You may be already sensing it.  If the keys on your PC touch orders to move product in the supply chain, you have likely already sensed it.    An emerging groundswell to change course.  After preparations to once again retrofit the supply chain towards growth, the consumer supply chain will refocus in a different direction for the second half of 2010.

There are three primary forces driving this.   First is the current market dynamics of retail.  As the economy likely recovers at a more moderate pace, competition among leading retailers for consumer loyalty has intensified. This has led to what many are now referring to as a price war.  The primary weapon in this war is promotion.   Wal-Mart, facing four straight quarters of anemic US growth, has switched out management and cranked up promotions, what they call “roll backs.”  Whatever they are called, price discounting is increasing across more and more categories in an attempt to bolster flagging demand.   Second is the growing competitive intensity down market retail.  Aldi, what a few years ago seemed to be an oddity in the US, is now becoming a force.  In the city of Chicago, they now count 20 locations alone.   Tesco’s entry into the US market, Fresh & Easy, continues to be refined.  Discounters are entering the market and providing additional alternatives for consumers.

The third force  is the increasingly mixed U.S. economic picture.   Just as firms prepared for new growth catalysts, consumer confidence pulled back.  The Conference Board reports that consumer confidence dropped 9.8 points in the month of June.  This is a drop in the index from 62.9 in May to 62.7 in June.  Financial markets have retrenched.  After closing above 10,400, the Dow now stands below 9,800.  The housing bounce back has stalled.  There is a growing consensus that a renewed growth catalyst is on hold for now.

These forces come with a price for today’s consumer supply chain.  Retailers and manufacturers will share the additional promotional investment.  Retailers will bear most of the brunt of higher competition.  For both, payback on growth investments will be delayed.  All these forces will converge into a much different supply chain priority list for the second half of the year.

Efficiency gains will now top the priority list.  Product change has already been done post 2007 melt-down.  For instance, most consumer products firms have already down-sized the portfolio, stripping out underperformers.  These firms have also, in many cases, already redesigned for profitability, a fancy term for re-sizing the package that offers less at the same price point.  Those moves are now past us.
What lies ahead is a renewed focus on process efficiency.  The second half of 2010 will have the following characteristics.

• A search for rapid solutions.  Long-term, transformative, solutions will get less attention if their payback goes beyond 12 months.
• A more intense push on working capital reduction.  A recently released study by the Grocery Manufacturers of America shows the growing change in supply chain priorities.  The study compared survey results from 2008 with 2010.  Working capital efficiency ranked among the top increases in management priority.  Only 23% of those surveyed in 2008 considered it a top initiative.  This year, working capital efficiency increased to about 45%.   It will only increase in priority as we move into the second half of the year.
• New, emerging technologies focused on demand planning that communicate end consumer demand upstream will start to reach an inflexion point.  Many of these technologies are deployed using software as a service models with variable cost, subscription pricing.  Companies will take a deeper dive into using these technologies as a way to seek greater efficiencies.  Bigger, ERP-based technologies will move farther down the priority list..

The US economic picture has grown murkier in the last few weeks.  Most economists continue to forecast a gradual recovery.  We have certainly been here before, as most recent recoveries experienced a period of pause before reaching full recovery.  As a response, supply chain priorities will change to insulate risk.  Priorities that in the first half of the year moved towards growth will now change to emphasize efficiency.

May 24, 2010

Wal-Mart continues to act as a barometer for the larger economy.  As the largest retailer in the world, its business results reflect an early view of future trends taking hold.  For leaders, these results can be a window in which successful strategies can be viewed.  As an investor, these results can act as both warnings and lights toward greater success.   Just as a the diversified conglomerate GE is often looked at as a barometer regarding infrastructure and business to business spending, Wal-Mart can be viewed in the same way with an eye towards the end consumer.

In February, on this blog, Wal-Mart’s fourth quarter earnings results were reviewed.  In that review, three trends were identified that are taking hold globally (read the post by clicking here).   These trends included changing consumer purchasing behavior, arguing that a segment of consumers felt renewed confidence to begin trading up once more.  These trends also included a heightened focus toward emerging markets as the growth platform in this recovery.  Wal-Mart’s 1Q earnings release occurred last week, so I took a look to see if the trends identified 3 months ago had strengthened as expected and to see what other trends could be emerging underneath the top-line earnings numbers.

Wal-Mart’s recent earnings strengthens the view that consumer behavior is indeed shifting.  Store traffic and same store sales for stores open at least a year in the United States continued to decline.  The decrease, at 1.2% year on year revenue, was double market expectations, illustrating that many consumers are increasingly taking their dollar elsewhere.  A Standard & Poor’s analyst captured the emerging consensus, “We expect U.S. comp-store sales growth to remain under pressure as consumers begin to trade up and take advantage of more convenient, but higher priced, competitors in a more stable economy.”

A heightened focus towards international markets also strengthened with first quarter results.  With US same store sales growth down more than 1%, Wal-Mart’s international division grew revenue by more than 20%.  Taking currency into account, this equated to a constant currency store growth of about 9%. Once again, China and Brazil were singled out as growth catalysts.  The growth rate in emerging markets for Wal-Mart continues to show a solid track record.  In that environment, capital investment and strategic focus will continue to be directed toward these markets, and away from what appears to be an uncertain environment in the United States.  For supply chains, this shift will be dramatic as emerging market supply chains will be reconfigured to serve domestic demand.

The third key trend identified in the fourth quarter, and validated last week, is Wal-Mart’s continued use of cost cutting as a competitive weapon.  On total sales growth of 5.9%, costs grew at 3.9%.  After each successive quarter, the economic recovery strategy being employed starts to emerge; continue to wring costs out, maintain position in the US, plow savings to grow the business in emerging markets.  The execution of this strategy continues.  A recent initiative recently became public that Wal-Mart is seeking to assume warehouse delivery responsibility in the US supply chain for many of its vendors.  Doing so, in essence taking over transportation responsibility up the supply chain, is directed toward lowering fuel costs and extracting more price cuts from its suppliers.

More confident consumers once again trading up, increased focus and capital moving into emerging markets, tightening cost controls in the US are the key strategies being used by Wal-Mart, visible in the earnings releases of the last two quarters.

There are more trends emerging.  In conjunction with its earnings release, Wal-Mart reduced its US sales forecast.  With the much higher than expected US sales declines, Wal-Mart’s view on US markets  is now uncertain.  Their response is to announce a new round of discounting to prop up demand in US stores.  Such discounting is now becoming widespread practice among leading grocery retailers seeking to hang on to their consumers.  With so many leading retailers engaging in this practice, inflationary fears in the broader US economy may quickly give way to industry fears of intensified price cutting.  This will have deep implications for the U.S. consumer goods market going forward.

April  27, 2010

The first quarter earnings season is upon us.   Over 100 of the S&P 500 have reported their first quarter financial results and the results so far have been positive.  According to the Seeking Alpha, a leading blog on the financial markets, over 80% of companies releasing earnings have exceeded market expectations.  Bloomberg estimates that earnings for S&P 500 companies have increased an average of 9.1% for the month of April, the largest monthly increase since 2006.   Adding to the overall sentiment is a good mix of revenue growth contributing to the earnings showing.  Top-line results support the belief that the economic recovery is continuing and broadening.  Prior to the onset of the current earnings season, Wal-Mart’s fourth quarter results revealed several trends taking hold in the recovery (see The Wal-Mart Earnings Barometer).   A look at selected earnings reports this quarter confirm this economic recovery is taking on its own set of characteristics.  These trends continue to act as a barometer towards business strategies that will prove successful in the current recovery.

These shifts include -

A Shift in Consumer Spending, Led by Apple

Apple’s leadership in the market is redefining the staple good.  Despite consensus that consumers are saving more and cutting back on discretionary items, Apple’s year on year sales for all sorts of iGizmos increased by 50%.   Their growth is simply immense given  Apple’s quarterly revenue run rate is now over $13  Billion, which makes their annual sales percentage growth all the more impressive.  Despite economic hardship, Apple sold close to 9 million iPhones in one quarter alone.  All of Apple’s products are sold at a premium, from Macs to iPhones.  Yet, their products continue to move into the mainstream.

Apple’s blowout sales increase is not happening due to a resurgent consumer.  Overall consumer sentiment regarding the economy has remained largely unchanged in the past six months and is far below pre-recession levels.

Consumers may be cutting back, but many of them – by the millions – consider an Apple gadget to be a requirement.

Apple is but a starter example of more to come.  Consumer spending is starting to shift again.  As the economic crisis unfolded, consumers traded down and retreated hard.  This resulted in a shift.  Now, the shift is on again.

International as the Growth Path

Those companies that outperformed earnings expectations did so almost solely through international growth.

• Coke had a great quarter, but the company’s growth in North America was close to 0%.  India, Vietnam, Brazil, and Russia were among the markets where Coke posted double-digit revenue growth.
• Whirlpool trounced market expectations, delivering Q1 earnings more than 60% above Wall Street’s guidance.  While overall revenue grew at 7%, sales in Latin America and Asia grew more than 60%.
• Caterpillar delivered its first earnings increase in the last seven consecutive quarters.  Raising its sales outlook for the rest of the year, CEO Jim Owens credits their participation in emerging markets for the results.

What was once considered optional is now a requirement.  Emerging markets lie squarely in the path towards renewed growth.  (see The China Supply Chain for a view on what this shift means for supply chains during this coming decade).

Not Your Father’s Technology

Headlines in technology companies show the sector is rebounding.  Corporate spending has indeed contributed as pent-up demand comes forward.  There are also indications that technology spending is rebounding in a different form.  IBM’s financial release is an example.  Their primary source of recent reported growth lie in software and not in services.  This is not how IBM’s business model looks like according to a financial analyst.  Software growth is intended to be a multiplier for services growth.  This result indicates a shift to new software platforms.  Cloud computing, a greater reliance on open systems and web services are changing the nature of the old technology revenue model.  Long to be forecasted, it is now fast approaching.

Returning technology spending, but in new forms.  Growth strategy that begins in international markets.  Innovative products that tap consumer’s cravings to be connected.  These are the trends underlying the economic recovery.

April 7, 2010

In late February, Campbell Soup announced a dramatic redesign to its iconic soup labels.  This announcement was accompanied by additional changes in how these products will be presented on the consumer shelf with the objective of simplifying product choices.  With sales starting to ebb in its core product lines, the company made these changes in the hopes that these bold moves would be noticed by shareholders and the market.   Yet the changes themselves were somewhat eclipsed by the process the company took in arriving at these decisions.

According to media reports, first in the Wall Street Journal, and then virally expanded, Campbell’s wired up test consumers with brain measuring devices.  Comparing heart rates and eye movements while consumers scanned shelves, Campbell’s was able to determine those aspects of the shopping experience which motivated decision, and those which created distraction.   With the data collected, it became clear to the marketers at Campbell’s that the consumer was confused.  So, therefore, color codes will be introduced at the shelf and the label will be redesigned.  The key objective of these steps is an easier, more guided, route through product choice to purchase decision that minimizes decision paralysis and increases sales.

A growing body of evidence suggests consumers are indeed mentally stuck by the complexity of choice.  In 2004, Barry Schwartz published an article in the Scientific American titled “The Tyranny of Choice.” That widely circulated article outlined Mr. Schwartz’s academic research asserting that increasing options often lead to sub-optimal and value decreasing choices.  After a certain point, diminishing returns take over and consumers meet more choices with increased anxiety, confusion, and decision paralysis.  This dynamic appears to be present in all walks of life where people are confronted with choice complexity.  Retirement planning is another relevant example.  Research by the Wharton School demonstrates that individual participation in 401-k retirement plans decreases as plan options increase.  The more plans offered, the less people participate.  As the academic research has piled up, it has been given the inevitable academic label – the “choice overload hypothesis.”

With all due respect to the rigor of academic research, there is no better illustration of the choice complexity consumers face today than Stephen Colbert’s description of potato chips.  In a recent episode of the nightly Colbert Nation (click here), the ever-present host unveiled all the ways you can make a Pringles potato chip.  Who knew there were so many kinds of Pringles available to be bought?  The choices are mind-blowing, which is, of course, the point.

The fact that this amount of product complexity still exists is a testament to the durability of bad incentives at the expense of consumer satisfaction.  In the consumer goods industry, shelf space after all is king.  Even more so today.  In the United States, learning from their European counterparts, the push is on the increase private label share.  Market share of retailer private label product in the US has always lagged its share in Europe.  With the current recession, retailers have sensed opportunity to increase share of their private label product.  Branded products are, literally, being pushed aside of the primary real estate of the shelf, to put private label in the command consumer position.   As a response to stem this tide, manufacturers respond with more products to defend this space, mainly with line extensions.  The net effect of all of this is more products fitted into the same shelf space….and more choices consumers are forced to navigate.

The costs of choice complexity have been long-known in the supply chain.  Greater inventory levels required for more products tie up cash.  Greater demand variability involved across multiple, similar products impacts production efficiency of hard assets, higher distribution costs, and requires more labor to respond to often chaotic breakdowns.

The growing body of evidence, first developed in academic circles but now being applied in the real world, suggests choice complexity is a real cost borne by consumers.  That cost is shared by both retailers and manufacturers in the form of lost sales and lower consumer satisfaction.  Perhaps the Campbell’s decision will represent an effective strategic alternative to the proliferation of choice.

March 19, 2010

The current political crisis in Thailand has its roots in the country’s economic structure.  Unless the country’s governing institutions become more durable, internal tensions could cross-over and affect the country’s markets and export infrastructure.

This week, approximately 100,000 “red shirt” protestors took to the streets in Thailand to demand a new government.   It is the latest installment in a prolonged political battle since a new government was installed by military force in 2006.   The main players in the battle are “red shirts,” a group of rural, relatively poor seeking a return to the previous administration and “yellow shirts,” groups representing the views from more prosperous Bangkok.

The Thai stock market seems to be in another, separate world.  Its performance has been resilient amidst these protests.  Since the date on this post, the Thai stock market has risen in 6 straight sessions, increasing its value by more than 7%.   “Crisis is opportunity,” a confident market trader in Bangkok was quoted as saying this week by Bloomberg.

These two separate worlds communicate 2 different, conflicting messages.  The prolonged protests without resolution communicate instability and uncertainty.  The markets communicate confidence and optimism.

The roots of the current political crisis are found in economics that extend farther back from the military coup in 2006 to before the financial crisis of 1997.  Through the early 90’s Thailand was the economic beneficiary of cold war chess.  With its neighbors darkened by the shroud of Soviet-styled communism, Thailand became one of few choices in the region as an export base.  Thailand became an export leader in the region, and was commonly referred to as a tiger economy.  It benefitted from U.S. aid in order to stop communist expansion.  As a result, its economy rocketed along, with the capital city of Bangkok receiving the lion’s share of that growth, prior to a crushing currency devaluation that sparked the Asian financial crisis in 1997.   Since the military coup in 2006, Thailand’s economic growth has underperformed the regional average.  Using data from the World Bank to compare Thailand with neighboring countries, Thailand’s average annual growth rate in that time has been 3 points less than the regional average of 5.6%.   For Thailand, that figure approximates a GDP economic growth gap of $8 Billion lost.  That gap is primarily due to a loss in domestic consumption.  Export levels have maintained solid growth rates above the regional average, but its rate of import growth was among the worst regional performance this past year.   Not much roar in the tiger of old.

This growth gap represents increased income inequality in the country, fueling the current political stalemate.  On one side are the “red shirts.” They are comprised of mainly rural, relatively poorer, who make their living in agriculture.  They favor a return to the Thaksin administration, whom they voted in power and who was overthrown in the 2006 coup.   Living in exile since, Thaksin is the main source of continual motivation for this group who is staging this week’s protests.   The group of “yellow shirts” are the other side of this stalemate.   Comprised of the more urbane, educated residents of establishment Bangkok, with their group of “yellow shirts,” backing the current prime minister.

The current economic situation suggests reasons for the divergence between market performance and political impasse.   The underlying optimism of the Thai stock market is externally driven, buoyed by a healthy export growth and a gradually improving economic picture in the US, one of its largest trading partners.    The political tensions are stoked by slower domestic growth and widening economic inequality.  But there are signs these two worlds may collide.   As just one sign, Thailand’s foreign direct investment – a key engine of future export growth – has declined for 3 straight years.  This is not the case for Thailand’s neighbors.

Thailand’s governing institutions stand at the bridge between these two worlds.  They are currently fragile.   As a reference point, Thailand has had 17 constitutions since 1932 (see this chart).  The current constitution is 3 years old.  Between 1971 and 1992, Thailand experienced 7 coup attempts (see a timeline), most of them successful.   Thailand’s government history is pendulum that swings from democratic attempt to autocratic rule.  After a brief respite, the tennis match has begun anew.  While the near-term focus remains on the resolving the current crisis, it is the longer-term vacuum of durable institutions that poses the greater risk.   Without it, the increasing risk premium for the country – fast money or slow – will divert dollars away from Thailand to now emerging alternatives.

If you are an investor, in the market or in assets on the ground, don’t be tempted into the blind optimism of others.  Be cautious and look to the durability of the country’s institutions as a guide to its future.

February 19, 2010

Wal-Mart, the retail giant that sits atop the industry in terms of size, released earnings for its fiscal fourth quarter on February 18.  The main headline was the decrease in same store sales located in the United States.  There is a first time for everything, and so it is with same store sales going down for Wal-Mart.  Taking a deeper look, findings from its quarterly financials release can be used as a barometer to figure out where the economy is headed and what strategies can be pursued for success in the current economic recovery.  

Wal-Mart’s decrease in US sales is a sign of shifting consumer behavior.  While price deflation was cited as the cause for the decline, other trends are likely afoot.  The company also noted that store traffic in US stores decreased.  Yet, total consumer spending in the US increased at an annual rate of 2% during roughly the same period. So consumers are showing up to buy, just not as much at the local Wal-Mart.  Just last year, these same Wal-Mart stores were growing sales greater than 2%.   In the depth of recession, Wal-Mart benefitted as consumers traded down by walking into Wal-Mart.  Many companies experienced significant shifts in demand to lower price-tiered products during this time. Now, with economic recovery appearing to take hold, consumers are moving once again.  Some analysts suggested that low-income, financial pressed consumers were at the root of the sales decrease.  A more compelling argument stems from consumers on the other end of the income spectrum.  So the other trend occurring here is that some, likely higher income, consumers are going back up the price ladder and trading up amidst the recovery.   Expect significant shifts in demand going forward as consumers behavior is on the move.

The other end of Wal-Mart’s revenue results were in international markets.  With US sales growth down almost 2%, it was growth elsewhere that enabled Wal-Mart to deliver company-wide sales growth of more than 4%.  While the company moderated its sales forecast for the US, it simultaneously shined a spotlight on China and Brazil as future growth sources.  Does this sound familiar?  The current economic cycle has accelerated the shift of the economic center of gravity away from the US and Europe and toward the BRIC countries, especially China and Brazil.   This is the other, larger trend visible in Wal-Mart’s results.  Companies used to view growth in BRIC markets as optional upside, but are now viewing growth in these markets as central to their strategies. 

Despite the revenue challenge in the US, Wal-Mart delivered a 22% profit increase.  While battling price deflation and a global slump, these results highlight just how good Wal-Mart is at executing the operations of the business.  Company management indicated that lower inventories led to a 21% increase in free cash flow.  That’s $2.5 billion dollars of inventory no longer sitting idle in the supply chain.  Of course, this is not the first time we have heard about Wal-Mart’s ability to tighten its supply chain (see a review of Wal-Mart’s Q12006 release).   The company has the ability to continue improving its supply chain, time after time, quarter after quarter.   The larger message here is that the competitive race in grocery retail will intensify with a heightened focus on supply chain.  Five years ago, coming out of the last global recession, the retail competition was about format, with a landscape split at the extremes between luxury and discount.  “Mass and Class” as it was sometimes called.  What no one could have predicted was the reemergence of the grocery chain.  The center channel revitalized itself and came back after being written off as obsolete.  No similar demonstrative change appears today on the horizon.  So now, the industry competitive race will be defined by companies that make their assets as lean as possible.  Supply chain is moving to the forefront.

After settling into recession, consumer behavior is on the move again.  Brazil and China are becoming the economic center of gravity.  Supply chain is moving to the forefront of retail.  In all these things, Wal-Mart is a barometer for the future.

February 4, 2009

I came across a survey recently published by The Global Supply Chain Council that caught my eye for its boldness.  The report contains survey results of 125 companies operating in China regarding their respective warehousing and transportation practices.  Here is what caught my eye; companies responding to the survey indicated their average logistics cost were 10% of sales.  With this newly reported number, the authors therefore conclude that logistics in the China market are now approaching new levels of efficiency.  This is an astonishing assertion.

This number reported by companies sits in stark contrast with commonly held views.  In fact, efficiencies approaching levels seen in only the most mature economies.  Numerous sources report logistics costs greater than 16%.   Another reported metric to gauge logistics costs is as a percent of GDP.  Using that metric, the audit firm KPMG reports that China’s logistics costs are 18% of GDP, compared with 8% in the US and 7% in EU countries.  In these more common views, the difference between China’s logistics costs with the US and Europe is widely attributed to the state of infrastructure.  Developed markets not only benefit from better roads, but also improved integration between modes of transportation such as road and rail, and better information exchange through established IT assets.

The difference between these two reported numbers, 10% and 18%, is huge, or, more precisely, about $1.7 Trillion.  So, what accounts for the difference?  Finding the answer is critical to anyone operating a supply chain designed to serve the Chinese consumer.

The reason for the difference is geographical.  Reading through the plethora of published reports on the topic, a fundamental point seems to have gone unaddressed; that China is really, at its highest level, 2 distinct macro economies.  To understand China’s true supply chain picture, one must start by segmenting the country into two basic parts.  One part is the eastern one-third of the country.  It is this region that China’s economic success story took root and grew.  Its export-based economies of Shenzhen and Guangzhou are here.  So is the glittering world city of Shanghai, as well as the nation’s capital of Beijing.   This area has its own distinct characteristics.  These characteristics include a rising professional class and dense urban centers.  Its infrastructure, in many ways, not only matches but is moving beyond the rest of the world.  The other part is the western two-third’s of the country.  It this area of the country that is more diverse and has its own set of characteristics that contrast it with the east.  It’s more rural, more sparse, and dramatically poorer.

This marked contrast between the eastern one-third and the west that accounts for the difference in reported logistics costs.  A closer look at the first survey, where individual companies reported a logistics cost of 10%, shows a majority of these companies operating within the eastern one-third of the country.  Their base of operations is localized around Shanghai and Shenzhen.  Other sources citing a higher logistics cost of around 16% use country-wide data that includes economic activity from every province.

A look at infrastructure data from two different provinces illustrates the point.  The Jiangsu province, just inland from Shanghai, is a good example.  Jiangsu is comprised of over 71 million people and is home to Nanjing, China’s historical capital.  It is home to 6 major expressways, all built in the last twenty years.   Although far from the glittering lights of Shanghai, this province has enjoyed significant economic growth.  Yunnan, a province in the far Western part of the country, has a different profile.  Home to over 40 million, it has only 2 major expressways.  Roughly put, western Yunnan has 57% of Jiangsu’s population, but only a third of the major freeways.  The picture below, sourced from Wikipedia, offers a visual view of the disparity. It shows China’s freeway system, where the prosperous eastern one-third can be seen distinctly between the western two-thirds.  The contrast increases when you look at the colors.  The routes color coded in Blue are completed, but the freeways coded in Red are under construction.

To study the Chinese economy is to be awash in large numbers.  1.3 Billion people.  13 million cars sold last year (world’s largest).  185 million refrigerators sold last year (world’s largest).  Retail sales growth of 17%.  These large numbers can (and often do) create the impression that China’s 1.3 Billion consumers will be reached the same way with the same cost structure.  Don’t be tempted by that impression.  A supply chain system to fully serve the Chinese consumer will hold different models.  Designing these models will start by recognizing the disparity between a more prosperous east and the trailing west.

January 6, 2009

A key supply chain challenge in the coming decade will be serving the Chinese consumer.  For many companies, doing so effectively will enable companies to tap the next growth wave in the global economy.

As the global economy stabilizes, eyes are turning to the Chinese consumer as an increased source for growth.  In the developed world, especially the US, debt-laden consumers are not expected to be the growth engine they once were.  In the past boom, consumer spending accounted for 2/3 of the US GDP, powering US growth and exports from abroad.  Yet, according to a recent column by Paul Krugman, US consumers are $11 trillion poorer compared with the start of the current recession.  The US consumer will likely be focused towards budget, not spending in the foreseeable future.  Just in time it seems, indications are that Chinese consumers are spending more.  This year, China may well pass the US as the largest consumer market.  The Chinese government recognizes the situation and its potential, viewing domestic consumers as the available source to replace waning export demand.   They are using numerous policies to support this transition.  Consumer lending by state-owned banks is increasing.  Tax incentives are being offered.   These steps are having an effect.  Retail sales growth in China was 17% this past year, as highlighted in a recent article in the New York Times.  And there is plenty of room for continued growth. A recent report by The McKinsey Global Institute highlights that consumption is only 36% of total China GDP, only half of US levels and 2/3 of levels in other developed economies.  This transition has been a trend for more than a few years, one that will accelerate and deepen as a new world order emerges with the economic recovery.   As these trends continue, the Chinese consumer will become the primary power underpinning next phase of global growth.

This emerging reality is not how current supply chains are designed.  Helped by a low exchange rate (some say artificially low) and US consumer spending, China became the source of supply as the first stop in a global supply chain.  The primary supply chain focus in China was tapping low labor costs to supply consumers elsewhere.  This will change.  The issues regarding Chinas’ fixed exchange rate will come to a head sooner rather than later.   Once they do, the supply chain model of using China primarily as a source of production in the global supply chain will end.  When it does,  supply chains will need to be reconfigured to serve the Chinese consumer and tap the next economic growth engine.

This transition will be complex.  First is the transition to a new supply chain network itself.   Certainly, companies can benefit from a burgeoning third-party logistics sector, benefiting from foreign entry in 2006 in conjunction with China’s WTO membership.  Even with this accelerator, the number of new  processes to change and create represents significant business change.  There is more complexity on the horizon.  Funded by massive government spending, China is currently building out its infrastructure of road, rail, and shipping on an unprecedented scale (see The Other Stimulus).  The speed of build-out in each of these areas is at a magnitude not seen in history.   In the four years leading up to the latest, increased round of investment, over 600,000 km in new highways were built.  More high-speed rail has been put in the ground in the last four years than in the last 20 across all of Europe.  As networks transition to serve demand domestically, keeping up with the dizzying pace of change will be an added challenge.

These two challenges are coupled with high risk factors.  AMR, a research institution, has called China the “world capital in supply chain risk.” This is primarily due to fears of IP infringement and also the cost of corruption.  A recent government audit suggests corruption is a $35 Billion dollar problem, annually.   These challenges will be faced and solved by companies seeking to go where the growth is.

The recent economic downturn, the most severe since the great depression of the 1930’s, has accelerated existing trends.  One of those trends is the emergence of the Chinese consumer class.  Supplying the demand for this emerging force will be one of the primary business challenges this decade.  Those who meet that challenge will be rewarded.

If you have shopped in a Costco store any time in the last few years, you have no doubt seen the flat screen televisions sold by Vizio. You can’t help but see them, positioned at the front of the store after immediately walking through the door. Multitudes have walked through those doors looking for bulk bananas and left with a large screen Vizio TV. Indeed, Vizio’s televisions have taken the market by storm the last few years, powered by the Costco channel. Some quick facts about the company; over $2 billion dollars in annual sales, market leader in LCD televisions, 87% year-on-year growth in unit shipments, founded in 2002 (7 years old). In the third quarter of this year, market share increased to approximately 16%. Catapulting from non-existence to number one has given the established category leaders like Sony and Panasonic fits. Vizio entered the category, took on established players, and is winning.

Ok.  Now, guess how many employees Vizio has?  About 200. That’s right. About 200 employees. In 2007, they obtained 13% market share with 7 employees. By contrast, Panasonic’s US division has 13,000 employees. Despite Panasonic’s larger footprint, the difference is striking…..almost mind boggling. Much has been written about Vizio and its success, but a significant point bears more emphasis – that a variable cost, virtual model was a key to success and growth.

You can probably guess where this is going. Vizio outsources and uses partner companies for practically every activity under its roof. Well, virtual roof. Design and marketing leadership are in-house. Everything else lies outside, with core functions executed by long-term, closely held partnerships. Vizio doesn’t even really do the design. They specify product performance specifications and engineers for other companies do the rest. The company’s primary contract manufacturer, AmTran, is also an equity investor, linking success of the two companies together. They truly leverage a network of third parties that gives them significant advantage.

Vizio’s founder and current CEO is William Wang. In 2002, Mr. Wang combined two ideas in the formation of the company. First, components for making LCD TVs were becoming widely available through Taiwan-based contract manufacturers, and second, that bringing the price down for these products would significantly increase their demand and move them into the mainstream.  He was, of course, right on the money. By using existing contacts through contract manufacturers, company founders designed their first LCD TV that sold at a retail price about half of current market offerings. With that, the company was born.

As the company grows, it is resisting the temptation of making large capital investments today that will become tomorrow’s legacy, stranded assets. Such assets and legacy costs slowed Vizio’s competitors in the market transition to digital. That’s the way the market works these days. In the old mindset, hard assets were nurtured into advantage. Today, in a horizontal, “flat” world, these same assets can become weights that slow speed to market and obscure market-based realities.

A related example are developments in the cell phone industry. Back a few years ago, Nokia dominated and simply seemed unbeatable. Their core strength was their supply chain. They offered pretty good phones that consumers wanted, all built on standard platforms. Using their supply chain as a cost weapon, Nokia attained profit margins the envy of the industry and beat everyone to market through line extensions of their platforms. Two events occurred that turned this strength on its head. First, new companies emerged that became private label houses for cell phone design. Everyone then had access to the building blocks of cell phone design. With that step, the commodity side of the market was lost. The second big event was Steve Jobs. Led by great design and innovation, a partner configured supply chain became the machine that supplied the market. Nokia’s strength in supply chain and standardization quickly turned from strength to liability. Today’s mobile phone market is dramatically different in structure. Motorola is betting its future not on in-house designed software, but instead on Google’s Android platform, as one example.

In 1999, John Hagel and Marc Singer published a groundbreaking and widely acclaimed HBR article Unbundling the Corporation. In it, the authors outlined a new framework for how companies would be structured in the new realities of the internet and outsourcing. With communication costs plummeting, it just makes less and less sense to put everything under one roof. That ground has now been broken repeatedly. I’m not sure Hagel and Singer imagined at the time the degree by which their concept would be applied, with a group of 200 beating an army of 13,000. With the recent economic downtown, these concepts are picking up speed. Companies that remain vertically integrated are being left behind.

Most times I read brochure ware or hear a speaker on the topic of demand and supply chain integration, there are way too many flow charts, power point diagrams, and acronyms to draw many insights. As I try to sort through all of this, the fundamental premise of demand and supply integration seems to be the use of end-point demand as the primary source of forecasting product movement through the entire supply chain.

Demand and supply chain often is used in the context of manufacturers working more tightly with downstream partners to gain efficiencies in the ordering and flow of product. End-point demand is a far better source of distribution and capacity planning. As point of consumption demand becomes more prevalent, gains in this type of integration are starting to happen. Product is placed more efficiently, which has the dual benefit of reducing the total product across the chain, reducing costs, and having more product where it is needed. This has the effect of raising sales at a lower per unit cost. It’s simply a matter of time before this information flow becomes seamless and more of a standard operating model.

Now events in the marketplace are happening that will spawn a rethink of how we define demand and supply chain integration. In the future, the definition will broaden from using consumer (or end-point) demand to improve the supply chain at large to a system organized around creating and supplying demand to each individual consumer. The rise of social networking will be the catalyst to spur this rethink. Social networking is a phenomenon that impacts everything, supply chain included. Facebook has experienced the largest share of global online usage in the last 3 years. Youtube is second (to see the detail of this, check out Mary Meeker’s recent presentation at the Web 2.0 Conference). Meanwhile, Apple has redefined the mobile experience and extending these platforms from the PC to the device formerly known as the wireless phone. There are now about 60,000 iPhone applications, depending upon how you count them. There will surely be more to come that will change how we think about our daily lives. No one really knows where this is going. Let’s call where we are now the “Experimentation phase.” Through use of these emerging technologies, companies are going to innovate new ways to connect with consumers and increase mindshare and revenue. The supply chain will have to keep up.

Let’s take an example. Kraft has a cool iPhone app. Since its launch last November, iFood Assistant has experienced more than one million downloads and has established a precedent for how companies use this technology. The application contains more than 7,000 recipes for the busy shopper, videos to help with preparation, functionality to translate recipes into shopping lists, and handy directions to your nearest grocery store. Wow. What a great, convenient – dare I say – entrepreneurial, idea to build mindshare with consumers and increase sales. It’s a unique innovation that has the potential to drive true, incremental demand. In case you haven’t noticed, grocery stores are driven by the coupon. Every aspect of the operations in a store from their interactions with manufacturers is defined by it. Yet one of the shortcomings in using coupons and other “on deal” events is that they don’t drive a lot of new demand. Instead, demand just gets moved around. For instance, consumers buy more than they normally would, in essence, pulling demand forward, but not creating it. But with the iFood Assistant application, new uses for products are created and literally “served up” to consumers (apologies for the pun).

It’s all good. One small exception. What if a user gets to the store and they are out of the product on the list? Unfortunately, it’s a common problem. A range of industry surveys suggest grocery store products are out of stock around 8% of the time. This percentage increases significantly if the item is included in the Sunday newspaper advertisement. So, what happens? The consumer going into the grocery store will be disappointed. Their excitement level and increased “equity” built through use of the application will decrease. Consumers will undoubtedly substitute products from another manufacturer, decreasing the revenue Kraft derives. In some cases, they could be inclined to “turn off” the application. Such are the issues with execution and bridging a demand creator with the realities of the supply chain.

To solve this specific issue, a manufacturer needs to have visibility into their product inventory downstream in the delivery chain. Claiming this opportunity is one of the next big challenges for the consumer supply chain. Once this happens, communications at an individual consumer level are possible. Going back to our example, the iFood Assistant can take the shopping list and recommend the nearest grocery store where that list is completely in-stock. This example could be extended one-step if you consider an online grocery retailer like Peapod. Once an iFood Assistant user (who also has an account with Peapod) selects a recipe and obtains a shopping list, they could be presented with an order page and a promise to deliver the necessary groceries in just in time for meal preparation.
This example – a scenario for the future – illustrates a deeper level of demand and supply chain integration. A scenario focused on the individual consumer. In this definition, supply capabilities can be matched with innovative, new marketing programs tailored to and targeting the individual.

It’s going to happen sooner than we think.