift its manufacturing focus from labor-intensive, low value added processes to higher-quality, advanced production techniques.  As a result, tax policy is being re-written to encourage investment in higher technology facilities.  One of the new policies affects tax classification for high tech corporations.  To qualify for tax benefits as a high tech manufacturer 60% of global R&D investment must occur in mainland China and 30% of employees must have a college diploma.  Many multi-nationals will no longer qualify for tax incentives leading them to rethink foreign direct investment in manufacturing capacity.
• Rising Wages – As the effects of capitalism continue to propagate throughout Chinese society, new levels of prosperity are being reached by the middle class.  The government has been fostering these trends with new regulation for minimum wages, overtime, severance and pension pay.  Minimum wages in China have grown 250% in the last 10 years.  Yet another factor contributing to the rising costs of exports.

Other Risks

There are a number of other political and socio-economic risks that have troubled supply chain planners for many years.  These include on-going political tensions with Taiwan; protests advocating the liberation of Tibet; and the risks of pandemic from possible resurgence of the Avian Flu.  Infrastructure and energy capacity are on-going areas of concern.  In fact, earlier this week there were several newspaper articles questioning whether China’s electrical grid has the capacity to support its power-hungry manufacturing sector?

Mattel’s Toy Recall

A Balanced View

Adding all of these factors up, it is easy to see how North American and European multi-nationals sourcing from China have reason for concern.  It should be noted that many of the factors contributing to uncertainty are no fault of China’s.  Although the PRC boasts the world’s largest population, they are not able to control the timing of inclement weather, rampant inflation in raw materials pricing or speculative behavior in the energy futures market.  Many of the design decisions about the material used in children’s toys were made by foreign buyers.  And while China’s influence on the US economy continues to grow, it cannot control the Federal Reserve policy on currency valuation or the labor negotiations with US port operators.  It is true that some of the issues listed above are, in fact, deliberate policy moves made by the government.  But it is difficult to question the logic in efforts to improve the standard of living of one’s lower class or to proactively make efforts to reduce pollution of the environment.

While none of these issues has resulted in a major supply chain disruption to date, the combined effect is beginning to create a crisis of confidence amongst some North American and European buyers.  The question is what will be the longer term impact of recent events on the sourcing strategies of foreign companies exporting from China.  It is too early to predict exactly how impactful these concerns will be, but one can expect that sourcing decisions will be subject to much higher scrutiny and more rigorous analysis going forward…

Global trade talks sponsored by the World Trade Organization (WTO) came to a halt earlier this week as the key parties were not able to resolve disputes over agricultural subsidies and tariffs.  The primary differences of opinion were between emerging market countries such as China and India and the more developed markets of Europe and the United States.  Experts state that this is the first multilateral trade agreement that has failed since the 1930s.   The trade talks’ failure has led many to question whether we will see a reversal in international trade patterns.  Some suggest that we are entering a new era of trade in which nationalist interests will prevail over open, globalized markets.  If true, it could mean that there are fewer food imports/exports and more in-country production. I think it is too early to predict the long term impacts of this week’s events, but there is no question that more of the food we eat will be harvested and produced locally.   However, in my opinion this changing dynamic will not be the result of government trade regulation or the WTO.  It will be driven by the consumer population’s growing interest in “locally grown” products.  

What is Local Food? 

While there are no constraints on the types of food that can be produced locally, the highest consumer interest is in the perishable categories of fruits and vegetables; dairy and cheese; meat and poultry; bread and eggs.  Other local categories are emerging quickly such as alcoholic beverages - think regional wines or microbrews.  

The interest in local foods is growing quickly as an increasingly broad segment of the consumer population is actively seeking out locally grown products.  The highest concentration of spend is from a group of consumers called locavores.  A locavore is someone whose diet consists of food grown or produced within their foodshed or a determined radius from his or her home.

You might ask what constitutes local versus remotely sourced.  A devout locavore would argue that only food produced within 30 miles of where they live is truly local.  However, others might accept a broader definition as food from my county, state or country of residence. 

Why buy Local? 

My research finds that there are eight characteristics of local food that are attracting record numbers of consumers.  Shoppers find local food to be:

1. Fresher – Consumers perceive that local foods will be fresher and taste better as they have not travelled as far to reach the store.
2. Healthier – Consumers expect local foods to contain fewer artificial colors, flavorings and preservatives.  Many local foods are organic.
3. Cheaper – Consumers perceive that local foods are cheaper due to the reduced transportation and storage expenses.
4. Greener – Less energy is consumed to transport local foods therefore less pollution is created.  Terms such as “food miles,” “farm to table” and “farm to plate” are becoming common metrics for evaluating local sourcing efforts.
5. More Neighborly – Local food supports farmers and merchants keeping jobs in the area.  In the case of rural markets, the primary consumers of the food may be the producers or neighbors within the community.
6. More Trustworthy – Consumers gain a sense of confidence by understanding where the product has come from.  The benefit is compounded in areas with a strong reputation for producing high quality foods.
7. Safer – Recent salmonella outbreaks and other safety issues from adjacent consumer product segments have led to a crisis of confidence in foreign products.  Consumers perceive lower risk with foods produced in their own country.
8. More Fun – Many consumers find it fun and interesting to shop for local foods.  The products offer a variety unobtainable from many of the popular, mass-market national brands.  Some consumers purchase local foods for special occasions or to support heritage.

Not everyone buys Local 

Not all consumers are agreed on the benefits of local sourcing.  Some consumers complain that local foods are:

• Expensive - Many consumers perceive local food to be in higher demand and therefore priced at a premium. 
• Inconvenient - Busier consumers do not have the time to visit specialty retailers or compare the place or origin when shopping.
• Lower Quality – Particularly in areas which do not have a strong reputation for local agriculture or high quality food products, quality is viewed to be substandard.
• Inconsistently Available – Due to the seasonal nature of fruits and vegetable harvests, many foods cannot be locally sourced year-round.

The Changing Food Industry 

The food industry is in the middle of period of radical change that could affect market dynamics for the next few decades.  Rising prices for commodities, restrictions on international trade and new preferences from consumers are changing the game for food producers worldwide.  This is a significant trend that will not only impacts food products and prices, but also the business models and supply chain processes of the industry overall.  More thoughts on this topic in a future post…

“May Contain Nuts” – No Longer Acceptable 

Today’s consumer is also more health-focused and socially conscious than ever.  And these educated consumers are demanding more information about products before they make purchasing decisions.  Consider the case of food.  Today’s health-conscious consumer wants to understand not just the brand, price and size of each SKU, but they also want to know:  

• Is it organic?  Have the ingredients been genetically engineered? 
• Is it locally grown?  If not, has it been imported from another country?  
• Is it carbon neutral?  Were environmentally friendly or recyclable packaging materials used?
• Is it fresh?  How long before its predicted expiration time frame?
• Is it safe for me?  Does it contain ingredients from common allergens such as nuts or shellfish?       
• Is it heart healthy?  How much cholesterol or sodium is included?
• Is it dietary?  How many grams of fat and carbohydrates are contained?
• Is it diabetic friendly?  How much sugar is contained? 

This growing selectivity of consumers is changing the landscape of food products forever.  The result is a proliferation of SKUs catered towards a range of different consumer segments based upon social responsibility (environmentalists, locavores, naturalists) and upon health characteristics (diabetes, food allergies or heart disease).  The grocery sector is migrating from the mass-market of the twentieth century towards a long tail of highly, specialized niche markets.  Retailers and brand owners must now market towards these new niche segments or risk extinction.  The challenge for category captains and retail merchandisers is being able to define an assortment that meets the specialized demands of today’s consumers.  Food manufacturers and retailers have responded by introducing new SKUs (e.g. diabetic -friendly, heart-healthy), redesigning store layouts (e.g. organics section, local produce aisle) and more detailed labeling (e.g. transfat content, allergen notices).  But further challenges exist, ones that can be directly solved through broader adoption of data synchronization.

100 Mile Diet National Bestseller in the US 

Information Hungry Consumers and Shifting Buying Behaviors 

Consumers are demanding more detailed information to make purchasing decisions.  In fact, studies by leading retailers have shown that the degree of product information available for a particular SKU will influence not only which brand consumers will purchase, but also which retailer they buy from.  Having detailed item attribute information represented on a product label or store shelf display is beneficial to consumers walking through a store, but is insufficient to satisfy the full needs of today’s multi-channel shopper.  What about the consumers who research recipes on a brand-owner’s web site or purchase groceries on-line for home delivery?  These shoppers expect complete item attribute data to be displayed at all steps of the decision making process.  The steps include not only the physical product labels but also home delivery storefronts, brand owner sites, in-store kiosks and newspaper advertisements.

Ocado - Popular British On-Line Shopping Web Site

Merchandise Managers Growing Appetite for Product Data 

Merchandisers must have ready access to detailed product attribute information as well.  For each SKU, there is an average of 200 data attributes that can be used to describe it - everything from brand name and packaging dimensions to ingredients and recycling instructions.  If you multiple the attributes per SKU by the number of products in the marketplace, you begin to appreciate the magnitude of the challenge.   Yes, the item attributes are displayed on the product label, but most merchandisers do not keep an inventory of products in their offices.  Nor do the retailers have the time or resources to search through file cabinets full of supplier product specification sheets or to navigate supplier web sites to find the information required.  Item attribute details must exist in merchandising systems in order for retail personnel to make decisions about which products to stock.  Highly automated, data synchronization processes are the only means of achieving any type of scale for managing product data. 

Retailers versus Suppliers – The Power Struggle 

Many of us who monitor and study the retail industry often debate whether the retailers or the consumer products companies have more power and influence over the supply chain.  Fifty years ago, the industry was dominated by large national brands which shaped consumer demand and drove retailer behavior.  Today, global retailers with multi-national footprints and large private label assortments have amassed considerable leverage over their suppliers.   But I believe that question of whether the retailer or supplier has more influence in the supply chain is becoming increasingly less relevant.  In today’s retail value chain it is the consumer that holds the greatest power.   And we see evidence of this phenomenon in IT investments.  Retailers continue to be more focused on customer-facing, store operations functions than internal-oriented, back office processes.  I believe the growing hunger of consumers for rich item data to perform purchasing decisions will shift data sync from a back office, cost reduction technique to a customer-facing differentiation strategy.  And this shift will ultimately be the catalyst that drives demand for data synchronization in the retail sector.

Steve Keifer

© Copyright 2008 GXS, Inc.  All Rights Reserved.

Earth Day and the Green Movement 

We will celebrate Earth Day later this week.  Unfortunately, I wasn’t able to enjoy much of the outside world today as we have been inundated with thunderstorms here in Washington DC.  Nothing like a good dose of acid rain to remind you of the need to proactively attack the environmental problems we are facing.  The customer service manager at the car dealership I purchased my last vehicle from told me that the Washington DC area suffers from some of the worst acid rain in the world.  I believe everything she said was truthful and in no way influenced by the desire to sell me an exterior paint sealant package…

Source: US Environmental Protection Agency 

Nonetheless there has been a tremendous groundswell of environmentalism sweeping the globe in the past 24 months.  What is fascinating to me is that the environmental problems such as the global warming and ozone depletion have been documented and publicized for over three decades.  Why in 2006 did we see such a surge in environmental responsibility around the world?  From my perspective, it was really the consumer population, not big business or national government, which is responsible for driving the change.  These days consumers are really the driving forces behind more and more policy initiatives particularly the recent wave of corporate social responsibility sweeping the Western hemisphere.  The green movement led me to start thinking about the challenges facing some of the supply chain initiatives being pursued around the world.  There are a number of noteworthy supply chain initiatives with strong business benefits that have yet to achieve significant adoption.  Some were created years ago, but still struggle to gain visibility and investment from corporate leaders.  Data synchronization is one that comes to mind.

Data Sync Movement 

For almost ten years now there has been a movement in the retail industry to standardize the process for exchanging product data between retailers and their suppliers.  Recent efforts have focused on utilizing XML and Internet based standards for product catalog exchange.  There are older EDI standards such as the ANSI X12 832 document and the EDIFACT PRICAT document, which provide a simple, cost-effective process for exchanging item and price information.  But like any process associated with EDI, these standards were deemed inadequate and the search for a new data sync standards framework was initiated.  Unfortunately, despite hundreds of millions of dollars in invested capital and hundreds of thousands of invested manhours, the industry still struggles with a lack of adoption.  Even in the most highly penetrated countries such as the UK and Australia, data sync adoption levels are between 10-20% of the overall retail community. 

Catalysts for Data Sync

Extensive business benefit studies have been conducted for data synchronization by the Grocery Manufacturers of America (GMA), Kurt Salmon Associates (KSA), AT Kearney, Accenture and other highly respected thought leaders.  Benefits such as accelerated new product introductions, fewer expected invoice deductions and higher perfect order fulfillment rates have been well established and quantified.  Furthermore, there have been several market forces in the recent years, which were believed to be catalysts that would drive data sync to a critical inflection point yielding mass adoption:

·  Standards efforts were unified at a global level by the GS1 organization which created a global product registry and Global Data Synchronization Network.

·  RFID technology, which depends upon clean and accurate product data, was mandated by large channel masters such as Wal-Mart and the US Department of Defense.

·  IBM, Oracle and SAP - three of the largest software vendors– have developed or acquired master data management suites, which require synchronization to populate product data repositories.

·  Several of the largest data pool providers have merged or consolidated including UCCnet and Transora, SINFOS and Agentrics as well as UDEX and GXS.

However, none of these catalysts has resulted in substantially higher adoption rates amongst retailers.  I believe that, much like in the environmental movement, it will be consumers and not businesses that will ultimately drive demand for data synchronization.  Retailers will be driven to data synchronization, not by back office efficiencies in accounting or receiving, but instead by the need to differentiate themselves to an increasingly information-driven consumer population.  More on this topic to follow shortly in an upcoming post…

Steve Keifer

© Copyright 2008 GXS, Inc.  All Rights Reserved.