Article discusses the importance of supply chain mapping

In a recent article, Supply Chain Digest offers thoughts on Supplier Relationship Management that echo comments made to the Triad Business Journal regarding the important first step of mapping your supply chain.

The Digest article states that there are 6 key steps to Supplier Relationship Management, with the first being “to segment supplies and identify a subset of those as ‘strategic.’ The most frequently used segmentation criteria, according to Webb and Hughes, are spend (historic, forecast or both), value opportunities, dependency, risk and business impact, account attractiveness and relationship complexity.”

In a nutshell, this is mapping based on the items a company actually buys, and triaging them based on “strategic” criteria – which items are mission critical to production, which items have a high per-unit cost, which items are a big-ticket expense (even if per-unit cost is low), etc.
The article stresses that after such analysis, appropriate changes in the supply chain itself will capture the savings by changing “existing supply chains and processes. The fundamental redesign of cost drivers has repeatedly unlocked savings in the range of 10-30 percent for leading organizations.”

The resulting relationship strategy depends on formalizing and managing key suppliers. These changes will typically require modification to or creation of key supply agreements that appropriately capture the Supplier Relationship Management results, and provide flexibility for future adjustments. Hence the reason legal counsel must be sensitive to and knowledgably of Supply Chain Management issues and concepts.

- - Greg Chabon

Greg Chabon quoted in Triad Business Journal SCM article

The Triad Business Journal turned to Womble Carlyle’s Greg Chabon for insight when putting together a major article on supply chain management. The article, “The missing link: Firms need to get to know their supply chain,” is written by staff reporter Michelle Cater Rash and appears in the Oct. 30-Nov. 5th edition of the newspaper.

Greg offers his thoughts on how companies can better understand supply chain management and control costs in this area. To get started, he suggests companies map out their supply chain to determine where money is being spent and where risks occur.

“It’s like your personal budget at home,” he tells the newspaper. “You need to look at everything you spend and where you spend it to see how you can control your costs.”

Rockslide closes I-40, creates supply chain headaches for truckers

Early on the morning of October 26th, a rockslide closed a part of Interstate 40 in western North Carolina. The highway is one of the state's key trucking routes, and one of the chief roads used by tourists and others traveling to the Blue Ridge Mountains, Tennessee and beyond.

According to experts in the trucking industry, the I-40 road closure will require truckers going both east and west to travel an extra 100 miles to detour around the rockslide. Depending upon their tariffs, it could cost an extra $125 to $200 each way. Typical daily truck volume through this section of I-40 is 12,000 to 15,000. That’s $3 million per day. The section is estimated to be closed for up to three months. That adds up to $270 million in extra freight costs, and right in the middle of the holiday season.

This unpredictable natural disaster underscores the need for continual review of your supply chain, and having recovery plans in place and multiple sources of supply and transport available.

- Greg Chabon

Supply, Demand and Finance - Managing Supply Chains in Uncertain Times

Supply chain management originated as means of fostering growth by making businesses leaner, more efficient and more responsive. But in the ongoing economic downturn, the old adage of “A chain is only as strong as its weakest link” has proven to be true about supply chains as well.

For many businesses, the difficulties are manifesting themselves at the end of the chain, as customer orders plummet. But economic problems at the front end of the supply chain also have created difficulties—for example, Best Buy recently noted that they could have sold more electronics in the first quarter, but suppliers were unable to provide the goods. Companies in the middle of the chain find themselves getting pinched at both ends.

As a result, risk assessment and risk management now must extend beyond a company’s own boundaries to include suppliers, distributors, creditors, customers and other business partners. Contributing editor Russ Banham addresses these risks, and how to address them, in an excellent article in CFO Magazine.

Banham found that companies now must perform much more intensive due diligence on assessing the financial security of their suppliers. Some businesses, such as Corning, are using the same methods that they previously have used to scrutinize customers to vet suppliers.

“We also talk to the suppliers’ suppliers,” Michael Kramer, CEO of Kellwood Co., is quoted as saying in the article. “We'll ask them flat out, ‘Are you getting paid?’ If they're not, it could be an indication that their customer — our supplier — has financial problems.”

Some companies are turning to outside consultants, such as the Insight Sourcing Group, for help in consolidating their vendor base, rationalizing SKUs and otherwise keeping their supply chains lean and functional. Insight is compensated based on the savings they generate for their clients, and they have a track record of success in reducing costs and improving EBITDA (earnings before interest, taxes, depreciation, and amortization).

- Jackie Camp

Global competition for the U.S. dollar?

The state-run China Daily reported two stories last week suggesting that the U.S. dollar may not be the touchstone of global trade, and that other currencies, such as the renminbi (or yuan), the official currency of the People’s Republic of China, will ascend in global importance. These stories underscore an obvious concern that sourcing prices in China will only continue to escalate in the short term. From a longer term perspective, these stories also highlight the need for vigilance in monitoring developments impacting supply chains and the contracts which define and control them.

The first story of interest was published on Thursday, May 21, when China Daily quoted Brazil’s President, Luiz Inacio Lula da Silva (while visiting the PRC) as calling for China and Brazil to trade in their own currencies and put an end to trade based on the U.S. dollar. In calling for finance ministers of the two countries to begin discussions on the matter, the Brazillian leader noted trade costs between the nations would be reduced by the elimination of fees to exchange currency into US dollars as an intermediate step to payment. Brazil already has agreements with other trading partner nations calling for trade in local currencies.

And on Friday, May 22, China Daily ran a piece predicting a greater global role for the yuan on account of China’s growing role in the global financial economy. Perhaps just as telling, in a manner casting China in the role of Queen Getrude to the world’s Hamlet, is the level of attention China continues to place on protesting (methinks too much) that it has not engaged in currency manipulation as a means to favor its own exporting industries. Consider, for example, the great pains taken to get out news, perhaps overlooked by the rest of the world, to the effect that the Obama administration (speaking through Treasury Secretary Geithner) does not view China as having manipulated the currency exchange rate for export advantage.

The emergence of such arrangements as called for by Brazil, and the push of the Chinese to elevate the global status of its own currency, could mark the beginning of a major trading shift away from U.S. dollar denominated transactions. Setting aside the likelihood of this actually coming to pass (perhaps not as far-fetched a notion as it was a year or so ago), or the time frame within which such a change would evolve, there are serious business risks and opportunities here, and some legal issues to keep in mind.

Consider, for example, all of the standing agreements in a typical global supply chain which base all of the interdependent transactions flowing through the chain on U.S. dollar demoninated pricing. Many of these agreements may be long term in nature, and while some may have termination provisions based on the convenience of a party or termination for cause under specified circumstances, major changes of this nature may likely not give a party who begins to suffer a competitive disadvantage on account of currency a right under current contracts to terminate for good cause. At best, most existing agreements would typically include a so-called “force majeure” (or temporary change in conditions) clause which would allow suspension of performance during the pendency of a currency crisis, but even then the right to terminate based on such an event is usually limited or non-existent in most iterations of this clause.

Therefore, closer attention to currency issues should be at the top of the list of external factors every supply chain manager should monitor, if not already at or near the top of the list given the current volatility in the world economy. While this truly would be a longer-term trend, if it does become a trend, currency provisions should also top the list of items for which to periodically reassess contracts, particularly as contracts are renewed or entered into during the ordinary course of business.

- Randy Hanson

Protecting accounts receivable for inventory sold under the UCC

In the current economic climate, sellers are increasingly seeing their sales on credit for what they are - a gamble on the buyer’s creditworthiness. If the buyer doesn’t pay its invoice, what rights does the seller have against the buyer? How do the seller’s rights compare to those of competing creditors? If there’s not enough money to pay everyone, does seller still get paid?

The Uniform Commercial Code (UCC) dictates the answers to these questions and the answer frequently depends on what steps the seller has or has not taken BEFORE the sale to protect its interests.

The UCC gives special treatment to sales of consumer goods. If the buyer is the end user of the product (the consumer), will not be reselling the product and is using it primarily for personal, family or household purposes, then a seller whose agreement with the buyer on credit (the store credit card agreement, for example) provides for a security interest in goods sold but not yet paid for, obtains an automatically perfected priority lien on the sold merchandise. No steps are required for perfection and seller’s claim to the merchandise will generally trump those of other creditors.

If, however, the goods sold constitute “inventory” in the hands of the buyer, meaning generally that they will be reselling them or will be using them in their business, then perfection is no longer automatic and affirmative steps must be taken to protect a seller’s rights if the buyer fails to pay for the goods purchased.

First, you need to be certain that your sale documents (e.g. purchase orders) contain effective language granting you a security interest in the items sold until such items are paid in full. In UCC terms this effects the “grant” of your security interest and gives you rights in the items sold as against your buyer/debtor. This does not, however, confer “perfection” of the security interest, which determines your priority among competing creditors.

In many if not most cases, you will likely be selling your products to a buyer who already has some form of general corporate financing in place, which financing is typically secured by a “blanket” lien on all assets of the debtor. That means that once you sell your products to buyer/debtor, buyer’s bank will get a lien in those assets in addition to yours. So whose lien comes first?

The answer under the UCC is that the bank’s lien on inventory will trump or prime your lien on your products sold to buyer unless you (1) file a UCC financing statement against the buyer with respect to your products sold BEFORE you sell the products to them AND (2) notify the competing bank creditor of your impending lien BEFORE you sell the products. These steps will allow your lien in products sold by you to your buyer to prime the bank or other inventory lender’s lien.

The burden of both filing the UCC and providing prior notice to an inventory lender before making a sale, as a practical matter, dictates that most sellers will pick and choose which sales and which buyers warrant this level of protection. In most cases, you, as seller, will not know if your buyer has an inventory lender or the identity of that lender, so a UCC search will need to be conducted first, an additional administrative burden. Nevertheless, for large sales and/or for buyers whose creditworthiness may be suspect (a growing group of buyers in these troubled economic times), extra diligence and action may be warranted.

- Jackie Camp

International Outsourcing - What Happens After Satyam?

This month Xerox announce a data center outsourcing deal worth more than $100 Million over six years with huge Indian service provider HCL Technologies. Under this deal, HCL will manage Xerox’s disaster-recovery preparation and consolidate Xerox's data centers in North America and Europe. As American and European companies continue to seek the cost savings of offshoring their vital business processes, the recently admitted mega-fraud announced at Satyam Computer Services Ltd. does not seem to affect their risk tolerance.

Most executives would agree that running data centers and managing disaster recovery would be important jobs to trust to an outside offshore company, and a hundred million dollars worth of service should be seen as financially significant. So how does a company like Xerox mitigate those risks and justify its decisions to the SEC? Certainly, conducting financial audits and SAS 70 audits can help, but it is likely that Satyam had passed those same tests. The same is true for operational risks and data security risk. There is no substitute for putting shoes on the ground with the prospective outsourcing vendors, sending in trusted examiners to review the books, interview the workers and manually inspect the operations.

Most companies looking to outsource important business processes are seeking trusted partners to integrate into corporate functions. In the Satyam debacle, State Farm chose to terminate its relationship after the trust disappeared, while GE continued with their contract. But should the Satyam disaster bring greater scrutiny to all outsourcing vendors, and if so, how do client companies force higher standards of review into their agreements? Simply calling for audits and reviews that were not negotiated into the original contract is usually not well received by the vendor in these intricate relationships

Alternatively, a customer company could terminate the agreement for cause, if possible, and then renegotiate. Such brinksmanship contains its own dangers, especially in fields where trust is crucial. Gartner predicts that the costs of offshore outsourcing are likely to fall between 5% and 20% over the next two years, in part because of contract renegotiation efforts. Companies wary of another Satyam could apply their newfound negotiating leverage to reduce costs, to build more accountability into the agreement, or both. Pushing for the lowest possible outsourcing prices can be counterproductive to managing the relationship risks.

US companies in major business process outsourcing arrangements should be looking at their contract termination provisions. Since most parties do not anticipate spectacular financial fraud as part of the relationship, it is seldom well addressed in the contract. In other words, an outsourcing customer rarely builds into its agreement the specific right to terminate the agreement or to punish the outsourcing provider where the provider’s underlying financials were built on lies. Instead, a North American customer of such services will have to either: 1) pay a termination fee if it wishes to terminate for convenience in this case, or 2) find a way to fit the provider’s crime into a general trigger for a “termination for cause” in the Agreement.

The customer can hope that a financial fraud leads to a different kind of contract violation that can allow termination for cause. For example, the Satyam fraud led to a sale of the entire entity, so Satyam customers who had built “no assignment/no transfer” terms into their contracts may have a way of changing providers without paying termination fees. Those outsourcing customers without such luck will have to rely on the fraud to lead to a violation of the outsource providers service levels, or for the fraud to trigger a more general term of default in the agreement, such as capitalization requirement (rare in these agreements), a general requirement of honesty and fair dealing, or a warranty or condition precedent that the outsource provider’s pre-contract representations about itself were truthful.

Will the Satyam fraud impact risk mitigation requirements imposed by Sarbanes-Oxley or by industry regulations? It is too early to understand how the admitted fraud will drive U. S. regulators to tighten risk requirements, especially in the current political mood that favors increased regulations on corporate operations. However, regulated or not, companies looking to outsource business processes are now on notice that even the largest and most apparently solid of outsourcing vendors must be carefully checked in all operational and financial aspects, and appropriately monitored through contract.

-- Ted Claypoole