BBK: supply risk management urgently needed in auto industry

Based in Shanghai, Mr. Duane Bolinger leads BBK's presence in Asia Pacific. He is a results-oriented executive with more than 30 years of experience in the automotive industry. He brings to BBK, an international business consulting firm, his expertise in corporate finance, due diligence, purchasing, supplier development, strategic planning and so on. He also has an acute understanding of the Chinese auto industry, based on which he offers his advices.

Difference between the supply chain managements

Gasgoo.com: We learnt that you’ve worked for Delco Remy, Delphi, and General Motors, and have rich experience in plant managing and global purchasing. So in your opinion, what are the fundamental, underlying differences in the supply chain between those global and local Chinese companies?

Duane Bolinger: After I came to China, the difference I found is the embracing of best practices. The US and European companies spent much time making their processes more lean. Most processes (manufacturing as well as business processes) used by Chinese companies are very manual and time-consuming. As an example, you can find lots of transactions are paper-driven; it’s not electronic. So as for the difference related to supply chain, they should look at how to make the process less bureaucratic, less time-consuming, more efficient and much leaner.

Why there’s the difference, and why Chinese companies manage their supply chain that way? When I talked with the companies here years ago, and it’s true today--- In line with China's push toward high quality, Chinese companies’ predominant improvement methodology is total quality management.  The Chinese focus above all else on customer satisfaction surveys. U.S. and European manufacturers most typically pursue continuous improvement practices.  They are looking to improve their processes, not only the manufacturing process, but also the process of communicating with their suppliers, and all the internal and external business processes. And the outcome of a continuous-improvement focus coincidentally is better customer satisfaction; also it gives you a cost-effective business process which China has not gained yet.

Where does the cost arise?

Gasgoo.com: There’re many interfaces—designing, manufacturing, distribution, aftersales and etc. During the whole supply chain, where did the most transaction costs arise?

Duane Bolinger: By most estimates, up to 70-80 percent of the total cost of any product you look at is defined by the product design.  The automobile manufacturers (and virtually any industry) increasingly realize that the quicker they can get a supplier into the product design and development process, the more cost effective they are able to bring their product to the customer. Suppliers should know as much as (if not more than) the OEMs about their product. So I would like to say that, the Chinese suppliers should realize very quickly that they need to develop greater product and or material development capabilities; no copy, no reverse engineering of automotive system to parts, but being able to work with a major OEM to help them design the next generation auto parts, give them ideas about how to cut cost. By developing greater design development capabilities, suppliers will be in a better position to differentiate themselves from their competitors.

Another 15-20 percent of the product cost is in the manufacturing process. My experience is that Chinese companies are very good at looking at ways to make the product more cost effective than their Western counterparts..  Anecdotal claims of savings of 30% or more are possible.

Moving from looking at the breakdown of the total product cost, to looking at transaction costs, the biggest area for improvement today is the distribution and logistics process. Most reports and data suggest that the percentage of logistic costs in China’s GDP is roughly twice of that in the US and Western Europe. There’re several reasons for that: Regional fragmentation of the supply chain and businesses in China still depend heavily on a hard-copy paper flow of documentation; Regional fragmentation of the supply chain decreases efficiency and increases costs.

I read recently that currently there are over 700,000 logistics providers registered in China with an average fleet size of less than 3 trucks! The single biggest logistics provider has less than 2 percent market share.

A good Supply Risk Management is key to managing Chinese suppliers

Gasgoo.com: What are the crucial dimensions to assess a supplier? (Quality, logistics, cost-control capability or anything else)

Duane Bolinger: A good Supply Risk Management process is one that proactively monitors and validates the financial and operational viability of a supply base, through the gathering and analysis of internal and external data and then implementing prompt measures to minimize risk within the supply chain. A Supply Risk Management process is critical for companies with the potential for supplier problems that could affect performance and delivery and for companies who have an inability to source from another supplier to prevent disruption. This may be due to suppliers with proprietary processes, the need to move customer-owned tooling, or simply the time necessary to validate and contract with a new supplier. This is particularly true when sourcing automotive components where the customer is dependent on customized product being received into just-in-time inventory systems.

An effective Supply Risk Management process can identify potential problems early on when more cost effective options are available. The earlier the problem is identified, the more time to find a solution or look to a new source to protect the customer from substantial revenue loss due to production interruptions or delays. A customer needs to evaluate its suppliers' financial and operational challenges both prior to awarding the contract and on a regular basis thereafter. This requires understanding aspects of the supplier's business that they might be hesitant to share, such as profitability levels.

In China, automotive exports have increased significantly as American and European manufacturers take advantage of China's increasingly capable supply base. Expansion of sourcing activities for both domestic consumption and export has created the need to qualify the China supply base in terms of financial viability prior to the initial sourcing decision. This is especially true when many potential suppliers have untested capabilities and it's difficult to understand ownership structures.

When reviewing the financial condition of existing suppliers in China, many customers with diligent Supply Risk Management procedures have found that historical financial statements are less precise than North American or European equivalents. At the same time, many China suppliers have an overly optimistic view of their financial and operational capabilities. They often underestimate launch costs, working capital requirements and capital expenditure needs. There is also a tendency to ignore labor and commodity price inflation when developing business cases for a program bid. This can create risk within a customers supply base on a post sourcing basis if potential pitfalls are not understood and incorporated in the customer's SRM process.

Understanding the implications of quality shortfalls is also paramount when sourcing out of China into North America or Europe, or anywhere where shipping distances are significant.  Most automotive component part shipments take seven to 11 weeks to reach their Free On Board destination (such as an overseas warehouse facility where safety stock requirements mean inventory can remain another one to three weeks before final shipment).

With eight to 14 weeks before the customer takes delivery and payment terms ranging from four to six weeks, a supplier might have to finance 12 to 20 weeks of sales. An undiscovered quality issue can result in dead inventory in the pipeline and necessitate air freight. Then depending on how much of the inventory is dead, the supplier can face months of expedited costs and be subject to customer containment and quality review costs. These are expenses the supplier may be unable to afford, so maintaining quality is vital.

Gasgoo.com: But if your supplier is already in jeopardy, do you need to help it out of difficulty like what happened in the North American markets, or just move to a new supplier?

Duane Bolinger: It depends on when the problem is identified. The earlier the problem is identified, the more time to find a solution or look to a new source. Assistance could be provided in several ways:

1. Change purchasing terms to enable suppliers to get their hands on cash earlier than usual.

2. Assist in operational improvements (i.e. inventory reduction, scrap reduction, throughput improvements, etc)

3. Increase price

4. Supplier could seek additional capital.

Gasgoo.com: Averagely speaking, is the Chinese supplier healthier than the suppliers in western markets?

Duane Bolinger: Last May, BBK released its annual study showing the financial health of the world's largest global automotive suppliers had improved slightly from 2006 to 2007. It is important to note that these results were prior to the tightening of credit markets and its impact on lower production volumes which is taking its toll and will certainly cause making another year of improvement difficult to achieve. We saw that 14 percent of the North American suppliers we evaluated received a lowest level of “F” rating; while the Asian suppliers were the healthiest and the performance of European suppliers were in between. The data shows that the consolidation and restructuring that is continuing are clearly a reflection of Darwin's principle of 'only the strong will survive.'

The study also revealed that privately-owned suppliers remain highly vulnerable to industry changes with 50 percent of them showing potential for financial distress. In 2007, and the first quarter of 2008, BBK rated 1,147 private companies globally and found the following results: 50 percent (589) of the private companies showed the potential for financial distress. The average rating for these companies was "C+" and 31 percent received an "F" rating.

It's especially important for OEMs and all suppliers to understand from a risk management standpoint, they must pay careful attention to the health of their supply chain because most supply chains are comprised of a 75 percent/25 percent split - private versus public companies.

A supplier may be experiencing financial distress if:

 -It is constantly using premium delivery services

 -It is late on product deliveries

 -It asks the customer for favorable non-contractual terms

 -It receives waivers from lenders regarding covenant violations

 -Its own suppliers stop deliveries due to non-payment

Supplier relationships; information flow

Gasgoo.com: In the North American market, people say the OEMs are becoming more deliberate of letting suppliers fail. But we can see several local OEMs in China are building their own supplier subsidiary in the group. Actually we’ve seen this “supplier realm” happened and fell in the US market. What’s your comment on that?

Duane Bolinger: More & more enterprises are striving to develop long-term relationships with a few competent suppliers that are both operationally as well as financially viable over the long term. Advantages are obtained by collaborating on product development, inventory management, non-core process outsourcing, etc.

I do not believe that is the case in North America, as we see OEMs as committed to positive and productive supplier relationships. In China, What we have to observe is that if the OEM invites or absorbs a supplier into its group (or “the family”), the supplier gives higher quote than a “non-family-member” supplier to the OEM and the OEM moves to the latter, then this model will collapse.

Consolidation has to take place, but we don’t see it happens today. If I was a regional Chinese OEMs, I would like every supplier in my group to be healthy; and I would be very cautious to pick a right supplier, to make sure that that supplier can survive. Secondly, I’m not only judge in price, but I’m also to use more value-added suppliers so that I could differentiate myself from my competitors.

Gasgoo.com: How could the automakers and their suppliers strengthen their ability to react to reduced order cycles and uncertainties in sales fluctuation? Is it feasible that the tier-one suppliers meet orders for parts rather than finished products?

Duane Bolinger: Information flow…information at the right time can give a company a competitive advantage.  Lean is as much about information flow as it is about material flow. The goal of any supply chain or logistics manager is to create a seamless flow of product going one way and information going the other way.  Every day saved in lead time, every percent gained in fill rate, and every dollar saved on inventory can mean the difference between success and failure.

A good supplier takes the customers' orders but they also know what's it really going to happen based on the history and the market trends, and they even would tell the customers' what the order is in a longer term. All these are linked to information at the right time. Another thing I want to point out is that lots of OEMs have the information related with orders, but they are reluctant to share information with their suppliers that would actually benefits the suppliers in how they manage their capacity.

Analysis of the Chinese market amid economic downturn

Gasgoo.com: Last question—what’s your analysis regarding the influence brought by the worldwide economic downturn?

Duane Bolinger: I'll start by saying that I believe most companies have no plans to move capacity from China.  The biggest reason to remain in China is access to its vast domestic market, availability of supply base, the IT infrastructure and the high quality of the Chinese labor.

China's manufacturing industry is however going through a transition period. Some Chinese manufacturers are operating now at a loss, and many have been severely impacted by the recent downturn. Competition has grown to a point where each manufacturer has a very small share of the market. Gaining market share means consolidation and acquisition, yet few operations have the cash to invest in purchasing other companies. The future will require companies to adjust to remain competitive and in some cases stay alive.  Those adjustments will include implementing best practices like Supply Risk Management, Lean principles and an understanding where higher value-added services (i.e. customer service, product or material design capability) can differentiate one supplier from another.