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Beyond BRIC: Opportunities in Global Markets for Premium Beauty & Personal Care

Posted on January 10, 2012

For global beauty and cosmetics companies, emerging markets present an attractive target as consumers yearn for luxury products and premium brands. Developing global markets have been the buzz in the industry for some time – especially the usual suspects, i.e. the BRIC countries – yet few have explored the dynamics that define these markets. Through our exclusive analysis, The Smart Cube has identified the top performers beyond the BRIC quartet, enabling you to pinpoint the best opportunities for growth.

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The Outlook for the Brazilian Real

Posted on August 18, 2011

Recent oil discoveries, the hosting of the 2014 World Cup and the 2016 Olympics, as well as improved sovereign ratings from credit agencies, have firmly placed Brazil as a ‘must-have’ investment in every emerging market focused portfolio.

However, investor interest in the country has actually been growing significantly over the last decade or so when Brazil first featured among the fastest growing emerging economies – the BRIC economies. The decade has been marked by stable macroeconomic policies – particularly the move to a floating exchange rate regime, stemming of inflation and improved credit availability – all leading up to the emergence of a larger middle class with the buying power to drive demand for homes, durables, cars, and beyond.

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Understanding the Recent Growth in Food Prices

Posted on August 18, 2011

The last year has seen an all too familiar pattern of food price hikes, not dissimilar to what we experienced back in 2007-2008. The 2008 food price hikes were driven by several factors, including high oil prices and the increasing use of biofuels driven by growing global demand. As crude oil prices exceeded $150 a barrel, logistics and fertilizer costs (both highly oil dependent) had a direct impact on food prices.

However, the 2010 food price hikes, and the subsequent increases that followed towards mid-2011, were not as significantly impacted by oil. Per-barrel prices averaged at around $83 during the second half of 2010, reaching $108 in May 2011. In fact, the current upswing is driven by a different and somewhat more volatile issue: bad weather. Indeed, the prevalence of adverse and unpredictable weather has developed into a global phenomenon that threatens food production across all major agricultural centers.

A popular topic among environmentalists, government officials, and scientists, the unfavorable weather experienced in the recent past is attributed to climate change, specifically global warming, brought about by increasing greenhouse gas emissions. Waves of snowstorms, droughts, and floods – all part of the changing climate – significantly damaged food crop yields in 2010. Moreover, adverse weather is increasingly likely to hamper food production during 2011 as well.

In essence, ‘bad’ weather has led to a poor harvest which has driven food prices up.

According to the UN Food and Agriculture Organization (FAO), the Food Price Index (FPI) increased by 34.1%, between July 2010 and May 2011, and by 29.3% during the second half of 2010. During this period, key food producing regions were impacted by either heat waves or massive floods. These adverse weather conditions have resulted in poor harvest yields, leading to price increases across several key food categories:

  • In Australia, floods damaged wheat crops, forcing farmers to convert most of their high grade stocks to animal feed; sugar prices also increased on the island continent in early 2011, based on the expectations of a lower sugarcane yield, as an aftermath of Cyclone Yasi (which struck major Australian production regions during January and February 2011)
  • In South-East Asia, flooding impacted Malaysian palm oil production, increasing the prices of cooking oil, commonly used throughout emerging markets within the region
  • In India, heavy rains during the 2010 monsoons caused a significant amount of damage to its stored wheat and rice stocks. According to some industry experts, prices for these grains might spike if the country starts importing as a result of lower stocks
  • In 2011, floods in the US South and Midwest have significantly damaged rice and corn plantations, impacting around 6.8 million acres of land, according to the US Army Corps of Engineers
  • In China, severe flooding in June 2011, across the eastern, southern, and southwestern regions (covering 432,000 hectares of land) resulted in a 20% year-on-year decline in vegetable output, driving price hikes for grains and vegetables
  • In addition, in 2010 and first half of 2011, about one fifth of the world’s land area (including parts of China, Russia, Europe, US, and South America) experienced unprecedented heat-waves and droughts
  • Record high temperatures registered in Russia reduced yields from grain crops by over 30%, destroying around 30 million tons of grain in 2010; heat had the same effect on wheat crops in most countries of the former Soviet Union, including Ukraine and Kazakhstan
  • Two of the largest corn and soybean exporters after the US (Argentina and Brazil), have also witnessed severe droughts, which pushed prices higher into 2011. Towards the end of 2010, analysts from Econometrica, an international consulting company, announced that they expected the extreme drought to reduce Argentina’s 2010 corn yields to 19 million tons, a 16% decrease over 2009
  • Massive heat waves in China have also caused droughts which threatened wheat production. According to the UN FAO, close to 36% of China’s wheat fields were affected by droughts that hit the country during the 2010-2011 winter season; further, in May 2011, the Chinese Office of State Flood Control and Drought Relief Headquarters reported that around 7 million hectares of arable land were impacted by the 2011 drought
  • In Western Europe, record droughts are expected to significantly impact the production of grains, particularly wheat. The 2011 spring was the warmest to hit the UK in the last 352 years, while France witnessed its driest season in 50 years; droughts are also expected to affect food crops in Germany and the Netherlands
  • Spring droughts, recorded in 2011 across the US, are likely to damage wheat production in the southern plains, including Texas, Oklahoma, Kansas, and Colorado

While undoubtedly a key factor, weather has not been the only driver in this issue. Several other issues have, and are, impacting food price volatility, including high risk-carrying commodity trades, inefficient management of agricultural plantation space, and poorly established energy policies regarding biofuels.

According to some industry experts, speculative commodity trading is another key driver of food price hikes. Speculators engage in trading commodity futures expecting to make a profit. This typically has a positive implication for the parties involved in grain production, as it stabilizes prices and creates demand. However, the introduction of commodity index funds made the situation more complex. These index funds can create artificial demand for commodities, as fund managers open long positions on various grain commodities and then proceed to further trade their promise of purchasing grain stocks for another contract that expires later in the future. It is this ‘false’ perception of higher demand that then causes food prices to rise.

Another factor that drives food prices is the limited availability of arable land, as food grains compete for production with other agricultural products such as soybeans. This issue is further aggravated as both soy and grain require rapid expansion to meet future consumption volumes. Demand for soybeans, used mainly as an ingredient for livestock feed, is growing at an annual rate of around 6%. This has led to a significant increase in the amount of land used for soy plantations. In the US, more land is allotted to soy than to wheat, while in Brazil, land used for soybean production exceeds areas growing all types of grain combined.

Growing demand for biofuels is the third key influencer of high grain prices. Since crude oil is expected to become increasingly more expensive in the medium term, usage of biofuels will only increase. In the US, growing adoption of biofuels pushed up demand and the prices of corn and sugar. According to the US Department of Agriculture, demand for ethanol in 2011 is forecast to grow by 5.1% over 2010, which will put further pressure on corn prices. It also reported that, in the US, around 35% of corn harvested in the 2010 season was used for biofuel production (likely to increase to 38% in 2012).

Broader Considerations

High food price volatility has complex implications even beyond the global economy. The surge in prices increases the vulnerability of economies, especially those that rely on food imports, or that have a limited budget allocated to food expenditure. This is the case in many politically unstable regions around the world, including Northern Africa and the Middle East.

(In fact, the upswing in food prices was one of the key drivers behind the riots that led to the downfall of Tunisia’s president, Zine el-Abidine Ben Ali. Growing food prices have also ignited numerous protests throughout Haiti, Somalia, Burkina Faso, Morocco, Algeria, and Pakistan. In Africa, rain-fed agriculture yields in many nations across the continent are forecast to halve by 2020 as a result of climate change, according to the 2007 Assessment of the Intergovernmental Panel on Climate Change.)

The escalating threats brought about by spikes in food prices have compelled many countries to stockpile large quantities of food. For example, towards the end of January 2011, Indonesia purchased around 800,000 tons of rice, and lifted import duties on rice, soybeans, and wheat. During January the same year, Algeria bought nearly 1.8 million tons of wheat. The situation is perhaps more serious than previously thought. Aside from encouraging imports, some countries place caps or completely ban grain exports. Russian officials, for example, imposed a ban on all grain exports until the end of the 2011 harvest season (having since announced their plans to lift the ban by July 2011, on account of a recovery in grain production). The ban was issued as a result of record droughts that have devastated approximately 9 million hectares of land. Following this announcement, Ukraine, another leading exporter of grain, imposed quotas on its grain export shipments. Such moves only add additional pressure on grain prices.

Implications

The implications of the above are there in the numbers.

The US Department of Agriculture stated that world grain productivity declined by close to 3% from 2008-2009 to 2010-2011, with wheat productivity falling by nearly 6% during the period. As harvest yields went down, food prices started to rise. The FAO announced that its FPI reached 231.4 points during May 2011, a 36.5% increase year-on-year. However, the real growth is seen when comparing to historic levels – the December 2010 index values were the highest since July 2008, while the February 2011 records (around 238 points) were the largest ever registered since the index first started in 1990.

With poor yields expected for this year’s harvest due to harsh weather, a relief in prices of food commodities, unfortunately, seems unlikely. With such a strong correlation between the weather and food prices, it will be interesting to observe the regulatory changes in the import/export caps for some of the large producers as well as consumers of food grains.

Clearly, a number of questions remain to be answered – What solutions are governments around the world developing in order to avert further price hikes? Could food commodity trading be regulated? What are the geopolitical implications of this latest food crisis? How will rising food prices impact global companies’ food supply chain strategies?

While the answers to these questions remain the subject of much debate, there is no doubt that they will remain topical for some time to come.

Author: Cristian Jorza, Strategic Services Practice

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Africa – A Closer Look

Posted on August 18, 2011

Africa is a continent that evokes a wide range of perspectives, from the cultural to the political to the economic.  In all of these different, yet interrelated ways, it is clearly a force to be reckoned with. Consider a few simple facts:

  • Africa accounts for more than 35% of the planet’s natural resources, 6% of the Earth’s total surface area, 20.4% of its total land area, and about 15% of the world’s human population
  • The western and northern parts of Africa have continued to be oil and natural gas hubs, while sub-equatorial Africa leads in the production of hard minerals.
  • Such fuels and hard minerals are abundant and have represented the mainstay of African economies – more than 60% of the economic earnings of countries such as Algeria, Angola, Botswana, Gabon, Guinea, Libya, Namibia, Niger, Nigeria, Zaire, and Zambia; and 50% of the export earnings of countries such as South Africa, Ghana and Egypt

While much economic attention has been focused, over the last couple of decades, on the emerging markets of Asia and the Middle East, Africa represents, for many, a still hidden economic gem.  The focus of this article is to provide a glimpse into its economic characteristics, providing the reader with a better understanding of the African continent.

The View from the Continent

Africa is a study in contrasts.  While some countries on the continent have indeed stagnated, many others have shown tremendous opportunity, growing at above global average rates.

With a billion people and GDP of more than $1.6 trillion (as of 2010), Africa’s contribution to the world GDP is in the region of 2%.  However, it is anticipated to play a vital role in the years to come and the GDP is likely to reach $2.6 trillion by 2020.

Driving the collective economy, agriculture, fuels, and minerals have been the major source of revenue for African countries, while manufacturing and services are slowly on the rise.  Raw materials, though, continue to contribute more than 60% of total sub-Saharan exports. (As one might expect, countries in Asia (particularly China) have become major trading partners.)  Countries such as Guinea, South Africa, Botswana, Zimbabwe, Tanzania, and Zambia continue to play a vital role in the metals and minerals markets.

Furthermore, 70% of the labor force of more than 20 countries across the continent is driven by agriculture:

  • Commodities such as sugar, maize, cassava, sorghum and rice are some of the major crops grown across the continent.
  • In addition, the western parts of Africa have started emerging as a regional hub for organic agricultural methods – countries such as Burkina Faso and Benin have slowly started competing against Asian countries such as India in the organic farming landscape.
  • Countries such as Kenya and Morocco continue to export cut flowers and fresh vegetables to European countries.
  • Namibia has started competing against the likes of Brazil and Argentina in exporting boneless beef to countries within the EU.  (In Namibia, producers have ensured full traceability and strict veterinary and animal welfare standards to meet EU requirements.)

Big Picture Characteristics

One way to consider the nature of the African continent is to look at the nature of its economics from a regional perspective.  As such, one can consider the continent in four parts, as follows:

Northern Africa:

  1. 1. Oil reserves
  2. 2. Emergence of real estate markets
  3. 3. Proximity to Europe

Eastern Africa:

  1. 1. Natural resources – chemicals, paper, pulp, fish, oil etc.
  2. 2. Investment hub – for the pharmaceutical industry, machinery, etc.
  3. 3. Privatization on the rise

Southern Africa:

  1. 1. Natural resources – Precious metals such as gold, diamond, etc
  2. 2. Higher literacy rate as compared against the other African countries
  3. 3. Tourism

Western Africa:

  1. 1. Natural resources – oil, chemicals, paper, pulp, etc.
  2. 2. Agricultural products – organic agricultural products such as cotton

Another way to look at Africa is to consider its economic characteristics at a more holistic level, which illustrates a clear alignment of encouraging factors that are and will continue to influence economic growth going forward.  This is illustrated in the following chart:

The Country Level

Of course, Africa is difficult to look at as a collective whole, given its tremendous diversity (defined in all its different ways).

Looking simply from an economic perspective, there are clear ‘centers of economy’, if you will.  Countries such as South Africa, Nigeria, and Egypt account for more than 44% of Africa’s total GDP.

GDP Segmentation – Select Countries (2010 Estimates) Africa’s Total GDP Segmentation

Country Agriculture Industry Services
 Morocco   17.1% 31.5% 51.4%
 South Africa 3.0% 31.2% 65.8%
Nigeria 31.9% 32.9% 35.2%
Mauritius 4.8% 24.6% 70.6%
Kenya 22.0% 16.0% 62.0%
Ghana 33.7% 24.7% 41.6%
Egypt 13.5% 37.9% 48.6%
Tunisia 10.6% 34.6% 54.8%

Furthermore, a host of key facts point to the tremendous opportunity represented by the African Economy:

  • As of 2010, 40% of Africans live in urban areas, a similar proportion to China’s and one thatis continuing to expand
  • By 2030, the continents’ top 18 cities could have a combined spending power of $1.3 trillion
  • By 2015, BRIC countries (Brazil, Russia, India, China) –African trade will increase threefold, to reach $530 billion from $155 billion in 2010
  • BRIC’s share of Africa’s total trade will increase from one-fifth as of 2010 to one-third by 2015
  • BRICS foreign direct investment stock in Africa will swell to more than $150 billion from around $60 billion today

World’s ten fastest growing economies (Annual Average GDP Growth, in %)

2010-11 GDP Growth, in % 2010-15 GDP Growth, in %
Angola 11.1 China 9.5
China 10.5 India 8.2
Myanmar 10.3 Ethiopia 8.1
Nigeria 8.9 Mozambique 7.7
Ethiopia 8.4 Tanzania 7.2
Kazakhstan 8.2 Vietnam 7.2
Chad 7.9 Congo 7.0
Mozambique 7.9 Ghana 7.0
Cambodia 7.7 Zambia 6.9
Rwanda 7.6 Nigeria 6.8

A SWOT Analysis of the African Continent:

While there is much to be positive about when it comes to considering Africa, there is no doubt that there is much to be done before Africa is perceived in the same vein as the Asia-Pacific markets have been in recent years.  Hence, a thoughtful SWOT analysis is important to ensuring a business effectively positions itself with regards to operating in the region:

Strength:

  • Presence of a very large talent pool with multi-lingual capabilities
  • Abundant natural wealth in the form of oil reserves, minerals, metals, fertile land, etc.
  • Large inflow of FDI from countries such as China, India, and Europe
  • Highly cost competitive
  • High regional co-operation for infrastructure services
  • Emergence of service-oriented sectors in telecom, e-governance, etc.
  • Emergence of organic agriculture

Weakness:

  • Penetration of internet and telephony is not widespread
  • Challenges in setting up businesses and hiring people
  • Lack of quality educational institutions

Opportunity:

  • Africa is positioned as a nearshore destination for European countries
  • Emerging IT/ITES services would propel the growth of the continent in all directions
  • Africa – by virtue of its sheer size, resources and economics – continues to act as a long term investment yield for sectors such as telecom, agriculture, services etc.

Threats:

  • Natural resources should be effectively and carefully managed considering national and regional economic security considerations
  • Emergence of other low cost countries in regions such as Latin America and Eastern Europe
  • Presence of regional politics, adding to existing operating turbulence

To attract more investors and companies, various African governments’ have started projecting themselves as friendly destinations for global businesses.  Such governments have started highlighting their role in the development of their communities and ensuring political stability so as to transform the perceptions across the world of Africa.  Governments have also started improving infrastructure and are focused on making the overall business environment more conducive to investment and long-term economic stability.

Indeed, Africa is clearly working hard to position itself as a ‘continent to consider’, by showcasing its natural advantages and its tremendous potential for economies across the world.  Africa could be the next ‘China in the making’ by acting as a hub for both finished products and raw materials.  In adition, the services sector is anticipated to drive the region forward, and likely to witness a boom with the further growth of the telecom sector.

Africa – The Next Outsourcing Frontier

Recent years have seen the emergence of the southern part of Africa as a hub for service-oriented sectors such as Business Process Outsourcing.

Africa’s geographic positioning is such that it can act as a gateway to the European Union and countries across the Middle East.  Its time zone maps to a majority of the countries in Europe, one of the most significant foundational drivers for the service sectors’ evolution in recent years.  Furthermore, historical European engagement within Africa has resulted in a range of language capabilities including English, French, German, Portuguese, Spanish, and Italian.  (The countries across North Africa were considered to be highly stable until the escalation of the Middle East crisis recently. As such, countries in North Africa have been the favored destination for French language call centers.)

Many Governments in Africa also provide liberal incentives and support for Call Center companies to set up bases within their cities.  In some cases, even US companies have benefitted by shifting their call centers to the African continent from India, as the work can be done via an evening shift as opposed to a late-night shift in India (with its resultant quality, control and attrition considerations).  From a cost perspective, a contact center operation within the African region will be at least 10-20% lower than a similar offering in India.

It is true, though, that initial investment costs (including infrastructure) can be significant (sometimes offsetting the pricing advantage), lower attrition and demand pressures can play a significant role in making African countries a more favorable outsourcing destination.

With increasing technology proliferation and education levels, it is only a matter of time before Africa emerges as an outsourcing destination to be considered in parallel with today’smore established markets.


Author:  Subash Chandar, Strategic Services Practice

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Delinquency Modeling Using Survival Analysis

Posted on August 18, 2011

For financial services organizations in the business of lending, understanding which customers should be granted a particular loan, and, importantly, how much, has been a central question that not just drives their profitability, but, as we have seen in the last few years, their very survival.

To this end, traditional predictive models such as linear regression, logistic regression, CART/CHAID, have been quite useful. However, it is possible to add an additional dimension to this analysis, through the incorporation of Survival Analysis, another name for ‘time-to-event’ analysis. Survival Analysis is a technique widely used in medical research, where the interest is in observation till such time that the subject of the research expires.

Applying Survival Analysis thinking to model the predictability of delinquency of loans can provide lending institutions with fundamental insights, to decide whether or not to sanction loans and, if so, then how much.

The first step in any traditional analysis is to understand the “Through The Door” (TTD) population from the existing base of customers whose application was approved or rejected. This includes delving deep into their demographics and loan related variables such as loan tenure, rate of interest, etc. of the approved applicants to identify any particular patterns across these variables. Thereafter, straight forward modeling techniques such as CHAID, logistic regression, etc. are used on the existing base of customers. Based on the probability of default, generated by the model, a decision is then taken on the likelihood of a new applicant defaulting. This is the often-used approach to identify and eliminate those who are more likely to become delinquent. However, this methodology can be enhanced significantly.

The types of analyses discussed above are solely focused on the likelihood of an applicant becoming a ‘defaulter’. The time of default does not enter the equation. The ‘Time of Default’ is defined as the time at which a customer turns delinquent. For instance, there could be two individuals with their chances of defaulting at 60% and 65%. If the lending institution chooses a default cut-off screen of 50%, both would be classified as defaulters. If, however, their time of default is also considered, than it is entirely possible that the individual with the 65% chance of defaulting might turn out to be a better ‘prospect’, as his/her default could be occurring much later.

Survival Analysis takes into consideration time to default, while computing the probability of default. This involves identifying the number of defaulters at different time intervals. The estimated ‘survival time’ of a person (the time until a person defaults on the loan) coupled with his/her probability of default at that time, turns out to be more meaningful and useful than just knowing the probability of default.

Further, at each time interval, Survival Analysis computes the probability of default. This enables the estimation of ‘time-wise’ default rates and provides a better sense of the risk involved in lending to the specific customer. For instance, based on our statistical modeling we get a sample of customers whose likelihood to default is more than 50%. Then these “bad” customers are further analyzed to see the time at which these customers are likely to default. The survival distribution chart below provides an illustration. Time is represented on the X-axis while the proportion of customers who remain non-delinquent is represented on the Y-axis.

At time t=0, 100% customers are non-delinquent. As time increases, the delinquency rate increases. At time t=3, about 22% customers are delinquent. This percentage increases to about 45% at time t=5. From time t=8 onwards the delinquency rate remains constant at about 70% and moves to 100% at time t = 22.

Using survival analysis to understand “when” a customer will go ‘bad’ rather than “if” the customer goes bad offers the following unique advantages:

1. It allows for estimating when default occurs, which helps in calculating the profitability of an applicant (profitability in terms of the payments the applicant would make before turning into a defaulter)

2. It provides help in deciding the tenure of the loan

Author: Nitin Jain, Data Analytics Practice

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Precious Metals – The Outlook for Silver and Gold

Posted on August 17, 2011

“The ultimate asset bubble.” This is how George Soros described gold last year, even as his fund took sizable long positions in the precious metal. Why not take advantage of rising values (so long as the bubble doesn’t burst), particularly when a host of central banks have boarded the bandwagon – the latest being Mexico, Russia and Thailand along with India and China. The main motive for these banks has been diversification of reserves away from the US Dollar, which typically accounts for 70% of holdings, with the rest in other currencies such as the Euro, Yen, Swiss Francs, and, of course, bullion which is mainly gold.

However, it isn’t only gold that is experiencing rising values but its closest associate, silver, as well. Considered now by some as another ‘safe haven‘, silver is, in many respects, an indispensible commodity for industry as a whole. Silver has wide industrial applicability, particularly in traditional sectors such as electronics as well as newer areas such as solar panels (the use of which seems to be growing with further demand from Emerging markets). It is much more affordable than gold and has shown high volatility, rising exponentially – to $49.85 on April 25th, 2011 from $16.46 on March 1st, 2010 and then falling. It’s now trading at a relatively lower level of $40.3 (Spot Prices from NY exchange as of 26 July 2011 : Source Bloomberg) (This is not the first time that silver has shown this level of volatility. It had reached a record high back in January 1980 as the Hunt brothers tried to capture the market, but fell drastically when the leverage rules were changed, leading to the famous Silver Thursday event.)

Clearly, precious metals have become a key portfolio ingredient, whether for central banks, hedge funds or the retail investor. What’s more, their rapid price rises can seem ‘bubble-like’ – certainly, such increases are very much the case for all assets that experience speculative build up. The current price pattern exhibited by silver recalls the same pattern exhibited by oil prices, which rose close to $150 and fell back down to below $40 a short while ago.

So When Does This Rally End?

To understand when the rally will end, one needs to look at all of the different factors that drive overall fundamental, as well as investment, demand for both gold and silver. Specifically, precious metals – in particular, gold – can be used as both an inflation and volatility hedge as well as a safe haven. While there are many reasons for their price increases, these two plus the demand from key market players, have had the greatest contribution.

Safe Haven:

During periods of high volatility, market participants’ have a tendency to flee to ‘safe’ instruments such as the US Dollar, the Euro, US Treasuries or gold. These could be periods of financial crisis such the credit crisis of 2007/2008, geopolitical tensions such as in the Middle East or North Africa, or natural disasters as in Japan and New Zealand. However, with the current state of the US and European economies – with very high levels of debt – the outlook is slowly shifting. Perceived risk levels are shifting and the S&P has even changed their outlook from stable to negative for the US, and downgraded some EURO Zone countries.

These factors are making market participants raise concerns about the viability of US and European currencies as safe haven assets. Consequently, gold and silver are gaining prominence as significant components of investors’ portfolios. The indirect correlation between gold and the US Dollar (since gold is priced in US Dollars and hence, as the US Dollar depreciates, gold prices rise automatically) is definitely helping the cause. This relationship can be seen in the chart below, which shows gold price movement on the left axis and Dollar index on the right.

Dollar index: A measure of the value of the U.S. dollar relative to the majority of its most significant trading partners. This index is similar to other trade-weighted indexes, which also use the exchange rates from the same major currencies (source- Investopedia)


Inflation Hedge:

With the credit crisis of 2007, governments around the world began to take action to avert economic decline. Stimulus programs were launched, while central banks offered low borrowing rates and undertook quantitative easing to bring their economies out of recession. In the process of doing this, most countries increased their deficit levels. The combination of stimulus programs and extended periods of low interest rates are now creating an environment where inflation is a major concern going forward.

In such environments, precious metals can become inflation hedges, as we have seen in the past. Consider the graph below, which depicts gold and silver and how each reacted during different market scenarios over the course of time. During the ‘peak’ of the last crisis in March 2009 when the Dow reached historical lows, gold and silver corrected because market participants at that point still had faith in the Dollar. However, when the dust settled, market participants realized that the Dollar was weak due to the levels of US debt and expectations of rising inflation. This led to gold’s current bull run.

There have been many similar instances in the past when there has been a rush to gold. For example during the economic crisis of 1980, when inflation was around almost 10% in the US (albeit for a short period of time), gold recorded an all time high of $1,850 an ounce in today’s dollar terms. The increase in demand for gold is fundamentally due to faith in gold, since it cannot be printed like currency. From that standpoint, there is still room for gold to increase from its current levels, which are still not at its all time high.

Although silver has never been seen as an inflation hedge historically, its high correlation with gold and hence its recent price increases, market participants have started looking at it as an alternative to gold.

Gold and Silver Demand by Different Market participants:

In the first quarter of 2011, central banks have been net buyers and expectations are

hat they will remain net buyers for the rest of the year. Among the major net buyers are the BRIC countries who are adding it to their reserves instead of the US Dollar. Similarly, banks such as HSBC and JP Morgan as well as university endowments, are committing more funds to gold in their asset allocation structure, increasing their allocation from current levels by 50% to 100%.

The following chart shows the amount of gold accumulated by BRIC countries and the Total ETF’s traded worldwide.

Adding further fuel is the fact that The People’s Bank of China is planning to set up new investment funds to diversify its holdings in foreign exchange reserves. As of the fourth quarter of 2010, China’s total reserves reached $2.91 trillion, of which gold represented only 1.63%. This percentage is insignificant when compared with the US’ 75.2% and Germany’s 71.2% (source: Bloomberg). We, therefore, believe that a meaningful sum of capital for the new funds will be invested in bullion and this should be a positive factor for price increases going into the future.

Given gold’s already high price (in absolute terms), market participants are diversifying into silver. The demand for silver has therefore increased worldwide by retail investors, hedge funds and mutual funds alike over the last couple of years. This year, the increase in demand from investors has led to a 25% increase in coins sold by the U.S mint over the previous year. Increasing consumer demand from Asian countries such as India – already the largest consumer of gold and which has now started stockpiling silver – is also adding to its price appreciation.

Outlook:

In conclusion, there seems to be significant demand for gold as a safe haven. Silver, on the other hand, does not enjoy the same status as that of gold, though its movements are highly correlated (94% correlated – see matrix below).

Over the longer term, there could also be a possible pair trading opportunity between the two. One metric to watch will be the Gold/Silver Ratio – which is currently at a historical low. Going by the theory of mean reversion i.e. that this ratio should revert towards the mean, either gold will rise much further than silver or the price of silver will drop.

Pair Trading: The strategy of matching a long position with a short position in two stocks of the same sector. This creates a hedge against the sector and the overall market that the two stocks are in. The hedge created is essentially a bet that you are placing on the two stocks; the stock you are long in versus the stock you are short in. (Source – Investopedia)


With the Fed not in a hurry to increase interest rates and the US Dollar depreciation underway (along with political and financial worries, including inflationary concerns), the rally does not seem to be at an end as yet. Given the myriad of drivers – finite supply of precious metals, falling global currencies, increasing demand from BRIC’s, central banks and investors of different types – it is more than likely that precious metals may just get pricier.

Authors: Arjun Sriram and Nikhil Agarwal, Quantitative Services Practice

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The Cloud and Corporate Computing Capacity

Posted on August 17, 2011

A lot has been written about ‘cloud computing’ as the next megatrend that is set to change the IT landscape.

Cloud computing is defined as a system where scalable and elastic IT capabilities (both hardware and software) are provided as a service to multiple customers using Internet technologies. In other words, think of it as a service similar to that of an electric utility, which allows you to use and pay for only the electricity consumed (as opposed to owning and running your own generator all of the time).

In its short life span, cloud computing has evolved to deploy a range of service models, including Cloud Software as a Service (SaaS), Cloud Platform as a Service (PaaS) and Cloud Infrastructure as a Service (IaaS). While still in its relative infancy, cloud computing is estimated to become a $26.6 billion industry by 2013 from $9.1 billion in 2008, growing at a CAGR of 24%. According to Gartner, public cloud services spending accounted for about 2% of global IT spending in 2010, however, it is expected to account for about 5% by 2015.

Enterprises are expected to spend $112 billion cumulatively on cloud-related technologies such as SaaS, PaaS and IaaS between 2011-2016

In certain segments, cloud computing is taking an increasingly larger share of overall IT spending:

  • In 2010, software as a service (SaaS) accounted for 10% of enterprise applications software spending at about $10 billion, and by 2015 this share is expected to increase to 15% and to exceed $20 billion in annual spending
  • According to a 2010 Gartner survey, companies spend about 10.2% of their budget for external IT services on cloud computing

As you would expect from such a young and dynamic industry, there are a host of new applications coming ‘onto the cloud’ almost every day – including many that were earlier thought to be impossible. Examples of such applications include Mesh by Microsoft (a web-based operating system that connects and sync all your devices (tablets, computers etc.) in the cloud), Animoto (online video creation software), FlexNet (a software licensing tool), LarkC, XenBee, and beyond. (Not to forget Apple’s big announcement of the iCloud.)

From a business operations point of view, one of the most interesting developments that this nascent industry has seen is the opportunity it now presents to corporations for more ‘constructive’ capacity management.

Traditionally, there has been no transparent means to tap excess computing capacity within one organization, by those that need it (for the short term) at another corporation. Usually, when a large organization has temporary excess computing capacity, there is little they can do with it other than let it go unused. Similarly, companies with short term computing needs either had to manage within their available resources or buy additional capacity from specific cloud computing service providers (including for temporary demand spikes).

However, recent months have seen the emergence of a potentially interesting model for more effective capacity management across companies, as cloud computing capacity is now being sold as a commodity on an exchange.

Specifically, February 2011 saw the launch of SpotCloud, which positions itself as the world’s first spot market for cloud computing. The company enables firms with excess computing capacity to sell this capacity to users with short-term needs through a bidding process, much like any other spot market for commodities.

At SpotCloud, sellers put their spare computing capacity on sale while buyers detail their requirements, such as configuration, location and price. SpotCloud matches the orders and makes its margin (up to 30%) on each transaction. Buyer and sellers remain anonymous which helps players such as datacenters sell their spare capacity without impacting their existing sales network.

Other players in this space include Amazon Elastic Compute Cloud (Amazon EC2), a web service that provides resizable compute capacity in the cloud. While SpotCloud is a marketplace for several buyers and sellers of computing capacity, Amazon EC2 is a single seller of its own computing capacity to several buyers. Amazon’s EC2 ‘Spot Instances’ is perhaps the closest competitor of SpotCloud. Spot Instances enable a buyer to bid for unused Amazon EC2 capacity – customers are charged the Spot Price, which is set by Amazon EC2 and fluctuates periodically depending on the supply and demand for Spot Instances’ capacity.

The Impact of Cloud Computing: Selected Facts and Figures

According to Gartner, public cloud services spending accounted for about 2% of global IT spending in 2010, however, it is expected to account for about 5% by 2015

Enterprises are expected to spend $112 billion cumulatively on cloud-related technologies such as SaaS, PaaS and IaaS between 2011-2016

In certain segments, cloud computing is taking an increasingly larger share of overall IT spending:

  • In 2010, software as a service (SaaS) accounted for 10% of enterprise applications software spending at about $10 billion, and by 2015 this share is expected to increase to 15% and to exceed $20 billion in annual spending
  • According to a 2010 Gartner survey, companies spend about 10.2% of their budget for external IT services on cloud computing

How Cloud Computing Will Transform Business

1. Computing devices will become mere instruments to access information from the cloud

  • Proprietary information and software will increasingly reside on the internet

2. Emerging economies will serve as both new markets and competitors

  • Emerging economies, such as China, India and Brazil, with relatively underdeveloped IT infrastructures, would witness higher adoption rates for cloud technologies
  • In line with this, emerging markets would be quicker to exploit new opportunities, skipping the need for managing legacy technologies, unlike developed countries
  • As the cloud empowers mobile devices, these devices will become instrumental to open up sizable new markets

3. Entrepreneurs will embrace the cloud

  • a. Entrepreneurs will utilize the cloud for rapid expansion, shorter entry-to-market and testing product ideas, as the cloud removes limitations of budget
  • b. Small companies would be able to expand into new geographies without incurring huge capital expenditures

4. Information will be available on-the-go

  • The cloud will make Information ubiquitous and available on-the- go

While the initial buzz for such an exchange concept has been positive, there are two key interrelated challenges that need to be addressed by exchange operators to sustain this model going forward:

Ensure disciplined management of the exchange, taking on the onus of delivering a safe and secure environment, whilst explicitly clarifying the duties and rights of buyers and sellers.

Build trust amongst enterprise buyers about anonymous sellers. This could take the form of service level agreements and guarantees to instill confidence in buyers.

Clearly, this market will benefit from players with strong brand value and financial strength, given that trust and security are key to such ‘anonymous’ trades.

That said, though, such issues can be resolved, and in future, we are likely to witness a slew of cloud computing services up for sale on such exchanges, thereby increasing the depth of offerings from what we see today – effectively turning computing into another utility – much like electricity and water to consumers. As a core user of cloud services, mobile users across professions will be able to stay connected – to their organizations and each other – as information is created, stored, accessed and exchanged on real time basis.

Author: Sourabh Gogna, Strategic Services Practice

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Nuclear Energy in Germany

Posted on August 17, 2011

Nuclear energy has been heralded by many as one of the most important solutions to the growing energy demands of the world, particularly given concerns regarding increasing greenhouse gas emissions and the rising price of oil. The popularity of nuclear energy increased in the second half of the previous decade as various countries searched for alternative sources of energy to continue to fuel their growth. The US, for example, is looking to build new nuclear plants to meet its increasing demand and proposals for building thirty additional nuclear plants are being currently considered. As of January 2011, nineteen nuclear plants were under construction in Europe, eleven of them in Russia, one of the fastest growing economies in Europe. China and India, two of the fastest growing economies of the world, have also been looking to increase the production of nuclear energy to meet their insatiable power requirements.

However, the nuclear meltdown in Fukushima, Japan has changed this perspective. Since then, the nuclear energy discussion has been taking place under a cloud of uncertainty, specifically given the potential for plant disasters and the resulting exposure to radioactive materials leading to a myriad of health impacts (including radiation sickness, central nervous system damage, cancer and other impacts). Questions are, in turn, being asked about the safety, viability, and societal costs of nuclear energy production – there have even been a number of protests organized in various countries across the world, from Germany to Switzerland to Taiwan, forcing many governments to evaluate their position with on nuclear energy.

Partly as a result of these protests and other deliberations, in May 2011, Germany announced plans to shut down all of its nuclear plants by 2022, with eight plants closing immediately. The announcement makes Germany the first large, industrialized country to shift completely away from nuclear energy.

This decision by Germany has generated similar responses elsewhere:

  • In Scotland, one of the leading members of the ruling Scottish Nationalist Party said that Scotland wishes to go down the same path as Germany.
  • Not surprisingly given the earthquake impact, Japanese Prime Minister, Naoto Kan, has outlined his intent to do away with nuclear power, a view supported by 70.3% of the Japanese people in a July 2011 poll by Kyodo news agency. The chance of other countries also expressing similar directional views on nuclear energy cannot be ruled out.
  • Also in May 2011, Switzerland decided to place a moratorium on building new nuclear plants and plans to stop using nuclear energy altogether. The date the Swiss have set to achieve this target is 2034, providing them sufficient time to bring about the change.
  • In a referendum in June 2011 in Italy, 94% voters opposed the government’s plan to restart its nuclear program, which had been stopped following the nuclear meltdown in Chernobyl.

Impact on German Energy

In Germany, while the threat to short-term power supply is considered low (as more fossil fuels will be used to make up for the supply shortage), opposition has been raised to the plan. Specifically, this opposition stems from the fact that the change is being made within a very short time horizon with no ‘concrete’ plans. Indeed, Energy experts have warned German Chancellor Angela Merkel of power outages in the future that may result (shutting down nuclear energy without taking into account the supply of alternative energy sources to make up the shortfall could affect supply in the long run).

These developments are expected to have sizable impacts on various industries in the region, including German utilities.

According to Wolfgang Pfaffenberger, an atomic energy expert from Bremen, Germany, electricity producers in Germany will see significant revenue impact as the eight plants that are being shut with immediate effect collectively generate revenues of €3 billion, while providing profits of €1.5 billion for the producers. The impact will be greater by 2022, as the profit impact on the 17 nuclear plants in Germany will be €4 billion and revenue impact equal to €7.5 billion.. Furthermore, these companies are already incurring high costs in the form of a nuclear fuel tax introduced by the German government in 2010. (The top electricity producers in Germany have decided to sue the government for retaining nuclear tax while ordering the closure of the nuclear plants that they operate.)

With the adoption of alternative fuel sources, more emissions certificates will be required by energy companies to emit CO2 – according to Uwe Leprich, the Energy Researcher from University of Applied Sciences, Saarbrücken, Germany. €4.2 billion worth of emissions certificates will be bought annually by coal companies in Europe, with the four main energy companies bearing a large part of this expenditure.

(With the nuclear plant shutdowns and the economic impacts, it is possible that German energy companies with significant presence in the nuclear space could emerge as acquisition targets as their valuations could fall in the absence of revenue from nuclear energy production.)

At a more tactical level, the price of electricity is expected to increase as this transition happens, potentially adding to inflation in the region and impacting economic recovery. According to Tor Arnt Johnsen of the Statistics Norway Research Department, “All capacity taken out of the market tends to give higher prices. And even if Germany were to replace nuclear power with renewable energy, it will lead to increase in power prices, because renewable power is more expensive than nuclear power. This price increase will result in more expensive power for both Norwegians and other Europeans, because Germany is a large market, and price increases will spill into the integrated European electricity market.”

Shifting away from nuclear energy to other electricity forms could lead to an increase in wholesale power prices by up to €50/MW-h, according to a committee formed by the German government to assess the economic and ethical aspects of atomic energy. Electricity costs had risen across Europe after Germany’s decision to suspend operations in seven nuclear plants in March 2011. This could lead to further upward pressure on prices, especially affecting the costs and margins of energy intensive industries such as chemicals and building materials. With the German government looking to shield industries from high electricity costs, consumers are also expected to come under pressure which could affect their spending power and the performance of consumer-driven industries in Germany. The impact is expected to be broad-based in other parts of Europe as well, given that there could be an increase in pan-European electricity prices.

Who Could Benefit?

Utility companies based outside Germany could benefit as demand for the import of electricity into Germany rises, along with the rise in electricity prices. France and the Czech Republic are two countries that are likely to meet the electricity demand from Germany through exports. CEZ, the largest power company in the CEE region, is expected to reap a short term windfall of €41 million, as electricity prices rose 23% in March 2011 following the Fukushima meltdown, on the Prague-based Power Exchange Central Europe (PXE). Germany is also home to some of the largest wind and solar power companies in the world, generating approximately €16 billion in revenue. Forbes has reported that First Solar, the manufacturer of photovoltaic solar modules and photovoltaic solar systems, is one of the companies that could benefit from this development due to its strong presence in Germany. Given the potential future growth that renewable energy companies could achieve as a result, the shares of Europe-based SolarWorld, SMA Solar, Nordex, Q-Cells, Phoenix Solar, Renewable Energy Corp, and Vesta gained between 2.7- 13.3% on the day of the announcement.

Until new renewable energy sources can be built, however, the German economy will be dependent on imports to meet its electricity demand and generate power from fossil fuels. Closing just 40 nuclear plants (of the 440 plants worldwide) is likely to drive an increase in worldwide consumption of natural gas by about 7 bcfd (billion cubic feet per day), consequently leading to increased gas prices. Liquefied Natural Gas (LNG) prices spiked world over after the shutdown of the nuclear plants in Japan and this movement could intensify as Germany and other countries shift away from nuclear energy, ensuring significant benefits for oil and gas producers. According to Guenther Oettinger, energy commissioner, EU, “We need more gas. After Berlin’s decision, gas will be a driver of growth.”

Russian energy companies, which are the leading suppliers of natural gas in Europe, are expected to be one of the largest beneficiaries of the nuclear shutdown in Germany. Even though bearish sentiment in Europe on the back of the Greek debt crisis has prevented any substantial increase in oil and gas prices in the region, worldwide increase in demand for oil and gas combined with various supply constraints (such as unrest in the Middle East, increased difficulty in finding new sources of oil and gas, among others) are expected to maintain upward pressure on prices.

Prices of Uranium (probably the commodity most affected by this decision) have been experiencing a steady fall since the nuclear meltdown in Fukushima and Germany’s decision to shut down its nuclear plants. However, uranium prices are expected to remain strong on the back of demand in different regions of the world, especially China and India. David A. Talbot, an analyst with Dundee Securities, believes that by 2020, the demand for uranium in China will be five times the present demand for the fuel in Germany. There are 27 nuclear power plants under construction in China, with an additional 50 plants in the planning phase. According to Adam Schatzker, analyst with RBC Capital Markets, “The market will begin to recover in 2012 as the events at Fukushima become less of a driving force and the supply-demand fundamentals re-assert themselves. There is not enough uranium production, either current or planned, to satisfy reactor needs, initial core requirements and inventories for new reactors. A sustainably higher price should help resolve this gap”. Annual demand for uranium is expected to increase at an average rate of 3.1% per annum until 2014 and large demand-supply deficits are expected to drive prices in the medium to long term. But in the short term, stock prices from uranium producers could be negatively affected on the back of unfavorable investor sentiment.

Infrastructure Investment

Germany’s plans are to increase share of renewable energy to 35% of total energy produced in the country, up from about 13% presently. As discussed above, these events and the shift away from nuclear energy could be most beneficial for manufacturers of renewable energy producers and manufacturers of new electricity grid products. According to the German Energy Agency, this increase in renewable energy production will require the construction of 3,600 kilometers (2,235 miles) of power lines by 2020, linking solar and wind farms with consumers. Construction of these power lines alone will cost €9.7 billion.

New wind farms are being planned in Germany and the government has offered $7.26 billion in loans as part of the Reconstruction Loan Corporation (KfW), to construct the first 10 wind farms. Most wind farms are located in northern Germany, so the country is facing a significant shortage of grid connectivity for providing wind energy in different parts of Germany. Remote energy developing areas are providing significant investment opportunities for grid developers. According to Simon Smith, Credit Suisse, “The scale of the capacity additions and the requirement for higher levels of availability suggest there will be disproportionate demand for offshore wind”.

Investments to increase the base load capacity and grids for transmission are expected to drive demand for power transmission equipment such as switchgears and transformers. These events will prove to be beneficial for European power equipment suppliers such as Alstom, Siemens, and ABB, in addition to French suppliers Schneider Electric and Legran. Apart from these, demand for grid management solutions and high-voltage direct current (HVDC) interconnections is expected to increase as well.

Conclusion

Germany’s decision is expected to have mixed ramifications for both the local and European energy industry. The cost of essential commodities, such as electricity and natural gas, are expected to increase, which could impact recovery across the EU. However, it is also an opportunity for developers/providers of wind and solar energy along with infrastructure developers and power equipment manufacturers in Germany and the EU.

That said, with global power demand expected to increase in the coming years on the back of economic growth in various regions of the world, players in the nuclear energy space are still expected to benefit significantly as the demand for nuclear energy is likely to remain strong.

Author: Dipanker Mahay, Strategic Services Practice

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Understanding the Concept of Market Basket Analysis

Posted on August 17, 2011

Retailing today is nothing if not a hypercompetitive industry. A complex & rapidly changing landscape, stiff competition, and ever more demanding customers are pushing progressive retailers to rethink how they operate. Their responses have included strategies of scale (consolidation, growth, international expansion, etc.), innovation (alternative store formats, brand extensions, etc.) as well as promotion (both online and offline), among others.

Irrespective of grand strategies and visionary shifts across the globe, though, it is a truism that the need to dive deep and understand the consumer mindset continues to sit at the center of all that a retailer must do. And over the last couple of decades, technology has played a tremendous role in informing strategies and tactics down to the SKU level.

Probably the most critical way that technology has aided the retailer is by enabling the capture of large volumes of consumer transactional data at very reasonable costs. Retailers can now obtain terabytes of information about their customers’ buying patterns, demographic information as well as (through various means) psychographic insight. This information can answer important questions including: When did the customer shop? How was the payment made? How many and what specific items were purchased? What was the relationship among the purchased items?

There is no doubt that this vast point-of-sales (POS) data has (when effectively utilized) empowered the retailer to better understand their business and improve decision making. Proactive retailers use this information to deliver targeted offerings that are aligned with consumer expectations and subsequently deliver positive revenue impact.

That said, though, how do retailers tactically use these terabytes of information?

Connecting products

Many times, as consumers, we tend to overlook how goods are physically arranged in a grocery store or supermarket. What might look (to us) to be ‘random distribution’, is actually a meticulously planned arrangement of goods. At its analytical core, the grocer assesses the purchasing pattern of his/her customers and arranges these purchased products accordingly.

Simply stated, every customer’s basket tells a story. The key is to discern his/her preferences – preferences that are buried deep inside the shopping basket. This technique of discovering relationships between products purchased together is known as Market Basket Analysis (MBA). As the name suggests, MBA essentially involves using consumer transactional data to study buying patterns and exploring the possibilities (and probabilities) of cross-selling. The objective of MBA is to utilize sales data effectively to improve marketing and sales tactics at the store level.

Since shelf space is limited, retailers have significant incentives to make these placement decisions correctly. Indeed, product assortment, product display area selection, shelf space allocation, and inventory control are critical retailing operations that directly impact the financial performance of retail stores. Thus, typical insights that can be derived from MBA are:

Table 1: Illustrative Purchases made at a Grocery on a given day

  • Products X,Y are typically purchased together
  • If products X,Y are purchased then product Z may also be purchased

The applications (and financial value) of understanding insights such as the above are evident.

The Mathematics of MBA

MBA works on the concept of probability of co-occurrence of events. There are several specific metrics that are taken into consideration to assess how strong the co-occurrence is:

  • Support: Ratio of the number of transactions that includes both Product A & Product B, to the total number of all transactions
  • Confidence: Ratio of the number of transactions that include both Product A & Product B, to the number of transactions that include a particular product
  • Lift: How good the rule is at predicting the “result” or “consequence” as compared to having no rule at all (i.e. to what extent is one better of deploying the rule rather than simply making a guess).

Let’s consider a simple example. Suppose that within a particular grocery store, a total of 80 transactions take place. Furthermore, two products – bread and butter – are purchased 60 times together out of this total of 80 transactions (refer to Table 1 above).

Based on this data, the probability of bread and butter being purchased together is 75% (i.e. 60 occurrences out of 80 in total). This is technically referred to as the support of buying bread and butter.

In addition, if there were 75 transactions (in total) for bread, then the confidence of buying butter along with bread is 80% (60 occurrences where bread and butter were purchased out of a total of 75 transactions involving bread).

Further, if we assume there were 60 transactions for butter, then the lift of buying butter with bread is 1.06 ((60 occurrences for combined purchase of bread and butter X 80 total occurrences)/ (60 transactions for butter X 75 transactions for bread)).

Table 2: The Confidence of the same Purchases made at the Grocery


Indicates that there is 80% confidence of buying butter if bread is purchased

Statistically, high support, confidence and lift are signs of solid associations between the occurrences of the events. Even demographics can be incorporated and utilized in developing association rules as part of MBA. For example, consumers in the age group of 8-15 years may have a higher propensity for purchasing video games than those in any other age groups (Here age group is variable A and video games is variable B).

The application of MBA can be found in non-retail sectors too. MBA has been used to develop decision tools for traffic safety. Specifically, a study had been conducted in Florida to analyze the patterns of crashes. Crashes were analyzed in conjunction with a range of other variables and the interdependence among these crash characteristics was studied. The analysis found significant dependence of the severity of crashes on lack of illumination. Further, it was found that under rainy conditions, straight sections with vertical curves were crash prone.

MBA: Benefits galore

The examples above, while simplistic, illustrate the power and value of a tool such as MBA. Indeed, its application is not limited to grocery stores alone but to other retail (and non-retail) subsector in operation today. Furthermore, MBA can be applied to online purchases equally as well. We see examples of this all the time at online stalwarts such as Amazon. Their recommendation to buy products are based on a careful analysis of the previous purchase history of consumers along with the purchasing history of those that bought any specific product.

Indeed, retailers adopting MBA are able to ensure that their product offerings and promotions match as closely as possible to consumer expectations, ultimately providing targeted campaigns and segment specific offers that generate substantially higher returns.

Author: Nitin Jain, Strategic Services Practice

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4 Key Trends Influencing Automotive Procurement

Posted on August 17, 2011

Few industries today are as global, interrelated and complex as the automotive sector. (Fewer still have gone through the level of challenge and change that we have seen over the past several years.)

As the automotive sector has emerged from the Great Recession, it is now beginning to work within a radically transformed environment – one that looks to balance vibrant market environments in some regions with saturated ones in others; one that needs to balance economic demands with social and environmental requirements globally; one that needs to integrate selected ‘tried and true’ marketing techniques of the past with the brave new world of digital and social media; one that sets, at its foundation, a philosophy of innovation and growth.

Given this fascinating environment, we have looked to identify four underlying trends that will directly influence automotive procurement in the near to medium term.

Trend #1: Geographic Diversification of the Supply Base beyond China

  • Although China has established itself as one of the most critical major component suppliers and supply bases to automotive companies, countries such as India, Turkey, and Eastern Europe have begun to play a more prominent role in impacting supply activity and growth.
  • The core drivers here are not only the low cost labor base, but also the availability of considerably skilled labor.
  • In line with this, German manufacturers have already started moving key elements of their supply bases to countries within Eastern Europe.
  • Furthermore, India’s indigenous automotive industry is also anticipated to factor into this wider global supplier base, increasingly attracting interest from original equipment manufacturers in the West

Trend #2: Active Supplier Diversification & Management to Mitigate Risk

  • A critical issue in recent years has been the tremendous risk posed by supplier insolvency and financial distress. While this has clearly been a two-way street, organizations are far more sensitized to the issue of risk management and supplier diversification than ever before
  • In line with this, automotive companies have begun analyzing and widening their supply base when sourcing key categories and components, as well as keeping a much closer eye on existing suppliers from a business and financial viability point of view
  • This more stringent management of the supplier landscape is expected to continue and run the gamut from tier 1, tier 2 suppliers and beyond, to encompass multiple suppliers that, though small, may have a critical impact on performance

Trend #3: The Rise of Fuel Efficient Vehicles, Technologies, and Modules

  • With oil prices in a constantly volatile state and political concerns about foreign oil dependencies, the emergence of hybrid vehicles using alternative fuel technologies has been consistently gathering pace and will ultimately redefine the entire supply chain
  • Procurement will be expected to play a critical role in continuing to support product development teams in driving innovation and development – essentially a market facing impact from what has traditionally been a ‘behind-the-scenes’ department
  • Essentially, the identification, monitoring and procurement of these new technologies, the identification and qualification of suitable suppliers, and the quality monitoring will be a key role of the progressive procurement professional
  • Fundamentally, this will require global coverage, constant monitoring and ongoing technology assessments to ensure procurement has a seat at the innovation table

Trend #4: Corporate Social Responsibility – A Procurement Responsibility

  • With the ever increasing demands for corporate social responsibility, particularly with global players based out of the west, responsibility for ensuring these requirements are met and managed across the supply chain will increasingly involve procurement teams
  • Indeed, buyers have started focusing on understanding the risks involved across the supply chain from monetary susceptibilities, product quality issues through to service performance considerations
  • In addition, we are already seeing buyers across continents work to ensure that their critical suppliers measure, manage and reduce the carbon footprint of their prevailing supply chains
  • In line with the “Evolving Procurement” remit – to establish itself as a progressive member of the corporate executive team – activities such as ensuring social responsibility ‘compliance’ will become a critical activity.

Author: Subash Chandar, Strategic Services Practice

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Success in Mergers & Acquisitions

Posted on August 17, 2011

Mergers and Acquisitions (M&A) activity is par for the course in the corporate world these days. Over the last several decades, there has been a consistent increase in both the number and value of transactions taking place, not only in North America and Europe, but across the world. Indeed, the total value of M&A activity through the end of the first quarter of 2011 was $717 billion, up 58% from the same period in 2010.

The fundamental basis for all of this inorganic growth is the existence of “synergies” – which quite simply translates into the “2+2=5” scenario i.e. a merger will allow the two companies to work more efficiently together than either would separately. There are many specific manifestations of this synergy concept – enhancing innovation and flexibility, access to investment capital, accessing new markets and distribution systems, the ability to surprise and delight existing customers with an expanded set of product offerings, technology benefits, the acquisition and integration of proprietary knowledge, tax benefits as well as other core competencies.

While the stated benefits are vast and organizations go into M&A events with the best of intentions, the scary reality is that between 60% – 80% of mergers and acquisitions fail . Sometimes, this failure can be explained by the simple fact that the buyer paid too much for the acquired entity. Having bid over-enthusiastically, the buyer may find that the premium they paid for the acquired company’s shares wipes out any subsequent gains made from the acquisition. However, even a deal that is financially sound can ultimately prove to be a disaster, if it is implemented in a way that does not deal effectively with both companies’ people and their different corporate cultures. There may be acute contrasts between the attitudes and values of the two companies, often exacerbated if the new partnership crosses national boundaries (but by no means limited to transnational deals). Certainly, corporate cultural differences have become the major ‘integration’ issue as companies grapple with how to successfully embed growth strategies that include joint ventures, mergers and acquisitions. Companies will almost always pay significant attention to the legal and financial considerations involved in a merger or acquisition, and far less on the implications for cultural environment – something that more often than not, proves equally as important in the long run.

What is corporate culture?

Corporate Culture is the collective set of shared assumptions, beliefs, values, and principles about “the most appropriate way of doing business” within an organisation. These are usually implicit within the specific corporate environment, having evolved over the years as the company has grown. It is usually embedded in a company’s systems, structures, processes, policies – what is considered ‘logical’, leadership behaviours, and the behaviours of all organisational members. Corporate culture dictates the unwritten ‘Rules of the Road’ about how things are done within the company.

No two corporate cultures are alike and the merger/acquisition is the ultimate crucible within which one discovers whether the two environments can mix or not. Indeed, while there is much dissension and debate as to the range of factors that will drive the success of a particular transaction, it is widely accepted that the ‘human factor’ can play an inordinately large role in making the integration between two companies work. There are, therefore, four critical takeaways for executives when it comes to driving successful mergers and acquisitions:

Engage Early: The integration of acquired companies is an ongoing process that should be initiated before the deal is actually closed. During the period in which the acquisition is being negotiated and subjected to regulatory review, the management of the two companies can liaise with each other and draw up a clear integration strategy. Starting earlier not only allows the integration to proceed faster and more efficiently, but also gives the company the opportunity to ‘get to know each other’, identify potential problems (such as drastic differences in management style and culture) at a stage when it is not too late to re-think the deal if the difficulties encountered seem severe.

  • Take Integration Management seriously: Integration management needs to be recognized as a “distinct business function”, with an experienced manager appointed specifically to oversee the process. The ‘integration managers’ that a company selects to oversee its acquisitions should come from a wide variety of backgrounds, but all must have the interpersonal skills and cultural sensitivity necessary to foster good relationships between the management and staff of the parent company and the acquired company.
  • Time is of the essence: If uncomfortable changes (such as layoffs and restructuring) have to be made at the acquired company, it is important that these are announced and implemented as soon as possible – ideally within days of the acquisition. This helps to avoid the uncertainties and anxieties that can demoralize the workforce of a newly-acquired company, allowing employees to move on and to focus on the future.
  • Communicate, communicate, communicate: Yes, there are many aspects that cannot be disclosed before their time, but lack of communication – whether about specific changes, but at minimum, about the process of change, is mandatory. Lack of communication fosters an environment of uncertainty – and uncertainty ultimately hampers business operations, and customers and revenue and profitability.

Don’t Underestimate Symbolic Changes: While structural changes, organizational reshuffling, new roles and responsibilities, streamlined operations and beyond are all essential, don’t forget basic changes that may not impact business directly, but will be noticed. Don’t have different name badges between the acquiring and the acquired company; employee numbers should be standardized; hold joint events to get to know each other, etc.

There is, of course, a school of thought that believes that there is no such thing as a merger, that the ONLY way to achieve success is for the acquiring company to absorb the acquired entity. Whether you believe this or not, it does not negate the most important takeaway, which is, perhaps, the most obvious: it is important to integrate not just the practical and technical aspects of the business, but also the firms’ workforces and their cultures. A good way to achieve this is to create groups comprising people from both companies, and get them to work together at solving problems.

Although it is obviously impossible to predict with certainty the outcome of a merger or acquisition before it takes place, thorough and thoughtful preparation will definitely help.

Author: Kanika Abrol, Strategic Services Group

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What’s Next for the Chinese Yuan?

Posted on April 12, 2011

On February 17th, in a significant announcement by Chinese authorities, plans to allow domestic trading of Yuan options against other currencies from April onwards were rolled out, with the fundamental aim of assisting Chinese exporters and importers hedge against currency risk. (Options allow businesses whose payments or incomes are denominated in foreign currencies to eliminate exposure to exchange rate risk by giving them the option of exchanging one currency into another at a predetermined rate). This comes on the back of the decision taken at the end of January to allow banks to trade currency swaps for corporate institutions (Currency swaps allow businesses to exchange principal and interest rates from one currency to the other at a predetermined rate for a fixed duration). Similarly, in early January, the state-owned Bank of China announced trading of the Chinese Yuan in the United States through its American branch. Taken together, these announcements signal an underlying willingness of Chinese authorities to tolerate a more flexible Yuan.

Indeed, the Chinese government had taken similar indicative steps over the last year, allowing limited trading of the Yuan in Hong Kong, Macau, Russia and Nigeria, thereby expanding the trading market for the Yuan. These steps have had a material impact as a result of reduced transaction costs and time, as importers will not have to convert their respective currencies into US dollars and exporters will not have to convert the Dollar to the Yuan. Read More…

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Is There Any Value in Forecasting? A Manager’s checklist

Posted on April 7, 2011

Year after year, as companies navigate their way through annual business planning cycles, executives and analysts alike work tirelessly to try and predict how the next fiscal year will unfold, making a range of decisions from where best to focus their efforts to how much to spend on each viable opportunity. The foundation for these decisions is an understanding of how much their specific business will grow (or not), and core to these calculations is their forecast for how their general industry, related sectors and/or the general economy will trend.

To understand these forecasts, many corporations turn to existing secondary literature—from standard research reports to published expert opinions. However, if the last two years have taught us anything, it is that we must consistently question how much faith we can place in such forecasts. A prominent observers noted last year, forecasting is the most difficult when it is most critical to do so. Read More…

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The Key to Establishing Procurement’s Credibility within the Organization

Posted on April 7, 2011

The last two decades have seen a sea change in the Procurement function’s (and the Procurement executive’s) standing within the organization. No longer the proverbial ‘back water’ department, Procurement now occupies an important seat at the executive table—a development that has been driven by two interrelated factors. The first is the clear realization of the value that the function can deliver to an organization—and by value, we don’t simply mean cost savings and thereby direct profit improvement (which is certainly the case) but also Procurement’s ability to contribute to growth, through innovation, new product development and more. The second factor is the flip side of this coin—the marked improvement in the caliber of the function and its resulting ability to deliver to the value creation remit.

In other words, not only should it be clear that procurement can deliver value, but it clearly must be able to deliver that value.

This ability to deliver value is itself a function of two intertwined forces—the caliber of the individuals within the function and their ability to effectively deploy the tools at their disposal to deliver results. Read More…

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China and its Influence on the Global Rare Earth Metals Market

Posted on April 7, 2011

“The Middle East has its oil, China has rare earth metals.” —Deng Xiaoping, Chinese President (1992)

Take an even a cursory look at any major business media today and China’s influence in the minerals and metals commodity markets is inescapable. Next to oil, minerals and metals are arguably the most important commodities for global industry and China is one of the leading cosnumers. What’s more, these are markets for which the Chinese government manages prices carefully through a mixture of trade control policies, export restrictions, tariffs, quotas and environmental policies. The strategic goal is to drive global prices of these commodities and, as demand for these commodities has grown globally, China uses its strong supply power to influence availability, impacting related supply chains all over the world. Read More…

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Four key challenges for supply chains in 2011 and beyond

Posted on April 7, 2011

These four challenges are highlighted in this article, along with a high level look into the types of informational tools and techniques that can be leveraged to help manage them effectively.

If there is a truism in supply chains, it is that there will always be a set of core ‘traditional’ challenges that organizations will continue to face going forward (in good times and in bad). These include stringent cost pressures, compressed time to market demands, continuous innovation, and even continued sustainability demands. None of these challenges will go away—if anything, they will become all the more critical, and the ability to manage and respond to these challenges will effectively become ‘hygiene’ factors for supply chain teams. Read More…

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The Evolving Model for Professional Services: A practitioner’s perspective.

Posted on April 7, 2011

These days, companies aren’t questioning whether to outsource as much as they are pondering how best to go about it. Although (at times) still the proverbial hot potato fraught with workforce issues, political quagmires, and public relations sensitivities, outsourcing moved from “emerging trend” to “new reality” quite some time ago. And it isn’t just the traditional areas—manufacturing and more recently, IT. From global corporations looking for strategy and supply chain intelligence to investment banks and private equity firms seeking commercial due diligence support, the concept of outsourcing knowledge-based services, including market and investment research, has gained tremendous acceptance in recent years. Read More…

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Rethinking Satisfaction Survey Analytics – How the factor performance index transcends the conventional importance-satisfaction matrix.

Posted on April 7, 2011

The core objective of the traditional customer satisfaction survey is to gauge the consumer’s overall satisfaction levels (or perceived satisfaction) with a given brand or a product. To make this information actionable from a marketer’s point of view, though, one needs to assess this satisfaction in terms of its ‘constituent’ elements i.e. understand satisfaction levels with the various parameters associated with the brand itself.

For example, to assess the overall driving experience of a specific brand of car, the researcher could ask for satisfaction scores on the exterior look of the car, its mileage, the price of the car, engine capacity, etc. Equally important, of course, is to capture the relative importance of each of these individual parameters. Indeed, a combination of satisfaction and importance scores present the complete picture of the strengths of a given brand or product and the specific improvement areas that need to be fixed. Thus, factors that are important in driving satisfaction should ideally have high satisfaction scores as well. By extension, low scores on these factors would be key areas of concern and therefore should be acted upon first. Read More…

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6 Key Actions – Aligning supply chains with corporate strategy.

Posted on April 7, 2011

The supply chain and procurement executive(s) has a ‘seat at the executive table’. To illustrate its potential impact from a pure economic perspective, where else in an organization does one executive have the ability to influence and manage the cost base of an organization so directly? In even more direct terms, if the supply chain executive contains his or her cost base by 10%, resulting in a savings of, say, $100 Million, consider how much product must be sold (say, at 10% net margins) deliver the same margin impact? The implication is clear.

Aligning a supply chain with a company’s broader corporate strategy requires a somewhat different mind-set to the traditional block and tackle of the past. To be clear, the block and tackle is essential, but several core actions must be considered in this respect: Read More…

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Copper – Primer & Outlook

Posted on April 7, 2011

Copper is regarded as the most valuable of primary base metals, barring nickel, even though it is not the largest base metal market in the world.

Indeed, it is considered a barometer for the state of the economy, given its significance in global industry. It has a myriad of end-use markets including building construction, electrical and electronic products, transportation equipment, consumer and general products as well as industrial machinery and equipment. It is also one of the most recycled of all metals and can be alloyed with other metals for use in highly specialized applications.

Unsurprisingly, given this significance, the price of copper has also closely reflected the economic crisis the world has experienced over the last few years—from a peak of $8,924/ton in July 2008, copper prices dropped to $2,837/ton in December 2008 and has now rebounded to $9,848/ton. Read More…

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