We’ve all heard the world is flattening and globalization is the next big business driver. What does that mean to food manufacturers and, in particular, to their supply chains? Will globalization be the new road to manufacturing efficiency?
Not so long ago, food industry leaders believed globalization would not significantly impact US manufacturers because: We are the largest market; we grow most of the raw materials; transportation costs are too high to ship food long distances; food is fragile and must be delivered to the consumer quickly; and too many unknown hazards exist within foreign manufacturing sectors.
Globalization has moved to the forefront with the emphasis on food manufacturers’ supply chains and how they are being impacted today and in the future. The consensus of those interviewed for this article is that the impact on food manufacturing is significant, but it is being applied differently based on the nature of a company’s business. However, that impact will continue to grow and must be understood to facilitate good business decisions.
According to Jim Hurley, president and CFO of Vegetable Juices, Inc., “Globalization is the process by which the economies of the world’s nations are becoming more closely integrated, particularly through trade, technology and financial flows across borders.” It is reducing the old artificial boundaries and opening up free trade between nations at a rapid pace.
From the field to the shelfAs food manufacturers look for more efficiency, many are choosing to offshore raw material sourcing, as well as food manufacturing, to suppliers in other parts of the world. Clearly, international companies have manufactured products for their local markets and regions in local factories for decades. Now, they have the opportunity to produce products for transport to the US market for US food manufacturers. Several strategies are being employed.
Dr. Angel Cabrera, president of the highly regarded Thunderbird’s Garvin School of International Management, states that “Capital will flow to where it can be used best-is a basic principle in globalization today. First, a country has to create a competitive difference which will provide an advantage to manufacture products in that locale. These advantages have traditionally been less expensive labor-but now may be less expensive or better raw materials, more creative sources of productivity, or even government incentives.” Then companies will invest the necessary capital to take advantage of this opportunity, he says.
Outsourcing shiftThe US food manufacturing industry has continued to outsource a portion of product manufacturing over the past years. Typically, major companies contract from 20 to 35% of their total production, whereas smaller companies may actually contract all production to avoid capital investment and take advantage of a contract manufacturer’s expertise. Key advantages of outsourcing include new product introductions that would otherwise require capital and space internally; the final production of foods in their “twilight” phase (where the demand is on a continuous decline); and the use of existing capacity in a selected contract manufacturer. Contract manufacturing is not new to food companies, but where the contract manufacturing lands is shifting.
“More work and value in the supply chain can be done globally” says John Church, vice president of supply chain operations for General Mills, “but the question is at what cost and quality?” A number of US food companies believe that foreign companies have great plants and technology, good workers and an evolving management talent base.
One strategy is to infuse capital into local partnerships or extended supplier relationships. The result is the manufacture of higher value ingredients, more intermediate or “base” products that will be shipped to the US plants for finishing and final products manufacturing for shipment to the US distribution system.
Lower labor costs have been the incentive in the past. But typically, labor is only 15 to 25% of the total manufacturing cost. Over time, labor costs tend to equalize, and lowest cost labor shifts to another part of the world. Labor cost is only one consideration for off-shoring manufacturing.
Retailers are taking a different approach by outsourcing private label or store brand products manufacturing to foreign plants with the goal of getting a desired price point on the shelf. In this case, the retailer typically has no capital risk and can control production quantities based on actual demand, not just initial forecasts.
According to Diane Wolf, vice president of global engineering for Kraft Foods, “A number of foreign manufacturers are continuing to ‘move up the value chain’ by producing more complex products and enhancing the value of ingredients. Examples are coffee bean producers moving to freeze-dried coffee for export, high-quality fruit concentrates and total custom spice blending. The objective is earning a bigger share of the profits through this value creation.” Clearly some ingredient suppliers are now leveraging their traditional advantage in new ways.
Does this mean US food manufacturing will become obsolete in the future? Most likely not, but there will likely be a period of correction as US companies find ways to exploit the opportunities of globalization. This global view will force continuous improvement everywhere. Outsourcing is viewed as a source of productivity in some sectors. Automation will continue to drive costs down everywhere, especially with sufficient capital investment in the capital-intensive food manufacturing business. However, it is likely that external manufacturers will play a larger role in manufacturing process and capability.
As companies increase investments with overseas manufacturers and suppliers, several strategies should be considered to better manage the risk. The global marketplace is rapidly changing and highly volatile. Investments can be made incrementally to create only the needed new manufacturing capability, without building new fixed costs. New joint ventures or partnerships will spread the risk to your partner-an additional incentive for success for both parties. “Projects and investments need to be made more flexible to reduce risk and increase the potential returns,” says Hurley. “The greater the uncertainty, the greater the value of flexibility.”
Raw material sourcingRaw material pricing continues to be a significant issue for food manufacturers. The recent food-versus-fuel debate is a great example of the global impact to ingredient pricing. Ethanol production is projected to consume 30% of the corn crop by the year 2010, up from 14% last year, according to the USDA. Farmers are shifting to planting corn, with more acres planted this year than at any time since World War II. However, the resulting impact is less soy beans and wheat being planted, increasing those and related commodities prices. Next year the European Union has stipulated that 6% of all diesel fuel produced in Europe must be biodiesel-up from a level of 2% today. In the US, California wants all gasoline to include 10% ethanol starting in 2009, and the US Senate passed energy legislation calling for increased use of ethanol in the future. The demand for corn and other grains can also be impacted by other global events such as a possible drought in China or elsewhere that could send more US corn overseas.
Recently, Mexico was forced to put a price cap on tortillas at $0.35/pound to control the impact of corn price increases. A similar impact can be seen in Brazil, where competition is underway for sugar cane for either cane-ethanol or for sugar production.
Food companies are looking at the impact of diversified growing regions and the diversification of foreign currencies for advantage in the raw material supply. Global seasonal differences can mean fresher ingredients throughout the year, and can manage the risk of crop failures due to droughts and shifting climatic changes. However, the extension to regional agriculture also can increase the complexity of managing future supply chains.
Another future driver could be the availability of land for organic farming. Much of the current farm land in the US would require significant time and effort to be certified organic. However, land in South America and Africa could be future sources for organic crops as their demand continues to grow globally.
The scenario may be that foreign companies will increasingly supply the US with raw materials, or US food manufacturing facilities may locate closer raw material sources. Future sourcing decisions may well be based on raw material quality and costs-not just labor.
Distribution and transportationThe continued rise of multi-national companies has resulted in more efficient transportation systems. New and expanded freight lanes are now available. The size of the Panama Canal will be doubled in the near future. Houston, one of the primary ports of entry for Wal-Mart imports, is also expanding. The result is transportation cost, in itself, will not be a barrier to off-shoring food manufacturing. However, transportation costs remain dynamic and will most likely continue to rise because of increased demand and rising energy costs.
Free trade agreements and preference programs (such as NAFTA, MERCOSUR, the European Union, WTO, Codex, etc.) have created new opportunities for the advantageous movement of ingredients and food products around the world. The elimination or lowering of these traditional barriers has significantly impacted the overall economic analysis of sourcing decisions. These agreements must be understood and integrated into US food manufacturers’ sourcing strategies.
Opportunity knocksThere are many opportunities for food manufacturers who effectively manage global supply chains. As new supply chain capabilities emerge, companies are taking a closer look at what they must make internally and what they can outsource.
There may be an opportunity for fresher products in the market. For example, building a cheese plant in the Middle East, but shipping the raw material (milk) from Australia.
Will a future concentration of capital create new knowledge and capabilities centers in new regions, such as the pharmaceutical industry’s concentration in Puerto Rico?
There is an opportunity to ship intermediate or finished products directly to the US plants for final processing/packaging close to the market. This may create “buffers” of supply in the supply chain.
Speed and agility will be key, and foreign plants may offer increased capabilities to source more complicated consumer-demanded products, such as assembled meal kits.
Sourcing value-added products in global locations allows for a focus on internal capabilities, protecting and enhancing core products and developing next generation products.
Alternative sourcing locations may allow for early production of products that have not yet been proven in the primary marketplace, with minimal financial risks. The resulting knowledge and experience can then be scaled up for major production once the product is proven.
Global organizations can provide other sources of knowledge or best practices. For example, one major food company has seen continuous improvement best practices from operations in Turkey.
The need for infrastructureGlobal supply chain management requires significant infrastructure. Certainly information systems are a key example. They must provide consistency and standards for not only production, but for product quality. They must focus on better forecasts due to the longer delivery lead times and address the seasonality of sales to an even larger degree. Decisions must be made as to where to ship the product. Advanced scheduling techniques are critical to an integrated supply chain. Lot tracking and traceability capabilities become even more complicated, but are critical to ensuring food safety as well as the reputation of the corporation.
PLM (Product Lifecycle Management) systems must be current and used across the global supply chain. With changing formulations and processing requirements for products being made across multiple geographies, a comprehensive PLM system is a necessity for the new expanded supply chain.
“Technology is essential to overcoming the barriers and achieving the benefits of globalization,” says Rory Granos, director of industry and product marketing for Infor. “Many companies just got ERP implemented and now must understand they must be demand-driven to compete in a global environment.”
IT systems are available for all size companies, not just Fortune 100 firms. However, some modules are not found in just one supplier. Granos cites the example that plant scheduling and production planning modules are not currently available from SAP. But they must be integrated with all elements of this new extended supply chain-whether they are “owned” by the food company or contracted to raw material suppliers and external manufacturers for actual production. He believes the keys to success are “quality, compliance and sustainability” as companies go more global.
A new perspective“We are seeing the unfolding of unintended consequences for the food industry’s shift, as we choose new partners and sources of supply,” says Hurley. “For the true paradigm shift to occur we must have effective regulations, the technology to support the extended business and an advantage that supports the general market need-all three elements are essential.” Leading food companies have already started, and others will follow once they determine their new business strategy and how to manage it.
A number of strategies are underway to improve overall supply chain costs for US food manufacturers. Some companies are just putting their toe in the water to check the temperature. Others are taking best practices from international businesses and reconfiguring where they source their raw materials and where they choose to actually manufacture their products for the US market. There is not one answer or direction for the food and beverage industry-and there probably never will be. Each company must address its own business requirements.
Without question, today’s world is flatter. Savvy manufacturers are rethinking how the supply chain will work. There are risks to be managed and new relationships and strategies to be developed. However, it is important to remember that any advantage is only temporary in nature. For a company to stay competitive, it must continuously learn and adapt to the next opportunity.
Not without risksAlthough there are many opportunities for US food manufacturers to offshore parts of their supply chains, there are also risks to be managed. Possibly the most significant risk is guaranteeing food safety. The recent pet food recall in North America is a good example of this. How do processors monitor and control a supply chain stretching around the globe?
Companies must have expanded traceability and tracking capabilities not only to ensure food safety but also to deal with counterfeiting of products and packages. Today’s low-cost source may not be tomorrow’s low-cost location.
Volatile dynamics are constantly changing the market and business environments.
Social and environmental compliance must be managed to protect the corporation’s reputation and image, now including your global “carbon footprint.”
Here are a few examples of risks to be managed in a global supply chain:
1. How long can a supply chain be and still manage “out of product” events due to inaccurate forecasting?
2. Political volatility in a country equals potential supply chain volatility.
3. How do you secure the transport of your products between producing locations and intended destination?
4. Do you understand the different cultures and values and how their behavior impacts your business relationships?
5. How do you ensure your product and ingredient quality requirements are met each and every time?
6. How do you manage concerns with product shelf life and fragile product damage?