The Supply Chain Strain Is Changing the Way Manufacturers Do Business

By: Money_Morning

Kerri Shannon writes: As growing demand boosts production in the second half of 2010, some companies will fail to meet output due to struggles in the supply chain.

Earnings season has shown industrial companies' surging profits in the first half of the year and increased optimism for the months to come. Emerging market strength and stable raw material prices have helped the manufacturing boost.

Industry giants like Caterpillar Inc. (NYSE: CAT) and Siemens AG (NYSE ADR: SI) all raised their outlooks and posted higher-than-expected earnings.

Siemens' second-quarter orders increased by 22% from a year ago and income rose 40% to a record high of $3 billion (2.3 billion euros). The demand increase Siemens is predicting for the rest of 2010 allowed the company to end the reduced working-hour arrangements it had set up with about 19,000 employees.

However, smaller suppliers that cut capacity to the bone when things got tough are now hindering a robust ramp up in production for companies like Siemens.

"In the downturn, companies were extremely quick to turn off the tap," Gautam Dalal, head of diversified industrials at KPMG, told the Financial Times. "In some cases this caused suppliers to cut back greatly on capacity and in some cases to go out of business altogether. Now that the big companies want to turn the tap back on again, they are finding it difficult to do this effectively."

As a result, the manufacturing sector has developed a trend of outsourcing suppliers, increasing the likelihood of blips in the supply chain. About 51% of big U.S. manufacturers experienced significant disruptions in the second quarter, and 42% of small and medium-sized suppliers received queries from bigger companies needing urgent assistance, according to a survey by MFG.com.

The Boeing Co. (NYSE: BA) is planning to boost production of its single-aisle 737 aircraft from 31.5 planes a month to 34 planes by 2012 - if its suppliers can keep up with a rebounding aviation industry.

"The supply chain is the key question," Jim McNerney, Boeing's chief executive officer, told the Financial Times. "Moving from where we've been - low 30s to something north of 35...while other airplanes are also moving up in rate can put pressure on suppliers."

In April, Boeing suspended shipments of parts of its 787 Dreamliner jet for up to five weeks when parts shortages halted plane assembly. Investors have been eyeing the 787 supply chain because Boeing won't receive full payments on its "revolutionary" new aircraft until it delivers the final products.

Boeing produces two Dreamliners a month, but it plans to ramp up production to 10 a month by 2013.

Boeing's second quarter earnings report reflected the supply chain strain. Deliveries were down to 114 aircraft from 125 in the same period a year earlier, bringing net income down to $787 million from $998 million the previous year. Boeing suffered a production disruption when it had to let go of one of its seat suppliers, Japanese company Koito, which falsified safety test results.

The technology sector was hardest hit by supply chain problems, with component makers struggling to meet demand. The semiconductor industry jumped to 94% capacity in the second quarter, up from 56% in the same period last year.

"Anybody in the electronic supply chain has seen the tightness around certain components," said General Electric Co. (NYSE: GE) Chief Executive Officer Jeffrey Immelt.

Some $50 million of second-quarter revenue was lost to disruptions in the supply chain, according to GE's Chief Financial Officer Keith Sherin.

U.S. semiconductor-maker Altera Corp. (Nasdaq: ALTR) said its lead times have lengthened to a maximum 26 weeks from 16 weeks, and German chipmaker Infineon said it would have trouble keeping up with orders for the rest of the year.

"Since the end of the second quarter, our plant utilization...ranges between 90 and 100% and it is therefore close to the capacity limit," Infineon CEO Peter Bauer told the Financial Times. "This will persist until the end of 2010."

German carmakers Audi AG (ETR: NSU) and Porsche had to slow production in plants last month because their car radio supplier, Harman Becker (NYSE: HAR), didn't have enough microchips to complete orders.

Cisco Systems, Inc. (Nasdaq: CSCO) has suffered more than competitors, which experts attribute to its specialized router hardware that offers capabilities more advanced than competitors. Some customers are looking elsewhere for faster service.

"As the technology industry moves through a recovering supply/demand environment, shifts in lead times and inventory levels will occur," Cisco CEO John Chambers said in May.

Planning Ahead Is Paying Off Now
Of course, while many manufacturers are scrambling to fix their supply chain problems, others companies that developed close relationships with suppliers before demand increased are enjoying a smoother transition back to booming production.

Traditionally, Japanese manufacturers have avoided disruptions because of their close relationship to suppliers. Through "just-in-time" manufacturing, originally employed by Henry Ford, they avoided overstocking before the downturn in global demand and were able to keep production from slipping to almost zero during the recession.

When the automotive industry struggled and General Motors Corp. needed bailout funds to stay afloat, Japanese carmakers like Toyota Motor Corp. (NYSE ADR: TM), Nissan Motor Co. (PNK: NSNY) and Honda Motor Co. (NYSE ADR: HMC) adjusted their just-in-time processes to order ahead and keep U.S. suppliers busy.

While Japanese companies shifted their business models, a U.S. construction giant traveled the world to assess the ability of its suppliers to pick up speed when the time came.

Caterpillar predicted 2010 demand growth last year, and visited with key suppliers at the end of 2009 to ensure they were equipped to handle a sharp upswing in production. Caterpillar projected suppliers' output would rise 30% - 40% this year to fill new orders and restock inventory.

As early as last fall, Caterpillar sent executives on a global supplier tour, visiting the 500 suppliers that contribute 80% of the manufacturer's goods. The company unveiled a lending plan for those that might have trouble obtaining bank loans in the stricter post-crisis borrowing environment.

"Many of these smaller companies have breached their bank covenants," says Caterpillar's Steve Wunning, who led the meetings with suppliers. "When they come in and say they need to borrow more money because they're hiring people and buying more material, what are these banks going to say? They're probably going to say, 'Wait a minute.'"

Caterpillar created a program that allowed suppliers to borrow from a bank against their receivables, allowing them to access funds within five days of delivering goods to Caterpillar, instead of waiting the traditional 60 days.

Caterpillar also offered freeze periods to give more stability to suppliers, meaning Caterpillar would not change an order for three-months after placement, allowing smaller companies to project revenue and business growth to banks when trying to secure loans.

As Caterpillar continues to keep its production moving forward, the supply chain squeeze is teaching the big guys to think ahead when times are slow.

"Many of them are starting to realize that they should have paid more attention [in the early stages of the recession] to keep supply lines going at least from their most critical suppliers," said KPMG's Dalal.

Source : http://moneymorning.com/2010/08/13/supply-chain/

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