Perspectives on Various Issues of Interest

Air Canada's Strategy to Manage Its Fuel Supply

An article published on December 1, 2008 in Wall Street Journal reported that Air Canada faces an unusual challenge in the airline industry of finding enough jet fuel. Part of the problem is that Canada's small pipeline infrastructure is overtaxed and the nation's major refiners are cutting back on production. Looking south doesn't help much because most U.S. refiners don't produce the extreme-cold-tolerant blend of jet fuel that Canada requires.

So Air Canada decided to boost its fuel supply itself. The ACE Aviation Holdings Inc. unit is building fuel-storage depots, pipelines and docks and leasing rail cars, trucks and barges. It is also scouring the globe for vessel shipments of refined jet fuel and buying the precious liquid with its own credit from as far away as Saudi Arabia, Nigeria and Venezuela. In March, Air Canada and the rest of the airlines that serve Toronto Pearson International Airport will open a satellite tank farm, pipeline and rail siding to bolster supplies at the nation's busiest airport.

"We want to own it, control it," says Paul Whitty, the carrier's director of fuel purchasing and supply, who recalls a time a few years ago when the shortage was so dire that the Toronto airport storage-depot operator used manual pumps to get every last drop of fuel from the tanks. "The only thing we're not doing is buying the crude and processing it" into jet fuel, he says.

Air Canada's efforts are keeping the carrier aloft and shaving up to 100 million Canadian dollars (US$80 million) a year from its overall fuel tab, which could reach C$3.5 billion this year. The carrier, which controls 60% of the Canadian market, consumed 25 million barrels of jet fuel world-wide last year, 65% of it in its home market.

The U.S. has plenty of refining capacity, many ports and an extensive interstate pipeline system. While only 10% of Canada's aviation fuel was imported eight years ago, imports accounted for 33% last year, according to the Canadian Petroleum Products Institute, a trade association of refiners and marketers.

John Armbrust, an aviation-fuel consultant in Palm Beach Gardens, Fla., says Air Canada's fuel problems also reflect a retreat by oil companies from many of the distribution options they offered 15 or 20 years ago. The airline's "supply chain has gotten longer," he says. "Instead of around the block, it's halfway around the world."

Source: Carey, Susan,  “Air Canada, Out in Cold, Learns Fuel Self-Reliance” Wall Street Journal, December 1, 2008.

Labor Arbitrage, Mass & Distance Issues in Supply Chain Management

An article published on December 3, 2008 in Wall Street Journal reported that conventional wisdom holds that supply chains prioritize labor-cost arbitrage over mere distance in the age of globalization but that geography could make a comeback.

Triple-digit oil provided the first intimation of this. Jeff Rubin, chief economist for CIBC World Markets, estimates $150 crude oil boosted the cost of shipping imports to the U.S. by 11%, costing roughly as much as trade tariffs in the 1970s.

Marc Levinson, author of container-shipping history "The Box," suggests the world also is hitting the limits of economies of scale in logistics, citing bottlenecks at ports and congested road and rail networks. These impose costs and delays and, as supply chains have become more complex, more potential points of failure. Initiatives forcing ships to reduce harmful emissions also will weigh on economics.

Innovation could change the equation again. But the ultimate facts of mass and distance are inescapable when it comes to rethinking logistics.

One answer will be shorter, regional supply chains -- a phenomenon observed in changing sources of U.S. imports during the 1970s oil shocks. That ought to have positive implications for exporting economies such as Mexico, while China could suffer.

U.S. workers cheered by the prospect of jobs returning home, however, shouldn't be too jubilant: Globalization and labor arbitrage aren't going away. And rising supply-chain costs mean U.S. workers will pay higher prices for the goods they buy.

Source: Denning, Liam ,  “Ship Ahoy: New World’s Supply Chain” Wall Street Journal, December 3, 2008.

The Impact of Economic Downturn on Inventory Planning

Corporate efforts to slash inventories -- or "destock" -- amid sliding demand have added significantly to the economic uncertainty facing the industrial sector heading into 2009.

A roster of big-name manufacturers and industrial conglomerates, including 3M Co., DuPont Co. and Illinois Tool Works Inc., say customers have sharply reduced orders in recent weeks, which has caused them to ratchet back production and contributed to downbeat forecasts for 2009.  "As we talk to a lot of customers, they would much rather be out of inventory at the end of [2008] rather than have excess inventory around," 3M Chief Financial Officer Patrick Campbell told analysts and investors during the company's outlook meeting. 

Mr. Campbell said 3M's sales plummeted about 17% in November, and he predicted more of the same for December. 3M held out some optimism that an estimated 10% slide in fourth-quarter volume will start to slow after the 2009 first quarter, although the company predicted volume next year still will be off 3% to 7%.

But the speed and breadth of the current inventory correction makes it unusual. Analysts say it is under way throughout the supply chain -- at manufacturers and distributors alike -- and it is being exacerbated by the slumping global economy and the credit crisis.

"There's a huge focus on managing for cash" in light of the credit crisis, said Tim Hanley, a Deloitte & Touche LLP vice chairman who leads the firm's process and industrial products section. Corporate executives "are taking all the steps they can, and one of those steps is to manage inventory levels" downward.

Eli Lustgarten, a Longbow Research analyst who follows the manufacturing sector, said the destocking is likely to reverberate in order rates over the next several quarters, although he said he thinks the biggest impact is being felt now, with global manufacturing activity essentially shut down for the time being. "The biggest uncertainty today is that the [economic] outlook is clouded [and]) there's no visibility. So nobody is quite sure once you get to where you want [on inventories] how to bring things back up."

"People are operating for cash all along the value chain," Ellen J. Kullman, DuPont's president and CEO-designate, told analysts. Customers "are absolutely taking their inventories down sharply in line with their sales decline."

Overseas bellwethers, such as Swedish bearing maker SKF AB, have been echoing much the same sentiment, and the duration of the trend could go a long way toward determining the ultimate depth of the anticipated slump in the industrial sector next year.

Source: Sechler, Bob,  “Orders Slow As Business Tap Inventory” Wall Street Journal, December 17, 2008.

Innovation by Automotive Suppliers

Ohio Turnpike is a testament to a little-recognized side benefit auto makers have long provided to industrial America: the spur they give suppliers to innovate. Paul Springer of Cleveland started a firm called Springco Metal Coating Inc. 32 years ago to make parts corrosion-resistant. To please the auto makers, he expanded his technology, such as by creating a conveyor system to carry parts through a series of chemical baths and ovens to apply complex coatings. Now he markets this technology well beyond the auto market, for products ranging from water heaters to laser-guided bombs.

"This industry was being driven by automotive in the early 1970s ... They were really the first to start the battle to make metal parts last longer," Mr. Springer says. Doing work for the car companies "put me in the position to put these coatings on all kinds of parts."

The domestic auto makers, while roundly criticized over the years for resisting product innovations, have often sparked inventiveness in parts manufacturers, which must compete hard for the business. In this way, the car makers infuse both technical innovation and other new business ideas, such as for cost-control, in the wider economy.

Economists are of two minds on the importance to the economy of the car makers' nurturing role. "The auto industry is a driving force for innovation in a variety of industries -- materials, electronics," says Peter Morici, a professor at the University of Maryland's Robert H. Smith School of Business. "I don't think you can have a true [major] economy without it."

Still, he says that function isn't vital enough, in itself, to justify bailing out the auto industry. Testifying to Congress last year, he warned that the government could end up supporting the auto sector indefinitely.

Nigel Gault, an economist at IHS Global Insight in Lexington, Mass., says one wouldn't "necessarily want to preserve an auto industry just because of its spillover benefits to the rest of the economy. If we don't use resources to build autos, but use them to build something else, maybe that something else would have just as much spillover benefits."

The effects of the industrial diaspora are evident all along one of America's major industrial corridors, the Ohio Turnpike. Anchored toward the west by Toledo, the self-styled "Auto Parts Capital of the World," and on the east by a sprawling GM plant in Lordstown, the turnpike links businesses that sprang up from the auto industry and branched out beyond it.

The auto industry has also pushed innovation to the larger manufacturing economy by shifting more research-and-development responsibility to suppliers.

Source: Aeppel, Timothy,  “Car-Industry Slump Imperils Role in Spurring Innovation” Wall Street Journal, January 30, 2009.

Some Critical Issues in the Electric Car Market

An article published on January 26, 2009 in Wall Street Journal reported a story on Think Global AS. The Norwegian start-up Think Global AS was one of the front-runners in getting electric cars to the market. It snagged big-name venture-capital backing and in 2008 manufactured about 350 of its latest model, a two-seater, plug-in city car. It planned to ramp up production to 10,000 units this year.  Then the financial crisis hit. As Think began its expansion, overall demand for cars fell, and the company wasn't able to raise the $60 million to $100 million it needed to finance the growth. The credit crunch prompted suppliers to demand faster payments. In mid-December, Think became one of the green technology world's first major casualties, filing for bankruptcy protection.

The two-seater, plug-in TH!NK city, a car with zero carbon-dioxide emissions, sold for around $30,000 in Norway. The credit crisis thwarted its manufacturer's plans to ramp up production to 10,000 units this year.  "We were so close to break-even and being cash-flow positive," said Think Chief Executive Richard Canny. "It doesn't seem right that the traditional auto companies are getting massive public money to stave off their decline, while newcomers in the electric-car space are being starved of capital."

Think's travails show how the financial crisis could delay new green technologies by starving innovative start-up companies of capital. They are also a sign of how venture capitalists, who have been pouring money into "clean technology" from wind power to biofuels, could start to see some of those bets go sour. Venture capitalists put $22.8 billion into green firms around the world in the past two years, according to market-research firm New Energy Finance in London.

India-based REVA Electric Car Co. makes cheap minicars that aren't crash-tested, and is backed by U.S. venture firm Draper Fisher Jurvetson. Making higher-end sports cars that cost over $100,000 are Fisker Automotive Inc., backed by venture firm Kleiner Perkins Caufield & Byers, and Tesla Motors Inc., funded by PayPal founder Elon Musk.

But the start-ups might end up being crushed by the big car makers. At the auto show in Detroit, Ford Motor Co., General Motors Corp. and Chrysler LLC showed prototypes of electric cars. Toyota Motor Corp. and Renault SA are also investing heavily to bring out mass-market plug-in cars as early as 2011.

"Cars are really difficult to build, the supply chain is long and complicated, and it requires tons of capital," said Christian Reitberger, a venture capital investor at Wellington Partners. "It's not an easy business for venture-capital-backed firms to succeed in." Mr. Reitberger prefers to focus his firm's green investments on companies in proven markets such as wind and solar power. However, the downturn could also claim victims in more established green industries. Finance for long-term, capital-heavy projects such as offshore wind farms, solar parks and waste-recycling plants was up 15% to $97 billion last year, said New Energy Finance but activity was slower in late 2008.

Source: Abboud, Leila,  “Faded Green: A Car Maker’s Woes,” Wall Street Journal, January 26, 2009.

Reengineering at American Eagle Outfitters

An article published on February 3, 2009 in Wall Street Journal reported that American Eagle Outfitters Inc. is trying to reengineer the way it produces clothes after steep discounting cut its margins last year.

It hopes to recalibrate its costs with moves that involve everything from changing where a garment is made (fewer Chinese factories and more Indian villages) to how it's shipped (less use of air freight) to how it looks (no patterned pockets in many jeans).

Many retailers fear they will be forced into still more rounds of price cuts as the economy continues to sputter. "Eighty percent off is the new normal," says Allan Haims, a retail consultant and former president of Wet Seal Inc.

Fire-sale prices please shoppers but they depress store margins. American Eagle's gross margins for its fiscal third quarter, ended Nov. 1, fell 6.4 percentage points to 41% of sales. Analysts believe that after the latest tide of markdowns during the holiday season, the margins at its 954 stores have declined further.

American Eagle hopes to cut its manufacturing costs significantly. Recently, the company began moving some production out of China, where wages are on the rise, and into cheaper labor markets in Cambodia and Vietnam, which are increasingly able to make hoodies and T-shirts in their factories. American Eagle is still moving cautiously in Southeast Asia, but it believes it can shave 4% to 8% from its per-garment production costs at its Chinese factories.

Next year about 10% of embroidering will be done in India, another new territory for the company. India "is really emerging for us," says Chief Executive Jim O'Donnell, who recently hired an agent there to scout the countryside for small operations that specialize in embroidery and bead sewing at lower costs than those in China. He also concedes that "the countries have very limited infrastructure," but is confident time will eliminate the kinks.

American Eagle plans to entice its customers with brighter colors, hipper silhouettes and ruffles on women's tops for spring. But it's cutting out a few things it hopes its teen customers won't miss: the ribbon that lines the waistband of its khakis, for example, and the color pattern on the material used for its jean pockets.

Changing pockets and eliminating ribbon saves only eight to 10 cents a garment, the company says. But eliminating relatively invisible features allows designers to add hip, visible details -- like embroidery on the back pockets of denim jeans -- that are more likely to lead to sales.

Swamped by low-end competitors like Old Navy, the specialty retailer realizes "we can't be the cheapest in the mall," says Mr. O'Donnell. "If they wash it twice and it falls apart, they'll say it's not a good shirt," he says. "There's a fine line between price and value."

Source: Casey, Nicholas, “Fashioning Ways to Hold Down Prices,” Wall Street Journal, February3,2009.